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When beginning a business in California, you must decide what form of business structure to create. For federal tax reporting purposes, your form of business determines which income tax return form you have to file with the IRS. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. Tax and legal considerations enter into selecting a business structure.
LLCs - limited liability companies - are also available in California. The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC business entity must file a corporation, partnership or sole proprietorship tax return. A Limited Liability Company (LLC) is a business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.
A California LLC generally offers liability protection similar to that of a corporation but is taxed differently. Domestic LLCs may be managed by one or more managers or one or more members. In addition to filing the applicable documents with the Secretary of State, an operating agreement among the members as to the affairs of the LLC and the conduct of its business is required. The LLC does not file the operating agreement with the Secretary of State but maintains it at the office where the LLC’s records are kept.
A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.
A California general partnership must have two or more persons engaged in a business for profit. Except as otherwise provided by law, all partners are liable jointly and severally for all obligations of the partnership unless agreed by the claimant. Profits are taxed as personal income for the partners. A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A California limited partnership (LP) may provide limited liability for some partners. There must be at least one general partner that acts as the controlling partner and one limited partner whose liability is normally limited to the amount of control or participation of the limited partner. General partners of an LP have unlimited personal liability for the LP’s debts and obligations.
S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.
To qualify for S corporation status, the corporation must meet various requirements.
A California corporation generally is a legal entity which exists separately from its owners. While normally limiting the owners from personal liability, taxes are levied on the corporation as well as on the shareholders. The sale of stocks or bonds can generate additional capital and the longevity of the corporation can continue past the death of the owners. Legal Counsel should be consulted regarding the variety of options available.
To form a corporation in California, Articles of Incorporation must be filed with the California Secretary of State’s office.
Effective January 1, 2012, there are two new subtypes of stock corporations in California — a "flexible purpose corporation" and a "benefit corporation." The new corporation subtypes allow entrepreneurs and investors to organize stock corporations that can pursue both economic and social objectives.
In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.
The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
Useful links on this topic include:
Call business attorney Mitchell A. Port to form a new entity.
The Government Proposes To Increase Certainty With Respect To Worker Classification
For both tax and nontax purposes, workers must be classified into one of two mutually exclusive categories: employees or self-employed (sometimes referred to as independent contractors).
Worker classification generally is based on a common-law test for determining whether an employment relationship exists. The main determinant is whether the service recipient (employer) has the right to control not only the result of the worker’s services but also the means by which the worker accomplishes that result. For classification purposes, it does not matter whether the service recipient exercises that control, only that he or she has the right to exercise it.
Even though it is generally recognized that more highly skilled workers may not require much guidance or direction from the service recipient, the underlying concept of the right to control is the same for them. In addition, only individuals can be employees. In determining worker status, the IRS looks to three categories of evidence that may be relevant in determining whether the requisite control exists under the common-law test:
(i) behavioral control, (ii) financial control, and (iii) the relationship of the parties.
For employees, employers are required to withhold income and Federal Insurance Contribution Act (FICA) taxes and to pay the employer’s share of FICA taxes. Employers are also required to pay Federal Unemployment Tax Act (FUTA) taxes and generally state unemployment compensation taxes. Liability for Federal employment taxes and the obligation to report the wages generally lie with the employer. For workers who are classified as independent contractors, service recipients engaged in a trade or business and that make payments totaling $600 or more in a calendar year to an independent contractor that is not a corporation are required to send an information return to the IRS and to the independent contractor stating the total payments made during the year. The service recipient generally does not need to withhold taxes from the payments reported unless the independent contractor has not provided its taxpayer identification number to the service recipient. Independent contractors pay Self-Employment Contributions Act (SECA) tax on their net earnings from self-employment (which generally is equivalent to both the employer and employee shares of FICA tax). Independent contractors generally are required to pay their income tax, including SECA liabilities, by making quarterly estimated tax payments.
For workers, whether employee or independent contractor status is more beneficial depends on many factors including the extent to which an independent contractor is able to negotiate for gross payments that include the value of nonwage costs that the service provider would have to incur in the case of an employee. In some circumstances, independent contractor status is more beneficial; in other circumstances, employee status is more advantageous.
Under a special provision (section 530 of the Revenue Act of 1978 which was not made part of the Internal Revenue Code), a service recipient may treat a worker as an independent contractor for Federal employment tax purposes even though the worker actually may be an employee under the common law rules if the service recipient has a reasonable basis for treating the worker as an independent contractor and certain other requirements are met. The special provision applies only if (1) the service recipient has not treated the worker (or any worker in a substantially similar position) as an employee for any period beginning after 1977 and (2) the service recipient has filed all Federal tax returns, including all required information returns, on a basis consistent with treating the worker as an independent contractor.
If an employer meets the requirements for the special provision with respect to a class of workers, the IRS is prohibited from reclassifying the workers as employees, even prospectively and even as to newly hired workers in the same class. Since 1996, the IRS has considered the availability of the special provision as the first part of any examination concerning worker classification. If the IRS determines that the special provision applies to a class of workers, it does not determine whether the workers are in fact employees or independent contractors. Thus, the worker classification continues indefinitely even if it is incorrect.
The special provision also prohibits the IRS from issuing generally applicable guidance addressing the proper classification of workers. Current law and procedures also provide for reduced penalties for misclassification where the special provision is not available but where, among other things, the employer agrees to prospective reclassification of the workers as employees.
Reasons for Change
Since 1978, the IRS has not been permitted to issue general guidance addressing worker classification, and in many instances has been precluded from reclassifying workers – even prospectively – who may have been misclassified. Since 1978 there have been many changes in working relationships between service providers and service recipients. As a result, there has been continued and growing uncertainty about the correct classification of some workers.
Many benefits and worker protections are available only for workers who are classified as employees. Incorrect classification as an independent contractor for tax purposes may spill over to other areas and, for example, lead to a worker not receiving benefits for unemployment (unemployment insurance) or on-the-job injuries (workers’ compensation), or not being protected by various on-the-job health and safety requirements.
The incorrect classification of workers also creates opportunities for competitive advantages over service recipients who properly classify their workers. Such misclassification may lower the service recipient’s total cost of labor by avoiding workers’ compensation and unemployment compensation premiums, and could also provide increased opportunities for noncompliance by service providers.
Workers, service recipients, and tax administrators would benefit from reducing uncertainty about worker classification, eliminating potential competitive advantages and incentives to misclassify workers associated with worker misclassification by competitors, and reducing opportunities for noncompliance by workers classified as self-employed, while maintaining the benefits and worker protections associated with an administrative and social policy system that is based on employee status.
The proposal would permit the IRS to require prospective reclassification of workers who are currently misclassified and whose reclassification has been prohibited under current law. The reduced penalties for misclassification provided under current law would be retained, except that lower penalties would apply only if the service recipient voluntarily reclassifies its workers before being contacted by the IRS or another enforcement agency and if the service recipient had filed all required information returns (Forms 1099) reporting the payments to the independent contractors. For service recipients with only a small number of employees and a small number of misclassified workers, even reduced penalties would be waived if the service recipient (1) had consistently filed Forms 1099 reporting all payments to all misclassified workers and (2) agreed to prospective reclassification of misclassified workers. It is anticipated that, after enactment, new enforcement activity would focus mainly on obtaining the proper worker classification prospectively, since in many cases the proper classification of workers may not have been clear. (Statutory employee or nonemployee treatment as specified under current law would be retained.)
The Department of the Treasury and the IRS also would be permitted to issue generally applicable guidance on the proper classification of workers under common law standards. This would enable service recipients to properly classify workers with much less concern about future IRS examinations. Treasury and the IRS would be directed to issue guidance interpreting common law in a neutral manner recognizing that many workers are, in fact, not employees.
Further, Treasury and the IRS would develop guidance that would provide safe harbors and/or rebuttable presumptions, both narrowly defined. To make that guidance clearer and more useful for service recipients, it would generally be industry- or job-specific. Priority for the development of guidance would be given to industries and jobs in which application of the common law test has been particularly problematic, where there has been a history of worker misclassification, or where there have been failures to report compensation paid.
Service recipients would be required to give notice to independent contractors, when they first begin performing services for the service recipient, that explains how they will be classified and the consequences thereof, e.g., tax implications, workers’ compensation implications, wage and hour implications.
The IRS would be permitted to disclose to the Department of Labor information about service recipients whose workers are reclassified.
To ease compliance burdens for independent contractors, independent contractors receiving payments totaling $600 or more in a calendar year from a service recipient would be permitted to require the service recipient to withhold for Federal tax purposes a flat rate percentage of their gross payments, with the flat rate percentage being selected by the contractor. The proposal would be effective upon enactment, but prospective reclassification of those covered by the current special provision would not be effective until the first calendar year beginning at least one year after date of enactment. The transition period could be up to two years for independent contractors with existing written contracts establishing their status.
California became the seventh state to adopt two new subtypes of stock corporations — a “flexible purpose corporation” and a “benefit corporation" as of January 1, 2012. Now, investors and entrepreneurs can pursue both social and economic objectives allowed by the new corporation subtypes. These two types of new entities may sound like marketing hype but they help shield them against lawsuits brought by shareholders who say that company do-gooding has diluted the value of their stock.
The new stock corporation subtypes differ from traditional for profit corporations that are organized to pursue profit and nonprofit corporations that must be used solely to promote social benefits.
Entrepreneurs who wanted to incorporate social causes or green initiatives often had to become non-profits which limited their ability to raise venture capital.
Approval from 2/3 of a company’s outstanding shareholders is needed to become a benefit corporation. A similar vote is needed to return to the traditional type of corporation.
The Articles of Incorporation for a benefit corporation must include the following additional statement: “This corporation is a benefit corporation.” The Articles of Incorporation for a benefit corporation may identify one or more specific public benefits that shall be the purpose or purposes of the benefit corporation. For complete legal authority, look at California Corporations Code sections 14600-14631.
For a flexible purpose corporation, the Articles of Incorporation must include one of the purpose statements required by California Corporations Code section 2602(b)(1), as well as a statement that a purpose of the flexible purpose corporation is to engage in one or more of the specific purposes provided in California Corporation Code section 2602(b)(2). For complete legal authority, look at California Corporations Code sections 2500-3503.
To help form one of these two new corporations, call business attorney Mitchell A. Port at (310) 559-5259.
Nevada Once Again Leads the Way in Debtor-Friendly Legislation
In his recent article describing the benefits of using a Nevada LLC as an asset protection tool, Jacob Stein wrote all of the following:
The laws of the 50 states aren't uniform when it comes to shielding or exposing a debtor's assets from the claims of creditors. For example, some states fully expose a debtor's residence to a creditor. Other states, such as Florida and Texas, provide a complete homestead exemption. But no state beats Nevada when it comes to consistently and aggressively enacting legislation designed to assure that a debtor's assets remain with the debtor and out of the clutches of creditors.
We repeatedly recite the mantra to all who will listen that investment real estate, be it commercial real estate, apartment building or raw land, should not be owned by the individual, but should be titled in a limited liability company ("LLC"). The laws of most states follow a pattern that prevents a creditor of a member of an LLC from reaching the assets of the LLC. Most states -- including California -- limit the creditor of a member to a charging order, an order issued by a court and directed to the manager of the LLC ordering that any distributions of LLC income or profits that would otherwise be distributed to the debtor-member be instead distributed to the creditor. But if there are no distributions, the charging order is ineffective and the creditor gets nothing. If the LLC is controlled by the debtor-member or someone friendly to the debtor-member, it's not too difficult to withhold distributions until the creditor tires of the hunt or to make distributions to one or more other members who are friendly to the debtor.
The rationale for treating creditors of members of LLC's this harshly is as follows: Let's assume that ten investors pool their resources and start a business, forming an LLC. The LLC purchases real estate and other business assets. Later, one of the members of the LLC develops a problem with creditors. It would disrupt the operations of the business and impact the investment of the other nine members if the creditors of one member were permitted to seize the assets of the LLC. So the law tracks a middle ground: The creditors of the debtor-member cannot seize the assets of the LLC, but they are permitted to intercept any distributions of profits or gains that might be made to the debtor-member, by means of a charging order.
Which brings us to the bottom-line question: If the charging order limitation is grounded in the protection of the other members, should the charging order limitation apply at all if the LLC has only one member, viz., the debtor-member? No state statute excludes single-member LLC's from the purview of the charging order limitation. Nevertheless, most careful practitioners counsel their clients to have more than one member in their LLC's if at all possible.
The Courts Speak
In 2003, the United States Bankruptcy Court for the District of Colorado addressed the issue head-on. In In re Albright, the Court ruled that, where a Colorado LLC had only one member, the Colorado charging order limitation did not apply, because
"the charging order limitation serves no purpose in a single member limited liability company, because there are no other parties' interests affected."
In light of the fact that this was the decision of a trial court, little credence was given to it. Last year, however, the first appellate court had the opportunity to squarely address the issue. In Olmstead v. Federal Trade Commission, WL 2518106 (July 6, 2010), the Florida Supreme Court was confronted with the efforts of a creditor of a 100% owner of a Florida LLC. Of course, the issue was whether the creditor was limited to a charging order. Florida's governing statute is somewhat unusual in that the operative restriction provides that:
"Unless otherwise provided in the articles of organization or operating agreement, an assignee of a limited liability company interest may become a member only if all members other than the member assigning the interest consent."
Florida Stats. 608.433(1).
The Florida Supreme Court held that this statute could not apply, because in the single-member LLC, there are no other members who could withhold or give their consent. Many states, notably California and Nevada (see California Corporations Code §17302(e)) are explicit in providing that the charging order is the only remedy available to a creditor of a debtor-member. Florida has no such provision, and this distinction may render Olmstead inapplicable, or at least distinguishable, from those states that have such a provision.
The Nevada Response
In what appears to be a direct response to the Florida Supreme Court's decision in Olmstead, in June, 2011, Nevada amended its governing statute to add the following highlighted clause:
This section...[p]rovides the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the member's interest of the judgment debtor, whether the limited liability company has one member or more than one member.
In Nevada, at least, the issue is settled.
Will California Defer to the Nevada Statute?
Let's assume that a real estate investor forms a Nevada LLC. The LLC owns a parcel of investment real estate in California. The investor is the sole member of the LLC. Because the LLC is conducting business in California, the LLC registers as a foreign limited liability company with the California Secretary of State. The investor defaults on a promissory note having nothing to do with the operation of the Nevada LLC. The judgment creditor seeks to satisfy his judgment against the assets of the LLC. Is the creditor limited to obtaining a charging order and waiting -- perhaps forever -- until there are distributions to the debtor-member? If the action were brought in Nevada, we know the result. But what if the action were brought in California?
California Corporations Code §17450(a) provides:
The laws of the state or foreign country under which a foreign limited liability company is organized shall govern its organization and internal affairs and the liability and authority of its managers and members.
A cursory reading of this statute might lead one to conclude that a California court should defer to Nevada's statute. After all, the issue of whether a creditor of a member is limited to a charging order or may have other remedies available would appear to be an issue involving the "liability" of the "members." But a creditor might argue that this statute, on its face, is intended to apply to the internal relations of the members and managers, not the liability of a member to third parties.
There is a bottom line here: If a person desires to form an LLC and has no other person to act as a co-member, the LLC should be formed under Nevada law. If a California court defers to the Nevada statute, so much the better. If the attempt fails, the debtor is no worse off than if he or she had formed the LLC under California law in the first place.
Still More Good News from Nevada
One of the basic distinctions between an LLC and a corporation -- at least from a debtor-creditor standpoint -- is that a creditor of a shareholder of a corporation can seize the shareholder's shares, usually by means of a "turnover order." If the debtor is the controlling -- or sole -- shareholder of the corporation, the seizure of the stock means that the creditor has a straight shot at all of the corporation's assets. But there is no possibility of a turnover order for a membership interest of an LLC, especially in those states such as California and Nevada that specify that the charging order is the only remedy that a creditor of a debtor-member has. It is for this reason that we often convert closely-held corporations into limited liability companies.
But this distinction no longer obtains in Nevada, which is now the first state to provide a charging order limitation to the shareholders of Nevada corporations! See N.R.S. 78.746. The limitation exists only for those Nevada corporations that have no more than 75 shareholders (close corporations), and does not apply at all to the subsidiaries of public companies or to professional corporations. But for every other shareholder of every other Nevada corporation, it's nice to know that the legislature is always there, vigilant in protecting their assets.
The IRS has an informative online resource for business owners in California counties of Los Angeles, Orange and Ventura that is worth reviewing before starting a new business. It is also a good review for existing businesses. Below is a list of topics covered by the IRS:
Business Forms and Pubs
This is a list of IRS Tax Publications for Business.
Small Business Resources
This page provides you links to sites that have specific information dealing with Small Business
Starting a Business
If you’re considering starting a business, then start here. This section provides links to everything from a checklist for a new business to selecting a business structure and more.
Operating a Business
This section is packed with the information you need to operate your business. Learn about operating a business with employees, business deductions and tax credits, filing and paying taxes, recordkeeping, and choosing an accounting method.
Online Internal Revenue Bulletins
The online Internal Revenue Bulletin (IRB) is the authoritative instrument of the IRS for announcing all substantive ruling necessary to promote a uniform application of tax law.
IRS Notices and Letters
This page provides links to topics found in the category of IRS Notices.
Employer ID Numbers (EINs)
A full explanation about the EIN, also known as a federal tax identification number.
This section provides links to resources to help the small business owner create a recordkeeping system, get the latest on the cash vs. accrual accounting methods, and tips on understanding their IRS notice.
The subject of employment taxes is not as formidable when you consult our comprehensive resources.
Closing a Business
There is more involved in closing your business than just locking the doors. This section provides procedures for getting out of business, including what forms to file and how to handle additional revenue received or expenses you may incur.
Appeal a Tax Dispute
The Office of Appeals is independent of any other IRS office. Our mission is to settle tax disagreements without having to go to Court and a formal trial.
Audit Technique Guide
The Market Segment Specialization Program focuses on developing highly trained examiners for a particular market segment. A market segment may be an industry such as construction or entertainment, a profession like attorneys or real estate agents or an issue like passive activity losses.
Community Based Outlet Programs
The IRS and local community organizations across the country are working together to increase the availability of tax forms, publications, and other tax materials. After joining the appropriate program, we will send you free copies of material (CD-ROM or paper) that can be used to provide tax information to your employees or the public.
Coordinated Issue Papers - LB&I
The IRS works to identify, coordinate, and resolve complex and significant industry wide issues by ensuring uniform application of the law through the issuance of coordinated issue papers. Although these papers are not official pronouncements on the issues, they do set forth the Service's current thinking.
Federal Payment Levy Program
Certain federal payments (OPM, SSA, federal employee salaries, and federal employee travel) disbursed by the Department of the Treasury, Financial Management Service (FMS) may be subject to a 15 percent levy through the Federal Payment Levy Program (FPLP) to pay your delinquent tax debt. Find out your appeal rights and how to resolve any dispute.
