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Author: Red Spot Design2

House Proposes Swapping Comp Time for Some Overtime

Posted on by Red Spot Design2

The fate of overtime rules continues to remain uncertain.

The “final rule” that was slated to go into effect on December 1, 2016, was put on hold indefinitely after a district judge in Texas blocked its implementation (for details of the rule, see box below). The judge found it likely that the Obama administration overstepped its authority with that rule, which the Trump administration opposes.

In the meantime, the Republican-controlled House of Representatives passed legislation that would authorize time off in lieu of compensation for overtime. That bill has moved to the Senate. The White House has voiced support for it.

Background Information

Under the Fair Labor Standards Act (FLSA), unless exempted, eligible employees must be paid time-and-a-half their regular pay rate for time worked beyond 40 hours a week. The white collar exemptions exclude certain executive, administrative and professional (EAP) employees and outside salespeople.

To be exempt from the overtime rule, the Department of Labor (DOL) requires most employees to meet each of the following three tests:

1. Salary basis test. The employee must be paid a predetermined and fixed salary that isn’t subject to reduction because of variations in the quality or quantity of work performed.

2. Salary level test. The amount of salary must meet a minimum amount. Currently, this figure is $455 per week for EAP employees (the equivalent of $23,660 annually).

3. Duties test. The employee’s job duties must primarily involve executive, administrative or professional duties as defined by the DOL regulations.

In addition, there is a relaxed duties test for certain highly compensated employees who receive total annual compensation of $100,000 or more and are paid at least $455 a week.

The regulations on overtime pay date back to 1940. Although they have been updated periodically, the last time was in 2004. The DOL issued its latest revisions in 2015, after several years of lengthy discussions. Now it’s back to the drawing board (see What Was in the Final Rule? below).

Introduction to the Proposed Bill

Under the House-passed measure, employers may let workers opt to accept extra time off instead of receiving overtime pay. Employees could accrue up to 160 hours of comp time during a 12-month period in lieu of overtime wages. Any unused comp time at the end of that period would have to be converted to overtime pay within 31 days. Employees would have to be paid at the greater of:

1. Their regular pay rate when the time off was earned, or

2. Their final regular rate received.

The accrued comp time, titled the Working Families Flexibility Act, could be used within a “reasonable” period after making a request for time off provided it doesn’t unduly disrupt the employer’s operations. Employees must provide adequate notice and employers would make necessary accommodations.

Employers could elect to cash out comp time that exceeds 80 hours or discontinue the swap policy by giving 30-day notice. Similarly, employees could choose to end their participation after giving notice within 30 days.

Finally, if the rules in the proposed bill were violated, employers might have to pay affected employees the amount owed for each hour of accrued comp time plus an equal amount as damages, minus any compensatory time the workers used. These provisions are subject to change.

Proponents of the proposed bill claim the measure would provide employees with the flexibility they want without creating hardships for employers. They note that the policy would be strictly voluntary. In addition, allowing employees to defer payment of comp time is essentially like getting an interest-free loan.

“This bill is about freedom, flexibility and fairness,” said Rep. Virginia Foxx (R-NC), chairwoman of the House Committee on Education on the Workforce. “It gives workers the freedom to choose what is best for themselves and their families. For some workers, money in the bank may be the best choice for them, and nothing in the bill would take that away, but other workers would seize the opportunity for time off with their family.”

Employees’ Interests

However, detractors are concerned about the interests of employees. “The bill weakens protections under the Fair Labor Standards Act at the moment that we ought to be strengthening the law,” Rep. Robert C. Scott (D-VA) reportedly argued on the House floor. “Under the bill, employers could withhold overtime pay for a long time, which otherwise would be a violation of the FLSA, and it undermines the 40-hour workweek mechanism,” he added

Different proposals for revising the overtime rules have been tabled during the past two decades, but this effort has some momentum with the support of the White House behind it.

What Was In the Final Rule?

The final rule, which is now in limbo, makes several significant changes to the overtime rules, including:

  • The standard salary level used to determine whether employees and computer professionals are eligible to receive overtime is increased from $455 a week ($23,660 a year) to $913 a week ($47,476 a year) for full-time workers.
  • For the first time, employers would be able to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10% of the standard salary level.
  • The total annual compensation threshold for a highly compensated employee would rise from $100,000 to $134,004 ($913 a week instead of the current $455 a week).

If new proposals emerge from the ruins, they may contain similar provisions or take a completely new approach.

Are You Ready for MOR? Affordable Housing Audit Tips to Meet HUD Standards

Posted on by Red Spot Design2
small houses
decorative background with tiny houses arranged in rows

Over the past eight years and now into the era of the new Republican White House, scrutiny on affordable housing developers, owners and management companies has increased. Whether the reasons are to root out abuses of Section 8 funding or to justify cutting the US Housing and Urban Development budget, politics have put pressure on HUD inspectors to increase their review of funding recipients. Based on a recent presentation we attended on the return of the HUD Management & Occupancy Review (MOR), we outline ways that owners and managers of HUD-funded properties can prepare for a potential MOR.

In 42 states including Texas, HUD Management and Occupancy Reviews (MORs) have not been conducted on Section 8 properties since 2011. After a series of lawsuits and protests brought by the Performance-Based Contract Administrators (PBCAs) who perform MORs on behalf of HUD, it looks like things have been resolved for now. MORs will be conducted in these states once again. Some may have already occurred in the second half of 2016. They may be annual or more frequent, but they are always random and with little notice.

The purpose of a MOR includes:

  • Maintaining housing for target populations
  • Protecting FHA insurance funds
  • Ensuring satisfactory management
  • Ensuring good physical and financial health of properties
  • Reviewing compliance with HUD rules
  • Proper administration of subsidy contracts

At-risk projects are more likely to get notification of a MOR, but in many cases a PBCA has approval to conduct a review on 100 percent of the portfolio under its jurisdiction in the state. If your property or organization has not already received notification of a pending MOR, it still makes sense to prepare as though it’s already happening.

