1099 Filing Season
1099 information returns are due by January 31st. Two common types of the 1099 are a 1099-PATR and a 1099-DIV. A 1099-MISC is required for payment for services of at least $600 to individuals and other businesses, excluding corporations. Common examples of these payments include director fees, payments to a deceased employee's estate, or attorney fees. A 1099-DIV is required for all dividend payments of at least $10. Cooperative patronage distributions are considered a return of margins and not dividends and should follow the 1099-MISC rules. Payments to stockholders for stock repurchase are not required to be reported on a 1099.
The 1099's are due to the payee by January 31st. If filing the 1099's using paper copies they are due to the IRS by February 28th. If done through electronic means an extension is given until March 31st. Those companies filing 250 or more information returns are required to file electronically and others are encouraged to do so.
The IRS requires all 1099's to be filed with the payee's taxpayer identification number or social security number. In cases where the payee has not provided their number, has provided an obviously incorrect number, or the IRS has notified the company of an invalid ID, backup withholding is required at a rate of 28%.
As usual with the IRS, failure to follow the guidelines can result in penalties to the company. If you have any questions please contact your Kiesling representative.
Life Insurance Proceeds
For life insurance contracts issued, or significantly changed, after August 17, 2006, the proceeds from these policies may be subject to taxation unless certain consent requirements are met and disclosure is made to the IRS with your annual tax filings.
Generally, proceeds of a life insurance policy paid by reason of the death of the insured are excluded from the income of the beneficiary of the policy. When a corporation purchases a life insurance policy on a key employee or other related party, the proceeds of the policy, payable upon death of that individual, would not be taxable to the corporation.
The consent requires the employee be notified in writing:
1) of the employers' intent to insure the employee and the maximum face amount of the policy
2) that the policy may continue after termination of employment
3) that the employer will be the beneficiary of any proceeds payable upon the death of the employee
A signed disclosure form by the employee would be the best documentation of this notification.
The disclosures to the IRS are done through Form 8925, Report of Employer-Owned Life Insurance Contracts. This form is attached to your annual income tax return.
The disclosures on the form include:
1) Number of employees at the end of the year insured under these contracts
2) Total amount of insurance in force
3) Confirmation of valid consents for each insured person
If your business has entered into a policy since August 17, 2006 please contact your Kiesling representative to ensure the notification and disclosure rules are being met.
Electronic Filing
Most taxpayers and tax preparers this year will use
IRS e-file to file their tax returns or get extensions of time to file. During this process, they will not have to send a single piece of paper to the Internal Revenue Service.
The IRS expects the total number of individual tax returns, both electronic and paper, to reach about 140 million in 2009. And it expects e-file returns to exceed last year's record of nearly 90 million taxpayers.
E-filers enjoy these benefits:
- Faster refunds. With IRS e-file, taxpayers get refunds in half the time it takes to file a paper tax return and receive a refund check. E-filers who choose direct deposit can receive their refund in as few as 10 days.
- Paperless. A taxpayer eliminates paperwork by creating his or her own Personal Identification Number (PIN) and filing a paperless return using tax preparation software or a tax professional. There is nothing to mail to the IRS. Some accounting firms are beginning to add a surcharge to their fees when being requested to paper file a tax return instead of e-filing.
- File now, pay later options. Taxpayers can file early and pay later by scheduling an electronic funds withdrawal any time through April 15, 2009. Taxpayers can also pay by credit or debit card when they e-file their returns. By enrolling in the Electronic Federal Tax Payment System (EFTPS), taxpayers can make all federal tax payments online or by phone.
- More accurate returns. In addition to the error checks built into return preparation software, additional checks are performed during the transmission of software enabled e-file returns. These checks reduce the chance a taxpayer will receive an error letter from the IRS.
- Quick electronic confirmation. E-filers are notified that their returns have been received.
- Convenient Federal/State e-filing. Taxpayers in 37 states and the District of Columbia can e-file their federal and state tax returns in one transmission to the IRS. The IRS forwards the state data to the appropriate state tax agency. In 2008, 46 million taxpayers filed federal-state electronic returns in Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, Wisconsin and the District of Columbia.
