January 2012 - Accountalent

Stop! Think Before You Incorporate

Posted on January 22, 2012 by admin

We work with a lot of college student entrepreneurs, young entrepreneurs and first-time entrepreneurs. We are often asked “..should we incorporate or form a Limited Liability Company (“LLC”)?” Sometimes, these entrepreneurs have visited a lawyer first, and have already incorporated or formed an LLC.

Based on our experience of often, “picking up the pieces”, we have developed three rules for these entrepreneurs. (Note that these do not apply to sponsor-backed (VC/PE/Angel) companies, but strictly to “bootstrapped” businesses that are funding operations with personal funds).

Before you make the decision to incorporate or form an LLC, visit an accountant who is familiar with closely-held businesses and discuss, quantify and thoroughly understand the following and ensure these additional and often substantial costs justify the corporate benefits:
- Income Taxes differences of a C Corporation, S Corporation, LLC, Proprietorship
- Secretary of State initial registration fees,
- Secretary of State annual fees/taxes
- Resident Agent fees
- Minimum annual State Income Tax
- Income Tax compliance fees

If you decide to incorporate or form an LLC, do not get talked into incorporating or forming in Delaware or Nevada – do it in the state where you are physically located. Delaware and Nevada are fine choices for sponsored-backed companies or companies about to go public, as the do have certain advantages, such as the Delaware business law flexibility and the Nevada indemnification benefits. For bootstrapped companies, though, these advantages are not worth the additional registration fees, annual fees and compliance costs – you will get a better return from these funds by investing them in your business. If you raise VC/PE/Angel funds, you can always choose to change your state of incorporation very inexpensively and with someone else’s funds.

Do NOT incorporate too soon. Even though your lawyer may be pushing the personal liability protection of corporations and LLCs – there is a good chance that no one will sue you, especially if you do not have substantial assets (such as college students). If you do get sued for Negligence or Fraud, the corporate veil will not protect your personal assets. If you decide not to incorporate, ensure that you register the business with your city or town (file a DBA) and have the proper Property and Casualty insurance. Also, if you have other partners, ensure that you develop and sign a comprehensive agreement that details issues, such as ownership of IP, ownership percentage of business, funding issues, tax allocations, withdrawal of a partner from the business, and all other potential issues involving the business. It is best to agree to this early in the life cycle of the business and then draft the agreement and, then, present to a lawyer to edit, finalize and memorialize.

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IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

International Taxation Hot Issue – Repatriation

Posted on January 19, 2012June 30, 2022 by admin

“…$1.4 trillion of corporate cash is trapped overseas…”

“…Corporate America needs a tax holiday to repatriate these funds…”

What does this mean? Why should we care about this?

To answer these questions, you need to know a little about International Taxation. So, here is an example that should shed some light on the issues:

Mega Corp. is a US based multi-national corporation with operations in the US and Ireland.
They file a US Consolidated Tax Return.
They manufacture and sell the same product in both locations.
Their taxable income is $1M in the US and $1M in Ireland.
Taxable income is measured by shipments from their facilities less corresponding expenses incurred.
Due to “throwback” rules, shipments to another country, most likely, be a taxable sale from the country where it shipped from (either the US or Ireland).
Assuming they are paying the top corporate tax rates, they will pay $350K (35% rate) in US taxes and will pay $125K (12.5% rate) in Irish taxes.
If they do not repatriate (i.e. wire transfer) funds from Ireland to the US, they will NEVER pay US taxes on their Ireland based income.
If they wire transfer funds from Ireland to the US, they will pay US taxes of 22.5% on these funds (the difference between the US rate of 35% and the Ireland rate of 12.5%).

So, one of the recent proposals is an 8.25% tax rate on these repatriated earnings (money transferred from Ireland to US in our example), which would be lowered to 5.25% if the money is used to create jobs. The most recent “tax holiday” was 2004. Results are tough to measure. Obviously, those who favor the holiday claim companies will use these funds to expand operations in the US. Others argue it is irrational to pay any US tax if these funds are not needed in the US.

