News On The Tax Front--The latest tax news.
Employment Tax Deposit Rules-- If you have employees, this article is a must read, even if you have a payroll service or your accountant prepares your payroll. The rules here are important. Make a mistake and the consequences are costly. The annual effective interest rate of penalties starts at 148%--and it's not tax deductible. Finally, a new law change may allow you to avoid some penalties, but you may have only 90 days to make an election
IRS Hot Topics--The IRS has been concentrating on certain industries and specific areas within those industries. Here's a list of these areas.
Abandonment Loss Not Deductible--Abandonment losses are normally deductible in full. However, there are exceptions. Don't fall into the trap.
Demolition of Buildings--If you demolish a building on your property, the undepreciated cost can't be deducted. It's got to be added to the cost of the land. There are some ways to mitigate this costly result.
Organizing the Shop Floor--You can improve efficiency, save money and maybe even lower your insurance premiums.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
In Internal Revenue News Release IR-1999-58 the Service announced that some businesses penalized for failing to make timely employment tax deposits during the first quarter of 1999 may be able to lower their penalties because of tax law changes that apply to federal tax deposits due after January 18, 1999. The IRS intended to inform taxpayers of this change, but failed to do so at the time. They will write taxpayers involved, explaining the relief. Several relief provisions were involved. You will have 90 days from the date of the letter to get relief.
The IRS has issued final and temporary regulations with respect to net operating loss carryforwards of consolidated groups. Generally, corporations filing as a consolidated group can offset income from one or more corporations against losses from other corporations in the group. However, corporations that come into the group as a result of an acquisition, can't use losses generated before joining the group to offset profits of other group members.
Selling property in exchange for a private annuity can make sense. However, you still have to report any gain from the sale on your tax return. In R. Scot Stokes (T.C. Memo. 1999-204) the taxpayer set up an annuity trust, then transferred all the business assets to the trust in exchange for a private annuity. When the business was sold, the taxpayer reported no income. The Tax Court found the transfer was a sham and should be disregarded for tax purposes.
The most innocent of transactions can have tax consequences. In Irv C. Jaffe (T.C. Memo. 1999-196) an ex-wife withdrew funds from a money market account she owned jointly with her ex- husband. The Tax Court found that one-half of the amounts withdrawn by her were alimony, taxable to her and deductible by her ex-husband. The Court found that a court order, not part of the divorce settlement, stipulated the funds were for the wife's support. Thus, half of the withdrawals by her were deemed to be a simple withdrawal of her own funds and half were considered from her husband's funds and thus were alimony.
If you're suing someone, or you're being sued, or settling a case out of court, the characterization of the damage award in the suit or settlement agreementcan determine the tax consequences. In Talley Industries, Inc. and Consolidate Subsidiaries (T.C. Memo. 1999-200) the corporation was disallowed a deduction for damages it had to pay for false claims for work it performed under a government contract. Payments for damages, legal fees, court costs, etc. may be deductible, punitive damages are usually not. The Court found the government settlement ambiguous. Since the taxpayer has the burden of proving the IRS wrong, and did not carry that burden, the amounts were nondeductible.
The IRS is preparing to announce that by the 2000 filing season it will centralize the management of all its telephone service operations. The Service's move to national management of these operations--telephone services currently are managed separately by the 33 different IRS districts--is a change that will apply to about 20 percent of the IRS's workforce.
Failing to file a return can turn into fraudulently failing to file, a much more serious issue. That's what happened in Ella Freidus (T.C. Memo. 1999-195). The Court found the taxpayer fraudulently failed to file because filing a return would have disclosed the fact that she was concealing assets and sources of income.
You can't avoid tax simply by transferring the income producing assets to a trust. If you're the beneficiary of the trust, or retain certain powers over the assets or the trust itself, the IRS can disregard the trust and you will be subject to tax on the income, just as if the trust never existed. In Frank and Virginia Muhich (T.C. Memo. 1999-192) the Tax Court found that the taxpayer transferred all his business assets into such a trust which created other trusts. The Court found the trusts to be a sham and held the taxpayer was liable for tax on the income from the business.
