By John Frey, CPA
Director, Assurance Services

Worker classifications issues have become a major tax administration focus in Washington.  On September 19, 2011 the Internal Revenue Service (“IRS”) and the Department of Labor’s Wage and Hour Division signed a memorandum of understanding to share information on investigations involving employment tax compliance.  The IRS announced it will be paying more attention to worker classification issues as the number of workers being classified as independent contractors is steadily increasing. 

Classification issues arise when the business owner treats a worker as an independent contractor rather than as an employee and thereby avoids paying Social Security, Medicare, and unemployment tax.

Two very high profile cases of abusing the tax code in this way have been that of courier service provider Fed Ex and insurance giant Northwestern Mutual. Fed Ex received a fine of over $300 million whereas Northwestern Mutual was slapped with a fine of over $200 million. Although you might never see fines of this magnitude in your business, you could find out that your tax liability has doubled under Internal Revenue Code (“IRC”) 6672 which defines a willful failure to collect and pay taxes, or attempt to evade or defeat tax.

There is relief, and in the past, employers who failed to classify workers properly as employees often did not suffer significant penalties. Further, where penalties were imposed, section 3509 was available to reduce the penalties and section 530 was available to permit employers to treat workers as independent contractors, if you meet the relief requirements: 

1)  You had a reasonable basis for not treating the worker as an employee,

2)  You treated the worker, and any similar workers as independent contractors, and

3)  You must have filed Form 1099-MISC for each worker unless they earned less than $600.

Going forward, in the event of an audit, taxpayers can expect the IRS to propose penalties that may be significantly greater than penalties taxpayers have been accustomed to for these audits. Taxpayers will likely have fewer opportunities for mitigating proposed adjustments and penalties through administrative settlement, as exemplified by the likely diminished availability of the section 530 and 3509 relief provisions.

In light of the increase scrutiny and potential penalties, on September 21, 2011 the IRS issued announcement 2011-64 establishing a new Voluntary Classification Settlement Program (“VCSP”).  To be eligible for the VCSP, a taxpayer must have consistently treated the workers (or a class or group of workers) as non-employees, and must have filed all required IRS Forms 1099 for the workers for the previous three years. The taxpayer cannot currently be under audit by the IRS, or under audit concerning the classification of workers by the Department of Labor or any state government agency. A taxpayer who was previously audited by the IRS or the Department of Labor concerning the classification of the workers will only be eligible for the VCSP if the taxpayer has complied with the results of that audit. Exempt organizations and governmental entities may participate in the VCSP if they meet all of the eligibility requirements.

To participate in the VCSP, a taxpayer must apply using IRS Form 8952, Application for Voluntary Classification Settlement Program. This Form should be filed at least sixty (60) days prior to the date the taxpayer wants to begin treating the subject workers as employees. A taxpayer participating in the VCSP will need to agree to treat the class of workers as employees for future periods. In exchange, the taxpayer will need to pay only ten percent (10%) of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of Internal Revenue Code (the “Code”) Section 3509. The taxpayer will not be liable for any interest and penalties on the liability, and will not be subject to an employment tax audit with respect to the worker classifications of those workers for prior years.

For example, assume that in the year 2010, a taxpayer paid $1,500,000 to workers that are the subject of the VCSP. Assume that all of these workers were compensated at or below the Social Security wage base (under $106,800 for the year 2010). The taxpayer submits the VCSP application on October 1, 2011 and wants the beginning date of the quarter for which it wishes to treat the class or classes of workers as employees to be January 1, 2012. The taxpayer looks to the amounts paid to the workers in 2010 for purposes of calculating the VCSP amount, since 2010 is the most recently completed tax year at the time the VCSP application is filed. Under Code Section 3509(a), the employment taxes applicable to $1,500,000 would be $160,200 (10.68% of $1,500,000). Under the VCSP, the taxpayer’s payment would be ten percent (10%) of $160,200, or $16,020.

If you are just starting your business, hiring additional employees, or have been selected for an employment tax examination and have questions, please contact John Frey, CPA,  847-733-7182 or email at jfrey@bkl-cpa.com

If you maintain foreign financial accounts, you may be required to file informational Form 8938, Statement of Specified Foreign Financial Assets, which was recently released for its first use with respect to 2011 income tax return filings.   No new income taxes are generated by the use of Form 8938, but Form 8938 helps the IRS keep track of your foreign investment earnings and where those earnings are reported on federal income tax return. 

Form 8938 does not replace Form TDF 90-22.1, Report of Foreign Bank and Financial Accounts, but is, instead, an additional form that may need to be completed and attached to your tax return.

