Tag Archive for: International Tax

how far back irs
Corporate Tax Changes Under Biden: What to Know

In March 2021, the current administration and congress were able to enact the American Rescue Plan, the plan provides cash payments to individuals and included tax law changes benefitting lower-income individuals and families. The American Rescue Plan tax changes are temporary (expiring at the end of 2021) remedies targeted at those affected by the economic downturn caused by COVID-19.

They include: 

  • A child tax credit of $3,600 per child under age 6 and $3,000 per child ages 6 through 17 is fully refundable and payable in advance. It will revert for 2022 to $2,000 per child under age 17 unless extended by legislation.
  • A child and dependent care tax credit maximum credit for one individual is $4,000 and $8,000 for two or more qualifying individuals and is refundable for some taxpayers.
  • EITC extended to workers under age 25; and for 2021, individuals as young as age 19 are eligible. 
  • Premium reductions for ACA coverage for two years.

On the docket for enactment are other tax implication-filled plans such as The American Jobs Plan aims to achieve the following:

  • Create new unionized jobs and train American workers for future jobs 
  • Invest in innovation by revitalizing American manufacturing 
  • Create caregiving jobs and raise wages of home caregivers
  • Modernize homes, commercial buildings, schools, and federal buildings
  • Upgrade highways and national infrastructure
  • Update drinking water infrastructure and develop a new electrical grid 

These intended projects are planned to be funded by the Made in America Tax Plan that the presidential administration has also proposed. Currently, this tax plan is projected to bring in a total of approximately $2 trillion to cover the costs of the projects mentioned above.

The intention of this proposed legislation is to ensure that large corporations and wealthy individuals will pay a higher rate to contribute to the national funding. As currently proposed, this plan will be funded over the coming 15 years, particularly concentrated over the next eight years

The details of this proposed plan will implement substantial changes for many corporations across America. Additional details of the Made in America Tax Plan are:

  • Increased Corporate Tax Rate

The Made in America Tax Plan proposed an increased corporate tax rate to 28%. These rates were previously cut down to 21% in 2017 as part of the Tax Cuts and Jobs Act enacted that year. Note that these proposed rates are still lower than the rates experienced prior to their lowering in 2017.

  • Minimum Book Tax 

President Biden’s proposed updates also include the implementation of a 15% minimum book tax on firms with $100 million or more in net income. Overall, this change is targeted at corporations that have significant annual income but pay little to no taxes. 

  • Clean Energy Incentives 

President Biden’s plan mentioned both tax and non-tax incentives with relation to clean energy. While the details surrounding this aspect of his plan are still not entirely clear, it was noted that existing subsidies would be eliminated and not be expected to cause significant impacts on the price or security of energy for Americans. 

It is also mentioned that Biden’s tax plan would advance existing clean energy production by extending existing production and investment tax credits for the next 10 years. 

  • Increased IRS Enforcement

Lastly, President Biden’s proposed plan calls for a significant strengthening of IRS enforcement. He aims to reach this goal by increasing funding to IRS to increase audits of international corporations that are not meeting their tax contributions. 

In more recent news, Biden has claimed he expects that increasing IRS enforcement will bring in an additional $700 billion over the next decade. This result is expected should the administration obtain the $80 million budget from Congress.

While the administration’s proposed plans are just that, proposed, it should be noted what intended actions might mean for businesses in the near future. The likelihood that these plans will see further edits and adjustments from Congress before being approved is high. 

Operating a Law Office Under the Tax Cuts and Jobs Act of 2017

Originally published by GP Solo Magazine for the American Bar Association.

Written by Lauren Suarez and Allison D.H. Soares.

April 15 symbolizes a lot of things to various lawyers, depending on whether you are a solo practitioner, a midsize firm, a partner in a large, national firm, or merely an individual just coming out of law school trying to decide whether to incorporate and hang your own shingle. 

As we look back at the impact the previous presidential administration had on the profession of law as a whole, one of the most crucial pieces of legislation of the Trump presidency was the Tax Cuts and Jobs Act of 2017(TCJA). When the TCJA was passed, it was difficult to predict whether our businesses would suffer, stay stagnant, or prosper under the new legislation. Additionally, only a handful of the TCJA adjustments were created to be permanent past 2025. As a result, many of those adjustments are set to expire in 2025 and leave us wondering where our next tax adjustments will take us. 

The TCJA is complicated enough for those who have entered into the world of tax either through preparation or controversy. In an attempt to make this area a bit easier to digest, we have provided a brief summary of the individual and business highlights of the TCJA and a synopsis of how law firms have been impacted over the last three years.