Ask yourself these questions, now:

Assume that you need more capacity, which will create more taxable income – with all else, other than taxes, being equal, where will you expand – the US and lose 35% of your profits or Ireland and lose only 12.5% of your profits in taxes?
Now ask yourself the same question and factor in that about every 5 years, Congress will approve a tax holiday.
Transfer pricing allows one facility to charge another facility within a company for products or services. This “funny money” charge is added to taxable income for the facility that provided the product or service; and a taxable expense for the other facilities using the product or service. Now, in our example, assume there is a major common part that makes sense manufacturing at just one facility (thus increasing that facility’s taxable income and decreasing the other facility’s taxable income). Doesn’t it make sense to increase profits in the country that is paying 12.5% taxes and lowering profits in the country that is paying 35% taxes?

We do not attempt to answer these questions, but present these issues to shed some light on this subject, which should get attention during the upcoming Presidential Elections.

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IRS Circular 230 Disclosure

UPDATE: Tax Plan Square Off: Romney vs. Santorum vs. Gingrich

Posted on January 17, 2012 by admin

After we published our blog on the Romney vs. Santorum tax plans, we were inundated with requests to add the Gingrich tax plan to the analysis. So, below is an updated chart that includes the results of the Gingrich tax plan. Our methodology remained the same, using the hypothetical taxpayers and the typical income and deductions.

The following are the hypothetical taxpayers and the typical income and deductions:

	Single Parent	Family	Executive	Retired
Filing Status	Head of Household	Married-File Jointly	Married-File Jointly	Married-File Jointly
Marital Status	Single/Divorced	Married	Married	Married
Dependent Children	3	3	3	0
Homeowner or Renter	Renter	Homeowner	Homeowner	Homeowner
W-2 Earnings – Parent One	$30,000	$85,000	$1,250,000	$0
W-2 Earnings – Parent Two	N/A	$35,000	$0	$0
Pension Income-Both Spouses	N/A	N/A	N/A	$30,000
Social Security Income-Both Spouses	N/A	N/A	N/A	$35,000
Interest Income	$0	$500	$10,000	$6,000
Dividend Income	$0	$0	$15,000	$1,000
Capital Gain Income	$0	$0	$250,000	$0
Mortgage Interest Paid	$0	$15,000	$40,000	$0
Charitable Donations Made	$0	$750	$10,000	$500
Real Estate Taxes Paid	$0	$4,000	$25,000	$2,500
State Income Taxes Paid	$900	$3,600	$45,000	$1,000

The following are the results:

	2011 Rates	Romney	Santorum	Gingrich
Single Parent:
Federal Taxes Paid	$0	$0	$0	$0
Federal Taxes Refunded*	$5,270	$4,631	$5,943	$5,270

Family:
Federal Taxes Paid	$9,469	$9,294	$5,616	$6,638

Executive:
Federal Taxes Paid	$402,147	$402,147	$331,864	$171,000

Retired:
Federal Taxes Paid	$3,594	$1,801	$3,063	$3,594

* A refund would be realized due to the Refundable Earned Income Tax Credit and the Refundable Child Tax Credit

Some notes about this Update (these are in addition to the notes in the Romney vs. Santorum blog):

The Gingrich tax plan gives taxpayers a choice between paying taxes under the current tax system or paying tax at the single 15% tax rate. The amounts on the chart above are the lesser of the Gingrich plan or the current tax system.
The Gingrich 15% tax rate would allow some deductions and would not include Capital Gain, Interest or Dividend Income. The deductions allowed would be Mortgage Interest, Charitable Contributions and a $12,000 personal exemption for each individual and dependent.
Gingrich would retain the expanded Earned Income and Child Tax credits. We assumed these would be retained at the 2012 levels.
We assumed that Social Security income would be taxed at 100% under the Gingrich 15% plan.