The reason for this is the extensive paperwork and reporting required during a MOR. However, if your organization has conducted a thorough financial audit, you already have much of the information available to prepare and share during a MOR. Some of the primary items include:

  • General physical appearance of property and security
  • Follow-up and monitoring of project inspections
  • Maintenance and standard operating procedures (SOPs) in place
  • Financial management and procurement processes
  • Leasing & Occupancy compliance
  • Tenant/management relations
  • General management practices

Prior to a MOR field visit, the PBCA will conduct what they call a Desk Review, which includes looking at the project’s previous MOR findings. Any issues with the physical property, timely reporting of financials or audit findings along with the history of operating expenses will be noted. In a side-by-side comparison of HUD’s primary MOR document, “Management Review for Multifamily Housing Projects”— known as HUD 9834 — the items listed for review are very similar to a general financial audit of a HUD-funded organization.

It, therefore, makes sense to prepare for a MOR not only by reviewing and answering the questions listed on HUD 9834, but also by reviewing and using your audit findings to make improvements. With some early preparation, you can be ready for MOR.

Continue Reading: Prepare for a Management & Occupancy Review (MOR)

Scott Bates, CPA, is a partner in Cornwell Jackson’s audit practice. He provides consulting to clients in real estate, including HUD-funded properties. Contact Scott at scott.bates@cornwelljackson.com or 972-202-8000.

Can You Monitor Your Employees Communications?

Posted on by Red Spot Design2

Employers have many reasons to monitor employee communications from time to time, including staying out of legal trouble. For example, if any kind of illegal discrimination or employee harassment is going on, and you allow it to continue by ignoring possible evidence of its occurrence, you could lose a lawsuit.

Or if employees are defaming your company through public social media postings — or revealing proprietary information about your products, services or strategic plans — your business could sustain serious competitive injury.

The point is simple: There are times you need to keep tabs on what employees are communicating, and doing so doesn’t make you a sinister “big brother.” The fact that there are so many ways employees can abuse communication systems makes the task of staying on top of it a bit trickier. For instance, your right to monitor employee emails sent from company-owned computers via the company’s email system is fairly straightforward. But, of course, that’s only part of the problem.

What’s in Your Employee Handbook?

You may be concerned about messages an employee is sending using a personally owned smart phone. Can you monitor those messages?  The answer begins with the policy you lay out in your employee handbook. As noted, in deciding employee privacy cases, courts typically consider whether the employee had a reasonable expectation of privacy. Such an expectation disappears when you spell out your policies clearly and in detail, then secure an acknowledgement that the employee has read and understood them.

Among other provisions, these policies generally should:

  • Explain their purpose in terms conveying that employees all ultimately benefit from the safeguards in place. That is, the policies are intended to protect the company (and, therefore, employee paychecks) and possibly to shield all concerned from defamatory communications that other employees could initiate.
  • Articulate which modes of communications are subject to employer monitoring, including emails and other forms of electronic communication on company-owned devices, including cell phones, and
  • Spell out the steps you might take pursuant to the policy.

Your rights to monitor employee communication, when employees have been put on notice that you’ll exercise them, might be greater than you expect. According to the Small Business Administration (SBA), “no specific laws govern the monitoring of an employee’s social media activity on a company’s computer” if you’re looking for unauthorized posting of company content.

The SBA cautions, however, that there have been rulings against employers who fired workers for complaining on social media sites about their workplace conditions. That is generally considered “protected speech” under the National Labor Relations Act. The SBA’s advice: “Provide employees with a social media policy and be sure to include information about what you consider confidential and proprietary company information that should not be shared.”

Employer Exemption

What about monitoring employee emails and telephone conversations? Although the Electronic Communications Privacy Act of 1986 (ECPA) prohibits the intentional interception of “any wire, oral or electronic communication,” it does include a business use exemption that permits monitoring of email and phone calls.

The SBA states, “Generally, if an employee is using a company-owned computer or phone system, and an employer can show a valid business reason for monitoring that employee’s email or phone conversations, then the employer is well within his or her rights to do so.” And as noted, if employees have been given a heads up and demonstrated they understand the policy, you’re in a strong position.

However, the SBA advises employers to be aware that the ECPA “draws a line between business and personal email content you can monitor – business content is OK, but personal emails are private.”

“BYOD” Policies

The latest frontier in discriminating between legitimately personal communications and employment related ones involves employees using their own laptops and smart phones pursuant to a “bring your own device” (BYOD) policy. There are practical advantages to BYOD policies, including employee convenience and also savings in the company’s IT budget. On the other side of the equation, employees using their personal devices can give them a false sense of impunity with respect to what company-related sensitive or offensive information they convey on them.

If you do have a BYOD policy, consider expanding the scope of your privacy policies to accommodate it. The policy could:

  •  State that you reserve the right to access, monitor and delete information from personally owned devices under specified circumstances,
  •  Stipulate which employee-owned devices can be used for work purposes and are eligible for tech support,
  •  Require the use of “mobile device management technology” to create an electronic barrier between personal and business-related data,
  •  Limit employee job categories eligible for using personal devices,
  •  Establish data security protocols, including standards for passwords, and
  •  Set a schedule for deleting business-related data maintained on personally owned devices.

The law governing employee privacy at a time of rapid evolution of communication technology isn’t entirely clear on all counts, can vary by jurisdiction, and is constantly changing. That’s why it’s prudent to consult with an attorney with relevant expertise as you develop your policies to balance your legitimate interests with those of employees.

OSHA Updates and Revises its Outreach Training

Posted on by Red Spot Design2

The Occupational Safety and Health Administration (OSHA) has updated its Outreach Training Program, including the courses for the construction industry. Meanwhile, the Government Accountability Office (GAO) has given the courses a thumbs-up in a study, saying they’re well-designed and operating efficiently.

The GAO compared OSHA’s design and evaluation efforts for its training program with leading practices in GAO’s training guide (which OSHA isn’t required to follow) and federal internal control standards. Based on its finding, the GAO stated that it won’t issue any recommendations for OSHA.

The agency’s report stated, “OSHA took steps to design the Outreach Training Program so that workers receive consistent and quality training by using data to identify the content of the training, developing training materials, and issuing detailed requirements for training providers.”

OSHA created its specialized training program to help ensure safe and healthy working conditions. Using a “train-the-trainer” model, the program authorizes someone who completes the curriculum to conduct training courses for employees in certain industries.