Correcting Employment Taxes
To correct employment tax errors discovered on or after 1/1/2009, use the new corresponding "X" forms to correct employment tax errors as soon as they are discovered. For example, use the new Form 941-X, Adjusted Employer's QUARTERLY Federal Tax Return or Claim for Refund, to correct errors on a previously filed Form 941.
For overpayments: Employers can choose to make an adjustment or claim a refund on the corresponding "X" form.
For underpayments: Employers correcting an underpayment must use the corresponding "X" form. Amounts owed must be paid by the receipt of the return. Payments can be made using EFTPS, by sending a check, or by credit card.
94X Series Adjusted Tax Forms
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Return previously filed
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Corresponding 94X series form
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Form 941, Employer's Quarterly Federal Tax Return (PDF)
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Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund, Instructions
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Form 943, Employer's Annual Federal Tax Return for Agricultural Employees (PDF)
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Form 943-X, Adjusted Employer's Annual Federal Tax Return for Agricultural Employees or Claim for Refund, Instructions
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Form 944, Employer's Annual Federal Tax Return (PDF)
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Form 944-X, Adjusted Employer's Annual Federal Tax Return or Claim for Refund, Instructions
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Form 945, Annual Return of Withheld Federal Income Tax (PDF)
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Form 945-X, Adjusted Annual Return of Withheld Federal Income Tax or Claim for Refund, Instructions
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Form CT-1, Employer's Annual Railroad Retirement Tax Return (PDF)
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Form CT-1X, Adjusted Employer's Annual Railroad Retirement Tax Return or Claim for Refund, Instructions
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Personal Use of Company-Provided Cell Phones
The IRS considers personal use of cell phones a taxable benefit and subject to federal and FICA withholding. To exclude these charges from personal income, certain rules need to be followed. The documentation rules to exclude these charges from income are similar to those related to vehicles. The documented evidence should include the amount of the expense, time, place, business purpose, and business relationship of the other party to the call. To meet these strict standards a taxpayer would typically need to retain billing statements with written comments on whom and why they were calling. This detail of recordkeeping would almost certainly result in significant time requirements to maintain these records for what would typically be insignificant amounts of taxable income. Most taxpayers would likely not meet these standards thus subjecting these items to challenge upon an IRS audit. The IRS recently indicated they are looking into easing these requirements to allow for an estimation method with a deminimis percentage test. This method could result in something close to 35% of the total bill being considered a standard for personal use. Two bills were introduced during 2008, however they were never enacted by congress. As a result, the IRS is now trying to fix things on their own. The current IRS guidance is still preliminary and would not be considered a safe harbor if audited by the IRS.
IRS Releases Revenue Rulings on Sale and Surrender of Life Insurance Policies
On May 1, 2009, the Internal Revenue Service released Revenue Rulings 2009‐13 (2009‐21 I.R.B. 1029) addressing the income tax implications of the sale and surrender of life insurance policies. For more information on this topic and related items, read on….
Revenue Ruling 2009‐13:
Sale or surrender of insured’s life insurance.
Surrender of a Policy. The surrender of a permanent policy by the insured individual is taxed under section 72(e) as ordinary income (see, Rev. Rul. 64‐51, 1964‐1 C.B. 322) to the extent the proceeds received exceed the investment in the contract. The investment in the contract equals the aggregate premiums and other consideration paid less aggregate amounts received from the policy that were excluded from gross income.
Sale of Policy to Third Party. The sale of a policy by an insured individual to a third party is taxed under section 1001 and the “substitute for ordinary income doctrine” so that any gain is taxed as ordinary income up to the amount that would have been ordinary income if the policy had been surrendered and any excess as capital gains. Unlike the surrender of a policy, however, when determining the basis in the policy, the aggregate of premiums paid must be reduced by that portion of the premiums paid that was expended for the provision of insurance before the sale.
Sale of Term Insurance to Third Party. The sale of a term policy by the insured individual to a third party is taxed under section 1001. Since there is no internal build‐up within a term policy there is no ordinary income element. The gain will be a capital gain. The adjusted basis in the life insurance contract for purposes of determining its gain or loss on sale is equal to the total premiums paid under the contract, less charges for the provision of insurance before the sale. As indicated more fully below, the above conclusions regarding the sale of policies will not be applied adversely by the Service to sales occurring before August 26, 2009.
