Author Archive: CCG

Is your business vulnerable to identity theft?

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According to data company Dun & Bradstreet, business identity theft increased more than 250% in the first half of 2020. You can thank the pandemic — and the government’s release of relief and recovery funds to qualified U.S. businesses — for this remarkable number. In a more typical year, crooks use stolen business identities to file fraudulent tax returns, apply for credit and empty bank accounts. However they might try to use your company’s information, there are steps you can take to reduce the risk.

Protecting sensitive information

Thieves often use malware to infect computers and gather sensitive data from businesses. They also create fake websites that trick employees into entering login and password information. To protect against these tactics, deploy patches when prompted and maintain up-to-date security software. Store all sensitive digital files such as financial statements, invoices, bank statements and aging schedules in secure, password-protected locations.

Also, secure paper documents in locked file cabinets. When you no longer need sensitive paper documents, destroy them using a cross-cutting shredder. If you need to shred a significant volume of paper, hire a reputable service to destroy documents on your premises.

Regularly review records

So that you can act on suspicious activity before it leads to financial losses and reputation damage, monitor official records and other public information. For example, keep an eye on your business credit as well as the personal credit reports of owners. Also regularly review business records and professional license information with state, county and city registrar offices.

Bank accounts deserve special attention. Reconciling bank accounts daily is your best bet. If a fraudulent transaction posts to your business’s account, you must notify your bank within a certain time period to not be liable for the transaction. Also note that criminals often use wires to move stolen money overseas and beyond the reaches of U.S. law enforcement. If you never send wires, instruct your bank to block that capability from your accounts.

Don’t forget employees

Finally, don’t forget to involve employees in your fight against business identity theft. Coach everyone from executives to rank-and-file workers about the threats facing your company and how they can do their part to ensure sensitive data doesn’t fall into the wrong hands. Contact us for help strengthening your internal controls.

© 2020 Covenant CPA

Taking distributions from a traditional IRA

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Although planning is needed to help build the biggest possible nest egg in your traditional IRA (including a SEP-IRA and SIMPLE-IRA), it’s even more critical that you plan for withdrawals from these tax-deferred retirement vehicles. There are three areas where knowing the fine points of the IRA distribution rules can make a big difference in how much you and your family will keep after taxes:

Early distributions. What if you need to take money out of a traditional IRA before age 59½? For example, you may need money to pay your child’s education expenses, make a down payment on a new home or meet necessary living expenses if you retire early. In these cases, any distribution to you will be fully taxable (unless nondeductible contributions were made, in which case part of each payout will be tax-free). In addition, distributions before age 59½ may also be subject to a 10% penalty tax. However, there are several ways that the penalty tax (but not the regular income tax) can be avoided, including a method that’s tailor-made for individuals who retire early and need to draw cash from their traditional IRAs to supplement other income.

Naming beneficiaries. The decision concerning who you want to designate as the beneficiary of your traditional IRA is critically important. This decision affects the minimum amounts you must generally withdraw from the IRA when you reach age 72, who will get what remains in the account at your death, and how that IRA balance can be paid out. What’s more, a periodic review of the individual(s) you’ve named as IRA beneficiaries is vital. This helps assure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs, as well as in your personal, financial and family situation.

Required minimum distributions (RMDs). Once you attain age 72, distributions from your traditional IRAs must begin. If you don’t withdraw the minimum amount each year, you may have to pay a 50% penalty tax on what should have been paid out — but wasn’t. However, for 2020, the CARES Act suspended the RMD rules — including those for inherited accounts — so you don’t have to take distributions this year if you don’t want to. Beginning in 2021, the RMD rules will kick back in unless Congress takes further action. In planning for required distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries.

Traditional versus Roth

It may seem easier to put money into a traditional IRA than to take it out. This is one area where guidance is essential, and we can assist you and your family. Contact us to conduct a review of your traditional IRAs and to analyze other aspects of your retirement planning. We can also discuss whether you can benefit from a Roth IRA, which operate under a different set of rules than traditional IRAs.

© 2020 Covenant CPA

Do you want to withdraw cash from your closely held corporation at a low tax cost?

