WHAT IS AN S CORPORATION?
S Corporations are “flow-through” tax entities, meaning income, deductions, credits and other activity are allocated to shareholders to be reported on their individual tax returns. When shareholders are allocated losses from an S Corporation they can use the losses to offset income from other sources — if the losses pass three tests, the first two of which, “stock basis” and “at-risk” limitation rules, are the subject of this article. Both are based on how the loss was funded.

The goal of stock basis and at-risk limitation rules is to limit a shareholder’s use of losses to those that have been personally funded by the shareholder. S Corporation shareholders can take losses to the extent of their personal investment in the corporation. Losses funded by loans from unrelated parties or loans from the shareholders of funds that are not at risk cannot be deducted. Instead, the losses are suspended and carried forward until the shareholder increases their stock basis and amount at risk.

TEST NO. 1: STOCK BASIS
A shareholder’s initial stock basis is determined by how they acquire their interest in the S Corporation: the money and other property a shareholder contributes to start the corporation or the amount paid to purchase shares in the corporation. If S Corporation shares are gifted, the recipient is also gifted the donor’s basis in the shares. The basis of inherited shares is adjusted to the fair market value at time of the decedent’s death.

From the initial basis, a shareholder’s basis can be increased by capital contributions, personal loans to the corporation, and income allocated to the shareholder; or decreased by distributions, repayment of loans from the shareholder, and losses allocated to the shareholder. If a shareholder has stock basis in excess of their loss at the end of the tax year, they pass the first test in determining whether or not they can deduct the loss.

TEST NO. 2: AT-RISK LIMITATION
To deduct an S Corporation loss, the taxpayer must also be sufficiently at risk. Simply stated, a shareholder’s amount at risk is the extent to which they have dipped into their own pocket to fund operations. In a partnership, partner tax basis includes their share of the partnership debt, including loans from third parties and banks. This often results in differences between partner basis and at-risk basis because the partners have basis for partnership debt but are not at risk. In an S Corporation stock basis and at-risk basis are often the same because shareholders typically do not receive stock basis for their share of S Corporation debt. There is one significant exception: an S Corporation shareholder’s basis includes money loaned by the shareholder to the corporation.

While an S Corporation shareholder receives stock basis for loans made to the corporation they are not always at risk for the debt. A shareholder is only at risk for loans it makes to the corporation if the shareholder is at risk for the funds loaned to the corporation. We often encounter scenarios where a shareholder personally borrows money and loans the proceeds to the S Corporation, a so-called “back-to-back” loan. A shareholder is not at risk for a back-to-back loan unless they are personally liable for the repayment of the loan, or if they have pledged property other than S Corporation property or their S Corporation stock as security for the loan. If the loan to the shareholder is “nonrecourse,” meaning they are not personally liable for the repayment, they will not receive at-risk basis by loaning the proceeds to their S Corporation.

If you are a shareholder in an S Corporation that has incurred a loss during the tax year, and you pass the stock basis and at-risk tests, you’re two-thirds of the way home in terms of being able to deduct your losses.

This is the first in a series. Read Can You Deduct Your S Corporation Losses? Passive Activity Loss Rule

On December 13, President Obama signed the 21st Century Cures Act which, among other things, allows certain small businesses with no group health plan to reimburse employees for medical expenses, including health insurance premiums, without incurring penalties under the Affordable Care Act (ACA).  The legislation also covers a broad range of other health-related topics, including medical research, drug development, mental health care, and Medicare.  Previously, the IRS had concluded that Employer Payment Plans and stand-alone Health Reimbursement Arrangements (“HRAs”) are group health plans that fail to comply with the ACA market reforms, and are therefore subject to fines up to $100 per day per employee, or up to $36,500 per year.