Information for the Tax Exempt Bond Community
Tax Exempt Bonds (TEB) provides specialized information and services to the municipal finance community, including tailored educational programs which focus on bond industry segments; pro-active education and outreach products which address non-compliance trends; and compliance programs devised to foster voluntary resolution of tax law infractions.
Internal Revenue Bulletins Picklist
Link to new IRB picklist.
IRM Part 4 Index
This section of the Internal Revenue Manual (IRM) discusses information reporting and record keeping for businesses.
Internal Revenue Manual (IRM)
The Internal Revenue Manual (IRM) and the Chief Counsel Directives Manual (CCDM) contain the policies, procedures, instructions, guidelines, and delegations of authority which direct the operation and administration of the Internal Revenue Service. Topics include tax administration, personnel and office management, and others.
IRS Non-Retaliation Policy
IRS has a zero-tolerance policy for retaliation and has had one in place since 1998.
Join "e-News For Tax Professionals"
The IRS e-News For Tax Professionals is an electronic mail service designed to provide general news for tax professionals, access to resources on the IRS.gov Web site and a section for local news and events specific to each State, The District of Columbia and International.
Main Index of Tax Topic Categories
An online version of our voice-response system. This area contains helpful tips and pointers to relevant resources for taxpayers.
Market Segment Understandings (MSU)
The MSU Program, first introduced in 1993, is a means of enhancing tax compliance while reducing taxpayer burden. This Program envisions that the IRS and taxpayers in particular market segments, work together to improve tax compliance in those areas through educational efforts and other collaborative approaches rather than through traditional audit techniques.
Procedures, Regs, Rulings FAQs
Qualified Intermediaries (QI)
A Qualified Intermediary (QI) is any foreign intermediary (or foreign branch of a U.S. intermediary) that has entered into a qualified intermediary withholding agreement with the IRS. A QI is entitled to certain simplified withholding and reporting rules.
Research Tax Credit - Internal Use Software
This tax calendar has the due dates for the current tax year that most taxpayers will need. The tax calendar is designed primarily for employers, however the calendar has important due dates for all types of businesses and for individuals.
Tax Code, Regulations and Official Guidance
The place to start for researching publicly accessible versions of the Internal Revenue Code, Treasury (Tax) Regulations, or other forms of official IRS tax guidance.
Small Business Tax Workshops and Webinars
These workshops are designed to help the small business owner understand and fulfill their Federal Tax responsibilities. Self-study formats are available online in both English and Spanish at the IRS online classroom. Webinars are designed to provide presentations on key topics.
In California, since different laws may be involved in a particular employment situation, it is possible that the same individual may be considered an employee for purposes of one law and an independent contractor under another law.
Not all workers are employees as they may be volunteers or independent contractors.
Employers sometimes improperly classify their workers as independent contractors so that the employers are not liable for payments under disability insurance, unemployment insurance, or social security. And, treating a worker as an independent contractor means the employer does not have to pay payroll taxes, the minimum wage or overtime. Finally, not treating workers as employees means the employer does not comply with other wage and hour law requirements and does not have to cover independent contractors under workers’ compensation insurance.
The state agencies most involved with the determination of independent contractor status are the Employment Development Department (EDD), which is concerned with employment-related taxes, and the Division of Labor Standards Enforcement (DLSE), which is concerned with whether the wage, hour and workers’ compensation insurance laws apply. There are other agencies, such as the Franchise Tax Board (FTB), Division of Workers’ Compensation (DWC), and the Contractors State Licensing Board (CSLB), that also have regulations or requirements concerning independent contractors.
Here are some good questions to help you decide what to do about your status as a worker. The answers to these questions can be found by clicking here.
1. How do I know if I am an employee or an independent contractor?
2. The person I work for tells me that I am an independent contractor and not an employee. He does not make any payroll deductions or withholdings for taxes, social security, etc., when he pays me, and at the end of the year he provides me with an IRS form 1099 rather than a W-2. By paying me in this manner does it mean I am automatically an independent contractor?
3. Does it make any difference if I am an employee rather than an independent contractor?
4. When I started my current job my employer had me sign an agreement stating that I am an independent contractor and not an employee. Does this mean I am an independent contractor?
5. How can it be that the Labor Commissioner determined I was an employee with respect to a wage claim I filed and won, and the Employment Development Department (EDD) determined I was an independent contractor, and denied my claim for unemployment insurance benefits?
6. As an employer, what obligations do I have to purchase Workers’ Compensation Insurance or comply with other labor laws for persons classified as independent contractors?
7. What can I do if I believe my employer has misclassified me as an independent contractor and as a result am not being paid any overtime?
8. What is the procedure that is followed after I file a wage claim?
9. What can I do if I prevail at the hearing and the employer doesn’t pay or appeal the Order, Decision, or Award?
10. What can I do if my employer retaliates against me because I thought I was misclassified as an independent contractor and objected to not being paid overtime?
Here are a few links – which is not all-inclusive - to basic federal tax information for people who are starting a business, as well as information to assist in making basic business decisions. Other steps may be appropriate for your specific type of business.
Selecting a Business Structure (Sole Proprietorships, Partnerships, Corporations, S Corporations, Limited Liability Company (LLC))
The California Franchise Tax Board has excellent information about the life of a business from start-up to liquidation and dissolution. Topics include the following:
For more legal help from a California business attorney, call Mitchell A. Port at (310) 559-5259.
Closing your California business? There’s much to do. The Internal Revenue Service provides procedures for getting out of business, including how to handle additional revenue received or expenses you may incur and what forms to file. Here are some useful links:
Need additional help? Call an attorney experienced in business transactions; call Mitchell A. Port at (310) 559-5259.
In a recent decision (Olmstead v. FTC, Supreme Court of Florida, June 24, 2010), the Florida Supreme Court held that Florida’s general collection statute authorizing liens and levies on all assets was not limited by the charging order statute even though the plain meaning of the charging order statute provides that it is the exclusive remedy for a creditor pursuing an LLC membership interest.
The text of the decision follows:
The Business Entities Section of the California Secretary of State's office processes filings, maintains records and provides information to the public relating to business entities (corporations, limited liability companies, limited partnerships, general partnerships, limited liability partnerships and other business filings).
Filing Tips: Tips for filing most corporation, limited liability company and limited partnership documents
Forms, Samples & Fees: Forms, document samples and associated fees
FAQs: Answers to the most frequently asked business entity questions
Name Availability: Corporation, limited liability company and limited partnership name availability inquiries and reservations
Annual/Biennial Statements: Corporation and limited liability company statements of information, common interest development association statements and publicly traded disclosure statements
Information Requests: Orders for certificates, copies and status reports
Service Options: Options for online searches and filings, document processing and information requests (for certificates, copies and status reports)
Service of Process: Substituted service of process
Victims of Corporate Fraud Compensation Fund: Restitution to victims of corporate fraud
The Secretary of State's office is often asked what other agencies a business entity may need to contact to ensure proper compliance. This link is a list of the agencies most often referenced.
Need access to California domestic stock, domestic nonprofit and qualified foreign corporations, limited liability company and limited partnership information of record with the California Secretary of State? Click here.
There are several agencies in the State of California that administer a variety of taxes. While other state and local agencies may issue licenses and permits and assess fees or taxes, this link is a list mostly of state agencies that can help determine your tax obligations and provide you with information about tax reporting and taxpayer rights.
Need additional help? Call a business attorney, call Mitchell A. Port at 310.559.5259.
The California Franchise Tax Board offers free webinars and the one on Wednesday, May 5, 2010, at 10 a.m. (PST) is designed for those who must withhold on California source income payments to resident and nonresident independent contractors. The FTB webinar will take a look at:
• The basics of resident and nonresident independent contractor withholding, including backup withholding.
• A summary of the three phases of withholding and what to do before payment (FTB Forms 587, 588, 589, 590), at the time of payment, and after payment of California source income to independent contractors (FTB Forms 592, 592-V, 592-B).
• How the FTB is preparing for process changes that will occur when it implements its new, automated withholding system in late 2010.
• Withholding resources and contact information you can use at any time.
Each webinar is approximately 40 minutes.
When closing a California business, you must file the final employment tax returns in addition to making final federal tax deposits of these taxes if you have employees. You must also file an annual tax return for the year you go out of business and attach a statement to your return showing the name of the person keeping the payroll records and the address where those records will be kept.
The annual tax return for an S corporation, corporation, partnership, limited liability company or trust includes check boxes near the top front page just below the entity information. For the tax year in which your business no longer exists, check the box that indicates this tax return is a final return. If there are Schedule K-1s, repeat the same procedure on the Schedule K-1.
You will also need to file returns reporting the exchange of like-kind property, reporting the disposition of business property and/or changing the form of your business.
Depending on your type of business structure you have, below is a list of common actions to take when closing your business:
• Issue payment information to sub-contractors.
• Report information from 1099s issued.
• Report the sale or exchange of property used in your trade or business.
• File final employee pension/benefit plan.
• Issue final wage and withholding information to employees
• Report information from W-2s issued.
• File final tip income and allocated tips information return.
• Report capital gains or losses.
• Report partner's/shareholder's shares.
• Consider allowing S corporation election to terminate.
• Report business asset sales.
• Make final federal tax deposits
• File final quarterly or annual employment tax form.
• Report corporate dissolution or liquidation.
• Closing a Business
• Canceling an EIN – Closing Your Account
• Contact state and local agencies because there may be requirements relating to state and local governments as well.
• The SBA also provides advice on closing a business.
The IRS has a website built to help the small business owner with a multitude of resources. Check out the IRS website used by small businesses and the self-employed. Here is what it looks like:
A-Z Business Topics
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Limited Liability Corporation/Partnership (LLC/LLP)
Closing a Business
Operating a Business
Starting a Business
Mitchell A. Port is a business attorney who can assist you and your business with any one or more of the topics listed above.
Next month, the Internal Revenue Service will begin its Employment Tax National Research Project (“ET NRP”). The last one was performed 25 years ago. The study is needed because business practices regarding employment tax issues may have changed significantly since the last IRS employment tax study.
Examinations comprising the study will be conducted to collect data that will allow the IRS to understand the compliance characteristics of employment tax filers.
The IRS will randomly select 2,000 taxpayers each year for the next three years. The examinations will be comprehensive in scope. Taxpayers will receive notices describing the ET NRP process.
When completed, this information will help the IRS select and audit future employment tax returns with the greatest compliance risk. The results will allow the IRS to gauge more accurately the extent to which businesses properly comply with employment tax law and related reporting requirements.
There are two main goals for the ET NRP:
To determine compliance characteristics so IRS can focus on the most noncompliant employment tax areas, and
To secure statistically valid information for computing the Employment Tax Gap.
Records pertaining to employment tax returns and issues will be subject to review during these examinations. Employers should have all of their records available to expedite these examinations.
Small business workshops on the topic of Federal and State Payroll Taxes are currently being offered throughout California.
These seminars are sponsored and presented by IRS partners who are Federal Tax specialists. The workshops are designed to help the small business owner understand and fulfill their federal tax responsibilities. Most are free but some workshops have fees associated with them. Any fees charged for a workshop are paid to the sponsoring organization, not the IRS.
The Internal Revenue Service recently posted tips regarding federal rules that apply to a worker’s status. As an owner of a small business, whether you hire workers as independent contractors or as employees will impact the amount of taxes you withhold from their paychecks and how much taxes you pay. Additionally, it will affect what documents and information they must provide to you, what tax documents you must give to them and how much additional cost your business must bear.
Here are the top ten things every business owner should know about hiring people as independent contractors versus hiring them as employees.
Attention California business owners: A Restricted LLC (limited liability company) and a Restricted LP (limited partnership) are special entities that will be allowed under Nevada law starting October 1, 2009. Nevada is the first and only state to allow these types of entities.
With a restricted LLC, the new statute imposes restrictions and limitations on the LLC's ability to make distributions. The statute provides, in part, that unless otherwise provided in the articles of organization, a restricted LLC shall not make any distributions to its members with respect to their membership interests until ten years after the date of formation of the LLC (or amendment of the articles of an existing LLC to become a restricted LLC), so long as the LLC has remained a restricted LLC.
Why set up an LLC which by its charter may not make any distributions to members for up to ten years? The reason is Internal Revenue Code Section 2704(b), which provides that when valuing an interest in an entity for gift tax purposes, the liquidation restrictions contained within the LLC operating agreement have to be disregarded by the appraiser if the LLC is owned by family members both before and after the transfer. Code Section 2704(b)(3)(B) provides however that a restriction that is imposed by state law cannot be ignored.
With these new entities, some appraisers provide a range of an additional 10% to 35% for the additional valuation discount. So, for example, if the valuation discount would have been 35% for a regular LLC, after adding the additional valuation discount, the valuation discount would instead be between 45% and 70%.
Remember that the new Nevada Restricted LLC and LP statutes only create a new ceiling on valuation discounts that no other state allows. This doesn't mean that you must lock the underlying assets in for ten years. Maybe five years is more appropriate. Maybe three years.
The Bill can be read online. The Restricted LLC language can be read in Sections 26 and 27 of the Bill. The Restricted LP language can be read in Sections 38, 39 and 49.2 of the Bill.
Starting a new business? Be aware of your federal tax responsibilities. Here are the top six things the IRS wants you to know if you plan on opening a new business this year. Also be sure and look at the IRS website for more information.
1. Decide the type of business entity you are going to establish either in California or some other state (such as Nevada or Delaware). The most common types of business are the sole proprietorship, partnership, corporation and S corporation.
2. The type of business you operate in California determines which tax form you have to file, what taxes you must pay and how you pay them. The four general types of business taxes are income tax, self-employment tax, employment tax and excise tax.
3. Generally, businesses need an EIN. An Employer Identification Number is used to identify a business entity. You can also apply for an EIN online at IRS.gov.
4. Good records are necessary. Which recordkeeping system is suited to your business is up to you so long as it shows your income and expenses. Except in a few cases, the law does not require any special kind of records. However, the business you are in affects the type of records you need to keep for federal tax purposes.
5. As a business taxpayer, you must figure taxable income on an annual accounting period called a tax year. The calendar year and the fiscal year are the most common tax years used.
6. You must also use a consistent accounting method, which is a set of rules for determining when to report income and expenses. The most commonly used accounting methods are the cash method and an accrual method. Under the cash method, you generally report income in the tax year you receive it and deduct expenses in the tax year you pay them. Under an accrual method, you generally report income in the tax year you earn it and deduct expenses in the tax year you incur them.
Want to incorporate? Create an LLC? Call a business attorney. Call Mitchell A. Port at (310) 559-5259.
As of June 30, 2009, the IRS has updated the information it makes available concerning subchapter S corporations. Much of what you may need to know about California and federal subchapter S corporations can be found by clicking here.
If you want more information or help forming your California corporation, call Mitchell A. Port at (310) 559-5259.
Similar to an Offer in Compromise for an individual, the offer for a business is computed based upon the business’s current assets and financial disclosure statement. The IRS uses the company’s reasonable collection potential to determine the Offer amount. The reasonable collection potential for a business is computed in a manner similar to that of an individual. However, unlike individual expenses, the IRS does not have “national standards” for business expenses. In most circumstances the IRS will allow all ordinary and necessary expenses of the business.
The IRS’s recent revisions to its Internal Revenue Manual make these types of Offers more difficult.
Offers submitted by an in-business taxpayer with payroll/trust fund recovery penalty liabilities will not be investigated unless the trust fund portion of the taxes are paid, the trust fund recovery penalties are assessed against all responsible persons, or the trust fund package has been forwarded for assessment.
To submit an Offer for an ongoing business, all of the responsible persons must either agree to be assessed with the trust fund recovery penalties, or pay the underlying trust fund amount.
Offers submitted by active businesses with trust fund liabilities no longer require that the Offer amount include the reasonable collection potential of both the entity and all responsible persons. Instead, the ongoing business is only required to offer an amount reflective of its reasonable collection potential.
This policy is likely due to the IRS’s renewed focus on the collection of the trust fund liabilities from all responsible persons, despite an Offer at the entity level.
The IRS will continue to collect the trust fund portion of the liability from the responsible persons despite the entity’s successful Offer; most responsible persons would not be motivated to file an Offer on behalf of the company due to their continued liability. The IRS’s interest in collecting from all responsible persons diminishes some of the benefits of an Offer for an ongoing business taxpayer.
These policies leave most responsible persons in a precarious situation because the Offer for the business will not alleviate their personal liabilities. Unless all of the responsible persons independently qualify for a personal Offer in Compromise, this might not be the best solution for the business. However, it may be the only solution available for the entity to remain in business.
For tax help on your unpaid payroll or income tax, call Mitchell A. Port at (310) 559-5259.
The Franchise Tax Board (FTB) in California has written useful material to help explain the various types of business entities that can be formed in California. A business attorney with knowledge about the benefits and tax implications of these types of entities should be consulted before one is formed. But to give you some useful background information about choices that can be made when forming your business, please read the highlighted topics.
Consult with Mitchell A. Port, a business attorney in Los Angeles, for more assistance when selecting and forming an entity. Call (310) 559-5259.
California's tax season means proper tax planning. A most important tool is the tax code. Access to the entire tax code for California is available by clicking here.
Here's a list of the tax code's table of contents.
CALIFORNIA REVENUE AND TAXATION CODE
TABLE OF CONTENTS
GENERAL PROVISIONS ................................................... 1-38
DIVISION 1. PROPERTY TAXATION
PART 0.5. IMPLEMENTATION OF ARTICLE XIIIA OF THE CALIFORNIA
Generally, businesses and trusts and estates in Los Angeles County, Orange County, Santa Barbara County and Ventura County, California need a new employer identification number (“EIN”) when their ownership or structure has changed. Changing the name of your business does not require you to obtain a new EIN.
What follows are some general rules about when getting a new federal EIN may or may not be appropriate:
You will be required to obtain a new EIN if any of the following statements are true.
• One person is the grantor/maker of many trusts.
• A trust changes to an estate.
• A living or intervivos trust changes to a testamentary trust.
• A living trust terminates by distributing its property to a residual trust.
You will not be required to obtain a new EIN if any of the following statements are true.
• The trustee changes.
• The grantor or beneficiary changes his/her name or address
You will be required to obtain a new EIN if any of the following statements are true.
• A trust is created with funds from the estate (not simply a continuation of the estate).
• You represent an estate that operates a business after the owner's death.
You will not be required to obtain a new EIN if any of the following statement is true.
• The administrator, personal representative, or executor changes his/her name or address.
Limited Liability Company (LLC)
An LLC is a new entity created by state statute. The IRS did not create a new tax classification for the LLC when it was created by the states; instead IRS uses the tax entity classifications it has always had for business taxpayers: corporation, partnership, or sole proprietor. An LLC is always classified by the IRS as one of these types of taxable entities.
You will be required to obtain a new EIN if any of the following statements are true.
• A corporation receives a new charter from the secretary of state.
• You are a subsidiary of a corporation using the parent's EIN or you become a subsidiary of a corporation.
• You change to a partnership or a sole proprietorship.
• A new corporation is created after a statutory merger.
You will not be required to obtain a new EIN if any of the following statements are true.
• You are a division of a corporation.
• The surviving corporation uses the existing EIN after a corporate merger.
