Streamed: Tuesday April 12, 2022
Duration: 30 minutes
Language: English
About This Webinar
Learn more about the latest enforcement initiatives from the IRS for the upcoming year.
Webinar Transcript
Steve Moskowitz:
Hello, everyone, and welcome. We’re excited to talk to you about 2022 IRS initiatives. So what we need to do is know about all the good things we have in store for us, but also know about what the IRS is looking to to make sure that if the IRS takes a look at us, we’re in full compliance and we don’t have any problems. So we’re going to be going over a number of different areas, and we look forward to helping you with all of them. I’d like to introduce my friend and colleague, tax attorney and accountant, Cliff Capdevielle, the head of our tax department. Cliff, take it away.
Cliff Capdevielle:
Thanks Steve. So as you mentioned, we’re going to be talking about IRS initiatives, particularly with regard to pass-through entities, which are S Corporations, LLCs and partnerships. What is the IRS looking at? One of their top focus areas is S Corporation distributions. Why? Because oftentimes these are incorrectly reported on the K-1s of S Corporations. So in particular, what are they looking at? The IRS is looking at instances where an S Corporation fails to report gain upon a distribution of appreciated property to a shareholder. An S Corporation might fail to determine that a distribution is actually a dividend and instances where shareholders fail to report non-dividend distributions in excess of their stock basis. So let’s talk about those a little bit.
When does a S Corporation fail to report a gain on distributed property to a shareholder? So this would be an instance where real estate or equipment or any appreciated property is distributed to a shareholder. That is typically going to be a taxable event if it was taxable in the hands of the corporation. Dividends. When is a S Corporation subject to a dividend? Steve, as you know, in general S Corporations don’t pay dividends, C Corporations do. But if an S Corporation was previously a C Corporation and a distribution would have been treated as a dividend by that C Corporation, it could, in this event be treated as a dividend to that S Corporation’s shareholder as well. Finally, in instances where distributions are coming out in excess of the [inaudible 00:03:32] corporation, those too could be taxable events.
So just to back up for a minute, in general, all net income from an S Corporation is taxed at the shareholder level to those individual shareholders in proportion to their ownership interest. However, once that tax is assessed at the individual level, typically that income or loss will be incorporated into the shareholder basis calculation, and therefore there’s no additional tax or no limitation on a loss.
Now, S Corporations are treated slightly differently than LLCs and partnerships in this regard, but it happens often that S Corporation shareholders will take out a credit card, for example, in the name of the S Corporation and then pay S Corporation bills with that credit card. Well guess what? The S Corporation shareholder is not allowed to deduct that expense paid with the S Corporation credit card to the extent that it exceeds the shareholder’s basis in that corporation. So very briefly, an S Corporation shareholder has basis to the extent they had initially invested in the corporation, to the extent that they paid tax on income to the corporation, and their basis is reduced by distributions.
But those distributions are limited to the basis in the corporation and the credit card liability does not create basis in an S Corporation distribution. This is something that the IRS is looking at. Many small business owners are not careful about how they treat their investments and distributions, and of course, credit cards. They sort of treat this all as part of their own property, their own investment. That’s not how it works when you’re in front of an IRS auditor. They’re going to make sure that any loans between the shareholders are carefully documented, that those credit cards are either in the name of the individual or the corporation, and those are going to affect the basis calculations. In general, respecting these corporate formalities is very important in terms of avoiding additional tax in an IRS audit.
Steve Moskowitz:
And to quote from the movies, we promised you the good, the bad and the ugly, and here’s a few things. As far as corporate formalities, that’s one of the things that, and so many of these things are interrelated. I’m just going to touch on the importance of this as it applies to some other areas, too. So what happens with the corporate formalities? They’re so very important because one of the reasons people become corporations, any type of corporation is for limited liability. So if something goes wrong, they get sued, that they don’t personally lose their assets. The first thing, the enemy lawyer that’s the lawyer that’s suing you does is see, are you observing the corporate formalities? If not, the enemy lawyer tries to convince the judge to take away your corporate protections to get your personal assets. That’s why it’s so vitally important to do that along with your accounting, all the problems that Cliff was talking about could easily be solved, but better yet prevented with good accounting.
And that’s one of the things that our firm offers you with our subscription services. We go ahead and do your monthly accounting. We go ahead and do your corporate compliance, and the meetings, and everything else. And there’s more to it. One of the things that cliff was talking about is distributions. Well, one of the things the IRS looks at is should a distribution, should it be wages they look at so called unreasonable compensation, is it a disguised dividend, but there’s still another reason to keep careful track of this and still another area that we’re not going to go over today, but we’ve done another areas. Something called 199A to pass through entities where you get to choose if you qualify to pay tax on only 80% of your profit, instead of a hundred percent. Oftentimes to qualify, it matters how much you’ve paid in wages.