Created by the IRS because Congress recently enacted legislation requiring it to improve tax compliance by taxpayers with offshore financial accounts, the purpose of Form 8938 is to report financial accounts maintained at foreign financial institutions as well as foreign financial assets, for example interests in foreign entities, that are not in held in accounts at U.S. or foreign financial institutions if the total value of all of these specified foreign financial assets (also known as SFFAs) is more than the following reporting thresholds:

Filing thresholds for individuals living in the U.S.

 Filing thresholds for individuals living abroad

 A blank Form 8938 can be found on the IRS website. The type of information you will need if you meet the filing thresholds can be seen below:

Part I: Requests information about your foreign bank accounts, such as the type of account and the account number or other designation.

Part II: Requests information for foreign financial assets that are not held in a foreign financial account, such as a description of the asset and the identifying number, if any, or other description.

Part III: Requests the types and amounts of income, deductions and credits attributable to SFFAs during the year, such as interest income, dividend income and investment fees paid on foreign accounts.

Because the penalties for failure to properly report specified foreign financial assets are so severe[i] , we suggest that you start early gathering the information you will need to determine if you are required to file Form 8938 for 2011 and to have that information available before the 2011 tax filing deadline[ii].

In addition, the IRS anticipates issuing regulations that may require domestic entities to file Form 8938 in the 2012 tax year.

If you have further questions on the requirements, please contact Neha Sethia, at nsethia@bkl-cpa.com.

In case you are not already familiar with secure portals, they have been around for many years.  Most of us use them every day without even knowing it.  For instance, when we pay bills on-line, we are using secure portals and when we log in to our investment accounts to check our portfolio values we likewise are using secure portals.

Here are some of the ways Brown, Kaplan + Liss LLP and clients will use secure portals:

Upon receipt of our clients’ personal tax data, we will scan it and place PDF copies in their portals; they will then have access to their tax data during the tax preparation process as well as anytime they need it in the future, for instance if they need copies of their w-2s to support mortgage loan applications

When we complete our clients’ tax returns, we will place PDF copies in their portals; as above,  they will then have access to their tax returns anytime they need it in the future, for instance if they need copies to support mortgage loan applications

Clients wishing to have us review confidential financial documents, such as leases, wills, trusts and contracts may place them in their portals rather than e-mailing them to us; we will then be able to retrieve those documents, review them and provide our comments

Clients wishing to give access to their portal to a relative, employee, business advisor or other person may do so or single use portals may be established on a temporary basis for use by persons other than clients themselves; any person with access to a portal may transfer documents to that portal.

Some documents, like tax returns and financial statements, will be retained in portals permanently so that they will be available for reference when needed.  Other documents, like memoranda, letters and workpapers will be purged occasionally from portals to reduce clutter.

Secure portals are the safest way to electronically transfer documents.  With e-mails, there is always the risk that they may be intercepted.  Although, e-mail encryption and passwords applied to documents delivered by e-mail offer some protection, the level of security is considerably less than the level of security available using secure portals. 

In anticipation that some states may make it unlawful for professionals to send confidential client information using e-mails and to provide the highest level of security when we electronically transfer or receive confidential client information, Brown, Kaplan + Liss LLP is moving away from sending confidential client information by e-mail and moving, instead, toward the electronic delivery of confidential client information using secure portals.

Secure portals are also a good alternative to delivering documents using the postal and private delivery services, such as FedEx and UPS.  Portals are less costly and reduce the need to create paper documents.

Brown, Kaplan + Liss LLP is in the process of establishing secure portals for every client.  It may take some time for clients to get acclimated to using secure portals, but over time we expect portal use to become the norm.  In the mean time we will also provide paper copies of tax returns, tax organizers and other documents until our clients feel comfortable without paper copies.

Once secure portals are created, the portal system automatically sends e-mails to clients with instructions for the establishment of user names and passwords.  When those user names and passwords are created by the clients, the portals are ready for use and the portal system sends e-mails to us letting us know that the portals are now active.  Each time documents are added to the portal, either by clients or Brown, Kaplan + Liss LLP, e-mails are sent notifying the other party that documents have been added.

Developing a portal system is a major undertaking, requiring resources that would be vastly beyond the resources of an individual accounting firm such as Brown, Kaplan + Liss LLP.  That is why the portal system that we use was developed by CCH (Commerce Clearing House), a Wolters Kluwer company.  The system is called ProSystem fx Portal. 