• A corporation declares bankruptcy.
• The corporate name or location changes.
• A corporation chooses to be taxed as an S corporation.
• Reorganization of a corporation changes only the identity or place.
You will be required to obtain a new EIN if any of the following statements are true.
• You are subject to a bankruptcy proceeding.
• You incorporate.
• You take in partners and operate as a partnership.
• You purchase or inherit an existing business that you operate as a sole proprietorship.
You will not be required to obtain a new EIN if any of the following statements are true.
• You change the name of your business.
• You change your location and/or add other locations.
• You operate multiple businesses.
You will be required to obtain a new EIN if any of the following statements are true.
• You incorporate.
• Your partnership is taken over by one of the partners and is operated as a sole proprietorship.
• You end an old partnership and begin a new one.
You will not be required to obtain a new EIN if any of the following statements are true.
• The partnership declares bankruptcy.
• The partnership name changes.
• You change the location of the partnership or add other locations.
• A new partnership is formed as a result of the termination of a partnership under IRC section 708(b)(1)(B).
• 50 percent or more of the ownership of the partnership (measured by interests in capital and profits) changes hands within a twelve-month period (terminated partnerships under Reg. 301.6109-1).
Speak to a California tax attorney about this and other business, estate/trust and probate questions. Call Mitchell A. Port at 310.559.5259.
California's business owners now have easy access to solutions made available by the Franchise Tax Board in response to errors made when trying to fulfill their California tax obligations. Here's a partial list of how business owners in the counties of Los Angeles, Santa Barbara, Orange and Ventura - and throughout the rest of California - can make unintended mistakes that delay processing those tax returns:
Incorrect math calculations, or incomplete or missing documents
Return account periods overlap
Omitting or using incorrect entity identification numbers
Incomplete entity name
One lump sum payment sent for multiple entities, or multiple payments sent in the same package/envelope
Incorrect payment amount claimed
Multiple tax returns filed for the same account period
Amended returns not clearly identified as amended
Limited Liability Companies (LLCs) filing incorrect forms
Using an incorrect form for the tax year account period indicated on the return
For tax help, speak with a tax lawyer. Mitchell A. Port is a tax attorney located in Los Angeles who can fix the problem. Call (310) 559-5259.
The Taxpayer Advocate independently represents your interests and concerns within the Internal Revenue Service. The Taxpayer Advocate Service is an independent organization within the IRS whose employees assist taxpayers who believe that an IRS system or procedure is not working as it should, who are seeking help in resolving tax problems that have not been resolved through normal channels, or who are experiencing economic harm. The goals of the Taxpayer Advocate Service are to protect individual and business taxpayer rights and to reduce taxpayer burden. This is accomplished in two ways:
Identifying issues that increase burden or create problems for taxpayers: Bringing those issues to the attention of IRS management and making legislative proposals where necessary;
Ensuring that taxpayer problems which have not been resolved through normal channels, are promptly and fairly handled.
Need further help? Call a qualified California tax attorney - call Mitchell A. Port at (310) 559-5259.
Simply not filing a federal tax return for your California business or for your income earned in California, be it a payroll tax return or a corporate tax return, or an individual income tax return doesn’t mean you or your California based business won’t be assessed a tax.
Internal Revenue Code Section 6020(b) is the authority given to the Commissioner of the Internal Revenue Service to prepare and process tax returns for non-filing business and individual taxpayers. If the tax returns prepared for you by the government are taxable, as they almost certainly will be, then a tax is assessed and collection efforts will be made.
Final regulations were recently issued by the Internal Revenue Service and they affect any person who fails to file a required federal tax return.
The final regulations relate to tax returns prepared or signed by the Commissioner or other Internal Revenue Officers or employees under Section 6020 of the Internal Revenue Code. The final regulations provide guidance for preparing a substitute for return under Section 6020(b).
IRC 6020(b) provides a way to prepare returns and secure assessments from non-filing taxpayers who:
Have an open filing requirement
Do not file a return as required
Speaking with the formality of final tax regulations, here’s what they say: “If any person required by the Internal Revenue Code or by the regulations to make a tax return, fails to make such return at the time prescribed for it, or makes, willfully or otherwise, a false, fraudulent or frivolous return, the Commissioner or other authorized Internal Revenue Officer or employee shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise. The Commissioner or other authorized Internal Revenue Officer or employee may make the tax return by gathering information and making computations through electronic, automated or other means to make a determination of the taxpayer’s tax liability.”
File your unfiled tax returns for your California business or for you personally. Negotiate with a tax attorney’s help how you can pay the tax and how much of it must be paid. Call Mitchell A. Port, an attorney formerly with the IRS, at (310) 559-5259.
Attention California small business owners: The 2009 IRS Tax Calendar for Small Businesses and the Self-Employed (Publication 1518) is now available in English and Spanish. The Tax Calendar is a handy resource to help small business owners meet their tax obligations. The twelve month wall calendar is packed with useful information on retirement plans, common tax filing dates, general business taxes, electronic filing and paying options, business publications and forms and a lot more.
Each page highlights different tax issues and tips that may be relevant to small-business owners.
Tax problems may nevertheless still come up in California and elsewhere. Call a tax attorney for help. Call Mitchell A. Port at (310) 559-5259.
New Section 19011.5 of the California Revenue & Taxation Code requires some taxpayers to make their tax payments using an electronic method which California calls “mandatory e-pay”.
There is a one percent penalty of the amount paid unless the failure to pay electronically was for reasonable cause and not willful neglect.
As a California tax attorney, I don’t know and the law remains unclear whether the penalty applies to those who are employees and who make regular tax payments by having employee withholding done by their employer.
In California, beginning January 1, 2009, personal income taxpayers whose tax liability is greater than $80,000 or who make an estimated tax or extension payment that exceeds $20,000 for taxable years beginning on or after January 1, 2009, must send the payment electronically. Once either of these conditions is met, all payments regardless of type, amount, or tax year must be remitted electronically by credit card, Electronic Funds Withdrawal (EFW), or web pay.
Taxpayers whose tax thresholds fall below the mandatory e-pay amounts may request to discontinue making electronic payments. In March 2009, the California Franchise Tax Board will provide a waiver form for taxpayers to file.
On December 1, the California Franchise Tax Board sent courtesy letters to taxpayers who made a payment in 2008 that could qualify them for mandatory e-pay. The letter informed these taxpayers of the law change, and that they may meet the mandatory e-pay threshold in 2009.
When closing a business in California, there is much to do. Some of the following suggestions may require help from your tax attorney or CPA.
You must file an annual return for the year you go out of business. If you have employees, you must file the final employment tax returns, in addition to making final federal tax deposits of these taxes.
The annual tax return for a partnership, corporation, S corporation, limited liability company or trust includes check boxes near the top front page just below the entity information. For the tax year in which your business ceases to exist, check the box that indicates this tax return is a final return. If there are Schedule K-1s, repeat the same procedure on the Schedule K-1.
You will also need to file returns to report disposing of business property, reporting the exchange of like-kind property, and/or changing the form of your business. Below is a list of typical actions to take when closing a business, depending on your type of business structure:
Make final federal tax deposits
Electronic Federal Tax Paying System (EFTPS)
File final quarterly or annual employment tax form
Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return
Form 941, Employer's Quarterly Federal Tax Return
Form 943, Employer's Annual Tax Return for Agricultural Employees
Form 943-A, Agricultural Employer's Record of Federal Tax Liability
Issue final wage and withholding information to employees
Form W-2, Wage and Tax Statement
Report information from W-2s issued
Form W-3, Transmittal of Income and Tax Statements
File final tip income and allocated tips information return
Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips
Report capital gains or losses
Form 1040, U.S. Individual Income Tax Return
Form 1065, U.S. Partnership Return of Income
Form 1120 (Schedule D), Capital Gains and Losses
Report partner's/shareholder's shares
Form 1065 (Schedule K-1), Partner's Share of Income, Credits, Deductions, etc.
Form 1120S (Schedule K-1), Shareholder's Share of Income, Credits, Deductions, etc.
File final employee pension/benefit plan
Form 5500, Annual Return/Report of Employee Benefit Plan
Issue payment information to sub-contractors
Form 1099-MISC, Miscellaneous Income
Report information from 1099s issued
Form 1096, Annual Summary and Transmittal of U.S. Information Returns
Report corporate dissolution or liquidation
Form 966, Corporate Dissolution or Liquidation
Consider allowing S corporation election to terminate
Form 1120S, Instructions
Report business asset sales
Form 8594, Asset Acquisition Statement
Report the sale or exchange of property used in your trade or business
Form 4797, Sales of Business Property
Contact local and California state agencies.
Speak with a California business attorney about this and your other business questions. Call Mitchell A. Port.
The IRS provided interim guidance with regard to the application of the 2-percent floor under Internal Revenue Code section 67 to certain investment advisory fees. Specifically, the IRS notice provides that, for taxable years beginning before January 1, 2009, non-grantor trusts and estates will not be required to “unbundled” a fiduciary fee into portions consisting of costs that are fully deductible and costs that are subject to the 2-percent floor.
On January 16, 2008, the Supreme Court of the United States issued its decision in Michael J. Knight, Trustee of William L. Rudkin Testamentary Trust v. Commissioner, 552 U.S. ___, 128 S. Ct. 782 (2008), holding that costs paid to an investment advisor by a nongrantor trust or estate generally are subject to the 2-percent floor for miscellaneous itemized deductions under § 67(a).
The IRS and the Treasury Department expect to issue regulations under § 1.67-4 of the Income Tax Regulations consistent with the Supreme Court’s holding in Knight. The regulations, however, will not be issued in time to be applicable to the 2008 taxable year.
The Internal Revenue Bulletin (IRB) is the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation, court decisions, and other items of general interest. It is published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin contents are compiled semiannually into Cumulative Bulletins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application of the tax laws, including all rulings that supersede, revoke, modify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements of internal practices and procedures that affect the rights and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts stated in the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices, identifying details and information of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have the force and effect of Treasury Department Regulations, but they may be used as precedents. Unpublished rulings will not be relied on, used, or cited as precedents by Service personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
Part II.—Treaties and Tax Legislation.
Part III.—Administrative, Procedural, and Miscellaneous.
Part IV.—Items of General Interest.
Interested in knowing more about how the IRS works? Call a tax attorney with experience working with the IRS. Call Mitchell A. Port at 310.559.5259.
The Government Accounting Office (GAO) was asked to review and report on the Internal Revenue Service's (IRS) processes and procedures to prevent and collect unpaid payroll taxes. Specifically, GAO was asked to determine (1) the magnitude of unpaid federal payroll tax debt, (2) the factors affecting IRS’s ability to enforce compliance or pursue collections, and (3) whether some businesses with unpaid payroll taxes are engaged in abusive or potentially criminal activities with regard to the federal tax system.Over 1.6 million businesses owed over $58 billion in unpaid federal payroll taxes, including interest and penalties as of September 30, 2007. Payroll taxes consist of your income tax withheld, social security and Medicare contributions, and the employer’s contributions.
Some of these businesses “abuse” the federal tax system and took advantage of the existing tax enforcement and administration system to avoid fulfilling or paying federal tax obligations. Over a quarter of payroll taxes are owed by businesses with more than 3 years (12 tax quarters) of unpaid payroll taxes. Some of these business owners repeatedly accumulated tax debt from multiple businesses. For example, the IRS found 18 individuals were responsible for not remitting payroll taxes for a dozen different businesses and over 1,500 individuals to be responsible for nonpayment of payroll taxes at three or more businesses.
IRS has not always promptly filed liens against businesses to protect the government's interests and has not always taken timely action to hold responsible parties personally liable for unpaid payroll taxes.
Although IRS has tools at its disposal to prevent the further accumulation of unpaid payroll taxes and to collect the taxes that are owed, IRS's current approach does not provide for their full, effective use. IRS's overall approach to collection focuses primarily on gaining voluntary compliance - even for egregious payroll tax offenders - a practice that can result in minimal or no actual collections for these offenders.
If your business has payroll tax problems you are at risk of the IRS putting you out of business, and assessing the trust fund recovery penalty resulting in owners, and officers having substantial personal tax liability. If you would like assistance in dealing with these, and other types of tax problems contact Los Angeles tax attorney Mitchell A. Port at 310.559.5259.
"Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all."
In carrying out its mission, the IRS creates tax problems for which you may need help from a qualified tax attorney. Call Mitchell A. Port at (310) 559-5259 and discuss how to fix your tax trouble.
Both California employers and California workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS. To read other articles on the topic of independent contractor, see previous blog entries by clicking here and here.
Are your workers independent contractors or employees? For more information, see the IRS website by clicking here.
California businesses often start out small. As a new business owner you need to know your federal tax responsibilities. Here are links to basic federal tax information for start-up businesses. Links are also provided to help in making certain business decisions. The list is not all-inclusive. Other steps may be appropriate for your specific type of business such as contacting a qualified California business attorney who can help.
Call Mitchell A. Port at (310) 559-5259 to discuss your California-based business.
About a year and a half ago, I asked: What are the consequences of treating an employee as an independent contractor? Now, I ask: Are your California workers independent contractors or employees?
Knowing the proper worker classification can be critical to your business. Don’t guess. Act now to make certain you know for sure.
How you answer that question can have a significant impact on how much tax you pay as a California business owner. Whether your workers who may be based in Los Angeles County, Santa Barbara County, Ventura County or Orange County are or are not independent contractors will affect the amount of taxes you must withhold from their pay. It will affect how much additional cost your business must bear to conform to California’s labor code and other laws, what documents and information those workers must provide to you, and what tax documents you must give to them.
California employers who erroneously classify workers as independent contractors can end up with large tax liabilities as well as penalties and interest for failing to pay employment taxes and failing to file required tax forms. Workers can avoid higher taxes and lost benefits if they know their proper status.
By filing a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the Internal Revenue Service, both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee.
Generally, whether a worker is an independent contractor or an employee depends on how much control you have as the owner. Your California workers are most likely employees if you have the right to control or direct not only what is to be done but also how it is to be done. If you can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your workers are probably independent contractors.
Three broad characteristics are used by the IRS to determine the relationship between businesses and workers - Financial Control, Behavioral Control and the Type of Relationship. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training, or other means. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.
Learn more about the determination of a worker’s status as an Independent Contractor or Employee at IRS.gov by selecting the Small Business link. Additional resources include IRS Publication 15-A, Employer's Supplemental Tax Guide, and Publication 1779, Independent Contractor or Employee.
The IRS seems to be growing more effective with enforcement in a number of key areas. The IRS is improving in areas important to maintaining an efficient and fair tax system while collecting billions of additional tax dollars. At the same time, the IRS says it continues to improve service to you and me.
Enforcement by the IRS increased in fiscal year 2007. For example, during 2007 the IRS audited 84 percent more returns of individuals with incomes of $1 million or more than during 2006. Overall, enforcement revenue reached $59.2 billion, up from $48.7 billion in 2006 and nearly $34.1 billion in 2002.
Highlights of the enforcement and services numbers for fiscal year 2007, which ended on September 30, include:
The IRS filed 3.8 million levies and almost 700,000 tax liens during 2007, an increase from the previous year and a substantial increase from five years earlier.
Audit rates increased in 2007, both for overall individual rates and for higher-income taxpayers.
Overall, the total individual returns audited increased by 7 percent to 1,384,563 in 2007 from 1,293,681 in 2006. That’s the highest number since 1998.
One out of 11 individuals with incomes of $1 million or more faced an audit in 2007. Audits of individuals with incomes of $1 million or more increased from 17,015 during fiscal year 2006 to 31,382 during fiscal year 2007, an increase of 84 percent.
Audits of individuals with incomes over $200,000 reached 113,105 returns, up 29.2 percent from the prior year total of 87,885.
The IRS increased audits of individual returns with income of $100,000 or more, auditing 293,188 of these returns in 2007, up 13.7 percent from last year’s total of 257,851.
With businesses, the IRS reviewed more tax returns of flow-through entities – S corporations and partnerships. Statistically, the IRS has placed more emphasis in the area of these flow-through returns. Though large corporate audits are slightly fewer, the Service has increased its focus on mid-market corporations – those with assets between $10 million and $50 million dollars.
Audits of businesses in general rose to 59,516, an increase of almost 14 percent from the prior year’s total of 52,223.
Audits of S Corporations increased to 17,681 during 2007, up 26 percent from the prior year’s total of 13,984.
Audits of partnerships increased to 12,195 during 2007, up almost 25 percent from the prior year’s total of 9,777.
Audits of mid-market corporations increased to 4,473, up 6 percent from last year’s total of 4,218.
Although the audits of large corporations declined slightly in 2007 to 9,644 audits, the number of audits is up 14 percent from the fiscal year 2002 level.
More people visited the IRS internet site, IRS.gov. The IRS site was accessed more than 217 million times in 2007, up more than 10.5 percent from the same period in 2006.
The IRS helped more taxpayers find out about their refunds through the agency’s internet-based system ‘Where’s my Refund?’ The system was accessed 32.1 million times during 2007, up 30 percent from last year’s usage of 24.7 million.
The agency held a 94 percent customer satisfaction rating for its toll-free telephone service.
As in the prior year, the IRS accuracy was 91 percent on tax law questions answered through its toll-free telephone service.
More taxpayers chose to file electronically in 2007 than during the prior year, with 57 percent of individual tax filers choosing to e-file in 2007, up from 54 percent in 2006.
Have a problem with the Internal Revenue Service or California State tax agencies? Call a tax attorney - call Mitchell A. Port for tax help.
California employers can outsource some of their payroll and related tax duties to a third-party payroll service. They can help assure deposit requirements with federal and California state authorities and filing deadlines are met.
Los Angeles County, Santa Barbara County, Ventura County and Orange County California employers who outsource some or all of their payroll responsibilities should consider the following:
For the employer’s protection, employers should ask the payroll service provider if they have a fiduciary bond in place. This could protect the employer in the event of default.
If there are issues with an account, the IRS will send correspondence to the employer at the address of record. The IRS suggests that the employer does not change their address of record to that of the payroll service provider as it may significantly limit the employer’s ability to be informed of tax matters involving their business.
The employer is ultimately responsible for the deposit and payment of federal and California tax liabilities. Even though the third-party is making the deposits, the employer is the responsible party. If the third-party fails to make the federal tax payments, the IRS may assess penalties and interest on the employer’s account. The employer is liable for all taxes, penalties and interest due. The employer may also be held personally liable for certain unpaid federal taxes.
Employers should ensure that their service providers are using EFTPS (Electronic Federal Tax Payment System) so the employer can confirm payments made on their behalf. Everyone should use EFTPS and Treasury regulations require electronic payment for payroll taxes over $200,000 in a calendar year. EFTPS maintains a business’s payment history for 16 months and can be viewed on-line after enrollment. In addition, EFTPS allows employers to make any additional tax payments that their third-party provider is not making on their behalf such as estimated tax payments. The IRS recommends employers verify EFTPS payments as part of their bank account reconciliation process.
For payroll and other tax problems, contact Mitchell A. Port at (310) 559.5259.
California small business owners now have access to reliable and authoritative information provided by the IRS by simply clicking here.
