Bangerter, Lund and Associates - Certified Public Accountants - Certified Public Accountants

August 2010 Newsletter

Bangerter, Lund & Associates, Inc.

As the Summer vacation draws to a close, we would like to take this opportunity to let you know what new tax rules are being considered by Congress and which ones have taken effect.  Items which affect Individual taxpayers are listed below.  Business owners, please be sure to also review your information which appears after the Individual information.

INDIVIDUALS

Income Tax Rates

Long range tax planning for individuals under current federal law remains difficult.  In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA).  The law addressed both estate and income tax rates, keeping them relatively steady through 2009, making 2010 a transition year and making them less favorable for 2011 and beyond.

Unless Congress makes changes in the law, the President Bush cuts of 2001 and 2003 will expire and our current rates will increase.  As the drumbeat for tax reform is increasing and the Bush tax cuts are likely to be extended for a brief period, talk of revamping the tax code to provide a more permanent solution is growing.  Even though the Obama Administration has proposed rates for 2011 which closely resemble our current rates, one bipartisan proposal bears watching: Senators Wyden (D-OR) and Gregg (R-NH) are pushing to reduce our current six tax brackets down to only three brackets.  The rates for singles would be half of those for couples.  While the brackets would continue to be indexed for inflation, the adjustments would be lower than now.

The chart below shows examples and differences of many proposed changes – only Married Filing Joint (MFJ) income amounts are shown:

* Projection of income limits provided by FiveCentNickle.com

** Projection provided by Tax Policy Center

*** Projection of income limits provided by MoneyBlueBook.com

If the Bush tax cuts are allowed to expire, other changes would include a 50% decrease in Child Tax Credit; the standard deduction for married couples will no longer be twice the single taxpayer amount, thereby restoring the “marriage penalty”; and the expense limit used in calculating the Dependent Care Tax Credit would be reduced by $600, among many others.

We will watch the Congress proceedings closely and notify you of any updates in our monthly newsletters.

Retirement Plan Distributions

Your retirement plans and IRAs may be among the largest, if not the largest, assets that you have.  Therefore, one of the most important planning areas for you is taking distributions from your IRAs and qualified retirement plans.  Understanding the basic tax rules and then planning your distributions to meet your personal financial and estate planning objectives is essential.  We can explain those rules and provide some strategies for you to consider as part of your overall tax plan.

Some taxpayers may consider early retirement as a viable option.  However, generally, a distribution made before you are 59-1/2 years of age is subject to a 10% penalty in addition to the tax otherwise payable on the distribution.  There are some exceptions.  The penalty may not apply for certain hardship cases, for first-time homebuyers, or to pay certain medical or education expenses.  Many distributions may be received tax free if they are transferred to an IRA or another eligible plan within 60 days of the distribution.

Though there is a penalty for premature distributions, there is also a penalty for failure to commence distributions by a certain age.  Minimum distribution rules are imposed to prevent participants from unreasonably deferring the tax on their retirement savings.  Under these rules, distributions are required to begin, for a participant other than a 5-percent owner, no later than April 1 of the calendar following the later of:

1. The calendar year in which the participant reaches age 70-1/2, or
2. The calendar year in which the participant retires.

The minimum distribution rules do not apply to Roth IRAs, but do apply to traditional IRAs, deferred compensation plans, tax-sheltered annuities, and qualified retirement plans.

BUSINESSES 

Independent Contractor vs. Employee 

Currently, the likelihood of your business being involved in a worker classification or employment tax audit is increased because the IRS is aggressively attempting to reduce the "tax gap," which is the annual shortfall between taxes owed and taxes paid. Employment tax noncompliance is estimated by the IRS to account for approximately $54 billion of the tax gap. Under-reporting of FICA makes up $14 billion; under-reporting of self-employment tax accounts for $39 billion; and under-reporting of unemployment tax accounts for $1 billion in lost revenue.

As a result of the Questionable Employment Tax Practice (QETP) initiative, in 2007 the IRS entered into agreements with workforce agencies in 29 states to share the results of employment tax examinations. These agreements provide a centralized, uniform means for the IRS and state employment officials to encourage compliance with federal and state employment tax requirements. In addition, for the 2008 through 2010 tax years, the IRS plans to examine 6000 randomly selected employers' Forms 941, Employer's Quarterly Federal Tax Return, as part of the National Research Program (NRP).

