Our Equinox Focus Event last week “Tax Update: What You Need to Know for 2012 (and 2011, too)!”  was quite a success with raves from our participants.   I wanted to share some of my key takeaways from the program.

-  Pre-Opening Costs.  For folks starting or launching a business, certain pre-opening costs are tax deductible.  In order to take advantage of this deduction for startups, you need to plan for the timing of your entity formation and your expenses.  Documentation is key as well. 

-  Compensation to S-Corporation Business Owners.  The “salary” part of business owners’ compensation in an S-corporation must pass muster with the IRS.  You cannot pay yourself too little salary so as to take advantage of the “profit” component.   There’s not a hard and fast rule on this, so you must work with your professional team to determine what is “reasonable.”  Also, it’s important to remember that this rule applies to any entity taxed as an S-corporation whether the company is an LLC or a corporation.   Proper assessment and documentation of compensation for owners is critical to defending against an audit.

-  Contractors versus Employees.   Mis-classification of workers as contractors is a huge area of audit at both the state and federal levels.  The IRS has 20 factors to consider whereas Washington State has a 6 point test (7 points if you’re a general contractor) where each of the points must be met.  If your “contractors” are found to be “employees,” you not only have back taxes, penalties and interest, but you may also have a disaster with respect to company retirement plans which require that you allow all eligible employees to participate.   To avoid these costs, be sure to classify these workers correctly.

-  Small Employer Health Insurance.  A tax credit exists through 2015 for employers with fewer than 25 full time equivalent employees and an average of $50,000 in average annual wages.  The credit has a pretty limited scope but if you think you qualify, you should look into it.

Business planning is not only about operations but also about finance and tax and mitigating risk.  Think about these factors in your business and any steps you should take to plan for the year to capitalize on these small business and startup incentives and protect your business against certain risks.

Our guest blog post this week is from Connie Lewis at CliftonLarsonAllen.  Connie’s practice focuses on state and local tax matters. 

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We are seeing more Washington Department of Revenue audits with our clients as the state attempts to meet their budget needs.  One area typically overlooked is the sales/use tax paid on items you use for your business.  Be careful if you purchase an item online or in another state that doesn’t have sales tax and bring it back here to Washington.  If you purchase an item online from a company that doesn’t have a filing requirement here in Washington they are not required to charge you sales tax.  Your business as the “user” is then required to pay the use tax (same rate as the sales tax) on your next business tax return.

Also beware of “free” items that you may receive to make presentations.  If you receive samples from a company that you represent which you use in your sales presentations you are required to pay the use tax on the “fair market rental value” of the item even if you haven’t paid anything for the item.  The term is called “bailment” and the department is looking for these types of transactions when they audit businesses.

Our guest blogger this week is Mary Marino, Partner at Clifton Larson Allen.  Mary’s practice specializes in planning and compliance for closely-held businesses and their owners.  Mary will also be our guest presenter at our upcoming Equinox Focus Event on January 25.

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There is a potentially lucrative tax credit that applies for the six year period beginning in 2010 and ending in 2015.  The Small Employer Health Care Credit provides a federal subsidy of up to 35% of employee health insurance premiums paid by a for-profit business, and up to 25% for a non-profit employer.  In general terms, you are eligible for this credit if you meet three criteria:

-   You have under 25 full-time equivalent (FTE) employees, excluding owners, their family members and seasonal employees

-  Your average payroll per employee for the year is under $50,000, again excluding owners, their family members and seasonal employees

-  The employer-paid portion of employee health insurance is at least 50% of the premium (whether the employee has single or family health insurance coverage)

The good news is that this credit can be lucrative.  An employer with eight employees and paying $40,000 of health insurance premiums could qualify for a $14,000 tax credit ($40,000 x 35%).  For a non-profit employer, that credit would be $10,000 ($40,000 x 25%).  The bad news, however, is that there are complicated phase-outs and only the smallest employers (those under 10 FTEs and under $25,000 of average annual wages) will get the maximum credit. 

If there is any chance that your FTE computation may be under 25 employees and also average wages may be under $50,000, you should investigate this credit further.  There are computation alternatives can may qualify you for at least a partial tax credit.  Further, after analyzing your numbers, there may be strategies to improve the credit in future years.

