Friday, December 17, 2010

The New Tax Bill…Merry Christmas!

The House and Senate passage of a bipartisan tax bill insures that we will have extension of the “Bush Tax Cuts.”
Here is a thumbnail sketch:
Individual income and payroll taxes.
The bill extends through 2012 the Bush-era tax rates enacted in 2001-2003, instead of allowing them to return to pre-2001 levels, effectively preventing a rise for nearly all U.S. taxpayers.
“Affluent” taxpayers also benefit from the two-year repeal of the "Pease" limitation (named for the congressman who sponsored it) and personal exemption phase-out (PEP). These are deduction limits that functioned as back-door tax increases for many affluent taxpayers. The Pease provision cut itemized deductions by 3% for incomes above a threshold; PEP eroded the value of the personal exemption.
For 2011 only, the bill imposes a reduction in Social Security (FICA) taxes, cutting by two percentage points the employee's portion of the 6.2% tax. Savings per worker will vary with income, but could be as much as $2,136 for those earning more than $106,800, the maximum amount subject to Social Security tax. Both members of a married couple can receive the benefit.
The bill also contains a two-year patch for the "alternative minimum tax" retroactive to January 2010. The AMT, an alternate tax regime originally meant to ensure that people with high incomes pay taxes, isn't indexed for inflation, and has come to include middle-class taxpayers. The patch spares an additional 21 million taxpayers this year.
Investment taxes.
The bill extends for two years the current tax rates on long-term capital gains and dividends. The top rate for both will remain at its historic low of 15%. The rate will remain zero for couples with taxable income below $69,000.
Deductions and credits.
Among the benefits extended through 2011: deductions for teacher expenses and for state sales taxes in lieu of state income taxes. Lawmakers also extended through 2011 the provision allowing taxpayers over age 70½ to make tax-free donations of IRA assets to qualified charities.
Several education benefits were also extended through 2012; not renewed was a property-tax deduction for non-itemizers.
Estate and gift taxes.
For 2011 and 2012, the top estate-tax rate falls to 35% and the exemption rises to $5 million an individual.
The bill also allows executors of 2010 estates to elect whether to use 2010 rules or 2011 rules. Also for the first time, estate, gift and generation-skipping taxes will be "unified" so that one $5 million exemption per individual applies to all three. "This will make it much easier for wealthy taxpayers to make gifts during life to grandchildren

Monday, November 29, 2010

Don’t Ignoring FBAR Disclosure

As reported by local newspapers, a Hillsdale woman pled guilty to filing false tax returns and admitted she concealed more than $750,000 in an offshore account set up with her father with UBS AG. Lucille Jackson admitted that in her 2005 tax return she failed to report interest, dividends and capital gain income from a Swiss account that had been opened in her name and funded by her father in order to evade IRS reporting requirements. Of all the UBS tax evasion cases around the country, so far this is the lowest tax loss that anybody has been charged with. Omitted from her tax returns the year 2000 and 2007 was a tax loss of more than $5,000 but less than $12,000. In this case, the taxpayer faces up to three years in prison while her father faces five years in prison.

Interest and dividends earned on foreign savings accounts are reported on Form 1040, Schedule B. In addition, the taxpayer must file Form TD F90-22.1 (Report of Foreign Bank and Financial Accounts (FBAR)) annually by June 30th to report financial interest in, and other authority over, each foreign account – even if the account does not generate any taxable income – if the value of the account exceeds $10,000 at any time during the calendar year.

For those who have filed FBAR disclosures, this conviction may seem like a “surprise.” It comes as no surprise to me as Treasury has been extremely diligent in tracking down foreign accounts. This conviction is a “shout out” to all who have foreign accounts that they better comply, or else.

Thursday, July 8, 2010


The following was reported in the July 8, 2010 edition of the Wall Street Journal:

The International Monetary Fund advised the Obama administration to consider raising taxes and reducing Social Security benefits as ways to contain the U.S. budget deficit and public debt.

In its annual review of the U.S. economy, the IMF forecast that the economy will grow 3.3% this year, and then not top 3% annual growth over the following five years,. As a result, the IMF projections of the deficit and debt top White House forecasts.

The administration has pledged to halve the deficit by 2013 and to stabilize the public debt at 70% of gross domestic product by 2015. However, the IMF projects that current policies would push the debt level up to 95% of GDP by 2020 and above 135% by 2030.

