Category Archives: Blog

IRS Changes Audit Procedures for Partnership Returns

June 18, 2018

Starting in 2018, the Internal Revenue Service is changing how they collect federal taxes from taxable income changes resulting from an IRS examination of a partnership return. In the past, any changes to a partnership’s taxable income after an examination were passed through to members and they were responsible for amending their tax returns.

For partnerships with tax years beginning on January 1, 2018 or later, any changes in taxable income will be calculated at the highest individual or corporate rate for the year under examination and the partnership will then be responsible for paying the tax, interest and penalties.

Certain partnerships may be able to elect out of this new simplified tax collection process. It will be an annual election made on the timely filed tax return and will be the decision of the members.

Please contact our office if you would like more details regarding the IRS’ Centralized Partnership Audit Regime.

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Buy-Sell Agreements

May 30, 2018

Buy-Sell agreements are important to every business owner and there is a high probability that, if not done right, they will lead to disputes and possible litigation. Buy-sell agreements are agreements among business owners, or between the owners and the business itself, setting forth the price and terms of the purchase of an owner’s interest when certain trigger events occur.

After a trigger event occurs the parties have conflicting interests. So buy-sell agreements should be created before any trigger event occurs.

Possible trigger events:

* Shareholder quits, is fired, retires, or dies.

* Shareholder is disabled–disability must be defined

* Divorce

* Bankruptcy

Types of Buy-Sell Agreements

There are two basic types of buy-sell agreement: redemption agreements and cross-purchase agreements. Under a redemption agreement, the company buys back a departing owner’s interest, while under a cross-purchase agreement the remaining owners purchase the interest. Typically, under either type of agreement, the purchase is funded by a life insurance.

A disadvantage of cross-purchase agreements is that they require each owner buy life insurance on all of the other owners’ lives. The number of life insurance policies can increase dramatically as the number of owners increases, and are very difficult to administer. As a result, most buy-sell agreements are structured as redemption agreements, under which the business owns the policies.

There are several approaches to setting the purchase price, including:

Fixed-price agreements — the price is agreed on before a trigger event and should be revised every year. But in most cases the owners fail to change the price over time. So the price may result in a bargain for either the buyer or the seller, depending on whether the value of the business increases or decreases over time. This often leads to costly litigation. What is needed is a methodology to fix the price at a later date if the value is no longer valid after the trigger event. These provisions often are not included in fixed-price agreements

Formula agreements — e.g., five times earnings. But there may be one-time events that increase or decrease earnings and skew the value of the business. It is almost impossible to create a formula that can account for all types of future events, whether they occur inside or outside the company.

Valuation process agreement. To avoid the problems with fixed-price and formula agreements, many companies adopt multiple appraiser agreements. The selling shareholder selects an appraiser and the buyer, usually the company, selects another appraiser. Typically, these appraisals set the price if the appraisals are within ten percent of each other. But that rarely happens. So, the two appraisers select a third appraiser to reconcile the difference. The agreement may provide for an average of the three appraisals, or the average of the third appraisal and the one closest to it, or the use of the third appraiser’s value. The standard of value must be agreed on and that is typically “fair market value,” which is the value at which a willing buyer and a willing seller, neither under any compulsion to act, would agree. There must also be agreement on how ownership percentage affects value. A minority interest may have a lower value than the selling owner’s pro-rata share of the value of the business.

Most problems can be avoided by having the parties select a single appraiser who, before any trigger event occurs, determines the value. The initial appraisal is a draft appraisal reviewed and agreed upon among the parties. Because a trigger event has not occurred, agreement is more easily reached among the parties. This value is used until the same appraiser does a re-appraisal, performed periodically. When a trigger event occurs, one of the parties may request a re-appraisal. The parties know that the re-appraisal will reconcile the new value with the previous value based on the company’s performance and conditions in the industry.

Life Insurance

Life insurance can create complexities. A case study demonstrates. Assume a company purchases life insurance on, say, two equal owners. Assume the value of the company is $8 million and each owner has a $4 million interest. Assume the life insurance is $6 million on each owner. Owner A dies and the company collects $6 million. At this point the company is worth $14 million and owner A’s estate has a $7 million dollar interest. The company pays A’s estate $6 million plus a note for $1 million. Now the remaining value of the company, all owned by owner B, is $7 million. This may seem fair, but if not agreed on in the buy-sell agreement, this arrangement can lead to a dispute and possibly litigation.