Although it seems early, January is the start of tax season… Now’s the time to begin conversations with accountants about last year’s business activities and plans for the current year. It’s time to pull together documentation to support deductions and gather 1099s. Most of the work here is done with your accountant and CPA. From a legal standpoint, however, there are a few key areas of interest on the tax front:

-          Independent Contractor Classification.  A key area for both state and federal audits is the misclassification of employees as contractors.  Washington State has a 7 part test that is a strict guideline as to the requirements necessary for a contractor to be so classified.   Companies hiring contractors on an ongoing or regular basis should be sure the contractors meet these requirements and include a warranty by the contractor that it complies with the requirements.  Interestingly, the federal requirements are more vague and may not find the same conclusion with respect to the classification of a contractor.  The IRS has instituted a safe harbor period where a company that has misclassified contractors can avoid penalties.  However, a recent change allows for the federal and state taxing authorities to communicate with one another.  This means that if you are found to have misclassified contractors at the state level, chances are you’ll also hear from the IRS on the matter – and vice versa.  

 -          Compensation to Owners.  Another area of federal audit risk relates to the wages paid to owners of a company.  Be sure that the amounts paid to you as an owner are reasonable wages for the industry and that you are properly withholding taxes or paying estimated taxes so as not to end up with penalties for late or non-payment of appropriate payroll taxes.   To formalize the decision, a business should formally adopt compensation policies for its owners through a Board of Directors or Member resolution.  

 -          Corporate Records and the Corporate Veil.  Ensuring the company is treated as a separate “person” from the owners remains a critical factor in protecting a business owner’s personal assets.  If you do not distinguish yourself from the business, the taxing authorities and courts will not provide you the protection of the corporate structure when it comes to liabilities.

 -          Wages and Taxes.  Remember that, despite the protection of the “corporate veil,” certain liabilities can attach to business owners personally.  If the business fails to pay its taxes, the owners of the business will be responsible personally for paying those obligations.  Similarly, if the business fails to pay wages to employees, the person(s) making the decision not to pay wages will be personally on the hook for those amounts.

Our guest blog post today comes from Kris Gray, Founder and Director of Business Financial Planning, and Jodi Giles, Director of Legacy Planning,  at Integrity Financial Corporation.   They share why the current lifetime gifting limits make now an ideal time to transfer ownership to the next generation in a company.

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Small and medium sized family businesses that are on a steady path of profitability should consider the new lifetime gift exemption levels as an ideal window for transferring shares to the next generation.

As part of the tax deal passed by Congress late last year, the lifetime gift-tax exemption jumped to $5 million from $1 million for individuals and to $10 million from $2 million for married couples in 2011 and 2012. This historic increase means that people can now give away significantly more than they could in 2010 without paying a penny in taxes.

The main benefit for those who make a gift now, is a transfer of shares at a much lower valuation than they will likely be at the time of death thereby shielding future appreciation from taxes. These are unprecedented numbers with huge tax savings potential. The catch? For now, the increased lifetime gift tax exemption amount is in force for 2011 and 2012, but it is anyone’s guess what will happen after 2012.

To think, just a year ago the lifetime gift tax exemption amount was only $1 million (a different figure than the estate tax upon death). Business owners now have the chance to pass a substantially larger stake in their businesses to the next generation during their lifetime while simultaneously coaching them on important business decisions.　

There are a number of ways to incorporate this potentially temporary gift tax exemption amount into a comprehensive estate plan. That said, transferring ownership could raise complicated succession and estate-planning issues that families need to address. Such issues often involve thoughtful conversations during the planning process. Given we are already halfway through this two-year window of opportunity, it makes sense for those wanting to take advantage of the new gift-tax ceiling to start planning now.

 ”‘In this world nothing can be said to be certain except death and taxes.”  In considering Benjamin Franklin’s familiar words, can you say what would happen to your assets and your loved ones if you died unexpectedly?

You might think you don’t need a will because you are young and healthy or perhaps you don’t have many assets. But everyone who owns anything has an estate.  This may include a home, cars, bank accounts, life insurance policies, retirement plans, and personal property such as furniture or jewelry.  You have worked your whole life to accumulate the property that you own, and you should be the one to decide how your property will be distributed when you are gone.  If you do not plan how your estate will be handled, the government will handle it for you, without regard for your wishes or those of your loved ones.

This fact is what makes estate planning a step of immediate importance that should not be ignored.  It helps to ensure that your property will go to the people you want it to go to, in the way you want it to, at the times you want it to and, to a certain extent, how much in taxes the government will receive.

Estate planning also allows you to provide tools and guidance to your family if you should become incapacitated.  Your estate plan allows you to make your wishes clear regarding medical treatments and end-of-life care and to appoint an agent to manage your assets if you become unable to do so.

Proper estate planning will give you confidence that your assets are protected and will assist your family with difficult decisions they may not be prepared to handle.  It is a sound investment for both you and your loved ones.