The IMF urged the administration to cut the budget deficit by about 8% of GDP by 2015, which is nearly three percentage points more than the administration plans.
Spending cuts aren't sufficient, the IMF said, and it suggested a number of politically difficult ways of reducing debt, including:
● eliminating the popular deduction for interest on mortgages,
● raising energy taxes,
● reducing Social Security benefits or
● imposing a national consumption tax.
Yet in another article the Wall Street Journal reported that Treasury Secretary Tim Geithner offered a glimmer of hope to investors who are facing huge tax increases on capital gains and dividends next January.
In a CNBC interview late Wednesday, Geithner said the Obama administration still hopes to hold the top tax rate on both capital gains and dividends to 20% next year – the level the White House has been proposing since taking office.
Of course, a 20% rate would represent a big increase over the current 15%. But it’s a lot better than the 39.6% top rate for dividends that congressional Democrats have signaled they were planning next year for higher earners.
Congress currently is planning to extend most of the Bush breaks – particularly those for middle-income earners – for some period, perhaps only a year or two. But budget rules that lawmakers passed earlier this year anticipated the Bush-era breaks for higher income earners would expire immediately. That would mean the tax on dividends for higher earners would return to the pre-Bush ordinary income rate. That rate is expected to rise to 39.6% next year.
However, there are growing worries among Democrats that their plans to allow taxes to rise substantially for higher earners will create drag on the recovery, and particularly on financial markets. That appears to be opening the possibility that some of their severest tax increases will be put off, at least for a bit longer.
“There’s…real concern about what would happen in the markets” if dividend rates went as high as 39.6%,” Stretch said. Given the fragile state of the economy, lawmakers “are not in the mood to experiment with the markets.”
So take your pick-higher taxes? Lower taxes? Maybe both!

Wednesday, June 9, 2010

Death, But Not Taxes, At Least for 2010

Ben Franklin famously said “but in the world nothing can be said to be certain except death and taxes.” While at least for the tax year 2010, Mr. Franklin may not be correct. When Congress enacted EGTRRA (the Economic Growth and Tax Relief Reconciliation Act of 2001), it included a 1-year repeal of the Estate and GST taxes and introduced a modified carryover basis regime in 2009, followed by a sunset provision that caused reversion to pre-EGTRRA law on January 1, 2011. The consequence of their actions is that this year 2010 there is no federal estate tax. Most estate planners presume that before the law sunset, a new estate tax law would be in place for the year 2010.

In late March, Dan L. Dunkin died. According to the New York Times report of June, 2010, his net worth is estimated to be $9 billion dollars, ranking him as the 74th wealthiest in the world. Because Congress allowed the estate tax to lapse for 2010, Mr. Dunkin’s heirs are quite happy. According to the article, Mr. Dunkin’s death could have resulted in $2 billion dollars in estate taxes being paid to the federal government but now his estate may pass to his heirs free of estate taxes.

As we are now in mid-June 2010, the likelihood of an estate tax being enacted in the year 2010 becomes less likely. Should the current law continue into effect for January 2011, the former federal exemption amount of $3.5 million dollars will be reduced to $1 million dollars.

A second troubling factor is carryover basis. Starting in the year 2010, we have tumbled into carryover basis requirements for property passed through estates. Our only experience with a carryover basis regime at death, was the ill-faded efforts to enact such a regime in the late 1970s. This change was so disliked that it was repealed before it went into effect. The objective of carryover basis is that rather than property acquired from a decedent having a new basis as was the rule for many years, such property is now subject to the same basis which the decedent had at the time of his death. When the new carryover basis rules come in 2011, each taxpayer is limited to $1.3 million dollars worth of a step-up basis. It will be the Executor’s job to allocate that to particular assets, like a house, and therefore to specific heirs. There is also a $3 million dollar step-up available for spouses for appreciated assets. But all other assets are to be valued at their original value.

The old step-up basis rules were a big tax break for heirs. What it meant is that if your father left you a house worth $1 million dollars that he purchased for $500,000 and then you turned around and sold it for $1 million dollars, you owed ZERO capital gains tax on that sale. This applied to all assets inherited at death. Now we will have to cope with carryover basis. The carryover basis rules are going to be difficult and time consuming to administer because the Executor will have to comb through the decedent’s records to determine date of death value. Unless a taxpayer can prove basis, it is presumed to be zero.

Perhaps before the end of the year, if Congress passes new legislation Ben Franklin’s famous quote might be correct as well for 2010.

Thursday, May 20, 2010

Updated Form 3115

IRS Updates Change of Accounting Form 3115.

A newly issued revenue procedure on accounting method changes has increased the number of methods of accounting eligible for which the IRS considers automatically granted, while also providing additional guidance on the process and scope of method changes.

The number of automatic changes now total 149.

Rev. Proc. 2009-39 added several accounting methods to the appendix of Rev. Proc. 2008-52 for obtaining the IRS's automatic consent of method changes. Among the additions were:
• materials and supplies (consistent with reg. section 1.162-3);
• repair and maintenance costs; and
• tenant construction allowances.

In the guidance, the IRS also clarified that certain actions constitute being under examination. The additions to section 3.08 of Rev. Proc. 2008-52 include a taxpayer exam before the Joint Committee on Taxation and a taxpayer exam in the compliance assurance process. Also, notification to a controlled foreign corporation's controlling domestic shareholders is now deemed an "issue under consideration."
Other portions of the guidance made clear when a taxpayer must file separate changes on separate forms (reg. section 6.02(1)(b)) and narrowed the automatic extension of time in reg. section 1.301-9100 for filing outside the window to "unusual and compelling circumstances."

Given that the guidance comes shortly before the September 15 extended tax return filing deadline for corporations, section 5 of the guidance notes that the effective date covers method change requests filed under Rev. Proc. 2008-52 made on or after August 27, 2009. The transition rule also gives some benefit to taxpayers that have already filed with the IRS a Form 3115, "Application for Change in Accounting Method," by allowing them to convert the filing to take advantage of the newly added automatic methods if filed by the later of October 26 or issuance of a letter ruling. Taxpayers can also amend previously filed change requests for the tax year ending December 31, 2008, or later tax years.

