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Written by: CPA Magazine

Published: 31 July 2017

Annette Nellen, Chair, AICPA Tax Executive Committee presented and provided a written statement to the U.S. Senate Committee on Small Business & Entrepreneurship on June 14, 2017. The hearing was on “Tax Reform: Removing Barriers to Small Business Growth.” Nellen’s statement included these 14 AICPA proposals:

1. Tax Rates for Pass-through Entities
2. Distinguishing Compensation Income
3. Cash Method of Accounting
4. Limitation on Interest Expense Deduction
5. Definition of “Compensation”
6. Net Operating Losses
7. Increase of Startup Expenditures
8. Alternative Minimum Tax Repeal
9. Mobile Workforce
10. Retirement Plans
11. Civil Tax Penalties
12. Tax Administration
13. IRS Deadline Related to Disasters
14. Other Small Business Tax Issues

1. Tax Rates for Pass-through Entities

As Congress moves forward with tax reform, it is important to recognize that a rate reduction for only C corporations is inappropriate. The vast majority of businesses are structured as pass-through entities (such as, partnerships, S corporations, or limited liability companies). In 2014, there were almost 25 million individual tax returns that included a non-farm sole proprietorship.

Congress should continue to encourage, or more accurately – not discourage, the formation of sole proprietorships and pass-through entities because these business structures provide the flexibility and control desired by many new business owners as opposed to corporations which are subject to more formalities. Entrepreneurs generally do not want to create entities that require extra legal obligations (such as holding annual meetings of a board of directors). They prefer business structures that are simple and provide legal and tax advantages, such as the flowthrough of early stage losses. As a business grows, however, it may need to change its structure to raise additional equity funding (such as, having employees become shareholders).

If Congress decides to lower income tax rates for C corporations (which are generally larger businesses), all business entity types including small businesses should also receive a rate reduction. Tax reform should not disadvantage sole proprietorships and pass-through entities at the expense of furthering larger C corporations, or require businesses to engage in complex entity changes to obtain favored tax status.

2. Distinguishing Compensation Income

We recognize that providing a reduced rate for active business income of sole proprietorships and pass-through entities will place additional pressure on the distinction between the profits of the business and the compensation of owneroperators. We recommend determining compensation income by using traditional definitions of “reasonable compensation” supplemented, if necessary, by additional guidance from the Secretary of the Treasury. Changes to existing payroll tax rules, such as a requirement for partnerships and proprietorships to charge reasonable compensation for owners’ services and to withhold and pay the related income and other taxes, will also facilitate compliance for small businesses.

We encourage Congress to consider the existing judicial guidance on reasonable compensation that reflects the type of business (for example, labor versus capital intensive), the time spent by owners in operating the business, owner expertise and experience, and the existence of income-generating assets in the business (such as other employees and owners, capital and intangibles).

We acknowledge that reasonable compensation has been the subject of controversy and litigation (hence, the numerous court decisions helping to define it). Therefore, the IRS should take additional steps to improve compliance and administration in this area. For example, the creation of a new tax form (or preferably, modification of an existing form, such as Form 1125-E, Compensation of Officers) or a worksheet maintained with the taxpayer’s tax records, would allow businesses to indicate the factors considered in determining compensation in a reasonable and consistent manner. These potential factors include:

a. Approximate average hours per week worked by all owners;

b. Approximate average hours worked per week by non-owner employees;

c. The owner’s years of experience;

d. Guidance used to help determine reasonable compensation for the geographic area and years of experience (such as, wage data guides provided by the U.S. Bureau of Labor Statistics); and

e. Book value and estimated fair market value of assets that generate income for the business.

Changes are also necessary for existing payroll tax rules to require partnerships and proprietorships to charge reasonable compensation for owners’ services and to withhold and pay the related income and other taxes. These types of changes to existing payroll tax rules will facilitate small business compliance. The partners and proprietors are not treated as “employees,” but rather owners subject to withholding – a new category of taxpayer – similar to a partner with a guaranteed payment for services. Similar rules requiring reasonable compensation currently exist in connection with S corporations and such owners are considered employees of the S corporation. The broader inclusion of partners and proprietors in more well-defined compensation rules, should facilitate and enhance the development of appropriate regulations and enforcement in this area.