The training isn’t a requirement. However seven states require workers to complete OSHA’s 10-hour construction safety training course before being allowed to work on state-funded construction projects. The seven states are: Connecticut, Massachusetts, Missouri, Nevada, New Hampshire, New York and Rhode Island.

The construction training program teaches workers about their rights, employer responsibilities, and how to file complaints as well as how to identify, abate, avoid and prevent job-related hazards. It includes 10-hour and 30-hour versions. The longer course is geared to supervisors or others with safety program responsibility.

Recent Updates

The updated program closely resembles the previous training, with instructors delivering the 10-hour or 30-hour courses at vocational schools, union facilities and factory floors. Among some of the revisions are:

  • Class time is shortened to 30 minutes from 60 minutes. This means that if a 10- or 30-hour class is held over many days, participants are required to meet for at least 30 minutes a day.
  • Prerequisites for taking a trainer course include five years of safety experience in the industry covered by the training. In order to substitute education for two years of experience to meet this requirement, students must have a bachelor’s degree or higher.
  • Construction-specific updates:
  • Minimum teaching time is 2.5 hours.
  • A new elective, Foundations for Safety Leadership.
  • To stay current on relevant OSHA matters, authorized trainers must complete the Update for Construction Industry Outreach Trainers course every four years. The Trainer Course in Occupational Safety and Health Standards for the Construction Industry may also be used to maintain authorized status.

OSHA has also clarified some issues:

  • Time spent on testing and other paperwork or recordkeeping activities doesn’t counts as “contact hours,” and
  • Students must be sent home after 7.5 hours of class time, and they can’t return until at least 8 hours later (so, if a class ends at 10 p.m., the students can’t return before 6 a.m. the next day.

The curriculum follows a robust topic design that is constructed to ensure that each individual receives similar training no matter what the work situation.

Specific Course Work

Overall, the training modules must cover a specific set of topics with an allotted time devoted to each topic. Although there’s a small degree of flexibility, typically at least two OSHA-specific electives are delivered in the 10-hour course and six in the 30-hour course.

The required 10-hour Construction topics include:

1. Introduction to OSHA,

2. Personal protective equipment and lifesaving equipment,

3. Health hazards in construction, and

4. The Focus Four Hazards, which covers:

  • Falls,
  • Electrocution,
  • Struck by (for example falling objects, trucks or cranes), and
  • Caught In or Between (for example trench hazards or equipment).

The elective topics include:

Cranes Stairways
Excavations Ladders
Material handling Hand and power tools
Scaffolds  

The required 30-hour curriculum mirrors the 10-hour version but is more in-depth. Elective topics are expanded to 12 hours.

Disadvantages of the Program

Nevertheless, OSHA Outreach Training isn’t meant to be the only training for employees. There are several other important considerations.

Critics note that the Outreach Program doesn’t offer any additional indemnity or level of compliance over other training alternatives, despite frequent employer assumptions that it does. Firms providing the training to employees are still legally responsible for workplace accidents and fatalities. OSHA cautions participants that training is intended to provide basic safety hazard awareness. It’s mainly up to employers to ensure operations are properly performed.

Also, a fundamental weakness of this or any type of standardized safety program is that the training rarely addresses the hazards specific to any single employee role or worksite. To be more effective, safety training should emphasize specific learning objectives relevant to the work experience.

Some analysts suggest that a better idea might be to base safety training on an analysis of the hazards of a specific job. Some common job tasks that would comprise a routine hazard analysis are:

  • Jobs that cause (or may cause) consistent injuries or illness,
  • Jobs that cause (or may cause) severe or disabling injuries or illness,
  • New jobs,
  • Jobs that have changed recently, and
  • Complex jobs that require written instructions.

Hazards that are identified during a safety analysis can then be incorporated into company training. In addition, training and education can help workers feel competent enough to identify and report hazards they may encounter.

Finally, the program doesn’t satisfy the training requirements specified in OSHA standards for construction. Additional training is required to address exposures and hazards that employers may face either directly or indirectly. Workers should be well-versed in OSHA standards for operations conducted at their worksites.

Stepping Stone

Given the number of fatalities and injuries sustained by construction workers, it may be worth considering the Outreach Training Program as a stepping-stone toward further improvement.

Fear the “Fatal” Four

The Focus Four hazards were responsible for nearly two-thirds (64.2%) of fatalities in construction in 2015.

According to the Department of Labor, 4,836 workers were killed in all private sector jobs in 2015, the highest total since 5,214 in 2008. On average, that amounts to more than 93 a week, or 13 deaths every day.

Of the total, 937 (21.4%) occurred in construction — more than one out of every five.

The leading causes of construction deaths (excluding highway collisions) were falls, followed by being struck by an object, electrocution and being caught in or between two objects.

IRS Spells Out Rules for Enhanced Research Credit

Posted on by Red Spot Design2

The research credit is back and maybe better than ever. This business credit, which had expired and been reinstated numerous times since its inception in 1981, was permanently preserved by the Protecting Americans from Tax Hikes (PATH) Act of 2015. What’s more, the PATH Act version of the credit contains a couple of key enhancements, making it even more attractive to some manufacturing firms.

Now the IRS has issued interim guidance relating to the “new and improved” research credit. The guidance provides important information on an election for qualified small businesses. (Notice 2017-23, 3/31/17)

Background Information

The research credit is intended to encourage spending on research activities by established firms and startups. In its current form, the credit generally equals the sum of:

  • 20% of the excess of qualified research expenses for the year over a base amount,
  • The university basic research credit (i.e., 20% of the basic research payments), and
  • 20% of the qualified energy research expenses undertaken by an energy research consortium (see box).

For this purpose, the base amount is a fixed-base percentage (not to exceed 16%) of average annual receipts from a U.S. trade or business, net of returns and allowances, for the four years prior to the year of claiming the credit. It can’t be less than 50% of the annual qualified research expense. In other words, the minimum credit is equal to 10% of qualified research expenses (50% rule times the 20% credit).

But be aware that the credit is available only for qualified expenses. This includes an expense if:

  • It qualifies as a research and experimentation expenditure under Section 174 of the tax code,
  • It relates to research undertaken for the purpose of discovering information that is technological in nature and the application of which is intended to be useful in developing a new or improved business component, and
  • Substantially all of the activities of the research constitute elements of a process of experimentation that relates to a new or improved function, performance, reliability or quality.