Select business topics using the IRS' A-Z listing, or by business type such as sole proprietor, corporation, etc. The IRS also provides links to major business subjects, such as Business Expenses, which provides a gateway to all related information on that subject.
Here is a list of some of the topics available to business entrepreneurs:
Keep abreast of the latest tax-related news that could affect your business.
The basics on self-employment, filing requirements, and reporting responsibilities for independent contractors.
Find out what qualifies as a deductible business expense, including depreciation.
Businesses with Employees
Guidance on tax-related responsibilities for an employer.
Small Business Forms and Publications
Download multiple small business and self-employed forms and publications.
Online Learning and Educational Products
Learn about business taxes on your own time, and at your own pace.
Employer ID Numbers (EINs)
Find out more on EINs or apply for one online.
Starting, Operating, or Closing a Business
Deductions, recordkeeping, accounting methods...
Filing and Paying Your Business Taxes
Information about how to pay your business taxes.
Electronic IRS: File, Pay.... and More
The IRS is making it easier than ever for you to conduct business with us electronically.
Filing Late and/or Paying Late
Before you decide not to file your tax return on time or not pay all of your taxes when they are due, consider this.
Independent Contractor (Self-Employed) or Employee?
It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
IRS Non-Retaliation Policy
IRS has a zero-tolerance policy for retaliation and has had a written non-retaliation policy in place since 1998.
Private Debt Collection Program
You've been contacted by a private collection agency concerning your overdue taxes. Now what? Click here for more.
Recursos para Pequeñas Empresas
Información y recursos para dueños de pequeños negocios. Infórmese sobre sus obligaciones tributarias.
Small Business Resources
This section offers links to a broad range of resources across federal and state agencies.
The Tax Gap
This page provides information on the tax gap and efforts to reduce it as outlined in news releases, statistics and technical fact sheets.
To discuss these and other topics with a business attorney in Los Angeles, call Mitchell A. Port at (310) 559-5259.
The answer to the question “What structure makes the most sense?” depends on the individual circumstances of each California business owner.
The IRS provides a handy fact sheet giving business men and women in Los Angeles County, Orange County, Ventura County and Santa Barbara County a quick look at the differences between the most common forms of business entities.
The most common forms of businesses are:
Limited Liability Companies (LLC)
Of all the choices you make when starting a California-based business, one of the most important is the type of legal organization you select for your company. This decision can affect how much you pay in taxes, the amount of paperwork your business is required to do, the personal liability you face and your ability to borrow money. Business formation is controlled by the law of the state where your business is organized.
While state law controls the formation of your business, federal tax law controls how your business is taxed. Federal tax law recognizes an additional business form, the Subchapter S Corporation.
All businesses must file an annual return. The form you use depends on how your business is organized. Sole proprietorships and corporations file an income tax return. Partnerships and S Corporations file an information return. For an LLC with at least two members, except for some businesses that are automatically classified as a corporation, it can choose to be classified for tax purposes as either a corporation or a partnership. A business with a single member can choose to be classified as either a corporation or disregarded as an entity separate from its owner, that is, a “disregarded entity.” As a disregarded entity the LLC will not file a separate return instead all the income or loss is reported by the single member/owner on its annual return.
The type of business entity you choose will depend on:
For more on the IRS fact sheet, click here.
To discuss this with a business attorney, call Mitchell A. Port at (310) 559-5259.
There is now tax relief for homeowners. In a news brief issued by the IRS for the benefit of those with troubled loans, the government now says that if your mortgage debt is partly or entirely forgiven during 2007, 2008 or 2009 you may be able to claim special tax relief by filling out Form 982 and attaching it to your federal income tax return for that year. Usually, forgiveness of debt results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude from tax up to $2 million of debt forgiven on your primary residence. The limit is $1 million for a married person filing a separate return.
Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, may qualify for this relief. The debt must have been used to buy, build or substantially improve your principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.
Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. In some cases, however, other kinds of tax relief, based on insolvency, for example, may be available.
If you have other federal or California state tax problems, speak with a qualified tax attorney about finding a solution. Call Mitchell A. Port at 310.559.5259.
In May and June alone, taxpayers reported almost 700 separate phishing incidents to the IRS.
The most common scams involve tax refunds and, this year, economic stimulus payments. The Internal Revenue Service cautions taxpayers to be on the lookout for a new wave of scams using the IRS name in identity theft e-mails, or phishing, that have circulated during the last two months.
The IRS has an interesting news article where the full details are available.
Here is a part of the article:
How Scams Work
"To lure their victims, phishing scams use the name of a known institution, such as the IRS, to either offer a reward for taking a simple action, such as providing information, or threaten or imply an unpleasant consequence, such as losing a refund, for failing to take the requested action.
"The goal of the scams is to trick people into revealing personal and financial information, such as Social Security, bank account or credit card numbers, which the scammers can use to commit identity theft.
"Typically, identity thieves use a victim’s personal and financial 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 or even commit crimes. Most of these fraudulent activities can be committed electronically from a remote location, including overseas. Committing these activities in cyberspace allows scammers to act quickly and cover their tracks before the victim becomes aware of the theft.
"People whose identities have been stolen can spend months or years — and their hard-earned money — cleaning up the mess thieves have made of their reputations and credit records. In the meantime, victims may lose job opportunities or may be refused loans, education, housing or cars."
Topics in the article also include:
Refund e-Mail Scam
Tax Court Scam
Economic Stimulus Payments Scam
Company Report Scam
Substitute Form 1040 Fax Scam
What to Do
Do you have other tax problems with the IRS or California tax authorities? If so, speak with Mitchell A. Port, a tax attorney in Los Angeles, about your concerns.
The Internal Revenue Service has a general questions and answers section you can read in detail here. Each year the IRS updates the answers to reflect the latest changes in tax regulations. These questions and answers came from taxpayers like you.
Frequently Asked Questions
1. IRS Procedures
1.1. General Procedural Questions
1.2. Address Changes
1.3. Amended Returns & Form 1040X
1.4. Code, Revenue Procedures, Regulations, Letter Rulings
1.5. Collection Procedural Questions
1.6. Copies & Transcripts
1.8. Forms & Publications
1.9. Injured Spouse
1.10. Name Changes & Social Security Number Matching Issues
1.11. Notices & Letters
1.12. Refund Inquiries
1.13. Reporting Fraud
1.14. Signing the Return
1.15. W–2 - Additional, Incorrect, Lost, Non-receipt, Omitted
1.16. W–4 - Allowances, Excess FICA, Students, Withholding
2. Filing Requirements/Status/Dependents/Exemptions
2.1. Filing Requirements
2.2. Filing Status
2.3. Dependents & Exemptions
3. Itemized Deductions/Standard Deductions
3.1. Autos, Computers, Electronic Devices (Listed Property)
3.2. Education & Work-Related Expenses
3.3. Gifts & Charitable Contributions
3.4. Interest, Investment, Money Transactions (Alimony, Bad Debts, Applicable Federal Interest Rate, Gambling, Legal Fees, Loans, etc.)
3.5. 5. Medical, Nursing Home, Special Care Expenses
3.6. 6. Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses)
3.7. 7. Other Deduction Questions
4. Interest/Dividends/Other Types of Income
4.1. 1099–DIV Dividend Income
4.2. 1099–INT Interest Income
4.3. 1099–MISC, Independent Contractors, and Self-employed
4.4. 1099 Information Returns (All Other)
4.5. Alimony, Child Support, Court Awards, Damages
4.6. Employee Reimbursements, Form W–2, Wage Inquiries
4.7. Gifts & Inheritances
4.8. Grants, Scholarships, Student Loans, Work Study
4.9. Life Insurance & Disability Insurance Proceeds
4.10. Ministers' Compensation & Housing Allowance
4.11. Savings Bonds
5. Pensions/Annuities/Retirement Plans (i.e., 401(k), etc.)
5.1. General/Taxability Issues including Distributions, Early Withdrawals, 10% Additional Tax, Defaulted Loans
5.3. Types of Plans
5.4. Plan Operations
5.5. Plan Design
5.6. Correcting Plan Errors
6. Social Security Income
6.1. Back Payments
6.2. Regular & Disability Benefits
6.3. Survivors' Benefits
7. Child Care Credit/Other Credits
7.1. Child and Dependent Care Credit & Flexible Benefit Plans
7.2. Child Tax Credit
7.3. Credit for the Elderly or the Disabled
7.4. Hope & Life Time Learning Educational Credits
7.5. Other Credits
8. Earned Income Tax Credit
8.1. Qualifying Child Rules
8.2. Taxable & Nontaxable Income
8.3. Other EITC Issues
9. Estimated Tax
9.2. Farmers & Fishermen
9.4. Large Gains, Lump-sum Distributions, etc.
9.5. Penalty Questions
10. Capital Gains, Losses/Sale of Home
10.1. Property (Basis, Sale of Home, etc.)
10.2. Stocks (Options, Splits, Traders)
10.3. Mutual Funds (Costs, Distributions, etc.)
10.4. Losses (Homes, Stocks, Other Property)
11. Sale or Trade of Business, Depreciation, Rentals
11.1. Depreciation & Recapture
11.2. Rental Expenses versus Passive Activity Losses (PALs)
11.3. Personal Use of Business Property (Condo, Timeshare, etc.)
11.4. Sales, Trades, Exchanges
12. Small Business/Self-Employed/Other Business
12.1. Entities: Sole Proprietor, Partnership, Limited Liability Company/Partnership (LLC/LLP), Corporation, Subchapter S Corporation
12.2. Form 1099–MISC & Independent Contractors
12.3. Form W–2, FICA, Medicare, Tips, Employee Benefits
12.4. Form W–4 & Wage Withholding
12.5. Form SS–4 & Employer Identification Number (EIN)
12.6. Forms 941, 940, Employment Taxes
12.7. Income & Expenses
12.8. Schedule C & Schedule SE
12.9. Starting or Ending a Business
13. Aliens and U.S. Citizens Living Abroad
13.1. Canadian & U.S. Tax Issues
13.2. Exchange Rate
13.3. Foreign Income & Foreign Income Exclusion
13.4. Nonresident Alien - General
13.5. Nonresident Alien - Tax Withholding
13.6. Nonresident Alien - Students
13.7. U.S. Citizens Overseas
14. Electronic Filing (e-file)
14.1. Age/Name/SSN Rejects, Errors, Correction Procedures
14.2. Amended Returns
14.3. Due Dates & Extension Dates for e-file
14.4. Forms W–2 & Other Attachments
15. Magnetic Media Filers
16. Other (Alternative Minimum Tax, Estates, Trusts, Tax Shelters, State Tax Inquiries)
17. Individual Retirement Arrangements (IRAs)
17.1. Distributions, Early Withdrawals, 10% Additional Tax
17.3. Roth IRA
17.4. Traditional IRA
As a California business person, have you asked yourself any of the questions below concerning employees and their tax for which you may be responsible in part? The IRS has the answers to these question on its website at IRS.gov.
Here are the questions:
As an employee, what happens if the IRS determines that I do not have adequate withholding?
If an employer no longer has to submit Forms W-4 claiming complete exemption from withholding or claiming more than 10 allowances, how does the IRS determine adequate withholding?
If the IRS determines that an employee does not have enough federal income tax withheld, what will an employer be asked to do?
As an employer who has received a modification letter (letter 2808C) from the WHC program, do I wait for another 60 days to change the marital status and/or number of allowances per the modification letter?
I have been directed to lock in an employee’s withholding. What happens if I do not lock in the employee’s withholding as directed?
As an employer, after I lock in withholding on an employee based on a lock-in letter from the IRS, what do I do if I receive a revised Form W-4 from the employee?
Our employees can submit or change their Forms W-4 on line. How can I prevent them from changing their Forms W-4 after they have been locked-in by the IRS?
What should I do if an employee submits a valid Form W-4 that appears to be claiming an incorrect withholding amount?
What do I do if an employee hands me a substitute Form W-4 developed by the employee?
I heard my employer no longer has to routinely submit Forms W-4 to the IRS. How will this affect me as an employee?
What if I don’t want to submit a Form W-4 to my employer?
What do I do if an employee hands me an official IRS Form W-4 that is clearly altered?
In the past, as an employer, I was required to submit all Forms W-4 that claimed complete exemption from withholding (when $200 or more in weekly wages were regularly expected) or claimed more than 10 allowances. What Forms W-4 do I now have to submit to the IRS?
Tax problems? Would you like tax help? Tax compliance a problem? Want to settle with the IRS? Call Los Angeles tax attorney Mitchell A. Port at 310.559.5259.
In an announcement made on July 1, 2008, the Internal Revenue Service determined that the deadline for extension requests filed by partnerships, including those formed in California, will be shortened by one month. For partnerships whose year ends on or after September 30, 2008, a calendar-year partnership requesting an extension on Form 7004 to file a partnership tax return (Form 1065) will have an extension granted to September 15th instead of to October 15th as it used to be.
The reason is that partnerships must issue K-1 forms when their Form 1065 is filed. Until now, a partner (who needs the K-1 form to file his own individual income tax return) might get the K-1 form after his or her own extended deadline.
That problem is avoided by having the partnership deadline end a month earlier. Partners will now have at least a month before their own extended deadline in which to incorporate their K-1 forms.
An unincorporated business jointly owned by a married couple is generally classified as a partnership for Federal tax purposes. For tax years beginning after December 31, 2006, the Small Business and Work Opportunity Tax Act of 2007 (Public Law 110-28) provides that a “qualified joint venture,” whose only members are a husband and a wife filing a joint return, can elect not to be treated as a partnership for Federal tax purposes.
Reasons Why a Husband and Wife Might Want to Make the Election Not to be Treated as a Partnership
Because a business jointly owned and operated by a married couple is generally treated as a partnership for Federal tax purposes, the spouses must comply with filing and record keeping requirements imposed on partnerships and their partners. Married co-owners failing to file properly as a partnership may have been reporting on a Schedule C in the name of one spouse, so that only one spouse received credit for social security and Medicare coverage purposes. The election permits certain married co-owners to avoid filing partnership returns, if each spouse separately reports a share of all of the businesses’ items of income, gain, loss, deduction, and credit. Under the election, both spouses will receive credit for social security and Medicare coverage purposes.
The rest of this article is available at www.irs.gov. It continues with a discussion of these business topics:
Definition of a Qualified Joint Venture
How to Make the Election to be Treated as a Qualified Joint Venture
A Business Owned and Operated by the Spouses Through a Limited Liability Company Does not Qualify for the Election
How to Report Federal Income Tax as a Qualified Joint Venture (Including Self-employment Tax)
In General, Spouses Do NOT Need an Employer Identification Number (EIN) for the Qualified Joint Venture
What to do if the Spouses Already Have an EIN for the Partnership
How to Handle Requests From the IRS for a Partnership Return from the Spouses for Tax Years for Which the Election is in Effect
If the Spouses Elect to be Treated as a Qualified Joint Venture, How Do They Report and Pay Federal Employment Taxes?
Duration that the Election Remains in Effect
Also, take a look at Husband and Wife Business.
For help from a California business attorney on these and other topics, call Mitchell A. Port at (310) 559.5259.
Due to rising gas prices, the mileage rate will increase by eight cents to 58.5 cents a mile for all business miles driven from July 1 through Dec. 31, 2008. The new rate for computing deductible medical or moving expenses will also increase by eight cents to 27 cents a mile. The rate for providing services for charitable organizations is set by statute, not the IRS, and remains at 14 cents a mile.
In an article this California tax lawyer thinks is worth reading, Marjorie E. Kornhauser (Arizona State) has published A Tax Morale Approach to Compliance: Recommendations for the IRS, 8 Fla. Tax Rev. 599 (2007).
Here is the introduction:
If people hate taxes so much why do they pay them? The common, seemingly obvious, answer—fear of being caught cheating—is only a partial answer. In fact, this “obvious” answer—based on the rational cost/benefit analysis of traditional economic theory— explains so little of tax compliance that the puzzle of tax compliance is why people pay taxes instead of evading them. The key to this puzzle is “tax morale,” the collective name for all the non-rational factors and motivations—such as social norms, personal values and various cognitive processes—that strongly affect an individual’s voluntary compliance with laws. Higher tax morale correlates with higher tax compliance. Although the exact components of tax morale are not yet fully delineated, Congress and the IRS should begin now to shape and administer income tax laws in accordance with tax morale findings. Delay can only increase the chance that voluntary compliance will deteriorate given the interaction of an individual’s tax morale with elements of the external environment, such as other people and institutions. The tax gap, for example, is more than a problem of lost revenue; it is a visible sign of non-compliance that can create a downward spiral. Non-compliance among other taxpayers can decrease an individual’s own tax morale and compliance. Once tax morale dips, it is hard to restore it to prior levels. Ironically, then, the more the tax gap is publicized, the greater this danger becomes. Consequently, Congress and the IRS should act now to narrow the tax gap and to foster compliance generally. This Report offers the IRS several concrete suggestions for improving individual taxpayer compliance based on the tax morale literature.
Part II discusses methodology and the limitations of empirical research.
Part III briefly describes the tax morale literature, focusing on the main findings regarding: 1) cognitive and affective processes; 2) personal and social values/norms, especially procedural justice, legitimacy, reciprocity, and trust; 3) external activation and suppression of tax morale; 4) demographic factors; and 5) a new tax morale model for tax administration.
Part IV contains recommendations for the IRS. It presents three major recommendations and several more specific suggestions for the IRS to improve individual taxpayers’ voluntary compliance. First, the IRS should establish a department devoted solely to exploring tax morale issues and implementing the findings. Second, the IRS should adopt a tax morale approach to tax compliance that incorporates the findings of the research and responds to—and strengthens—taxpayers’ internal motivations to comply. Third, using tax morale research, the IRS should implement ongoing educational (long - and short term) programs and media campaigns. Although sticks as well as carrots are needed to ensure compliance, this Report examines only the carrots.
Part V provides a short conclusion.
Solutions to tax problems and California tax help from a qualified tax attorney is available by calling Mitchell A. Port at (310) 559-5259.
Want to dissolve, surrender or cancel your California-based business whether you operate as a domestic corporation, foreign corporation, limited liability company or partnership? The California Franchise Tax Board has a helpful brochure to tell you how. Click here.
Winding-down your Los Angeles County, Orange County, Ventura County or Santa Barbara County business can be done with the help of a qualified attorney. Call Mitchell A. Port at (310) 559-5259 if you would like assistance.
The California legislature is considering a bill that would allow the Franchise Tax Board (the FTB) to suspend occupational and professional licenses because of unpaid income tax liabilities and notify the applicable licensing agency of the suspension.
The bill would allow the FTB to suspend an individual’s occupational or professional license because of unpaid income tax liabilities. The FTB would suspend a license only after the following have been provided to the debtor:
Notice of State Income Tax Due,
Final Notice Before Levy,
Order To Withhold (OTW) is issued (if debtor’s bank information is available to the FTB),
Notice of State Tax Lien (issued when a state tax lien is recorded),
60-day preliminary suspension notice.
The FTB would be allowed The FTB to disclose to the licensing boards the reason for the suspension – unpaid taxes.