Keep in mind that death is only one of many trigger events and probably not the most common one. The payout when the departing owner does not die has to be funded by something other than life insurance, such as the issuance of a promissory note, a bank loan, or the accumulation of assets over time.

The foregoing discusses buy-sell agreements without including the effects of income taxes, yet income taxes can be a critical consideration. We urge you to contact us before finalizing a buy-sell agreement for a review of the possible income tax effects on the parties.

 

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Business Travel Isn’t What it Used to Be – Tax Ramifications

April 25, 2018

The Tax Ramifications of Business Travel

With conference calls and Web meetings increasingly prevalent, the sheer volume of corporate travelers has probably diminished. But there are still plenty of dedicated “road warriors” on the job. And if your company is sending some into battle, it’s important to understand the tax ramifications.

Accountable Plans

Generally, for federal tax purposes, a company may deduct all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. This includes travel expenses that aren’t deemed lavish or extravagant, which can qualify as a “working condition fringe benefit.”

Working condition fringe benefits are any property or service provided to an employee to the extent that, if he or she paid for the property or service him- or herself, it would be tax-deductible. Such benefits aren’t included in the employee’s gross income or subject to FICA taxes or income tax withholding.

Under the Internal Revenue Code, an advance or reimbursement for travel expenses made to an employee under an “accountable plan” is considered a working condition fringe benefit. In general, an advance or reimbursement is treated as made under an accountable plan if an employee:

  • Receives the advance or reimbursement for a deductible business expense paid or incurred while performing services for his or her employer,
  • Accounts for the expense to his employer within a reasonable period of time and in an adequate manner, and
  • Returns any excess reimbursement or allowance within a reasonable period of time.

By contrast, an advance or reimbursement made under a “nonaccountable plan” isn’t considered a working condition fringe benefit — it’s treated as compensation. Thus, the amount is fully taxable to the employee, and subject to FICA and income tax withholding for the employer.

Business Travel Status

Although business transportation — going from one place to another without an overnight stay — is deductible, attaining “business travel status” fully opens the door to additional tax benefits. Under business travel status, the entire cost of lodging and incidental expenses, and 50% of meal expenses, is generally deductible by the employer that pays the bill. What’s more, those amounts don’t equate to any taxable income for employees who, as mentioned, are reimbursed under an accountable plan.

So how does a business trip qualify for business travel status? It generally must involve:

  • Overnight travel,
  • An employee traveling away from his or her “tax home,” and
  • A temporary trip undertaken solely, or primarily, for ordinary and necessary business reasons.

Bear in mind that “overnight” travel doesn’t necessarily mean an employee must be away from dusk till dawn. Any trip that’s long enough to require sleep or rest to enable the taxpayer to continue working is considered “overnight.”

Home Sweet Tax Home

One particular aspect of business travel tax treatment that many companies struggle with is the concept of a “tax home.” In a nutshell, the IRS allows deductions for meals and lodging on business trips because these expenses are duplicative of costs normally incurred at employees’ homes and employees are required to spend more money while traveling. Consequently, a taxpayer can’t claim deductions for meals and lodging unless he or she has a home for tax purposes and travels away from it overnight.

A “tax home” — that is, an employee’s home for purposes of the business-travel deduction rules — is located at either his or her:

  • Regular or principal (if more than one regular) place of business, or
  • Regular place of abode in a real and substantial sense, if he or she has no regular or principal place of business.

If an employee has two or more work locations, his or her “main” place of work will be considered the tax home. In determining which location is the main place of work, the IRS looks at factors such as total time spent at, degree of business activity in, and amount of income derived from, each business location.

There may be situations, however, in which an employee has no permanent residence. For example, an itinerant salesperson who moves from place to place is only “home” wherever he or she stays at each location. Because the taxpayer doesn’t have duplicative expenses, there’s likely no deduction for meals and lodging.

There is an exception under which local, “nonlavish” lodging expenses incurred while not away from home overnight on business may be deductible if all facts and circumstances so indicate. One factor specified in the regs is whether the employee incurs the expense because of a bona fide employment condition or requirement. An example is a business that’s hosting a conference at a local hotel, where it’s necessary for some employees to stay at the hotel to effectively run the conference.

Important Rules

Even if your company has pumped the brakes on business trips of late, knowing the tax rules involved remains important. These rules can save your organization tax dollars and spare your employees aggravation and increased liability on their own returns. Contact us for help ensuring you’re handling travel expenses properly.

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