When the PATH Act permanently preserved the research credit, it improved it for qualified small businesses in two ways:

1. AMT liability. Effective for 2016 and thereafter, an eligible small business may claim the research credit against alternative minimum tax (AMT) liability. For this purpose, the business must have $50 million or less in gross receipts.

2. Payroll taxes. Also effective for 2016 and thereafter, a qualified small business may elect to claim the research credit against up to $250,000 in payroll taxes annually for up to five years. In this case, the company must have less than $5 million in gross receipts.

Regarding the payroll tax election, the credit amount is applied against the Old Age, Survivors and Disability Insurance (OASDI) tax liability paid for employees, the portion of FICA commonly called “Social Security tax.” For wages earned in 2017, the employer share of Social Security tax is equal to 6.2% of each employee’s wages up to a base of $127,200. The Social Security Administration (SSA) adjusts this wage base annually.

A manufacturing firm or other business entity must make the election to use the research credit against payroll tax liability on an original return. Thus, the election can’t be claimed on amended returns. Because the election takes effect for credits generated in 2016, it is available to offset payroll taxes during the second quarter of 2017.

New IRS Guidance

The new Notice includes interim guidance with respect to the payroll tax election.

First, it clarifies that the definition of “gross receipts” used to qualify a business is determined under Section 448(c)(3) of the tax code without regard to Section 448(c)(3)(A) and its accompanying regulations. In essence, this means that there’s no exclusion of amounts representing returns or allowances, receipts from the sale or exchange of capital assets under Section 1221, repayments of loans or similar instruments, returns from a sale or exchange not in the ordinary course of business and certain other amounts.

Second, to make a payroll tax credit election, the IRS requires a qualified small business to attach a completed Form 6765 (Credit for Increasing Research Activities) to a timely return, including any extensions, for the appropriate tax years.

Third, the new Notice provides interim relief for qualified small businesses that filed returns for tax years after 2015 in a timely fashion, but failed to make the payroll tax credit election. In this case, the entity may make the election on an amended return filed on or before December 31, 2017. To accomplish this, the business must either:

  • Indicate on the top of its Form 6765 that the form is “FILED PURSUANT TO NOTICE 2017-23;” or
  • Attach a statement to this effect to the Form 6765.

A qualified small business can claim the payroll tax credit for the first calendar quarter beginning after it makes the election by filing the Form 6765. Similarly, if the small business files annual employment tax returns, it may claim the credit for the return including the first quarter beginning after the date on which the business files the election. The business is instructed to attach a completed Form 8974, providing the Employer Identification Number (EIN) shown on Form 6765, to the employment tax return.

When your small business files quarterly employment tax returns, use Form 8974 to apply the Social Security tax limit to the amount of the payroll tax credit elected in Form 6765 to determine the credit amount allowed on its quarterly return. If the payroll tax credit elected exceeds the employer share of the Social Security tax for that quarter, the excess determined on Form 8974 is carried over to the next quarter, subject to the applicable Social Security tax limit.

The new guidance, which is technical in nature, is probably best left to the tax professionals. What manufacturing firm owners and managers can take away is the realization that the research credit, which is valuable in its own right, can now be used to offset payroll tax liability for qualified small businesses. Factor this into your business decisions.

Simple Does It

In lieu of claiming the regular 20% research credit, your firm can rely on the alternative simplified credit (ASC).

Currently, the ASC is equal to 14% of the amount by which qualified expenses exceed 50% of the average for the three preceding tax years. The ASC, which first became available in 2007, replaced the alternative incremental research credit (AIRC).

Some manufacturing firms prefer the ASC to the regular credit. For instance, the ASC may be used instead of the regular credit if the firm has a high base amount for the regular calculation, doesn’t have detailed records to support qualified expenses during the base period years, has experienced significant growth in receipts in recent years or has a complex history of organizational activity (e.g., mergers, acquisitions and dispositions).

Reclassifying Business Expenses as Constructive Dividends

Posted on by Red Spot Design2

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that’s helpful and appropriate for your business. No Deduction for Dividends

Beyond Personal Expenses

Constructive dividends can come in many shapes and sizes. The most common example is when a shareholder mistakenly tries to claim personal expenses — such as medical, vehicle or housing costs — as business expenses. Other types of related-party transactions that the IRS may reclassify as constructive dividends include:

  • An excessive payment for corporate use of a shareholder’s personal property, such as rental payments for the company’s office or warehouse space,
  • A purchase or lease by a shareholder of company property at a price that’s significantly below fair market value,
  • A purchase or lease by the company of a shareholder’s property at a price that far exceeds fair market value,
  • Excessive compensation paid to shareholders or their family members,
  • Use of company-owned vehicles and other company property by shareholders (or their family members) without paying fair market value, and
  • A corporate loan (often at a below-market interest rate) made to a shareholder to fund personal items, where there’s no reasonable expectation of repayment.

The IRS sometimes challenges deductions claimed for certain types of business expenses. In doing so, an examiner might claim that payments made by a corporation to a shareholder for personal items or that are above or below fair market value constitute “constructive dividends.” Reclassifying business expenses as dividends has adverse tax consequences, as a recent case demonstrates.

Typically, a successful corporation pays out dividends to its shareholders, based on earnings for the year. The exact amount of dividends a shareholder receives depends on his or her proportionate share in the company. These dividends are declared by the company on a specified date and then paid out in cash or reinvested in more shares for the shareholder.

However, a corporation may make other payments to one or more shareholders, which the IRS might classify as “constructive dividends.” This often happens when owners of a closely held business use corporate funds to pay personal expenses. But it can also occur at multibillion-dollar conglomerates, and it may involve more than just running personal expenses through the business. (See “Beyond Personal Expenses” at right.)

The crux of the matter is: Owning all (or part) of a company doesn’t give you the unrestricted right to pay and record expenses in the manner in which you see fit. Notably, there are tax rules and restrictions that must be followed.