The new legislation overrules the IRS position by defining “group health plan” as not including “any qualified small employer health reimbursement arrangement.”  Therefore, employers that are not “applicable large employers” and do not offer a group health plan to any of their employees may now reimburse employees for the costs of health insurance premiums and/or other medical costs such as deductibles and copays without facing penalties.  In order to be a qualified HRA under the new rules, the HRA must meet all of the following requirements:

• It is provided on the same terms to all eligible employees. An eligible employee is any employee of the employer, except that the HRA may exclude from consideration employees who haven’t completed 90 days of service, employees who haven’t attained age 25, part-time or seasonal workers, employees covered in a collective bargaining unit, and certain nonresident aliens. Also, the law allows for an employee’s benefit under the arrangement to vary in accordance with the variation in the price of an insurance policy in the relevant individual health insurance market based on the employee’s age and the number of family members covered under the arrangement.
• It is funded solely by the employer, and no salary reduction contributions may be made under the HRA.
• It provides, after the employee provides proof of coverage, for the payment of, or reimbursement of, an eligible employee for expenses for medical care incurred by the eligible employee or the employee’s family members (as determined under the HRA’s terms).
• Annual benefits under the HRA cannot exceed $4,950 per year ($10,000 if family members are covered). For years after 2016, these amounts are subject to cost of living increases. For employees who are covered by a qualifying HRA for less than a year, the above dollar limits are prorated.

The new rules apply to years beginning after December 31, 2016.  Also, the law provides transition relief from the ACA penalties for years beginning before December 31, 2016, for HRAs offered by employers that are not applicable large employers.

Please contact me or your HBK representative with any questions.

To Our Clients and Friends:

As 2016 winds down, business owners may still benefit from several tax savings strategies. At HBK CPAs & Consultants, we want to ensure that our clients and colleagues are aware of the many opportunities still available and applicable even at this late date in the year.

Year-end planning for 2016 is complicated by impending changes to 2017 (and future years) the new Congress and Administration may make to the Tax Code.  President elect Trump made tax reduction a centerpiece of his economic plans during his campaign, by, among other things, proposing lower and consolidated individual income tax rates, expanded tax breaks for families, and the intent to repeal the Affordable Care Act.  Specifically, he proposed lowering the corporate income tax rate to 15 percent, taxing pass-through entities (sole proprietorships, partnerships, and S Corporations) at a flat rate of 15 percent for income retained in the business, and increasing the annual cap on Code Sec. 179 expensing from $500,000 to $1 million.  Campaign materials also state unspecified business tax incentives would be eliminated.

Businesses seeking to maximize tax benefits through 2016 year-end tax planning should also look ahead and consider the potential impact of changes to the tax code to their businesses.  If these proposals become law your tax planning needs to be reviewed.  We will work with you to maximize your businesses potential tax savings.

TAX LEGISLATION

In 2015, Congress passed the Protecting Americans from Tax Hikes (PATH) Act which permanently extended many tax incentives that were previously temporary. However, other provisions were not extended past 2016. The following is a summary of some of the more common business provisions.

Bonus depreciation and Code Sec. 179 expense deduction.  Many businesses utilize enhanced Code Sec. 179 expensing as a key component of year-end tax planning.  Both bonus depreciation and the increases in the Code Sec. 179 expense deduction and investment limits were meant to provide temporary incentives for business investment and were set to expire at the end of 2014.  The PATH Act permanently extended the $500,000 per year Sec. 179 limitation and dollar-for-dollar phase out for businesses with qualifying equipment purchases exceeding $2 million.  Starting in 2016, the annual Sec. 179 limitation will be adjusted for inflation.  The Act also extended bonus depreciation at 50% for qualifying equipment placed in service through 2017.  Bonus depreciation will phase down to 40% in 2018, and 30% in 2019.

Code Sec. 179 property is generally defined as new or used depreciable tangible Code Sec. 1245 property that is purchased for use in the active conduct of a trade or business.  Off-the-shelf computer software and qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) are also eligible for Sec. 179 expensing.

Generally, property qualifying for bonus depreciation is new or original use tangible personal property.  Certain real property falling within the definition of qualified leasehold improvement property was also eligible for bonus depreciation through the end of 2015.

Beginning in 2016, the PATH Act replaced the bonus depreciation allowance for qualified leasehold improvement property with a bonus allowance for a new class of property, qualified improvement property.  Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service.  Qualified improvement property does not include any expenditure attributable to enlarging the building, any elevator or escalator, or the internal structural framework of the building.  This new class of bonus property also does not include the pre-2016 requirements that the expenditure be made pursuant to a lease, or be placed in service more than three years after the date the building was first placed in service.

Year-end placed-in-service strategies can provide an almost immediate tax discount for qualifying purchases.  Although a bonus-depreciation election should be factored into a year-end strategy, a final decision on making it is not required until a return is filed.  Bonus depreciation is not mandatory.  Certain taxpayers should consider electing out of bonus depreciation to spread depreciation deductions more evenly over future years.