Meals and Entertainment – Deduction Limitations
The expense of providing entertainment to a client, customer or employee can qualify as an ordinary and necessary business expense. Entertainment activities can include the cost of meals (food, beverage, tax, tip). Entertainment can be provided at facilities such as nightclubs, social clubs, sports facilities, theaters, or on hunting, fishing, vacation and similar trips.
Dues paid to clubs with a principal purpose of providing entertainment to members or guests are not deductible. Included are dues paid to country clubs, golf and athletic clubs, social clubs, airline clubs, hotel clubs, and business luncheon clubs. Business meals and entertainment expenses incurred at these clubs are 50% deductible if the other requirements are met.
Dues are deductible for most business organizations such as business leagues, trade and professional associations, as well as civic and public service organizations such as Kiwanis, Lions, Rotary and similar groups. However, if the principal purpose of any of these organizations is to provide entertainment, the dues paid will not qualify for a deduction.
First, to qualify for the meal and entertainment deduction, the expenses must be directly related to or associated with the active conduct of business.
Directly related means that the taxpayer must show that the main purpose of the event was business, or that the event was to engage in business with a person or persons during a meal or entertainment activity and have more than a general expectation of receiving income or some other specific business benefit in the future.
Associated with means that the taxpayer provides entertainment or a meal directly before or after a substantial business discussion. The taxpayer must actively engage in a meeting, discussion or other business transaction to obtain income or some other specific business benefit. It is not necessary that the taxpayer devote more time to business than entertainment.
Meals with business associates and coworkers are generally not deductible unless the taxpayer can establish a clear business purpose.
Expenses are not allowed for entertainment that is lavish or extravagant. Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs or resorts. However, the expenses must be reasonable considering the facts and circumstances.
If you pass the directly related or associated tests, then generally the deduction for meals and entertainment will be limited to 50% of the amounts that would be eligible. This limit also applies to meals associated with business travel, and applies even if the meal cost is not separately stated from the total cost of the event (IRC 274(n)).
However, there are exceptions (meaning 100% deductibility), including:
· Meals provided on the employer’s premises for the employer’s convenience, if more than 50% of the employees are included (de minimus fringe benefit)
· M&E that are treated as taxable compensation to the employee
· Promotional activities made available to the general public
· Employer provided social or recreational expenses for the benefit of employees (holiday or summer parties)
· Meals and entertainment sold to customers (i.e., a restaurant business)
Most other M&E expenses will be limited to 50%.
General meal deductibility guidelines:
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Meals
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0% Deductible
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50% Deductible
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100% Deductible
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Lavish and extravagant
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X
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Meal w/employee, business discussed
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X
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Meal w/employee, no business discussed
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X
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Meal w/customer, business discussed
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X
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Meal w/customer, no business discussed
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X
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Meal w/customer during travel, no business discussed:
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Customer’s meal
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X
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Taxpayer’s meal
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X
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Employers cost of meal for employees working overtime/weekends (if deemed de minimus)
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X
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Lunch ordered for staff meeting (de minimus)
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X
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Dinner for customer and spouse, no others present
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X
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TAX AUDITS
The IRS will audit hundreds of thousands of individual tax returns this year. Although that represents but a small percentage of all returns filed, this is little consolation if your return is among those selected for audit.
The purpose of the audit is to verify items reported on a tax return. The easiest way to survive a tax audit is to prepare for one in advance. On an ongoing basis you should systematically maintain documentation-invoices, bills, cancelled checks, receipts or other proof-for all items to be reported on your tax return. Keep all your records in one place and hold on to your calculations.
The government normally has three years within which to conduct an audit, and often the audit won't begin until a year or more after you file your return.
The scope of an audit depends on the complexity of the return being examined. A return reflecting business or real estate income and expenses is likely to take longer to audit than a return reflecting only salary income. You can facilitate matters by having the necessary records arranged in an orderly and systematic fashion for presentation to the IRS agent. The typical IRS agent is experienced and knows his job. Trying to outsmart the agent or sidestepping questions is likely to create friction and raise suspicions in the agent's mind.