TCJA BASICS

With the passing of the TCJA, one of the biggest and most con-fusing additions was the qualified business income (QBI) deduction and how it affects flow-through entities and their partners/shareholders. A majority of law firms are established as a flow-through entity, whether this is a limited liability partnership (LLP) or an S corporation, and the partners of the firms end up carrying the tax liability burden. 

The TCJA affected various other business aspects such as depreciation, the ability of an S corporation to convert to a C corporation, employer tax credits for paid family and medical leave, business interest expense, and limitations on losses. All of these have played out in different ways for firms and individuals over the last three years. To tackle all these adjustments would take more time than we have, but we will briefly touch on those that we feel are the most important for the law profession today.

FLOW-THROUGH LAW FIRMS 

A majority of law firms are set up as an LLP, in which the income is passed through to the individual partners of the firm. There is no tax paid at the partnership level. Each individual partner reports and pays income tax on their personal return. 

The QBI deduction was not created to act as a deduction to the gross income or a firm expense. It was created to reduce the taxable income by a maximum of 20 percent. There were limitations built into the QBI deduction based on the taxable income of the individual as well as the field in which the business is engaged. Law firms are not included in the definition of a “qualified business” and therefore do not qualify for the20 percent deduction. The practice of law falls into the category of “specified service business,” which includes professionals involved in the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. However, a loophole was created that still allows firm partners to take advantage of the 20 percent QBI deduction if they have taxable income from other sources outside their practice. The QBIdeduction has a limitation based on taxable income and filing status that creates a sliding scale of$157,500 to $207,500 for single filers and $315,000 to $415,00for joint filers. The deduction is not available if the filer exceeds the maximum taxable income threshold. 

Additionally, guaranteed part-ner payments do not qualify for the deduction as an alternative to wages related to “specified service business.” Thus, the QBI deduction ultimately makes firms review how they categorize their partner payments for the year and still keep their allocated shares. 

Here are a few examples to explain this concept. A husband and wife file a joint tax return and earn $800,000. The wife, Wendy, has worked at a law firm for years and has finally become a partner. The husband, Henry, has $100,000 of taxable income. Wendy’s portion of her law firm income (which is considered qualified business income) is$700,000. Unfortunately, Wendy and Henry are not entitled to a20 percent deduction because, as mentioned above, the practice of law is a specified service business and they earned more than$415,000.

Now consider the same facts, but with Wendy’s income reduced to $260,000; her portion of the law firm profit income is $200,000 and her W-2 wages are $60,000. (W-2 wages are the total wages paid by the firm with respect to the employment of its employees during the calendar year.) Wendy and Henry may qualify to take a 20 percent deduction because Wendy’s taxable income is below $315,000.Wendy could take a 20 percent deduction of the $200,000 of her share of the law firm income, which would be $40,000.

Where this example gets complicated is when joint filers earn and have taxable income between$315,000 and $415,000. The deduction would then be limited to the lesser of 20 percent of business income or a “W-2 limitation” based on wages or wages. One of the biggest and most confusing additions in the TCJA is the qualified business income (QBI) deduction. plus a capital element. The W-2 limitation equals the greater of 50 percent of W-2 wages paid by the business, or 25 percent of wages paid by the business plus 2.5 percent of the unadjusted basis of“qualified property.”

At the end of the day, if you are an attorney with a flow-through entity and your pass-through income is below $315,000 for joint filers and $157,500 for other filers, you may be entitled to take the full 20 percent deduction on your personal Form 1040 tax return. If your taxable income is more than $415,000 for joint filers or $207,500 for single filers, you will not be entitled to a deduction. If your taxable income is between those two thresholds amounts from $315,000/$157,500and $415,000/$207,500, you may get a partial deduction that is phased out as you reach the maximum amount.

NON-FLOW-THROUGH INCORPORATIONS

Though a majority of law firms are incorporated as flow-through entities, there are a number of individuals who decided to incorporate as a C corporation. If the firm is incorporated as a C corporation, the QBI deduction does not allow you to take advantage of the 20 percent flow-through deduction to your taxable income. C corporations are double-taxation entities; thus, there is no flow-through because there is taxation at both the entity and individual levels. However, you will have noticed a significant tax reduction on the overall net income of the business. 