The AICPA believes there are advantages of this reasonable compensation approach for owners of all business types. These advantages include:

a. Fairness that respects the differences among business types and owner participation levels;

b. A reduced reliance by both taxpayers and the IRS on quarterly estimated tax payments for timely matching of the earning process and tax collection;

c. Diminished reliance on the selfemployment tax system (since businesses would include payroll taxes withheld from owners and paid for owners along with their employees); and

d. Simplification from uniformity of collection of employment tax from business entities, and an ability to rely on a deep foundation of case law (in the S corporation and personal service corporation areas) to provide regulatory and judicial guidance.

In former Ways & Means Committee Chairman Dave Camp’s 2014 discussion draft, a proposal was included to treat 70% of pass-through income of an owner-employee as employment income. While this proposal presents a simple method of determining the compensation component, it would result in an inaccurate and inequitable result in many situations. If Congress moves forward with a 70/30 rule, or other percentage split, we recommend making the proposal a safe harbor option. For example, the proposal must make clear that the existence and the amount of the safe harbor is not a maximum amount permitted but that the reasonable compensation standard utilized for corporations will remain available to sole proprietorships and pass-through entities. These rules will provide a uniform treatment among closely-held business entity types. Appropriate reporting requirements, when the safe harbor option is not used, would also address the enforcement challenges currently faced by the IRS. For example, the modification of Form 1125-E would fully disclose factors considered in determining compensation that the IRS currently struggles to track.

3. Cash Method of Accounting

The AICPA supports the expansion of the number of taxpayers who may use the cash method of accounting. The cash method of accounting is simpler in application than the accrual method, has fewer compliance costs, and does not require taxpayers to pay tax before receiving the income. Therefore, entrepreneurs often choose this method for small businesses. We are concerned with, and oppose, any new limitations on the use of the cash method for service businesses, including those businesses whose income is taxed directly on their owners’ individual returns, such as partnerships and S corporations. Requiring businesses to switch to the accrual method upon reaching a gross receipts threshold unnecessarily creates a barrier to growth.

Limiting the use of the cash method of accounting for service businesses would:

a. Discourage natural small business growth;

b. Impose an undue financial burden on their individual owners;

c. Increase the likelihood of borrowing;

d. Impose complexities and increase their compliance burden; and

e. Treat similarly situated taxpayers differently (because income is taxed directly on their owners’ individual returns).

Congress should not further restrict the use of the long-standing cash method of accounting for the millions of U.S. businesses (e.g., sole proprietors, personal service corporations, and passthrough entities) currently utilizing this method. We believe that forcing more businesses to use the accrual method of accounting for tax purposes increases their administrative burden, discourages business growth in the U.S. economy, and unnecessarily imposes financial hardship on cash-strapped businesses.

4. Limitation on Interest Expense Deduction

Another important issue for small businesses is the ability to deduct their interest expense. New business owners incur interest on small business loans to fund operations prior to revenue generation, working capital needs, equipment acquisition and expansion, and even to build credit for larger future loans. These businesses rely on financing to survive. Equity financing for many start-up businesses is simply not available. A limitation in the deduction for interest expense (such as to the extent of interest income) would effectively eliminate the benefit of a valid business expense for many small businesses, as well as many professional service firms. If a limit on the interest expense deduction is paired with a proposal to allow for an immediate write-off of acquired depreciable property, it is important to recognize that this combination adversely affects service providers and small businesses while offering larger manufacturers, retailers, and other asset-intensive businesses a greater tax benefit.

Currently, small businesses can expense up to $510,000 of acquisitions per year under section 179 and deduct all associated interest expense. One tax reform proposal under consideration would eliminate the benefit of interest expense while allowing immediate expensing of the full cost of new equipment in the first year. However, since small businesses do not usually purchase large amounts of new assets, this proposal would generally not provide any new benefit for smaller businesses (relative to what is currently available via the section 179 (expensing rule). Instead, it only takes away an important deduction for many small businesses who are forced to rely on debt financing to cover their operating and expansion costs.