If you have more than one business entity, you can't just decide to where to report the income and expenses. You have to report it on the entity that actually earns the income and incurs the expenses. While you can switch entities, you have to do so formally. In Richard C. and Hattie M. Martin (T.C. Memo. 1999-193) the Court found that the corporation was the taxable entity, not the corporation's shareholder and his brother. Thus, the losses could not be deducted on their individual returns.
If your records are poor, the IRS (and most states) have the power to reconstruct your income using alternative methods. In Fatai King, Mary King (99-1 USTC 50,570; U.S. Court of Appeals, 3rd Circuit) the Court found allowed the IRS to reconstruct the taxpayers' income using several approaches including the percentage markup method. The Court disallowed some of the taxpayers' deductions for which they had no evidence, or for which they presented altered records.
If expenditures qualify as research and experimentation expenses, they can be deducted immediately, even if they would be capital in nature and subject to depreciation or amortization under normal circumstances. In Leonard Charles, Ekman, Kaye Layne Ekman, (99-1 USTC 50,580; U.S. Court of Appeals, 6th Circuit) the taxpayers were modifying a Porsche auto engine to increase its horsepower. They succeeded in doing so and attempted to deduct the cost of the engine purchased as a test bed. The Court disallowed the deduction, requiring the taxpayers to depreciate it.
If the divorce decree isn't clear, one way to tell child support from alimony is that alimony is subject to certain contingencies. In this case (Linda J. Baxter, T.C. Memo. 1999-190) those contingencies included the relocation and or the remarriage of the taxpayer.
As we reported earlier, the IRS is making it easier for taxpayers to secure an offer in compromise, that is, to settle their outstanding tax liability for less than the full amount. The new approaches have been formalized in the Internal Revenue Manual Handbook on the subject. If you're considering an offer in compromise, keep these facts in mind:
An embarrassment of riches. That's what House and Senate lawmakers are facing. Apparently the budget surplus is larger than originally anticipated. That should translate into bigger tax cuts. But President Clinton is once again arguing to save social security first. It's still early, but unless Congress messes up, look for some substantial cuts.
If you're a partner in a partnership or LLC or shareholder in an S corporation, be sure to monitor the business carefully. In Mark D. Pridgen and Kay D. Pridgen (T.C. Memo. 1999- 188) the Court found that the partnership had unreported income and that the partners were taxable on their share of that income notwithstanding the fact that the sales were illegally made by the partnership's managing partner. Furthermore, the passive partners were liable for the negligence and substantial understatement provisions of the accuracy-related penalty.
Don't keep good records? That can be an even bigger problem if you transact business in cash. In Beatrice DiPierro (T.C. Memo. 1999-189) the Court noted that cash deposits were prima facie evidence of income. The taxpayer had the burden of proving the IRS wrong. The taxpayer claimed the deposits had been reported earlier or were from loans, but her testimony did not convince the Court. In addition to income taxes, she was also subject to the self-employment tax.
If you've got passive losses there are generally only two ways to use them to save taxes. One is to sell the property, S corp. shares, etc. generating the losses. The other is to generate passive income. But there are some problems with the latter. Not all income from passive activities is passive income. Specifically if you rent property to your C (regular) corporation, the income will not be considered passive. Why? You could easily generate passive income by charging your corporation an inflated rental. That's what the Tax Court held in Michael F. & Jane H. Connor, T.C. Memo. 1999-185.
The IRS doesn't have to allow you any deductions if you can substantiate the expenses. In Mark D. Pridgen and Kay D. Pridgen (T.C. Memo. 1999-188) the Tax Court sided with the IRS in disallowing a partnership engaged in buying and selling tobacco some of its cost of goods sold that it could not document.
In Announcement 99-58 (I.R.B. 1999-24, 51) the IRS reported that Form 3115, Application for Change in Accounting Method has been revised. The new version has a May 1999 revision date. The only changes to the form are to question 18 (page 3) to clarify the tax year to which that question relates and to question 28 (page 3) to update the cite to Rev. Proc. 99- 1. The instructions were revised to update the list of automatic change procedures and the user fee provisions.
