Is Your Advance Debt or Equity? It Matters.

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Business owners often make capital contributions or loans to their corporations.   Debts are paid to creditors including owner-creditors before distributions are made to owners.  So when cash flow is tight or insufficient, having a clear distinction between loans and contributions is important in deciding who gets paid first and how much.
Knowing the difference between debt and equity is also important for tax purposes.  Unpaid debts can give rise to a tax deduction when the debt becomes worthless.  Unreturned equity can only give rise to a capital loss.   Further, drawing a distinction between a business bad debt and a non-business bad debt can be critical.
If a corporation is unable to repay a business debt, the non-corporate business owner can deduct the unpaid debt against ordinary income as a business bad debt in full in the year the debt becomes worthless.  But if the debt is not a business debt, the unpaid advance is treated as a short term capital loss and can only be deducted against ordinary income to the extent of $3,000 per year.
In a recent case, the Court of Appeals for the 9th Circuit concluded that a CEO, who was also a Director and minority Shareholder, could not take a bad debt deduction for advances he made to the corporation.  The court in this case found that the advances were equity investments in the corporation and not bona fide debt.  In making this determination, the Court of Appeals referred to the following factors:

1. The labels on the documents evidencing the indebtedness;
2. The presence or absence of a maturity date;
3. The source of payment;
4. The right of the lender to enforce payment;
5. The lender's right to participate in management;
6. The lender's right to collect versus right of unrelated creditors;
7. The parties' intent;
8. The adequacy of the borrower's capitalization;
9. Whether the owners' advances are in the same proportion as their equity ownership;
10. The payment of interest out of only money available for distribution to owners; and
11. The borrower's ability to obtain loans from outside lenders.

If you intend to advance money to your corporation, you should take the time to prepare promissory notes and other loan documentation to evidence the loan as a business debt.  Documenting the advance as a loan will give you priority over the other owners and, to the extent you take a security interest, may give you priority over unsecured creditors.  Evidencing the advance as a debt may also entitle you to claim a business bad debt deduction if the debt is not repaid in full.  Call or email me at jsenney@pselaw.com or 937-223-1130 if you would like some help with loan documentation or want to discuss this matter further.

AND ONE MORE THING.  Under Ohio law, a “responsible party” is liable for unpaid trust fund taxes such as sales tax or income tax withholding.  This liability extends to late filing charges, interest and penalties as well.  The tax authorities often attempt to treat all officers of a corporation as responsible parties.   If you are a corporate officer, you want to make sure all trust fund taxes (and late filing charges, penalties and interest) are paid in full and on time.   Give me a call or email if the IRS or state tax authorities are trying to collect from you as a responsible party.

Some Positive Tax News– Guest Blogger Joseph Mattera

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While we await possible major tax impacts from further implementation of President Obama’s health care legislation and continuation or lapse of the Bush tax cuts, there is some good news to report this week.  Due to inflation adjustments, the IRS has announced several increases in various tax benefits in 2013 in the areas of gifting, the “kiddie tax” and retirement savings.

Currently, the annual gift tax exclusion is $13,000 per person per donee.  This annual exclusion is the amount you can gift to any number of individuals per year with no gift tax implications.  For example, if you have 3 children, you can gift each child up to $13,000 per year (total gifts of $39,000) under the current exclusion.  Starting January 1, 2013, this annual exclusion amount increases to $14,000.  While this $1,000 per person per donee increase seems small, remember that your spouse can double the annual exclusion amount by joining in the gift (or can make a gift in the same amount), and that you and your spouse can make annual gifts to any number of persons.

For tax year 2012, taxpayers can reduce a child’s unearned income subject to the “kiddie tax” by $950.  For 2013, the number increases to $1,000.  This will permit a child to earn $50 more before being taxed at their parents’ tax rates.

The maximum an employee can now contribute to a 401(k) plan is $17,000.  In 2013, the number will increase to $17,500.  Employees aged 50 and over may continue to contribute an additional $5,500 per year, bringing their maximum to $23,000 per year starting in 2013.

If you have any questions or comments about these tax benefits, please call or email Joseph Mattera at Jmattera@pselaw.com or 937-223-1130.

AND ONE MORE THING.  The BWC offers grants to employers under the Safety Intervention Grants Program, the Drug Free Safety Program, the Workplace Wellness Grant Program and the Transitional Work Grants Program. Sarah Carter can provide more information about these grant programs. If you have any questions or comments about any tax or business matter, please call or email me or Sarah Carter at Scarter@pselaw.com or Jsenney@pselaw.com or 937-223-1130.

Now is a Good Time to Borrow Money from Yourself

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Want to take a bunch of money out of your corporation but don’t want to pay all the taxes that would apply if you took out a dividend or paid yourself a bonus?   Consider borrowing the money from your corporation.

The IRS publishes applicable federal rates (“AFRs”) each month.  The AFRs are the minimum interest rates that the IRS requires be charged on demand and term loans in various situations.  The extremely low interest rate environment of the last several years has produced extremely low AFRs.  For example, for the month of October, the short-term AFR (3 years or less) is 0.23% and the mid-term AFR (more than 3 but less than 9 years) is 0.93%. The long-term AFR (more than 9 years) for October with monthly or quarterly compounding is 2.34%.

Based on the AFR rates for October, you could have your corporation loan you significant dollars for a term of less than 9 years and pay interest on such money at the rate of only 0.93%.  This is way better than taking a taxable bonus or dividend.  Especially if you, like many other small business owners, expect to make additional capital contributions to the corporation from time to time in the future.

But you need to steer clear of pitfalls. The loan must be set up properly to avoid having the loan characterized as a taxable dividend or compensation payment. Some of the key factors for determining when a bona fide loan exists are:

(1) Whether there is a cap on how much can be advanced to the owner.

(2) Whether the owner gives collateral for the loan. Such collateral could be a pledge of the owner’s stock.

(3) Whether the owner is financially able to repay the loan. The owner’s stock in the corporation, other unrelated assets and salary as an employee of the corporation is considered in making this determination.

