CPA’s to Become Agents of the IRS?

TIGTA is one of my favorite acronyms coming out of the federal government.  It’s hard consonants are appropriate.  Even if you don’t know what it means, most folks would instinctively be leary of dealing with something called TIGTA.

TIGTA is the Treasury Inspector General for Tax Administration.  It is a division of the IRS and they are the “Eichmann” division of the IRS.  Their mandate is to increase the efficiency and effectiveness of the IRS.  If you have ever been through an IRS audit, you know they are no fun.  But chances are you were not subjected to a TIGTA audit, which the IRS  equivalent of a colonoscopy, your return is audited line by line, where full documentation of every number item is required.   

The man in charge of TIGTA is J. Russell George.   In a statement made recently, Mr. George chilled me to the bone.  The topic affects tax preparers directly, but it is a statement that not just tax preparers should be afraid of, but all taxpayers.  Mr. George said the following:

“Paid tax preparers prepared more than half of individual tax returns in 2009.  The IRS must step up its efforts to engage this community in its effort to close the tax gap.”

OMG.  They want to engage ME in it’s effort to close the tax gap.   I see three huge problems. 

1. People taking money under the table don’t come to somebody like me and if they do they don’t tell me about it.
2. This puts me in a HUGE conflict of interest.  If my clients think I am playing cop, they won’t want to do business with me. I am the taxpayer’s advocate, not the government’s.  Next it will be the Justice Department wanting more cooperation from criminal defense lawyers at curtailing crime. 
3. Me and my fellow CPAs, for the most part, do not want to be a tool of Big Brother.  

Don’t get me wrong, I hate the fact that there is a tax gap.  I do not aid and abet my clients in cheating the government.  I think tax cheats out to go to jail and serve significant time.  I hate that certain segments of the population feel like they shouldn’t have to pay taxes, but the other guy should.   Polls, anonymous ones of course,  show that the same people that would never steal a grapefruit from a fruit stand actually boast about how they cheat on their taxes.  But the minute they force me to get involved in correcting that, I am out of here.  It will be like working for the IRS, but without the job stability and the government pension. 

Of course, this may be what the IRS really wants “Hey taxpayer, let US, the friendly folks at the IRS, prepare your return.  We will do a really good job on you, oops,  I mean we will do a really good job.”

Musings About Asset Protection for California Real Estate Investors

I visited with a client of mine yesterday.  He’s about one year into “asset protection mode.”  He has several problem properties teetering on the edge, where the personal guarantees could bankrupt him.   Creditors are circling, but have not yet pounced.  It’s a Kabuki dance, will they or won’t they.  This client wants to be sure if they do pounce, they can’t wipe him out, like they did in the 90′s.

Since I am not an attorney, I can only assume the following that he told me is correct, but I cannot be sure.  This is what I learned.

1.   Get your money out of California bank accounts!  A creditor can walk into a judge the day you default and get a pre-judgment lien on your bank accounts.  Day 1.  A California judge cannot give a creditor such a lien on an account in Wyoming.

2.  Hold your properties in an LLC, preferably an LLC with members not involved in the day-to-day workings of your real estate enterprise. It is much harder for a creditor to get a hold on your assets in an LLC (vs. a corporation or no entity at all).

3.  Be out-of-town on the day of default (so you can’t be served).

4.  Begin squirreling away money into bank accounts that won’t honor a California judgment.  Many foreign jurisdictions, including plenty of ones where it is safe to keep your money,  will not do so.  I knew better than to ask where he was putting his.

5. Pay your federal taxes, file your returns, report your foreign bank accounts and keep on VERY good terms with the IRS.  Chances are, with all the real estate losses floating around, the IRS is not very high on any real estate investor’s creditor list.  The IRS has a worldwide power to collect, unlike the State of CA, and most people are unwilling to stomach the measures necessary to defy that power.

On that cheery note, if you have potential net worth-ending creditor problems and you have not done any bona fide asset protection, you are  a year behind the smart ones who learned their lessons in the 90′s.