CCH is an international company that provides research and software products, as well as other publications, for accountants and lawyers.  Based on Brown, Kaplan + Liss nearly half century of experience using CCH products, including this past year when we have been testing ProSystem fx Portal, we have the utmost confidence in the security, safety and operational integrity of  ProSystem fx Portal.  If you wish to do your own due diligence, you may learn more at CCH Portal

If you have any comments or questions about how Brown, Kaplan + Liss LLP will use secure portals or how you may be affected, please e-mail me at jliss@bkl-cpa.com or call me at 847-733-7185.

 For the tech savvy, you can also download the free IRS2G application for your iPhone or android smartphone.  The application allows you to check your federal refund status and also provides tax tips.  The app requires the same information as the website link for obtaining your refund status.  If you haven’t received your federal refund, please follow one of these secure methods to look up your refund status. 

 One way to circumvent receiving a late refund for the quickly approaching 2011 tax filing season is to electronically file with direct deposit.  E-filing is a safe and easy way to file your tax return, reduces errors, speeds up refunds, and saves trees.

 Don’t let the IRS hold onto your money any longer – search today for your refund status and hopefully your piece of the $153.3 million will slide cheerfully into your pocket before the New Year!

 If you need assistance looking up your refund status or claiming your refund, or would like to learn more about the benefits of e-filing your tax return, please call me at 847-733-7195 or email me at kmcelroy@bkl-cpa.com.

The 2011 VOW to Hire Heroes Act, signed into law on November 21, 2011, created the Returning Heroes and the Wounded Warriors Tax Credits to reward employers for hiring from targeted veterans groups as follows:

 A credit of up to $5,600 per employee – Employers that hire veterans who have been looking for employment for six months may be eligible for a Returning Heroes Tax Credit of up to $5,600 per employee; employers that hire veterans who have been looking for employment for less than six months may be eligible for a credit up to $2,400 per employee.

 A credit of up to $9,600 per employee – Employers that hire veterans with service-connected disabilities who have been looking for employment for more than six months may be eligible for a Wounded Warriors Tax Credit of up to $9,600 per employee. 

Qualified employers that are eligible for these credits have been expanded to allow tax-exempt organizations

Both the Returning Heroes Tax Credit and the Wounded Warriors Tax Credit apply to employees that begin work between November 21, 2011 and December 31, 2012.

To qualify for the tax credits employers must submit form 8850 to pre-screen candidates and to make a written request to their state work force agency to certify that applicants are members of the targeted groups qualifying for the credits.  Forms 8850 should be filed with the state work force agency no later than the 28^th day after employees begin work.  State workforce agency contact information can be located on the Department of Labor Employment Training Administration website at Directory of WOTC State Coordinators

For more information about either the Returning Heroes Tax Credit or the Wounded Warrior Tax Credit, please call me at 847-733-7186 or send me an e-mail at rkertes@bkl-cpa.com.

In addition, a special rule permits a taxpayer to make an election to treat a qualified charitable distribution made in January of 2011 as having been made on December 31, 2010. If this election is properly executed, then the distribution made in January 2011 counts toward the $100,000 exclusion limitation and the required minimum distribution for the 2010 calendar year.

As you may know, IRA owners must either withdraw the entire balance or start receiving periodic distributions from their traditional IRAs by April 1 of the year following the year in which they reach age 70-1/2.The minimum distribution that is required each year is computed by dividing the IRA account balance as of the close of business on December 31 of the preceding year by the applicable life expectancy. An IRA owner who does not make the required withdrawals may be subject to a 50-percent excise tax on the amount not withdrawn.

Many taxpayers, who receive taxable distributions, also contribute to charitable organizations. You can reduce your taxable income by excluding up to $100,000 of your IRA distribution from gross income when you transfer it directly to a charitable organization. This exclusion is available for taxable Roth IRA distributions as well as minimum required distributions from a traditional IRA.

Although a charitable contribution may be motivated by humanitarian reasons rather than by tax considerations, it is, nevertheless, wise to take tax considerations into account when making a contribution. Since this distribution must be made by the IRA trustee directly to a qualified (i.e., 50-percent) charitable organization, you should review your charitable tax giving as soon as possible. The provision is set to expire on December 31, 2011.

Please call our office at 847-866-6800 to discuss this option

According to the IRS, a household employee is someone you hire and you control what and how work is done, regardless of how often or when they work for you in your home. Given that information, a babysitter is considered a worker who does household work. You should consider the following thresholds throughout the year to determine if you may have filing requirements with regard to your household employees:

If you …
1. Pay cash wages of $1,700 or more in 2011 to any one household employee. Do not count wages you pay to: your spouse, your child under the age of 21, your parent or any employee under the age of 18 at any time in 2011 (unless this is his/her principal occupation, i.e. not a student).