Representation. Even if you prepared your own return, it is often advisable to have a tax professional represent you at an audit. Your representative knows what issues the IRS agent is likely to focus on and can prepare accordingly. More importantly, a tax professional knows that in many instances IRS agents will take a position (for example, to disallow deduction of a certain type of expense) even though courts and other authority have expressed a contrary opinion on the issue. Because the representative knows and can point to the proper authority, the IRS agent may be convinced to throw in the towel.
If you are facing a tax audit or simply want to improve your recordkeeping, Kiesling stands ready to assist you. Please contact your Kiesling representative to discuss this or any other aspect of your taxes.
Estimated Taxes Explained
The United States income tax is a pay-as-you-go tax, which means that tax must be paid as you earn or receive your income during the year. You can either do this through withholding or by making estimated tax payments. If you do not pay enough tax, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will have paid enough tax to avoid this penalty if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.
Generally, the payments should be made in four equal amounts to avoid a penalty. However, if you made unequal payments because your income was received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income.
The penalty may be waived in certain situations:
1. The failure to make estimated payments was caused by a casualty, disaster or other unusual circumstance and it would be inequitable to impose the penalty, or
2. You retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required to be made or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.
If you receive salary and wages, you can avoid having to pay estimated tax by asking your employer to take more tax out of your earnings. To do this, file a new Form W-4 with your employer.
You do not have to pay estimated tax if you meet all three of the following conditions. First, you had no tax liability for the prior year, you were a US citizen or resident alien for the whole year AND your prior tax year covered a full 12-month period. (You had no tax liability in the prior year if your total tax was zero or you did not have to file an income tax return.)
If you owed additional tax for the prior year, you may have to pay estimated tax for the current year (for example, if you owed tax in 2007, you may have to pay estimated payments for 2008.) You must pay estimated tax for the current tax year if BOTH of the following apply.
1. You expect to owe at least $1,000 in tax for the current year, after subtracting your withholding and credits.
2. You expect your withholding and credits to be less than the smaller of:
a. 90% of the tax shown on your current year return, or
b. 100% of the tax shown on your prior year return covering a full 12 months.
*HIGHER INCOME TAXPAYERS – If your adjusted gross income (AGI) was more than $150,000 ($75,000 if your filing status is married filing separately), substitute 110% for 100% in 2b above.
**Note that there are special rules for farmers and fisherman.
Independent Contractors
It is important to know the difference between an employee and an independent contractor, especially when it comes to employment taxes. The determination could affect how you pay your federal employment taxes, social security and Medicare taxes. The IRS looks at three categories when determining if a person is an employee or independent contractor; behavioral control, financial control and type of relationship.
Behavioral controls are those the business has a right to direct and control how the worker does the task, generally through instructions or training. Instructions are given through how, when or where to do the work, what tools or equipment to use, what assistants to hire to help with the work and where to purchase supplies and services. These indicate the worker may be an employee.
Financial controls show the right to control the financial and business aspects of the worker's job. Independent contractors tend to have more continuing cost, unreimbursed expenses and a significant investment toward the services provided. They are usually paid a fee for the job and should present an invoice before payment is made.
Last is the type of relationship which includes written contracts, employee-type benefits and permanency of the relationship. Written contracts can be very important in describing the relationship the parties intend to create. Insurance, pension plan, vacation pay or sick pay are benefits an employee could receive. An independent contractor should never be in the payroll system, receive an employee handbook or attend social events for employees. They are usually there for a specific project or period of time.
As an employee, your employer must withhold income tax and your portion of social security and Medicare taxes. The employer will be responsible for paying social security, Medicare, FUTA taxes and will give each employee a W-2 showing the amount of taxes withheld. Any business expenses not reimbursed to an employee can be deducted on Schedule A of their income tax return provided they meet the additional tax rules.
An independent contractor will receive a 1099 showing the amounts that have been paid for a job and they will be required to pay their own income tax and self-employment tax. No taxes will be withheld from the payments and the independent contractor may be required to make estimated income tax payments to cover their tax liabilities for the year. Independent contractors are allowed to deduct business expenses on their income tax return, Schedule C.
Remember when deciding whether a worker is an employee or independent contractor, consider (1) behavioral control-who has the direct right or control over a project, (2) financial control-who has the controls over making the business decisions, and (3) nature of relationship. If you are still unsure, you can file a SS-8 Determination of Workers Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS or contact your KA representative for guidance.
