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Monthly Archives: June 2018

URGENT MEMO FOR COMPANIES THAT SELL TANGIBLE PROPERTY INTO MULTIPLE STATES

Memo

To:        VA Tax Files / VA Clients
From:    Peter V. DeGregori, CPA MST CGMA
Date:     June 28, 2018
Re:        Change in Sales Tax: Supreme Court Ruling for South Dakota v. Wayfair


Summary:

On June 21, 2018, the U.S. Supreme court issued a decision in South Dakota v. Wayfair, overturning the physical presence standard explained in Quill v. North Dakota (Sup Ct 1992) 504 U.S. 298, and other related cases. Prior to this ruling, the Quill case was an important case, which required a physical presence standard for a company to be subject to sales tax if they sold tangible property (typically items you can touch).  In general, the “physical presence” standard is a requirement for a company to be subject to sales tax.  This law became a common case / item to review if an out of state company was subject to sales tax in another state.

As an example, if you have a company, located only in Florida, then generally that company would only be subject to sales tax in Florida based on sales to Florida consumers.  However, if the company shipped products into other states, then they generally they would not be subject to other states’ sales tax if they didn’t have any physical presence in that other state.   So, the outcome would be products sold outside of Florida didn’t have sales tax applied against them and this is the issue that has soured the change of this law.  If a business wasn’t subject to sales tax, then typically the consumer is responsible to pay use tax to their state.  But most consumers do not pay use tax, so the states want a method to subject out of state businesses to sales tax and this new court case has now removed the hurdle of the Quill doctrine.  States want more sales tax revenue, and they have been trying hard to collect sales tax from out of state businesses for a long time.  Now the law has changed based on this court case and states are going to be able to charge sales tax based on where the consumer resides regardless of “physical presence”.

Now, let’s look at what is meant by “physical presence”.  First, this is a generalization, as each state may, unfortunately, have a different set of guidelines, in general, physical presence means that the company had property (fixed assets, inventory, etc.), people, or some other physical connection in a state to subject them to sales tax.  So, this was the concern based on the example above, the company in FL could sell products to every other state and wouldn’t be subject to sales tax in any state other than FL.  This created an unfair playing field with companies in states in which out of state resellers sold into.  So, the US Supreme Court changed the law and now companies are subject to sales tax based on revenue that is generated from a state which is also called “economic nexus”.

Now this is a BIG change for business that sell products to multiple states.  Typically, this is going to affect internet companies but will also affect companies as in my example above.  Most states have not updated their laws to adjust for this Supreme Court ruling, but we are assuming they will soon, as this only allows the states to generate more revenue.

If we look at the current laws, about 29 states have an “economic nexus” already on the books.  So, with this Supreme Court ruling, sales tax would be owed to the state in which an out-of-state company generated an “economic” benefit from.  What is economic benefit? It is typically a generation of revenue or sales.  So, based on my example, if the FL company sold products into other states and those states have an “economic nexus” law, the FL company now needs to be concerned with registering in that state and begin charging, collecting and remitting sales tax.  I know it is a pain, but companies need to follow the laws as those states are allocating resources to find out of state companies that owe them money.

Any good news?  Well, yes.  Most states currently have a revenue or quantity threshold to exempt small businesses.  However, the states define small business differently.  For example, most states are not going to require an out of state retailer with only “economic nexus” to be subject to their sales tax if their gross sales in that state are under $100,000 and less than 200 transactions.  This is what is deemed to be the small business exclusion.  However, some other states have a threshold of $250,000 and 200 transactions, but the state of Washington currently has a threshold of $10,000.  Most of these threshold tests are based on prior year sales.  Be careful, please review the current law with us or your tax advisor to make sure you are applying the law correctly.

Based on the Supreme Court ruling, we would expect states to update their “economic nexus” laws and create one if they don’t have one.  So, a retailer should first look at sales by state for the prior year, and then work with us or their tax advisor to determine which state(s) the company is generating revenue from and those states have economic nexus rules.  These rules should not be ignored as most states have stiff penalties, and if needed, the state will have their department of justice file a lawsuit against the out of state business that they feel owe sales tax.