5. Definition of “Compensation”

Tax reform discussions have recently considered whether the tax system should use the same definition for taxable compensation of employees as it does for the compensation that employers may deduct. In other words, should businesses lose some of their current payroll-type deductions if employees are not required to report those same compensation amounts as income?

We are concerned, particularly from a small business perspective, about any decrease of an employer’s ability to deduct compensation paid to employees, whether in the form of wages or fringe benefits (health and life insurance, disability benefits, deferred compensation, etc.). We are similarly concerned about expansion of the definition of taxable income for the employees, or removal of the exclusion for fringe benefits. Such changes in the Tax Code would substantially impact the small and labor-intensive businesses’ ability to build and retain a competitive workforce.

6. Net Operating Losses

Congress should also provide tax relief to small businesses in the calculation of benefits related to net operating losses (NOLs). An NOL is generally the amount by which a taxpayer’s business deductions exceed its gross income. Corporations currently operating at a loss can benefit from carrying these NOLs back or forward to offset taxable income. According to the current rules, these losses are not deducted in the year generated, but carried back two years and carried forward 20 years to offset taxable income in such years.

One of the purposes of the NOL carryback and carryover rules is to allow a taxpayer to better reflect its economic position over a longer period of time than generally is allowed under the restraint of the annual reporting period. Since 1987, our experience with the 90% AMT limitation on the use of NOLs shows that this limitation often imposes a tax on corporations, especially small businesses in their early growth years, when such businesses are still struggling economically. Therefore, a proposal for a 90% limitation on NOLs imposes an artificial restriction on a company’s use of business losses and discriminates against companies with volatile income which could potentially pay more tax than companies with an equal amount of steady income over the same period.

For sole proprietors, the calculation of the NOL is overly complicated. Congress should simplify the calculation while retaining the carryback option for small businesses. Most startup businesses are formed as pass-through entities and the initial startup losses incurred are “passed down” and reported on the owners’ tax returns. Because individual taxpayers report both business and non-business income and deductions on their returns, the required calculations to separate allowed business losses from disallowed personal activities is complex. Individual business owners would benefit from more specific guidance on NOL computations.

7. Increase of Startup Expenditures

In the interest of economic growth, we encourage Congress to consider increasing the expensing amount for startup expenditures. Section 195 allows immediate expensing of up to $5,000 of startup expenditures in the tax year in which the active trade or business begins. This amount is reduced dollar for dollar once total startup expenditures exceed $50,000, with the excess amortized ratably over 15 years. Thus, once startup expenditures exceed $55,000, all of these expenditures are amortized over 15 years. The rationale for the $5,000 expensing was to “help encourage the formation of new businesses that do not require significant startup or organizational costs.” These dollar amounts, added in 2004, are not adjusted for inflation. Only for tax years beginning in 2010, the $5,000 was increased to $10,000 and the $50,000 phase-out level was increased to $60,000. This change was described as “promoting entrepreneurship.”

The AICPA recommends increasing the $5,000 and $50,000 amounts of section 195 and adjusting them annually for inflation. These changes will further simplify tax compliance for small businesses by reducing (or eliminating) the number of such businesses that must track and report amortization of startup expenses over a 15-year period. In addition, as was suggested for the 2004 and 2010 legislative changes, the larger dollar amounts will better encourage entrepreneurship. Higher dollar amounts also reflect the costs for legal, accounting, investigatory, and travel that are frequently incurred when starting a new business. Also, in light of the increased, inflation-adjusted dollar amounts under section 1791 to help small businesses, it is appropriate to similarly increase the section 195 dollar amounts and adjust them annually for inflation.

8. Alternative Minimum Tax Repeal

Congress should repeal AMT for both individuals and corporations. The current system’s requirement for taxpayers to compute their income for purposes of both the regular income tax and the AMT is a significant area of complexity of the Tax Code requiring extra calculations and recordkeeping. AMT also violates the transparency principle in masking what a taxpayer is allowed to deduct or exclude, as well as the taxpayer’s marginal tax rate. Businesses, including those businesses operating through pass-through entities and certain C corporations, are increasingly at risk of being subject to AMT.

