IRS Red Flags to Avoid

Red Flags that may Trigger an IRS Audit

Thank you to John Siebert from Siebert & Reynolds, CPA's (columbus-cpa.com) for the following information. In case you were unaware, 2013 is over. Hopefully you take the next few months to compile (or have your CPA do it) the information required to minimize your federal tax burden. Every year there seems to be a debate over what deductions to take, and whether taking those deductions will result in an audit of your tax return. First, if you are entitled to take a deduction, I believe that you should take it. Of course, the caveat is you should have the documentation to support that deduction (a step often missed or forgotten by taxpayers). That being said, there are a number of "red flags" that may increase the chances that your tax return will be subjected to an IRS audit.  

1. Making too much money. Believe it or not, your chances of an audit increase the more money you make. The examination rate for all returns is approximately 1%. However, for those with income in excess of $200,000, that rate increases to 3.7%. Should you make over $1,000,000, the risk of audit jumps to 12.5%. Not a reason to deny a pay or distribution increase, but it is a good idea to make sure your documentation is in order. 
2. Neglecting to include income on your tax return that was reported on a W-2 or 1099. It should be common sense that if you have income reported on a document that states the information is reported to the IRS (as W-2s and 1099s often do), then you should include that income on your tax return. It is common to see this type of information omitted with respect to 1099s generated from the sale of securities (e.g., from retirement accounts). Even if the result of the sale is a loss, the income from the 1099 still must be reported.
3. Large charitable donations. Specifically, if your donations to charity are larger than the average, the IRS may take a look at your return. The average charitable contributions reported for Adjusted Gross Income ("AGI") of $50,000 to $100,000 for 2012 was $2,693.Therefore if you claim charitable contributions in excess of that number, you need the documentation to back it up (for example, receipts from donation centers, statements from Non-profits, etc.).
4. Home office deductions. This has been a red flag, not due to the difficulty of the calculations, but rather because the IRS realizes that many taxpayers are poor record-keepers with respect to the use of the home.
5. Rental Real Estate losses. If your return includes losses from rental real estate, and you claim to be a real estate professional, be aware that the IRS has stepped up its scrutiny in this area, and there is a risk your losses could be deemed to come from passive activity (less favorable tax treatment).
6. Meal and entertainment deductions. Specifically if you are self-employed, it is critical that you keep good records of the business purposes for your meal and entertainment deductions.
7. Vehicle usage. Claiming 100% of your vehicle usage can result in an IRS visit to examine your return. Whether you claim 100% of your vehicle or not, it is important to keep a contemporaneous mileage log if you use your vehicle for work. It can be digital or hard-copy, but it should include date, where you went and for what specific purpose (i.e. training, perform service, etc.), and of course the mileage. 
8. Consistent large losses. If you file a Schedule C that consistently has large losses, the IRS may deem your "business" to actually be a hobby, which results in significantly different (and less favorable) tax treatment. Just another reason why it is important to have a written business plan and separate bank accounts for your business.
9. Cash businesses. Bars, restaurants (and their workers) and handymen, I am looking at you (and so is the IRS). Businesses that are primarily cash income businesses continue to be a favorite target for audits. 
10. Foreign bank accounts. There should be no surprise that foreign bank accounts are of significant interest to the IRS. 
11. $10,000 transactions. Repeated currency transactions of $10,000 or more suggests to the IRS that there may be unreported income. 
12. Excessive itemized deductions. Taking itemized deductions that are comparably large to income can trigger an audit. The relevant deduction information from 2012 for a taxpayer with AGI of $50,000 to $100,000 was as follows:
• Medical Expenses: $7,100
• State & Real Estate Taxes: $6,050 (Ohio is generally higher, which is recognized by the IRS)
• Mortgage Interest: $10,600 (again, Ohio is generally higher)

You should not be fearful of an IRS audit SO LONG as you have proper documentation with respect to your deductions. That being said, considering the red flags above is important for any taxpayer. If you have questions, feel free to contact me at Josh@theHElawfirm.com or (614) 759-4603. 

Short Primer for Business Owners on the Affordable Care Act

As I believe the Affordable Care Act will have vast and far-reaching implications on business owners and society at large, I thought it prudent to set forth a few important points for those who may be interested in how their businesses will be impacted.