Tax credits.  The following tax credits scheduled to expire at the end of 2014, were extended by the PATH Act.

• Research Credit. The research credit is claimed for increases in qualified research expenditures. The Research Credit was permanently extended by the PATH Act. The Act also allows the eligible small businesses (generally those with no more than $50 million in gross receipts) to offset both regular tax and AMT with research credits.  Start-up small businesses can now elect to apply a portion of the research credit against payroll tax instead of income tax.  These positive changes to the research credit can have significant benefits for many taxpayers.
• Work Opportunity Credit. The work opportunity credit for all targeted groups is extended through December 31, 2019.
• Differential Wage Credit for Activated Military Reservists. Eligible small employers can claim a tax credit for up to 20% of the military differential wage payments it makes to activated military reservists. The differential wage credit for activated military reservists was permanently extended by the PATH Act.

Recognition period for S Corporation built-in gains.  The PATH Act permanently extends the shortened S Corporation built-in gains holding period.  For purposes of computing the built-in gains tax, the recognition period is the five years beginning with the first day of the first tax year in which the corporation was an S corporation.

REVISED DEADLINES

The due date for filing partnership and C corporation returns was modified by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015.  Generally applicable to returns for tax years beginning after December 31, 2015, both Forms 1120-S and 1065 are due on or before the 15th day of the third month following the close of the tax year (March 15 for calendar-year taxpayers).  The due date for the filing of Form 1120 by C corporations is changed to the 15th day of the fourth month following the close of the tax year (April 15 for calendar-year taxpayers).

Many taxpayers and tax professionals have long advocated for these changes to return due dates.  These staggered due dates were recommended not only to enable taxpayers to receive Schedule K-1 information in time to meet their initial filing deadlines.  They also help even out the workflow faced by tax preparers both in dealing with initial deadlines and with extensions.  Further, the revisions are expected to contribute to a reduction in the need for extended and amended individual income tax returns.

AFFORDABLE CARE ACT

Despite several delays and legislative tweaks, the basic structure of the ACA for businesses, both large and small, generally remains intact.  If an employer is an applicable large employer (ALE), this triggers employer shared responsibility provisions and the employer information reporting provisions.  Small businesses, too, are affected by the ACA and should take the ACA into account in year-end planning.  Some incentives under the ACA, including health reimbursement arrangements and small business health care tax credits, can help maximize tax savings for small businesses. Information reporting under the ACA continues to challenge all businesses.  We will keep you posted of developments.

Reporting requirements. Under the Affordable Care Act, applicable large employers (those with 50 or more full-time employees, including fulltime equivalent employees), and providers of self-insured health plans are required to take new actions.  These employers must file information returns with the IRS and also provide statements to full-time employees about health coverage the employer offered or to show the employer didn’t offer coverage.

All applicable large employers were required to report health coverage information for the first time in early 2016 for calendar year 2015.  If paper filed, Forms 1095-B and 1095-C must be filed with the IRS by February 28^th of the year following the calendar year in which minimum essential coverage is provided.  If filing electronically, the due date is extended to March 31^st.  Employers must provide a copy of the 1095-C to their employees by March 2, 2017. Please contact us to discuss your potential ACA filing requirements.  We can assist your business with the preparation and filing of these forms.

Repair-Capitalization Rules

The now three-year old final regulations on the treatment of payments to acquire, produce or improve tangible property still provide the potential for tax saving.  Businesses are required to use these new rules in determining whether they can deduct their costs as repairs under Code Sec. 162(a) or must capitalize the costs, to be recovered over a period of years under Code Sec. 263(a).

The regulations provide a number of taxpayer friendly provisions, including the de minimis safe harbor threshold amount under the final “repair regs” for taxpayers.  Currently, a de minimis safe harbor under the repair regs allows taxpayers to deduct certain items costing $5,000 or less (per item or invoice) and that are deductible in accordance with the company’s accounting policy reflected on their applicable financial statement (AFS).  An AFS is generally an audited financial statement.  The IRS regulations also provide a $2,500 de minimis safe harbor threshold for taxpayers without an AFS.  This $2,500 threshold for businesses without an AFS was increased from $500 for tax years beginning on or after January 1, 2016.