Monday, April 26, 2010

Cash Audits and the Mark-Up Methodology

Why should you care about cash audits?

You should know that the Division of Taxation has created 21 field audit teams strategically located throughout the State of New Jersey. These “in-state field audit” teams are responsible for the examination of taxpayer’s books and records to insure compliance with existing laws and regulations. Audits are usually performed on site at the taxpayer’s place of business or at a site provided by the taxpayer’s representative. Audits are comprehensive in nature and intend to include all taxes administered by the Division of Taxation, however, their primary focus is on sales and use tax and corporation business tax.

Additionally that the Division, and now the IRS, has recently placed a special emphasis on the audit of smaller “cash” businesses. The initiation of the cash audit program is intended to strengthen compliance in collection efforts as well as level the playing field for compliance of businesses.

New Jersey Case Law

Since 2005, there have been two key decisions that have been decided on which the Division of Taxation relies. The first is Yiolmaz, Inc. v. The Director, 22 N.J. Tax 204 (2005); affirmed on appeal 390 N.J. Super. 433 (2007) and Charlie O’s, Inc. v. The Director, 23 N.J. Tax 171 (2006).
Both of these cases were “cash audit cases.”
The underlying question in these cases were the propriety of the auditor adding additional sales to the taxpayer’s records in order to determine the amount of sales tax due.

When a taxpayer challenges an assessment of sales tax by the Division of Taxation based on an audit of a cash business involving only factual issues and a method employed by the Director, the taxpayer can rebut the presumption that the assessment is correct only by “cogent evidence that is definitive, positive and certain in qualify and quantity to overcome the presumption.” In the absence of evidence that the amount of the assessment is “far wide of the mark,” the taxpayer cannot overcome the presumption simply by attacking the Director’s methodology. Under our statutes, the Director is given broad authority to determine the tax from any available information, and, if necessary, to estimate the tax from external indices. N.J.S.A. §54:32B-19. The taxpayer’s evidence must focus on the reasonableness of the underlying data used by the Director and the reasonableness of the methodology used. An aberrant methodology will overcome the presumption of correctness. An imperfect methodology will not.

In Yiolmaz, the taxpayer operated a restaurant.
The taxpayer had virtually no record of its receipts for the 1995 through 1998 audit period as required by the statute from which to verify the gross receipts reported on its tax returns; it did not retain cash register receipts, did not use guest checks and did not maintain summary records of sales.1 Accordingly, the Director's auditor used an indirect "markup" procedure to reconstruct the income and receipts of taxpayer's cash business and determine the sales tax assessment and deficiency and resulting increases in the corporate business tax (CBT) and gross income tax (GIT) withholding assessments. Under this methodology, the auditor selected a test period, which in this case was the calendar year 1997. The auditor then compared the cost of goods sold by the taxpayer for that period, as developed from invoices and the records of suppliers, to the menu prices, developing a ratio of selling price to cost, or "markup." The auditor then applied that ratio to the cost of purchases for each year covered by the audit to arrive at an estimate of gross receipts subject to sales tax for the audit period.2

Using the gross sales determined from his markup analysis, the auditor computed a sales tax deficiency and recomputed taxpayer's CBT for 1995, 1996 and 1997 and computed the tax for 1998 because no return had been filed for that year, and made assessments for all of the audit years. He also made an assessment of additional GIT (withholding) based on his calculation of adjusted employee wages and estimated salary attributed to Mr. Yilmaz. In the absence of any documentation or evidence presented by the taxpayer to support the information reported on the returns, the Director issued a notice of assessment.

The principal issue at trial was the "reasonableness of the methods employed by the Director for an audit period where the taxpayer had virtually no records of its receipts." The Tax Court began its analysis with the well settled principle that the Director's assessments of tax are presumed to be correct and the taxpayer has the burden of overcoming the presumption.3 These cases have recognized that the "naked assertions" of the taxpayer, without supporting records or documentation, are insufficient to rebut the Director's presumption.4 The court noted, however, that the extent of the burden of proof placed on the taxpayer to overcome the presumption was ill-defined, and the case law needed a specific, workable standard.
When a taxpayer challenges an assessment by the Director based on an audit of a cash business, involving only factual issues and the methods employed by the Director, the taxpayer can rebut the presumption that the assessment is correct only by cogent evidence that is "definite, positive and certain in quality and quantity to overcome the presumption."5

In the absence of evidence that the amount of the assessment is "far wide of the mark," the taxpayer cannot overcome the presumption simply by attacking the Director's methodology.6 As the court noted, the Director is given broad authority to determine the tax from any available information and, if necessary, to estimate the tax from external indices. See N.J.S.A. 54:32B-19. The court rejected the taxpayer's suggestion that the onus should be on the Director to establish that it used "the most reasonable means available" or "the best possible method" to estimate the taxpayer's receipts. The court reasoned that it would be contrary to the purpose of the recordkeeping statute to place such a high burden and expense on the Director when it was taxpayer's own failure to maintain proper records that "forced the Director to resort to the markup method in the first place."7

The taxpayer's evidence must focus on the reasonableness of the underlying data used by the Director and the reasonableness of the methodology used. An "aberrant" methodology will overcome the presumption of correctness. An imperfect methodology will not.