The rule is that you can only deduct away from home expenses if the job in the other locale is expected to last no longer than a year. The taxpayer's challenge of this clear rule was turned down by the Tax Court. The Court also disallowed some of his job search expenses since the trip was primarily personal in nature. The Court allowed some of his lodging expenses. John Allen and Glenna A. Lyle, T.C. Memo. 1999-184.
You can't avoid the IRS (or another party) from levying on property by transferring it for little or no consideration to a relative or friend. The court can look through the scheme and hold that the relative is just a nominee holder with you as the true owner. That's what the Court did in Edith LiButti, doing business as Lion Crest Stable (99-1 USTC 50,562; U.S. Court of Appeals, 2nd Circuit).
One of the main advantages of doing business as a partnership or LLC is that your share of the debts of the partnership for which you're liable increases your amount at risk. That could enable you to deduct losses that exceed your equity investment and any loans you made to the business. However, you must be able to show that you could be truly liable for the partnership debts. In Robert L. Whitmire (99-1 USTC 50,563; U.S. Court of Appeals, 9th Circuit) the Appeals Court affirmed an earlier Tax Court decision, finding that the partner was not at risk with respect to the partnership debts. While a bank loan was recourse to the partner, the partner was protected from any real economic loss because of a guaranty agreement between the partnership and other entities.
If you have employees, this article is a must read, even if you have a payroll service or your accountant prepares your payroll. The rules here are important. Make a mistake and the consequences are costly. The annual effective interest rate of penalties starts at 148%--and it's not tax deductible.
In our last issue we discussed some of the basics of employment taxes. The current topic is trickier, and mistakes can be costly. If you handle your own payroll, you should know the rules. Even if you don't, this article is important reading so you have an idea of what's involved.
Why is this topic so important? The IRS sends about 3.5 million federal tax deposit penalty notices annually. While some employers probably receive several notices a year, that still means a large number of employers are paying deposit penalties. And that can be expensive. Here's a quick rundown of the penalties for late deposits:
2% Deposits made 1 to 5 days late.
5% Deposits made 6 to 15 days late.
10% Deposits made 16 or more days late. Also applies to amounts paid within 10 days of the date of the first notice the IRS sent asking for the tax due.
10% Deposits made at an unauthorized financial institution or paid directly to the IRS.
10% Amounts subject to electronic deposit requirements but not deposited using the Electronic Federal Tax Payment System (EFTPS)
15% Amounts still unpaid more than 10 days after the date of the first notice the IRS sent asking for the tax due or the day on which you receive notice and demand for immediate payment, whichever is earlier.
Why the concern? The penalties translate into very high effective interest rates. For example, if you're 5 days late, the penalty is 2%. That's comparable to interest at 148% per year--and it's not deductible. If you're 16 days late the penalty is 10%. That's an effective interest rate of 228%.
Deposit Rules--Monthly or Semiweekly?
How soon after paying your employees you have to make your deposit depends on the size of the withheld taxes. Unfortunately, there are several rules involved. Please note. There are some special rules not discussed below. They apply to a very limited number of taxpayers.
Less than $1,000 accumulated during the quarter. If you accumulate less than a $1,000 tax liability during the quarter you may make the payment with Form 941 instead of depositing it. For example, you're a sole proprietor and have one, part time employee. During January your employment tax liability (for withheld income taxes, withheld FICA, and your portion of FICA) amounts to $350. During February the amount totals $250; for March it's $275. Since the total is less than $1,000 you can send the IRS a check when filing Form 941.
Caution 1--If you are unsure that you will accumulate less than $1,000, you should deposit under the appropriate rules so that you won't be subject to a penalty.Caution 2--The $1,000 threshold is pretty low. You can break the threshold with just one employee with a modest salary.