The Affordable Care Act includes requirements that impact both small and large businesses. However, its impact is primarily aimed at those businesses with 50 or more "full-time equivalent" employees. 

• Businesses that are under that threshold do not have to modify their current insurance coverage, nor must they provide coverage to those employees whom the employer does not currently insure.
• Businesses with 50 or more "full-time equivalent" employees must offer those employees health insurance or they will face a monetary penalty.
• The health insurance plan offered by covered businesses must be "affordable" - that means any share of the premium paid by the employee cannot be greater than 9 1/2 % of the amount reported on the employee's Form W-2, Box 1 (i.e. wages). This limit applies to employee-only coverage.
• The Affordable Care Act also requires that the health care plan provide at least 60% of a covered employee's anticipated costs for health care.
• "Full-time equivalent" does not simply mean "full time". A "full time" employee is one who works 30 or more hours per week, and they are covered in the definition of "full-time equivalent." However, part-time employees may also constitute "full-time equivalent" employees. Each month, their hours must be counted and then divided by 120 hours to determine how many part-time employees are covered under the Affordable Care Act. 
• Businesses that primarily utilize seasonal employees, such as landscaping companies and some retail companies, are also subject to the Affordable Care Act. However, they may be excepted from the requirement to provide health care coverage if during the year prior to the reporting year the business utilized 50 or more full time equivalent employees for less than 121 days, and the employees who resulted in the employer exceeding the 50 full-time equivalent limit were "seasonal employees" as defined by the Department of Labor.
• Business owners should expect increased scrutiny from the Internal Revenue Service with respect to part-time and seasonal employees, as there is concern that employers will attempt to avoid the requirement to provide affordable health insurance coverage that provides the value required under the Affordable Care Act.
• The start date on which covered businesses must provide health care coverage in accordance with the Affordable Care Act was originally January 1, 2014. However, the start date has been postponed and rescheduled for January 1, 2015. This extension did not alter the October 1, 2013 deadline by which employees of businesses with more than $500,000 in annual business were to be provided written notice of state health insurance exchanges.

The rescheduled start date provides you the opportunity to evaluate your obligations under the Affordable Care Act, and to plan accordingly. Do not waste that opportunity.

Brief Overview of Ohio Gun Laws

In the wake of the current political and legal climate, gun laws have been at the forefront of discussions around the country. For those of you in Ohio, here is a short primer on the laws governing firearms in the Buckeye State.

Open Carry

Generally, neither a permit nor license is needed to openly (versus concealed) carry a firearm in public. Additionally, Ohio currently does not have any type of restrictive ban on firearms (other than Title II Firearms and magazines with a capacity in excess of 31 rounds), and does not require a waiting period to purchase a firearm. (Conversely, California imposes a 10-day waiting period). There is no statewide registration of gun ownership.

There are restrictions about how a firearm can be transported in a vehicle. Generally, the firearm must be unloaded and enclosed in a container in the vehicle. Additionally, separate the ammunition from the firearm. These restrictions do not apply to concealed carry permit holders.

In Ohio, municipal and county governments are prohibited from enacting gun laws that impose greater restrictions on gun rights than the state law restrictions.

Concealed Carry

Ohio permits individuals to carry firearms in a concealed manner, so long as a permit is obtained. The Buckeye State is a “shall-issue” state – the Sheriff is must issue a concealed carry permit to all applicants who qualify. A qualified applicant is an individual who

• Is at least 21 years old;
• Has been an Ohio resident for at least 45 days;
• Has been a resident of the county in which they apply, or an adjacent county for at least 30 days;
• Completes an exam to demonstrate they are competent with a firearm; and
• Pass a background check.

In extreme situations, temporary emergency permits can be issued.

Currently, Ohio has reciprocity agreements with respect to concealed carry permits with the following states: Alaska, Arizona, Arkansas, Delaware, Florida, Idaho, Kansas, Kentucky, Louisiana, Michigan, Missouri, New Mexico, North Carolina, North Dakota, Nebraska, Oklahoma, South Carolina, Tennessee, Utah, Virginia, Washington, West Virginia and Wyoming.