Actions to Consider:

If you are a retailer of tangible products, and you sell into multiple states, and you do not pay sales tax in those states, run a sales report by state for the prior year, and review the economic nexus rules by state with your tax advisor.  Contact us to work with you to minimize the headache.

If you have states in which your company should have been subject to sales tax, and you haven’t been contacted by the state, then consider looking into a voluntary disclosure program (VDP) to request acceptance into the states’ program and hopefully receive the benefit of only having to file sales tax returns for up to three years versus six to eight and be in a position to not have to pay penalties.

Also, if your company sells to resellers, typically you are still required to register and file sales tax returns and show the reduction of taxable sales as they are sold for resale.  This does give the state the right to audit you, so make sure you have annual copies of resell certificates.

Unfortunately, sales tax laws are specific to each state and company based on the transactions, so call us to discuss.

Other Considerations:

There are many other items to consider.  For example, if a company manufactures, resells and sells to consumers, perhaps there is a benefit to dividing up the company so that the manufacturer activity is separated from the reselling activity.  Also, you may need to consider state income tax.  So, to comply with these new sales tax rules, make sure you understand other items that may be related like sales tax, state registration, change in your sales software and invoicing, etc.

There is much to think about and Congress could again change the law, but I feel they are too busy with other things, so all one can do is to deal with the current laws, understand them and apply them accordingly. Please contact us at 949-756-8080 or Advisors@VerticalAdvisors.com if you would like to discuss.

Overview of Economic Nexus as of June 28, 2018

STATEECONOMIC NEXUSTHRESHOLD
AlabamaYes.$250,000
AlaskaN/AN/A
ArizonaNo.N/A
ArkansasNo.N/A
CaliforniaNo.N/A
ColoradoNo.$100,000
*Special Law, ask tax preparer for details
ConnecticutYes.$250,000 or 200 units
District of ColumbiaNo.N/A
DelawareN/AN/A
FloridaNo.N/A
GeorgiaYes.$250,000 or 200 units
HawaiiYes. $100,000 or 200 units
IdahoNo.N/A
IllinoisYes.$100,000 or 200 units
IndianaYes.$100,000 or 200 units
IowaYes.$100,000 or 200 units
KansasN/AN/A
KentuckyYes.$100,000 or 200 units
LouisianaYes.$100,000 or 200 units
MaineYes.$100,000 or 200 units
MarylandNo.N/A
MassachusettsYes.$500,000 or 100 units
MichiganNo.N/A
MinnesotaNo.Less than $100,000
*Special Law, ask tax preparer for details
MississippiYes.$250,000
MissouriNo.N/A
MontanaNo.N/A
NebraskaNo.N/A
NevadaNo.N/A
New HampshireN/AN/A
New JerseyNo.N/A
New MexicoNo.N/A
New YorkNo.N/A
North CarolinaNo.N/A
North DakotaNo.N/A
OhioYes.$500,000
OklahomaNo.N/A
OregonN/AN/A
PennsylvaniaYes.$10,000
Rhode IslandYes.$100,000 or 200 units
South CarolinaNo.N/A
South DakotaYes.$100,000 or 200 units
TennesseeYes.$500,000
TexasNo.N/A
UtahNo.N/A
VermontNo.$100,000 and notify purchasers who bought more than $500
*Special Law, ask tax preparer for details
VirginiaNo.N/A
WashingtonYes.$100,000 in gross receipts or referrers having at least $267,000 in gross income
*Special Law, ask tax preparer for details
West VirginiaNo.N/A
WisconsinNo.N/A
WyomingYes.$100,000 or 200 units
Note: this is very high level summary and laws do change, so please discuss with us or your tax advisor and we
recommend you review with our tax memo dated 6/28/2018

Watch out for tax-related identity theft scams all year long

With the filing date for 2017 in the rear-view mirror for most businesses and individuals, the last thing they probably want to think about is income taxes. Unfortunately, though, criminals who commit tax-related identity theft don’t work seasonally — they’re constantly devising and unleashing new schemes.