(4) Whether there is a repayment schedule and whether the owner made any repayments.

(5) Whether there is a definite maturity date.

(6) Whether the corporation makes any effort to collect the loan when due.

(7) The size of the loan.

(8) Whether the owner controls the corporation.

(9) Whether the corporation has any earnings and dividend payment history.

(10) Whether the loan is evidenced by a promissory note.

(11) Whether the corporation recorded and reported the loan on its accounting records and tax returns.

Give me a call or email at 937-223-1130 or jsenney@pselaw.com if you have any questions or comments about shareholder loans, or if you would like some help with properly structuring your loan arrangement.

AND ONE MORE THING.  Don’t forget capital loss carryovers you have from prior years.  You can only deduct $3,000 a year of capital loss against active income.  But you can deduct an unlimited amount of capital loss carryover against capital gains.  So make sure you consider realizing some capital gain to offset against your suspended capital losses.  If you are holding appreciated stock that you could sell at a gain, but you want to retain such investment, consider selling the stock to realize the gain, and then repurchasing the stock.  The wash sale rules only apply to losses so you can sell and repurchase at the same price on the same day.  Give me a call or email at Jsenney@pselaw.com or 937-223-1130 if you want to talk about year-end tax planning.

Related Party Sale May Have Unexpected Results

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Sale, exchange or distribution of appreciated property between related parties can create certain adverse tax consequences for sellers including recharacterizing capital gains as ordinary income, denying installment sales reporting, disallowing realized losses and restricting the use of like-kind exchanges.

Gain on the sale of depreciable real property held for more than one year can be subject to three (3) different tax rates.  Depreciation recapture is taxed as ordinary income at a max rate of 35%.  Unrecaptured gain on depreciable real property is taxed at a max rate of 25%.   And long-term capital gain is taxed at the capital gain rate (currently at a max rate of 15%).

In addition, under Internal Revenue Code section 1239, gain that would otherwise be treated as capital gain is converted to ordinary income if the property was depreciable and was sold, exchanged or distributed between related parties. This rule applies to property that can be depreciated by the buyer, whether or not the seller could depreciate the property and whether or not the buyer chooses to depreciate the property.  The special rule of section 1239 does not apply to property such as raw land which is not depreciable.

When applying the depreciation recapture rules and the special rule of section 1239 to a related party sale, the seller first allocates the gain on sale of the property between the depreciable property and the non-depreciable property.  The seller then applies the depreciation recapture rules to the portion of the gain attributable to the depreciable property.  The remainder of the gain on the depreciable property if any is then treated as ordinary income under section 1239.

For purposes of section 1239, “related parties” include a taxpayer and all controlled entities.  In determining who are related parties, the constructive stock ownership rules apply.  Similar but different rules apply where the property is held by a partnership.  More about that in a future blog.  Please call or email me at 937-223-1130 or Jsenney@pselaw.com if you have any questions or comments.

AND ONE MORE THING.  The federal estate tax exemption in 2012 is $5,120,000.  The federal estate tax exemption is scheduled to return to $1,000,000 in 2013.  With this in mind, some people are gifting real estate and other appreciated assets to their children and grandchildren this year.   And to get even more bang for the buck, people are contributing these appreciated assets to an LLC or other closely-held company, and then gifting ownership interests in the LLC rather than gifting the appreciated asset itself.  The reason?  Valuation discounts of 30 to 40% can be taken when gifting a minority interest in an LLC rather than gifting the appreciated asset itself.   If you are interested in doing some end of year gifting, please give me a call.   Jsenney@pselaw.com or 937-223-1130

Determining Full-Time Status under Affordable Care Act

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The Affordable Care Act, imposes a penalty on an “applicable large employer” that either fails to offer its full-time employees and their dependents the opportunity to enroll in certain minimum essential and/or affordable care coverage.  The ACA defines an applicable large employer, with respect to any calendar year, as an employer that employed an average of at least 50 full-time employees on business days during the preceding calendar year. For this purpose, the term “full-time employees” means the sum of the employer's full-time employees and full-time equivalent employees.  The IRS has now issued Notice 2012-58 which provides guidance on the determination of full-time status.

Existing Employees:  In a prior Notice, the IRS both described a possible approach to determining whether existing employees were full-time.  This approach would permit employers to use an optional “look-back safe harbor period” to determine whether ongoing (rather than newly hired) employees are full-time.  Practitioners responded favorably to this approach, and the IRS issued Notice 2012-58 which essentially adopts this approach.  Under the look-back method, an employer determines each ongoing employee's full-time status by looking back at a standard measurement period (3 to 12 consecutive months) chosen by the employer. The employer gets to determine the months in which the standard measurement period starts and ends, subject to a requirement that it be uniform and consistent for all employees in the same job category.  If the employer determines that an employee averaged at least 30 hours per week during the standard measurement period, then the employer would be required to treat the employee as a full-time employee during a subsequent “stability period”  without regard to the employee's number of hours of service during such stability period. The stability period would be a period of at least 6 months that is no shorter than the standard measurement period, and that begins after the standard measurement period.

Recognizing that employers may need time between the standard measurement period and the stability period to determine which ongoing employees are eligible for coverage and to notify and enroll those employees, Notice 2012-58 provides an optional administrative period safe harbor. This administrative period following the standard measurement period and may last up to 90 days. However, the administrative period between the standard measurement period and the stability period may neither reduce nor lengthen the measurement period or the stability period.

New Employees:  In a prior Notice the IRS had also described a possible approach to determining the full-time status of new employees working variable hours.   A variable hour employee is an employee where, based on the facts and circumstances on the date the employee starts work, it cannot be determined if the employee will work an average of at least 30 hours per week.  Under the possible approach described in the prior Notice, employers would be given 3 months (or 6 months in some cases), to determine whether a variable hour new employee is a full-time employee, without incurring a penalty under the ACA.  After considering this possible approach, many practitioners requested that employers be allowed to use a look-back measurement period of up to 12 months.   In response, the IRS expanded the proposed approach in a manner similar to that available for existing employees (by use of a 3 to 12 month look-back measurement period, a stability period, and the use of an administrative period).  The same rules would also apply to seasonal employees.  But once a new employee is employed for an entire measurement period, the employee must be retested for full-time status beginning with that standard measurement period at the same time and under the same conditions as other existing employees.