Restrictions

Ohio prohibits carrying a firearm (regardless of whether you have a concealed carry permit) in the following areas:

• Law enforcement facilities
• Detention facilities
• Airports
• Institutions for caring for the mentally ill
• Courthouses
• Churches
• Child daycare centers
• Schools and universities
• Most places that sell alcohol for on-premises consumption (there is an exception for concealed carry permit holders who are not consuming alcohol)
• Businesses that post a sign banning weapons

Castle Doctrine

In 2008, Ohio enacted a self-defense law based on the castle doctrine. Under Ohio law, you may “stand-your-ground” in your home or vehicle – you may use deadly force within your homes or vehicles without a duty to retreat if you are confronted by a person illegally entering the home or vehicle.  

Previous to 2008, the victim of a home invasion in Ohio was required to retreat before using deadly force against an intruder, and one who used deadly force in such a situation had to prove they acted out of fear of serious physical injury or death. The law now creates a presumption that you acted in self-defense or in defense of another in those situations (if you were charged, a prosecutor would have to prove the intruder did not enter your home or vehicle with the intent of causing harm).  This law also bars criminal offenders from recovering civil damages for injuries they incur while engaging in criminal conduct.

Limited Liability Company (LLC) as Asset Protection Device

So your Ohio Limited Liability Company has been properly established, you are not commingling funds or assets, and business is going well, when disaster strikes and your find yourself on the wrong side of a lawsuit (i.e. a defendant). The situation goes from bad to worse when you lose the lawsuit and a judgment is entered against you (perhaps you ignored the summons and did not respond within the time required, or the facts were not in your favor). Before long, the winning party, now a creditor, is attempting to collect on that judgment and you are attempting to figure out the extent of your financial exposure and if your company is at risk.

Let's assume that you took the necessary steps to ensure that your limited liability company is a distinct and separate entity from you as an individual (Check out these previous posts: http://generallygoodadvice.blogspot.com/2012/08/does-your-llc-really-limit-your.html; and http://generallygoodadvice.blogspot.com/2012/10/commingle-funds-and-your-liability.html). In Ohio, Code Section 1705.19 provides that a "charging order" is the sole and exclusive remedy that a judgment creditor may seek to satisfy a judgment against the membership interest of a member. This applies equally to a single-member limited liability company and one with multiple members. That means the creditor cannot take control over the LLC's assets, and the creditor cannot demand a distribution. Rather, the creditor must apply to the court for a charging order and then is limited to LLC distributions, if they are made (practically speaking distributions will likely be made at some point). Depending upon the amount of the judgment and the details regarding your limited liability company (profits, leveraged assets, etc), a creditor may be reluctant to expend the time, legal resources and money to pursue the charging order. 

The obvious questions are:

1. Have you properly established your Limited Liability Company in Ohio (or multiple LLC's in many circumstances)?
2. Have you properly transferred the necessary assets to your LLC?
3. Once the assets are transferred, have you taken additional steps to minimize their exposure and increase the protection of those assets?

And most importantly, if and when you receive a summons (or any legal document for that matter), contact a lawyer immediately to discuss your rights and any exposure you or your company may have. 

At Hallowes & Ebbeskotte, LLC, our Ohio business law attorneys are well versed in evaluating and providing guidance to business owners. If you have questions about your business, or would like us to review the structure of your limited liability company and establish an asset protection plan for you, contact me at josh@thehelawfirm.com or (614) 759-4603. Also, feel free to subscribe to this blog moving forward so I can keep you up to date and informed. 

Your Business and Taxes

Have you given serious thought to how your business is taxed (other than the fact that you believe it is taxed too much)? For many business owners, this area is often overlooked until taxes are due, and by that time many tax advantages available to business owners may have been missed. As 2012 comes to a close, and with the threat of the fiscal cliff and higher tax rates looming, now is the time to plan for 2013.

There are a number of entity selections for your business, and the most common types of business entities are Proprietorships, General and Limited Partnerships, C and S Corporations, and Limited Liability Companies. The two issues this post will focus on are how each type is treated from a liability standpoint, and from a federal tax perspective. Think of this as a broad overview of each entity type, and should you have more pointed questions, don’t hesitate to email me at Josh@theHElawfirm.com.

