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Private Business Services Blog - An Accounting & Advisory Resource

New ACA Penalty as of July 1

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July 16, 2015

Gibson_NewBy Dan Gibson, CPA

For those small employers (less than 50 employees) who are thinking they can provide their employees with medical insurance coverage but avoid the medical insurance hassle in covering their employees with a company plan, please consider the following. Many employers have come up with a plan of just giving their employees the money to go out to purchase their own health coverage; thereby avoiding the headaches of shopping for and then maintaining medical insurance plan for their worker pools. This may have worked years ago, prior to the Affordable Care Act (“ACA”), but not anymore. Doing this could result in fines of $100 per day, per employee or $36,500 per year, per employee. The ACA is truly an employer-driven system and this rule has been set up to keep it that way.

Employers were provided some transitional relief from this penalty, but that expired on June 30, 2015.

Federal tax law prohibits any form of "employer payment plan" with respect to non-sponsored or integrated "individual" health policies (other than certain "excepted benefits" such as limited-scope dental or vision policies). Specifically, employers are prohibited from making or offering any form of payment for individual policy premiums, whether through pretax reimbursements, premium reimbursement arrangements (i.e., HRAs), after-tax reimbursements, or cash compensation. This limitation exists, regardless of employer size.

As a small business, what are your options?

  1. Get health insurance on your state’s SHOP Exchange.
  2. Hire an insurance broker/agent and ask them to obtain an ACA-compliant plan.
  3. Don’t offer any employee health insurance.

None of these are particularly creative, but the penalties being assessed by ignoring them can be onerous.


Borrower Beware

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June 26, 2015
Gibson_New(1)By Dan Gibson, CPA

There are occasions when individuals are advised to borrow money against property (non-residence) or securities they own in order to fund the purchase of, say, a home or a vehicle. Then, they are often incorrectly told that the interest is deductible as either mortgage interest or investment interest.    

Interest on a loan not secured by the first or second home, as is the case above, must be traced. Traced interest means categorized based on the use of the loan proceeds. These categories include trade/business, passive activity, investment, portfolio and personal. 

For example, Joe takes out an equity loan against his rental property, so that he can purchase a new car for personal use. Mortgage company issues a Form 1098, reporting the interest paid. However, since he used the proceeds for personal use, the interest expense is not deductible against the rental income. In fact, the interest is not deductible at all because it is considered personal interest. Alternatively, if Joe had taken out an equity loan against his principal residence and purchased a car, the interest would have been deductible as mortgage interest. (This is assuming the balance of his equity loan against his residence is less than $100,000 and he is not subject to the alternative minimum tax.)

In an actual tax court case, Ellington, T.C Memo 2011-193, the taxpayers purchased a personal residence and secured the loan, used to make the purchase, partially against the residence and partially against securities owned. The taxpayers deducted the interest on the portion of the loan secured by the securities as investment interest expense. The Court disallowed that deduction, stating that the interest on the loan not secured by the residence must be categorized based on the use of the loan proceeds, not the assets securing the loan. Since that portion of the loan was not secured by the residence, the interest on that portion was considered personal and not deductible.

Installment Agreement Options

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June 9, 2015

Gibson_NewBy Dan Gibson, CPA

Over the last few posts, we’ve discussed offers-in-compromise (Fresh Start and Cash Flow , Fresh Start and Net Equity, and Doesn’t Everyone Deserve a Fresh Start?).  Here’s one more fact about offers-in-compromise: about 50% of them are approved. So, for those left wondering what to do when an offer won’t work, here are some installment agreement options that you can use with the IRS.

First of all, the IRS normally wants to figure out how they can get the taxpayer to full pay as soon as possible. However, with a little persistence and, most likely, handing over your financial information by way of a Form 433, the IRS will eventually give in and accept payment in installments. Here is a summary of installment plans that are available:

  1. Guaranteed: Basically, the IRS is required to accept an installment arrangement from a taxpayer with tax debt (excluding penalties and interest) of $10,000 or less, who can pay the debt in 3 years, who has not entered into a recent installment agreement, has filed prior year returns and agrees to stay current going forward. No Form 433 is needed.    
  2. Streamlined: 
    • $25K or less – Available to taxpayers with a balance due (taxes, penalties and interest) of $25,000 or less who can pay the balance within the earlier of the expiration of collection statute expiration date or 72 months. No 433 is required.
    • $25K to $50K – Similar to the $25K or less arrangement, except that some financial information may be needed and the taxpayer must agree to paying installment with a direct debit to a bank account.
  3. Partial Payment: If the taxpayer can demonstrate, through a Form 433, that they can pay make some installment payments but not enough to cover the debt owed by the collection statute expiration date, the IRS does have the authority to enter into a partial payment installment agreement. This is sometimes known as the poor man’s offer-in-compromise as it can be done at a relatively low cost. However, the downside is the IRS will be checking in every 2 years and will want you to refresh the Form 433 to determine if your financial status has changed.
  4. Negotiated:  If none of the above works, you’re left with doing it the old-fashioned way. The taxpayer will be required to provide a Form 433 and will need to haggle with the IRS about the terms of the installment agreement.

Again, the agent dealing with your case will normally start up the discussion wanting to know when they can expect to received full payment for the amounts due to the IRS. If an installment plan is needed, the taxpayer or practitioner will have to persist and the agent should back down. If not, never shy away from this question: “Who’s your boss, and can I speak with him or her, please?”

Fresh Start and Cash Flow

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June 8, 2015

Gibson_NewBy Dan Gibson, CPA

As stated in my posting on May 14, 2015, determining an offer-in-compromise amount to extinguish debt owed to the IRS is made up of 2 components – net equity and cash flow. These are used by the IRS to determine reasonable collection potential or RCP. RCP represents net equity plus monthly cash flow multiplied by 12 (if offering to make payment in 5 installments or less) or 24 (if offering to make payment in 6 to 24 installments). If the RCP exceeds the amount owed, chances are your offer will be rejected. If it falls below the amount owed, you might have a shot as getting an offer accepted.

In my last posting, I discussed the net equity calculation. In this posting, we’ll take a look at the cash flow calculation.

In most cases, you would think this is pretty easy: “Count the cash I bring in every month and subtract what I have to pay out every month; whatever is left over is discretionary and available for use against, say, amounts due to the IRS.” Unfortunately, the IRS doesn’t quite see it that way.

The IRS appears to start out right by asking you to provide income information supported by pay stubs or a business income statement. Then things take a turn for the worse: The portion that you subtract from this income is not necessarily the amount that you actually pay. Surprised? The IRS has created what are called collection financial standards, which might restrict the amounts you can subtract from your income. The living expenses that are allowable are considered by the IRS to be reasonable amounts that you would otherwise need to spend. Thus, that discretionary amount ends up being higher than you thought. From my past experience, the IRS is pretty rigid when it comes to the standards, but will allow some leeway when the taxpayer has excessive commuting costs, court-ordered payments, medical expenses or education needs for a special needs child. But by no means are they a lay-up. You need to put forth your case for allowing these excessive costs with solid substantiation. By the way, there are some costs which the IRS will normally not allow at all; namely, credit card payments, payments on unsecured debt, private school tuition and charitable contributions.

The key to understanding the logic of the IRS when it comes to determining cash flow is to know about the collection financial standards. Your cash flow bottom line calculation, based on the standards, can make or break your chances of getting to “yes” when it comes to an offer.

Fresh Start and Net Equity

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May 21, 2015

Gibson_New(1)By Dan Gibson, CPA

When submitting an offer-in-compromise with respect to settling amounts due to the IRS for a lower amount, the IRS focuses on a term known as “Reasonable Collection Potential.” In doing this calculation, the IRS reviews two key components: One is the net equity of assets that the taxpayer owns at the time of the offer and the other is the expected earning potential of the taxpayer. For this posting, we’ll focus on net equity.

At the sake of oversimplifying, net equity for OIC purposes is cash plus quick sale value of assets that you can “tap” into. For example, you may have an individual retirement account. An individual can usually cash out an IRA, less any early withdrawal penalties and related taxes. So this cash (less penalties and taxes) would be included in your net equity. On the other hand, if you had an interest in a retirement account with your employer that you currently have no access to, this would not be included.