Reliance on the Notice:  Employers may rely on the safe harbors contained in Notice 2012-58 for compliance with the ACA at  least through the end of 2014.

If you have questions on how to determine full-time status of your employees for purposes of the ACA, or otherwise how to comply with the ACA, please call or email me at 937-223-1130 or Jsenney@pselaw.com.

AND ONE MORE THING.    We all face the prospect of a darker tax climate in 2013 for investment income and gains. Under current law, higher-income taxpayers will face a 3.8% surtax on their investment income and gains. Additionally, if the "tax break" sunsets go into effect, all taxpayers will face higher taxes on investment income and gains, and the vast majority of taxpayers also will face higher rates on their ordinary income. Plus, the tax break sunsets will increase estate and gift taxes. As a result, year-end gifts to family members can yield even greater overall family tax savings than in prior years.  Give me a call if you want to discuss gifting property or investments to your children or grand-children.  Jsenney@pselaw.com or 937-223-1130.

False Claims Act

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The False Claims Act is a federal law that imposes liability on contractors who defraud governmental programs. The law includes a provision that allows people who are not affiliated with the government to file legal actions on behalf of the government.  These whistleblowers are eligible to receive a portion (15–25%) of any damages recovered. Claims made under the law often involve health care, military and other government spending programs.  The federal government  has recovered tens of billions of dollars under the False Claims Act since 1987.

Under the Act, a person is liable when he or she improperly receives payment from, or avoids payment to, the federal government. The Act prohibits:

• Knowingly presenting, or causing to be presented a false claim for payment or approval;
• Knowingly making, using, or causing to be made or used, a false record or statement material to a false or fraudulent claim;
• Conspiring to commit any violation of the False Claims Act;
• Falsely certifying the type or amount of property to be used by the government;
• Certifying receipt of property on a document without completely knowing that the information is true;
• Knowingly buying government property from an unauthorized officer of the government, and;
• Knowingly making, using, or causing to be made or used a false record to avoid, or decrease an obligation to pay or transmit property to the government.

The most frequent claims involve situations where someone overcharged the federal government for goods or services. Other typical claims involve failure to test a product as required by government specifications or selling defective products.

Certain claims are not actionable, including: (a) certain actions against armed forces members, members of Congress, members of the judiciary, or senior executive branch officials; and (b) claims, records, or statements made under the Internal Revenue Code including tax fraud.

There are rather unique procedural requirements in False Claims Act cases. For example: (i) complaints under the False Claims Act must be filed under seal; (ii) complaints must be served on the government but must not be served on the defendant; and (iii) complaints must be supported by a detailed memorandum, not be filed in court, but be served on the government detailing the factual support for the complaint.

If you are a contractor dealing with the federal government, you need to be very careful when delivering or billing for services or products to avoid inadvertently violating the Federal Claims Act.    If you would like to know more about the Federal Claims Act please call or email me at 937-223-1130 or Jsenney@pselaw.com.

AND ONE MORE THING. Under the federal income tax code, “S” corporations are not permitted to be owned by corporate shareholders. So “S” corporations cannot be part of a parent-subsidiary consolidated group of corporations. One way around this limitation is to use qualified “S” subsidiaries commonly referred to as “QSSS”. Call or email me if you have a question about QSSS. Jsenney@pselaw.com or 937-223-1130.

Sunsetting Tax Provisions: What to Do?

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Congress is headed towards a battle over sunsetting tax rules, already expired tax breaks, and soon-to-expire tax breaks.  It appears that this fight won’t end until late this year. A reasonable alternative would be for Congress to give itself some time to work out a comprehensive tax reform plan by deferring the expiring tax provisions for another year. But in today's partisan political environment, a reasonable, albeit temporary, solution may not prevail. It therefore seems wise to consider and plan for both the best and worst scenarios, so you are ready to make a move when the legislative picture becomes clearer.

Below is a summary of some of the more important sunsetting tax law changes that you should consider.  You should discuss these items with your tax advisor and get prepared.

Tax rates will go up for most everyone.  The 10% bracket will disappear.  The lowest bracket will be 15%.  The top four brackets will rise from 25%, 28%, 33% and 35%  to  28%, 31%, 36% and 39.6%.
Long-term capital gain will be taxed at a maximum rate of 20% (18% for assets held more than five years).  Dividends paid to individuals will be no longer qualify for capital gain treatment and will be taxed at the same rates that apply to ordinary income.

The exclusion for employer-provided educational assistance will end after 2012.  The deduction for student loan interest will phase out over lower modified adjusted gross income (AGI) ranges and will only apply to interest paid during the first 60 months.

The standard deduction will be lower.  Most itemized deductions of higher-income taxpayers will be reduced by 3% of AGI above an inflation-adjusted figure.   Higher-income taxpayer's personal exemptions will be phased out when AGI exceeds an inflation-adjusted threshold.

The accumulated earnings tax rate and the personal holding company tax rate will rise from 15% to 39.6%.
The estate tax rules will change dramatically.  The top rate will be 55%.  A 5% surtax on the wealthiest of estates will phase out the benefit of graduated rates.  The unified credit exemption equivalent will be only $1 million, but the family-owned business deduction will be reinstated.  The generation skipping tax will be reinstated, with a top rate of 55% and a GST exemption amount of $1 million.  The gift tax rate will also increase to 55%.

If you would like to discuss any of the sunsetting tax law provisions, please give me a call or email 937-223-1130 or jsenney@pselaw.com.

AND ONE MORE THING. Thinking about selling your business? Do you know how to determine the value of your business? Are you getting paid cash at closing or over time in installments? Are you selling stock or assets? Is the buyer requiring you to make a 338 election?  Is the buyer assuming any liabilities? Are you staying on as an employee or consultant to help transition the business? Is the buyer keeping your employees? Do you know what the tax consequences of the sale will be? There are a lot of things to consider when selling a business. Call or email me if you want to talk about it. Jsenney@pselaw.com or 937-223-1130.