Proprietorship

This is the simplest form in which you can organize your business. There is only one owner, the Proprietorship is not considered a separate entity from that owner and no separate federal income return is required (you include the income on your Schedule C). A Proprietorship is a “flow-through” tax entity which means that the net profit or loss flows through to you and is accounted for on your return. You are taxed on all the net profit, even if you leave some cash in the business, and you do not receive a tax deduction for cash draws out of the business. Further, the net profit is subject to self-employment taxes and losses from prior years cannot be carried forward or backward to offset self-employment taxes in other years.

In my opinion, the greatest drawback of a Proprietorship is that you, as the owner, are personally liable for all the debts and liabilities of the Proprietorship. While this may be less of an issue for owners engaged in lower-risk activities with adequate insurance coverage, I believe by operating as a Proprietorship, you are subjecting yourself to unnecessary risk in addition to missing out carrying forward losses to offset future income.

Partnership

When two or more individuals or business entities create a business without forming a Corporation or other legal entity, a Partnership has been created (there are some minimal state requirements which must be met including filing specific documents and paying the appropriate fees). A Partnership also receives flow-through tax treatment. All income, loss, gains, deductions, and credits flow through to the partners. Partnerships that operate a trade or business will generally result in self-employment income or loss to general partners (but not limited partners).

The liability structure differs from the Proprietorship because a Partnership is considered separate from the partners. Therefore, the Partnership is primarily responsible for its debts and liabilities. However, if the company does not have sufficient assets to satisfy its debts and liabilities, the partners become responsible. Note the distinction between General and Limited Partnerships discussed below.

In a General Partnership, the partners share liability and management. In a Limited Partnership, the general partner(s) share liability and management, but limited partners are only liable for their capital contributions to the Partnership, and any debts the limited partner(s) personally guaranty. There are some circumstances where a limited partner could be held personally liable, but that is a conversation for another day.

Corporation

You have likely heard about C-Corporations and S-Corporations. Both types provide limited liability protection to owners (known as “shareholders”) as a shareholder is generally only responsible for Corporation debts and liabilities up to the amount of the shareholder’s capital contributions and any personally guaranteed debts. But beware of Courts “piercing the corporate veil” to render a shareholder personally responsible for Corporation debts and liabilities. This can be avoided by, among other things, complying with Ohio’s filing requirements.

A C-Corporation, considered a separate entity from the shareholder, is subject to a “double tax” regime, meaning income is taxed at both the Corporation level, and again at the shareholder level as dividends. A C-Corporation is not a flow-through tax entity. Losses do not pass through to the shareholders; rather they are either carried back to prior years or forward to offset future Corporation income. See the benefit realized by GM discussed at http://online.wsj.com/article/SB10001424052970203609204574314180298525294.html. Finally, the dividend distributions to shareholders are not deductible by the C-Corporation.

An S-Corporation is also considered a separate entity from the shareholders, but is a flow-through tax entity. Generally, any item of income, loss, gain, deduction and credit passes through to the shareholders. Similar to the C-Corporation, shareholders are not subject to self-employment tax on the company’s profits. An additional benefit of the S-Corporation is that there is no second level of tax.

Limited Liability Companies

The LLC is perhaps the most popular entity selected by business owners today. LLC’s offer the liability shield present with a Corporation, but with the flexibility to be taxed as a Proprietorship, C-Corporation, S-Corporation or Partnership. An LLC can have a single or multiple owners (called “Members”), and if a Member is an active participant in management, he or she will likely be subject to self-employment tax. Ohio’s filing requirements are minimal for an LLC, but be sure to have your Company Minute Book properly created and updated regularly to avoid problems with liability, Member-buyouts and the other common pitfalls for LLCs.

I did not discuss it here, but there are some intriguing ways to combine the business entities outlined above in order to benefit your business even further. If you would like to find out more, or if you have questions you need answered in more depth, I am available at Josh@theHElawfirm.com, or (614) 759-4603. 