A couple of other points to keep in mind when calculating your net equity for OIC purposes:

  1. Non-cash items (real estate, autos, etc.) are discounted by 20% of fair market value, which the IRS considers to be the quick sale value.
  2. Cash amount are calculated by using the average cash balance over the past 3 months, reduced by one month’s worth of allowable expenses and then further reduced by $1,000 (not to go below zero). We’ll talk about allowable expenses in a future posting.
  3. In addition to the 20% discount, auto values are reduced by debt on the vehicles. The net amount (auto value less debt) is then further reduced by a $3,450 exclusion (not to go below zero). The $3,450 exclusion can be used for 2 vehicles per household as long as the vehicles are used for work, production of income or family welfare.
  4. Business taxpayers can exclude income-producing assets. The thinking here was to eliminate the double-dip of the IRS getting both the value of the asset and the income in the calculation to come up with the reasonable collection potential. The IRS has been provided some discretion here to include the value of the asset and exclude the income it produces, if it so deems.
  5. As a general rule, the net equity of an asset cannot go below zero. So if you have real estate that is underwater with a mortgage greater than the quick sale value, you would report zero equity.
  6. Unsecured debt is normally not allowed as a reduction in determining your reportable net equity.

As you can probably tell, there are some planning opportunities that you can take advantage of when preparing an offer-in-compromise, so it is not just as simple as preparing a  form. Some thinking and strategizing can go a long way in saving dollars when submitting an OIC. 

Doesn’t Everyone Deserve a Fresh Start?

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May 14, 2015

Gibson_NewBy Dan Gibson, CPA

In doing tax collection work, the issue that needs to be addressed by practitioners and by revenue officers at the Internal Revenue Service is whether we can balance the need for the government to collect the tax against the ability of the taxpayer to pay the tax. Recognizing this, the IRS went through the process of easing the standards for troubled taxpayers in order to allow them to enter into what is known as an offer-in-compromise. This process of easing is known, in part, as the Fresh Start Initiative that was put into effect during 2012.

This OIC program is not for everyone. If the IRS believes that, based on the taxpayer assets and earning potential, they can receive a full payment within the time allowed by law (normally ten years), they will normally reject a submitted OIC application.

On the other hand, if there is enough uncertainty in collecting a full payment, the IRS can be persuaded to consider an OIC application. This will allow them to get the most payment in a shorter amount of time -- and enable them to clear the taxpayer debt from their inventory. Keep in mind, the IRS needs to be convinced that it is in their interest to accept this offer, not that of the taxpayer.

In summary, this is how the calculation goes.  The OIC is made up of 2 components: net equity and net income. Net equity consists of cash plus assets (normally discounted at 20% of their fair market value) less allowable debt. Added to that is net income, which consists of gross income less allowable monthly expenses. Depending on the method of payment, the net income is then multiplied by 12 or 24 (if the taxpayer wants to pay off the offer in 5 monthly installments or less, then the multiplier is 12; if the taxpayer wishes to do it with 6 to 24 monthly installments, the multiplier is 24).

Note: Prior to 2012, the multipliers were 48 and 60, respectively. A big difference!

There is much more to say on this topic -- and I’ll be saying it in future postings. Stay tuned.

Surprising Bankruptcy Case

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May 11, 2015

Gibson_New(1)By Dan Gibson, CPA

In the case Mallo v. IRS, the Tenth Circuit Court turned the bankruptcy world on its head.

The Bankruptcy Code states that personal taxes are dischargeable if all the following criteria are met:

  1. Due date of the return was more than 3 years prior to bankruptcy filing.
  2. Return was filed more than 2 years prior to bankruptcy filing.
  3. The tax must have been assessed 240 days or more prior to bankruptcy filing.
  4. The taxpayer must not have violated the fraud rule by filing a fraudulent return or willfully attempting to evade paying the tax.

In the Mallo case, the taxpayers failed to file their 2000 and 2001 returns and the IRS eventually prepared returns for them by filing what is called a Substitute for Return (SFR). Subsequently, the Mallos replace the SFRs by filing returns for those non-filed years.

Then in 2010, the Mallos decided to file Chapter 13 in the Bankruptcy Court. The case eventually converted over to a Chapter 7 liquidation case. Upon the discharge of their debt, the taxpayers inquired about their 2000 and 2001 income tax debt. The IRS claimed, not surprisingly, that the taxes were not dischargeable.

The IRS and the Taxpayers ended up before the Tenth Circuit, United States Appeals Court. The Court determined that neither the SFRs nor the late-filed 2000 and 2001 returns were dischargeable in bankruptcy. The Court’s decision hung on language in the bankruptcy code which states that a return means one which meets the “applicable filing requirements.” The Court interpreted applicable filing requirements to mean that the return must be filed timely.

A loud warning should go out to all who are in this type of a situation. Many taxpayers may be surprised to learn that they may be responsible for income tax that they thought would otherwise be discharged in bankruptcy.

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