And even though the IRS has taken successful steps to reduce tax-related identity theft in 2017, it cautions taxpayers to stay alert for scams year round and especially right after the tax filing season ends.

What is tax-related identity theft?

According to the IRS, tax-related identity theft generally occurs when a thief uses a stolen Social Security number (SSN) to file a tax return claiming a fraudulent refund. The victimized taxpayer may not learn of the theft until he or she attempts to file a tax return and finds that a return has already been filed for that SSN. Alternatively, the taxpayer might discover the theft upon receipt of a letter from the IRS saying it has identified a suspicious return that uses the taxpayer’s SSN.

Thieves have devised a variety of methods to obtain the information they need to file a tax return under another person’s SSN. During the past several years, the IRS, Federal Trade Commission (FTC) and state tax agencies have issued warnings as new methods come to the forefront.

How does tax-related identity theft occur?

But filing fraudulent returns isn’t the only way that taxpayers are victimized. Scam artists are using multiple channels to conduct their tax-related identity theft schemes, including:

Phone schemes. This past April, less than 10 days after the tax return filing deadline, the IRS highlighted a new phone scam conducted by fraudsters who program their computers to display the phone number of the local IRS Taxpayer Assistance Center (TAC) on the taxpayer’s Caller ID. If the taxpayer questions the legitimacy of the caller’s demand for a tax payment, the caller directs him or her to IRS.gov to verify the local TAC phone number.

The perpetrator hangs up, calls back after a short period — again “spoofing” the TAC number — and resumes the demand for money. These scam artists generally require payment on a debit card, which allows them to directly access the victim’s bank account.

In another phone scheme, the criminals claim they’re calling from the IRS to verify tax return information. They tell taxpayers that the agency has received their returns and simply needs to confirm a few details to process them. The taxpayers are prompted to provide personal information such as an SSN and bank or credit card numbers.

Digital schemes. Emails that appear to be from the IRS are part of phishing schemes intended to trick the recipients into revealing sensitive information that can be used to steal their identities. The emails may seek information related to refunds, filing status, transcript orders or PIN information.

The scammers have developed twists on this approach, too. The emails might seem to come from an individual’s tax preparer and request information needed for an IRS filing. Or the information request could arrive via text messages. Whether by text or email, the communication states that “you are to update your IRS e-file immediately” and includes a link to a fake website that mirrors the official IRS site. Emails also could include links that cause the recipients to download malware that infects their computers and tracks their keystrokes or allows access to files stored on their computers.

Do businesses need to worry?

The short answer is yes — businesses have also been targeted by criminals intent on victimizing their employees or the businesses themselves.

For several years now, criminals have employed different spoofing techniques known as business email compromise (BEC) or business email spoofing (BES). They disguise an email to a company’s human resources or payroll department so it seems to come from an executive in the company. The email requests a list of all employees and their Forms W-2 — information that can be used to file returns in the employees’ names.

Scammers also are pursuing businesses’ Employer Identification Numbers (EINs). They then report false income and withholding and file for a refund in the companies’ names. Even worse for the companies, the IRS could go after them for payroll taxes reported as withheld but not remitted.

The IRS recently announced that it has seen a sharp increase in the number of fraudulent filings of certain business tax forms, including Schedule K-1 and those filed by corporations and partnerships. As a result, the IRS may ask businesses for additional information (such as the driver’s license numbers of owners) to help identify suspicious tax returns.

How does the IRS contact taxpayers?