Don’t Let The Tax Man Drive The Bus

I have said this to my clients many times.  Don’t let the tax man drive the bus.   What this means is don’t let the tax implications be the driving force for ANY financial decision.  “But Bob” you say “You’re a tax guy.  How can you say that?”  Sure I am a tax guy, but before I got my MS in Tax I got my degree in finance and was a few classes short of another degree in economics. 

People want to pay less tax, for sure.  But the answer to the question of “Hey Bob, should I buy a new truck?” is ALWAYS, do you need a new truck.   The main deciding factor in any business decision should ALWAYS be determined by the underlying economics, not the tax effect.  If you don’t need a new truck, don’t just do it because you get a tax break.  Don’t spend a dollar to save forty cents.  Now if you are thinking you MIGHT need that new truck, that is the perfect time to call, and we’ll go through the economics first, come up with an answer and maybe, just maybe, we’ll let the tax rules affect the answer.

And “Don’t Let The Tax Man Drive The Bus” is the foremost thing I would tell the tax policy makers in Washington.  In general, as of this minute, my business clients are not enticed in the new tax breaks for hiring new employees or for investing in new equipment.  They will tell you as far as their little corner of the economy is concerned, these moves will not stimulate job or business growth, because they do not make decisions about the economics of their business based merely on tax incentives.  To do so would allow the tax man to get be hind the wheel of the bus.

Close That Home Purchase Now!

If you are closing a house, make sure you act while there are still available tax credits for homebuyers.  I have covered this topic in the past, so I will be brief. 

Congress just extended the first-time homebuyer’s credit until October 1, 2010 for buyers who had a written binding contract to purchase a principal residence prior to May 1, 2010.  LOTS of buyers were unable to close their purchase by the original July 1 deadline.  Now they have extra time as Congress did not want to penalize homebuyers because lender caused delays in processing all the paperwork.  The President has indicated he will sign the legislation.

The money provided for the California credit for a first-time homebuyers will be all gone in a next few days.  If you were trying to get this credit, you need to FAX, not mail, Form 3549A claiming the credit ASAP.

There is another California credit still available for new home purchases.  Only about 40% of the $100 million in funds has been used.  For this one you have time.

Planning for Estate Tax Still Very Uncertain

I was at a conference last week where estate planning was discussed.  As you may or may not know, right now, for this 2010 calendar year, and this year only, there is NO estate tax.  This law was part of the Bush tax cuts.  When the Bush tax cuts came into law in 2001, there was a 10 year “sunset” date when the tax cuts  would go away without an act of Congress.  That date is December 31, 2010.  As of January 1, 2011, without an act of Congress, all the tax laws return to the pre-Bush rules.

In 2001 the maximum estate you could have without paying estate taxes was $1 million.  By 2006 (and carrying through to 2009) the maximum estate you could have without paying estate taxes had grown to $3.5 million.  This seemed to be a politically acceptable number to both sides of the aisle. And going back to $1 million for a taxable estate in 2011 seems righteously unfair to most folks in Congress.

The sure bet was by the time we got to 2010 Congress would have done something and the zero estate tax year would be a dead duck.   Certainly there would be too much opposition to be willing to let the estate tax  disappear, even for just one year.  However, as you might suspect, the debate over to what amount should the taxable estate be changed to has not been resolved, so here we sit with no estate tax.

But the issue of 2010 remains unresolved.  Congress is contemplating a new retroactive 2010 estate tax law.  Most constitutional law scholars think there is sufficient legal precedent to allow this.    This literally freezes any 2010 estate planning in its tracks.

While there was not a lot of new information at my conference, the speaker did have a point that I had failed to consider.  Estate taxes are due 9 months after the date of death.  That means the first tax payment from a 2010 death is not due until at least October 1.   The speaker thought that asking for a check more than 9 months after the date of death is the straw that will break the back of the constitutionality issue.   Very interesting.

But you can bet your bottom dollar the constitutionality of a retroactive estate tax law will be challenged.  A Texas pipeline tycoon named Dan Duncan died in March 2010 with a net worth of what Forbes Magazine estimated at $9 billion.   Do you think they will have enough money for lawyers?