So if you have a business that’s made a million dollars in profit, that business owner would like to pay tax on only 800, instead of the million. Part of it in doing the formula, which I won’t trouble you with at the moment, we take a look at the wages. So if that business owner’s going to take a million dollars out of the business, how much should be in wages and how much should be in distributions, not to mention the effect on your social security taxes. These are all things we do for you. You want to spend your time running your business, but you want to be like the Fortune 500. You don’t want to pay a penny more than you have to, and look at all those companies that makes billions in profits. They don’t pay any taxes. These are all the type of things that we watch out for you. And now, back to Cliff.
Cliff Capdevielle:
Thanks, Steve. And we’ve been in those situations, unfortunately, where if a client had come to us and spent just a couple of hours going over the distribution plan, we could have saved them in some cases, millions of dollars. And they-
Steve Moskowitz:
Something you never want to hear from your lawyer is, “Oh, too bad you did it that way.” You never want to hear that.
Cliff Capdevielle:
Yeah. So this is something that the IRS is focused on. It’s a real concern. And just an hour or two with the tax attorney, could potentially save you a lot of money planning the corporate distributions.
And as I mentioned, the S Corp losses and excessive basis is real focused this year and that is really where these corporate formalities tracking those loans between shareholders and S Corporations, very important. The IRS has found in many cases that shareholders claim losses and deductions that they’re not entitled to because they don’t have sufficient basis just for those, for very technical reasons. That the loans were made improperly, that credit cards were used improperly. These are things that can be prevented with just a short consultation with a tax attorney.
Steve Moskowitz:
And one of the things we promise you is, if you consult with us, we promise you we won’t give you a law school course in how to do these things. We’ll just tell you what to do to save taxes and maximize your benefits in plain simple English.
Cliff Capdevielle:
Another problem that comes up occasionally is the built-in gains tax. And this happens when S Corporations, which were previously C Corporations sell assets, you’ve seen this, Steve. What is the problem when you convert from a C Corp to an S Corp with appreciated assets?
Steve Moskowitz:
There’s certain attributes that are trapped in there and that’s what the government is trying to prevent. And what happens is, there’s an awful lot of- When you file to become a corporation, you’re automatically a C Corp. You have to ask to be an S Corp. And there’s an awful lot of people, and I’ll ask them all the time in practice, “Hey, C Corp, you’re paying double taxes. Why in the world are you paying taxes at the corporate level when you don’t have to? Why pay twice?” And they say, “Oh, I didn’t know that.” So we’ll go ahead. And we’ll convert them from C to S, but before we do that with an existing corporation, we make sure there won’t be a problem here, or sometimes we’ll delay it. There could be a situation where the C Corp has a loss that’s trapped in there not having any benefit. So we’ll say let’s have some gains to offset that, not pay tax on those gains and then convert. This is all part of what we do. But again, we promise we’ll do it in simple English.
Cliff Capdevielle:
And it’s very important to plan here, too, Steve. So oftentimes we have clients who maybe they’ve Googled something, or they’ve talked to their brother-in-law and they’ve heard that it’s better to be an S Corp than a C Corp, and they do the conversion. And then they find out too late that they’re subject to this built-in gains tax. With a little bit of planning, they could have avoided it, and it’s too bad, but this is one area that the IRS is focused on. [crosstalk 00:13:46] Yeah, before you convert from a C Corp to an S Corp, you want to talk to a tax lawyer.
Steve Moskowitz:
That’s one of the things that I say on the radio all the time, beware of Dr. Google.
Cliff Capdevielle:
Yes. IRS is also looking at sale of a partnership interest. And what are they looking at here? Well, they’re looking at assets that are other than capital. So oftentimes on an individual’s income tax return, when they sell a partnership interest, they take all of that gain as long term capital gain at 20% or less. And guess what? Certain types of assets, inventory, receivables, et cetera. Those are all ordinary assets and are subject to ordinary income tax rates. And the IRS realizes that this is an issue, they’ve audited, many, many partnership returns and have found that’s a consistent problem. So if you’re thinking about selling a partnership interest, make sure that you’ve properly allocated the capital assets, and the inventory, and other non-capital assets.
Steve Moskowitz:
You know Cliff, a question I get all the time in practice, “Steve, why now? These things have been around for a long time. Why is the IRS going guns a blazing now?” And that’s simple. Remember that president Biden wants to double the size of the IRS. They’ve already hired a lot more people. And remember president Biden has charged the IRS with collecting an additional, tremendous amount of money, because he believes, and so does the commissioner of internal revenue that billions of dollars are not paid every year. And the president is very concerned about this because with all the social programs we’ve had and businesses have benefited greatly from PPP, and ERC, and lots of other government programs. Well, the government is giving away money to businesses, but where’s the money going to come from? And part of it’s going to come right here. That’s why this is such a big deal now, although it’s always been around. The government is really, really jumping on the enforcement bandwagon.