A similar case was that of Charlie O’s, Inc. v. Division of Taxation, 23 N.J. Tax 171(2006). In Charlie O’s, the taxpayer was a New Jersey corporation that operated a restaurant. The taxpayer’s corporate business tax returns consistently reported larger amounts of gross receipts than did the taxpayer’s sales tax returns. The Director conducted an audit and determined that additional sales and use tax was due. The court found that since the CBT returns and sales tax reports reporting wholly different gross receipts, the auditor had sufficient authority under N.J.S.A. §54:32B-19 to use the mark up method to determine whether the taxpayer had underreported its gross receipts on the sales tax returns.

The methodology employed by the auditor, however, was aberrant, in that he conformed gross receipts for sales tax purposes with the gross receipts as reported on the CBT returns increasing the purchases made by the taxpayer by an arbitrary amount which, when multiplied by the mark up ratio, produced estimated gross receipts that conforming with those reported on the C.B.T. returns. At trial, the auditor when confronted with the difference in the C.B.T. returns and sales tax returns the court noted that it warranted a closed examination and the auditor had a wide latitude to make a determination regarding sales tax that are due using one or more several methodologies as he saw fit. The court noted this authority, however, is not unlimited. The court found that there was no authority for the auditor to adopt the gross receipts as reported on the C.B.T. returns rather than the gross receipts as reported on the sales tax returns merely because it was more convenient to do so or because the use of the gross receipts reported on the C.B.T. return produced a larger sales tax liability. The basis which the auditor used for making this conclusion was because the taxpayer lacked any cash register tapes through which receipts could be verified. His concern was that the taxpayer did not report all of its receipts in the bank. The court pointed out that N.J.S.A. 54:32B-16 requires vendors to keep records of every purchase in the form that the Director may, by regulation, require. “Such records shall include a true copy of each sales slip, invoice, receipt, statement or a memorandum” showing the amount of separately stated tax.

A true copy of all sales slips, invoices, receipts, statements, memoranda of price, or cash register tapes,8 issued to any customer by a vendor who is required to be registered pursuant to the provisions of the Sales and Use Tax Act (N.J.S.A. 54:32B-1 et seq.) and records of every purchase and purchase for lease must be available for inspection and examination at any time upon demand by the Director, Division of Taxation, or his or her duly authorized agent or employee and shall be preserved for a period of four years from the filing date of the quarterly period for the filing of sales tax returns to which such records pertain.

In addition, N.J.A.C. 18:24-2.4(a) provides that when a taxpayer maintains summary records showing total receipts and taxable receipts, the taxpayer may dispose of individual sales slips, invoices, receipts, statements, memoranda of price or cash register tapes. The taxpayer’s cash receipts and cash disbursements journals were summary records. Under the Director's regulations, taxpayer's records were deemed to be adequate.

A key point was the fact that the taxpayer’s expert was able to demonstrate that the entries in the cash receipts and disbursement journal corresponded with bank statements and a spreadsheet which reconstructed the taxpayer’s records. The spreadsheet showed that the taxpayer’s gross receipts were overstated on the CBT prepared by the taxpayer’s prior accountant. The court, based on the evidence presented, agreed with the taxpayer and reduced the tax consistent with the taxpayer’s records.9


As these cases demonstrate a cash audit of a small business can be a very devastating event where the taxpayer fails to maintain proper records. The problem is that taxpayers often do not have cash register tapes or the tapes are incomplete. This is one strike against the taxpayer. The second strike is the failure to maintain proper original books of entry such as journals and ledgers; the third strike is the failure to maintain summary records.

Couple the failure to maintain records with the ability of the auditor to use any reasonable means to determine the taxpayer’s gross sales and often there will be a significant sales tax deficiency as well as an income tax liability. The auditor will often also look at other aspects of the taxpayer’s business including expenditures, salaries, draw and non-deductible business expenses, travel and entertainment, cars and other personal use vehicles, and in some cases, an examination of the taxpayer’s residence and lifestyle.

Taxpayer should be well advised that in the event he or she is notified of a cash audit they should not take it lightly. They should be prepared. They should have their tax professional review all of their records to substantiate their reported corporate income tax and sales tax. A “red flag” is often the difference between the reported CBT income and the sum total of the sales tax reported.

In addition to a potential increase in sales tax, a cash business also faces the issue of an increase in the use tax. The use tax is paid on items purchased for which no sales tax was paid. An auditor will examine a taxpayer’s records to isolate these transactions, compute the appropriate use tax. This includes looking at credit card receipts, checks written, etc.

As part of the taxpayer’s records, the taxpayer should maintain appropriate certificates such as resale certificates for property sold to others who in turn are going to be reselling the property, form ST-3, or if the property is going to be used for exempt use then purchaser must complete form ST-4 and such records must be maintained by the taxpayer.