The FTB staff would provide a hearing, upon request, for license holders who would experience a financial hardship as a result of the suspension.
This bill would define the following:
“Hardship” means financial hardship, as determined by the FTB, where the licensee is financially unable to pay any part of their taxes including penalties, interest, and applicable fees and is unable to qualify for an installment payment arrangement pursuant to Section 19008 of the Revenue and Taxation Code.
“License” includes certificate, registration, or any other authorization to engage in a business or profession issued by a state governmental licensing entity.
“Licensee” means any individual authorized by a license, certificate, registration, or other authorization to engage in a business or profession issued by a state governmental licensing entity.
The bill would allow the Contractors State License Board and the FTB to have concurrent authority to suspend a contractor’s license.
This bill requires licensing boards to provide the FTB information at a time requested by the FTB.
This bill would allow a limited hearing for license holders with outstanding tax liabilities as of the date of enactment to substantiate that the license holder has paid the tax liability reflected in the notice of state tax lien.
The revenue impact of this bill would depend on the number of delinquent taxpayers that possess an occupational or professional license. This estimate was calculated using the actual account balances of the department’s accounts receivables for the affected taxpayers, excluding accounts in bankruptcy and installment agreements. Taxpayers subject to this proposal are those with an outstanding liability of $1,000 or more and have owed that debt for one year or more.
It is estimated that 17,200 taxpayers with occupational and professional licenses will enter the collection process annually. Of the 17,200 taxpayers, it is estimated 38%, or 6,600, are expected to pay their delinquent debts upon notice from the FTB. Current departmental data indicates the average payment amount for compliant taxpayers would be approximately $2,000, resulting in an annual revenue increase of approximately $13 million (6,600 x $2,000 = $13.2 million). The average payment amount was calculated by the amount of payments made in response to filing enforcement notices.
Current departmental data also indicates unresolved cases of approximately 25,000 delinquent taxpayers with occupational and professional licenses in the collection process. Based on the 25,000 taxpayers, it is estimated that nearly 9,500 taxpayers would comply upon notice from the FTB resulting in a revenue increase of $19 million in the first year ($2,000 x 9,500 = $19 million). The revenue for fiscal year ending 2009-10 is estimated to total $32 million ($19 million + $13 million).
It is assumed that 50 percent of the $32 million would be collected in fiscal year 2009-2010, reducing revenue to $16 million. The remaining $16 million from fiscal year 2009-10 would be collected in 2010-11, in addition to the $13 million that is assessed annually, for a revenue impact of $29 million ($16 million + $13 million = $29 million) in 2010-11. Thereafter, the annual fiscal impact of $13 million would be collected. Because the revenue from this bill would be from tax liabilities from prior years, the estimates in the table are all accrued back one year.
If you are having an income tax collection problem with the FTB, call a tax attorney: call Mitchell A. Port at (310) 559-5259 for help.
Like the IRS, California's Franchise Tax Board has its own taxpayer advocate. (See my earlier posting on August 27, 2007 entitled "What Has The IRS' Taxpayer Advocate Done Lately?"). It claims that "The Taxpayer Advocate's office is available to provide an independent review of your unresolved tax problems."
Your rights as a California taxpayer are described on the Franchise Tax Board's Advocate's website in English, Spanish, Chinese, Korean and Vietnamese.
There is also a comparison of California law with federal law concerning the taxpayers' bill of rights.
Common California Advocate Responsibilities Include:
Resolve problems when normal channels don’t work
Protect taxpayers’ rights
Determine whether to suspend collections while case is in review
Ensure courteous treatment of the public
Maintain independent status
Provide independent review
Adhere to agency tax laws
Identify trends and issues
Encourage public suggestions
Promote understandable and simple:
Finally, there is a link to a list of taxpayer advocates in the California Board of Equalization (BOE), Employment Development Department (EDD), Franchise Tax Board (FTB) and the Internal Revenue Service (IRS).
If you continue to have tax problems even when dealing with the taxpayer advocate, call tax attorney Mitchell A. Port for tax help at 310.559.5259.
Attention California business owners: here is a list of some useful sites and links to provide you with solutions to some of your questions about operating your business in the California counties of Los Angeles, Santa Barbara, Orange and Ventura.
U.S. Customs and Border Protection
U.S. Customs and Border Protection is the unified border agency within the Department of Homeland Security.
Environmental Protection Agency
The mission of the U.S. Environmental Protection Agency is to protect human health and to safeguard the natural environment--air, water and land--upon which life depends.
U.S. Tax Court
Congress created the Tax Court to provide a judicial forum in which affected persons could dispute tax deficiencies determined by the commissioner of Internal Revenue prior to payment of the disputed amounts.
Small Business Administration
The mission of the SBA is to maintain and to strengthen the nation’s economy by enabling the establishment and viability of small businesses and by assisting in the economic recovery of communities after disasters.
Business.gov guides you through the maze of government rules and regulations and provides access to services and resources to help you start, grow, and succeed in business.
The U.S. government's official Web portal.
Department of the Treasury
The mission of the Department of the Treasury is to promote the conditions for prosperity and stability in the United States and encourage prosperity and stability in the rest of the world.
Department of Commerce
The Commerce Department’s mission is to create the conditions for economic growth and opportunity by promoting innovation, entrepreneurship, competitiveness and stewardship.
Social Security Administration
The Social Security Administration is the nation's primary income security agency. It pays retirement, disability and survivors benefits to workers and their families, administers the Supplemental Security Income program, and issues Social Security numbers.
Department of Agriculture - Office of Small and Disadvantaged Business Utilization (OSDBU)
The mission of the OSDBU is to provide maximum opportunities for small businesses to participate in USDA contracting activities by establishing and attaining small disadvantaged business program goals.
Department of Labor: Occupational Safety & Health Administration (OSHA)
OSHA's mission is to assure the safety and health of America's workers by setting and enforcing standards; providing training, outreach, and education; establishing partnerships; and encouraging continual improvement in workplace safety and health.
This page provides links to various federal, state and private sites that provide legal information for the small business owner.
Department of Education
The Education Department’s mission is to ensure equal access to education and to promote educational excellence throughout the nation.
A collection of links to State government Web sites with useful information for businesses. Whether you're already in business, just starting or expanding to a new state - there's something here for you!
State and Local Contacts
The State and Local Government on the Net directory provides convenient one-stop access to the Web sites of thousands of state agencies and city and county governments.
U.S. Census Bureau
The Census Bureau serves as the leading source of quality data about the nation’s people and economy.
U.S. Department of Labor
The department administers a variety of federal labor laws including those that guarantee workers’ rights to safe and healthful working conditions, a minimum hourly wage and overtime pay, freedom from employment discrimination, unemployment insurance and other income support.
U.S. Equal Employment Opportunity Commission
The mission of the EEOC is to eradicate employment discrimination at the workplace.
SBTV.com is a television network on the Web devoted exclusively to providing engaging streaming video content to small businesses. It provides technical information on how to run your business, inspirational stories from entrepreneurs across the country, information about small business conferences and events, and resources to help solve day-to-day business challenges.
El portal oficial en español del Gobierno de los EE. UU (The U.S. government's official Spanish-language Web portal)
Has your ex-spouse or former employee turned you in? Are you the victim of a false claim?
The Internal Revenue Service has a Whistleblower Office – it even has a director for it: he is Stephen Whitlock. Recently, the IRS outlined ways informants can report violations of the tax law and possibly claim a reward based on the amount of additional tax, penalties and interest that is owed.
If you earn a reward, you have to pay your own income tax on it. All awards will be subject to normal tax reporting and withholding requirements.
To be eligible for an award under the new procedures, the tax, penalties, interest, additions to tax, and additional amounts in dispute must exceed $2 million for any taxable year and, if the taxpayer is an individual, the individual’s gross income must exceed $200,000 for any taxable year in question.
The Whistleblower Office was created about a year ago, December. To make a claim, an informant must file new Form 211, Application for Award for Original Information, which asks informants for an explanation of how the informant obtained the information, to provide an estimate of the tax owed and the facts in the case.
The IRS’ Whistleblower Office will make the final determination about whether an award will be paid and the amount of the award for claims that it processes. Awards will be paid in proportion to the value of information furnished voluntarily with respect to proceeds collected.
Under the new procedures, the amount of award will be at least 15%, but no more than 30%, of the collected proceeds in cases in which the IRS determines that the information submitted by the informant substantially contributed to the collection of tax. The award percentage may be reduced in some circumstances, which are described in IRS guidance.
Has your ex-spouse or former employee turned you in? Are you the victim of a false claim? Call Mitchell A. Port at 310.559.5259 for tax help.
LLCs are subject to an $800 annual tax if they are doing business in California or have articles of organization accepted, or a certificate of registration issued by the California Secretary of State. The annual tax is prepaid for the privilege of doing business in California, and is due and payable on or before the 15th day of the 4th month after the beginning of the taxable year. The annual tax must be paid for each taxable year until the appropriate papers are filed.
In addition to the annual $800 tax, every California LLC must pay a fee based on total annual income. The LLC fee is due on or before the 15th day of the 4th month after the close of the LLC’s taxable year. The California Franchise Tax Board has a booklet containing much of what one needs to know about LLCs. For taxable years beginning on or after January 1, 2002, use the following chart to compute the fee:
If total annual income is equal to or over – but not over –
$250,000 to $499,999 the fee is $900
$500,000 to $999,999 the fee is $2,500
$1,000,000 to $4,999,999 the fee is $6,000
$5,000,000 and over the fee is $11,790
If the California Franchise Tax Board (FTB) determines multiple LLCs were formed for the primary purpose of reducing fees, the LLC’s total income from all sources that are reportable to California could include the aggregate total income of all commonly controlled LLC members. “Commonly controlled” means control of more than 50% of the capital interests or profit interests of the taxpayer and any other LLC or partnership by the same persons.
Strategic planning is necessary when working with LLCs. Expert tax advice is essential to accomplish business goals. Call Mitchell A. Port at 310.559.5259 to discuss your ideas.
The IRS has a full discussion of offers in compromise on its website. Click here for the full article. Here is what the article says:
An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer's tax liabilities for less than the full amount owed. If the liabilities can be fully paid through an installment agreement or other means, the taxpayer will in most cases not be eligible for an OIC. For information concerning installment agreements, refer to Topic 202.
In most cases, the IRS will not accept an offer unless the amount offered by the taxpayer is equal to or greater than the reasonable collection potential (the RCP). The RCP is how the IRS measures the taxpayer's ability to pay. The RCP includes the value that can be realized from the taxpayer's assets, such as real property, automobiles, bank accounts, and other property. In addition to property, the RCP also includes anticipated future income, less certain amounts allowed for basic living expenses.
The IRS may accept an OIC based on three grounds. First, acceptance is permitted if there is doubt as to liability. This ground is only met when genuine doubt exists that the IRS has correctly determined the amount owed. Second, acceptance is permitted if there is doubt that the amount owed is collectible. This means that doubt exists that the taxpayer could ever pay the full amount owed. Third, acceptance is permitted based on effective tax administration. An offer may be accepted based on effective tax administration when there is no doubt that the liabilities have been correctly determined and no doubt that the full amount owed can be collected, but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances.
When submitting an OIC, taxpayers must....
Is your name on the list? Keep it off!
The California Franchise Tax Board is going after taxpayers who owe about $200,000 up to almost $27 million in back income taxes by listing their names and debts on the agency's website. California Revenue & Taxation Code Section 19195 directs the Franchise Tax Board to publish an annual list of the top 250 taxpayers with liened state income tax delinquencies greater than $100,000.
Of California's roughly 20 million taxpayers, about 250 owe huge debts. Before the FTB publishes the list, each taxpayer who may potentially be on the list gets a letter which provides them an opportunity to voluntarily settle their liability.
The notification letters, titled Notice of Public Disclosure, provide taxpayers 30 days to pay their debts or obtain FTB approval to make installment payments, pay the liability in full, enter into an Offer in Compromise, or substantiate a bankruptcy filing.
The California State Board of Equalization is also required by law to post similar information concerning back sales and use taxes every quarter, removing amounts that are being addressed through bankruptcy, payment arrangement, appeal or litigation.
Get tax help now! Call Mitchell A. Port, a California tax attorney experienced in resolving tax problems.
Did you believe you were an employee at your job rather than an independent contractor? Did your employer mistakenly treat you as an independent contractor perhaps because it was perceived as a way to save Social Security and Medicare Taxes on wages? If you were erroneously treated as an independent contractor, the Internal Revenue Service has developed a new form for employees who have been misclassified as independent contractors by an employer.
Form 8919, Uncollected Social Security and Medicare Tax on Wages, will now be used to figure and report the employee’s share of uncollected social security and Medicare taxes due on their compensation.
By using Form 8919, the worker’s social security and Medicare taxes will be credited to their social security record. To facilitate this process, the IRS will electronically share Form 8919 data with the Social Security Administration.
Generally, a worker who receives a Form 1099 for services provided as an independent contractor must report the income on Schedule C and pay self-employment tax on the net profit, using Schedule SE. However, sometimes the worker is incorrectly treated as an independent contractor when they are actually an employee. When this happens, Form 8919 will be used beginning for tax year 2007 by workers who performed services for an employer but the employer did not withhold the worker’s share of social security and Medicare taxes.
In addition, the worker must meet one of several criteria indicating they were an employee while performing the services. The criteria can be reviewed at this site:
In the past, misclassified workers often used Form 4137 to report their share of social security and Medicare taxes. Misclassified workers should no longer use this form. Instead, Form 4137 should now only be used by tipped employees to report social security and Medicare taxes on allocated tips and tips not reported to their employers.
Whether you are an employee or the employer, tax help is available to be sure you comply with the new rule. Call Mitchell A. Port at 310.559.5259 for tax help.
The Truth about Frivolous Tax Arguments is the Internal Revenue Service’s response to anyone who contemplates arguing on legal grounds against paying their fair share of taxes. It discusses and rebuts many of the more common frivolous arguments made by individuals and groups that oppose compliance with federal tax laws.
This 74-page document is updated at least once a year by the IRS and is designed to help individuals and groups understand their responsibilities and not violate the law.
The document explains many of the common frivolous arguments made in recent years and it describes the legal responses that refute these claims. This document is available on IRS.gov and will help taxpayers avoid wasting their time with frivolous arguments and incurring penalties.
In 2006, Congress increased the amount of the penalty for frivolous tax returns from $500 to $5,000. The increased penalty amount applies when a person submits a tax return or other specified submission, and any portion of the submission is based on a position the IRS identifies as frivolous.
A section of this document explains the penalties that the courts may impose on those who pursue tax cases on frivolous grounds. It should be noted that the cases cited as relevant legal authority are illustrative and are not intended to provide an all-inclusive list relating to frivolous tax arguments.
In November, 2007, the U.S. government sued the owners of a San Diego, California tax preparation firm, asking a federal court to shut them down and permanently bar them from preparing tax returns for others. The civil injunction suit was filed in San Diego, California against Roosevelt Kyle and Rebecca Tyree, both of San Diego, and their businesses—Century One Resorts Ltd., COA Financial Group LLC, and Eagle Financial Services LLC.
According to the government’s complaint, the defendants operate their business in National City, California, and have prepared more than 12,000 federal tax returns since 2000. The suit alleges that Kyle and Tyree understated their customers’ tax liabilities by preparing returns with fabricated business-expense and charitable deductions. The complaint alleges that the Internal Revenue Service estimates that the defendants’ misconduct has caused losses to the U.S. Treasury totaling $18 million.
According to the complaint, the IRS has penalized Kyle three times in the past for understating customers’ tax liabilities. In 2002 a federal jury found Kyle guilty of failing to file his own 1995-1998 tax returns.
Call Mitchell A. Port at 310.559.5259 if you would like a referral to a California tax return preparer who is fair, has integrity, is honest and helpful.
Employment Tax Evasion Schemes
California employers: be careful! Employment tax evasion schemes can take a variety of forms. Los Angeles County, Santa Barbara County, Orange County and Ventura County employers use a few of the most common techniques. Some of the more prevalent methods of evasion include pyramiding, employee leasing, paying employees in cash, filing false payroll tax returns or failing to file payroll tax returns.
Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns
Preparing false payroll tax returns understating the amount of wages on which taxes are owed, or failing to file employment tax returns are methods commonly used to evade employment taxes.
Employee leasing is another legal business practice, which is sometimes subject to abuse. Employee leasing is the practice of contracting with outside businesses to handle all administrative, personnel, and payroll concerns for employees. In some instances, employee-leasing companies fail to pay over to the IRS any portion of the collected employment taxes. These taxes are often spent by the owners on business or personal expenses. Often the company dissolves, leaving millions in employment taxes unpaid.
"Pyramiding" of employment taxes is a fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the IRS. Businesses involved in pyramiding frequently file for bankruptcy to discharge the liabilities accrued and then start a new business under a different name and begin a new scheme.
Paying Employees in Cash
Paying employees, whole or partially, in cash is a common method of evading income and employment taxes resulting in lost tax revenue to the government and the loss or reduction of future social security or Medicare benefits for the employee.
Other schemes include:
Unreliable Third Party Payers.
Offshore Employee Leasing.
Misclassifying worker status.
Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns.
S Corporation Officers Compensation Treated as Corporate Distributions.
For further reading, look at IR-2004-47, titled "IRS Warns Businesses, Individuals to Watch for Questionable Employment Tax Practices."
To resolve and fix these and other tax problems, call Mitchell A. Port at 310. 559.5259.
It’s important for you to find qualified tax professionals if they need help preparing and filing you income tax returns. You are legally responsible for what’s on your own individual income tax returns even if prepared by someone else. It is important to choose carefully when hiring an individual or firm to prepare personal income tax returns. If you pay someone to prepare your tax return, choose that preparer wisely. Here are some points to keep in mind when someone else prepares your return:
Never sign a blank tax return, and do not sign in pencil.
Review and ensure you understand the entries and are comfortable with the accuracy of the return before you sign.
A Paid Preparer is required by law to sign the return and fill in the preparer areas of the form. The preparer should also include their appropriate identifying number on the return. Although the Preparer signs the return, you are responsible for the accuracy of every item on your return. In addition, the preparer must give you a copy of the return.
Review the completed return to ensure all tax information, your name, address and Social Security number(s) are correct. Make sure that none of these spaces is left blank.
A Third Party Authorization Check Box on Form 1040 allows you to designate your Paid Preparer to speak to the IRS concerning how your return was prepared, payment and refund issues and mathematical errors.
If you have provided specific authorization in a power of attorney filed with the IRS, you may have copies of notices or refund checks mailed to your preparer or representative; but only you can sign and cash your refund check.
Unqualified tax preparers may overlook legitimate deductions or credits that could cause you to pay more tax than you should. Unqualified preparers may also make costly mistakes causing their clients to incur assessed deficiencies, penalties, and interest. Here are some suggestions to consider when hiring a tax professional:
Avoid preparers who claim they can obtain larger refunds than other preparers. If your returns are prepared correctly, every preparer should derive substantially similar numbers.