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Owners of closely held corporations are often interested in easily withdrawing money from their businesses at the lowest possible tax cost. The simplest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient, since it’s taxable to you to the extent of your corporation’s “earnings and profits.” And it’s not deductible by the corporation.

Other strategies

Fortunately, there are several alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five strategies to consider:

  • Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make future cash contributions to the corporation, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.
  • Compensation. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient(s). This same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In both cases, the compensation amount must be reasonable in terms of the services rendered or the value of the property provided. If it’s considered excessive, the excess will be a nondeductible corporate distribution.
  • Loans. You can withdraw cash tax free from the corporation by borrowing money from it. However, to prevent having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or note. It should also be made on terms that are comparable to those in which an unrelated third party would lend money to you, including a provision for interest and principal. Also, consider what the corporation’s receipt of interest income will mean.
  • Fringe benefits. You may want to obtain the equivalent of a cash withdrawal in fringe benefits, which aren’t taxable to you and are deductible by the corporation. Examples include life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other corporation employees. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.
  • Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50%-owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50%-owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those in which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.

Minimize taxes

If you’re interested in discussing any of these ideas, contact us. We can help you get the most out of your corporation at the lowest tax cost.

© 2020 Covenant CPA

Estate planning and your art collection

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If you’re an art collector, it’s critical for your estate plan to address your collection separately from other types of assets. Investments in artwork may be motivated in part by potential financial gain, but for most collectors the primary motivation is a passion for the art itself.

As a result, managing these assets involves issues that aren’t presented by purely financial assets. Naturally, you’ll want to preserve the value of your collection and avoid unnecessary taxes, but you’ll also be keenly interested in how your collection will be managed and displayed after you’re gone.

Know the collection’s value

It’s vital to have your collection appraised by a professional at least every three years, if not annually. Regular appraisals give you an idea of how the collection is growing in value and help you anticipate tax consequences down the road. Also, most art donations, gifts or bequests require a “qualified appraisal” by a “qualified appraiser” for tax purposes.

It’s also important to catalog and photograph your collection and gather all appraisals, bills of sale, insurance policies and other provenance documents. These items will be necessary for the recipient or recipients to carry out your wishes.

Review your options

Generally, there are three options for handling your art collection in your estate plan: Sell it, bequeath it to your loved ones, or donate it to a museum or charity.

If you opt to sell, keep in mind that capital gains on artwork and other “collectibles” are currently taxed at a top rate of 28%, compared to a top rate of 20% for most other types of assets. Rather than selling the collection during your lifetime, it may be preferable to include it in your estate to potentially take advantage of the stepped-up basis, which allows your heirs to reduce or even eliminate the 28% tax.

If you prefer to keep your collection in the family, you may opt to leave it to your heirs. You could make specific bequests of individual artworks to various family members, but there are no guarantees that the recipients will keep the pieces and treat them properly. A better approach may be to leave the collection to a trust or other entity — with detailed instructions on its care and handling — and appoint a qualified trustee or manager to oversee maintenance and display of the collection and make sale and purchasing decisions.

Donating your collection can be an effective way to avoid capital gains and estate taxes and to ensure that your collection becomes part of your legacy. It also entitles you or your estate to claim a charitable tax deduction.

Before bequeathing your collection to loved ones or donating it to charity, discuss your plans with the intended recipients. If your family isn’t interested in receiving or managing your collection or if your charitable beneficiary has no use for it, it’s best to learn of this during your lifetime so you have an opportunity to make alternative arrangements. Contact us with questions.

© 2020 Covenant CPA

Should you go phishing with your employees?

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Every business owner is aware of the threat posed by cybercriminals. If a hacker were to gain access to the sensitive data about your business, customers or employees, the damage to your reputation and profitability could be severe.

You’re also probably aware of the specific danger of “phishing.” This is when a fraudster sends a phony communication (usually an email, but sometimes a text or instant message) that appears to be from a reputable source. The criminal’s objective is either to get recipients to reveal sensitive personal or company information or to click on a link exposing their computers to malicious software.

It’s a terrible thing to do, of course. Maybe you should give it a try.