Cliff Capdevielle:
Absolutely. Particularly with regard to businesses, there’s a lot of political pressure that says, “Well, individuals have been subject to tremendous IRS scrutiny for many years. What about businesses? They’re getting away with all kinds of tax dodges. And that’s why the IRS and Congress are looking at these. They’ve developed these campaigns recently to collect from business, which they believe are under reporting their income.
So lot of new things came out of the Tax Cut and Jobs Act in 2017. Steve, you mentioned the section 199A, how has that worked for your clients and what are the issues with regard to their qualified business income deduction?
Steve Moskowitz:
Well, it’s tremendous. The first thing is, do you qualify? And although if you just look at Dr. Google, you’ll see that in the pass-through entities, individuals, sole proprietors and S Corporations, not C Corporations, and partnerships, and LLCs qualify. And you say, “Well, okay, I’m a sole proprietor. Why should I bother to incorporate?” Well, first of all, we’re talking about asset protection because we want to protect as much as we can, but also as to an individual there’s severe limitation. So it’s only really partially beneficial. Whereas that individual would convert into a pass-through entity, say like an S Corp, you could have an unlimited amount as long as you do the proper number crunching. So basically what happens is this, with the 199A, you get to make an election to pay tax on only 80% of your profit instead of a hundred percent. Well, no brainer or who wouldn’t say, I’d rather pay on 80% than a hundred, but there’s some requirements that you have to meet.
And one of them is the type of business that you’re in. Sometimes we’ll have a situation where we’ll go ahead and split what the business does. So if you have a portion in there that doesn’t qualify, we split out into the business that does. Also with the qualifications without getting too technical, how much you pay in wages, how much depreciation you take can all factor into this. That’s why the tax accounting is so vitally important because going back to the example I used earlier, if you’ve made a million bucks in profit, how you take it could determine whether you pay tax on the million or whether you pay tax on the 800,000. And I bet everybody would rather pay tax on the 800,000 and get a freebie on the 200 grand. That’s why it’s so vitally important and there’s a lot of technicalities here.
And essentially one of the things that we always pride ourselves in the firm is communicating to clients in simple English. You hate it when a doctor uses some words with you that you don’t know it’s good or bad, you hate it when a lawyer does that too. We just tell you, “Look, here’s what we’re trying to do. Pay tax on only 80% of the profit instead of a hundred, leave it to us as to how to do it.” And that’s why all the things are interrelated. Like the benefits, like our subscription services, and the monthly accounting. They all go together to achieve all these things for you, and you don’t have to worry about it. You just reap the benefits and do your business and we’ll do ours and everybody’s better offs set the IRS and that’s okay, because Congress gave us these benefits.
Cliff Capdevielle:
Thanks Steve. So what are the kind of things that you should review with your tax attorney, if you’re as S Corp or and LLC? As we mentioned, we want to make sure that you’ve properly treated your personal expenses. That loans are properly documented. Steve mentioned unreasonable compensation. This has become a tremendous focus to the IRS. We’re going to take a look at compensation that you’re paying from the S Corp to the owners, make sure that’s reasonable so that can survive an audit. The related party transactions, whether they be loans, distributions, make sure that those are going to be… And you’re going to be entitled to deductions for those, make sure that your S Corporation is valid.
Make sure that you don’t have any owners in there that are going to disqualify you. And there’s certain restrictions on who can be an S Corporation owner. And if you have a shareholder, an S Corporation who’s not qualified, guess what? Nobody’s qualified, you’ll be treated as a C Corporation and you’ll be subject to double taxation. We talked about the built-in gains tax. Be mindful of that, if you’ve converted from a C Corp to an S Corp. We’re going to take a look at your accounting method, make sure that makes sense for you. Oftentimes it makes sense to convert from accrual to cash. Sometimes there’s big tax savings available. We’re also looking-
Steve Moskowitz:
And Cliff, on that one do you want to explain the big government benefit that we got with the change in tax law, how much higher the ceiling is now?
Cliff Capdevielle:
Yeah, so we work with a lot of construction companies, restaurants, medical providers, doctors, and dentists. And for many of these entities, they were subject and required to report on the accrual basis until relatively recently, and it can convert to cash. It makes a lot more sense, especially if you’re an S Corporation and you have an annual reporting requirement, you can match that now with your own individual reporting. It’s a lot simpler. And in many cases, when we do the conversion, shareholders end up saving a lot of money.