Lookback period. If you accumulate $1,000 or more during a calendar quarter, you'll be on one of two deposit schedules--monthly or semiweekly. Which one is determined by reviewing your deposits during a four quarter lookback period. Your deposit schedule for a calendar year is determined by adding all your deposits for the period that begins July 1 and ends June 30 six months before the start of the year. For example, for the year 2000, total your deposits for the 3rd and 4th quarter of 1998 and the 1st and 2nd quarter of 1999. If you reported $50,000 or less of taxes for the lookback period, you're a monthly schedule depositor. If you reported more than $50,000, you're a semiweekly schedule depositor. When calculating the total taxes, use the original amounts shown on the Forms 941 and don't reduce it for any advance EIC payments.
Example--Madison Inc. showed a liability of $10,000 for the July 1 through September 30 quarter of 1998; a liability of $15,000 for the October 1 through December 31 quarter; a liability of $14,000 for the January 1 through March 31, 1999 quarter; and a liability of $10,000 for the April 1 through June 30, 1999 quarter. The total is $49,000 so for the year 2000, Madison is a monthly depositor.
Monthly deposit schedule. If your total taxes for the lookback period are $50,000 or less, you're a monthly schedule depositor. Under the monthly deposit schedule, you must deposit taxes on payments made during a month by the 15th day of the following month.
Example--Madison Inc. is a monthly depositor. During March, 2000 Madison has $17,000 in withheld taxes, withheld FICA and the company's share of FICA. Madison has to deposit the total by April 15, 2000.
If you're a new employer your tax liability during the lookback period will be zero. For the first calendar year of business, you'll be on a monthly deposit schedule.
Caution--A special rule applies if you accumulate $100,000 or more on any day during a deposit period. See below.
Semiweekly deposit schedule. If your taxes during the lookback period were more than $50,000, you're a semiweekly depositor. In this case, taxes on payments made on Wednesday, Thursday, and/or Friday must be deposited by the following Wednesday. Taxes on payments made on Saturday, Sunday, Monday, and/or Tuesday must be deposited by the following Friday.
Example--Madison Inc. pays employees at its Chatham location on Wednesday. Chatham must deposit the taxes by the following Wednesday. It pays employees at the Hudson location on Friday. These taxes must also be deposited by the following Wednesday. Employees at the Milford site are paid on Monday. These taxes must be deposited by Friday of the same week.
Note. Once you're on a semiweekly schedule, the amount of the deposit is immaterial in figuring the timing.
If a quarter ends on a day other than Tuesday or Friday, taxes accumulated on the days during the quarter just ending are subject to one deposit obligation, and taxes accumulated on the days covered by the new quarter are subject to a separate deposit obligation. For example, if one quarter ends on Thursday, taxes accumulated on Wednesday and Thursday are subject to one deposit obligation and taxes accumulated on Friday are subject to a separate obligation. Separate deposits are required because two different quarters are affected.
Deposits on banking days only. If a deposit is required to be made on a day that is not a banking day, the deposit is considered timely if it is made by the close of the next banking day. In additional to federal and state bank holidays, Saturdays and Sundays are nonbanking days.
Semiweekly depositors have at least 3 banking days to make a deposit. That is, if any of the 3 weekdays after the end of a semiweekly period is a banking holiday, you will have one additional banking day to deposit. For example, if you're a semiweekly depositor and have accumulated taxes for payments made on Friday and the following Monday is not a banking day, the deposit normally due on Wednesday may be made on Thursday (allowing 3 banking days to make the deposit).
Note. Your liability to deposit only arises when you pay wages. For example, because of the size of the taxes it paid during the lookback period Madison Inc. is a semiweekly depositor. However it only pay wages on the last day of the month. Madison makes only one deposit, on the day determined by the schedule above. Thus, if the wages are paid on August 31, a Tuesday, the only deposit for the month of August would be made on that Friday.