Tax Consequences

From an income tax perspective, dividends paid out by corporations are taxable to shareholders at the personal level. Qualified dividends received by a C corporation shareholder are taxable at the same preferential tax rates as long-term capital gains. Currently, the maximum tax rate for qualified dividends is 15% (20% if you’re in the top ordinary income tax bracket).

On the downside, dividends can’t be deducted by the corporation. So, dividends are paid using after-tax dollars, meaning they’re effectively taxed twice.

Compensation and most other types of payment (such as consulting or management fees) are taxable to shareholders at ordinary income tax rates. However, these legitimate expenses are usually fully deductible by the company (unless they aren’t at arm’s length). As a result, depending on its circumstances, a corporation may try to disguise dividends as compensation or some other type of payment.

This is where the IRS could jump into the fray. If it treats a payment as a constructive dividend, the business deduction the corporation tried to claim for that payment (for example, a compensation deduction) is disallowed, thereby increasing its tax liability. Furthermore, the IRS may impose penalties and interest for tax underpayments. And, if the company’s owners purposely evaded their tax responsibilities, they may face criminal sanctions.

For the shareholders, constructive dividends are taxable as ordinary income. However, unlike compensation, a dividend payment isn’t subject to payroll taxes. Therefore, the overall tax results for shareholders will vary.

Case in Point

The IRS is likely to step in if it perceives that a company is paying personal expenses on behalf of shareholders. That was the main issue presented to the U.S. Tax Court in a recent case. (Luczaj & Associates v. Commissioner, T.C. Memo 2017-42, March 8, 2017)

The taxpayers, a married couple residing in California, owned a C corporation. The husband held 51% of the stock, and the wife owned 49%. The wife was the company’s sole employee during the tax years in question, while the husband worked full-time as a high school adult transition coordinator, supervising and teaching special needs students.

The corporation was engaged in the business of originating home mortgages, acting as an independent contractor for California Mortgage Group (CMG). Its main function was to solicit clients for CMG. After the company referred clients to CMG, those individuals were offered loans to help purchase homes.

The wife’s sole responsibility was client recruitment for CMG. She had a desk in CMG’s main office in California, where she worked at least two days a week. She testified at trial that she worked from home the rest of the week and typically met clients at home or in a public place.

For 2012 and 2013, the corporation claimed deductions for a wide variety of expenses, including travel and entertainment, insurance, telephone, advertising, gifts, medical expenses, utilities and maintenance, depreciation, and dues and subscriptions. Some of these expenses included repairs to the couple’s personal residences, swimming pool costs and personal entertainment expenditures.

The IRS contested most of the reported business expenses due to lack of substantiation or lack of business purpose. It argued that the payments constituted constructive dividends to the shareholders. Finally, the IRS imposed accuracy-related penalties for the tax years in question.

The Tax Court agreed with the IRS. The court determined that many of the expenses that were claimed as marketing and promotional expenses were actually payments of personal expenses that directly benefited the shareholders. For instance, the wife claimed 100% business use of two vehicles, but didn’t follow IRS procedures for documenting business use. The court also ruled that payments may be treated as constructive dividends without the corporation making a formal declaration of dividends.

The Bottom Line

It’s easy to run afoul of the IRS on this issue. So, businesses always should keep detailed, contemporaneous records to support deductions and other tax positions, especially when it comes to transactions with related parties.

The IRS generally won’t, for example, treat a payment as a constructive dividend if the company can demonstrate that it lacked sufficient earnings to pay dividends or that a payment was, in fact, used to pay ordinary and necessary business expenses, rather than personal expenses.

In some instances, expenses may fall into a “gray area” where you’re unsure of the appropriate tax treatment. If you have questions or concerns about your situation, ask your professional tax advisor for help.

Are Contingent Attorneys’ Fees Tax Deductible?

Posted on by Red Spot Design2

If you agree to a contingent-fee arrangement with your attorney, you may wonder whether the expense is deductible for federal income tax purposes. Unfortunately, the guidance on this controversial issue isn’t favorable to taxpayers in most situations.

Beyond Taxable Recoveries to Individuals

The main article focuses on contingent fees related to taxable judgments or settlements collected by individual claimants in cases that aren’t business-related. Here’s an overview of the rules that apply to contingent fees for other types of recoveries.

Nontaxable Awards

An injured party can’t deduct attorneys’ fees incurred to collect a tax-free judgment or settlement, including a court-awarded recovery for a physical injury or sickness. In other words, no deductions are allowed for fees to collect tax-free compensation.

Punitive Damages

As a general rule, payments for punitive damages — which are designed specifically to punish the wrongdoer — and payments of interest are taxable even if they’re paid as part of the compensation for physical injuries or sickness. Therefore, contingent attorneys’ fees allocable to the collection of punitive damages or interest will be treated as miscellaneous itemized deductions. (See main article.)

Business-Related Payments

In cases involving business-related judgments or settlements, taxpayers are allowed to deduct all ordinary and necessary expenses incurred in carrying on an active business. Legal expenses constitute such ordinary and necessary expenses when they arise from an active business venture.

However, fees to acquire a business asset, such as real estate or a patent, must be capitalized as part of the cost of acquiring the asset and then depreciated or amortized. Finally, legal expenses incurred in connection with the business of being an employee are treated as miscellaneous itemized deductions, which can be unfavorable for the taxpayer. (See main article.)

Non-Contingent Attorneys’ Fees

In general, attorneys’ fees that aren’t contingent on the outcome of a case are treated in the same fashion as contingent fees. For example, non-contingent fees paid to collect a taxable non-business judgment or settlement would be treated as miscellaneous itemized deductions unless the above-the-line exception applies. (See main article.) And non-contingent fees paid to collect a tax-free judgment or settlement wouldn’t be deductible.

The federal income tax treatment of contingent fees paid to an attorney out of a taxable non-business judgment or settlement has been a source of confusion. Here’s an overview of the outcome of litigation between individual taxpayers and the IRS, along with a taxpayer-friendly exception to the general rule.

History Lesson

Some court decisions have concluded that an individual claimant must:

  1. Include 100% of the taxable portion of a legal judgment or settlement in gross income, and
  2. Treat the related contingent attorneys’ fee as a miscellaneous itemized deduction.