Discounting Capital Credits
In a recent private letter ruling the Internal Revenue Service gave guidance to a tax exempt electric cooperative on how it could implement a program allowing members and former members to elect to receive early redemption of some or all of their patronage capital credits without jeopardizing the cooperative’s tax exempt status. The capital credit discounting program described in the ruling could serve as a model for other tax exempt electric and telephone cooperatives interested in reducing their capital credit retirement obligation.
A cooperative is an organization that conducts business with its members on a not-for-profit basis. Any amounts collected from the members in excess of the costs of operations are returned to the members. In some cases the excess is returned shortly after the end of the year in cash, but in most cases only part or none of the excess is paid in cash with the balance distributed in the form of patronage capital credits. Capital credits represent the cooperative’s obligation to make cash payments of the excess amounts collected from the members at some future date. The cooperative generally retains the cash for investment in plant and equipment and will redeem the capital credits when cash becomes available. Capital credits may be outstanding for 10 or more years before they are redeemed in cash.
Cooperative telephone companies and like organizations such as cooperative electric companies that receive 85% or more of their revenue from members can qualify as tax exempt organizations under section 501(c)(12) of the Internal Revenue Code. The cooperatives must operate in a manner consistent with not-for-profit cooperative principles to retain their tax exempt status.
In private letter ruling 200601031 the cooperative instituted a capital credit discount program allowing members and former members on a voluntary basis to redeem early some or all of their capital credits at a discounted rate. The cooperative retains the amount representing the difference between the face value of the capital credits and the discounted amount. The discount amount is kept in the member’s name as a permanent Class B Credit redeemable only upon the cooperative’s dissolution or liquidation.
The IRS ruled that since the capital credit discounting program adopted by the cooperative did not result in a forfeiture of the member’s patronage capital, it was not inconsistent with operating on a not-for-profit cooperative basis. Therefore, the policy would not result in the cooperative losing its tax exempt status.
A cooperative wish cash available to retire capital credits in advance of the normal retirement schedule, but is concerned about its ability to maintain sufficient cash flow in the future to continue retiring the full amount of its capital credit obligation, might want to consider adopting a voluntary capital credit discounting program either on a permanent or a temporary basis.
Accumulated Earnings Tax
In deciding how much to pay out as a dividend a corporation should consider its susceptibility to the Accumulated Earnings Tax (AET). This tax, unlike the traditional income tax system, is not self-assessing. Its applicability depends on the Internal Revenue Services assessment that a corporation has accumulated earnings beyond its business needs with tax avoidance intent.
The Accumulated Earnings Tax would apply to a corporation that has retained sufficient earnings and profits in both the current and prior years to replace fixed assets, retire outstanding debt per scheduled maturities, maintain adequate working capital to replenish inventories, or sustain other business needs (including growth opportunities). Rather than paying the remaining current year earnings out as a dividend to its shareholders the corporation decides to invest the undistributed earnings in some unrelated business activity. Essentially, the corporation is investing profits on behalf of its shareholders rather than declaring a dividend and allowing the shareholders to invest the funds themselves, thus avoiding a layer of income tax.
Historically, the highest individual tax rate has applied in determining a corporation’s AET obligation. This rate was reduced to 15% in legislation signed into law by President Bush for tax years beginning before December 31, 2008. Without further action by Congress the rate will return to the highest individual tax rate thereafter.
Corporations with a limited number of shareholders, particularly if they are related, should carefully consider whether they are vulnerable to actions brought by the IRS on this issue. However, having a large number of shareholders is not an available defense to an assessment for AET; AET is to be assessed without regard to the number of shareholders of a corporation.
In situations where there is a substantial balance in retained earnings, corporations need to demonstrate that there is a genuine business purpose for retaining current earnings and profits. This is especially true when there is significant earnings retention coupled with a large investment in readily marketable securities. Generally the burden of proof lies with the taxpaying corporation to prove a justified business purpose for its retention of accumulated taxable income within the organization. If no arguable business purpose exists, and the corporation wishes to avoid AET assessment, it must declare and pay a dividend during or within two and one-half months after the close of the applicable tax year.