$100,000 next-day deposit rule. If you accumulate a tax liability (reduced by any advance EIC payments) of $100,000 or more on any day during a deposit period, you must deposit the tax by the next banking day, whether you are a monthly or semiweekly depositor. For purposes of the $100,000 rule, don't continue accumulating tax liability after the end of a deposit period. For example, if a semiweekly schedule depositor has accumulated a liability of $95,000 on a Tuesday (of a Saturday through Tuesday deposit period) and accumulated a $10,000 liability on Wednesday, the $100,000 next day rule does not apply. The usual rules apply. Thus, $95,000 must be deposited by Friday and $10,000 must be deposited by the following Wednesday.
If you are a monthly depositor and accumulate a $100,000 tax liability on any day during a month, you become a semiweekly schedule depositor on the next day and remain so for at least the rest of the calendar year and for the following calendar year.
Accuracy of deposits rule. You're required to deposit 100% of your tax liability on or before the deposit due date. However, penalties for depositing less will not apply if both of the following conditions are met:
For monthly depositors, the shortfall must be paid by the due date of the Form 941. For semiweekly depositors, it must be made by the earlier of the first Wednesday or Friday that falls on or after the 15th of the month following the month in which the shortfall occurred or the due date of Form 941 for the quarter.
It generally doesn't make sense to pay only 98% of the amount due. Any cash flow benefits will be negated if you make a mistake. Better to pay the full amount of the liability and save the rule as an escape should you make an error. In fact, if you use this approach consistently, you may find the IRS will give you no break should you inadvertently make a mistake on a deposit.
New Rule Can Reduce Penalties
Getting caught up in federal tax deposit penalties can be a nightmare. First, straightening out the problem with the Service can take time and energy. If you have your outside accountant do it, it can be costly. Second, if the issue isn't resolved in timely fashion the IRS can put a lien on the company's assets, your bank account first. There's no need to elaborate on what that could do to your business.
To make matters worse, the IRS generally applies tax deposits to any past due undeposited amount, with the oldest liability satisfied first. The result? Until all amounts have been deposited, you could get hit with a penalty every month or deposit period.
Example--You're required to deposit $1,000 on February 15th. but don't make the deposit. You're required to make another $1,000 deposit on March 15th and another $1,000 deposit on April 15th. You make the March 15th deposit and deposit $2,000 on April 15th, making up for the February deposit. You'll have a $100 penalty (10% of $1,000) for the February deposit, that's clear. However, the March deposit will be applied to your February shortfall, so you'll be late with the March deposit and get hit with another $100 penalty.
There's even a term for this, it's called cascading penalties. Fortunately, there may be a solution in a recent law change. Now, you generally have 90 days from the date of a penalty notice to designate how to apply your deposits. Thus, in the example above you could elect to have the extra April amount cover the February underpayment. You'd still owe a penalty for February, but that would eliminate the penalty for March.
This is not the time to procrastinate. You have only 90 days from the date of the notice to make the designation. In our example above, the penalty was minor. But the deposit amount was small. In fact, probably only an employer with just a few low paid employees would have only $1,000 in monthly liability. You could easily have $10,000 in monthly liability. The penalties would then be $1,000 each time.
How long will it take the IRS to assess a penalty? Generally, you'll receive a notice 6 to 10 weeks after filing your quarterly Form 941.
Tax Tip--There's another penalty exception. If you switch from being a monthly depositor to a semiweekly one, you won't be liable for a late payment penalty for the first semiweekly deposit. Remember, this is a one-time waiver.
Summary
If you're in business and have employees, payroll tax deposits are a necessary evil. While the rules may sound complicated, probably only a few will apply to your situation. You may be able to avoid considerable hassle by simply having a payroll service take care of the details. If you plan to do it yourself, here are some points that can save you penalties and extra expense.
The IRS has changed its audit tactics in recent years. Its approach is now more industry specific and within industries, it's looking at individual issues. The approach allows it to generate audit adjustments faster. If you're in a targeted industry, you should know what the hot topics are. We've compiled a list applicable to small businesses. We've excluded certain industries like banking, railroads, insurance, etc.
Aerospace
Deductibility of bribes, kickbacks and other illegal payments
Construction & Real Estate
Advances for personal services
Data Processing
Capitalization of lease related expenses
Rotable spare parts
Farmer's Cooperatives
Income from excess capacity
Disposition of capital stock
Food
Charitable contributions of surplus food
Investment tax credit on refrigerated structures
Package design costs
Forest Products
Paper machine structure.
