James W. Rahmlow, The Daily Record Newswire
The issue of payments of unreasonable compensation to employee shareholders has been contested by the IRS for C corporations for many years. Specifically, those situations where the compensation is set at unusually high amounts so as to allow the corporation to get the tax deduction for the wages paid is analyzed.
If the amounts had been paid as dividends, the company would get no tax deduction and the amount would thus be effectively double taxed. While this type of analysis has taken on less of a priority with the proliferation of flow through entities since 1986 (in fact the tactics are exactly opposite with flow through entities to reduce payroll taxes), it can still be a significant concern for C corporations.
In Aries Communications Inc. & Subs., TC Memo. 2013-97, this issue was litigated by the Tax Court after the IRS opposed the compensation level of the corporation’s sole shareholder who also served as general manager of the venture. The case is not particularly difficult from a fact standing, but is a great refresher in the various analyses and methodologies employed by the IRS including an analysis of comparable salaries for comparable positions and an analysis of the amount of earnings required to be retained by the corporation to satisfy an investor.
Future tax law changes open for discussion
The last significant modifications to tax law are generally considered to be those done in the 1980s. Currently, with an unbalanced federal budget, sequestration, expense cutting and revenue generation all on the table for discussion, we are hearing more and more about reforms to the tax laws. While the U.S. Senate and House of Representatives have their own views on tax modification and reform, President Obama has just released his fiscal 2014 budget and it does include some proposed tax changes. Following are a summary of select provisions, acknowledging that such provisions may have no support in the Senate or House and may never become law.
• Limitation on itemized deductions — Originally proposals considered that there would be a cap on the maximum amount of certain itemized deductions (charitable contributions, etc.) that an individual taxpayer would be allowed in any given year. The public outcry was large from the affected interest groups, not for profits for charitable contributions, the housing and financing industries for mortgage interest, etc. A proposal that seems to be getting more traction and has been specifically offered by the president is not limiting the aggregate amount of such deductions rather, limiting their value. Specifically, the maximum value that these amounts could be deducted to reduce taxable income would be 28 percent. For those in the 33 percent, 35 percent and 39.6 percent brackets, this would still provide a deduction, but at a significantly lowered value.
• Cap on retirement accounts — Considered here is a provision that would limit the amount that a taxpayer may accumulate in their tax deferred plans to reduce what is viewed as overfunding. This would relate to qualified plans, IRAs, deferred compensation and tax-sheltered annuities. I haven’t seen a mention of the ROTH IRA to date.
• Estate tax — Proposed is that the current maximum exclusion will be reduced to the 2009 level of $3.5 million, with $1 million for gift tax purposes for all estates after 2017.
• Section 179 deduction — Proposed to be made permanent.
• LIFO inventory — There would be a repeal of the currently approved last-in, first-out (LIFO) method of inventory.
Don’t make your reservations yet for the tax havens. These are only the president’s budget proposals and they may bear no resemblance to any ultimate changes, if there are changes.
However, the tenor warrants your monitoring.
IRS audit rates released for 2012
As it does each year, the IRS recently issued its Annual Data Book for fiscal 2012 (2012 IRS Data Book, IR-2013-32). The devil is in the details, but in general, the tax return audit rates decreased year over year from fiscal 2011. What is important to be remembered here is that the IRS adds its correspondence audits (by mail) along with its face to face audits to arrive at a total audit percentage.
For individual returns, the overall audit rate is 1.0 percent for the fiscal 2012 period, a decrease from the 1.1 percent in the prior year. Interestingly approximately half of these audits were correspondence audits and only approximately half of the audits were face to face. The statistics are further stratified here, pointing out possible items of interest by category:
• Small corporations: The audit rate of returns, (correspondence and face to face total) ranged from 1.7 percent for those in the $250,000 to $1 million revenue range to 2.6 percent for those in the $5 million to $10 million range.
• Larger corporations: Those in the $10 million to $50 million range saw their audit rate decrease to 10.5 percent. At the other end of the scale, those in the $5 billion to $20 billion range saw their rate decrease to 45.4 percent.
• Flow-through entities(S corporations and partnerships): The overall audit rate was 0.5 percent, which is less than most of the individual audit rates.
• Individual returns without business income: The most audited were those over $200,000 at 1.96 percent to 27.37 percent for those over $10 million.
• Individual returns that included business income: Anyone over gross receipts of $100,000 had a minimum 3.6 percent chance of being audited and it only increased as gross receipts got larger.
I would be glad to provide the complete set of statistics around the above mentioned highlights or, as referenced above, you can go to the 2012 IRS Data Book.
Thresholds for reporting foreign assets
Much has been written concerning the thresholds at which individuals must report foreign assets to the IRS. There are minimum levels starting at $50,000 which increase based upon filing status and location of the individuals who are filing. Additionally, the IRS has attempted to clarify which types of assets need to be reported subject to the minimum levels.
For those individuals who must file, the assets must be reported on Form 8938, Statement of Specified Foreign Financial Assets. The reporting is required by the Foreign Account Tax Compliance Act, beginning for tax years after March, 18, 2010.
The types of assets that must be reported include financial accounts maintained by a foreign financial institution, including savings, deposit, checking and brokerage accounts held by a bank or a broker-dealer. Additionally, the following assets, while not held by a financial institution must also be reported:
• Stocks or securities issued by a foreign corporation;
• A note, bond or debenture issued by a foreign person;
• Qualifying swaps, options and derivatives;
• An interest in a foreign partnership, foreign estate or foreign retirement or deferred compensation plan; and
• An interest in a foreign insurance or annuity contract with cash surrender value.
Assets excluded from reporting include foreign real estate and foreign currency as long as they are not maintained in a foreign entity. Art, jewelry, precious metals and other collectibles also do not need to be reported.
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James W. Rahmlow, a certified public accountant, is a partner with Mengel, Metzger, Barr & Co. He can be contacted at jrahmlow@mmb-co.com.