Filing an Affidavit of Non-Ohio Residency

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In a recent Blog I listed numerous steps that a current Ohio resident should take if they want to become a resident of Florida (or some state other than Ohio) for tax purposes.  As pointed out in that Blog, the primary consideration is the length of time you spend in Florida versus Ohio.   But there are many other factors to consider.  To view all the relevant factors, check out my prior Blog post here.

Not discussed my prior Blog was the Affidavit of Non-Ohio Residency.  Under Ohio law, you can create an irrebutable presumption of being a non-Ohio resident if you satisfy the following 5 requirements: (1) during the entire year you had at least one abode outside Ohio; (2) during the year you spent no more that 182 "contact days" in Ohio; (3) you were not a part-year resident of Ohio; (4) by June 1st of the prior year you file an Affidavit of Non-Ohio Residency; and (5) the Affidavit of Non-Ohio Residency does not contain any false statements.

If you can't satisfy all of the above requirements, there is no reason to file the Affidavit (or take the position you are not an Ohio resident).  Even if you do satisfy all the requirements, you may choose not to file the Affidavit.  Filing the Affidavit may act like a red-flag and invite unwanted audit attention.  In addition, filing the Affidavit of Non-Ohio Residency has certain non-tax ramifications.   Other state agencies such as the Ohio Board of Regents, the Ohio Bureau of Motor Vehicles, and the Ohio Elections Division will likely not recognize you as a resident of Ohio.

On the other hand, Florida has an Affidavit of Residency that can be signed and filed with the Florida County Recorder's Office to help establish you as a Florida resident.  More about that in a future Blog.
AND ONE MORE THING.   On July 3, 2012, significant revisions to Ohio’s Consumer Sales Practices Act took effect.  For years, Ohio’s Consumer Sales Practices Act has proved to be both a trap for the unwary and a sword for consumers.  Among the attention getting provisions of the Act were the potential for suppliers to be liable for three times a consumer’s damages and their reasonable attorney fees, a rather unique remedy in Ohio.  However, on July 3, 2012, Ohio entered an era where it becomes one of a growing number of states that provides an opportunity for a supplier to “cure” any claimed violation.  If you are interested in learning more about how to cure a claimed violation of the Consumer Sales Practice Act, see Michael Sander's article at www.pselaw.com or contact Michael at at 937-223-1130 or MSander@pselaw.com.

Severance Payments Not Subject to FICA

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The Court of Appeals for the Sixth Circuit, has recently held in US v. Quality Stores Inc. that severance payments are not subject to FICA taxes.  Accordingly, it allowed a refund of over $1 million in employer and employee FICA taxes paid on the severance payments.   The Sixth Circuit determined that the severance payments at issue qualified as supplemental unemployment compensation benefits under Code Sec. 3402(o) and were not taxable wages for income tax purposes.

Downsizing is rather common in today’s business environment and often results in severance payments to terminated workers. The Court’s decision gives companies who made such payments to terminated workers, and the workers themselves, an opportunity to recover FICA taxes paid on the severance payments.   Future severance payments also may escape FICA taxes under the authority of this Court case.  Employers and terminated employees in the Sixth Circuit, which includes Ohio, Michigan, Kentucky and Tennessee, should carefully consider filing a refund claim.

Some caution is advised however.  The Federal Circuit has reached a contrary result on similar facts.  In view of these conflicting decisions and given the potential amount of revenue involved, the IRS may well appeal the current Court case to the Supreme Court.

If you paid FICA tax with respect to severance payments to terminated employees in the last few years, and you are interested in filing for a refund or finding out more about the court case, please call or email me at 937-223-1130 or jsenney@pselaw.com.

AND ONE MORE THING.  The Small Business Jobs Act of 2010 removed cell phones from the list of items for which detailed substantiation record keeping was required.   To provide guidance concerning how to handle reimbursements and stipends paid to employees who use cellphones, the IRS released Notice 2011-72.   The Notice states that when an employer provides an employee with a cell phone primarily for non-compensatory business reasons, the business and personal use of the cell phone is generally nontaxable to the employee.  And the IRS will not require the employee to maintain detailed records of business use in order to receive this tax-free treatment.    Please call or email me at 937-223-1130 or jsenney@pselaw.com with any questions.

Want to Be a Florida Resident?

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Some of my older and not-so-old clients have asked about what is required to become a Florida resident for tax purposes.   While there are many relevant factors that determine where someone resides for tax purposes, the most important factor is where you spend most of your time.   Generally, a person is considered as resident of whichever state he or she spends more than half the year.
But many people travel on business and pleasure and may not spend half the year in any one place.  In these situations, the state of residency is determined by looking at where you spend the most time and by examining other factors.  To support your Florida residency you and your spouse should do the following:

1.  Complete and file a Florida Residency Declaration.

2.  Apply for a Florida driver’s license.

3.  Register to vote in Florida.

4.  Become a member of a church in Florida.

5.  Join the Rotary club, Lions Club, Elks club or similar organization in Florida

6.  Join a gym or YMCA or golf club in Florida.

7.  Get a library card from the local Florida library.

8.  Get a land line phone for your Florida house.

9.  Get a new cellphone with a Florida area code number

10.  Register your cars in Florida and get Florida license plates

11.  Change the billing address on all your credit cards to your Florida address

12.  Establish personal banks account in Florida

13.  If you are operating a Florida management company or other business that will provide services to a non-Florida operating company, set up a Florida bank account for the Florida management company.

14.  Set-up a website for the Florida management company and advertise it as providing sales and management consulting services.

15.  Do small Yellow Pages ad for the Florida management company and its business.

16.  Get some Florida management company business cards and stationary printed up.

17.  Develop a relationship with a Florida doctor and dentist

18.  Use credit cards to pay for everything so you have a record of all the days you are in Florida

19.  Consider having someone house sit your non-Florida house while you are in Florida (this is actually a good idea just for protection of the property, but it also makes it more credible that the non-Florida house is your vacation house and the Florida house is your principal residence).

