Preparing for a Disaster

Planning ahead to prevent the loss of important financial information is critical to reducing the cost and time needed to recover from a disaster.  A disaster can be large or small and can be natural or man-made.  Examples include an earthquake, fire, flood, computer hacking, accidental deletion, and identity theft.  In addition to planning for your business, be sure to also include your personal finances and digital libraries.  Good practices and safeguards I recommend include:

• Offsite computer file back-up.  For home computer backup, consider an online service such as Mozy.com that automatically backs up your data several times a day.
• Computer firewall, anti-virus, and anti-spyware programs that are kept current with at least weekly scans.
• Email spam and phishing filters.  Also, be sure never to click on suspicious file attachments, even if the email is sent by someone you know.  I will occasionally receive dangerous email attachments from friends who have had their email address book hacked.
• Use a login password to access your computer with a screen-saver that will re-lock your computer after a period of inaction, such as 10 minutes.
• Do not let the internet browser save your usernames and passwords associated with your financial accounts.  Keep your usernames and passwords private.  Use the "InPrivate Browsing" feature when using public-access computers, and then be sure to completely logout of the site and clear the browsing history.
• Use paperless statements and automatic bill paying services.  This eliminates private information from sitting in your mail box and paper statements from being accessible at home.  Shred old records and scan those that you wish to keep.
• Don't give out personal or financial information over the phone or email unless you initiated the contact or know who you dealing with.  Remember the IRS and your financial institutions won't contact you for such information.  They already have it!
• Make a video recording of your home, your valuables and business equipment for insurance purposes.
• Plan for how you will contact your customers, employees and family members, and where you will meet.
• Have available 72-hour emergency kits with some food, water, lighting, shelter, and medical supplies.
• Learn how to perform CPR and to handle minor medical emergencies.

Several good resources are available with information to help you take action to prepare for disasters.

• Federal Trade Commission Identity Theft Site:  http://www.ftc.gov/bcp/edu/microsites/idtheft//
• Utah Government Identity Theft Reporting Information System (IRIS):  http://www.idtheft.utah.gov/
• Internal Revenue Service:  http://www.irs.gov/businesses/small/article/0,,id=180547,00.html
• Be Ready Utah:  http://bereadyutah.gov/
• U.S. Homeland Security:  http://www.dhs.gov/index.shtm
• American Red Cross:  http://www.redcross.org/
• Small Business Administration:  http://www.sba.gov/services/disasterassistance/disasterpreparedness/index.html

Consider Paying Corporate Dividends Before 2011

Dividends paid by C corporations are taxable to shareholders and are not deductible to corporations.  This is the classic "double tax" treatment of C corporation profits.  For this reason most privately-owned C corporations do not pay dividends.  Dividends are ordinary taxable income, but since the Bush tax cuts of 2003, the maximum qualified dividend tax rate has been 15%, equal to that of long-term capital gains.  The Bush tax cuts expire at the end of 2010.  If Congressional action is not taken, the maximum dividend tax rate would increase to 39.6% for dividends received after 2010.  Pres. Obama has proposed that the maximum dividend tax rate not exceed 20%.  The post-2010 tax rate is hard to predict given the dysfunction of our national leaders.  Furthermore, the so-called health care reform law will add an additional 3.8% Medicare tax to dividend income beginning in 2013, for individuals having modified adjusted gross income of $200,000 or more ($250,000 for joint filers).  Given the higher, possibly dramatically higher, dividend tax rates in the near future, should your corporation pay dividends before 2011?

There are several specific circumstances where paying a dividend could make sense.  Additional financial and tax analysis is necessary to determine whether the ideas below are proper for your circumstances.