Prior to the TCJA, personal service corporations were taxed at a flat 35 percent. That figure was reduced to 21 percent with the TCJA. However, a C corporation will still be subject to double-taxation, which, depending on the individual’s tax bracket, could be good or bad. Interestingly enough, due to the inability of many partners to take advantage of the QBI deduction, either due to their choice of incorporation or has phased out of the income thresholds, a large number of firms either remained as C corporations or converted from a pass-through entity in order to take advantage of having dividends taxed at 23.8 percent at the individual partner level. Although the QBI deduction was one of the largest overall changes to affect the firms and partners, all firms and partners also saw changes to their ability to take unreimbursed business expenses, meals, and entertainment.

IMPACT ON ALL BUSINESSES AND TAXPAYERS

The meals and entertainment deduction was an unexpected change in the TCJA. Prior to the TCJA, when a business had a meal or entertainment expense, the business was allowed to take50 percent of the cost as a deduction on its tax return. However, the TCJA has now disallowed all entertainment expenses and has restricted the types of meals that a business is allowed to deduct. For example, a business is no longer allowed a 100 percent deduction for meals provided on the business premises. 

The TCJA also limited the commuting and parking expenses that employers would incur on behalf of their employees. In larger cities, this is a benefit that had been offered to many employees and can be extremely expensive. However, over the years, many employers have taken this expense and moved it to an amount tied to their lease and taken it as a rental expense.

CHANGES THAT IMPACTED ALL INDIVIDUAL TAXPAYERS

There are many good changes that came from the TCJA, including lower tax brackets. For example, the tax bracket for individuals was reduced from 39.6 to37 percent. Attorneys, whether they are single, married, or head of household, can have an impact on the potential 10 percent to 12 percent reduction toward their overall tax liability because their income will be taxed at a lower rate on their individual returns. Those lower tax brackets, however, impacted other areas that traditionally lowered one’s tax liability. For example, charitable contributions were impacted because taxpayers had less of a need for itemized deductions. Taxpayers may also want to consider accelerating any potential medical procedures because the total threshold will increase to the meals and entertainment deduction was an unexpected change in the 10 percent this year. 

However, there are many items that put many taxpayers at a disadvantage. The state and local tax (SALT) deduction is one of those areas. The SALT deduction has been quite lucrative for many taxpayers throughout the years, particularly for those who live in high-tax states such as New York, New Jersey, and California. This deduction includes state and local property taxes paid, as well as either state and local income taxes or sales taxes. It also became one of the most contentious parts of the tax reform process. Many Republicans wanted to do away with the deduction entirely. But after some compromise, the SALT deduction survived. The TCJA created a $10,000 annual cap on the SALT deduction. This was a big disappointment to taxpayers in high-tax areas. For example, the average SALT deduction taken in New York was more than $21,000 in a recent tax year. Therefore, the average New York taxpayer, who historically claimed the SALT deduction, would see their deductible amount cut by more than half. The $10,000 cap is not in effect for Schedule E or C properties. Now, taxpayers need to plan at the beginning of the year for itemized deductions, considering the cap on SALT, mortgage interest, medical expenses, and charitable contributions. 

Additionally, between December 31, 2017, and January 1, 2026, business losses are also limited for non-corporate taxpayers. Taxpayers are limited to a business loss equal to the business gains plus $250,000 if single and plus $500,000 if filing jointly. If a taxpayer has losses that exceed those limitations, they will be carried forward to a subsequent tax year for use. 

Now that we are three years into the TCJA, attorneys are starting to see the results of this legislation on their personal and business taxes, and many are already aware of how their business and personal finances have been affected by the TCJA. As tax controversy attorneys, we are starting to see these issues come up during tax audits. So far, the most prominent issue that has been audited is the QBI deduction for individuals and businesses. Auditors want to confirm wages paid, the number of employees, and that the assets used to calculate the unadjusted basis of the business are all related to the necessary business operations. Some QBI deductions can be significant depending on the size of the business, and the Internal Revenue Service (IRS) is definitely going to look closer at something new and unknown. 

Deductions such as SALT, meals and entertainment, unreimbursed employee expenses, charitable contributions, and employee transportation are appearing differently in IRS audits. These transactions are typically caught by accident as an auditor reviews other income and expense items on the personal or business audit side. As the returns filed during the TCJA time period begin to come up within the audit win-dow, always keep your records on hand and have a clear delineation between business and personal income and expenses. 

As a final thought, we now have a Democratic presidential administration and a Democratic majority in Congress (at least for two years). They will likely reexamine and make substantial changes to the TCJA. The Biden administration has already made some predeterminations as to how they intend to dismantle the TCJA. Whether that comes to fruition or not remains to be seen. 