If a taxpayer is making capital improvements, then form ST-8 must be completed by the property owner and maintained by the taxpayer. If the taxpayer is a contractor and making a purchase for erecting structures or building, etc. for exempt purchases then form ST-13 must be completed.

These are some of the forms that need to be maintained by the taxpayer in order to have proper records in the event of an audit.

Not only has New Jersey stepped up in enforcement provisions and along with that the courts decisions which provide wide latitude to State auditors, but in addition in the event of increase and the underlying tax, penalties and interest provisions will apply. There are penalties for failure to file tax returns on time which is 5% per month up to a maximum of 25%. There is a penalty for underpayment of tax required to be shown on a return which unless there is reasonable cause will amount to 5% of the underpayment of the tax, and there is interest on the deficiency which is charged at 3% plus the prime rate assessed for each month compounded annually at the end of each calendar year. There are also penalties for fraud, etc.

Accordingly, cash based taxpayers would be well advised to maintain good records and remit their taxes timely. In the past, taxpayers could rely on the “audit lottery” and if they were caught they grudgingly would pay the tax penalties and interest. But with the increased enforcement, better auditing tools plus case law in favor of the State, the audit lottery is no longer a good “bet.”

The IRS Cash Audit Guide

The IRS has posted an Audit Techniques Guide (ATG) to provide guidance to its agents on how to examine income in a cash intensive business.10 While the ATG is not an official pronouncement of the law or IRS's position and cannot be used, cited, or relied upon as such, it does provide valuable information to practitioners and taxpayers on how IRS audits cash intensive businesses including specific types of cash businesses.

The ATG is presented in several chapters.

The ATG notes that the individual income tax “gap” is thought to be in the hundreds of billion of dollars. In part, this may be because there is an increasing underreporting of income by those taxpayers with the ability to determine their own reported income, such as businesses that receive most of their income in cash. Cash transactions are anonymous, leaving no trail to connect the purchaser to the seller, which may lead some individuals to believe that cash receipts can be unreported and escape detection.

Ways cash is misappropriated. The ATG observes that there are three main ways to misappropriate cash from a business:
... It can be skimmed from receipts before it is recorded.
... It can be stolen after it has been recorded.
... A fraudulent disbursement can be created.

Indicators of underreported income. The ATG states that the most significant indicator that income has been underreported is a consistent pattern of losses or low profit percentages that seem insufficient to sustain the business or its owners. Other indicators of unreported income include:
... A life style or cost of living that can't be supported by the income reported.
... A business that continues to operate despite losses year after year, with no apparent solution to correct the situation.
... Application of the Cash Transaction examination method (Cash T) shows a deficit of funds.
... Bank balances, debit card balances and liquid investments increase annually despite reporting of low net profits or losses.
... Accumulated assets increase even though the reported net profits are low or there's a loss.
... Debt balances decrease, remain relatively low or don't increase, but low profits or losses are reported.
... A significant difference exists between the taxpayer's gross profit margin and that of his industry.
... Unusually low annual sales for the type of business.

Examination techniques. The ATG stresses that examination techniques must be tailored to provide for the best analysis of a specific taxpayer's possible income stream. There are several techniques that can be used successfully when working with cash intensive businesses. First, a financial status analysis including both business and personal financial activities should be done, the ATG advises. This is a required minimum income probe. If it shows an imbalance in the cash flows indicative of underreported income, an examiner is told to request clarification or explanation from the taxpayer before beginning the use of an Indirect Method (Financial Status Audit Techniques).

Indirect methods, such as a fully developed Cash T, percentage mark-up, source and application of funds or bank deposit and cash expenditures analysis, can then be used to confirm the amount of any understatement. The ATG says that the most critical aspects to successfully examining a cash intensive businesses is the examiner's ability and skill in gathering information about how the taxpayer conducts business, documenting cash inflows and outflows, and conducting a detailed interview with the owner of the business relating to business and non-business cash receipts and cash expenditures.

Cash intensive business. A cash intensive business is one that receives a significant amount of receipts in cash. This can be a business such as a restaurant, grocery or convenience store, that handles a high volume of small dollar transactions. It can also be an industry that provides cash payments for services, such as construction or trucking, where independent contract workers are generally paid in cash.

A careful practitioner should closely examine the ATG pronouncement and look for signs of underreporting of income before the client is audited.
1. See N.J.S.A. 54:32B-16 requiring records of sales to be retained for examination and inspection by the Division for a three-year period from the filing of the return, or longer if required by the Director); N.J.A.C. 18:24-2.3(a)(requiring the retention of cash register tapes for three years, amended effective June 1, 1998 to require a four-year retention period, 30 N.J.R. 2070(b)(June 1, 1998)); N.J.A.C. 18:24-2.4(a), (b) (permitting cash register tapes to be discarded after a certain period where summary records of sales are maintained; the summary records must be retained for four years).

2.In developing his markup ratio, the auditor reduced taxpayer's audited gross receipts by various allowances for discounts, giveaways and specials.

3. Atlantic City Transp. Co. v. Dir., Div. of Taxation, 12 N.J. 130, 146, 95 A.2d 895 (1953).

4. TAS Lakewood, Inc. v. Dir., Div. of Taxation, 19 N.J. Tax 131, 140 (Tax 2000); Ridolfi v. Dir., Div. of Taxation, 1 N.J. Tax 198, 202-03 (Tax 1980).