1. The C corporation has accumulated excess funds that are not needed for business purposes.  An accumulated earnings penalty tax of could be imposed by the IRS on the corporation.  The penalty tax rate is equal to the maximum dividend tax rate.  Paying a dividend of the excess accumulation avoids the risk of the penalty tax.
2. The C corporation has sold assets and has retained the after-tax sale proceeds to invest.  If the investments produce interest, dividends, royalties, rents, and annuity income, and such income equals 60% or more of the adjusted ordinary gross income of the corporation, then the corporation must pay the personal holding company penalty tax.  The penalty tax rate is equal to the maximum dividend tax rate.  Distributing the investments in liquidation of the corporation eliminates the annual problem of the personal holding company tax.  Note, however, that the corporation could recognize a taxable gain on the dividend distribution if the investments have appreciated in value.
3. The S corporation was previously a C corporation having accumulated earnings and profits.  If the S corporation earns passive investment income in excess of 25% of gross receipts, then a penalty tax applies.  Furthermore, the S election is lost after three consecutive years of excess passive income.  Passive investment income includes interest, dividends, royalties, rents, and annuity income.  The penalty tax is equal to the maximum C corporation tax rate, currently 35%.  A special election is available to distribute the accumulated C corporation earnings as profits as a taxable dividend.  The election and distribution will purge the S corporation of the problem of accumulated C corporation earnings and profits and enable the S corporation to avoid the penalty tax and potential loss of the S election.
4. The C corporation has strong cash flow, low debt, and currently pays dividends.  A special dividend that is financed with debt could be paid in 2010 in order to capture the lower tax rates.  The special dividend is in essence a prepayment of future dividends.

Overview of the Small Business Jobs Act of 2010

The Small Business Jobs Act of 2010 (the "Act") was signed by Pres. Obama on September 27, 2010.  The name of the Act is somewhat of a misnomer in that there are tax provisions that apply to large companies and also tax provisions that apply to individuals.  The Act provides $12 billion of tax incentives that are paid with $12 billion of accelerated tax collections and penalty increases.  Some of the important tax provisions are generally described below.  As always, the devil is in the details.

1. The 50% bonus depreciation for the purchase of new business equipment that expired at the end of 2009 is retroactively extended until the end of 2010
2. The Section 179 expensing election for the purchase of new or used business equipment is modified for tax years beginning in 2010 and 2011:
   >  The maximum deduction is increased from $250,000 in 2010 and from $25,000 in 2011 to $500,000
   >  The beginning of the phase-out of the deduction is increased from $800,000 in 2010 and from $200,000 in 2011 to $2,000,000
   >  Computer software remains eligible for Section 179 expensing through 2011
   >  New for the first time, eligible Section 179 property will now include up to $250,000 of certain qualifying real estate improvements made during 2010 and 2011
   >  After 2011 the Section 179 limits will drop down to $25,000 and $200,000
3. The tax on so-called "built-in gains" of S corporations that were formerly C corporations does not apply to gains recognized in 2011 if the fifth year since the S election ends before 2011
4. Eligible small businesses can carry back unused tax credits generated in tax years beginning in 2010 five taxable years instead of the usual one year
5. Up to 100% of the gain on the sale of certain small business stock acquired after September 27, 2010 and before 2011 may be excluded if the stock was held for at least five years
6. The business start-up expense deduction limits have been modified for one year, for tax years beginning in 2010, as follows:
   >  The maximum immediate deduction is increased from $5,000 to $10,000
   >  The beginning of the phase-out of the deduction is increased from $50,000 to $60,000
7. The computation of net earnings subject to the self-employment tax can now include a deduction for health insurance costs, but only for the tax year beginning in 2010
8. Companies that maintain a Roth 401(k) account may now amend their plans to permit participants to rollover all or a portion of their pre-tax 401(k) account balances to the Roth 401(k) account.  This is similar in concept to the conversion of a traditional IRA to a Roth IRA.  The rollover is taxable, but rollovers accomplished in 2010 are taxable one-half each in 2011 and 2012, unless an election is made to include the rollover income in the 2010 tax return.  After 2010 rollovers are fully taxable in the year of rollover.  The rollover isn't subject to the 10% pre-age 59 1/2 penalty.
9. Owners of rental real estate must begin issuing Forms 1099 for rental expenses of $600 or more paid to service providers (e.g. a plumber or painter, etc.) after 2010.
10. Penalties for the non-filing or late-filing of Form 1099 information tax returns are dramatically increased for returns due after 2010.  Taxpayers having average gross receipts of no more than $5 million would suffer a smaller annual maximum penalty as disclosed in [brackets].
    >  Not more than 30-days late, increased from $15 to $30 per day for each form, the annual penalty limit increasing from $75,000 to $250,000 [from $25,000 to $75,000]
    >  More than 30-days late but filed on or before August 1st, increased from $30 to $60 per day for each form, the annual penalty limit increasing from $150,000 to $500,000 [from $50,000 to $200,000]
    >  Filed after August 1st, increased from $50 to $100 per day for each form, the annual penalty limit increasing from $250,000 to $1,500,000 [from $100,000 to $500,000]
    >  Intentionally failing to file information tax returns will increase from $100 to $250 per day
    >  The penalty amounts will be indexed for inflation after 2012
11. The above penalty is for not filing information returns with the IRS.  A DUPLICATE PENALTY applies if the information return wasn't also provided to the companies to which payments were made.  So, in most situations, if an information return is missed, two penalties apply and the amounts shown above are effectively doubled!  The government's practice of enacting new burdensome tax requirements and then imposing draconian financial penalties in order to "pay" for certain tax breaks is very concerning because it can financially destroy businesses and families who inadvertently fail to comply with constantly changing and increasing tax filing requirements.