The AMT was created to ensure that all taxpayers pay a minimum amount of tax on their economic income. However, small businesses suffer a heavy burden because they often do not know whether they are affected until they file their taxes. They must constantly maintain a reserve for possible AMT, which takes away from resources they could allocate to business needs such as hiring, expanding, and giving raises to workers.

The AMT is a separate and distinct tax regime from the “regular” income tax. IRC sections 56 and 57 create AMT adjustments and preferences that require taxpayers to make a second, separate computation of their income, expenses, allowable deductions, and credits under the AMT system. This separate calculation is required for all components of income including business income for sole proprietors, partners in partnerships and shareholders in S corporations. Small businesses must maintain annual supplementary schedules used to compute these necessary adjustments and preferences for many years to calculate the treatment of future AMT items and, occasionally, receive a credit for them in future years. Calculations governing AMT credit carryovers are complex and contain traps for unwary taxpayers.

Sole proprietors who are also owners in pass-through entities must combine the AMT information from all their activities in order to calculate AMT. The computations are extremely difficult for business taxpayers preparing their own returns and the complexity also affects the IRS’s ability to meaningfully track compliance.

9. Mobile Workforce

The AICPA supports the Mobile Workforce State Income Tax Simplification Act of 2017, S. 540, which provides a uniform national standard for non-resident state income tax withholding and a de minimis exemption from the multi-state assessment of state non-resident income tax.

The current situation of having to withhold and file many state non-resident tax returns for just a few days of work in various states is too complicated for both small businesses and their employees. Businesses, including small businesses and family businesses that operate interstate, are subject to a multitude of burdensome, unnecessary and often bewildering non-resident state income tax withholding rules. These businesses struggle to understand and keep up with the variations from state to state. The issue of employer tracking and complying with all the different state and local tax laws is quite complicated, consumes a lot of time and is costly. S. 540 would provide long-overdue relief from the current web of inconsistent state income tax and withholding rules on nonresident employees. Therefore, we urge Congress to pass S. 540 that provides national uniform rules and a reasonable 30-day de minimis threshold before income tax withholding is required.

10. Retirement Plans

Small businesses are especially burdened by the overwhelming number of rules inherent in adopting and operating a qualified retirement plan. Currently, there are four employee contributory deferral plans: 401(k), 403(b), 457(b), and SIMPLE plans. Having four variations of the same plan type causes confusion for many plan participants and small businesses. Congress should eliminate the unnecessary complexity by reducing the number of choices for the same type of plan while keeping the desired goal intact: affording employers the opportunity to offer a contributory deferral plan to their employees and allowing those employees to use a uniform plan to save for retirement.

Startup business owners are inundated with a myriad of new business decisions and concerns. These individuals may have expertise in their business product or service, but rarely are they experts in areas such as retirement plan rules and regulations. We encourage Congress to consider creating a uniform employee contributory deferral plan to ease this burden for small businesses.

11. Civil Tax Penalties

Congress should carefully draft penalty provisions and the Administration should fairly administer the penalties to ensure they deter bad conduct without deterring good conduct or punishing innocent small business owners (i.e., unintentional errors, such as those who committed the inappropriate act without intent to commit such act). Targeted, proportionate penalties that clearly articulate standards of behavior and are administered in an even-handed and reasonable manner encourage voluntary compliance with the tax laws. On the other hand, overbroad, vaguely-defined and disproportionate penalties create an atmosphere of arbitrariness and unfairness that can discourage voluntary compliance.

The AICPA has concerns about the current state of civil tax penalties and offers the following suggestions for improvement:

a. Trend Toward Strict Liability
The IRS discretion to waive and abate penalties where the taxpayer demonstrates reasonable cause and good faith is needed most when the tax laws are complex and the potential sanction is harsh. Legislation should avoid mandating strict liability penalties. Over the past several decades, the number of increasingly severe civil tax penalties have grown, with the Tax Code currently containing eight strict liability AICPA penalty provisions (for example, the accuracy penalty on non-disclosed reportable transactions).