5. Pantasote, supra, 100 N.J. at 413, 495 A.2d 1308 (quoting Aetna Life Ins. Co. v. City of Newark, 10 N.J. 99, 105, 89 A.2d 385 (1952)).

6. Id. at 414-15, 495 A.2d 1308.

7. Yilmaz, supra, 22 N.J

8. Cash register tapes are source documents that enable the Division to spot check the accuracy of the summary records. In other words, although not absolutely required by the regulations if summary records are available, cash register tapes are helpful, and if an auditor has reason to believe that a taxpayer's summary records are inaccurate, and no cash register tapes are available, the use of a markup analysis is appropriate. N.J.S.A. 54:32B-19.

9. The court mused that the negotiating of gross sales on the corporate income tax return may have to be done to facilitate a loan.


Friday, March 26, 2010

New York Sales Tax Trap

For many business owners, the LLC form of doing business is the preferred format. An LLC provides a number of benefits to the owner by limiting liability, providing for a single tax (no tax at the entity level) and by providing flexibility in capitalization and ownership. For those LLCs which are doing business in the State of New York, however, this form of business can be deadly. In a decision handed down on December 23, 2009 by the New York Tax Appeals Tribunal, the panel upheld the provision of the New York Sales and Use Tax law that imposes absolute personal liability on any member of a partnership or limited liability company for all of the unpaid liabilities of the partnership or LLC in which they hold an interest.

In the Matter of Santo DTA821797, N.Y.S. Tax App. Triv. December 23, 2009, the court found that Joseph P. Santo who entered into a business venture structured in the form of an LLC was personally liable for unpaid sales taxes. Mr. Santo entered into this business venture (a restaurant) with others. Mr. Santo contributed no capital to the LLC, but later loaned the LLC all of his savings - $15,000. Another member (Scotti) was in charge of all the financial operations of the LLC. In 2005, the restaurant opened, but had difficulty paying its construction creditors. In May of 2006, the tax department issued a Notice of Determination to Mr. Santo finding him liable for almost $200,000 of the LLC’s unpaid sales tax.

At trial, the Administrative Law Judge applied the “duty to act standard” found in the statute, and determined that Mr. Santo was not responsible for the financial management of the LLC and, therefore, was not responsible to pay the sales tax. In December 2009, however, the Appeal Tribunal reversed the Administrative Law Judge holding that it was an error for the Administrative Law Judge to treat Mr. Santo as if he were an officer or employee of a corporation. The Tribunal stated that Mr. Santo was a member of an LLC, and as with members of a partnership, such members are subject to the absolute liability standard and “subject to per se liability for the taxes due from the LLC.”

The statute involved in the decision is N.Y. Tax Law Section 1131. The applicable provision is Section 1 of the statute entitled “Persons Required to Collect Tax.” A careful reading of the statute indicates that a person required to collect tax is “any member of a partnership or limited liability company.” The Tribunal interpreted this provision of the Act to impose per se (absolute) liability on any member of a limited liability company.

This decision can be a ticking time bomb for many taxpayers. Moreover, the statue does not only apply to New York limited liability companies, but to all limited liability companies which would be subject to collecting New York sales tax. That would mean any LLC or partnership that was qualified to do business in New York no matter where they were formed.

It would seem that there is a “glitch” in the statute, however, the New York State tax department has issued numerous assessments against individuals who invested small amounts of money to LLCs formed to operate restaurants, bars or similar ventures in exchange for small minority interests in the LLCs with absolutely no right or ability to oversee their operations. It is common for restaurants and similar business to fail and have unpaid sales tax. Often these businesses have little or no records and assessments are made based on estimates which are often much greater than the actual liability. The tax department’s position is that each individual member of the LLC (as well as individual members of upper-tier LLCs) is jointly and severely liable for the full amount of the tax, penalties and interest.

Clients who find themselves in this position should be advised to review the structure of their business to determine their exposure and to modify their business to avoid personal liability.

Wednesday, March 24, 2010

The True Cost of Health Care

Thing We Should Have Been Told Before The Vote

Tax Changes Relating to Universal Health Coverage Mandate

Penalty for remaining uninsured

Effective for tax years beginning after Dec. 31, 2013, non-exempt U.S. citizens and legal residents would have to maintain minimum essential coverage. or pay a penalty. Those failing to maintain minimum essential coverage in 2016 would be subject to a penalty equal to the greater of: (1) 2.5% of household income over the threshold amount of income required for income tax return filing, or (2) $695 per uninsured adult in the household. The fee for an uninsured individual under age 18 would be one-half of the fee for an adult. The total household penalty wouldn't exceed 300% of the per adult penalty ($2,085), nor exceed the national average annual premium for the “bronze level” health plan offered through the Insurance Exchange that year for the household size.

The per adult annual penalty would be phased in as follows:
$95 for 2014; $325 for 2015; and $695 in 2016. For years after 2016, the $695 amount would be indexed to CPI-U, rounded to the next lowest $50. The percentage of income would be phased in as follows: 1% for 2014; 2% in 2015; and 2.5% beginning after 2015. If a taxpayer files a joint return, the individual and spouse would be jointly liable for any penalty payment.