Understand that the most reputable preparers will request to see your receipts and will ask you multiple questions to determine your qualifications for expenses, deductions and other items. By doing so they have your best interest in mind and are trying to help you avoid penalties, interest or additional taxes that could result from an IRS examination.
A paid preparer must sign the return as required by law.
Find out if the preparer is affiliated with a professional organization that provides or requires its members to pursue continuing education and holds them accountable to a code of ethics.
Choose a preparer you will be able to contact and one who will be responsive to your needs. Ask who will actually prepare the return before engaging services. Avoid firms where your work may be delegated down to someone with less training or some unknown worker. You should know exactly who works with your tax matters at all times and how to contact him or her; after all, you are paying for it. Determine if the preparer is exporting your return to a foreign country for preparation. Foreign countries do not have the same security and privacy laws as the United States nor is there any recourse should your information be compromised as a result of lax or nonexistent privacy procedures.
Beware of a preparer who guarantees results or who bases fees on a percentage of the amount of the refund. A practitioner may not charge a contingent fee (percentage of your refund) for preparing an original tax return.
Investigate whether the preparer has any questionable history with the Better Business Bureau, the state’s board of accountancy for CPAs, the state’s bar association for attorneys or the IRS Office of Professional Responsibility (OPR) for enrolled agents or the oversight agency in states that license or register tax preparers.
Determine if the preparer’s credentials meet your needs or if your state mandates licensing or registration requirements for paid preparers. Is he or she an Enrolled Agent, Certified Public Accountant (CPA) or Tax Attorney? Only attorneys, CPAs and enrolled agents can represent taxpayers before the IRS in all matters including audits, collection actions and appeals. Other return preparers may represent taxpayers only in audits regarding a return that they signed as a preparer.
Check IRS.gov for information regarding abusive shelters and other tax schemes and scams.
The IRS can help you prepare your own returns without the assistance of a paid preparer. Before seeking a paid preparer, you might consider how much information is available directly from the IRS through the IRS Web site. Check these links:
Tax evasion is both risky and a crime, punishable by up to five years imprisonment and a $250,000 fine. Remember, no matter who prepares a tax return, you are legally responsible for all of the information on that tax return.
Unfortunately, unscrupulous tax return preparers do exist and can cause financial and legal problems for their clients. Examples of improper actions by unscrupulous preparers include the preparation and filing of false paper or electronic income tax returns that claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions.
Report suspected tax fraud and abusive return preparers by completing Form 3949-A and mailing it or a letter with similar information to:
Internal Revenue Service
Fresno, CA 93888
Call Mitchell A. Port, a California tax attorney at 310.559.5259, for a referral to a tax professional who will work together with you this tax season and going-forward on your tax planning needs.
In California, what other agencies will a business entity need to contact to ensure proper compliance? The following is a list of business resources and of agencies for your reference. In addition, I have included several links to websites that may assist you in your business endeavors.
The California Department of Corporations is responsible for the regulation of securities, franchises, off-exchange commodities, investment and financial services, independent escrows, consumer and commercial finance lending, and residential mortgage lending.
The California Department of Justice, Registry of Charitable Trusts has information relating to charitable trusts and public benefit corporations.
The California Department of Financial Institutions provides information relating to credit unions, industrial loan companies, banks, savings and loan associations or savings banks.
The California Employment Development Department provides information relating to unemployment insurance, disability insurance and employment tax.
The California Department of Industrial Relations, Division of Workers' Compensation provides information relating to worker's compensation requirements.
The California Department of Insurance has information relating to requirements for insurance companies, agents and brokers.
The State Bar of California Office of Certification provides information relating to registration of law corporations and limited liability partnerships.
The California Department of Consumer Affairs has information relating to licensing requirements at the state level for specific business entities.
The California Tax Information Center has information relating to income, payroll, sales and use tax for businesses.
The California Business Investment Services provides tailored site selection and investment counseling services for businesses, real-estate executives, and site selection consultants considering California for new business investment and expansion.
The California Chambers of Commerce provides links to the websites of California Chambers of Commerce.
The California Small Business Fairs offers free seminars for small business owners sponsored by several tax agencies to assist with the tax aspects of a business.
The California State Association of Counties has information relating to city/county business licenses, fictitious business name requirements, zoning, building permits, etc., dependent on business entity activities.
CalGOLD provides detailed information on the business permit, license and registration requirements from all levels of government.
The Small Business Administration provides information regarding starting and managing small businesses.
The U.S. Customs has information regarding importing and exporting issues related to the U.S. Customs Service.
The U.S. Department of Commerce promotes American businesses, keeps a vast array of economic statistics, conducts the census, issues patents and trademarks, sets industrial standards.
The U.S. Business Advisor has information and services provided by the government for the business community.
In the State of California there are several agencies that administer a variety of taxes. The following is a list of state agencies that can assist you in determining your tax obligations and provide you with information about tax reporting and taxpayer rights. Other state and local agencies may issue California permits and assess fees or taxes; they are not listed here.
The Employment Development Department (EDD) issues employer account numbers (sometimes called state employer identification numbers, SEINs, state ID numbers, or reserve account numbers) and administers California's payroll taxes, including State Disability Insurance, Employment Training Tax, Unemployment Insurance, and California Personal Income Tax withholding.
The Franchise Tax Board (FTB) administers corporate and personal income and franchise taxes for the State of California. For questions, you can contact the Franchise Tax Board from inside the U.S. at (800) 852-5711 or from outside the U. S. at (916) 845-6500 (not toll-free).
The State Board of Equalization (BOE) is responsible for the administration and collection of the states sales and use, fuel, alcohol, tobacco, and other special taxes and fees, and issues seller's permits. The BOE is involved in California property tax assessment and administration. The BOE also acts as the appellate body for personal income and franchise tax appeals. For more information call 1-800-400-7115.
The California Tax Service Center provides information relating to income, payroll, sales and use tax for businesses in one handy location.
The Internal Revenue Service (IRS) administers federal payroll taxes, including social security, Medicare, federal unemployment insurance and federal income tax withholding, and issues federal employer identification numbers.
Need help dealing with any of these tax authorities for tax problems you or your California based business have? Please call Mitchell A. Port at 310.559.5259.
What is an LLC?
Is there an annual tax?
What is the annual fee and filing requirements?
Can a California LLC have nonresident members?
What are an LLC's California filing requirements?
Do I have to file a California Schedule K-1 (568) to report a Member’s Shares of Income, Deductions, Credits, Etc.?
Can I get an extension of time to file?
What does "Doing business in California" mean?
How does the California Franchise Tax Board handle it's LLC billings and notices?
How do I cancel my LLC’s registration?
What is a "Short Form Cancellation"?
Where can I get forms and where do I mail them?
How do I organize or register an LLC?
I never did any business or even opened a door, bank account or anything. Why do I owe the $800 annual tax?
I stopped doing business in California; what do I need to do to stop the requirement to pay the annual tax?
How are the fees calculated?
How do I complete the LLC Income Worksheet?
What is a protective claim?
What are the procedures for filing an LLC fee protective claim?
I'm a corporation that converted to an LLC during the current year. Am I liable for the tax as a corporation and as an LLC in the same year?
If I'm classified as a partnership for federal purposes and file federal Form 1065 U.S. Partnership Return of Income, why am I required to file Form 568 Limited Liability Company Return of Income, instead of Form 565 Partnership Return of Income, for state purposes? And, do I still have to pay the fees?
If I have nonresident members, and cannot get all their signatures on the consent release form, can I still file the return?
What is a Series LLC and how does it file in California?
My clients, including those in Ventura County, Los Angeles County, Santa Barbara County and Orange County, are creative when explaining how they ended up with an IRS tax problem including unpaid income tax, unpaid payroll tax and unfiled tax returns. Here are some examples:
I don't have to claim the cash I received, only the checks.
Putting it on the corporate credit card automatically makes it deductible.
It's the accountant's job to figure out how to write that off.
If I'm in a California probate, I won't have to pay estate tax and income tax.
Filing late in the filing season near April 15 decreased your audit risk.
If you show you owe at least $1 instead of getting a refund, you are less likely to be audited.
The Amish don't pay income tax.
There is a Slavery Reparation tax credit for African Americans who never received their '40 acres and a mule'.
There are loopholes to benefit the rich which your tax professional doesn't even know.
I only have to claim the income for which I received a 1099.
I can deduct the cost of keeping my dog as a security system.
I can avoid estate tax at death if I give away all of my property right before I die.
Because the IRS didn't audit me, the deduction I have been taking all these years must be legal.
Filing an extension and filing near Oct 15 decreases your audit risk.
Taxpayers over age 65 who are still working don't have to pay Social Security tax.
Taxing labor/services is unconstitutional.
Attorneys can deduct their cable bill because Court TV is educational.
AMT is only for high income taxpayers.
"Only the little people pay taxes." - Leona Helmsley, Federal Inmate
The federal income tax is unconstitutional because the 16th Amendment was never properly ratified by the states.
The federal income tax is voluntary and applies only to those who volunteer to pay it.
You can incorporate your business in Nevada and pay no state income taxes, even though the corporation does business in your home state and other states.
Filing on extension and claiming a large refund increases your audit risk.
Life insurance proceeds are not taxable.
Nurses/police/EMTs on call can deduct the cost of their monthly phone bill since they need to have a phone to keep their job.
Firefighters can deduct the cost of their lunch since they are on duty 24 hours a shift.
Claiming an office in the home increases your audit risk.
S corp owners don't have to claim a salary.
You can claim your live-n girlfriend as a dependent.
Someone has to win the Irish Lottery.
The Internet Tax Fairness Act forbids states from imposing sales or use taxes on goods ordered over the internet and shipped from outside the buyer's state.
Newly arrived legal immigrants or refugees get a seven-year federal income tax holiday.
You can deduct the cost of your car and all its operating expenses (or mileage) as a business expense if you put advertising on the car.
You can deduct the cost of your vacation if you go on a job interview (keep that business card of the interviewer) while away.
Showing $495 as a non cash donation has less audit risk than showing $500.
Most IRS agents/officers are mean and hard to deal with.
I can deduct a gift of up to $12,000 given to my child.
Police officers can deduct $5 a day as Walking Around Money (WAM).
Criminals (i.e. drug dealers, etc.) are not required to pay taxes on their illegal business income.
If I don't file my return, I don't owe any tax.
Receiving a 1099 increases your audit risk.
Using the pre-printed IRS label increases your audit risk.
My tax at year end is determined by how I fill out my W-4.
If I go to one of those "pennies on the dollar" places, I will only owe them and the government "pennies on the dollar."
I don't pay taxes. I got a refund.
My return is easy, it'll only take you about 5 minutes to do.
IRS Taxpayer Assistance Centers (TAC) are your source for personal tax help in Los Angeles County, Santa Barbara County, Orange County and Ventura County California when you believe your tax issue cannot be handled online or by phone, and you want face-to-face tax assistance. Taxpayer Assistance Centers are closed for all Federal Holidays.
To view a list of all Taxpayer Assistance Centers in your state, click on the map or state links below.
To search for the Taxpayer Assistance Center closest to you, enter your 5-digit ZIP Code into the Office Locator- Walk-In Site Search.
Tax problems? Tax trouble? Income taxes overdue? Have a tax debt? Unfiled tax returns? Want tax help? Call Mitchell A. Port at 310.559.5259.
The following examples of employment tax fraud investigations are excerpts from public record documents on file in the court records in the judicial district in which the cases were prosecuted. Funny thing, though: as a tax attorney in California, only two of approximately twenty cases occurred in California despite its size and the number of businesses operating here.
Three People Sentenced in Tax and Insurance Fraud Scheme
Owner of Farm Labor Contracting Business Sentenced to 24 Months in Prison
Massachusetts Man Sentenced for Tax Evasion and Filing False Employment Tax Returns
Pennsylvania Businessman Sentenced to Prison for Tax Evasion
Oregon Woman to Serve 30 Months in Prison for Tax Evasion
Nursing Home Owner Sentenced to 30 Months in Prison for Failing to Pay Millions in Payroll Taxes
Chief Executive Officer of Company Sentenced for Failure to Pay Over Employment Taxes
Local Businesswoman Sentenced to More Than Five Years in Prison; Fined $1.2 Million for Tax Fraud
Owner of Altus Financial Sentenced to Federal Prison for Failing to Collect and Pay Employment Taxes
Ohio Attorney Sentenced for Tax Crimes
Landscaper Sentenced on Employment Tax Fraud Charges
Payroll Service Sentenced for Employment Tax Fraud
To read the entire story, as well as many other samples, click here.
If you believe you have a tax problem or simply want answers to your tax questions, call Mitchell A. Port at 310.559.5259.
How To Report Abusive CPAs, Attorneys Or Enrolled Agents
Report suspicious actions by tax professionals - including California lawyers, CPAs or EAs - to the email address of the IRS Office of Professional Responsibility which is firstname.lastname@example.org.
If you suspect or know of an individual or company that is not complying with the tax laws, you may report this activity on Form 3949-A and mail it to:
Internal Revenue Service
Fresno, CA 93888
If you do not want to use Form 3949-A, you may send a letter to that address. You should include the following information, if available:
Name and address of the person you are reporting
The taxpayer identification number (social security number for an individual or employer identification number for a business)
The estimated dollar amount of any unreported income
The years involved
A brief description of the alleged violation, including how you became aware of or obtained the information
Your name, address and daytime telephone number
Although you are not required to identify yourself, it is helpful to do so. Your identity can be kept confidential. You may also be entitled to a reward.
While a tax attorney may be unnecessary to help in this situation, you may wish to consult with Mitchell A. Port at 310.559.5259 nonetheless.
Last month, the IRS announced that effective for tax years beginning after December 31, 2006, the U.S. Corporation Short-Form Income Tax Return, Form 1120-A, can no longer be filed. For the 2007 tax year, all domestic corporations must file Form 1120, U.S. Corporation Income Tax Return unless required to file a special return.
For this and other tax issues, call Mitchell A. Port at 310.559.5259.
Earlier this month, the Internal Revenue Service and more than two dozen state workforce agencies - including California's - announced they have entered into agreements to share the results of employment tax examinations.
California, Michigan, New Jersey, New York and North Carolina all are part of the team that developed the strategy, and they were instrumental in helping make sure the agreements meet the needs of the participating states as well as the needs of the IRS.
The agreements, part of the Questionable Employment Tax Practice (QETP) initiative, provide a centralized, uniform means for the IRS and state employment officials to exchange information and data. As a result, they can leverage resources and encourage businesses to comply with federal and state employment tax requirements.
These agreements present a united front for the IRS and its state partners to improve compliance with filing tax returns and paying employment taxes. Combining resources will help IRS and the states uncover employment tax avoidance schemes, reduce fraudulent filings and ensure proper worker classification.
The state agencies, the U.S. Department of Labor, the National Association of State Workforce Agencies, the Federation of Tax Administrators and the IRS worked together on various facets of the exchange agreements.
So far, 29 states have entered into individual information-sharing agreements with the IRS. The states that have signed partnership agreements with the IRS thus far are:
Arizona, Arkansas, California, Colorado, Connecticut, Hawaii, Idaho, Kentucky, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Nebraska, New Hampshire, New Jersey, New York, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, South Dakota, Texas, Utah, Vermont, Virginia, Washington and Wisconsin.
In addition to coordinating compliance activities, the agreements call for collaborative outreach and education activities designed to help businesses understand their employment and unemployment tax responsibilities.
The exchange agreements are the first result of the QETP initiative. The QETP team will use the results of the project to find new opportunities for collaboration and to work toward improved employment tax compliance.
Do you have federal or California state tax problems? Contact Mitchell A. Port for help at 310.559.5259.
Are you an employee of your own California corporation? How much are you paying yourself as salary? How much are you paying yourself as a year-end bonus? Are you unwittingly creating a tax problem for yourself?
An employer, including a California employer, is not entitled to deduct certain compensation paid if that compensation was not reasonable in amount. The excess monies paid are a disguised dividend which causes a tax problem for the employer who will have to pay tax on the amount deducted deduction that will be disallowed by the IRS.
Internal Revenue Code Section 162(a)(1) permits a corporation to deduct “a reasonable allowance for salaries or other compensation for personal services actually rendered.” The test for deductibility in the case of compensation payments is whether they are reasonable and are in fact payments purely for services.
A deduction for compensation that is, in fact, reasonable is an amount “as would ordinarily be paid for like services by like enterprises under like circumstances.”
The 9 Factor Test of Reasonableness
The reasonableness inquiry is governed by the nine - factor test based on a case called Owensby & Kritikos, Inc. v. Cmm'r., 819 F.2d 1315, 1323-24 (5th Cir. 1987).
These nine factors are:
1. The employee's qualifications;
2. The nature, extent and scope of the employee's work;
3. The size and complexities of the business;
4. A comparison of salaries paid with gross income and net income;
5. The prevailing general economic conditions;
6. Comparison of salaries with distributions to stockholders;
7. The prevailing rates of compensation for comparable positions in comparable concerns;
8. The salary policy of the taxpayer as to all employees; and
9. Compensation paid in prior years.
Courts will examine and weigh the totality of the facts and circumstances in determining reasonable compensation so that no one factor will be determinative of reasonableness.
The IRS's determination of reasonableness is presumptively correct which shifts the burden to the taxpayer to establish that he is entitled to a deduction larger than that allowed by the Service.
If you have been challenged by the IRS about your compensation deduction and would like to consult with a tax attorney, call Mitchell A. Port at (310) 559.5259.
California business owners can now request an Employer Identification Number (EIN) - a tax I.D. - through a web-based system that immediately processes requests and generates identification numbers in real time, the Internal Revenue Service recently announced.
Here's how it works. California business owners such as those in Los Angeles County, Orange County, Santa Barbara County and Ventura County, access the internet EIN system through IRS.gov and enter the required information. If the information passes the automatic validity checks, the IRS issues a permanent EIN. If the information does not pass the validity checks, the application is rejected. You then have an opportunity to correct the information and resubmit the application.
The internet EIN application is interactive and asks questions tailored to the type of entity you are establishing.
The system provides "help" screens throughout the application process. This means you will no longer have to print the EIN instructions and separately search for answers while requesting an EIN.
When the EIN application process is complete, you have the option to view, print and save your confirmation notice; you no longer have to wait for the IRS to mail it. Third parties authorized by you can also be provided with the EIN, but the third party cannot view, print or save the confirmation notice. Instead, the confirmation notice is mailed to you.
An EIN assigned through internet submission is immediately recognized by IRS systems. You can begin using the EIN immediately for most business purposes.
What Government Assistance Is Available to California Employers and California Businesses?
Here's a collection of links to California State government web sites with useful information for businesses in Los Angeles County, Santa Barbara County, Orange County and Ventura County. There is something here for you whether you are already conducting business in California, just starting in Los Angeles, Beverly Hills or Culver City, or expanding to a new state.
Visit the California State web sites here and find helpful information on doing business in California, links for California employers, California taxation and more.
Doing Business in the State
For doing business and related tax matters in all the other States, the IRS website has terrific information. Go to State Links.