Then you need to:
Withhold and pay social security and Medicare taxes. The taxes are 13.3% of cash wages. Your employee’s share is 5.65%. (You can choose to pay it yourself and not withhold it.). Your share is 7.65%.

If you …
2. Pay total cash wages of $1,000 or more in any calendar quarter of 2010 or 2011 to household employees. Do not count wages you pay to your spouse, your child under the age of 21, or your parent.

Then you need to:
Pay federal unemployment tax. The tax is usually 0.8% of cash wages. After June 30, 2011, the tax is scheduled to decrease to 0.6% of cash wages. Wages over $7,000 a year per employee are not taxed.

You must file certain forms to report any Social Security, Medicare, or FUTA wages paid the household employee, or wages from which you withhold federal income tax. These forms include a separate W-2 for each household employee to whom wages were paid and a Schedule H, the household employment tax form, with your federal individual income tax return in order to calculate and report your portion of FICA and FUTA taxes on these wages.

Though you may be required to withhold and pay federal social security, Medicare and unemployment taxes, you are not required to withhold federal income tax from wages you pay to a household employee. If your household employee requests and you agree to withhold federal income taxes, you must obtain a completed Form W-4, Employee’s Withholding Allowance Certificate, from the your household employee.

You also must consider additional requirements imposed by your state taxing authority. Illinois, for example, states that anyone who pays a nanny, housekeeper, home health aide or other household employee to work in their home is a household employer. If you pay wages of $1,000 or more in a quarter, you must pay Illinois unemployment insurance. To file as a household employer in Illinois you must first register in the state and elect to file and pay annually. Once you register with Illinois you will receive your contribution rate which can range from .7% to 8.4% of covered wages. Generally, you also have to withhold Illinois income tax for your Illinois employee if you are required to withhold federal income tax.

Give us a call at 847+866+6800 if you have more questions or need assistance with the filings.

The IRS ruling describes an IRA owner who died after attaining her required beginning date for required minimum distributions. She was survived by her two children, a son and daughter. At death, the IRA owner had named her estate as the sole beneficiary of the IRA. The estate’s personal representative intends to divide the IRA into two equal one-half shares; one for the son and the other for the daughter. This will be accomplished by means of a series of trustee-to-trustee transfers, into two distinct sub-IRAs, each established as an inherited IRA. Each such inherited IRA will be maintained in the name of IRA owner for the benefit of either the son or daughter as a beneficiary of Mildred’s estate.

The IRS approved each sub-IRA as a separate inherited beneficiary IRA for purposes of determining minimum distributions under the remaining life expectancy rule. This requires that each sub-IRA be distributed to the son and daughter over the IRA owner’s remaining life expectancy determined according to IRS tables at the date of death.

For example, assume that the IRA owner died age 80 in 2010, and that her IRA had a $400,000 balance on Dec. 31, 2010. In 2011, the son attained age 50 and the daughter attained age 53. The minimum IRA payout for 2011 for each sub-IRA is $21,739 ($400,000 ÷ 9.2 (Single Life Table life expectancy of 10.2 years for someone age 80, the IRA owner’s birthday in the year of death, reduced by 1) ÷ 2). The son and daughter may continue using the IRA as a tax-sheltered account until the close of 2020, the last distribution year.

There are two alternatives that would have yielded a better tax solution:

1. 1.     The IRA owner could have maintained two separate IRAs, each with a $200,000 balance, with the son designated as beneficiary of one, and the daughter designated as beneficiary of the other. This way, the son’s required payout in 2011 would have been only $5,847.95 ($200,000 ÷ 34.2 (Single Life Table life expectancy of 34.2 years for someone age 50)), and the daughter’s required payout in 2011 would have been only $6,369.43 ($200,000 ÷ 31.4 (Single Life Table life expectancy of 31.4 years for someone age 53)). The son could have used his IRA as a tax-sheltered account for 34 years; the daughter would have had 31 years of tax-deferred savings. What’s more, if either the son or daughter would die before his or her IRA is depleted, the balance would continue to accrue earnings on a tax-deferred basis and would continue to be paid out (e.g., to the son’s and daughter’s beneficiaries) over what would be left of the original term of their respective life expectancy when payouts to each beneficiary began.
2. 2.        Alternatively, the IRA owner could have maintained the one IRA but named both her children as beneficiaries (instead of her estate). In that case, the payouts after her death would have been made over the daughter’s 31.4 year life expectancy since as a general rule, where there is more than one IRA designated beneficiary, the one with the shortest life expectancy (that is, the oldest one) is treated as the designated beneficiary for determining distributions. After the IRA owner’s death, the children could have split up the IRA into separate accounts no later than Dec. 31, 2011, the end of the year following the year in which their mother died.