An upfront investment

That’s right, many businesses are intentionally sending fake emails to their employees to determine how many recipients will fall for the scams and how much risk the companies face. These “phishing simulations” can be revealing and helpful, but they’re also fraught with hazards both financial and ethical.

On the financial side, a phishing simulation generally calls for an investment in software designed to create and distribute “realistic” phishing emails and then gather risk-assessment data. There are free, open-source platforms you might try. But their functionality is limited, and you’ll have to install and use them yourself without external tech support.

Commercially available phishing simulators are rich in features. Many come with educational tools so you can not only determine whether employees will fall for phishing scams, but also teach them how to avoid doing so. Developers typically offer installation assistance and ongoing support as well.

However, you’ll need to establish a budget and shop carefully. You must then regularly use the software as part of your company’s wider IT security measures to get an adequate return on investment.

Ethical quandaries

As mentioned, phishing simulations present ethical risks. Some might say that the very act of sending a deceptive email to employees is a betrayal of trust. What’s worse, if the simulated phishing message exploits particularly sensitive fears, you could incur a backlash from both employees and the public at large.

A major media company recently learned this the hard way when it tried to lure employees to respond to a phishing simulation email with promises of cash bonuses to those who remained on staff following layoffs related to the COVID-19 pandemic. Users who “clicked through” were met with a shaming message that they’d just failed a cybersecurity test. Angry employees took to social media, the story spread and the company’s reputation as an employer took a major hit.

Plan carefully

Adding phishing simulations to your cybersecurity arsenal may be a good idea. Just bear in mind that these aren’t a “one and done” type of activity. Simulations must be part of a well-planned, long-term and broadly executed effort that seeks to empathetically educate users, not alienate them. Contact us to discuss ways to prudently handle IT costs.

© 2020 Covenant CPA

Disability income: How is it taxed?

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Many Americans receive disability income. You may wonder if — and how — it’s taxed. As is often the case with tax questions, the answer is … it depends.

The key factor is who paid for the benefit. If the income is paid directly to you by your employer, it’s taxable to you as ordinary salary would be. (Taxable benefits are also subject to federal income tax withholding, although depending on the employer’s disability plan, in some cases aren’t subject to the Social Security tax.)

Frequently, the payments aren’t made by the employer but by an insurance company under a policy providing disability coverage or, under an arrangement having the effect of accident or health insurance. If this is the case, the tax treatment depends on who paid for the coverage. If your employer paid for it, then the income is taxed to you just as if paid directly to you by the employer. On the other hand, if it’s a policy you paid for, the payments you receive under it aren’t taxable.

Even if your employer arranges for the coverage, (in other words, it’s a policy made available to you at work), the benefits aren’t taxed to you if you pay the premiums. For these purposes, if the premiums are paid by the employer but the amount paid is included as part of your taxable income from work, the premiums are treated as paid by you.

A couple of examples

Let’s say your salary is $1,000 a week ($52,000 a year). Additionally, under a disability insurance arrangement made available to you by your employer, $10 a week ($520 for the year) is paid on your behalf by your employer to an insurance company. You include $52,520 in income as your wages for the year: the $52,000 paid to you plus the $520 in disability insurance premiums. In this case, the insurance is treated as paid for by you. If you become disabled and receive benefits, they aren’t taxable income to you.

Now, let’s look at an example with the same facts as above. Except in this case, you include only $52,000 in income as your wages for the year because the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, the insurance is treated as paid for by your employer. If you become disabled and receive benefits, they are taxable income to you.

Note: There are special rules in the case of a permanent loss (or loss of the use) of a part or function of the body, or a permanent disfigurement.

Social Security benefits 

This discussion doesn’t cover the tax treatment of Social Security disability benefits. These benefits may be taxed to you under different rules.

How much coverage is needed? 

In deciding how much disability coverage you need to protect yourself and your family, take the tax treatment into consideration. If you’re buying the policy yourself, you only have to replace your after tax, “take-home” income because your benefits won’t be taxed. On the other hand, if your employer pays for the benefit, you’ll lose a percentage to taxes. If your current coverage is insufficient, you may wish to supplement an employer benefit with a policy you take out.

Contact us if you’d like to discuss this in more detail.