20.   Consider putting the non-Florida house in a trust or family LLC to get it out of your name (this would negate the principal residence gain exclusion on sale of this house so need to think about this one).

Give me a cal if you are interested in moving to Florida and becoming a Florida resident.  We can help you with any questions you may have about the process.

AND ONE MORE THING.    It is that time of year when we need to be thinking about taxes.  Deferring income to next year or accelerating expenses to this year obviously reduces your taxes this year.  But depending on what happens in the upcoming election, you may end up paying tax at a higher tax rate in future years.  Year-end tax planning doesn't occur in a vacuum, and has to take account of your particular situation and goals.  Let me know if you have any questions on year-end tax planning in general or any particular issues.  Jsenney@pselaw.com or 937-223-1130.

New 3.8% Medicare Tax Starting in 2013

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Starting in 2013, the Health Care and Education Reconciliation Act of 2010 will subject some taxpayers to a 3.8% tax on unearned income. This new Medicare tax will apply to single taxpayers with modified adjusted gross income (MAGI) over $200,000 and married taxpayers who file jointly with a MAGI over $250,000.  Married taxpayers who file separately will be subject to the tax if they have MAGI over $125,000. This new tax clearly targets wealthier taxpayers and  was added by Congress as a way to raise revenue to pay for the health care reform package.

For most taxpayers, MAGI will be equal to their adjusted gross income.   The new tax will be equal to 3.8% of the lesser of net investment income or the amount by which MAGI exceeds the threshold amount ($200,000 in the case of a single taxpayer).

Net investment income includes interest, dividends, annuities, royalties, rents, and income from other passive activities.  Net investment income does not include distributions from qualified retirement plans or IRAs, or tax-exempt interest.  But net gain attributable to the disposition of property, other than property held in an active trade or business, is subject to this tax.  Gains from trading in financial instruments or commodities are included, as is the taxable gain on the sale of a personal residence in excess of the personal residence exclusion amount.

Estates and trusts can be subject to this tax.  The tax will not apply to nonresident aliens or a trust in which all of the unexpired interests are devoted to charitable purposes.  The tax also does not apply to a trust that is exempt from tax under section 501 or a charitable remainder trust.

This tax on net investment income is not deductible when computing other federal taxes.   Taxpayers are required to make estimated tax payments with regard to this tax.

Now may be a good time for taxpayers to analyze their investment portfolios and start cashing in on any year-end gains, thereby limiting the amount of MAGI subject to the 3.8% tax in 2013.   Since the “wash sale rules” do not apply to gains, selling an appreciated security at year-end and then repurchasing it after year-end may make sense.

Any mechanism that reduces MAGI in 2013 and after is worth looking at.  Taxpayers may want to avoid buying securities that generate dividends, and instead consider investments that will create long term capital gain.  Taxpayers may also want to consider investments in tax-exempt securities.  Taxpayers should consider after-tax IRA investments versus annuities because income from an IRA is not subject to this tax.   And maximizing the amount of investments in any qualified plan or IRA should be considered as an alternative to other investments, since distributions from a qualified plan or IRA will not be subject to the tax.

Taxpayers should also buying life insurance products. The cash surrender value which builds up inside a life insurance policy  is not subject to the new tax, or are the proceeds payable on death.

In the case of a trade or business, the tax only applies if the trade or business is a passive activity.   Under current regulations, investors in a trade or business can avoid the new Medicare tax on their pass-through income if they are active (not passive) investors.  While the pass-through income of a sole proprietorship or partnership is always subject to self-employment tax, pass-through income of an S corporation is not.  So taxpayers should consider operating their active businesses in the form of an S corporation.  This way, the taxpayers avoid the new Medicare tax because they are operating an active business, yet they also avoid self-employment tax (that would apply if the business were taxed as a sole proprietorship or partnership).
If you have any questions concerning the new Medicare 3.8% tax, please give me a call.  Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING. Minority interests in a closely-held company are worth less that controlling interests in the same company because minority interests lack the ability to control company decisions. Interests in a closely-held company are also worth less than comparable interests in a publicly-traded company because there is no stock exchange or other ready market for sale of closely-held stock.  It is important for the owners of a business to consider and agree on how interests in the company are to be valued now and in the future for estate planning, succession planning and other reasons.   Call if you have any questions about how to value interests in your company.  Jsenney@pselaw.com or 937-223-1130.

How Do I Protect My Business Name?

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If you use a name for your business other than your personal name, you want to register the name in the state or states where you do business so that other businesses can't use your name. Going through the  registration process also keeps you from using a business name that someone else already uses.  In Ohio and some states, registration of a trade name is done with the Secretary of State’s office.  In other states, the registration is done at the county level.

A corporation does not have to separately register its name in the state where the corporation is incorporated.  The same is true for an LLC.  But a corporation or an LLC should register its trade name in other states where it does business.  Sole proprietorships and partnerships are not incorporated anywhere, so generally the owners of a sole proprietorship or a partnership will want to register their business name everywhere they do business.

Before you select a name for your product or business, you should conduct a name search.  You should do an internet search on Google and Yahoo, and a search with the state registries where you intend to do business now or in the future.  You should also do a search of the federal register of trade and service marks at www.uspto.gov.  There is a cost involved in doing these state and federal registrations.  But it can be far more costly in terms of time, money and lost opportunity if you have to change the name of your business or product because you used someone else's name.

If you are using a trademark, be sure to state on your packaging and advertising materials that you own the mark.  If you have federally registered the mark, use an “R” with a circle around it to indicate this.  If you have registered the mark with the state or not at all, use the letters “TM” for trademark or “SM” for service mark to indicate your ownership of the mark.  And make sure you enforce your rights by notifying other businesses in writing if they improperly use or infringe on your mark.