PUBLISHED IN GPSOLO, VOLUME 38, NUMBER 3, MAY/JUNE 2021 ©2021 BY THE AMERICAN BAR ASSOCIATION. REPRODUCED WITH PERMISSION. ALL RIGHTS RESERVED. THIS INFORMATION OR ANY PORTION THEREOF MAY NOT BE COPIED OR DISSEMINATED IN ANY FORM OR BY ANY MEANS OR STORED IN AN ELECTRONIC DATABASE OR RETRIEVAL SYSTEM WITHOUT THE EXPRESS WRITTEN CONSENT OF THE AMERICAN BAR ASSOCIATION

ppp fraud

2020 was a challenging year for many business owners. The ongoing global pandemic not only brought on a health crisis, but an economic crisis to match. While many companies were able to stay open because they were deemed to be essential workers, many others struggled to maintain their day-to-day operating costs on their own and turned to the government’s SBA PPP and EIDL programs for support. 

 

SBA informed lenders Tuesday, May 4th that the PPP general fund was out of money. The remaining funds ($8 billion) are set aside for community financial institutions (CFIs).  CFIs work with businesses in underserved communities. An additional $6 billion is being held in reserve for PPP applications that are still under review.

 

Between stimulus checks, PPP loans, and EIDL funds, the government was able to help many businesses and individuals hold on through these challenging times. 

 

While government support was critical to many businesses, it has recently come to light that not all recipients of the distributed PPP loans were eligible to receive such financial support. The Small Business Administration (SBA) announced that they would begin auditing loan recipients following the revelation that many recipients of PPP funds applied under false pretenses.  

 

It was initially declared that any business that received a loan of $2 million or more would be audited by SBA to confirm the correct receipt and usage of their loan. Now as we surpass a full year since the initial release of PPP funds, IRS Criminal Investigation Division says they have reviewed more than “350 cases and $440 million in tax and money laundering cases have been investigated in the last year.” As a result, they intend to continue similar audits going forward based on their findings thus far. 

 

Some instances included people attempting to take advantage of the benefits set forth by the Coronavirus Aid, Relief, and Economic Security (CARES) Act include establishing fake businesses to claim eligibility or even claiming loans for businesses that were closed years prior. 

 

For those businesses that received PPP funds but did not keep close track of the funds, those who commingled funds with operating funds and did not adequately document the ways n which those funds were used, the specter of audit may loom large.  Loans under $150K have largely been written off as forgiven.  Applicants who ask for forgiveness must keep records of the expenses paid with the PPP funds for 3 years (we suggest 5).  

 

In the event of an SBA audit, there is a very limited window in which the audited party can respond, provide paperwork and verify the correct usage of PPP funds. If you are audited by SBA, call the law offices of John Milikowsky immediately.  We have resolved over 300 cases of IRS, EDD, and other government audits and we can guide you through the rocky waters of your audit.

EDD Audits: A Cautionary Tale

No one wants to find themselves under audit. Whether from IRS, EDD CFTB, or other government agencies, audits are stressful and time-consuming. When it comes to facing an audit, how you react at the start of the audit can make all the difference.  Some business owners feel that it is an overreaction to call a lawyer, or, that that is somehow an admission of guilt. In cases of government audits, it is wise to bring in qualified counsel at the start of the audit to prevent the audit from expanding to other areas beyond the initial scope. The importance cannot be underestimated, don’t wait until your situation has gotten out of control to bring in a qualified tax attorney. 

Allow us to present two scenarios culled from multiple cases we have encountered in the case of EDD and other government audits. In our first example, the client came to us for support immediately upon receiving notice of their audit. The second example reflects a client who first brought on a criminal defense attorney without a specialty in tax audits. 

Case Study 1 (the safe route)

Our first client case study features “Ryan,” a business owner in the construction field whose company has grown quickly over a short period of time. His business was the subject of a construction site sweep resulting in an audit by the Employment Development Department (EDD).  EDD auditors arrived at Ryan’s home, called his business associates, and sent aggressive letters to his business and residence alarming him, his business partners, and his family.  Ryan researched EDD audits and saw that the vast majority of EDD audits result in fines of over $200K, a business-breaking amount for the small business he owned and operated. Ryan immediately reached out to the team at Milikowsky Tax Law through a google search for EDD audit representation

Our first step was to take a deep dive into the areas of the business that were being audited. As is often the case with the construction industry, employing 1099 contractors was at the root of the audit. Employee misclassification is routinely the cause of an EDD audit, whether from an EDD site sweep or a contractor whose services are no longer required filing for unemployment. In the latter case, that filing immediately triggers a contractor classification audit, even if the filer did so in error, unwitting of the consequences to the business. In other cases, competitors will file complaints against a business to tie them up in red tape and audit troubles (though those cases are thankfully rare). Whatever the trigger, once an audit has begun there are strict rules around when documentation must be provided. Failure to adhere to these deadlines results in forfeiture of your case and often in high monetary penalties and required business restructuring. 