© 2020 Covenant CPA

Controls are ineffective when managers go rogue

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Management overrides of internal controls can make your company more vulnerable to fraud. This is true even when managers have innocent intentions — for example, they don’t feel they have time to follow proper accounts payable procedures because a vendor is requesting immediate payment. Your company is at even higher risk of fraud losses if a senior manager intentionally ignores the rules to manipulate financial statements.

Warning signs

Management overrides of financial controls can be difficult to detect. However, there are several warning signs that a manager isn’t fully adhering to the policies and procedures your organization has adopted. For instance, a manager may fail to call attention to business risks or dispute an auditor’s findings regarding his or her department. A senior manager may be unwilling to discuss issues that could require financial adjustments or insist on releasing overly optimistic reports on current or future performance.

Such behavior doesn’t prove that fraud is occurring. However, it suggests that you need to improve or open new paths of communication and consider retraining managers on the importance of internal controls. If you do suspect fraud, you must be willing to investigate — regardless of whom it might implicate.

Encouraging honesty

To prevent management overrides, build a culture that encourages honesty and supports employees who speak up when they suspect something’s wrong. Think about whether your managers experience pressure that unwittingly encourages fraud. For example, if your industry has seen increased business failures, some employees may think they need to keep profits at specified levels. They might also feel stressed if their compensation depends on achieving stretch goals for cash flow or operating results.

Employees a level or two below senior managers are most likely to observe management overrides. Give them access to a confidential hotline and they’re more likely to report fraud before it seriously harms your business. And if you extend your hotline to vendors and customers, you’ll increase your chances for learning of improprieties early.

A difficult year

This year has been challenging for businesses of every size and in every sector. With many employees working from home and some companies downsizing, managers may be tempted to take short cuts they wouldn’t under ordinary circumstances. Or worse, managers with access to financial statements may feel pressure to fudge numbers to improve your company’s public profile or boost their own compensation. We can help identify flaws in your fraud-prevention program and design policies that even those bent on fraud will have trouble overriding.

© 2020 Covenant CPA

Tax responsibilities if your business is closing amid the pandemic

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Unfortunately, the COVID-19 pandemic has forced many businesses to shut down. If this is your situation, we’re here to assist you in any way we can, including taking care of the various tax obligations that must be met.

Of course, a business must file a final income tax return and some other related forms for the year it closes. The type of return to be filed depends on the type of business you have. Here’s a rundown of the basic requirements.

Sole Proprietorships. You’ll need to file the usual Schedule C, “Profit or Loss from Business,” with your individual return for the year you close the business. You may also need to report self-employment tax. 

Partnerships. A partnership must file Form 1065, “U.S. Return of Partnership Income,” for the year it closes. You also must report capital gains and losses on Schedule D. Indicate that this is the final return and do the same on Schedules K-1, “Partner’s Share of Income, Deductions, Credits, Etc.”

All Corporations. Form 966, “Corporate Dissolution or Liquidation,” must be filed if you adopt a resolution or plan to dissolve a corporation or liquidate any of its stock.

C Corporations. File Form 1120, “U.S. Corporate Income Tax Return,” for the year you close. Report capital gains and losses on Schedule D. Indicate this is the final return.

S Corporations. File Form 1120-S, “U.S. Income Tax Return for an S Corporation” for the year of closing. Report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.

All Businesses. Other forms may need to be filed to report sales of business property and asset acquisitions if you sell your business.

Employees and contract workers

If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income, Social Security and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.

If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”

Other tax issues

If your business has a retirement plan for employees, you’ll want to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met by a terminating plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for your employees.

We can assist you with many other complicated tax issues related to closing your business, including Paycheck Protection Plan (PPP) loans, the COVID-19 employee retention tax credit, employment tax deferral, debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.

We can advise you on the length of time you need to keep business records. You also must cancel your Employer Identification Number (EIN) and close your IRS business account.

If your business is unable to pay all the taxes it owes, we can explain the available payment options to you. Contact us to discuss these issues and get answers to any questions.