b. An Erosion of Basic Procedural Due Process
Taxpayers should know their rights to contest penalties and have a timely and meaningful opportunity to voice their feedback before assessment of the penalty. In general, this process would include the right to an independent review by the IRS Appeals office or the IRS’s FastTrack appeals process, as well as access to the courts. Pre-assessment rights are particularly important where the underlying tax provision or penalty standards are complex, the amount of the penalty is high, or fact-specific defenses such as reasonable cause are available.

c. Repeal Technical Termination Rule
We recommend the repeal of section 708(b)(1)(B) regarding the technical termination of a partnership. A technical termination most often occurs when, during a 12-month period there is a sale or exchange of 50% or more of the total interest in partnership capital and profits. Because this 12-month time frame can span a year-end, the partnership may not realize that a 30% change (a minority interest) in one year followed by a 25% change in another year, but within 12 months of the first, has caused the partnership to terminate.

In practice, this earlier required filing of the old partnership’s tax return often goes unnoticed because the business is unaware of the accelerated deadline due to the equity transfer. Penalties are often assessed upon the business as a result of the missed deadline. This technical termination area is often misunderstood and misapplied. The acceleration of the filing of the tax return, to reset depreciation lives and to select new accounting methods, serves little purpose in terms of abuse prevention and serves more as a trap for the unwary.

d. Late Filing Penalties of Sections 6698 and 6699
Sections 6698 and 6699 impose a penalty of $200 per owner related to late-filed partnership or S corporation returns. The penalty is imposed monthly not to exceed 12 months, unless it is shown that the late filing is due to reasonable cause.

The AICPA proposes that a partnership, comprised of 50 or fewer partners, each of whom are natural persons (who are not nonresident aliens), an estate of a deceased partner, a trust established under a will or a trust that becomes irrevocable when the grantor dies, and domestic C corporations, is considered to have met the reasonable cause test and is not subject to the penalty imposed by section 6698 or 6699 if:

· The delinquency is not considered willful under section 7423;

· All partnership income, deductions and credits are allocated to each partner in accordance with such partner’s capital and profits interest in the partnership, on a pro-rata basis; and

· Each partner fully reported its share of income, deductions and credits of the partnership on its timely filed federal income tax return.

e. Failure to Disclose Reportable Transactions
Taxpayers who fail to disclose a reportable transaction are subject to a penalty under section 6707A of the Tax Code. The section 6707A penalty applies even if there is no tax due with respect to the reportable transaction that has not been disclosed. There is no reasonable cause exception to this penalty.

Under section 6662A, taxpayers who have understatements attributable to certain reportable transactions are subject to a penalty of 20% (if the transaction was disclosed) and 30% (if the transaction was not disclosed). A more stringent reasonable cause exception for a penalty under section 6662A is provided in section 6664, but only where the transaction is adequately disclosed, there is substantial authority for the treatment, and the taxpayer had a reasonable belief that the treatment was more likely than not proper. In the case of a listed transaction, reasonable cause is not available, similar to the penalty under section 6707A.

For example, a company that engaged in a “listed” transaction which gave rise to a deduction of $25,000 over the course of two years and inadvertently failed to report the transaction may be subject to a $200,000 penalty per year, for a total penalty of $400,000. The penalty can apply even if the deduction is allowable.

We propose an amendment of section 6707A to allow an exception to the penalty if there was reasonable cause for the failure and the taxpayer acted in good faith for all types of reportable transactions, and to allow for judicial review in cases where reasonable cause was denied. Moreover, we propose an amendment of section 6664 to provide a general reasonable cause exception for all types of reportable transactions, irrespective of whether the transaction was adequately disclosed or the level of assurance.

f. 9100 Relief
Section 9100 relief, which is currently available with regard to some elections, is extremely valuable for taxpayers who inadvertently miss the opportunity to make certain tax elections. Congress should make section 9100 relief available for all tax elections, whether prescribed by regulation or statute. The AICPA has compiled a list of elections (not all-inclusive) for which section 9100 relief currently is not granted by the IRS as the deadline for claiming such elections is set by statute. Examples of these provisions include section 174(b)(2), the election to amortize certain research and experimental expenditures, and section 280C(c), the election to claim a reduced credit for research activities.