Because we are highly experienced in EDD audits, the team at Milikowsky Tax Law was able to reframe Ryan’s situation to EDD. As in many cases, assumptions are made about business structures that are at times, not correct. Among other details, verification, and understanding of the unique situation of this case, we were able to correctly classify the few workers who were incorrectly classified and help Ryan stay in business.*

The second client case study we are sharing took a different route than the case mentioned above. While Ryan immediately took action to contact our team of EDD, IRS, and government audit experts, this second story client did not do the same. 

Let’s call this client, “Joe.” Joe also owns a construction company and received a letter, call and visit his workplace letting him know he was being audited not only for worker misclassification but also licensing problems.  Joe’s first response was to ask his brother-in-law what to do.  The advice he got was to contact a criminal defense attorney. While a criminal defense attorney may be a helpful resource in the event of a criminal investigation, in this case, the attorney had no experience with EDD audits. 

When this client began working with their criminal defense attorney, they were advised to reach out and speak to EDD themselves. Choosing to take this action ultimately incriminated  Joe further. Speaking with EDD as a layperson, inexperienced in the intricacies of EDD’s audit processes and procedures leaves the door open for missteps and in this case, further incrimination. 

In their direct conversations with EDD, Joe willingly provided additional documentation to EDD that opened up investigations into other areas of his business financial dealing, other groups of employees/ 1099 contractors and worsened his audit dramatically. The criminal attorney did little research into the business structure, did not interact with EDD or IRS, and, as the deadline for high fees and criminal charges approached, Joe reached out to us.  

With weeks left in the allocated time period, we did hours of research into Joe’s business setup, his contractors, the services he provides, and how his workers are classified, not only as individuals but as groups by their functions.  We build a case for some reclassification and some dismissal and spend hours of time on the phone with EDD and IRS negotiating the settlement.  With only 3 days until Joe’s high fines and possible jail time were to be inflicted, both government agencies settled.  Joe is still in business, though the fees he had to pay were higher because of the additional audits on top of the initial inquiry.   

If you have received notice of an upcoming audit of your business, contact our team of experts at Milikowsky Tax Law immediately. Working with an experienced professional that is familiar with the details of IRS, EDD, and SBA audits may ultimately be the difference between losing your business or staying in business. Call or contact us today to discuss your case and get started. At Milikowsky Tax Law, we keep businesses in business. 

*This and all case studies on the website are not promises of results.  Cases vary widely and individual situations must be looked at with the full context in order to determine the correct path forward.  Not a guarantee of results. 

Form 5472

One important aspect of being a business owner is ensuring that you keep up with changing laws and regulations that may be applicable to your business. There are consistent changes and updates being made to various legal requirements and ignoring those changes or failing to recognize them could result in negative consequences for your business. 

One ruling that business owners should be sure to maintain awareness of is the need to complete and file Form 5472. 

Who must file Form 5472? 

Form 5472 must be filed by any business owner that has a foreign owner or foreign shareholders of 25% or more of the company. Form 5472 is used by IRS to understand global transactions and transfer pricing issues between domestic and foreign-related parties. 

The requirement for eligible business owners to file this form began in 2017. It should be noted as well that this form should be filed by the corporation rather than the individual or shareholders themselves. 

What happens if I don’t file Form 5472 and am supposed to?

New laws enacted in 2017 significantly increased penalties related to not appropriately filing. Penalties include fines of between $10,000 to $25,000. These penalties may be enacted both for failure to form or filing in an incomplete manner. Penalties may also be charged for failing to maintain adequate records. 

Form 5472 Foreign Owned Company Filings

What do I need to report on Form 5472? 

All reportable transactions must be included in the submission of Form 5472. Reportable transactions are broadly defined by IRS as:

  • Any type of transaction listed in Part IV (sales, rent, etc.) for which monetary consideration was the sole consideration paid or received during the reporting corporation’s tax year
  • Any type of transaction or group of transactions listed in Part IV, if:
    • Any part of the consideration paid or received was not monetary consideration 
    • Less than full consideration was paid or received

To put this information in simpler terms, if you receive any money from, pay any money to, or pay anything on behalf of an eligible LLC, you must file For 5472. 