The IRS has made it clear that it will not:

  • Threaten to bring in law enforcement to have someone arrested for nonpayment of taxes,
  • Revoke a driver’s license, business license or immigration status for nonpayment,
  • Demand a specific payment method, such as a prepaid debit card, gift card or wire transfer,
  • Request a debit or credit card number over the phone,
  • Demand the payment of taxes without the opportunity to question or appeal the amount owed (the IRS usually mails a bill when a taxpayer owes taxes),
  • Send unsolicited emails, texts or messages through social media channels suggesting taxpayers have refunds or need to update their accounts, or
  • Request any sensitive information online.

The IRS will call or visit a home or business in only very limited circumstances. It might do so, for example, if a taxpayer has a severely overdue tax bill, to secure an employment tax payment, or to tour a business as part of an audit or a criminal investigation. But even in those special situations, the IRS generally will first send several notices by mail.

What can victims and targets do?

If you know or suspect you’ve fallen prey to tax-related identity theft, you’ll need to file IRS Form 14039, “Identity Theft Affidavit.” The IRS and FTC recently announced a joint project that allows people to report such theft to the IRS online through the FTC’s IdentityTheft.gov website. Remember, though, that filing the affidavit doesn’t eliminate the need to pay your taxes.

In addition, the FTC advises victims of all types of identity theft to file a complaint on its website and contact one of the three major credit bureaus (TransUnion, Experian and Equifax) to place a fraud alert on their credit records. You also should contact your financial institutions and close any financial or credit accounts opened or tampered with by identity thieves.

If you received, but didn’t fall for, a scam email, you should still report it. The IRS urges individuals who receive unsolicited emails purporting to come from the IRS to forward the messages to phishing@irs.gov before deleting.

Stay alert

Don’t make the mistake of letting your guard down because tax season has passed. If you receive a suspicious communication from the IRS or other taxing authority, contact us for confirmation of its validity and advice on how to proceed.

© 2018

Tax Cuts and Jobs Act offers favorable tax breaks for businesses

The Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017, contains a treasure trove of tax breaks for businesses. Overall, most companies and business owners will come out ahead under the new tax law, but there are a number of tax breaks that were eliminated or reduced to make room for other beneficial revisions. Here are the most important changes in the new law that will affect businesses and their owners.

New 21% corporate tax rate

Under pre-TCJA law, C corporations paid graduated federal income tax rates of 15% on taxable income of $0 to $50,000; 25% on taxable income of $50,001 to $75,000; 34% on taxable income of $75,001 to $10 million; and 35% on taxable income over $10 million. Personal service corporations (PSCs) paid a flat 35% rate.

For tax years beginning in 2018, the TCJA establishes a flat 21% corporate rate, and that rate also applies to PSCs.

Reduced corporate dividends deduction

Under pre-TCJA law, C corporations that received dividends from other corporations were entitled to partially deduct those dividends. If the corporation owned at least 20% of the stock of another corporation, an 80% deduction applied. Otherwise, the deduction was 70% of dividends received.

For tax years beginning in 2018, the TCJA reduces the 80% deduction to 65% and the 70% deduction to 50%. These reductions are part of the price businesses have to pay for the new 21% corporate rate.

Corporate alternative minimum tax repealed

Prior to the TCJA, the corporate alternative minimum tax (AMT) was imposed at a 20% rate. However, corporations with average annual gross receipts of less than $7.5 million for the preceding three tax years were exempt. For tax years beginning in 2018, the new law repeals the corporate AMT. For corporations that paid the corporate AMT in earlier years, an AMT credit was allowed under prior law. The new law allows corporations to fully use their AMT credit carryovers in their 2018–2021 tax years.

New deduction for pass-through businesses

Under prior law, net taxable income from pass-through business entities (such as sole proprietorships, partnerships, S corporations and LLCs that are treated as sole proprietorships or as partnerships for tax purposes) was simply passed through to owners. It was then taxed at the owners’ standard rates. In other words, no special treatment applied to pass-through income recognized by business owners.

For tax years beginning in 2018, the TCJA establishes a new deduction based on a noncorporate owner’s qualified business income (QBI). This new tax break is available to individuals, estates and trusts that own interests in pass-through business entities. The deduction generally equals 20% of QBI, subject to restrictions that can apply at higher income levels.

QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss from any qualified business of the noncorporate owner. For this purpose, qualified items are income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.

The QBI deduction isn’t allowed in calculating the noncorporate owner’s adjusted gross income (AGI), but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.

W-2 wage limitation. For pass-through entities other than sole proprietorships, the QBI deduction generally can’t exceed the greater of the noncorporate owner’s share of:

  • 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.

Qualified property is the depreciable tangible property (including real estate) owned by a qualified business as of year end and used by the business at any point during the tax year for the production of qualified business income.

Under an exception, the W-2 wage limitation doesn’t apply until an individual owner’s taxable income exceeds $157,500 ($315,000 for joint filers). Above those income levels, the W-2 wage limitation is phased in over a $50,000 range ($100,000 range for joint filers).

Service business limitation. Finally, the QBI deduction generally isn’t available for income from specified service businesses (such as most professional practices other than engineering and architecture and businesses that involve investment-type services such as brokerage and investment advisory services). Under an exception, the service business limitation doesn’t apply until an individual owner’s taxable income exceeds $157,500 ($315,000 for joint filers). Above those income levels, the service business limitation is phased in over a $50,000 phase-in range ($100,000 range for joint filers).

The W-2 wage limitation and the service business limitation don’t apply as long as your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.

New limits on business interest deductions

Subject to some restrictions and exceptions, prior law stated that interest paid or accrued by a business generally is fully deductible. Under the TCJA, affected corporate and noncorporate businesses generally can’t deduct interest expenses in excess of 30% of “adjusted taxable income,” starting with tax years in 2018. For S corporations, partnerships and LLCs that are treated as partnerships for tax purposes, this limit is applied at the entity level rather than at the owner level.

For tax years beginning in 2018 through 2021, adjusted taxable income is calculated by adding back allowable deductions for depreciation, amortization and depletion. After that, these amounts aren’t added back in calculating adjusted taxable income.

Business interest expense that’s disallowed under this limitation is treated as business interest arising in the following taxable year. Amounts that cannot be deducted in the current year can generally be carried forward indefinitely.

Taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three previous tax years are exempt from the interest deduction limitation. Some other taxpayers are also exempt. For example, real property businesses that elect to use a slower depreciation method for their real property with a normal depreciation period of 10 years or more are exempt. Another exemption applies to interest expense from dealer floor plan financing (for example, financing by dealers to acquire motor vehicles, boats or farm machinery that will be sold or leased to customers).

Reduced or eliminated employer deductions for business-related meals and entertainment

Prior to the TCJA, taxpayers generally could deduct 50% of expenses for business-related meals and entertainment. Meals provided to an employee for the convenience of the employer on the employer’s business premises were 100% deductible by the employer and tax-free to the recipient employee. Various other employer-provided fringe benefits were also deductible by the employer and tax-free to the recipient employee.

Under the new law, for amounts paid or incurred after December 31, 2017, deductions for business-related entertainment expenses are disallowed. Meal expenses incurred while traveling on business are still 50% deductible, but the 50% disallowance rule will now also apply to meals provided via an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer. After 2025, the cost of meals provided through an on-premises cafeteria or otherwise on the employer’s premises will be nondeductible.

Changes to some employee fringe benefits

The new law disallows employer deductions for the cost of providing commuting transportation to an employee (such as hiring a car service), unless the transportation is necessary for the employee’s safety.

It also eliminates employer deductions for the cost of providing qualified employee transportation fringe benefits (for example, parking allowances, mass transit passes and van pooling), but those benefits are still tax-free to recipient employees.

Foreign tax provisions

The TCJA includes a bevy of changes that will affect taxpayers who conduct foreign operations. In conjunction with the reduced corporate tax rate, the changes are intended to encourage multinational companies to conduct more operations in the United States, with the resulting increased investments and job creation in this country.
 