Other beneficial provisions include the safe harbor for routine maintenance, the small taxpayer safe harbor for repairs and improvements to real property, and the deduction for a partial asset disposition.

Ideas for Your Business

Get a Tax Credit for Paying Health Insurance Premiums.  Small employers with no more than 25 full-time equivalent employees may qualify for a special tax credit to help offset the cost of health insurance for their employees.  The employer must pay average annual wages of no more than $50,000 per employee (indexed for inflation) and maintain a qualifying health care insurance arrangement.  Generally, health insurance for employees must be obtained through the Small Business Health Options Program (SHOP), which is part of the Health Insurance Marketplace.

Get a Cost Segregation Study to Accelerate Deductions.  Cost segregation is a highly beneficial and widely accepted tax planning strategy utilized by real estate owners and tenants to accelerate depreciation deductions, defer tax, and improve cash flow.  A cost segregation study is based on a detailed engineering analysis that is used to support the acceleration of depreciation deductions by identifying costs that can be allocated to shorter recovery periods: primarily 5, 7 and 15-year, as opposed to 27.5 (residential rental) or 39-year (commercial).

There are a number of benefits associated with cost segregation and its various applications.  The primary benefit is significantly improved cash flow.  This is most often achieved through the acceleration of depreciation deductions and the resulting tax deferral.  Commercial or residential rental property, of any size, placed in-service after December 31, 1986 may qualify for a cost segregation study.

Your Expenses May Qualify for the Domestic Production Activities Deduction. This deduction is available to companies involved in domestic manufacturing, construction, engineering or architectural services related to construction projects, and other eligible production activities.  For 2016, the deduction is 9% of the lesser of: (1) qualified production activities income or (2) taxable income before taking the deduction into account.  However, the deduction can’t exceed 50% of W-2 wages allocable to domestic production gross receipts.  If your company is eligible, the deduction could cut your taxes and increase your after-tax profits without any additional outlay.

Evaluate Your Business Entity Structure. The structure of your business – C Corporation, S Corporation, Partnership, Limited Liability Company (LLC), or Sole Proprietorship – determines how your business income is taxed.  A C Corporation pays tax on its income at corporate tax rates.  Generally, the income, losses, deductions and credits of an S Corporation, Partnership, or LLC are passed through to the owners to be reported on their tax returns.  Sole proprietors also report business income and deductions on their tax returns.

The “single layer” of taxation offered by S Corporations, Partnerships and LLCs has been beneficial for many taxpayers.  Starting in 2013, these owners (as higher income taxpayers) faced new year-end planning challenges in the form of a higher individual tax rate of 39.6% and additional surtaxes on passive income by way of the net investment income surtax of 3.8% plus the Additional Medicare Tax of 0.9% on compensation.  Faced with these individual income tax rate increases, it may help businesses to be taxed as a C Corporation.

Business tax planning involves, not only economic planning for that year, but also making wise tax decisions that will benefit the business for years to come.  Tax-saving strategies must take into account short-term and long-term goals so that decisions made for the current tax year also represent sound tax decisions in following years.  Often, because business planning opportunities must be viewed in conjunction with personal tax planning, a taxpayer should also consider planning tips affecting their individual return and investment considerations when making business decisions.

Consider Qualified Retirement Plan Options.  Offering your employees a variety of benefits, including the opportunity to participate in a qualified retirement plan can help you attract and retain the best employees.  To receive a benefit in 2016, some plans must be established by the end of the year. There are a number of plan options to consider.  HBK can help you decide which option is best for your business.

Environmentally Friendly Ideas

Take Advantage of the Business Energy Credit.  Businesses can receive a tax credit of up to 30% of the cost of qualified energy property placed in-service during a tax year.  Qualified energy property includes solar property, geothermal property, qualified fuel cell or microturbine property, combined heat and power systems property, qualified small wind energy property, and geothermal heat pump systems.  There are also various related grants available for purchasing or constructing qualified energy property.

Get a Tax Deduction for Energy Efficient Commercial Buildings.  A tax deduction of up to $1.80 per square foot is available to owners or designers of new or existing commercial buildings that save at least 50% of the heating and cooling energy of a building that meets ASHRAE Standard 90.1-2001.  Partial deductions of up to $.60 per square foot can be taken for measures affecting any one of three building systems: the building envelope, lighting, or heating and cooling systems.  This deduction is not currently eligible for property placed in service after 2016.