Taxpayers don’t generally favor this treatment, because miscellaneous itemized deductions are subject to a 2%-of-adjusted-gross-income threshold under the regular federal income tax rules. Additional miscellaneous itemized deductions are completely disallowed under the alternative minimum tax (AMT) rules. So, the actual allowable write-off for contingent fees is significantly reduced or maybe even completely disallowed if the taxpayer is subject to AMT.

Instead, taxpayers favor other court decisions that exclude contingent fees from the claimant’s gross income, because the fees are considered “owned” by the attorney rather than the claimant. This reasoning is consistent with the fact that the claimant never takes possession of the cash; rather, contingent fees go straight to the attorney.

Supreme Court Decision

Which treatment is correct: treating the fees as a miscellaneous itemized deduction or excluding them from gross income? The Supreme Court addressed this question in 2005, ruling that an individual taxpayer must include in gross income the portion of a taxable judgment or settlement that goes to the taxpayer’s attorney under a contingent-fee arrangement. (Commissioner v. Banks, II, 95 AFTR 2d 2005-659, Supreme Court 2005)

The decision was based on the Supreme Court’s review of Banks (a Sixth Circuit Court of Appeals decision) and Banaitis (a Ninth Circuit Court of Appeal decision). In both of those decisions, the appellate courts had reversed the U.S. Tax Court, concluding that the taxpayers could exclude from gross income amounts paid to their attorneys under contingent-fee arrangements.

The Supreme Court disagreed with these reversals, however. The Court ruled that, even though the value of taxpayers’ legal claims are speculative at the time they enter into a contingent-fee arrangement with an attorney, that factor doesn’t cause the arrangement to be properly characterized for tax purposes as a partnership or joint venture between taxpayer and attorney.

The Court concluded that the attorney-client relationship is more properly characterized as a principal-agent relationship. As such, the taxpayer (the principal) must include the entire taxable amount earned from the legal action in gross income and then hope to be able to claim a deduction for contingent fees paid to the attorney (the agent).

In essence, the Supreme Court’s decision reaffirmed one of the oldest principles in federal income taxation: A taxpayer can’t assign taxable income to someone else, even though the attempt to do so may occur before the income is actually earned. Instead, taxpayers must include the income on their return when it’s earned, and then hope to be able to deduct amounts that go to other parties (such as contingent fees paid to attorneys).

Taxpayer-Friendly Exception

The Supreme Court’s decision seems to close the door on any argument that contingent attorneys’ fees paid out of a taxable non-business judgment or settlement can be excluded from a claimant’s gross income. But Congress provided an exception that basically amounts to the same thing for certain taxpayers.

Specifically, the Internal Revenue Code permits an above-the-line deduction for attorneys’ fees and court costs paid in legal actions involving:

  • Certain claims of unlawful discrimination,
  • Certain claims against the federal government, and
  • Private causes of action under the Medicare Secondary Payer statute.

Treating the expense as an above-the-line deduction means you don’t need to itemize deductions on your tax return to benefit. Under this treatment, contingent attorneys’ fees are effectively subtracted from taxable income on your return, so you don’t have to pay tax on money that went to your attorney. The Internal Revenue Code provides a list of legal actions that are defined to be for unlawful discrimination, including, but not limited to, claims of violations of:

  • The Civil Rights Acts of 1964 and 1991,
  • The Congressional Accountability Act of 1995,
  • The National Labor Relations Act,
  • The Family and Medical Leave Act of 1993,
  • The Fair Housing Act,
  • The Americans with Disabilities Act of 1990, and
  • Various whistleblower statutes.

Important note: Above-the-line deduction treatment for qualifying contingent legal fees and related costs effectively allows you to directly subtract these expenses from the amount of the judgment or settlement that you claim. So, you pay taxes on only the amount you keep.

For More Information

Determining the proper tax treatment of an individual’s attorneys’ fees can be tricky. Your tax advisor can figure out the right answer. Get your advisor involved early in litigation, because he or she might be able to help you achieve a more tax-favorable result by planning ahead.

Green Tax Breaks: Are You Claiming All the Credits You Deserve?

Posted on by Red Spot Design2

In recent years, the IRS has offered “green” tax credits to individuals who purchase qualifying residential energy-efficient equipment and certain electric vehicles. Some of these breaks expired at the end of 2016. But others are still ripe for the taking in 2017 and beyond. Here’s what you need to know to take advantage.

Expanded Green Tax Breaks for 2016

For 2016, individual taxpayers could claim a 30% federal tax credit for the following expenditures for a U.S. residence, including a vacation home:

  • Qualified solar electricity generating equipment,
  • Qualified solar heating equipment,
  • Qualified wind energy equipment,
  • Qualified geothermal heat pump equipment, and
  • Qualified fuel cell electricity generating equipment. (The maximum credit is limited to $500 for each half-kilowatt of fuel cell capacity.)

For 2017, only the first two items are still eligible for the 30% credit.

Additionally, a more modest residential energy credit also expired at the end of 2016. It had a lifetime maximum of $500 and covered qualified expenditures for:

  • Advanced main air circulating fans,
  • Natural gas, propane, and oil furnaces and hot water boilers,
  • Electric heat pumps,
  • Electric heat pump water heaters,
  • Biomass fuel stoves,
  • High-efficiency central air conditioners,
  • Natural gas, propane and oil water heaters,
  • Energy-efficient windows, skylights and doors,
  • Energy-efficient roofing products, and
  • Energy-efficient insulation.

You can claim these now-expired credits on your 2016 federal tax return if you completed installation of the qualified equipment last year. If you already filed your 2016 return without claiming your rightful credits, your tax pro can help you file an amended return to collect the tax savings.

Residential Solar Energy Credit

You can claim a federal income tax credit equal to 30% of expenditures to buy and install qualifying energy-saving solar equipment for your home. Because this gear is expensive, it can generate big credits. And there are no income limits — even billionaires are eligible for this tax break. The 30% credit is available through 2019. In 2020, the credit rate drops to 26% and then to 22% in 2021. After that, the credit is scheduled to expire.

The credit can be used to reduce both your regular federal income tax bill and your alternative minimum tax (AMT) bill, if applicable.