© 2020 Covenant CPA

Don’t forget about making a portability election

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Portability allows a surviving spouse to apply a deceased spouse’s unused federal gift and estate tax exemption amount toward his or her own transfers during life or at death. For 2020, the exemption amount is $11.58 million, and the IRS just announced that that amount will increase to $11.7 million for 2021.

To secure these benefits, however, the deceased spouse’s executor must have made a portability election on a timely filed estate tax return. The return is due nine months after death, with a six-month extension option. Unfortunately, estates that aren’t otherwise required to file a return (because they don’t meet the filing threshold) often miss the deadline.

Qualifying for an automatic extension

In 2017, the IRS made it easier for estates to obtain an extension of time to file a portability election. For all deaths after 2010, the IRS grants an automatic extension, provided:

  • The deceased was a U.S. citizen or resident,
  • The executor wasn’t otherwise required to file an estate tax return and didn’t file one by the deadline,
  • The executor files a complete and properly prepared estate tax return on Form 706 within two years of the date of death, and
  • The following language appears at the top of the return: “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER §2010(c)(5)(A).”

Other considerations

Bear in mind that portability isn’t always the best option. All relevant factors should be considered, including nontax reasons that might affect the distribution of assets under a will or living trust. For instance, a person may want to divide assets in other ways if matters are complicated by a divorce, a second marriage or unusual circumstances.

Also, absent further legislation, the federal gift and estate tax exemption is slated to revert to pre-2018 levels after 2025. Portability continues, though, for those whose estates will no longer be fully sheltered, so additional planning should be considered.

Don’t miss the deadline

If your spouse predeceases you and you’d benefit from portability, be sure that your spouse’s estate files a portability election by the applicable deadline. Contact us with any questions you have regarding portability.

© 2020 Covenant CPA

Now more than ever, carefully track payroll records

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The subject of payroll has been top-of-mind for business owners this year. The COVID-19 pandemic triggered economic changes that caused considerable fluctuations in the size of many companies’ workforces. Employees have been laid off, furloughed and, in some cases, rehired. There has also been crisis relief for eligible businesses in the form of the Paycheck Protection Program and the payroll tax credit.

Payroll recordkeeping was important in the “old normal,” but it’s even more important now as businesses continue to navigate their way through a slowly recovering economy and ongoing public health crisis.

Four years

Most employers must withhold federal income, Social Security and Medicare taxes from their employees’ paychecks. As such, you must keep records relating to these taxes for at least four years after the due date of an employee’s personal income tax return (generally, April 15) for the year in which the payment was made. This is often referred to as the “records-in-general rule.”

These records include your Employer Identification Number, as well as your employees’ names, addresses, occupations and Social Security numbers. You should also keep for four years the total amounts and dates of payments of compensation and amounts withheld for taxes or otherwise — including reported tips and the fair market value of noncash payments.

In addition, track and retain the compensation amounts subject to withholding for federal income, Social Security and Medicare taxes, as well as the corresponding amounts withheld for each tax (and the date withheld if withholding occurred on a day different from the payment date). Where applicable, note the reason(s) why total compensation and taxable amount for each tax rate are different.

So much more

A variety of other data and documents fall under the records-in-general rule. Examples include:

  • The pay period covered by each payment of compensation,
  • Forms W-4, “Employee’s Withholding Allowance Certificate,” and
  • Each employee’s beginning and ending dates of employment.

If your business involves customer tipping, you should retain statements provided by employees reporting tips received. Also carefully track fringe benefits provided to employees, including any required substantiation. Retain evidence of adjustments or settlements of taxes and amounts and dates of tax deposits.

Follow the records-in-general rule, too, for records relating to wage continuation payments made to employees by the employer or third party under an accident or health plan. Documentation should include the beginning and ending dates of the period of absence, and the amount and weekly rate of each payment (including payments made by third parties).

Last, keep copies of each employee’s Form W-4S, “Request for Federal Income Tax Withholding From Sick Pay,” and, where applicable, copies of Form 8922, “Third-Party Sick Pay Recap.”

Valuable information

Proper and comprehensive payroll recordkeeping has become even more critical — and potentially more complex — this year. Our firm can help review your processes in this area and identify improvements that will enable you to avoid compliance problems and make better use of this valuable information.

© 2020 Covenant CPA