Insect loss
Logging truck roads
Replanting losses
Computation of timber casualty loss
Capitalization of reforestation costs
Intangibles
Amortization of employment contracts
Covenants not to compete
Inventory
Dollar value LIFO; segments of inventory
Dollar value LIFO; bargain purchase inventory
Media & Communications
Capitalization of cable television franchise costs
Transponders
Converter deposits
Federal communication commission station license
Network affiliation agreement
Mergers & Acquisitions
Equity pool investment fees
Loan commitment fees in a stock redemption
Mining
Strike costs
Motor Vehicles
Dollar value LIFO; definition of an item
Remanufacturers' inventory of cores
Excess parts inventory
Partnerships
Subchapter K anti-abuse Regulation 1.701-2
Petroleum
Estimated dismantlement and removal costs
Line pack gas
Interstate fixed gas contracts
Research & Experimentation Credit
R&E credit for tech writers
Qualifying wages under Section 41; contributions to qualified plans
Retail
Contributions to 401(k) plans attributable to compensation paid after year end under 401(a)(6)
Tenant's rent leveling IRC Sec. 467 lease agreements
ACRS for suspended ceilings
Heating, ventilating, and air conditioning (HVAC) systems, depreciation (ACRS)
Valuation of an acquired retailer's inventory
Reserve for inventory shrinkage
Tenant allowances to retail store operators
Retail LIFO valuation of in-transit inventory
Securities and Financial Services
Taxable year of inclusion of stock broker's commission income
Capitalization of costs to obtain management contracts
Utilities
Membership payments made to industry-created research organizations
Excess deferred taxes and Section 1341
Meal allowances
Line pack gas
Abandonment Loss Not Deductible
When a business abandons an asset, generally the company can write off any unamortized basis in the property. That's true for tangible personal property, real property and intangibles. However, a special rule applies to intangibles purchased in the acquisition of a going business and in the demolition of a building. (See the article below for the rules for a demolition.) The tricky part is usually disposing of the asset in some way so it cannot be recovered. The easiest way is to have it hauled away by a salvager if you can't sell it. Be sure to get a receipt. As long as you can prove your adjusted basis in the property and that you irrevocably abandoned it, the loss should be allowed. For example, you purchased machine for $25,000. After two years of depreciation, your basis is reduced to $12,000. But the machine is now obsolete. Your best deal is to get a scrap dealer to take it away for free. You can deduct the remaining basis of $12,000 in that year.
There's an exception to this general rule. If you acquire a group of assets with an intent to abandon one or more of them, you can't claim a loss on the assets abandoned. Instead, you must allocate their cost basis to the other assets acquired. In one case the Tax Court said "the law is well settled that in order to be deductible a loss must be unintentional or involuntary". While a strict reading of the law would seem to indicate the regulations apply only to the demolition of a building, the courts have held on a number of occasions that the rule applies to property other than buildings.
The sticking point here is the word intent. You may have to prove that it was not your intent to abandon the property when you acquired it. That may be difficult to do. You can bolster your case by retaining and using the property for some time before abandoning it. Your case would be improved if you could show that an outside factor, not known at the time of acquisition (such as obsolescence of the equipment), precipitated the abandonment. Abandoning the property shortly after purchasing it is sure to raise suspicion.
It's important to keep this in mind when acquiring a business. You don't want to allocate substantial value to assets that you know may be abandoned. That's a good way to raise a challenge from the IRS. The outcome may be that the value ends up on intangible assets that will have to be amortized over 15 years.
In the article above we mentioned that you might not be able to claim an abandonment loss if you can't show that your intent was to use the property at the time of acquisition. That used to be the rule for structures too.
A 1984 law changed that. The rule now is that if you demolish a structure any costs expended for the demolition or any loss sustained on account of the demolition must be added to the cost of the land. That's the worst possible scenario. The cost of the land is not depreciable or amortizable. Thus, you get no deduction for the costs are locked in until you sell the property.