How do I file Form 5472? 

It should be noted that in order to file Form 5472, you must have an Employer Identification Number (EIN). Once your EIN is obtained, you can file Form 5472. Unlike many other forms, Form 5472 cannot be filed electronically. It must be filed and submitted by paper or fax. 

While IRS provides specific instructions on how to complete the filing of Form 5472, the instructions are complex and may be confusing for many. 

If you’re concerned about your Form 5472 being filed correctly, our team of experts at Milikowsky Tax Law may be able to support you. Avoid penalty charges by ensuring that your filings are completed correctly the first time. In the event that you do face penalties, we are prepared to help keep them to a minimum and make necessary adjustments. Call or contact us today to get started. 

Insights for CPAs to Minimize Audit Risk for Their Clients

Late in 2020 IRS announced that they intended to increase audits of small businesses by 50%. This news came as a shock to many small business owners who were still attempting to recover from the economic downturn brought on by the COVID-19 pandemic. While many businesses have struggled to hold on, and others closed their doors permanently there were a handful of industries whose revenues actually increased despite their early concern that they would be negatively impacted.

While IRS tax audits are daunting, there are ways to protect yourself from the negative outcomes of an audit including fees, penalties, and even jail time. 

Maintain Good Records 

Keeping good records can make the difference between being audited by IRS and coming out the other side with reduced or non-existent penalties… or not. IRS looks for businesses and individuals whose returns are inconsistent with their income and information. Incorrectly declaring your income or claiming deductions that are not applicable to your business are sure ways to have IRS take a closer look. 

Maintaining clean records facilitates fewer errors on your returns. Whether intentional or not, identifiable mistakes are a flashing red light for IRS to investigate. 

Utilizing a reputable bookkeeper or CPA can help keep your records in line to avoid errors and ensure that all legal deductions are taken.  Business owners have a wide array of totally legal deductions that can offset higher taxes, a qualified CPA can guide you to the right write-offs. Having a CPA that’s already familiar with your business can be an augmentation to your current strategy in the event that your business is audited by IRS. CPAs and tax attorneys create a partnership that will provide significant benefits to business owners in the case of a tax audit. 

Make sure you’re claiming proper deductions 

Taking advantage of as many deductions as possible is well within the legal scope for businesses. Be sure that you make use of any opportunities to save money by working with your CPA to help them understand your business structure, acquisitions outside of regular business dealings, any employee benefits changes you have made, and more. 

IRS attempts to identify taxpayers who have made incorrect claims or deductions and often chooses to audit those returns. In the event that a business or individual has claimed deductions that they are not eligible for, they may have done so repeatedly and over a prolonged period of time. In these cases, other discrepancies can be uncovered during the audit process, increasing the liability of the business owner being audited. 

Make timely payments 

Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.

Corporations generally have to make estimated tax payments if they expect to owe a tax of $500 or more when their return is filed.

When estimated your expected tax payment, IRS suggests using Form 1040-ES to correctly figure your estimated tax. It may be helpful to utilize income, deductions, and credits for the prior year as a starting point when estimating your expected tax payment. 

Estimated taxes are due on a quarterly basis. If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax.  

Why IRS is Planning to Audit More Small Businesses This Year

Make sure to correctly classify any independent contractors

While employing independent contractors may be critical to the success of your business model, you should be very careful in doing so. IRS uses specific rulings to determine whether a worker should be classified as an employee or an independent contractor. 

If it is found that you may have incorrectly classified your workers as independent contractors, the Employment Development Department (EDD) will likely partner with IRS to perform an audit. 

Some triggers that might lead to an audit of this nature include an independent contractor applying for unemployment, for which they are ineligible, or having a significantly higher number of independent contractors than full-time employees. In some cases, businesses may utilize this as a tactic to avoid paying additional taxes. 

The consequences of an underpayment or misclassification will depend on whether the auditor finds the discrepancies to have occurred intentionally or unintentionally.

Unintentional misclassifications may result in a $50 penalty for each W-2 form that was not filed for an employer classified as a contractor. The employer also faces penalties of 1.5% of employee wages to compensate for income tax withholding, 40% of employee payroll taxes, 100% of matching employer payroll taxes plus interest on each of these penalties, and a Failure to Pay Taxes penalty of 0.5% of the unpaid tax liability for each month delinquent.

Intentional and fraudulent misclassifications may result in additional penalties, such as 20% of all wages paid and 100% of payroll taxes — employer and employee share-alike. Criminal penalties, including a $1,000 fine per misclassified worker and up to one year in prison, may also be imposed. California employers can see total fines of up to $25,000 per misclassification violation.