Because the existing worker classification rules are complex and ambiguous, much uncertainty surrounds their interpretation and application. The lack of a single, definitive test for classifying workers as either employees or independent contractors contributes significantly to the worker classification problem.

Therefore, understanding the difference between an employee and an independent contractor is very important. If you are an employer, you are required to withhold and contribute a matching amount of FICA and Medicare taxes from your employee's income. However, if your workers are independent contractors, you are only required to report payments of $600 or more on a Form 1099-MISC (Miscellaneous Income). Failing to make the right classification could cost you money.

If you have workers who make substantial financial investments in tools, equipment, or a place to work, or undertake some entrepreneurial risks, they are probably independent contractors. However, when you control and direct the workers who perform services for you as to the end result and how it will be accomplished, you are probably involved in an employer-employee relationship.

Unless there is a reasonable basis for treating your employees as independent contractors, failing to withhold income and employment taxes from their wages can result in severe penalties and interest, in addition to the back taxes owed. Of course, penalties for intentional worker misclassifications are harsher than they are for inadvertent mistakes.

Your benefit plan may also be in jeopardy if any eligible employees have been misclassified as independent contractors. Since these employees have been excluded from plan participation, your retirement plan may lose its tax-favored status. The problem is compounded when excluded employees seek restitution for lost benefits not only due to their exclusion from the benefit plan, but also for health coverage and other employee benefits.

Since the potential liability is considerable, we feel that it would be beneficial for you to verify that your workers are properly classified. It is also important that your employment tax records are in compliance with IRS guidelines, especially in the event of an audit.

Travel and Entertainment Review 

Although the computer age and modern telecommunications have reduced the need for in-person contact, it is still sometimes necessary for businesses to send employees out of town on business, or to entertain clients and customers. How travel and entertainment expenses are handled can have an impact on your net income, your paperwork burden, and on the tax results for you and your employees.

If you require employees to substantiate travel or entertainment expenses that are bona-fide business deductions, partial or complete advances or reimbursements are not treated as compensation income to the employee, and the advance or reimbursement is not subject to social security taxes or to income tax withholding. However, only 50 percent of any business-related meal or entertainment expense is deductible by the company, including costs of meals consumed by employees while they are traveling.

To ensure that the reimbursement is not subject to payroll and withholding taxes, the business must maintain a fairly detailed recordkeeping system. For travel, employees must submit a written statement of the time, place, destination and business purpose of the trip and the amount of expenses incurred by category (e.g., travel, meals, lodging). For meals or entertainment, the employee must submit a written statement showing time, place and cost of the event, who was entertained, and the business purpose of the meal or entertainment (if the event follows or precedes a business discussion, additional recordkeeping is required). Finally, the employee must keep and turn in to the employer documentary evidence such as receipts for all lodging expenses, and for other travel and entertainment expenses over $75.

Because the recordkeeping can be onerous, the law provides some shortcuts, depending on the type and frequency of the travel and entertainment expenses. For example, the paperwork burden and the cost of travel expenses can be decreased by giving employees who travel for business purposes a flat daily allowance, a per diem, which varies by destination, to cover meals, lodging and incidental expenses. If the daily allowances do not exceed IRS-determined maximums, they are payroll and income tax free with a minimum of paperwork; all that is required is a record of the time, place and business purpose of the travel. To-the-penny accounting of expenses and corroborating receipts is not necessary.

One simple way to cut out paperwork while boosting company tax deductions is to give employees a flat allowance for anticipated travel and entertainment, and not require these expenses to be substantiated. The allowance is fully deductible as compensation (assuming the employees' compensation packages are reasonable), and there is minimal paperwork required. The allowance, however, is subject to payroll and income tax withholding, and the company may not be able to determine what their actual travel and entertainment expenses are for budgeting purposes. In addition, there are unfavorable tax consequences for the employee, even if the travel and entertainment expenses are deducted on their own returns.

Travel and entertainment expenses are particularly susceptible to challenge by the IRS. However, in some instances, businesses may fail to deduct qualifying travel and entertainment expenses, or may be deducting these expenses improperly. We can perform a confidential review of your company's travel and entertainment expenses to ensure compliance with the complex rules that govern these deductions.

We hope this information is helpful.  As always, if you have any questions we are happy to answer them for you.  Please call our office at (801)397-1000 weekdays between 8am and 5pm for details on how the new changes may affect your specific situation and/or to schedule a confidential review of your current status and to plan any changes necessary for the remainder of this tax year and the future.

Sincerely,

Bangerter, Lund and Associates, Inc.