A state trademark registration can be done in a few weeks and creates a presumption of use throughout the state.  The state registration may also entitle you to attorney fees upon infringement.  A federal registration can take 18 months or more, but results in a presumption of use throughout the US.  A Federal registration can give the owner the right to collect statutory damages and attorney fees.

Your business name can be the most valuable asset you business owns.  Protect it.  If you are interested in finding out how to register or otherwise protect your tradename or trademark, give me a call.

AND ONE MORE THING.   We all face the prospect of a darker tax climate in 2013 for investment income and gains. Under current law, higher-income taxpayers face a 3.8% surtax on their investment income and gains under changes made by the Affordable  Care Act.  In addition, if the "Bush tax cuts" are allowed to lapse, all taxpayers will face higher taxes on investment income and gains, and the vast majority of taxpayers also will face higher rates on their ordinary income. If you have any questions about how the Affordable Care Act or your personal tax planning give me a call.   Jsenney@pselaw.com or 937-223-1130.

Captive Insurance Companies

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Tired of paying so much federal and state income tax?  Looking for tax deductions?  Tired of spending so much money on property casualty insurance?  Wish you could save more money for future expansion or to create a rainy-day fund?  For some businesses, setting up a captive insurance company may be the answer.
Setting up a captive insurance company which complies with IRC section 831(b) has several advantages.  The premiums paid to the captive are deductible by the operating company, but are not treated as income by the captive.  The captive pays tax only on the investment income it generates.  The operating company would still likely maintain some reinsurance to cover catastrophic loss, but the cost of insurance paid to third parties is reduced.   And setting up a captive creates a pool of assets that are protected from the operating company's creditors.

Generally speaking, the annual operating cost for a captive ranges from $50,000 to $75,000 which includes underwriting, policy writing, financial reports, bookkeeping, audit fees, actuary review and risk pool fees (if the captive is not a stand-alone).    The amount of the annual premium that is paid to the captive is generally in the $500,000 to $1,000,000 range.   The maximum annual premium permitted is $1,200,000.
If you are interested in finding out more about captive insurance companies, please give me a call or email.  Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING. In an effort to create jobs in  Ohio, the legislature enacted a new "InvestOhio" Tax Credit to reward investments in an eligible small business.   Under the new law, a non-refundable 10% tax credit is available for any qualifying “cash for equity” investment in a small business up to $1 million per eligible investor ($2 million for spouses filing jointly).  An eligible investor is an individual, estate or trust subject to  Ohio personal income tax.   The Director of Development is authorized to award up to $100 million in tax credits during the current State of Ohio fiscal biennium, which ends on June 30, 2013.  If you have any questions about how to apply for the InvestOhio tax credit give me a call.Jsenney@pselaw.com or 937-223-1130.

Squeeze-Out Merger - LLC

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A squeeze-out merger is a device used to eliminate unwanted minority owners.  Under the Ohio statute (and the statute of many states), mergers of limited liability companies must by all of the managers or all of the members unless the Operating Agreement provides for a different number or percentage.   Many LLC Operating Agreements contain language that permits a majority or super-majority of the managers or members to make decisions affecting the LLC.  If this is the case, one or more managers or members holding the required majority or super-majority can eliminate minority owners.

The squeeze-out works as follows: (1) the controlling owners create a new LLC owned only by them; (2) the old LLC is merged with and into the new LLC; (3) the merger agreement provides that the controlling owners are the only owners of the surviving LLC; and (4) the minority owner is paid fair cash value for his or her LLC ownership units.

If the squeeze-out merger is properly done, the minority owners only recourse is to argue that the compensation they received in exchange for their ownership interests was not fair cash value.   The minority owners are unable to prevent the merger.

A squeeze-out merger can be a powerful tool for controlling owners to remove disruptive minority owners.  But a squeeze-out merger can also be a heavy-handed way for greedy control owners to eliminate minority owners when the LLC is starting to generate cash and build value.

To protect yourself, you need to read and understand what the Operating Agreement says.  If you want to talk about squeeze-out mergers or would like some help reviewing or drafting appropriate Operating Agreement language give me   a call.  Jsenney@pselaw.com or937-223-1130.

 
AND ONE MORE THING. If you or a friend have invented a new product, or have improved an existing product, you need to be careful to preserve your rights as to such invention or improvement. To protect your rights, you can seek a provisional patent or a full utility patent. But you must make an application within one year after the first public disclosure of the invention.  A public disclosure is any disclosure of information about the invention that is made without restriction on the recipient’s right to disseminate such information. To avoid making a public disclosure, it is important to have every person or entity that will receive information about such invention sign a non-disclosure agreement. Call or email me if you need a non-disclosure agreement drafted.   Jsenney@pselaw.com or 937-223-1130

Security Law Concerns When Raising Money for a Business Opportunity

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Starting or growing a business takes money.  Sometimes a lot of money.  Often more than the business owner has access to.  There are many ways to raise money for a business.  You can borrow money from friends and family.   Or you can ask friends and family to invest and become partners.   You can ask suppliers or even competitors to lend money or become a partner in your new venture.   Or you can seek out angel investors who find your project interesting.  You can borrow money or you can sell stock or LLC ownership interests.  In each of these situations, federal and state security issues arise.

As a general rule, security offerings must be registered with the Securities Exchange Commission and the various state security agencies unless otherwise exempt.  There are a number of exemptions that might apply in a particular situation.  At the federal level, the most common exemptions are the intrastate exemption (only offer to residents of a single state), sales only to accredited investors (persons of high net worth and/or income) and other Regulation D offerings.   Regulation D offerings are offerings to accredited investors and up to 35 non-accredited investors where certain disclosures concerning the business, the business owners, the securities being offered, and the risks and rewards of the securities are made to investors.

At the state level, offerings are often exempt when less than a specified number of persons in the state acquire the security.  For example, in Ohio sales to 10 or fewer persons in a rolling 12 month period are exempt.  Most states also have exemptions that parrot the Regulation D exemptions.