g. Form 5471 Penalty Relief
On January 1, 2009, the IRS began imposing an automatic penalty of $10,000 for each Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, filed with a delinquent Form 1120, U.S. Corporation Income Tax Return, series return. When imposing the penalty on corporations in particular, the IRS does not distinguish between: a) large public multinational companies, b) small companies, and c) companies that may only have insignificant overseas operations, or loss companies. This one-size-fits-all approach inadvertently places undue hardship on smaller corporations that do not have the same financial resources as larger corporations. The AICPA has submitted recommendations regarding the IRS administration of the penalty provision applicable to Form 5471. Our recommendations focus on the need for relief from automatic penalties assessed upon the late filing of Form 5471 in order to promote the fair and efficient administration of the international penalty provisions of the Tax Code.

12. Tax Administration

The current degradation of the IRS taxpayer services is unacceptable. The percentage of calls from taxpayers the IRS answered between 2004 and 2016 has dropped from 87% to 53%, however, the need for taxpayer assistance increased (the number of calls the IRS received increased from 71 million to 104 million).

As tax professionals, we represent one of the IRS’s most significant stakeholder groups. As such, we are both poised and committed to being part of the solution for improving IRS taxpayer services. We recently submitted a letter to House Ways and Means Committee and Senate Finance Committee members in collaboration with other professional organizations. Our recommendations include modernizing IRS business practices and technology, re-establishing the annual joint hearing review, and enabling the IRS to utilize the full range of available authorities to hire and compensate qualified and experienced professionals from the private sector to meet its mission. The legislative and executive branches should work together to determine the appropriate level of service and compliance they want the IRS accountable for and then dedicate appropriate resources for the Service to meet those goals.

Additionally, we recommend the IRS create a new dedicated practitioner services unit to rationalize, enhance, and centrally manage the many current, disparate practitioner-impacting programs, processes, and tools. Enhancing the relationship between the IRS and practitioners would benefit both the IRS and the millions of taxpayers, including small businesses, served by the practitioner community. As part of this new unit, the IRS should provide practitioners with an online tax professional account with access to all of their clients’ information. The IRS should offer robust practitioner priority hotlines with higher-skilled employees that have the experience and training to address complex issues. Furthermore, the IRS should assign customer service representatives (a single point of contact) to geographic areas in order to address challenging issues that practitioners could not resolve through a priority hotline.

13. IRS Deadlines Related to Disasters

Similar to IRS’s authority to postpone certain deadlines in the event of a presidentially-declared disaster, Congress should extend that limited authority to state-declared disasters and states of emergency. Currently, the IRS’s authority to grant deadline extensions, outlined in section 7508A, is limited to taxpayers affected by federal-declared disasters. State governors will issue official disaster declarations promptly but often, presidential disaster declarations in those same regions are not declared for days, or sometimes weeks after the state declaration. This process delays the IRS’s ability to provide federal tax relief to impacted businesses and disaster victims. Taxpayers have the ability to request waivers of penalties on a case-by-case basis; however, this process causes the taxpayer, tax preparer, and the IRS to expend valuable time, effort, and resources which are already in shortage during times of a disaster. Granting the IRS specific authority to quickly postpone certain deadlines in response to state-declared disasters allows the IRS to offer victims the certainty they need as soon as possible.

This past year, multiple states along Southeastern U.S. were affected by Hurricane Matthew, including Florida, Georgia, North and South Carolina, and Virginia. From October 6 through 10, Matthew traveled north along the southeast coast. A federal state of emergency was declared for Florida on October 6 and later extended to include Georgia and South Carolina. Tax preparers and taxpayers living in the affected regions not only lost access to power and the Internet, but lost tax documents and financial information due to flooding and destruction of both their homes and businesses. On October 13, 2016, the IRS issued IR-2016-132 offering federal tax relief to regions of North Carolina. The relief arrived two days before the major October 15 extended tax filing deadline – which caused tax practitioners unnecessary stress and burden for the days leading up to the issuance of the relief. Three days after the extended filing deadline, on October 18, the IRS issued relief for Florida and Georgia – which was, unfortunately, too late to make a substantial difference. More recently, on March 13, 2017, Winter Storm Stella hit the Northeast and Mid-Atlantic U.S. covering many states in multiple feet of snow two days before the March 15 business return due date. Before 2:00 pm (ET) on the first day of the storm, governors in New York and other states began issuing emergency declarations while the AICPA and state CPA societies along the northeast received calls from members needing federal filing relief from the IRS. Two days later, at approximately 4:30 pm (ET) on the March 15 filing due date, the IRS finally issued IR-2017-61 offering business taxpayers affected by Winter Storm Stella additional time to file. Receiving federal extensions are helpful, but the sooner the IRS can grant this relief, the greater the beneficial impact on victims.