ADDITIONAL ASSISTANCE

Our affiliated financial services firm, HBKS^® Wealth Advisors, works closely with their clients to help create investment portfolios that incorporate many aspects of a tax sensitive investment management structure. HBKS does so by developing a thorough understanding of a client’s financial condition and objectives, collaborate with their CPA where appropriate, and apply the latest advances in wealth management technological and industry processes. This season, we are pleased to invite you, as a client of HBK CPAs & Consultants, to a complementary consultation with an HBKS Financial Advisor to develop financial plans, including tax-efficient portfolios, that address client-specific problems and design solutions specific to clients’ financial needs and goals. Contact us to schedule a time to talk. We look forward to meeting with you.

Conclusion

The importance of year-end tax planning for 2016 has been heightened by the potential for a reduction in future tax rates.  It is possible your 2016 and 2017 tax liability can still be reduced through careful planning.  At HBK, we can determine how best to maximize your tax savings for 2016 and beyond.  We are available to assist you through each step of this process and we will keep you apprised of any legislative changes impacting your tax circumstance in real time. Please don’t hesitate to contact us with questions, concerns or ideas you about how to reduce your taxes.

Established in 1949, HBK CPAs and Consultants (HBK) offers the collective intelligence of hundreds professionals in a wide range of tax, accounting, audit, business advisory, financial planning, and other business operational and support services from offices in four states. HBK professionals deliver industry-specific expertise in manufacturing; healthcare, including long-term care; real estate and construction; automotive dealerships and not-for-profit organizations. HBK combines the technical resources and expertise of a large national accounting and professional consulting firm with the personalized attention of a local company. The firm is ranked in both Accounting Today and Inside Public Accounting magazines’ Top 100, and supports clients globally as a member of BDO Alliance USA. HBK maintains locations in Alliance, Columbus and Youngstown in Ohio; Blue Bell, Erie, Hermitage, Meadville and Pittsburgh in Pennsylvania; Cherry Hill and Princeton in New Jersey; and Fort Myers, Naples, Stuart, and Sarasota in Florida.

To learn more about HBK, call 800.733.8613 or visit us at  hbkcpa.com

HBKS^® Wealth Advisors is not a CPA or legal firm, and does not give tax advice.  Investment advisory services offered through HBK Sorce Advisory LLC, doing business as HBKS^® Wealth Advisors. Not FDIC Insured – Not Bank Guaranteed – May Lose Value, Including Loss of Principal – Not Insured by any State or Federal Agency. The foregoing was prepared by Hill, Barth & King LLC, and is not a product of HBKS^® Wealth Advisors.  Please remember, the information in this document is intended only as a general discussion of the tax laws.  It does not address your individual facts and circumstances, and can not be considered as tax advice.  If you would like to receive tax advice, please contact a properly licensed CPA or tax attorney.

To learn more about HBKS, call 866.536.5776 or visit us at  www.hbkswealth.com

Ohio can impose its commercial-activity tax (CAT) on out-of-state companies that sell products and services to Ohioans, but have no physical presence in the state, the Ohio Supreme Court ruled on Thursday, November 17, 2016.

In a 5-2 decision, the Supreme Court determined the U.S. Constitution’s commerce clause does not prevent a state from imposing a “privilege to do business” tax, such as the CAT, on online retailers. Writing for the Court majority, Justice William M. O’Neill determined that while a physical presence in a state may be required to impose the obligation to collect sales taxes and use taxes on an out-of-state seller, that requirement does not apply to a business tax on an interstate company. Ohio’s $500,000 in annual sales threshold for the CAT to apply meets the commerce clause requirement, he concluded.

Please contact your HBK representative to find out how this impacts your business.

On November 18, the IRS issued Notice 2016-70, which extends the due date to send individuals the 2016 Form 1095-B, Health Coverage, and the 2016 Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, from January 31, 2017 to March 2, 2017. Therefore, it will not be necessary for taxpayers to request an extension for sending those forms to the recipients, and no further extensions are available.