My current bet is that those “lucky” enough to die in 2010 will indeed escape estate tax and those dying in 2010 will get hosed.   But don’t ask me to do any planning right now, because I just don’t know.  Ask me in October when this whole retroactive issue supposedly goes away.  There are some cool things we can do, especially regarding “generation skipping,” passing assets down to the grandkids.  Expect to hear from me in October.

Get Uncle Sam to Pay Part of Your Utility Bill

Summer officially starts in a  few days and it’s getting hot.  That means high summer electric bills.  One of the questions I am most often asked is what energy related tax credits are available to homeowners. 

Homeowner Energy Conservation Tax Credits

If you are considering making home improvements, consider energy efficient improvements that can generate tax credits that can offset some of the cost. The credit only applies for improvements to your primary residence, so upgrades for second homes and vacation homes don’t fly.  The tax credits cover “normal” improvement items such as HVAC systems, water heaters and insulation as well as nonstandard products like fuel cells, windmills, solar panels or geothermal energy.

For conventional home improvement items there is a 30-percent credit on purchases (through December 31, 2010) for items such as heating, ventilating and air conditioning (HVAC) systems, insulation, roofs, water heaters and windows and doors. The combined maximum credit for purchases in both 2009 and 2010 is $1,500, so if you took the full credit last year, you can’t take more this year.  For you folks who are not math wizards, think of the maximum cost you get a credit for is $5,000 of qualified costs. 

Not all roofs, insulation, water heaters, etc. qualify.  Qualifying products must meet stringent energy efficiency standards.  Never take the seller’s word about  unless they have what is known as the Manufacturers Certification Statement.  These certifications are available either at the time of purchase or on the manufacturer’s website. Taxpayers should make sure they get a copy for their records.   

The credit is usually based on the total purchase price of qualified equipment, including sales taxes, but air conditioning/furnace systems, water heaters and biomass stoves installation does count. Not so for installation costs of roofing, windows, doors and insulation. Make sure the contractor breaks out the labor costs separately so you can see the qualifying.

That’s the good news, now the bad news, if the utility is giving you a rebate, most rebates  reduce the amount eligible for the federal tax credit.  Also, unlike 2009, the credit for 2010 does not offset alternative minimum tax (AMT). So if you typically pay alternative minimum tax or otherwise think you might for some reason owe it in 2010, don’t count on this credit helping you.  And this credit does not carry over to any other year, so if you can’t use it in 2010, you lose it.

Even Better Credits for Solar, Wind, Geothermal

There is  a more “robust” class of energy credits that apply to homeowners buying geothermal heat pumps, small wind turbines and solar energy systems including solar water heaters for residential energy efficient property (REEP).  It applies to equipment used for household use (i.e. not swimming pools or hot tubs) and solar electricity generators for general use in a dwelling.  Here again it covers 30% of cost (sorry, no installation costs this time), but for this credit there is no $1,500 limit.  This credit expires December 31, 2016.  There is also a REEP credit for fuel cells but the rules are complicated and are beyond the scope of this article.

There are other this credit does qualify for AMT purposes so, if large enough, it can offset your entire tax bill.  And while the credit is not refundable, you can carry over any unused credits to future years. There is no expiration date on this credit, so unlike the homeowner credit, there’s no use it or lose it.

Tax Planning for the Real Estate Investor

Does this topic sound too dry?  Better than being all wet!! See the outline and exhibits for the Real Wealth Network  event on February 17, 2010.

 Tax Planning for the Real Estate Investor

Exhibits for Tax Planning for the Real Estate Investor

I had to resort to this outline instead of a power point presentation when the office computers crashed.  Everything was backed up and not a single client bit or byte of client data lost, but it sure did a number on my productivity.

Need a Real Estate CPA?

Man, times are tough and keep getting worse in the real estate CPA business.  I’ve been in the real estate CPA business a long time, and this makes the early 80s, the late 80s and the early 90s look like a walk in the park. 

I saw the real estate bubble like a car speeding towards the cliff.  Some real estate developers and investors were smart, they saw the cliff coming, slowed down early and stopped in time.  Some saw the cliff coming too late, slammed on the brakes, but still skidded over the edge and went into the abyss.  And then there were the ones emulating the ending of the film “Thelma and Louise” reaching the cliff “peddle to the metal,” launching themselves into the deepest depths of the debtor’s abyss, exploding in a huge fireball of unpaid creditors. 