When doing a Regulation D offering, there can be no general solicitation.  A Form D is prepared and sent to the SEC.  The state security agencies where the investors reside are notified of the offering.  Investors are provided with an offering circular, a subscription agreement and an investor statement.  The offering circular describes the risk and rewards of the offering, and can be used to defend the issuer from claims by investors that the issuer misled them with false information.  The investor statement requires the investor to state where he or she resides and whether he or she is an accredited investor.  The subscription agreement requires the investor to specify exactly how much he or she will invest in the securities.

If you are trying to raise money to start a business or expand an existing business, we can help you avoid running afoul of the federal and state security laws.  Committing security fraud can subject the issuer to treble damages and possible civil and criminal actions.  Please call or email us with any questions or comments at 937-223-1130 or jsenney@pselaw.com.

AND ONE MORE THING.  The State of Ohio like many states is trying to raise revenue.  The state has engaged many private attorneys and collection firms to track down unpaid tax assessments.  Many of the assessments they are trying to collect are 20 to 30 years old.  The tax returns, cancelled checks and other information taxpayers would use to defend against these assessments has often been discarded.  If you receive a notice from a tax collector seeking to collect an unpaid tax assessment, give us a call or email at 937-223-1130 or jsenney@pselaw.com.

2013 Flexible Spending Account Limits

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The Affordable Care Act (sometimes called Obamacare) imposes a new limit on the annual salary reduction contributions that employees may make to a health care flexible spending account.  The new limit is $2,500 per year and starts January 1, 2013.

The limit applies only to the amount the employee contributes.  It does not limit the amount the employer may contribute on behalf of the employee.  The limit applies on per participant basis.  So if husband and wife are both employed, each can contribute $2,500.

Employer's that sponsor cafeteria plans with flexible spending accounts will need to amend their plans to incorporate the new contribution limits.  But this is not the only change imposed by the Affordable Care Act.  More on other aspects of the new law will be included in an upcoming blog.

Please call or email if you have any questions about the Affordable Care Act, the new FSA contribution limits or how to amend your cafeteria plan at Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING:   Over the last few years, banks mortgage companies were very aggressive in collecting mortgage loans and foreclosing on residential properties.  When a property is foreclosed on, or a deed is given in lieu of foreclosure, the bank will forgive the unpaid balance of the loan.  The amount forgiven is reported to the IRS on IRS Form 1099-C and is generally treated as taxable income.  However, for debt forgiveness that occurs prior to January 1, 2013, forgiveness of qualified principal residence debt is not taxable.  Call if you want to know more about this qualified principal residence debt exclusion or any other tax matter.  Jsenney@pselaw.com or 937-223-1130.

Do I Need an Employee Handbook for My Business?

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If you have more than 3 or 4 employees or more, you should seriously consider adopting an employee handbook.  An employee handbook can be an effective mechanism for setting the culture of your business and limiting your liability exposure. 

An employee handbook offers you the opportunity to answer common employee questions and address issues before they arise.  Your employee handbook can be used by managers and supervisors as a reference book so they act in a consistent and reasonable manner when dealing with employee issues.  Your employee handbook can also contain a code of ethics for employee behavior, while setting forth job performance expectations and award requirements.  And, not to be forgotten, your employee handbook can be used as a tool to remind your employees of all the compensation and benefits they enjoy as a result of their employment with your company.

There are certain things that should be in all employee handbooks.  At a minimum your employee handbook should generally explain to employees your policies and procedures governing “at will” employment, normal work hours, overtime pay, sexual harassment and non-discrimination policy, alcohol and drug policy, maternity leave, dress code, and use of computers, email, social media and internet for personal matters.

You should avoid putting legalese and references to statutes and code sections in your employee handbook.  The employees often won’t understand what these references mean, and you can set a trap for yourself.  For example, the Family and Medical Leave Act (“FMLA”) allows eligible employees to take up to 12 weeks off work during a 12 month period when the employee or a family member has a serious health condition, gives birth, adopts a child, or has any qualifying emergency related to the military.  But FMLA does not apply to your business unless you employ 50 or more employees within a 75 mile radius.  So if your employee handbook says you comply with FMLA, you can be compelled to comply even if you otherwise would not be required to. 

Before creating an employee handbook it is wise to seek advice from a qualified employment law attorney.  We can help you if you want to create or review an employee handbook.  Please call or email if we can assist you in any way with your employee handbook  at  Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING.     Social media enables people to communicate via the internet to share resources.    The National Labor Relations Board has issued a report regarding the protected nature of employees' Facebook, Twitter and YouTube postings. This report is a guide not only for Union employers, but also non-Union employers.  Attorney Matt Stokely of PS&E has reviewed and written an article summarizing the NLRB Report.   Give him a call at 937-223-1130 to discuss any questions you have about the NLRB Report or would like a copy of Matt's article.

How Do I Fire a Problem Worker?

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Ohio is an “employment at-will” state.  That means in Ohio you can generally fire anyone, at any time, with or without a reason.  But there are some situations that are not within the scope of the employment at-will doctrine or that require special handling.

If you have executed an employment agreement with the employee, and such agreement provides for a specified term of employment, then firing the employee prior to the end of the term would be breach of contract and subject you to damages.  If you have a union workforce and you are firing a union worker, you will need to comply with the firing procedures set forth in the collective bargaining agreement or risk having the union bring labor relations charges against you.

If the employee you are terminating is over 40, disabled, a female or a minority, you may find that the terminated employee makes claims of wrongful discharge based on age, disability, race or sex discrimination.  To defeat such claims you need to properly document the "non-prohibited" reason you are firing the employee.

When terminating an employee, it is best to have a system and to follow the system. You should have regular reviews where the employee’s performance and problems are evaluated and addressed.  If an employee is tardy, or absent, or fails to follow instructions, or is insubordinate, or is simply incompetent, you need to document such matters when they occur.  The employee should be given a “pink slip” and such slips should become part of the employee’s personnel file.  The employee personnel files should be kept under lock and key so employees can’t remove evaluations and reprimands from their file.

Please call or email if you have any questions about how to terminate a problem employee.