Now some analysis (this is in addition to the analysis in the Romney vs. Santorum blog):

The biggest, most obvious difference between the Gingrich plan and all the other plans, is the amount of taxes high-earners will pay under the Gingrich plan. In our example, none of the Capital Gain, Interest and Dividend income will be taxed and the salary ($1,250,000) is only taxed at 15% for the Executive. It results in about a 50% reduction or $160,000 less in taxes than the Santorum plan. Even if we assumed that Capital Gain, Interest and Dividend income would be taxed under the Gingrich plan, it would still result in a 35% reduction or $120,000 less in taxes than the Santorum plan.
Both Santorum’s and Gingrich’s plan would result in substantial savings for the Family, also. The Gingrich plan would give a $12,000 personal exemption for each individual and dependent. The results for families with one or fewer children would be very different, though (our example assumes three children). For example, assuming the same income and deductions for the Family, but having only one child, would actually result in higher taxes under the Gingrich alternative method (but according to his plan, you would be able to select the lower tax calculated under the current tax system).

If you want to review our backup information, including tax returns for each of these scenarios, please email us at [email protected].

Prior to publishing this blog, we sent it to the Gingrich campaign for their comments, but did not hear back from them.

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IRS Circular 230 Disclosure

Tax Plan Square Off: Romney vs. Santorum

Posted on January 16, 2012 by admin

Following the Iowa Presidential Caucus in early January, 2012 where only 8 votes separated candidates Mitt Romney and Rick Santorum, we thought it would be a good idea to compare their proposed tax plans. We wanted to get very specific, though. So, before we delved into the details of either plan, we created four hypothetical taxpayers:

Single Parent with three dependent, minor children
A working Family, where both parents work with three dependent, minor children
An Executive with one high-earning parent working and three dependent, minor children
A Retired couple

The next step was to determine typical income and deductions for these hypothetical taxpayers. In our opinion, the following are typical for these taxpayers:

	Single Parent	Family	Executive	Retired
Filing Status	Head of Household	Married-File Jointly	Married-File Jointly	Married-File Jointly
Marital Status	Single/Divorced	Married	Married	Married
Dependent Children	3	3	3	0
Homeowner or Renter	Renter	Homeowner	Homeowner	Homeowner
W-2 Earnings – Parent One	$30,000	$85,000	$1,250,000	$0
W-2 Earnings – Parent Two	N/A	$35,000	$0	$0
Pension Income-Both Spouses	N/A	N/A	N/A	$30,000
Social Security Income-Both Spouses	N/A	N/A	N/A	$35,000
Interest Income	$0	$500	$10,000	$6,000
Dividend Income	$0	$0	$15,000	$1,000
Capital Gain Income	$0	$0	$250,000	$0
Mortgage Interest Paid	$0	$15,000	$40,000	$0
Charitable Donations Made	$0	$750	$10,000	$500
Real Estate Taxes Paid	$0	$4,000	$25,000	$2,500
State Income Taxes Paid	$900	$3,600	$45,000	$1,000

Now, we dove into the details of each tax plan. We intentionally delayed this step until we determined the hypothetical taxpayers’ profile and the typical income and deductions, as we did not want the details of the tax plans to influence this determination. Here are the results:

	2011 Rates	Romney	Santorum
Single Parent:
Federal Taxes Paid	$0	$0	$0
Federal Taxes Refunded*	$5,270	$4,631	$5,943

Family:
Federal Taxes Paid	$9,469	$9,294	$5,616

Executive:
Federal Taxes Paid	$402,147	$402,147	$331,864

Retired:
Federal Taxes Paid	$3,594	$1,801	$3,063

* A refund would be realized due to the Refundable Earned Income Tax Credit and the Refundable Child Tax Credit

A few very important notes:

The 2011 Rates column shows the taxes for each scenario under the existing tax rates and law.
For the Romney and Santorum columns, we applied the existing 2011 rates and law, but made changes based on their published tax plans on their websites. We also consulted the Tax Policy Center of the Urban Institute and Brookings Institution for details on Romney’s position on the Earned Income Credit.
Where there was no specificity, such as with Romney’s position, “…in the long run, Mitt Romney will pursue a conservative overhaul of the tax system that includes lower and flatter rates on a broader tax base.,.”, we made no changes to the 2011 tax rates.
Santorum states that he would reduce the current 6 tier rate structure to a 2 tier rate structure. His rates would be 10% and 28%. We felt this position was specific enough for us to apply these two rates, but needed to make an assumption to the applicable income levels, as this specificity was not articulated by Santorum.
Most importantly, the results are reflective of only the income and deductions that, in our opinion, were typical for these hypothetical taxpayers. Changing any of these variables can change the results and analysis greatly. (Editor’s Note: we spent a significant amount of time and effort building a model and very thoroughly understanding the tax plans of each candidate. We can easily accommodate any request for “what ifs” using different input values for income and deductions. Feel free to email us at [email protected] with any request).