Among those individuals who would be exempted from the penalty: Individuals who cannot afford coverage because their required contribution for employer sponsored coverage or the lowest cost “bronze plan” in the local Insurance Exchange exceeds 8% of household income; those who are exempted for religious reasons; and those residing outside of the U.S.

Low-income tax credits for participating in health exchanges

For tax years ending after 2013, tax credits would be available for individuals and families with incomes up to 400% of the federal poverty level ($43,420 for an individual or $88,200 for a family of four) that are not eligible for Medicaid, employer sponsored insurance, or other acceptable coverage. These individuals and families would have to obtain health care coverage in newly established Insurance Exchanges in order to obtain credits. Additionally, effective on the enactment date, a “cost-sharing subsidy” would be provided to low income individuals to help with health insurance costs.

Employer responsibilities

Effective for months beginning after Dec. 31, 2013 an “applicable large employer” (generally, one that employed an average of at least 50 full-time employees during the preceding calendar year) not offering coverage for all its full-time employees, offering minimum essential coverage that is unaffordable, or offering minimum essential coverage that consists of a plan under which the plan's share of the total allowed cost of benefits is less than 60%, would have to pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee. The penalty for any month would be an excise tax equal to the number of full-time employees over a 30-employee threshold during the applicable month (regardless of how many employees are receiving a premium tax credit or cost-sharing reduction) multiplied by one-twelfth of $2,000.

Also, an applicable large employer that offers, for any month, its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an employer sponsored plan would be subject to a penalty if any full-time employee is certified to the employer as having enrolled in health insurance coverage purchased through a State exchange with respect to which a premium tax credit or cost-sharing reduction is allowed or paid to such employee or employees.

“Free choice vouchers.”

After 2013, employers offering minimum essential coverage through an eligible employer-sponsored plan and paying a portion of that coverage would have to provide qualified employees with a voucher whose value could be applied to purchase of a health plan through the Insurance Exchange.

Qualified employees would be those employees: who do not participate in the employer's health plan; whose required contribution for employer sponsored minimum essential coverage exceeds 8%, but does not exceed 9.5% of household income; and whose total household income does not exceed 400% of the poverty line for the family. The value of the voucher would be equal to the dollar value of the employer contribution to the employer offered health plan.

Tax credits for small employers offering health coverage

Effective for tax years beginning after 2009, a qualified small employer would be given a tax credit for nonelective contributions to purchase health insurance for its employees. A qualified small business employer for this purpose generally would be an employer with no more than 25 full-time equivalent employees (FTEs) employed during the employer's tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000. However, the full amount of the credit would be available only to an employer with 10 or fewer FTEs and whose employees have average annual fulltime equivalent wages from the employer of less than $25,000. These wage limits would be indexed to the Consumer Price Index for Urban Consumers (“CPI-U”) for years beginning in 2014.

For tax years beginning in 2010 through 2013, the credit would be 35% for small employers with fewer than 25 employees and average annual wages of less than $50,000 who offer health insurance coverage to their employees. In 2014 and later, eligible small employers who purchase coverage through the Insurance Exchange would be eligible for a tax credit for two years of up to 50% of their contribution.

Dependent coverage in employer health plans

Effective on the enactment date, the health reform measure would extend the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan to any child of an employee who has not attained age 27 as of the end of the tax year. This change would also be intended to apply to the exclusion for employer-provided coverage under an accident or health plan for injuries or sickness for such a child. Also, self-employed individuals would be permitted to take a deduction for any child of the taxpayer who has not attained age 27 as of the end of the tax year.

Health-Related Revenue Raisers

Excise tax on high-cost employer-sponsored health coverage

For tax years beginning after Dec. 31, 2017, the bill would place a 40% nondeductible excise tax on insurance companies and plan administrators for any health coverage plan to the extent that the annual premium exceeds $10,200 for single coverage and $27,500 for family coverage. An additional threshold amount of $1,650 for single coverage and $3,450 for family coverage would apply for retired individuals age 55 and older and for plans that cover employees engaged in high risk professions.

The tax would apply to self-insured plans and plans sold in the group market, but not to plans sold in the individual market (except for coverage eligible for the deduction for self-employed individuals). Stand-alone dental and vision plans would be disregarded in applying the tax. The dollar amount thresholds would be automatically increased if the inflation rate for group medical premiums between 2010 and 2018 is higher than the Congressional Budget Office (CBO) estimates in 2010.

Employers with age and gender demographics that result in higher premiums could value the coverage provided to employees using the rates that would apply using a national risk pool.
The excise tax would be levied at the insurer level. Employers would be required to aggregate the coverage subject to the limit and issue information returns for insurers indicating the amount subject to the excise tax.

New employer reporting responsibilities

For tax years beginning after Dec. 31, 2010, employers would have to disclose the value of the benefit provided by them for each employee's health insurance coverage on the employee's annual Form W-2.