If you are a small business and have recently prepared your annual tax return, you may be at risk of an upcoming audit. In the event that you receive an audit notification from IRS, you should reach out to an experienced tax attorney immediately. Our team of tax professionals at Milikowsky Tax Law has significant experience defending businesses in tax audits. We help keep businesses in business. Contact us today to get started. 

Insights for CPAs to Minimize Audit Risk for Their Clients

If you are a CPA, here are 4 things to help your client reduce the risk of an EDD, IRS, or SBA audit:

1. Confirm that your client’s 1099-K (provided by a merchant processor) does not report gross proceeds from credit card sales that are higher than the amount you are reporting as “gross receipts” on a business income tax return. 

If there is a difference, you may consider adding a statement to explain a legitimate difference. For instance, chargebacks and returns are not subtracted from the amount of “gross proceeds” on the 1099-K form.

2. If you have a client who has more 1099 contractors than employees, have your client provide facts to support these workers have a legitimate and independent business i.e. EIN, business entity, website – something to establish a legit business. 

EDD and IRS typically look under one the following expense categories for contractors to identify contractors that paid by a business: 

  • Schedule C: “commissions and fees”; “contract labor”; or “Legal and professional”; 
  • 1120S (S corp) and 1065 (LLC): typically find these are reported under COGS or under “other deductions” with a label such as “outside services” or “contractors.”

If you prepare a business return where the business has, for instance, 10 independent contractors and only 2 employees (i.e. where the business owners are also officers of the corporation), you should spend time with the company’s management team to analyze whether the 1099 contractors are legitimate under your state’s law and federal law. 

California recently passed a new law called AB5 (effective as of 1/1/2020) that changes the analysis of a worker’s status. AB5 now has a 3-part test that is more difficult for companies to satisfy. 

You will want to review your client’s general ledger and confirm they are properly reporting ALL 1099s. You should confirm that every independent contractor who provides services (over $600) receives a 1099. If one is missed, the Employment Development Department (EDD) may extend a 3-year audit to 8 years and assess an additional penalty, where the penalty may be higher than the tax.

When reviewing the general ledger, confirm the payees are truly contractors and not workers that should be reported as employees.

Insights for CPAs to Minimize Audit Risk for Their Clients

3. If your client is selling a business, the buyer will require the current owner to produce a “tax clearance certificate” from the California Department of Tax and Fee Administration (CDTFA), the agency responsible for collecting and regulating sales tax in California.

We have had numerous audits that commenced during escrow, possibly a result of the Tax Clearance Certificate application that was filed with the tax agency. So, you may want to review your client’s general ledger and confirm that the amount of sales tax reported and paid to the state is accurate and the proper correct sales tax rate was used (that includes both local and city tax), as well as confirming that exempt sales are truly exempt.

4. If your client applied for a PPP loan, and receives a request for information and documents from their bank to substantiate their financials, consider calling a tax attorney to review SBA’s regulations and any questions from the bank. 

The Small Business Administration (SBA) is currently investigating all SBA Payment Protection Program (PPP) loans, regardless of the dollar amount of the loan.

Based on information obtained from SBA, once a request has been made for additional documents following the funding of the loan, there is an active investigation. The response from you, the CPA, and your client will affect whether the case is referred to for potential criminal investigation. This would be the case when the information simply does not support the financials or the requirements of the PPP loan.

Issues that have come up in some of our cases include: 

  • Not having a legitimate work visa
  • Using PPP funds obtained by one company that another company applied for and obtained through SBA

There are significant benefits to a CPA working with our firm. Some include the following: 

  • Our law firm does NOT prepare tax returns. We work with CPAs referring clients to those who need a business/personal tax return.
  • We typically have joint representation during an EDD or IRS audit.
  • We also handle criminal tax investigations to protect you and your client because your communications with an IRS Criminal Investigator are NOT protected by any privilege. However, having an attorney represent your client will ensure the communication and evidence your client provides are protected.

For more information or to get started working with us, contact us today. 

How Taking Advantage of the Tax Deadline Extension May Benefit You

As a result of the ongoing global pandemic, IRS has elected to extend the 2020 tax submission deadline to May 17, 2021. Following last year’s deadline extension to July 15, it was predicted early on that this would likely be the case. 

As the original deadline has recently passed and the extended deadline draws near, taxpayers are once again in a position to ensure that their information is submitted correctly in a timely manner to avoid the possibility of an IRS tax audit. 