AND ONE MORE THING.     Thinking about selling your business?  Do you know how to determine the value of your business?  Are you getting paid cash at closing or in installments? Are you selling stock or assets?  Is the buyer assuming any liabilities?   Are you staying on as an employee or consultant to help transition the business?  Is the buyer keeping your employees?  Do you know what the tax consequences of the sale will be?  There are a lot of things to consider when selling a business.  Call or email me if you want to talk about it.  Jsenney@pselaw.com or 937-223-1130.

Is there Any Relief Available if I Misclassified Workers?

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Surprisingly, the answer is often “yes.”  Section 530 of the Revenue Act of 1978 generally allows a business to treat a worker as an independent contractor for employment tax purposes regardless of whether the worker would otherwise be treated as an employee under the IRS 20 factor test, so long as the business has a “reasonable basis” for so treating the worker and certain other requirements are met.  The relief provided by Section 530 was originally scheduled to expire in 1979, but was extended permanently.

Under Section 530, a reasonable basis for treating a worker as an independent contractor is considered to exist if the business relied on:  (1) published rulings or case law; (2) long-standing practice in the industry; (3) past IRS audit results for the business; or (4) some other reasonable basis.  The legislative history to Section 530 provides that it is to be liberally construed in favor of the business.

Section 530 relief does not apply if the worker or any other person doing similar work has been treated by the business as an employee at any time (after 1977) in the past.  Section 530 also does not apply if the worker is a "leased employee" and provides services for another person, as an engineer, designer, drafter, programmer, analyst or similar skilled worker.   There are additional very specific situations, such as workers who serve as school room supervisors or test proctors, where Section 530 does not apply.

Proper classification of workers is important. But if the IRS determines you have misclassified a worker as an independent contractor, and the worker would be an employee under the IRS 20 factor test, you might be able to use Section 530 to avoid reclassifying the worker, and avoid the tax, penalties and interest the IRS attempts to impose.  Please call or email me to discuss any issues you may have with proper worker classification at  Jsenney@pselaw.com or 937-223-1130.    

AND ONE MORE THING.  The Department of Homeland Security recently announced that certain young people who were brought to the United States as young children, do not present a risk to national security or public safety, and meet several key criteria will be considered for relief from removal from the country or from entering into removal proceedings. Those who demonstrate that they meet the criteria will be eligible to receive "deferred action" for a period of two years, subject to renewal, and will be eligible to apply for work authorization.  If you know someone who might be eligible for deferred action, or want more information about the deferred action program, please have them call (937-223-1130) or email me (jsenney@pselaw.com) or Shahrzad Allen (sallen@pselaw.com).

Should My Workers be Employees or Independent Contractors?

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Treating a worker as an employee typically costs the employer more than treating the worker as an independent contractor.  If a worker is properly characterized as an employee, the employer will be required to pay the employer-portion of the social security and medicare taxes, withhold the employee-portion of social security and medicare taxes, pay unemployment tax, pay workers compensation premiums, pay the employer-portion of any pension or profit-sharing plan contributions, health plan contributions and other employee fringe benefit programs, provide vacation, sick days and maternity leave for the worker, and otherwise permit the worker to participate in all employer-sponsored employee benefit and welfare programs.

On the other hand, if the worker is properly characterized as an independent contractor, the employer is not required to provide any of the above benefits, or pay or withhold any of the above taxes.  The employer is simply required to provide the worker with whatever payments are specified in the independent contractor agreement, and the worker is responsible for paying the appropriate income tax, self-employment tax, workers compensation and other taxes related to such payments.

The IRS looks closely at how employers characterize their workers.  The IRS has a 20 factor test it applies to evaluate whether a particular worker, or group of workers, should be treated as an employee or independent contractor.  Although the IRS test includes 20 factors, theses 20 factors can be summarized into 2 main points of inquiry.  These points of inquiry are: (1) does the employer have the right to control the details of how the worker does his or her job or only evaluate the final product or performance; and (2) does the worker have a real risk of loss.  If the employer has the right to tell the worker how to do his or her job, when to do it, where to do it, when and where not to do it, the worker looks more like an employee.   On the other hand, if the employee is free to do the job when he or she wants to, using whatever procedures or methods he or she wants to, wherever he or she wants to do the job, using assistants or sub-contractors, and the employer controls only the evaluation of the final product or job performance, then the worker is more like an independent contractor.

If the worker is reimbursed for expenses, paid a salary or an hourly wage and is provided a car or tools necessary to do the job, the worker has little risk of loss on the job and looks more like an employee.  To the contrary, if the worker is not reimbursed for expenses, is paid a specified sum for the job and is required to provide his or her own shop or office, transportation and tools, the worker looks more like an independent contractor who runs his or her own business.

Proper classification of workers is important.  If one or more of the workers treated as an independent contractor fails to properly pay income and self-employment tax, and the IRS determines (in its opinion) the worker should have been treated as an employee, the IRS will go after the employer to collect unpaid employee income tax withholding, and both employer and employee social security and medicare taxes.  If this happens, there are some defenses.  The first line of defense is that the IRS is wrong and the worker is properly treated as an independent contractor.  If this does not work, there is a second line of defense based on Section 530.  Section 530 is a piece of legislation that permits the employer to continue treating misclassified workers as independent contractors if certain conditions are met.  More about section 530 in the next Blog posting.   Please call or email if you have any questions about proper classification of your workers.   Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING.  Under a Notice issued by the IRS in 2010, if the estate of a deceased spouse fails to use all of his or her federal estate tax exemption, the surviving spouse may inherit the unused portion.  But to obtain this benefit, the estate of the deceased spouse is required to file an estate tax return, even if no return would otherwise be required.  Earlier this year, the IRS announced an automatic extension of time for smaller estates to make an election to transfer the unused estate tax exemption to the surviving spouse.  This automatic extension applies to estates of married individuals with assets of $5,000,000 or less, but only if the deceased spouse died in the first 6 months of 2011, and the executor requests the extension no later than 15 months after the date of death.  Call or email if you have any questions about taking advantage of this extension.