Example--You purchase an old factory building for $1,000,000, allocating $600,000 to the building, and $400,000 to the land. You make $300,000 of improvements. Your basis in the building is now $900,000. After depreciating the property for several years your basis is $814,000. You decide to demolish the building and erect an apartment house. The remaining $814,000 of basis must be added to the cost of the land and can't be depreciated.
Knowing that you can't write off the undepreciated cost of the building could change your decision on what to do with the property.
While the article below was written with a manufacturing firm in mind, the ideas can be used in many businesses. Here are some thoughts on how to make your business more productive.
Previously Reported In Daily Update
State income and sales tax liability . . . If your only connection with a state (other than your home state) is that you take orders by mail and/or over the internet, you don't have to charge sales tax or pay income tax to that state. For example, you have an LLC headquartered in New York, but send catalogs and take orders from customers in Massachusetts. Assuming you have no salesmen or property in Massachusetts, you don't have to collect sales tax or pay income taxes to Massachusetts. But many states are looking for any possible additional connection that could subject you to tax. In a recent Massachusetts ruling, a corporation headquartered in another state had been doing business in the state through retail outlets. It closed it's retail operations, but was unable to terminate the leases. The company sublet the space to others. The Massachusetts Department of Revenue held that, because of those leases, the business was still liable for the collection of sales tax and the payment of income taxes. Since other states might take a different approach, you've got to research the rules in your state. Be careful if you have property, such as demo equipment, or lease office or retail space or even personal property such as an auto used by a representative. If you work through independent reps, you might be able to avoid the problem if they purchase the equipment, lease the car or space, etc. and you reimburse them.
Be prepared for success . . . A large, well-known corporation recently scored a coup with their advertising campaign. They got new customers in droves. It turned out to be a disaster. They couldn't adequately service all the customers. Not only were new customers disappointed, the drop in service alienated existing customers. The company had to accelerate its expansion plans which resulted in extra costs. It also had to add extra employees and pay overtime for existing ones. The final results aren't in, but it's possible the ad campaign will result in a net loss for the next few quarters. The overall effect of customer satisfaction is harder to quantify. The situation isn't unique. Test your ad campaign before doing a full-scale launch. Even then it's tough to predict the full response. Make sure you're prepared for all possibilities.
Estate fees . . . How much of your estate will the executor and lawyers take? A typical scale is 5% for the first $100,000; 4% of the next $200,000; 3% of the next $700,000; 2.5% of the next $4 million, and 2% of anything over $5,000,000. That's the amount the executor is usually entitled to. The lawyer often charges a similar amount. On a $1,000,000 estate that could mean $34,000 to the executor and another $34,000 to the attorney. That may be reasonable compensation if you have a complex estate, if your estate includes a business, etc. On the other hand, if it's a simple one, you may want to plan ahead. You, or the executor, may be able to negotiate an attorney's fee based on a time spent with a fixed maximum. The executor's fee can be lower if you have a friend who will agree to do the job for less.
Discounted equipment . . . The ideal of selling equipment at a substantial discount in order to lock the customer into a service contract is not new, it just seems to be showing up more frequently lately. For example, you can get a free cellular phone--if you sign up with the retailer's service provider. If you don't, the cost of the phone rises to $400. The same is true for security systems, oil burner contracts, etc. Is that a bad deal? It depends. You've got to evaluate all the costs. In the case of a cellular phone, the deal probably makes sense. More than likely you're limited to a choice between only a few competitors. Moreover, the competition is fierce. On the other hand, with an oil burner you may be forced to buy from the oil distributor for the next five years at a price well above the market. The best approach? Get quotes with and without service, then do some quick math. You won't be able to quantify all the factors. Instead, consider carefully any that are particularly onerous. You may decide to avoid the deal because of the length of the contract, the fact that the market is very volatile, etc.