Please contact our office if you have any questions.  (IRS Private Letter Ruling 201128036, 7/15/2011).

Nevertheless, taxpayers do receive e-mails claiming to come from the IRS, sometimes containing a real or made-up employee name, address and similar information to make an e-mail seem credible.    

These e-mails usually are scams whose purpose is to obtain personal and financial information — such as name, Social Security number, bank account and credit card or even PIN numbers — from taxpayers which can be used by the scammers to commit identity theft. Identity thieves use the data to empty the victim’s financial accounts, run up charges on the victim’s existing credit cards, apply for new loans, credit cards, services or benefits in the victim’s name, file fraudulent tax returns and more.

Typically, IRS-impersonation scam e-mails state that the IRS needs certain personal and financial information to process a tax return, tax payment or refund. They may claim the e-mail recipient is being audited. They may mention specific monetary amounts or genuine programs, such as the Electronic Federal Tax Payment System (EFTPS), to add credible detail to the scam. The e-mails often contain links or attachments to what appears to be the IRS web site or an IRS form. However genuine in appearance, these phonies are designed to elicit the information the scammers are looking for.

Alternatively, a link in a scam e-mail may download malicious software onto the taxpayer’s computer when clicked. The software is often designed to search out and send back to the scammer personal and financial information contained on the taxpayer’s computer or obtained through keystrokes that the scammer can use to commit identity theft.

Unsolicited e-mails claiming to be from the IRS or an IRS-related component, such as EFTPS, should be reported to phishing@irs.gov. 

For more information on consumer scams, see Protect Your Personal Information and Suspicious e-Mails and Identity Theft

Background. An employer may pay a per-diem amount to an employee on business-travel status instead of reimbursing actual substantiated expenses for away-from-home lodging, meal and incidental expenses (M&IE). If the rate paid doesn’t exceed IRS-approved maximums, and the employee provides simplified substantiation (time, place and business purpose), the reimbursement is treated as made under an accountable plan—it isn’t subject to income- or payroll-tax withholding and isn’t reported on the employee’s Form W-2. Receipts of expenses aren’t required.

In general, the IRS-approved per-diem maximum is the GSA (general services administration) per-diem rate paid by the federal government to its workers on travel status. This rate varies from locality to locality.

High-low rates. Since at least the early ’90s, instead of using actual per-diems, employers have been able to use a simplified “high-low” per-diem, under which there is one uniform per-diem rate for all “high-cost” areas within the continental U.S. (CONUS), and another per-diem rate for all other areas within CONUS. For example, under the optional high-low method for post-Sept. 30, 2010 travel, the high-cost-area per diem is $233, consisting of $168 for lodging and $65 for M&IE. The per-diem for all other localities is $160, consisting of $108 for lodging and $52 for M&IE. ( Rev Proc 2010-39, 2010-42 IRB 459, Sec. 5.02 )

“High-low” method will be discontinued. In Rev Proc 2010-39, IRS asked for comments on whether the high-low method was still needed. Having received no comments, IRS says it intends to discontinue this method.

Observation: There’s no indication of when the high-low method will be discontinued, so employers currently using it should continue to do so until IRS says otherwise. Under Rev Proc 2010-39, there are a number of restrictions on use of the simplified per-diem method. One of these states that a payor using the high-low substantiation method for an employee must use it for all amounts paid to him or her for travel away from home within CONUS during the calendar year. However, the payor may still reimburse the employee’s actual expenses, use the meals-only per-diem method, or use the regular federal per-diem rate for travel outside CONUS.

In 2011, IRS will publish a revenue procedure providing the general rules and procedures for substantiating lodging, meal, and incidental expenses incurred in traveling away from home (omitting the high-low substantiation method). It will publish a revenue procedure in subsequent years only when modifying the substantiation rules and procedures, and will publish the special transportation rate in an annual notice.

Observation: Under the special transportation rate, payors in the transportation industry may use a uniform amount as the M&IE rate for all localities within CONUS and a larger uniform amount for all localities outside of CONUS. These amounts currently are set at $32 and $36, respectively.

© 2011 Thomson Reuters/RIA. All rights reserved.