Steve Moskowitz:
And much better for your cashflow because a real killer with the accrual and I was a CPA before I was a tax attorney, so I’m familiar with this stuff and so is Cliff, is that with the accrual basis of accounting, a business has to recognize as income when it’s been earned, even though it hasn’t been paid. So if a client or a customer hasn’t paid their bill, you’re paying the tax on money you never receive. When you pay the IRS, you’re paying them in cash. You’re not making an accrual entry. And that’s better for a lot of taxpayers where they have customers not paying them or slowly paying them, imagine paying the tax on money you’ve not received. We can avoid that. So that’s still another reason that the cash method of accounting is so much better for so many taxpayers.
Cliff Capdevielle:
Absolutely. And we’re going to look at the nexus issues for state income and sales tax. That’s a big issue this year, Steve, a lot of small businesses now have operations in multiple states. They have employees in multiple states in the U.S. and out of the U.S. and these create tax saving opportunities, but also traps if the reporting is improper. So we want to look at that with you. Unclaimed property, we’ve we’ve had clients who have realized, if they’re older businesses or if they’ve purchased a business, maybe they have unclaimed property issues, bank accounts that have been closed and have balances. We’re looking at success reliability for taxes. This can be a killer. If you don’t properly understand the business that you’re purchasing, any tax issues that that seller of the business had, you can really get yourself in a lot of trouble.
Steve Moskowitz:
Any still another reason to hire attorneys to help you, because if you’re buying a business, you don’t want to be buying their problems. And there’s a lot of unscrupulous sellers who won’t tell you something or actually hide it or try to hide it and you want to avoid that. And we get in, there’s all kinds of other related areas. Are you buying their business? Are you buying the assets? What’s the legal aspects? What are liabilities? What are the taxes? We go over all of that with you. And another thing too is, you want to do everything properly, but if you’re in a situation, you say, “You know guys, that’s really nice, but in real life, there’s something that you did that wasn’t proper.”
Oftentimes, not all the time, but oftentimes there’s a way to fix it. Even if the government questions your ability to be an S Corp itself, sometimes we’ve been successful in going to the government and say, “Well, some T’s weren’t crossed and some I’s weren’t dotted, but this was good enough.” And a lot of times the government will say, “Okay.” So if the government says, you’re not an S Corp, don’t just say, “Okay.” You give up, we can go ahead and take a crack at because if you fail, you are going to pay taxes twice. And I can’t imagine anybody that wants to pay taxes twice when you could pay taxes once by utilizing an S Corp.
Cliff Capdevielle:
Yeah. And Steve, you mentioned the qualified business income deduction. This is huge for S Corporation owners. Want to make sure that’s maximized every year, and there are things that you can do in terms of organizing your expenses and your income to make sure that you qualify for the maximum.
Steve Moskowitz:
But one of the things- [crosstalk 00:26:52] out there Cliff, that you know so very well in order to maximize your benefit, there are things that you have to do by December 31st. That’s why the monthly accounting is so vitally important because if you bring your taxes to somebody in the next year and they say, “Oh, too bad.” I mean, imagine if you could have paid much less taxes, but for a simple accounting entry and you didn’t, and you’re paying all that real money because somebody didn’t make an accounting entry on or before December 31st, you’ll be kicking yourself. So let’s not kick yourself, let’s instead save those taxes.
Cliff Capdevielle:
Yes. And another issue that we see quite often, both from the IRS and from the states is scrutiny over the classification of workers. So if you’ve improperly identified a worker as an independent contractor versus an employee, this can get you in big trouble and cause a big penalties and we really want to help you avoid that. So make sure that you talk to a tax lawyer. If you have any question, whether somebody should be-
Steve Moskowitz:
Let’s just talk about that for a second, because that comes up so very often that a business owner pays someone as an independent contractor that should have been an employee. Eventually you’re going to get caught. Now well, somebody that swore up and down he was an independent contractor, you let him or her go and they file for unemployment or they get hurt and they file for workers’ comp, and the government says, “Hey, this guy was never recorded as an employee.” And the government comes down on you and Department of Labor comes down on you. And you’re looking at some tremendous expenses. So suppose right now you’re listening to this. You’re worried because you have all these people and you in your heart of heart knows they’re employees., You’ve been treating them as independent contractors. The IRS has this wonderful program where if you go to them before they go to you and you say, “Hi, I want to fess up.” You pay a tiny, tiny, tiny little pittance and all is forgiven. They don’t audit you and you treat them as employees going forward.
That saves tremendous money. But the one big hurdle of getting into that program is you’ve got to go to the IRS before they come to you. And think about it, you get a chance to right all these wrongs without paying the tax that you should have. There’s just a tiny, tiny smattering, a little pittance that you pay, tiny little pittance and it’s all clean and good. That’s a tremendous money saver. So that’s something you also want to think about talking to us about.