When you pay your employees, you do not pay them all the money they earned. As an employer, you have the obligation of withholding taxes from their paychecks. Your employees trust that you pay the withholding to the Treasury by making Federal Tax Deposits. That is why they are called trust fund taxes. The income tax and employees' share of FICA (social security and Medicare) that you withhold from your employees' paychecks are part of their wages you pay to the federal government instead of to your employees.
Through this withholding, your employees pay their contributions toward retirement benefits (social security and Medicare) for current retirees and the income taxes that are owed and reported on their tax returns. Your matching share of FICA along with your employees' trust fund taxes, are paid to the government through the Federal Tax Deposit System. The withheld part of these taxes is your employees' money, and the matching portion is their retirement benefit. Refer to Employment Taxes and the Trust Fund Recovery Penalty (TFRP) for more information.
Employment tax deposits are a current expense. Postponing paying them is not the same as making a late payment on your utility bill. Congress has established penalties for delays in turning over employment taxes to the Treasury. The longer it takes to pay that money, the more it will cost you. Refer to Publication 15, Circular E, Employer's Tax Guide, for more information.
Need answers to questions about your trust fund tax, call Mitchell A. Port at (310) 559-5259.
For a lot of reasons, including an IRS audit, a good recordkeeping system includes a summary of your business transactions. Business transactions are ordinarily summarized in ledgers and journals.
A ledger is a book that contains the totals from all of your journals. It is organized into different accounts.
A journal is a book where you record each business transaction shown on your supporting documents. You may have to keep separate journals for transactions that occur frequently.
Whether you keep ledgers and ledgers and how you keep them depends on the type of business you are in. For example, a recordkeeping system for a small business might include the following items:
Employee compensation records
Check disbursements journal
Daily summary of cash receipts
Monthly summary of cash receipts
The system you use to record business transactions will be more effective as you follow good recordkeeping practices. Generally, it is best to record transactions on a daily basis. For example, record expenses when they occur, and identify the source of recorded receipts.
The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove (substantiate) certain elements of expenses to deduct them. Generally, you can meet your burden of proof by having the information and receipts (where needed) for the expenses. You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. Additional evidence is required for travel, entertainment, gifts, and auto expenses. You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses.
For expert representation before the IRS or California Franchise Tax Board, please call Mitchell A. Port at 310.559.5259.
Records for employment taxes should be kept for at least four years. These should be available for IRS review. Records should include:
Dates and amounts of tax deposits you made.
Your employer identification number.
Dates of employment.
Amounts and dates of all wage, annuity, and pension payments.
Copies of returns filed.
The fair market value of in-kind wages paid.
Names, addresses, social security numbers, and occupations of employees and recipients.
Records of fringe benefits provided, including substantiation.
Periods for which employees and recipients were paid while absent due to sickness or injury and the amount and weekly rate of payments you or third-party payers made to them.
Copies of employees' and recipients' income tax withholding allowance certificates (Forms W-4, W-4P, W-4S, and W-4V).
Any employee copies of Form W-2 that were returned to you as undeliverable.
Amounts of tips reported.
Records of allocated tips.
Consider having your power of attorney, your California tax lawyer, represent you when questions arise concerning your taxes. Call Mitchell A. Port at (310) 559-5259.
It is fairly well-settled among tax lawyers and tax accountants that the length of time you should keep a document depends on the expense, action, or event the document records. Generally, you must keep your tax records that support deductions on a tax return or an item of income until the period of limitations runs out for that return.
The period of limitations is the period of time that the IRS can assess additional tax or in which you can amend your tax return to claim a credit or refund. Below is information containing the periods of limitations that apply to income tax returns. The years mentioned below refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.
It is important to note that you should keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return.
1. You owe additional tax and situations (2), (3), and (4), below, do not apply to you; keep records for 3 years.
2. You do not report income that you should report, and it is more than 25% of the gross income shown on your return; keep records for 6 years.
3. You file a fraudulent return; keep records indefinitely.
4. You do not file a return; keep records indefinitely.
5. Keep all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
6. You file a claim for a loss from worthless securities or bad debt deduction; keep records for 7 years.
7. You file a claim for credit or refund after you file your return; keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.
For a more complete explanation, see my blog posting from August 6, 2007.
As you decide whether to keep a document or throw it away, consider whether the records are connected to assets. In other words, keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these records to figure any amortization, depletion deduction, or depreciation and to figure the gain or loss when you sell or otherwise dispose of the property.
Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the bases of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.
If you have an existing business confronting a serious IRS tax audit or other examination, a federal or California state tax problem and would like to speak with a California business lawyer and former IRS tax lawyer about serving as your power of attorney, this is an important posting. Call Mitchell A. Port at (310) 559-5259.
As a business person operating in California, you may choose any recordkeeping system suited to your business that clearly shows your income and expenses. Generally, the law does not require any special kind of records. However, the business you are in affects the type of records you need to keep for federal tax purposes. Your recordkeeping system should also include a summary of your business transactions. This summary is usually made in your ledgers and accounting journals. Your books must show your gross income, as well as your deductions and credits.
Supporting Business Documents
Purchases, sales, payroll, and other transactions you have in your business will generate supporting documents such as invoices and receipts. Supporting documents include canceled checks, paid bills, sales slips, deposit slips, receipts and invoices. These documents contain the information you need to record in your books. It is important for you to keep these documents because they support the entries in your books and on your tax return. You should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense. For more detailed information refer to Publication 583, Starting a Business and Keeping Records.
The following are some of the types of records you should keep:
California business owners must keep records. Indeed, everyone in business must keep records. Good records will help you do the following:
Monitor the progress of your business
Prepare your tax returns
Support items reported on tax returns
Keep track of deductible expenses
Identify source of receipts
Prepare your financial statements
Did you know that the Internal Revenue Service publishes a list of tax-exempt organizations which have lost their tax-exempt status? You can see a recent list by clicking here. Some of those troubled by tax problems are in California. No longer exempt under section 501(c)(3) of the Internal Revenue Code, these organizations no longer qualify to receive tax-deductible contributions under Code section 170(c)(2).
When the Internal Revenue Service revokes recognition of section 501(c)(3) status, Publication 78 does not immediately reflect the change. Instead, the IRS publishes the change in the Internal Revenue Bulletin (IRB), which can be accessed by clicking on the organization’s name here. Here is a cumulative list of such organizations published in the IRB from November 2005 to present. Click here for a page listing revocations back to January 2005.
Want to form a 501(c)(3) and it's equivalent in California? Call Mitchell A. Port for a consultation at (310) 559-5259.
Are you a California taxpayer with a tax problem involving income tax withholding? Have you found that your employer in Los Angeles County, Santa Barbara County, Orange County or Ventura County can be more helpful without having to consult with a tax attorney? The IRS published a list of 13 questions and answers about compliance with income tax withholding requirements. Here they are:
Q1: In the past, as an employer, I was required to submit all Forms W-4 that claimed complete exemption from withholding (when $200 or more in weekly wages were regularly expected) or claimed more than 10 allowances. What Forms W-4 do I now have to submit to the IRS?
A1: Employers are no longer required to routinely submit Forms W-4 to the IRS. However, in certain circumstances, the IRS may direct you to submit copies of Forms W-4 for certain employees in order to ensure that the employees have adequate withholding. You are now required to submit the Forms W-4 to IRS only if directed to do so in a written notice or pursuant to specified criteria set forth in future published guidance.
Q2: If an employer no longer has to submit Forms W-4 claiming complete exemption from withholding or claiming more than 10 allowances, how does the IRS determine adequate withholding?
A2: The IRS is making more effective use of information contained in its records along with information reported on Form W-2 wage statements to ensure that employees have enough federal income tax withheld.
Q3: If the IRS determines that an employee does not have enough federal income tax withheld, what will an employer be asked to do?
A3: If the IRS determines that an employee does not have enough withholding, we will notify you to increase the amount of withholding tax by issuing a “lock-in” letter that specifies the maximum number of withholding allowances permitted for the employee. You will also receive a copy for the employee that identifies the maximum number of withholding exemptions permitted and the process by which the employee can provide additional information to the IRS for purposes of determining the appropriate number of withholding exemptions. If the employee still works for you, you must furnish the employee copy to the employee. If the employee no longer works for you, you must send a written response to the IRS office designated in the lock-in letter indicating that the employee is no longer employed by you. The employee will be given a period of time before the lock-in rate is effective to submit for approval to the IRS a new Form W-4 and a statement supporting the claims made on the Form W-4 that would decrease federal income tax withholding. The employee must send the Form W-4 and statement directly to the IRS office designated on the lock-in letter. You must withhold tax in accordance with the lock-in letter as of the date specified in the lock-in letter, unless otherwise notified by the IRS. You will be required to take this action no sooner than 45 calendar days after the date of the lock-in letter. Once a lock-in rate is effective, an employer can not decrease withholding unless approved by the IRS.
Are you running a small business anywhere in the U.S and in particular Los Angeles County, Santa Barbara County, Orange County or Ventura County, California? Would you like a calendar packed with valuable business tax information?
The IRS is offering a free calendar to help you keep track of tax deadlines and important dates throughout the year.
This widely-used special business tax calendar provides the small business owner with a ready resource for meeting his or her tax obligations.
Topics include information on general business taxes, IRS and Social Security Administration customer assistance, electronic filing and paying options, retirement plans, business publications and forms, common tax filing dates, federal holidays and much more.
The Tax Calendar for Small Businesses and Self-Employed Individuals from the Internal Revenue Service is a 12-month calendar is filled with deadline reminders, important information such as changes in deductible mileage rates and business tips such as how to organize business and travel expenses.
Each page of the calendar highlights different tax issues and tips such as business planning, accounting methods, tracking your records, and protecting your information that are especially relevant to small-business owners. The calendar has room each month to add notes, state tax dates or business appointments.
The 2007 Tax Calendar for Small Businesses, IRS Publication 1518, is now available in both English and Spanish versions. You may also want to look at IRS Publication 509 entitled “Tax Calendars for 2007”.
California business owners take heed: the Internal Revenue Service published the “Executive Compensation - Fringe Benefits Audit Techniques Guide” giving you a road-map to what it will examine when auditing your executive perks.
Corporate executives in Los Angeles County, Santa Barbara County, Ventura County and Orange County and throughout California often receive extraordinary fringe benefits that are not provided to other employees. New income tax problems arose because of changes in the law.
In 1984, the Internal Revenue Code (“Code”) was changed to include the term “fringe benefits” in the definition of gross income found in Code §61. A fringe benefit provided in connection with the performance of services, regardless of its form, is treated as compensation includible in income under Code §61. Any property or service that an executive receives in lieu of or in addition to regular taxable wages is a fringe benefit that may be subject to taxation.
Whether a fringe benefit is taxable depends on whether there is an exclusion under the law that applies to the benefit. For example, when Code §61 was amended to include the term “fringe benefits”, §132 was added to provide exclusions for certain commonly provided fringe benefits.
Section 132 provides exclusions for working condition fringes, qualified moving expenses, de minimis fringes, no additional cost services, qualified transportation fringes, qualified employee discounts and qualified retirement planning services.
Although fringe benefits are taxable, employers may not treat them as wages for income and employment tax purposes. Employers may classify a taxable fringe benefit under expense accounts other than compensation and thereby not subject the fringe benefit to income and employment taxes.
Why Should I Keep Records?
Everyone in business - California businesses as well - must keep records. Keeping good records is very important to your business. This discussion involves advice I give to my clients in Los Angeles County, Ventura County, Orange County and Santa Barbara County, California. Good records will help you do the following:
Monitor the progress of your business
Keep track of deductible expenses
Identify source of receipts
Prepare your financial statements
Support items reported on tax returns
Prepare your tax returns
Here’s an interesting read. Published by the IRS and read by tax attorneys like me as well as by others, The Truth About Frivolous Tax Arguments addresses some of the more common false "legal" arguments made by individuals and groups who oppose compliance with the federal tax laws.
These arguments are grouped under several general categories, with variations within each category. Each contention is briefly explained, followed by a discussion of the legal authority that rejects the contention. The second section deals with frivolous arguments encountered in collection due process cases. The final section illustrates penalties imposed on those pursuing frivolous cases.
That question comes up often with my clients in Los Angeles County, Orange County, Santa Barbara County and Ventura County. It isn’t exactly a big tax problem for which a Los Angeles tax attorney like myself needs to offer tax help. But the length of time a document must be retained depends on the action, expense, or event the document records. Generally, records that support an item of income or deductions on a tax return must be retained until the period of limitations for that return runs out.
PERIOD OF LIMITATIONS DEFINED:
The period of limitations is the period of time in which a tax return can be amended to claim a credit or refund, or that the IRS can assess additional tax.
I've listed below the periods of limitations that apply to income tax returns. (Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.)
KEEP RETURNS FOR 3 YEARS IF:
If you file a claim for credit or refund after you file your return; keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.
KEEP RETURNS FOR 4 YEARS IF:
It is an employment tax record. Keep all such records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
KEEP RETURNS FOR 6 YEARS IF:
You do not report income that you should report, and it is more than 25% of the gross income shown on your return.
KEEP RECORDS FOR 7 YEARS IF:
You file a claim for a loss from worthless securities or bad debt deduction;
KEEP RECORDS INDEFINITELY IF:
You have filed a fraudulent return, or
You do not file a return;
BUT WAIT, THERE'S MORE:
The following questions should be applied to each record as you decide whether to keep a document or throw it away.
PAY SPECIAL ATTENTION TO RECORDS CONNECTED WITH PROPERTY:
Records relating to property must be retained until the period of limitations expires for the year in which you dispose of the property in a taxable disposition.
Those records are needed to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.
Generally, if property is received in a nontaxable exchange, your basis in that property is the same as the bases of the property you gave up, increased by any money you paid. Records must be retained on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.
THE TIME IS UP. NOW WHAT?
Even when records are no longer needed for tax purposes, they should be retained until it is certain they will not be needed for other purposes. For example, an insurance company or creditors may require the records to be held for a period of time beyond what the IRS requires.
If you have concerns about this issue and other tax controversies and tax problems, please call Mitchell A. Port at (310) 559-5259 to discuss the tax help you need.
The Online Payment Agreement (OPA) allows eligible individuals to apply for an installment agreement to pay off their tax liability. To qualify, you must have your bill from the IRS and have filed all required tax returns. You must owe less than $25,000 and be able to pay the entire liability within 60 months.
Paying your taxes in full and on time avoids unnecessary penalties and interest. However, if you cannot pay your taxes in full, you may request a payment agreement.
This application will allow you or your authorized representative (Power of Attorney) to self qualify, apply for an installment agreement, and receive immediate notification of approval.
There may be times when you will need to mail in paperwork or speak with us before we can determine your eligibility for an installment agreement. If that is the case, the OPA application will give you an address or a toll-free phone number to reach the IRS.
When I was employed at a tax lawyer at the Office of Chief Counsel in Washington, D.C., I was involved in tax litigation. It was left to others to take the specifics of laws enacted by Congress and translate them into detailed regulations, rules and procedures.
Seven of the most common forms of guidance regarding IRS tax administration are explained briefly here.
Private Letter Ruling
A private letter ruling or PLR is issued in response to a written request submitted by a taxpayer and is binding on the IRS if the taxpayer fully and accurately described the proposed transaction in the request and carries out the transaction as described. PLRs are generally made public after all information has been removed that could identify the taxpayer to whom it was issued. A PLR is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer's specific set of facts. A PLR is issued to establish with certainty the federal tax consequences of a particular transaction before the transaction is consummated or before the taxpayer's return is filed. A PLR may not be relied on as precedent by other taxpayers or IRS personnel.
Revenue rulings are published in the Internal Revenue Bulletin for the information of and guidance to taxpayers, IRS personnel and tax professionals. A revenue ruling is the conclusion of the IRS on how the law is applied to a specific set of facts and is an official interpretation by the IRS of the Internal Revenue Code, related statutes, tax treaties and regulations. For example, a revenue ruling may hold that taxpayers can deduct certain automobile expenses.
A revenue procedure is also published in the Internal Revenue Bulletin for the information of and guidance to taxpayers, IRS personnel and tax professionals. A revenue procedure is an official statement of a procedure that affects the rights or duties of taxpayers or other members of the public under the Internal Revenue Code, related statutes, tax treaties and regulations and that should be a matter of public knowledge. While a revenue ruling generally states an IRS position, a revenue procedure provides return filing or other instructions concerning an IRS position. For example, a revenue procedure might specify how automobile expenses should be computed by those entitled to the deduction by applying a certain mileage rate in lieu of calculating actual operating expenses.
How does the Internal Revenue Service apply partial payments made by a California business entity (or any other State entity) before January 1, 2003 on its Form 941 employer tax liability where the Trust Fund Recovery Penalty (“TFRP”) liability has been assessed and the Letter 1153 (DO) has been sent to the responsible person before June 19, 2000?
Partial payments made by businesses in Los Angeles County, Santa Barbara County, Ventura County or Orange County, California to the IRS without written direction to designate payments to the trust fund portion for the most recent tax period will be applied by the Service “in the order of priority that the Service determines will serve its best interest.” (emphasis added).
Generally, the order of priority that the IRS determines will serve its best interest means that undesignated payments are applied first to the liability with the shortest or most imminent statute of limitations for collections, then to the liability with the next shortest statue and so on and so forth. The tax period or liability with the shortest collection statute is not always the earliest or oldest tax period or liability.
A voluntary partial payment made by a California business entity before January 1, 2003 on its Form 941 employer tax liability, where the TFRP liability has been assessed and the Letter 1153 (DO) has been sent to the responsible person before June 19, 2000, will be applied pursuant to the taxpayer’s written instructions.
A partial involuntary and/or undesignated payment made under the same circumstances will be applied first to the non-trust fund portion of tax, then to assessed lien fees and collection costs, then assessed penalties, then assessed interest, then accrued penalties and accrued interest, and then finally to the trust fund portion of the tax.
In an IRS Office of Chief Counsel Release 200036045, dated May 16, 2000, two issues were raised:
First: Whether the terms of a trust prevent the attachment of the federal tax lien.
Second: What collection device, if any, should be used to collect from the taxpayer's interest in the trust.
The Chief Counsel’s Release arrived at two conclusions:
First: The taxpayer has a property interest in the trust subject to the federal tax lien, despite the spendthrift, discretionary, and remainder interest provisions. The Internal Revenue Service believed that this property interest is limited to the payments to be made as provided for by the trust.
Second: A suit to foreclose the federal tax lien would be the collection action, if any, that the Internal Revenue Service would recommend.
The Chief Counsel’s Release draws a distinction between fully discretionary trusts and those requiring payments for support: “Where a trust gives the trustee uncontrolled, absolute discretion with respect to the distributions, if any, made to a beneficiary, the beneficiary has no basis to compel the trustee to make a distribution. Therefore, he does not have any interest which is subject to the federal tax lien. On the other hand, a beneficiary does have a right to property subject to the federal tax lien where, under state law, he can force the trustee to act, as is the case with a support trust.”
Strategic Planning Lessons Learned:
First: A trust created by parents or other third parties can help to protect business assets from creditors and estate taxation.