Additional Hospital Insurance Tax (HI) for high wage workers

For tax years beginning after Dec. 31, 2012, the HI tax rate would be increased by 0.9 percentage points on an individual taxpayer earning over $200,000 ($250,000 for married couples filing jointly); these figures are not indexed.

Surtax on "High Earner" unearned income

For tax years beginning after Dec. 31, 2012, a 3.8% surtax called the Unearned Income Medicare Contribution, would be placed on net investment income of a taxpayer earning over $200,000 ($250,000 for a joint return). Net investment income would be interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Net investment income would be reduced by properly allocable deductions to such income.

New limit on health FSA contributions

The amount of contributions to health flexible spending accounts (FSAs) would be limited to $2,500 per year, effective for tax years beginning after Dec. 31, 2012. The dollar amount would be inflation indexed after 2013.

Restricted definition of medical expenses for employer provided coverage
For purposes of employer provided health coverage (including health reimbursement accounts (HRAs) and health flexible savings accounts (FSAs), health savings accounts (HSAs), and Archer medical savings accounts (MSAs)), the definition of medicine expenses deductible as a medical expense would generally be conformed to the definition for purposes of the itemized deduction for medical expenses. But this change would not apply to doctor prescribed over-the-counter medicine. Thus, the cost of over-the-counter medicine (other than insulin or doctor prescribed medicine) could not be reimbursed through a health FSA or HRA. In addition, the cost of over-the-counter medicines (other than insulin or doctor prescribed medicine) could not be reimbursed on a tax-free basis through an HSA or Archer MSA. These changes would be effective for tax years beginning after Dec. 31, 2010.

Increased tax on nonqualifying HSA or Archer MSA distributions

The additional tax for HSA withdrawals before age 65 that are used for purposes other than qualified medical expenses would be increased from 10% to 20%, and the additional tax for Archer MSA withdrawals that are used for purposes other than qualified medical expenses would be increased from 15% to 20%, both effective for distributions made after Dec. 31, 2010.
Modified threshold for claiming medical expense deductions

For tax years beginning after Dec. 31, 2012, the adjusted gross income (AGI) threshold for claiming the itemized deduction for medical expenses would be increased from 7.5% to 10%. However, the 7.5%-of-AGI threshold would continue to apply through 2016 to individuals age 65 and older (and their spouses).

Deduction for employer Part D would be eliminated

The deduction for the subsidy for employers who maintain prescription drug plans for their Medicare Part D eligible retirees would be eliminated, for tax years beginning after Dec. 31, 2012.

Industry-specific revenue raisers

The following revenue raising changes would be imposed on health related industries:

● A new deduction limit on executive compensation would apply to insurance providers.

● Pharmaceutical manufacturers and importers would have to pay an annual flat fee
beginning in 2011 allocated across the industry according to market share.

● Manufacturers or importers of medical devices would have to pay a 2.3% of the sale price is imposed on the sale of any taxable medical device by the manufacturer, producer, or importer of the device.

● Health insurance providers would face an annual flat fee on the health insurance sector effective for calendar years beginning after Dec. 31, 2013.... The indoor tanning industry would be hit with a 10% excise tax on indoor tanning services, effective for services provided on or after July 1, 2010.

● Non-profit Blue Cross Blue Shield organizations would have to maintain a medical loss ratio of 85% or higher in order to take advantage of the special tax benefits provided to them, including the deduction for 25% of claims and expenses and the 100% deduction for unearned premium reserves.

Non-Health Related Revenue Raisers

Corporate information reporting

Businesses that pay any amount greater than $600 during the year to corporate providers of property and services would have to file an information report with each provider and with IRS, effective for payments made after Dec. 31, 2011.

Codification of economic substance doctrine and imposition of penalties

The economic substance doctrine is a judicial doctrine that has been used by the courts to deny tax benefits when the transaction generating these tax benefits lacks economic substance. The courts have not applied the economic substance doctrine uniformly. The manner in which the economic substance doctrine should be applied by the courts would be clarified and a penalty would be imposed on understatements attributable to a transaction lacking economic substance. These changes would be effective for transactions entered into after the enactment date.
Estimated taxes for large corporations

Other Tax Changes

Simple cafeteria plans for small businesses

For tax years beginning after 2010, a new employee benefit cafeteria plan to be known as a Simple Cafeteria Plan would be established. This plan would be subject to eased participation restrictions so that small businesses could provide tax-free benefits to their employees; it would include self-employed individuals as qualified employees.

Liberalized adoption credit and adoption assistance rules

For tax years beginning after Dec. 31, 2009, the adoption tax credit would be increased by $1,000, made refundable, and extended through 2011. The adoption assistance exclusion also would be increased by $1,000.

New credit for new therapies

Effective for expenses paid or incurred after Dec. 31, 2008, in tax years beginning after that date, a two-year temporary credit would be created, subject to an overall cap of $1 billion, to encourage investments in new therapies to prevent, diagnose, and treat acute and chronic diseases.

New exclusion for certain health professionals

Payments made under any State loan repayment or loan forgiveness program that is intended to provide for the increased availability of health care services in underserved or health professional shortage areas would be excluded from gross income, effective for amounts received by an individual in tax years beginning after Dec. 31, 2008.