The financial challenges imposed upon many businesses and individuals in the past year + make the possibility of being faced with an audit more intimidating. Many business owners have undergone financial difficulties and are relying on government funding, such as PPP loans or EIDL funding, to stay afloat. That being said, it has come to light that not all government support was claimed with integrity, resulting in an increased rate of audits and in-depth reviews. 

What does the delay in the deadline mean for taxpayers preparing their taxes by the upcoming deadline? 

Is it worthwhile to take advantage of the deadline extension? What are the benefits of doing so? 

Despite the fact that tax day rolls around at the same time every year, many people still leave their filings until the last minute. Last-minute filing can lead to reporting that is rushed, and potentially incorrect as a result. In the event that your taxes are filed incorrectly, you’re likely an easy target for an IRS audit. 

If taking advantage of the extended deadline is the difference between taking the time to review your records to ensure proper filings or potentially filing mistake-riddled taxes, you’re certainly better or taking the extra month to do so. 

Even in a normal year, any taxpayer is eligible for an extension for their tax filings. “Filing Form 4868 gives taxpayers until October 15 to file their 2020 tax return but does not grant an extension of time to pay taxes due.” While Form 4868 allows taxpayers an extension to file, they are still responsible for paying their federal income tax by the original required date, in this year’s case, May 17, 2021. 

When there is an identified issue with your submitted return, it is advisable to complete an amended return. While best practice is to complete your tax return correctly the first time, amendments are available in the event that you or your CPA recognize an issue that was submitted with your return. 

While an amendment might not be ideal to have to prepare and submit, if you know there’s an issue, you’re better off pointing it out before IRS uncovers it. If IRS finds a mistake before you do, you run the risk of an audit. 

Taking the additional time to do things such as consulting a CPA or lawyer, reviewing records and reporting, and verifying that your submission is complete and accurate before submitting. 

Paycheck Protection Program (PPP) funds from SBA, EIDL loans, Employee Retention Credits, and certain debt relief programs have added a level of complexity and challenge for business taxpayers. If you feel that taking advantage of the deadline extension will make a difference in the integrity and correctness of your return, it is worth your while to take the time granted to review the tax options your company has with your CPA and bookkeepers to ensure correct filings. 

If you have been contacted by IRS notifying you of an upcoming audit, reach out to our team of legal professionals for support. We have over 300 cases defending clients in tax audits. For more information, contact Milikowsky Tax Law today. 

What to do If Your Tax Return is Flagged by IRS

Tax season brings on additional stress for many. First, the hurry to get your information prepared and submitted for review by IRS. Then follows the thoughts of whether or not your information was submitted correctly or whether you’ll be faced with an audit. 

Ideally, your taxes will be submitted correctly the first time. That being said, if you recognize an error in your return, you should attempt to submit an amended return as soon as possible. While it’s best to fix any mistakes yourself before IRS discovers them, you still may not be 100% safe from a potential audit. 

While there are multiple various aspects of your return that may trigger an audit, there’s also always a possibility that you may be selected at random for review by IRS as well. Regardless of how careful and precise you are in your tax submissions, no one is ever fully exempt from the threat of an audit. 

What happens if my tax return is flagged by IRS? 

There are multiple types of IRS notices that you may receive. Some may simply be sent to request further information or ask for clarification on an aspect of your return. That being said, some IRS notices will alert you of an upcoming audit. 

Your best bet when you receive a notice from IRS is to be prepared for the worst-case scenario. Should you or your business receive notice of IRS’s intent to conduct an audit, you should not initially panic. It’s important that you reach out to appropriate resources as quickly as possible to give them the opportunity to build a case to support you. 

While your CPA is an excellent partner to organize, prepare, and submit your tax return, in the event of a tax audit you may want to solicit additional support. CPAs are tax experts within their field but that does not directly include defending clients against IRS or EDD audits. In this case, a tax attorney may be a suitable addition to your partnership. 

The addition of a tax attorney to your team does not serve to replace the role of your CPA. Rather together, they form a stronger team to represent and protect you in the event of an audit. 

That being said, should you receive notice of an upcoming audit, consulting with your CPA and hiring a tax attorney should be your immediate first response. 

While the receipt of an IRS notice may not have significant effects on you or your business, your safest response is to prepare. In the case of an IRS notice, this likely means reaching out to an experienced tax attorney. Our team of legal experts at Milikowksy Tax Law has significant experience in successfully defending our clients against audits from IRS. To learn more about how we can partner with your existing tax team to support your needs, call or reach out today!