Small Tax Exempt Charities at Risk of Losing Tax Exempt Status

Small charities must file annual information tax returns.  For charities with annual gross receipts of $25,000 or less (increasing to $50,000 in 2010), only a so-called electronic postcard, Form 990-N is required.  For charities with annual gross receipts of more than $25,000 but less than $500,000 and whose total assets are less than $1,250,000 (dropping to $200,000 of gross receipts and $500,000 of total assets in 2010); the short-form 990-EZ is required.  The tax returns are due on the 15th day of the fifth month following the charity's year end.  Small charities that haven't filed tax returns for 2007, 2008, and 2009 will lose their tax exemption on October 15, 2010 unless they file the past three years under the IRS special one-time relief program.  The IRS estimates some 300,000 charities could be affected.  The IRS has published a list by state of the charities that will lose their exemption at: http://www.irs.gov/charities/article/0,,id=225889,00.html  Check the list for your charity!

For those charities eligible to use Form 990-N, an automatic extension is granted until October 15, 2010 to file the past-due tax returns.  For those charities eligible to file From 990-EZ, their past-due returns must also be filed by October 15, 2010 but they must also pay a small compliance fee of from $100 to $500, depending on the amount of their gross receipts. See http://www.irs.gov/charities/article/0,,id=225705,00.html for more information.  

The IRS filing relief program does not apply to larger charities that must file the full form 990, nor does it apply to private foundations.  Private foundations must file the full form 990-PF.  Private foundations cannot file an e-postcard, and there isn't a short form.  Surprisingly, unfunded private foundations, those with no prior contributions or assets still must file Form 990-PF to avoid losing their exemption.  This could be a sleeper issue for some individuals who may have already formed a private foundation in connection with their estate planning documents but haven't funded it yet.  There is no exemption from filing Form 990-PF based upon the size or the funding of the foundation.

Volcker Report on Tax Reform Released

The President's Economic Recovery Advisory Board, chaired by former Federal Reserve Chairman Paul Volcker, released their report on August 27, 2010 on options for changes in the current tax system.  The Board was tasked with generating options to simplify the tax system, to improve taxpayer compliance with tax law, and to reform the corporate tax system.  The Board was created in February 2009 and consisted of 17 members drawn from industry, academia, and economics.  The Board was instructed by the president to exclude options that "would raise taxes for families with incomes less than $250,000 a year."  Furthermore, the Board did not consider major overarching tax reform, such as the introduction of a value-added tax.  The report doesn't endorse specific recommendations, but the findings could be referenced in future tax legislative proposals.  This report could also be overshadowed by the Alan Simpson and Erskine Bowles committee which will report (after the November elections) on ways to cut the federal budget deficit.