Now some analysis:

Santorum’s plan’s results in lower taxes or a higher refund (due to the refundable earned income and child tax credits) in three of the four scenarios.

Romney’s plan results in lower taxes for the Retired couple only because he would not tax interest and dividend income for taxpayers with Adjusted Gross Incomes below $200,000. In this scenario, we assumed $7,000 in interest and dividend income would not be taxed and the elimination of this income results in a smaller amount of the Retired couple’s Social Security being taxed. In our tax compliance experience, we find that retired taxpayers often have significant interest income.
Romney’s plan does not significantly change the existing tax rates and law. There is very little change for taxpayers with Adjusted Gross Income above $200,000.
Santorum’s plan is oriented very favorably towards families with multiple children, as he wants to increase the personal exemption for dependent children from $3,700 to $11,100. In our opinion, there would need to be a separate rate category for taxpayers with one or no children. It may be very difficult to significantly lower the income tax rate for families with many children and triple the amount of their dependency exemption, but lower rates are a part of the Santorum plan.
The results above for the Santorum plan would be significantly different for Single Parent and Family assuming one or fewer dependent children.
The results for the Executive under the Santorum plan are greatly influenced by our assumption on the Santorum income tax rate table. We applied this assumed table to all scenarios, but it influenced the Executive scenario the most.

If you want to review our backup information, including tax returns for each of these scenarios, please email us at [email protected].

Three days prior to publishing this report, we sent this paper and our backup notes to the Romney and Santorum campaigns for their feedback. We received no feedback.

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IRS Circular 230 Disclosure

IRS Targets Family Real Estate Transfers

Posted on January 2, 2012June 30, 2022 by admin

It is not uncommon for family members to transfer (technically a gift, often subject to Gift Tax in the eyes of the IRS) real estate between each other for Estate Tax, Medicare planning or asset protection purposes. Tax law states than any gift with a value over $13,000 is taxable to the donor. Typically, though, the donor will elect to use a portion of their lifetime Unified Credit (currently $5,000,000) to avoid paying this Gift Tax on these transfers.

Tax law states, though, that the donor needs to file a Gift Tax Return (Form 709) on all gifts valued above $13,000, even though no Gift Tax may be owed by the donor due to the utilization of the Unified Credit. The Gift Tax rate quickly gets to 35% (gifts over $500,000) of the value of the gift.

Last month, a Federal Court instructed the CA Board of Equalization to turn over to the IRS the names of CA citizens who transferred realty at little or no consideration between 2005 and 2010. The IRS wants this information to go after taxpayers who transferred realty to family members and did not file a Gift Tax return (due April 15^th).

Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington and Wisconsin have already turned over similar information to the IRS. Compliance in Ohio was close to 0% and the average in Florida and Virginia was only 10%. It appears the IRS will expand this program to other states.

So, if you transferred real estate to a family member for little or no consideration, you should file Form 709, even though it may be beyond the due date. The IRS is looking for Failure to File and Failure to Pay penalties and, possibly, delinquent Gift Taxes.

Editors Note: It is questionable why the IRS is going through these efforts and costs to amass this information, when the present Unified Credit is $5,000,000. Therefore, if you are contacted by the IRS for non-filing, but your transfer was less than $5,000,000 (in 2011 and thereafter), there should be no tax due, albeit they can collect Failure to File penalties. Also, note that the Unified Credit amount has steadily increased in the last ten years, from a low of $675,000 in 2001, to $2,000,000 in 2006 to the present $5,000,000. So, if you made a transfer in 2001 of greater than $675,000, there would be Gift Tax due.

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IRS Circular 230 Disclosure