Commingle Funds and Your Liability Shield May Disappear

Now that you have taken to heart the information provided in the previous post, Does your “LLC” really limit your liability?, don’t jeopardize the shield created between your business and your personal assets. I have often heard the phrase, “As a business owner, it is not ‘if’ you get sued but rather ‘when’ you get sued.” In determining whether a business owner is personally liable for the debts of a company, courts evaluate a number of factors, the most important of which is whether an owner’s personal funds have been commingled with the funds of the business. Frankly, if you treat your company as your personal piggy bank by using your company’s funds as your own, there is a good chance your personal assets will be exposed to your company's creditors (e.g., Plaintiffs suing your company).

Commingling takes a variety of forms, including but not limited to:

1. Failing to establish company checking and credit accounts that are separate from your personal accounts;
2. Utilizing company credit cards or accounts to pay for personal expenses;
3. Loaning money to or borrowing money from your company WITHOUT DOCUMENTING THE TRANSACTION (for example, record a resolution in the corporate minutes, execute a valid promissory note with fair market rate interest, and ensure that regular payments are made);
4. Depositing company funds (e.g., checks payable to your company) into your personal account; and
5. Failing to properly title company property.

While the list set forth above is by no means exhaustive, it does provide an overview of the most common examples of commingling that you should avoid. In addition to risking exposure to personal liability, commingling often results in understating or overstating deductible business expenses, as well as difficulty in creating financial reports and determining the best direction for your company.

Do not succumb to sloppy business practices, and be sure to document, document, and document. In the event that commingling does occur, correct it immediately. Maintaining the separation of owner and business is a critical component to protecting your personal assets.

As a business law attorney at Hallowes & Ebbeskotte, LLC, my goal is ensure that your business operates in a manner that protects you personally. If your company is a mess, and you need help cleaning it up, please feel free to contact me at Josh@theHElawfirm.com (or at 614-759-4603) or visit our website at www.theHElawfirm.com.

Does your “LLC” really limit your liability?

As a business owner, the question is not "if" you will be sued; rather, it is likely "when" you will be sued. To protect against personal liability, the Limited Liability Company (“LLC”) has become one of the more popular entities chosen by business owners to operate their respective businesses. The LLC provides the flexibility and ease of creation of a partnership while at the same time establishing a liability shield similar to a traditional corporation.

My experience in meeting with business owners is that there is a common misconception that so long as Articles of Organization are filed with the Ohio Secretary of State, the owners will get the full protection of the LLC. However, in order to be protected from personal liability, you must establish that the LLC is a separate entity from you as the owner (or owners). In order to do this, it is advisable to take some steps above and beyond merely filing the Articles of Organization.

First, you need to choose a business name and make sure it is available. In Ohio, the name of your LLC must contain some specific words, as well as be distinguishable from any other names on file (with some limited exceptions). Typically you complete this step before filing the Articles of Organization.

You should also negotiate and execute an Operating Agreement. An Operating Agreement will differ if the LLC is a Single Member LLC versus a Multimember LLC. Additionally, the Operating Agreement should address tax treatment, buy-sell options, management, capital contributions required from each Member and how profits and losses will be allocated. While there are template Operating Agreements available, an Operating Agreement should be tailored to your business, your Members and your specific situation to increase the likelihood of protection from personal liability.

At Hallowes & Ebbeskotte, LLC, we create and maintain a Company Minute Book for your LLC that includes all of your company documents, including the Articles of Organization, the Operating Agreement, Subscriptions to Membership Interests, Organization Minutes, Membership Interest Certificates, Descriptions of Membership Interests, and Capital Contributions.

Don’t forget to determine what tax and other regulatory obligations the LLC is subject to, along with any required registrations. These include requesting an Employer Identification Number (“EIN”), registering for Ohio payroll taxes and BWC coverage, and required notifications when new employees are hired.

Once the LLC has obtained an EIN, the Articles of Organization have been approved, any requisite local licenses and/or registrations have been obtained, and bank accounts have been opened on behalf of your LLC, you are ready for business.*

Remember, to protect yourself from personal liability, it is critical that you take the proper steps to establish the liability shield a limited liability company can provide. Visit http://thehelawfirm.com for more information on how the business law attorneys at Hallowes & Ebbeskotte, LLC can guide you through the necessary steps.

*Future posts will address the importance of refraining from co-mingling your personal funds and assets with the funds and assets of the LLC in order to maintain personal liability protection. Stay tuned…