The IRS did not, however, extend the deadline for filing these forms with the IRS. The forms, along with Form 1094-B or 1095-B, as applicable, must still be filed with the IRS by February 28, 2017 (for those filing less than 250 forms on paper) and March 31, 2017 (for those filing electronically). An automatic 30-day extension is available for filing the forms with the IRS by completing Form 8809. The IRS also extended its relief from penalties under Sections 6721 and 6722 for taxpayers that make a good faith effort to comply with the 2016 reporting requirements, provided statements are furnished to individuals and filings are made with the IRS on a timely basis.

Please contact your HBK representative with any questions.

The Ohio state legislature has proposed a bill that would significantly impact withholding taxes for Pass-Through Entities (PTEs) in the Buckeye State if passed. Sponsored by Republican Senator John Eklund and supported by Republican Senators Frank LaRose, Bill Seitz and Tom Patton, Senate Bill (SB) 288 aims to alter the law governing how taxes on income from PTEs are reported and paid both by the entities and any of their investors.

What is a PTE?

A PTE is an entity which is not subject to federal income tax because its individual owner is directly taxed on income based on the company’s profits and losses. They typically include sole proprietorships, partnerships, LLCs and S corporations.

How Would Ohio Senate Bill 288 Impact PTEs?

Under existing law, PTEs and their owners are subject to many types of tax filing and payment provisions. Proposed S.B. 288 will eliminate the PTE “withholding” tax and instead require any PTE with non-resident investors to file a single, composite tax return on behalf of its non-resident investors.  Some of the more specific changes of SB 288 include:

• Replacing the business income tax rate of 3% with the current withholding rates of 5% and 8.5% for non-resident individual owners and non-resident upper-tier PTE owners, respectively. NOTE: The tax and withholding rate of 3% mirrors the business income tax rate recently passed by Ohio lawmakers.
• Requiring that every PTE owned by one or more non-residents of Ohio to file a composite return that would include adjustments to the PTE’s income when computing taxes owed.
• Individual taxpayers that want to take advantage of the business income exclusion of $250,000 will still need to file personal income tax returns as this deduction would not be taken on the required composite returns.

What Taxable Income Would SB 288 Affect?

If it is made into law, SB 288 would apply to taxable years ending on or after January 1, 2017.

If you have any questions or concerns about SB 288 and how it affects your business, please contact a member of the HBK Tax Advisory Group and we will be glad to help.

Basis and at-risk basis rules for S Corporations.

S Corporations are flow-through tax entities meaning their income, deductions, credits and other activity is allocated to the shareholders to be reported on their tax returns.  When a shareholder is allocated a loss from an S Corporation they can use the loss to offset income from other sources if they pass three tests.  The first two tests, discussed here, examine how the loss was funded.  To use the loss the shareholder must (1) have stock basis and (2) be considered “at-risk.”  The third test deals with passive and non-passive income which will be addressed in a future article.

A shareholder’s initial stock basis is determined by how they acquire their interest in the S Corporation.  The money and other property a shareholder contributes to start an entity or the amount paid to purchase shares in the corporation is their initial basis.  If S Corporation shares are gifted the recipient is also gifted the donor’s basis in the shares.  The basis of inherited shares is adjusted to the fair market value at the decedent’s date of death.  From there, a shareholder’s basis is generally increased by capital contributions, personal loans to the corporation, and income allocated to the shareholder.  Basis is decreased by distributions, repayment of loans from the shareholder, and losses allocated to the shareholder.  So long as a shareholder has stock basis in excess of their loss at the end of the tax year they will pass the first test in determining whether or not they can deduct the loss.

The second test for deducting a loss requires a taxpayer to be sufficiently at-risk.  Simply stated, a shareholder’s amount at-risk is the extent they have dipped into their own pocket to fund operations.  In a Partnership, partner tax basis includes their share of the partnership debt, including loans from third parties and banks.  This often results in differences between partner basis and at-risk basis because the partners have basis for partnership debt but are not at-risk.  In an S Corporation stock basis and at-risk basis are often the same because shareholders typically do not receive stock basis for their share of S Corporation debt.  However, there is one significant exception.  An S Corporation shareholder’s basis includes money loaned by the shareholder to the corporation.