The credit equals 30% of qualified expenditures (including costs for site preparation, assembly, installation, piping and wiring) for the following:

Qualified solar electricity generating equipment. This must be installed in a U.S. residence, including your vacation home. You must use the residence personally; so, the credit can’t be claimed for a property that is used exclusively as a rental.

Qualified solar water heating equipment. This also must be installed in a U.S. residence, including your vacation home. To qualify for the credit, at least half of the energy used to heat water for the property must be generated by the solar equipment. The credit can’t be claimed for a property that is used only as a rental. Also, you can’t claim the credit for equipment used to heat a swimming pool or hot tub. No credit is allowed unless the equipment is certified for performance by the nonprofit Solar Rating & Certification Corporation or a comparable entity endorsed by the state where your residence is located. Keep the certification with your tax records.

You can only claim the credit for expenditures on a “home,” which can include a house, condo, co-op apartment, houseboat, or mobile home, or a manufactured home that conforms to federal manufactured home construction and safety standards.

Keep track of how much you spend, including any extra amounts for site preparation, assembly, and installation. Also record when the installation is completed, because you can claim the credit only in the year when the installation is complete. In addition, ask your tax advisor whether you’re eligible for state and local tax benefits, subsidized state and local financing deals, and utility company rebates.

Credit for New Plug-In Electric Vehicles

Another green tax break that’s still available for 2017 and beyond is the federal income tax credit for qualifying new plug-in electric vehicles. The credit can be worth up to $7,500.

To be eligible for the credit, a vehicle must:

  • Be new (not used or rebuilt),
  • Draw propulsion from a battery with at least four kilowatt hours of capacity,
  • Use an external source of energy to recharge the battery (thus the term “plug-in”),
  • Be used primarily on public streets, roads, and highways,
  • Have four wheels,
  • Meet applicable federal emission and clean air standards, and
  • Be used primarily in the United States.

It can be either fully electric or a plug-in electric/gasoline hybrid. Finally, the vehicle must be purchased rather than leased. If you lease an eligible vehicle, the credit belongs to the manufacturer, and that may be factored into a lower lease payment.

The credit equals $2,500 for a vehicle powered by a four-kilowatt-hour battery, with an additional $417 for each additional kilowatt hour of battery capacity. The maximum credit is $7,500. Buyers of qualifying vehicles can rely on the certification of the allowable credit amount provided by the manufacturer or distributor.

The credit begins phasing out over four calendar quarters once the total number of qualifying vehicles sold by a particular manufacturer for use in the United States reaches 200,000. So far, no manufacturers have crossed that line, although General Motors might reach this threshold in 2018 or 2019 if sales of the Chevy Bolt and Volt continue at their current pace.

The credit can be used to offset your regular federal income tax and any alternative minimum tax (AMT) liability. And there are no income restrictions.

Not all eligible vehicles qualify for the maximum $7,500 credit. Some plug-in electric/gas hybrids are eligible only for lower amounts. According to Edmunds.com, the current list of eligible vehicles and credit amounts is as follows:

Fully Electric Vehicles

Make and Model Credit
BMW i3 $7,500
Chevrolet Bolt $7,500
Fiat 500e $7,500
Ford Focus Electric $7,500
Hyundai Ioniq Electric $7,500
Kia Soul EV $7,500
Mercedes-Benz B-Class EV $7,500
Nissan Leaf $7,500
Tesla Model S $7,500
Tesla Model X $7,500

Plug-In Electric/Gas Hybrids

Make and Model Credit
Audi A3 e-tron $4,205
BMW i3 (with range extender) $7,500
BMW i8 $3,793
Chevrolet Volt $7,500
Chrysler Pacifica $7,500
Ford C-Max Energi $4,007
Ford Fusion Energi $4,007
Hyundai Sonata Plug-In Hybrid $4,919
Kia Optima Plug-In $4,919
Toyota Prius Prime $4,502
Volvo XC90 T8 $4,585

In addition, residents of some states may be eligible for state income tax credits, rebates, or reduced vehicle taxes and registration fees for buying or leasing electric vehicles.

Need Help?

These green tax breaks are available for a limited time only. Contact your tax advisor for help claiming and maintaining adequate records to support these eco-friendly purchases.

Wedding Bells and Taxes: Tax Issues to Consider Before Tying the Knot

Posted on by Red Spot Design2

Summer — the traditional wedding season — is just around the corner. Marriage changes life in many ways. Here’s how it may affect your tax situation.

Marital Status

Your marital status at year end determines your tax filing options for the entire year. If you’re married on December 31, you’ll have two federal income tax filing choices for 2017:

  • File jointly with your spouse, or
  • Opt for “married filing separate” status and then file separate returns based on your income and your deductions and credits.

Here are two reasons most married couples file jointly:

1. It’s simpler. You only have to file one Form 1040, and you don’t have to worry about figuring out which income, deduction and tax credit items belong to each spouse.

2. It’s often cheaper. The married filing separate status makes you ineligible for some potentially valuable federal income tax breaks, such as the child care credit and certain higher education credits. Therefore, filing two separate returns may result in a bigger combined tax bill than filing one joint return.

Risks of Filing Jointly

Filing jointly isn’t a sure-win for one big reason: For years that you file joint federal income tax returns, you’re generally “jointly and severally liable” for any underpayments, interest and penalties caused by your spouse’s deliberate misdeeds or unintentional errors and omissions.

Joint-and-several liability means the IRS can come after you for the entire bill if collecting from your spouse proves to be difficult or impossible. They can even come after you after you’ve divorced.

However, you can try to claim an exemption from the joint-and-several-liability rule under the so-called “innocent spouse” provisions. To successfully qualify as an innocent spouse, you must prove that you:

  • Didn’t know about your spouse’s tax failings,
  • Had no reason to know, and
  • Didn’t personally benefit.

If you file separately, you’re certain to have no liability for your spouse’s tax misdeeds or errors. So, if you have doubts about a new spouse’s financial ethics, the best policy may be to file separately.

Penalty vs. Bonus

You’ve probably heard about the federal income tax “penalty” that happens when a married joint-filing couple owes more federal income tax than if they had remained single. The reason? At higher income levels, the tax rate brackets for joint filers aren’t twice as wide as the rate brackets for singles.