Commercial development remains at an absolute standstill.  When commercial landlords can’t keep their spaces rented, who on earth would want to create more spaces?  And it’s not just the empty spaces that are causing the problem.  Strong tenants know the landlords are weak.  Tenants with renewals coming up are demanding concessions.  The strongest tenants are demanding mid-lease concessions, testing the will of landlords that desperately need them to stay.  And it’s not just the strong tenants demanding concessions.  Tenants who are weak themselves have come to landlords begging for concessions so they can stay out of default.  I’ve seen many a landlord make such concessions only to have the tenant fail anyway. 

All this activity has made the banks stark raving paranoid.  They are going after debtors who haven’t missed a payment for violating loan-to-value covenants, demanding loan re-margins or other down payments.  Negotiations in favor of the landlord who is current on the mortgage are nonexistent.  They are literally forcing the landlord to default, just to get their attention.  Lawsuits are coming.  Creditors can get an injunction on a defaulting creditor (even just ones out of covenant) and attach their bank accounts.  Mark my words, this is coming very soon unless the economy recovers PDQ.  For landlords owning multiple properties, with multiple banks as creditors, a lawsuit by one lender likely means a rush to the courthouse by the remaining lenders.  Going back to the car and the cliff analogy, the car may have stopped in time, but now the cliff is eroding, and it’s getting really close for many commercial property owners.  2010 could get VERY ugly.

On a modestly brighter side, on the residential side homebuilding is showing some signs of life, for those players who still survive, albeit on life support.  New home inventory is almost non-existent and there is just enough demand for homebuilders to carefully try to build one or two homes and try to sell them.  Nobody I have talked to expect to expose themselves to more than a few homes under construction at once until a consistent demand can be assured. 

Residential landlords are experiencing an extremely soft  rental market, and many rentals have loan to value ratios that are under water.  I have had many clients come to me and say that they have serious negative cash flow issues and cannot get a workout done with the bank.  That’s when I tell them they HAVE to stop making payments to get the bank’s attention.  If you are experiencing  negative cash flow and facing foreclosure, the worst thing you can do right now is to hesitate.  Either make the committment to carry the property for X years (if they can hold out that long) and wait for property values to come back or GET OUT NOW.  If you can’t hold out, if you wait six months and then default, that’s six more months of negative cash flow for no reason!  That money is wasted.  Use that money to pay down other debts you will continue to carry.   

And by the way, times are tough for this real estate CPA, when my clients are hurting, my business suffers too.  I saw the cliff coming and I put in some measures that kept me away from the edge.   Fortunately these measures did not forced me into auditing school districts and battling Turbo Tax and H&R Block for simple 1040 business.   I am surviving by helping my clients survive, and I’m taking on new clients who want that kind of expertise. 

Does your accountant or CPA know this kind of stuff?  Would having a CPA who is current on the local market forces, and has information on what his other clients are doing that could help you?  Does your CPA have a Masters in Tax and more than 25 years in real estate tax background?  Times are tough.  Get some help fighting back.

How much does it REALLY cost?

I took my car in to fix a problem this morning.  The mechanic called me a few minutes ago to say it was fixed, and it didn’t cost quite as much as the estimate.  When was the last time our federal government was able to say that? 

Why does our Federal government estimate  how much a program will cost, be it a military program or social program, only to have it NEVER come in under budget? Even when they seem to not care about how much it costs, with a “do it at any price” mentality; why do they feel it necessary to lowball the estimates of how much it costs? If they were honest, it would come in under budjet one time, over the next.

If you hired a contractor, and they lowballed the cost of the job, you’d expect them to eat the difference, right?  Or at the very worst, if they became beligerent, you might pay them the full price and never hire them back.  Right? 

Well Congress is always beligerent and never backs down and we always pay full price, even if they were totally dishonest when asked how much does it really cost.  Why do we hire them back?

Oh, and don’t get me started about Congress not living up to the part about ”everything’s fixed.” I mean, the recession is over, right?