Other changes

Here are some of the other business-related changes in the TCJA:

  • For business net operating losses (NOLs) that arise in tax years ending after December 31, 2017, the maximum amount of taxable income that can be offset with NOL deductions is generally reduced from 100% to 80%. In addition, NOLs incurred in those years can no longer be carried back to an earlier tax year (except for certain farming losses). Affected NOLs can be carried forward indefinitely.
  • More generous business asset expensing and depreciation tax breaks are available. The maximum Section 179 deduction increases to $1 million, and the phaseout threshold amount is increased to $2.5 million (from $510,000 and $2.03 million respectively). There are also much better first-year bonus depreciation rules.
  • The Section 199 deduction, also commonly referred to as the domestic production activities deduction or manufacturers’ deduction, is eliminated for tax years beginning after December 31, 2017, for noncorporate taxpayers and for tax years beginning after December 31, 2018, for C corporation taxpayers.
  • A new limitation applies to deductions for “excess business losses” incurred by noncorporate taxpayers. Losses that are disallowed under this rule are carried forward to later tax years and can then be deducted under the rules that apply to NOLs. This new limit kicks in after applying the passive activity loss rules. However, it applies to an individual taxpayer only if the excess business loss exceeds the applicable threshold.
  • The eligibility rules to use the more-flexible cash method of accounting are liberalized to make them available to many more medium-size businesses. Also, eligible businesses are excused from the chore of doing inventory accounting for tax purposes.
  • The Section 1031 rules that allow tax-deferred exchanges of appreciated like-kind property is allowed only for real estate for exchanges completed after December 31, 2017. Beginning in 2018, there are no more like-kind exchanges for personal property assets. However, the prior-law rules still apply if one leg of an exchange has been completed as of December 31, 2017, but one leg remains open on that date.
  • Faster depreciation is allowed for eligible farming assets.
  • Compensation deductions for amounts paid to principal executive officers generally cannot exceed $1 million per year, subject to a transition rule for amounts paid under binding contracts that were in effect as of November 2, 2017.
  • Specified R&D expenses must be capitalized and amortized over five years, or 15 years if the R&D is conducted outside the United States instead of being deducted currently. This begins with tax years beginning after December 31, 2021.

Any questions?

The TCJA is the largest overhaul of the tax code in more than 30 years, and we’ve covered only the highlights of the business-related tax provisions here. Please contact us if you have questions about how they may affect your business.

© 2017

Sending Your Kids To Day Camp May Provide a Tax Break


When school lets out, kids participate in a wide variety of summer activities. If one of the activities your child is involved with is day camp, you might be eligible for a tax credit!

Dollar-for-dollar savings

Day camp (but not overnight camp) is a qualified expense under the child and dependent care credit, which is worth 20% of qualifying expenses (more if your adjusted gross income is less than $43,000), subject to a cap. For 2018, the maximum expenses allowed for the credit are $3,000 for one qualifying child and $6,000 for two or more.

Remember that tax credits are particularly valuable because they reduce your tax liability dollar-for-dollar — $1 of tax credit saves you $1 of taxes. This differs from deductions, which simply reduce the amount of income subject to tax. For example, if you’re in the 24% tax bracket, $1 of deduction saves you only $0.24 of taxes. So it’s important to take maximum advantage of the tax credits available to you.

Qualifying for the credit

A qualifying child is generally a dependent under age 13. (There’s no age limit if the dependent child is unable physically or mentally to care for him- or herself.) Special rules apply if the child’s parents are divorced or separated or if the parents live apart.

Eligible costs for care must be work-related. This means that the child care is needed so that you can work or, if you’re currently unemployed, look for work.

If you participate in an employer-sponsored child and dependent care Flexible Spending Account (FSA), also sometimes referred to as a Dependent Care Assistance Program, you can’t use expenses paid from or reimbursed by the FSA to claim the credit.

Determining eligibility

Additional rules apply to the child and dependent care credit. If you’re not sure whether you’re eligible, contact us. We can help you determine your eligibility for this credit and other tax breaks for parents.

© 2018