Taxpayer liable for payroll taxes . . . You contract with a payroll processor to submit payroll tax reports and to make the required employment tax deposits. The processor fails to make the deposits and/or file the returns. Who's liable? In Field Service Advice the IRS held that the delegation of duties didn't relieve the taxpayer of his obligation to pay the tax or the associated penalties. In short, the taxpayer was responsible for the taxes. Courts have held that delegating your responsibility for other tax returns, payments, etc. won't let you off the hook, even if your accountant, attorney, etc. lied to you. Check up on your payroll processor, accountant, etc. If you get a notice from the IRS, don't give it to the other party to check out. Either research it yourself, or have some independent party do so. That's particularly true for employment tax issues where the penalties can be very heavy. (Note. While field service advice issued by the IRS has no precedential value, it's a good indication of IRS thinking on an issue.)
When can you deduct free samples or office supplies? . . . You package free samples of your product. The sample packages are even clearly marked, not for resale. When can you deduct the cost of the samples? One pharmaceutical company thought they could deduct them immediately. In Field Service Advice the IRS cited Reg. Sec. 1.162-3. Basically, the section states that if you carry incidental materials or supplies on hand for which no record of consumption is kept or for which no physical inventories are taken, you can deduct those items when purchased. However, if you inventory or keep track of such items, you can only take a deduction in the year the items are consumed. Office supplies are rarely inventoried. Thus, they're deductible when purchased. However, in the case of the pharmaceutical company, the company had to maintain a record. Thus, the free samples weren't deductible until they were distributed to physicians and pharmacies.
Allocation of legal fees . . . Some legal fees are deductible immediately; some may have to be capitalized and added to the cost of the associated asset and may be amortizable (e.g., legal fees incurred in the purchase of equipment or a lease); some may have to be capitalized and only recoverable when the equipment is sold or abandoned. The problem is that you may have a bill from your attorney that has to be divided several ways. If you don't have a detailed breakdown, the IRS will probably claim the entire amount should be capitalized. In one situation, a company sued for copyright infringement and deducted all its legal fees. On audit, the IRS said that some of the fees were incurred to defend or perfect title. These costs had to be capitalized. Some of the fees were incurred to recover lost income. Those fees were immediately deductible. Best advice? Always get a detailed breakdown of all legal bills.
Estimated taxes and S corporations . . . Generally, an S corporation doesn't pay taxes. The income and losses are passed through to the shareholders and reported on their individual returns. But when is the income of the S corporation income to the shareholder for estimated tax purposes? That is, if the shareholder's share ofS corporation earnings for the first 3 months of the year is $50,000, must the shareholder take that amount into income when computing his or her estimated taxes? Or is the income taken into account as a lump sum at the end of the year? The answer is that you have to use the quarterly income of the S corporationfor estimated tax purposes. That means you've got to get information from the S corporation on a regular basis. The other, simpler, alternative is to base your estimated taxes on last year's liability. That is, pay in each quarter an amount equal to one-fourth of last year's liability. That's not only simpler, it's a smarter move if your income this year is higher than last. However, if this year's income is less, you can lower your estimated tax payments by annualizing this year's income.
Sales incentives . . . Sales incentives often make considerable sense. They can boost sales and increase employee morale. However, they can also generate considerable abuse. One major electronics manufacturer found that out. They made two mistakes. First, quotas and sales volume were generally tallied quarterly, but the end of the company's fiscal year was a critical time. Result? A mad rush to book orders at the end of the year. That resulted in a factory backlog, pressure on suppliers and factory personnel who handled the paperwork for the orders. Worse, it led to mistakes and customer complaints about pressure from salesmen, shipping errors and even generated 'orders' that were reversed after the end of the year. It also resulted in less than optimum profit margins on equipment since so much was booked in the last quarter of the year. Solution? It will probably depend on your particular situation. But try to shift the emphasis from year-end sales. You might give more credit for sales during the first 3 quarters than during the last quarter. The second mistake was that all sales were treated equally. A high-margin sale counted as much as a low-margin one when it came to computing salesmen's bonuses. The company changed that. They provided special incentives for high-margined items and those they wanted out of inventory.
Copyright 1999 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536