THINGS YOU SHOULD KNOW IF YOU OWN AN S CORPORATION

From the Tax Resources for Small Businesses, Issue No. 2009-14, July 8, 2009

Recently released IRS guidance provides useful information for S corporations on the proper employment tax treatment of payments made to shareholder-employees and officers and explains how most shareholder-employees (owning 2% or more) treat company-paid health insurance premiums. The guidance also discusses various stock basis issues.

Background. S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. S shareholders report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates.

A shareholder may deduct his share of passed-through items only to the extent of his basis in his S corporation stock.  This is determined by taking into account the increases in basis for his share of the S corporation income during the year, and the decreases in basis for distributions for the year, plus any debt owed to him by the corporation.

Compensation.  S corporations must pay reasonable compensation to a shareholder-employee in return for services that he provides to the corporation before non-wage distributions may be made to the shareholder-employee.  The IRS is on the lookout for S corporations not paying wages to avoid paying social security and other payroll taxes.

Some factors considered in determining reasonable compensation include:

•  
  • training and experience;
  • duties and responsibilities;
  • time and effort devoted to the business;
  • dividend history;
  • payments to non-shareholder employees;
  • timing and manner of paying bonuses to key people;
  • what comparable businesses pay for similar services;
  • compensation agreements; and
  • use of a formula to determine compensation.

Medical insurance premiums. Health and accident insurance premiums paid on behalf of most S corporation shareholder-employees are deductible by the S corporation as fringe benefits and are reportable as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. They are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. This additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder, but is not included in Boxes 3 or 5 of Form W-2.

To offset that extra income, most S corporation shareholders are eligible for an above-the-line deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation (and the shareholder or the shareholder’s spouse isn’t eligible to participate in any subsidized health care plan). A medical plan is considered established by the S corporation if the S corporation paid or reimbursed the shareholder-employee for premiums and reported (a) the premium payment and (b) the reimbursement as wages on the shareholder-employee’s W-2

The IRS has ruled that if a shareholder purchased the health insurance in his own name and paid for it with his own funds the shareholder would not be allowed an above-the-line deduction. However, IRS stated that if the medical coverage plan is in the name of the shareholder and not in the S corporation’s name, a medical care plan could be considered to be established by the S corporation if it

1. Paid or reimbursed the 2% shareholder for the premiums and
2. reported the premium payment or reimbursement as wages on the shareholder’s Form W-2

S corporation stock and debt basis. The Schedule K-1 reflects the shareholder’s S corporation’s income for the year and also includes any losses or deductions which are allocated to the shareholder for the year. Also showing on the K-1 is the shareholder’s distributions received during the year.  If a shareholder receives a from an S corporation, the distribution is typically tax-free to the extent it doesn’t exceed the shareholder’s stock basis.

If a shareholder is allocated an S corporation loss or deduction flow-through, he must first have adequate basis to claim it. The order in which stock basis is increased or decreased is important since both the taxability of a distribution and the deductibility of a loss are dependent on stock basis. The following are key rules that a shareholder should keep in mind:

•  
  • A distribution in excess of stock basis is taxed as a capital gain on the shareholder’s personal return, usually a long-term capital gain;
  • Nondeductible expenses reduce a shareholder’s stock and debt basis before loss and deduction items. If nondeductible expenses exceed basis, they do not get carried forward;
  • Losses and deductions not allowable in the current year are suspended due to basis limitations;
  • Suspended losses and deductions due to basis limitations retain their character in subsequent years. Any suspended losses or deductions in excess of stock and debt basis are carried forward indefinitely until basis is increased in subsequent years or the shareholder disposes of the stock;
  • In determining current year allowable losses, current year loss and deduction items are combined with the suspended losses and deductions carried over from the prior year, though the current year and suspended items should be separately stated on the Form 1040 Schedule E or other appropriate schedule on the return;
  • A shareholder is only allowed debt basis to the extent he has personally lent money to the S corporation. A loan guarantee is not sufficient to allow the shareholder debt basis;
  • Part or all of the repayment of a debt previously used as basis to deduct losses is taxable to the shareholder;
  • If stock is sold, suspended losses due to basis limitations are lost. The sales price doesn’t have an impact on the stock basis. A stock basis computation should be reviewed in the year stock is sold or disposed of.