The AICPA has long supported a set of permanent disaster relief tax provisions and we acknowledge both Congress’s and the IRS’s willingness to help disaster victims. To provide more timely assistance, however, we recommend that Congress allow the IRS to postpone certain deadlines in response to state-declared disasters or state of emergencies.

14. Other Small Business Tax Compliance Issues

There are several other small business tax compliance burden proposals that we support, including:

a. Listed Property
We suggest removing “computer or peripheral equipment” from the definition of “listed property” in order to simplify and modernize the traditional tax treatment of computers and laptops. Classifying computers and similar property as “listed property” under section 280F is clearly outdated in a business environment where employees are increasingly expected to work outside of traditional business hours. Various forms of technology, including laptops, tablets and cell phones, are all converging to serve similar purposes. The costs for the Internet and service plans are now frequently sold in “bundles” and shared between multiple devices and it has become arguably impossible to segregate the cost of service between a cell phone, tablet, and laptop. The AICPA believes legislative change to update the treatment of mobile devices is the best simplification, similar to section 2043 of the Small Business Jobs Act of 2010, where cell phones were removed from the definition of listed property for taxable years beginning after December 31, 2009.

b. Executive Compensation
The AICPA supports that section 409A requirements should apply only to public companies. Section 409A, which applies to compensation earned in one year but paid in a future year, was enacted to protect shareholders and other taxpayers from executives guarding their own financial interests without concern for the financial interests of the organization, its shareholders or other creditors.

The rules apply to a broad array of compensation arrangements, including many business arrangements that are not thought of as deferred compensation. Nonpublic companies often want arrangements with employees to allow for sharing equity or providing capital accumulation for long-term employees, and constraining the nonpublic business owner by rules designed to protect absentee shareholders should not occur.

Many nonpublic entities have noncompliant plans that are not correctable under the existing administrative correction programs. The cost of a noncompliant 409A plan is excessive given the unintended violations. In addition to accrual base income recognition, the additional 20% tax applies to the recipient, often a person unknowingly affected by the violations. Requiring private companies to pay for the specialized tax guidance needed to ensure that a compensatory arrangement is 409A compliant should not occur. The cost of imposing 409A requirements on nonpublic companies is far in excess of any benefit derived.

c. Elimination of Top-Heavy Rules (for Retirement Plans)
Small businesses are especially burdened by the overwhelming number of rules inherent in adopting and operating a qualified retirement plan. Therefore, we support repealing the sole remaining top-heavy rule, which limits the adoption of 401(k) and other qualified retirement plans by small employers and requires a minimum contribution or benefit. The determination of top-heavy status is difficult and the required 3% minimum contribution is often made for safe harbor 401(k) plans. Without the top-heavy rules, more small businesses would adopt plans to benefit their employees.

d. Provide Full Deductibility of Health Insurance
We recommend allowing full deductibility of health insurance costs in calculating the self-employment tax for self-employed individuals. This suggestion would provide that deductions allowed in determining income subject to Survivors, and Disability Insurance (OASDI) and health insurance (HI) taxes remain consistent amongst taxpayers regardless of whether they are employees or self-employed individuals. Currently, employees receive this deduction for their health insurance costs while self-employed individuals are not allowed a deduction in determining their net income subject to these taxes. The calculation of income subject to a particular tax should remain consistent amongst all taxpayers.

e. Increase the Passive Income Percentage to 60% and Eliminate the Three-Year Termination for S Corporations
The AICPA recommends increasing the threshold of an S corporation’s income that is considered passive without incurring an entity-level tax to 60% (from 25%). Additionally we recommend eliminating the current rule that terminates an S corporation’s pass-through status if the S corporation has excess passive income for three consecutive years.