Some of the interesting options listed in the report include the following:

• Eliminating some of the penalty-free early withdrawal provisions from IRAs, such as for withdrawals for education, first-time home buyer expenses, and medical expenses.
• Eliminating minimum required distribution requirements where total retirement accounts are less than $50,000.
• Replace the numerous different long-term capital gain tax rates with a 50% exclusion.
• Limit or repeal Section 1031 like-kind exchanges.
• Have the IRS send taxpayers who don't itemize deductions a pre-filled tax return that they could simply sign or make simple updates to.
• Dedicate more resources to the IRS for enforcement actions, increase the statute of limitation period for audits, and examine multiple tax years at once.
• Increase information reporting and institute income tax withholding on "large payments" to independent contractors.
• Reduce the top C corporation tax rate from 35% (the second highest rate among developed nations) while expanding the tax base by preventing businesses possessing certain "corporate" characteristics from being classified as a pass-through entities (thereby avoiding C corporation taxes) such as a partnerships, LLCs, or S corporations.
• Reduce the amount of interest expense that can be deducted by C corporations by 10% of the amount of interest in excess of $5 million.
• Eliminate the domestic production deduction.
• Eliminate or reduce accelerated depreciation.
• Eliminate the exemption of credit unions from income tax.

New Education and Medicaid Spending Bill Enacted

On August 10, 2010, Pres. Obama signed into law $26 billion of new spending for education and Medicaid assistance to the States, H.R. 1586.  According to the New York Times, the US Senate was in such a hurry to get to their summer vacation when they passed the bill on August 5th that the Senate failed to even put a name to the bill.  The US House was already on vacation and came back for one day on August 10th to pass this nameless bill.  The cost of the bill was "paid for" by enacting $9.0 billion of tax increases "reforming" international taxation (details beyond the scope of this blog), saving $1.1 billion by ending the advance earned income credit used by low-income individuals (which appears to be a one-time accounting gimmick), by cutting food stamp money by $11.9 billion beginning on March 31,2014 (which cuts may never really happen), and by making cuts in "budgetary authority" to programs that cannot spend their allocated funds fast enough before the programs expire.

Congress has left for another day the very important work in considering the following tax matters:

• The estate tax whipsaw in 2010 and 2011,
• Extending income tax provisions that expired at the end of 2009, such as the research and experimental credit, sales tax deduction, etc.
• Dealing with the Bush-era tax cuts that expire on December 31, 2010 resulting in large income tax increases beginning January 1, 2011, and
• Patching the alternative minimum tax exemption amount for 2010 so that 22 million more middle-class taxpayers don't fall into the AMT trap.

I expect that a lot of tax law changes will occur this Fall.  But again, with this Congress, maybe not.

Financial Reform Act Signed into Law

Pres. Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010.  The Act is the most sweeping overhaul of the financial system since the Great Depression.  At over 2,300 pages, many of the provisions won't be understood for years, as various commissioned studies and regulations are completed.  We can be sure that the "law of unintended consequences" will apply to something so vast and unrefined.  For example, the limits to be imposed upon debit card swipe fees charged by banks and other fee limitations could lead to the loss to consumers of no-fee checking accounts and the reduction of benefits associated with the use of credit cards, such as cash back and travel point programs.

The Act is proclaimed to be able to prevent future financial meltdowns for which the American taxpayer will be on the hook, and to protect consumers with the creation of a Bureau of Consumer Financial Protection to be housed in the Federal Reserve.  Nevertheless, regulation of the Fannie Mae and Freddie Mac mortgage companies, which represent the largest exposure for taxpayer bailouts, was left out of this bill, as was the regulation of financing departments of auto dealers which touch the lives of most consumers.

The Act instructs the SEC to conduct a 6-month study of whether to apply a fiduciary standard of care to registered broker-dealers when providing investment advice to consumers.  Presently the fiduciary standard applies to investment advisors but not to broker-dealers.  Broker-dealers only have to recommend investments that are considered "suitable" for their customers.  If the fiduciary standard is extended to brokers, then they will be required to recommend investments that are "in the best interest" of their customers.

The Act also permanently raises the FDIC deposit insurance limit to $250,000 retroactively to January 1, 2008.  Previously the insurance limit was scheduled to drop to $100,000 after 2013.