Second: Giving a trust beneficiary the power to withdraw assets for his or her support makes the trust assets subject to an IRS lien for outstanding taxes.
If you want to discuss your own situation with a California tax attorney, call Mitchell A. Port at (310) 559-5259.
California business lawyers and California promoters claimed Nevada corporations provide great asset protection benefits. Until this year, these asset protection claims (some of which I have heard from Los Angeles business transaction attorneys I know) regarding Nevada corporations were far from the truth, unfortunately. On July 1, 2007, all of this changed. Under a new Nevada statute, for any corporation that has two to seventy-five shareholders, the statute provides that a creditor's sole remedy is a "charging order."
Before SB 252, some proponents of Nevada corporations alleged that since shareholder information is not public and Nevada does not report to other states, that a creditor is less likely to discover your assets through an asset search with a Nevada corporation.
It is true that, if title is not in your individual name, a Nevada corporation or any revocable trust for that matter provide at least a small degree of asset protection. However, almost all creditors proceed to discovery regardless of whether an initial asset review revealed a debtor's assets. During discovery, you will truthfully disclose your ownership interest in a Nevada Corporation or revocable trust.
Many of my California clients make interest-free or low-interest loans to their children as part of a business transaction between them. Many business clients either forego interest altogether or miss collecting all the interest. In either case, foregone interest or missed payments must be imputed on loans between family members at the AFR (applicable federal rate).
Consider, for instance, that in January 2007 you loaned $500,000 to your child which was payable in 9 years. Also assume you are not charging interest. Loans three to nine years are considered mid-term loans. In January 2007, the AFR that the IRS publishes was 5.51%. The imputed interest is $27,550 each year which must be recognized on your income tax return. If your child doesn’t pay the interest, then you are deemed to have made a gift to your child. Your child does not get a tax deduction for the $27,550 since no payments were actually made.
Some of the tax consequences can be avoided if you qualify for either of two exceptions:
First, if the amount of below-market loans you make to a child doesn’t exceed $10,000, no interest will be imputed. To get this tax break, the loan can’t be used for income-producing investments.
Second, if the amount of below-market loans you make to a child doesn’t exceed $100,000, no income tax consequences will apply. That will be the case if the child’s net investment income is no more than $1,000 each year.
Try to keep loans below those levels, see that the other requirements are met, and put all intra-family loans in writing to minimize tax problems.
If you have to write a business contract, negotiate a business transaction, want to form a new entity, or have other questions related to your business you would like to discuss with an attorney, call Mitchell A. Port at (310) 559-5259.
The other day, the Internal Revenue Service today alerted us in California and elsewhere to the latest versions of an e-mail scam intended to fool us into believing we are under investigation by the agency’s Criminal Investigation division.
The IRS’s news release states that the e-mail purports to be from IRS Criminal Investigation falsely states that we are under a criminal probe for submitting a false tax return to the California Franchise Tax Board. The e-mail entices us to click on a link or open an attachment to learn more about the complaint against us. The e-mail link and attachment is a Trojan Horse that can take over our computer hard drive and allow someone to have remote access to the computer.
The IRS urged us not to click the link in the e-mail or open the attachment. Similar e-mail variations suggest a customer has filed a complaint against a company and the IRS can act as an arbitrator.
Keep in mind that the IRS does not send out unsolicited e-mails or ask for detailed personal and financial information. Additionally, the IRS never asks people for the PIN numbers, passwords or similar secret access information for their credit card, bank or other financial accounts.
The IRS also sees other e-mail scams that involve tricking victims into revealing private personal and financial information over the Internet, a practice that is known as “phishing” for information.
Recipients of questionable e-mails claiming to come from the IRS should not open any attachments or click on any links contained in the e-mails. Instead, they should forward the e-mails to email@example.com (follow the instructions).
Since the establishment of the mail box last year, the IRS has received more than 17,700 e-mails from taxpayers reporting more than 240 separate phishing incidents. To date, investigations have identified host sites in at least 27 different countries, as well as in the United States.
Other widespread e-mail tells taxpayers the IRS is holding a refund (often $63.80) for them and seeks financial account information. Another fraudulent e-mail scams try to entice taxpayers to click their way to a fake IRS Web site and ask for bank account numbers. Still another email claims the IRS’s ‘anti-fraud commission’ is investigating their tax returns.
According to IRS estimates, incorrect deduction of hobby expenses account for a portion of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes. No doubt California contributes significantly to those billions. Tax help is available, however, to address this tax problem before it becomes a major controversy with the Internal Revenue Service.
The Internal Revenue Service provides guidelines to determine whether an activity is a business or a hobby (which is defined as an activity not engaged in for profit). Those of us living and working in Los Angeles County, Orange County, Santa Barbara County or Ventura County would benefit by reviewing those guidelines before a tax problem arises.
The rules for determining if an activity qualifies as a business and what limitations apply if the activity is not a business are explained by the Internal Revenue Service in Publication 535.
In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.
In order to make this determination, taxpayers should consider the following factors:
Does the activity make a profit in some years?
Does the time and effort put into the activity indicate an intention to make a profit?
Have you made a profit in similar activities in the past?
Can you expect to make a profit in the future from the appreciation of assets used in the activity?
If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
Has the taxpayer changed methods of operation to improve profitability?
Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
Do you depend on income from the activity?
Sidley Austin LLP Pays IRS $39.4 Million Penalty
The IRS reached a settlement yesterday with the law firm of Sidley Austin LLP, which paid a civil tax shelter promoter penalty of $39.4 million. The penalty results from the firm’s failure to comply with tax shelter registration requirements and promotion of abusive tax shelters.
The firm issued opinions in connection with potentially abusive tax shelters to over 700 high-net worth individuals and corporations. Some of the packages marketed to these individuals included listed transactions such as BOSS (Bond & Option Sale Strategy), variants of the so-called “Son of BOSS” shelter that went by names of BLIPS (Bond Linked Issue Premium Structure), COBRA (Currency Options Bring Reward Alternatives), and COINS (Currency Option Investment Strategy), and others that went by the names of OPIS (Offshore Portfolio Investment Strategy), FLIP (Foreign Leveraged Investment Program), and POPS (Partnership Option Portfolio Securities).
The firm also issued tax opinions in connection with certain potentially abusive non-listed transactions involving distressed assets, bond and equity strips and lease strips.
“Sidley Austin has paid a significant penalty for its role in promoting abusive tax shelters,” said IRS Acting Commissioner Kevin M. Brown. “The firm has also taken concrete steps to prevent a recurrence of this behavior in the future, which they have agreed to maintain going forward. We appreciate their actions and their cooperation in our ongoing investigations.”
The Internal Revenue Service recently came out with its list of what California business owners need to know with regard to federal tax responsibilities. Tax help is available to business owners in Los Angeles County, Ventura County, Santa Barbara County and Orange County by clicking on any of the links below.
Starting, Operating or Closing a Business
Checklist for Starting a Business
Employer ID Number (Form SS-4)
Understanding and complying with tax requirements
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Tax Court litigation arose in Los Angeles County, California which surprised my client who currently conducts his business in West Los Angeles. The IRS issued a Notice of Deficiency (the so-called “90 day letter”) disallowing business expenses my client knew were legitimate. The earlier IRS audit claimed my client was engaged in a hobby and hobby losses are not deductible. Through his accountant, my client retained me as his tax attorney to fight the IRS to contest the proposed income tax, penalty and interest assessment.
My client sold his former business in Orange County years before he began a new phase of his career when we met. My client’s new business was to seek out ideas in the technology field for the purpose of identifying exploitable opportunities around which he could assemble a team of experts to build another going-concern to deploy to the public and later sell at a profit.
To uncover profitable business opportunities and as one of several methods methodically employed, my client did what other early-stage investors did by forming a private equity firm specializing in advising, investing in and acquiring middle market companies. The private equity firm was a sole proprietorship and not an entity in California such as an LLC, partnership, subchapter C or S corporation.
He looked for opportunity in corporate divestitures, succession planning of family-owned businesses, entrepreneurial exits and restructurings of public and private entities. He sought to make investments or acquisitions providing them with control so as to be able to drive a business in the manner he thought would have been in the interest of making a profit. He focused on continually building value in his companies by partnering with strong management teams, adding experienced leadership and developing growth strategies.
Most California employers are conscientious about collecting and paying over their employment taxes. Some of my clients is Los Angeles County, Orange County, Ventura County and Santa Barbara County have problems with access to capital and cannot help it when they become unable to pay the FICA tax. But for other California employers, federal employment tax avoidance is intentional and takes various forms. Some of the more common methods of avoidance include paying employees in cash, employee leasing, filing false payroll tax returns or failing to file payroll tax returns, and pyramiding.
Paying Employees in Cash
The loss or reduction of future social security or Medicare benefits for the employee is one of the consequences when paying employees in whole or partially in cash. Cash payments are a common method of avoiding income and employment taxes.
Employee leasing is commonly used by employers who contract with outside businesses to handle all personnel, administrative, and payroll duties for employees. Employee leasing is a legal business practice which is sometimes abused. At times, employee-leasing companies fail to pay to the IRS any portion of the collected employment taxes. These taxes are often spent by the owners on business or personal expenses. Often the employee-leasing company dissolves and leaves unpaid millions in employment taxes. The company owners are likely to become personally liable for a large portion of the unpaid tax which the IRS diligently works to collect.
Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns
Employment taxes are avoided when employers prepare and file false payroll tax returns which understate the amount of wages on which taxes are owed. Employers also fail to file employment tax returns to avoid employment taxes.
Pyramiding of employment taxes is where a business withholds taxes from its employees quarter after quarter but intentionally fails to pay them to the IRS. Often, a business involved in pyramiding will file for bankruptcy to discharge the non-trust fund portion of the liabilities accrued and then start a new business under a new name and begin a new scheme. Despite the bankruptcy, the company owners are likely to become personally liable for a large portion of the unpaid trust fund portion of the tax which the IRS diligently works to collect.
In each of these situations, the employer is bound to be contacted by the IRS. At the time of contact, if not sooner, the employer ought to reach his California tax attorney who is knowledgeable about resolving tax controversies. For tax help, call Mitchell A. Port at 310.559.5259.
What are the consequences of treating an employee as an independent contractor?
If you as a California employer classify an employee as an independent contractor and you have no reasonable basis for doing that, you will be held liable for employment taxes for that worker. Internal Revenue Code section 3509 has additional information about the consequences to the California employer as that section discusses several onerous penalties applied against the employer.
If you do not pay those employment taxes, re-read my blog posting on February 16, 2007 regarding the application of the 100% penalty assessment to California employers which is a technique used by the IRS to convert the payroll tax, employee social security tax and Medicare tax from a deductible tax payable by your business to a non-deductible tax that is owed by you personally.
To determine how to treat payments you make for services, knowing about the business relationship that exists between you and the worker performing the services is important. The worker performing the services may be:
An independent contractor
A common-law employee
A statutory employee
A statutory nonemployee
The limited liability company (“LLC”) is a relatively new type of entity which is now available in almost every state in the U.S., including California. It has a combination of features which is not found in any of the other available business forms.
The LLC is very desirable for situations in which the California business owners wish to have partnership-type flow-through tax treatment, along with protection from personal liability. These are the same features which attract business owners to the S corporation, but the S corporation form has many limitations which restrict its use. Many California based businesses which would like to use the S corporation form are not eligible for S corporation status. In addition, the S corporation rules have many prohibitions and conditions which make it less attractive, even when it is an option.
Since corporations and non-resident aliens cannot be shareholders of an S corporation, the S corporation structure is not an option for enterprises owned by foreigners or for joint ventures involving corporations.
The desirable flow-through tax treatment (passing the tax consequences of losses, investment tax credits, and depreciation through to the individual owners) is regarded as “partnership” tax treatment, as opposed to “corporate” tax treatment. The tax return of the organization - the S corporation or LLC – shows the profits and losses, but the tax consequences of that informational return are prorated among the shareholders (or “members” in an LLC).
The key benefits of this flow-through of tax consequences are that profits and gains are taxed only once and taxed at the tax rate of each shareholder or member.
The tax treatment of LLCs can be more fully described as follows:
The creation of an LLC which will operate in Los Angeles County, Orange County, Ventura County, Santa Barbara County and throughout California requires the filing of articles of organization with the California Secretary of State’s office and execution of an operating agreement among the members. A qualified business attorney can be helpful in accomplishing this.
The articles of organization for an LLC formed under California law must set forth the LLC’s name, a date for its dissolution, a statement of purpose, the agent for service of process, and a statement indicating whether the LLC is to be managed by managers and not by all of its members or managed by only one manager.
The operating agreement is not a legal requirement under California law, but it is a necessity, since the parties will find it necessary to define all the rights, privileges and obligations of the members of the LLC. The operating agreement should contain provisions addressing at least the following topics:
1. The rights and duties of members;
2. Contribution of cash, property, or services by members and other issues relating to capital structure;
3. Allocations of profits and losses and other tax consequences of the LLC;
4. Distributions to the members;
5. Maintenance of capital accounts, accounting records and financial information, and delivery of financial reports and tax information to the members;
6. Meetings of members, meetings of managers, and voting requirements;
7. How the LLC is to be managed, whether by the members, by a management group of members, or by hired management;
8. Disposition of interests of members, termination of memberships, assignment of membership interests, admission of additional members, and withdrawal of members;
9. Rights of the LLC or other members to buy out the interest of a member under specified circumstances;
10. Rights of the LLC or other members to buy out the interest of a deceased member;
11. Dissolution of the LLC; and
12. Procedures for amending the operating agreement.
The LLC is not the perfect entity for any business in California. All aspects of the LLC must be considered for each business situation.
An important limitation in California is that most licensed occupations are prohibited from using the LLC. If the business must hold any type of state license, check out the potential licensing limitations on the LLC first. The broad prohibition on using an LLC for state licensed activities has been an unwelcome surprise for many business people.
Another concern in California is that LLCs are subject to the minimum franchise tax of $800, plus a gross receipts tax according to a schedule. The gross receipts tax kicks in at $900 on gross receipts of $250,000 to $499,999, $2,500 on gross receipts of $500,000 to $999,999, $6,000 on gross receipts of $1,000,000 to $4,999,999, and $11,790 of gross receipts of $5,000,000 or more.
In California, S corporations pay a 1.5% tax on their net income. LLCs are taxed on their gross receipts. So depending on the entity's ratio of gross receipts to taxable income, there may be an advantage to operating as an S corporation. For example, assume a grocery stock with $10,000,000 of gross receipts and profits of $200,000. As an LLC, the grocery store would pay $8,585 in taxes (the maximum for gross receipts, $800 + $11,790, but only $3,000 as an S corporation (1.5% of $200,000). However, if the entity earned $5,000,000 in income, as an LLC it would still pay the maximum of $12,590 in taxes, but as an S corporation, it would pay $75,000 in taxes (1.5% of $5,000,000). Thus, understanding the gross receipts to net income ratio of the entity is extremely important when deciding whether to operate as an S corporation or LLC.
Whether your LLC was formed in California or is registered to do business in California, the California LLC fee was ruled unconstitutional in two separate decisions issued by the California Superior Court.
In the face of these two decisions, the California Franchise Tax Board has a steep uphill battle to avoid loss of fees that eventually could cause lost future revenues for California in the hundreds of millions of dollars and possibly force billions of dollars of refunds.
In Northwest Energetic Services, LLC v. California Franchise Tax Board, Cal. Super. Ct., No. CGC-05-437721, 4/13/06, the Court decided that the annual fee (starting at a minimum of $800), based on gross income worldwide violated the fair apportionment requirements of the Due Process and Commerce Clauses of the US Constitution. Northwest Energetic had NO business activity in California during the years in question.
If you are a member of an LLC, you should consider filing a protective claim for refund with the California FTB if the LLC does business outside of California and has paid the annual fee based on gross income earned both inside and outside California. The refund claim would be for the fee paid on gross income earned from outside California. Contact a California tax attorney to pursue your claim.
In a second California Superior Court case called Ventas Finance I, LLC v. California Franchise Tax Board, the Court again decided the annual LLC fee was unconstitutional. This case involved a real estate investment trust based outside California but registered to do business as an LLC in the state. The LLC apparently did less than ten percent of its business activity in California during the years in question. The Court held that this LLC tax was unconstitutional because it was not fairly apportioned and was based on worldwide gross receipts rather than its in-state activities.
These two decisions indicate that the LLC fee is unconstitutional regardless of whether the LLC has all of its activities or a part of its activities outside of California. In the end, the LLC fee may be found to be unconstitutional even with respect to California-based LLCs that have no activities outside of California.
Since no California appellate court has reviewed either of the lower Court decisions, the propriety of collecting the fee remains up in the air. You can continue to pay the fee and at the same time file a protective claim for refund so that you do not incur penalties and interest for nonpayment and so you can avoid suspension by the California Secretary of State's office.
If you would like to consult on this topic or obtain other tax help, call Mitchell A. Port at 310.559.5259.
To influence prompt payment by California employers for workers in Los Angeles County, Ventura County, Santa Barbara County and Orange County of withheld income and employment taxes including social security taxes, Congress passed a law that provides for the trust fund recovery penalty (“TFRP”).
The TFRP is the same as the so-called 100% penalty. These taxes are called trust fund taxes because as a California employer you actually hold the employee's money in trust until you make a federal tax deposit in that amount. As an employer in California, you are fully liable for 100% of the amount you collected from your employees that ought to be paid to the IRS. The TFRP may apply to you if these unpaid trust fund taxes cannot be collected right away by the IRS from your business. In order for the TFRP to be assessed, your business does not have to have stopped operating.
Who Can Be Responsible for the 100% Penalty
The TFRP may be assessed against you if you willfully fail to collect or pay the trust fund taxes and if you are responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes.
For willfulness to exist, you as the responsible person:
(i) Must have been, or should have been, aware of the outstanding taxes and
(ii) Either intentionally disregarded your legal obligations or were plainly indifferent to its requirements (no evil intent or bad motive is required).
Using available funds to pay other creditors when your business is unable to pay the employment taxes is an indication of willfulness.
You may be considered a responsible person or part of a group of people who has the duty to perform and the power to direct the collection, accounting, and payment of trust fund taxes. As a responsible person you may be:
Do you have a tax exempt entity in California? The Internal Revenue Service has launched a new web-based version of its popular Exempt Organizations Workshop covering tax compliance issues confronted by your small and mid-sized tax exempt organizations.
The free online workshop – Stay Exempt – Tax Basics for 501(c)(3)s – consists of five interactive modules on tax compliance topics for exempt organizations. They are:
Tax-Exempt Status – How can you keep your 501(c)(3) exempt?
Unrelated Business Income – Does your organization generate taxable income?
Employment Issues – How should you treat your workers for tax purposes?
Form 990 – Would you like to file an error-free return?
Required Disclosures – To whom do you have to show your records?
You can access this new training program at www.stayexempt.org. You can complete the modules in any order and repeat them as many times as you like. The online training website does not require registration and its visitors will remain anonymous.
If you would like the help of a tax lawyer, call Mitchell A. Port at 310.559.5259.