While an S Corporation shareholder receives stock basis for loans made to the corporation they are not always at-risk for the debt basis. A shareholder is only at-risk for loans it makes to the corporation if the shareholder is at-risk for the funds loaned to the corporation.  We often encounter scenarios where a shareholder personally borrows money and loans the proceeds to the S Corporation (referred to as a back-to-back loan).  A shareholder is not at-risk for back-to-back loans unless they are personally liable for the repayment of the loan, or if they have pledged property other than S Corporation property or their S Corporation stock, as security for the loan.  If the loan to the shareholder is non-recourse, meaning they are not personally liable for the repayment, they will not receive at-risk basis by loaning the proceeds to their S Corporation.

The goal of the stock and at-risk basis rules is to limit a shareholders use of losses to those which have been personally funded by the shareholder.  An S Corporation shareholder can take losses to the extent of their personal investment in the corporation.  Losses funded by loans from unrelated parties and loans from the shareholders of funds which are not at-risk cannot be deducted.  Instead, the losses are suspended and carried forward until the shareholder increases their stock basis and amount at-risk.

The Internal Revenue Service and its Security Summit partners are warning taxpayers and tax professionals of fake IRS tax bills circulating that are allegedly related to the Affordable Care Act.

Multiple Reports of Scams
The IRS has received numerous reports of scammers sending copies of a fraudulent version of a notice for tax year 2015. The fake notice is labelled CP2000. The issue has been reported to the Treasury Inspector General for Tax Administration and it is currently under investigation.  The IRS is warning taxpayers and tax service providers that this scam may arrive as an email attachment or via a postal service mailing. It contains the following red flags that automatically identify it as fraudulent:

• The CP2000 notices appear to be issued from an Austin, Texas address.
• The accompanying letter says the issue is related to the Affordable Care Act and requests taxpayer information regarding their 2014 coverage.
• The payment voucher lists the letter number as 105C.
• The notice asserts a request that all checks be made out to IRS and sent to the “Austin Processing Center” at a post office box.

The Real Deal
An authentic CP2000 notice is used when income reported from third-party sources such as an employer does not match the income reported on the tax return. Unlike the fake, it provides extensive instructions to taxpayers about what to do if they agree or disagree that additional tax is owed. A real notice requests that checks be made out to “United States Treasury.”

Official IRS Sites
IRS impersonation scams take many forms, including but not necessarily limited to threatening phone calls, phishing emails and demanding letters. Learn more at Reporting Phishing and Online Scams The IRS does not initiate unsolicited email contact or contact by social media. The IRS and its Security Summit partners – the state tax agencies and the private-sector tax industry – are conducting a campaign to raise awareness among taxpayer and tax professionals about increasing their security and becoming familiar with various tax-related scams such as this one. Learn more at Taxes, Security, Together  or Protect Your Clients, Protect Yourself

If you have any questions or concerns about this or any other fraudulent notices, please contact a member of the HBK Tax Advisory Group and we will be glad to help.

Do the math. Does your service department cost you more to operate than it bills? A key to dealership profitability is a service department where sales revenue outweighs expenses. And the keys to such performance are found in your labor rate and department efficiency.

How did you come to your current service labor rate? Most service managers tell me they started with an existing rate which they have increased gradually over the years, typically adding three percentage points and rounding up about every year or so (although a year or so often becomes two years or longer). An alternate approach involves raising labor rates in conjunction with raises for technicians, but technician wages are not the only departmental expense and such an approach can create big problems for the dealership over time.

The first problem with increasing labor rates periodically by some flat percentage is that service department expenses grow at different, higher rates. Your DMS system, health insurance, manufacturer training – such expenses need to be considered as you determine a labor rate. Most dealers expect a 70 percent gross profit margin; but, maybe your service department expenses are such that you need a higher gross margin to be profitable. So how do you go about setting your labor rate to both stay competitive and increase profits?

Steps for Setting an Effective Labor Rate

• First, review your financial reports to see the impact of expenses on your department’s bottom line – that is, do the math.
• Second, determine what labor rate the market will bear. Many dealers call around to find out both the effective and posted labor rates of other local dealers and independent shops, especially those with whom you compete for service business and those with a similar service offering. (Caution: don’t fall into the trap of just setting your rate based on some rate in the middle of your competitors. Do you know their expense structure? Do you know if they are even profitable?)
• Third, set a reasonable rate that leaves enough margin for the department to be profitable. But don’t stop there. What if the rate that you need to be profitable exceeds that which the market will bear? Use efficiencies and technician incentives to bridge the gaps.