For example, the 28% rate bracket for singles starts at $91,901 of taxable income for 2017. For married joint-filing couples, the 28% bracket starts at $153,101. If you and your spouse each have $90,000 of taxable income in 2017, for a total of $180,000, you’ll pay a marriage penalty of $807. That’s because $26,900 of your combined taxable income will fall into the 28% rate bracket ($180,000 – $153,100). If you stay single, none of your income will be taxed at more than 25%. The marriage penalty is usually a relatively modest amount; so, it’s probably not a deal-breaker.

On the other hand, many married couples collect a federal income tax “bonus” from being married. If one spouse earns all or most of the income, it’s likely that filing jointly will reduce your combined tax bill. For a high-income couple, the marriage bonus can amount to several thousand dollars a year.

Important note: The preceding explanation of the marriage penalty and bonus assumes that the current federal income tax rates will remain in place for 2017. However, rates and rate brackets could change depending on tax reforms that may be proposed and enacted before year end. Ask your tax advisor for the latest details on federal tax reform efforts.

Home Sales

When people get married, they often need to combine two separate households before or after the big day. If you and your fiancé both own homes that have appreciated substantially in value, you may owe capital gains tax.

However, there’s a $250,000 gain exclusion for single taxpayers who sell real property that was their principle residence for at least two years during the five-year period ending on the sale date. The gain exclusion increases to $500,000 for married taxpayers who file jointly.

Suppose you and your fiancé both own homes. You could both sell your respective homes before or after you get married. Assuming you’ve both lived in your respective homes for two of the last five years, then you could both potentially claim the $250,000 gain exclusion. That’s a combined federal-income-tax-free profit of up to $500,000.

Conversely, let’s say you sell your home and move into your spouse’s home. After you’ve both used that home as your principal residence for at least two years, you could sell it and claim the larger $500,000 joint-filer gain exclusion.

In other words, you could potentially exclude up to $250,000 of gain on the sale of your home. Then you could later claim a gain exclusion of up to $500,000 on the sale of the house that your spouse originally owned. With a little patience and some smart tax planning, you could potentially exclude a combined total gain of $750,000 on your home sales.

Got Questions?

Getting hitched may open up new tax risks — and some new tax planning opportunities. It pays to be well-informed. Contact your Cornwell Jackson tax advisor for guidance on how getting married could change your tax situation in 2017.

Give Employees a Running Start with a Strong Onboarding Program

Posted on by Red Spot Design2

Your new hire may be thrilled to have secured a job with your company. But most likely, he or she will still be nervous at the outset. More than that, the first few weeks on the job is a time of vulnerability, presenting hazards both for the new employee and for your organization.

Research in a report by the Society for Human Resource Management (SHRM) underscores just how big the danger is. That is, half of hourly workers leave new jobs within about four months, and half of senior outside hires fail within 18 months. But employers that implement step-by-step programs orienting employees toward their new roles and organizational norms are more effective than those that don’t.

The 4 “Cs”

What are the ingredients of an effective onboarding program? Here are four dimensions:

  1. Compliance. Acquaint new employees with basic employer policies, including legal requirements.
  2. Clarification. Make sure new employees know what’s expected of them.
  3. Culture. Give employees a sense of formal and informal organizational norms.
  4. Connection. Facilitate the development of relationships that employees need to feel comfortable and know where to get answers.

When you’ve got these dimensions covered, the results will generally be lower turnover and higher job satisfaction (which tend to go hand-in-hand), better performance, reduced employee stress and effective career management.

Be Prepared

The most effective onboarding programs are obviously customized to the specific employer’s organization. For example, the Massachusetts Institute of Technology (MIT) gives its managers detailed onboarding checklists. The checklists identify anticipated outcomes for each of several phases of the process.

One key to success at MIT is getting started before a new employee arrives. The goal — and outcome, if successful — is that the new employee finds a “welcoming work environment with informed colleagues and a fully equipped work space,” according to the school’s website.

MIT emphasizes that new employees should feel as settled in as possible the day they start. That requires making sure the new employee’s workstation is well-equipped and functional (with computers and phones hooked up). In addition, incumbent employees should be prepared to greet new hires and begin establishing working relationships with them. MIT also endorses linking up new hires with a “buddy” to smooth their transition.

On the first day, in addition to having all of the above set to go, MIT managers are expected to:

  • Outline the employee’s schedule for the first week,
  • Describe the purpose and goals, and place these in the organizational structure of the new hire’s department, along with his or her role within the department, and
  • Review the job description, duties and expectations, as well as basic work policies, and employee benefits.

In theory, there should be no surprises at this point (assuming the job was described accurately during the hiring process). Other routine HR paperwork tasks, such as completing I-9 forms, will also need to occur, though they aren’t technically part of an onboarding program.

Over the course of the first week, if not on the first day, the new employee should have an initial assignment in hand. He or she also should be informed about the performance review and goal-setting process, as well as the probationary employment period.

Debriefing Sessions and More

During this early period, an effective onboarding program will include debriefing sessions after the new hire has attended meetings. The purpose is to ensure appropriate takeaways have been absorbed. This also is a good time to check that the new employee has signed up for or completed any training that may be helpful or is required.

After the employee has had a month on the job, you should seek feedback on how the work is going, and how well-acclimated the new employee feels to the organization. Inevitably there will be some questions, but even if very few arise, you’re communicating your willingness to answer questions in the future.

It’s also important to discreetly assess whether a new employee is fitting in socially and building relationships with coworkers. The MIT checklist suggests managers continue introducing the new hire to key people and ensure he or she is invited to relevant events.

By the time the six-month milestone arrives, if the onboarding process has done its job, says MIT, the new employee should have “gained momentum in producing deliverables, begun to take the lead on some initiatives,” and have a degree of confidence and a feeling of engagement in his or her new role.

A performance review should be conducted at that point, which can mark the end of the formal onboarding process. However, if the review identifies performance shortfalls, it’s important to identify whether the problem is in the onboarding process or elsewhere. Either way, the indicated issues should be addressed promptly.

Obviously, problems with a job can arise at any point. But as the saying goes, “well begun is half done.” A strong start gives an employee a running chance for success in a new position and a chance to make a real contribution to your company.

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