A Scenario to Consider
For example: A technician earning $12 per clock hour with 50% of the technician’s time charged on work orders is really costing the shop $24 per charged hour, so to maintain a 70% gross margin, you find you need an $80 per hour posted rate. But what if the market will bear only $70?

First, look at your parts department. Increasing efficiency by having a ready inventory of parts to reduce technicians downtime is good for profitability and also good for customer satisfaction.

Second, look at your technician payplan. Providing productivity incentives, such as a bonus based on the technician increasing the percentage of chargeable hours will likely increase the technician’s pay while increasing the profitability of your service department.

Using the example above, if we can raise the productivity of the $12 per hour technician from 50% to 60% the effective cost of labor drops from $24 to $20 per hour and the $70 posted labor rate yields an acceptable gross profit margin slight above 71%.

So do the math. Find areas and ways to improve productivity. Then set your labor rates accordingly. The process will allow you to achieve your desired gross margin while staying competitive in your marketplace.

On August 4, 2016 Proposed Regulations were issued by the Treasury Department which may have a significant impact on your estate plan. If the Proposed Regulations are enacted as currently drafted, it may result in the loss of both the lack of control and lack of marketability valuation discounts for transfers of interests in family-owned entities to other family members. For wealthy families who utilize valuation discounts as a means of minimizing future estate taxes, it is essential that they understand the impact of these regulations and the immediate planning options that may be available.

Background
IRC Section 2704 was enacted in 1990 as part of an initiative by Congress to limit valuation discounts taken when interests in family-owned entities were transferred to family members. Over time the ability of the IRS to use Section 2704 as a means of limiting discounts has effectively been eliminated due to various state laws and taxpayer-friendly court cases. The Proposed Regulations effectively negate the effect of these state laws and court cases and provide the IRS with additional means by which to limit valuation discounts.

What are discounts?
Discounts are a reduction in the value of an interest in an entity due to the lack of control the owner of a minority interest may have, the difficulty of the owner to find a willing buyer of a minority interest, and other factors that may play in to a third party’s desire to own that interest. The effect of these discounts may be illustrated as follows:

Sam has a gross estate worth $20 million, which includes a family business valued at $10 million. He gifts 40% of the business to a trust in order to remove any appreciation on the business from his estate. The gross value of the interest transferred to the trust is $4 million ($10 million multiplied by 40%). However, since a minority owner of the interest cannot force a sale or redemption of the interest, the value of the interest transferred to the trust is worth less than the gross value. The value is therefore reduced by up to 40% or more to reflect the difficulty of marketing the non-controlling interest. If Sam is successful in arguing a 40% discount, the gross value of the interest will be reduced to $2.4 million and Sam would have reduced his estate by $1.6 million simply by making the transfer.

What may the impact of the election be?
As with most things, the impact of these Proposed Regulations combined with the results from the upcoming election is uncertain. If the Democratic Party maintains control of the White House and is able to take control of the Senate, then it is possible will be successful in enacting their current estate tax proposals. These proposals currently include a reduction of the estate tax exemption to $3.5 million without adjustments for inflation, a reduction of the gift tax exemption to $1 million, and a high tax rate of 45%. In addition, the new president may continue to push for other changes that President Obama has sought, including the restriction or elimination of Grantor Retained Annuity Trusts (GRATs) and the sale of assets to grantor trusts via an installment note.

What should you do?
The regulations will be effective 30 days after the regulations are finalized. The IRS is holding a hearing on December 1, 2016 and many expect the final regulations will be issued before President Obama leaves office on January 20, 2017. If so, then these regulations may be effective in mid February. Time is of the essence in determining what planning options you may have. Once the Proposed Regulations are effect, which may be as early as the end of the year, the ability to claim these valuation discounts may be substantially reduced or eliminated. This will have a significant impact on your tax and asset protection planning flexibility.

Many of you may remember the mad rush in late 2012 with the fear that the estate, gift, and generation skipping transfer tax exemptions were going to be reduced to $1 million in 2013. Many of our clients incurred significant costs and hassles in implementing planning quickly, and were frustrated when the reduction never occurred. The current situation is vastly different. While the Proposed Regulations could be changed before them become effective, the more likely scenario is that they will be finalized in their current format and the ability to claim valuation discounts will be severely curtailed.

We encourage you to contact us as soon as possible to discuss the impact these Proposed Regulations may have on you and your estate plan.