Currently, if an S corporation has excess passive income for three consecutive years, even though incurring a corporate-level tax is a possibility due to the taxable income limitation, the S election is subject to termination, creating uncertainty in S corporation operations. Under current law, if the S corporation unknowingly has $1.00 of accumulated earnings and profits, the S election is terminated if the S corporation has excess passive investment income for three consecutive years. The IRS routinely grants waivers of the involuntary termination under section 1362(d)(3). S corporations without C corporation earnings and profits may receive an unlimited amount of passive investment income and are not subject to the S election termination.

f. Guidance Needed on Emerging Issues
Online crowdfunding and the sharing economy are quickly expanding mediums through which individuals obtain funds, seek new sources of income, and start and grow businesses. Individuals may understand the steps through which they can use these new crowdfunding and sharing economy opportunities to their advantage. However, many tax preparers and their clients do not have the guidance necessary to accurately comply with the complex, out-of-date, or incomplete tax rules in these emerging areas.

Lawmakers and tax administrators must regularly review existing laws, against new changes in the ways of living and doing business, to determine whether tax rules and administration procedures need modification and modernization. We urge Congress and the IRS to develop simplified tax rules and related guidance in the emerging sharing economy and crowdfunding areas. Some of the areas in need of modernization include information reporting (such as to avoid reporting excluded income, such as a gift, as income), simplicity in reporting and tracking rental losses from year to year, and simplified approaches for recordkeeping for small businesses. Offering clarity on these issues will allow taxpayers to follow a fair and transparent set of guidelines while the IRS benefits from a more efficient voluntary tax system. In addition, it is not recommended to bypass these evolving opportunities of connecting businesses and customers, and generating funds for equity and sales, due to entrepreneurs concerned about uncertain tax effects.

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Written by: Robert E. McKenzie, J.D.

Published: 31 July 2017

The IRS is now utilizing two menacing collection alternatives. First, the IRS is now assigning collection duties to private collection agencies which are compensated on a contingent fee basis. Second, taxpayers who owe delinquent taxes could lose their right to a United States passport.

Private Collection

If the IRS is bugging you about your unpaid taxes, what if it is a private debt collector collecting for the IRS? That is now a reality, since President Obama has signed the 5-year infrastructure spending Bill. It added private IRS collectors as part of H.R. 22 – Fixing America’s Surface Transportation Act, the “FAST Act.” What does a private IRS have to do with highway funding, you might ask? The answer is money.

Congress wants more of it collected from taxpayers, especially what the IRS considers to be hard to collect tax bills. In fact, for some hard to collect bills, the law now requires—rather than just permits—the IRS to use private collectors. Many people think that having the IRS farm out collection work to private contractors is a bad idea. Last year, National Taxpayer Advocate Nina Olson advocated against it in a letter. She said the 2006- 2009 program using private collectors didn’t even raise revenue.

The IRS has gone in for private collectors twice over the last 18 years. And although those programs were not especially successful, Congress has gone back to it in a big way. Congress included it in the FAST Act, and the President signed it into law. Here are nine things you should know:

1. First, the private collector usually will contact the taxpayer by letter.

2. If the taxpayer’s last known address is incorrect, the private collector searches for the correct address. Next, the private collector will telephone the taxpayer to request full payment.

3. If the taxpayer cannot pay in full right away, the private collector offers an installment deal for up to five years.

4. If the taxpayer is unable to pay even over five years, the collector asks for taxpayer financial information to see what sort of deal the taxpayer should get. There are controls on financial data, but there is considerable worry about having taxpayer data in private hands.

5. Private collectors cannot accept payments. Do not pay them directly!

6. The Fair Debt Collection Practices Act applies to private collectors. This is the same law that applies to collectors in other circumstances. Notify the collection agency that you refuse to deal with them and that it must cease further communications.

7. There are many reports required under the law. Congress and the Treasury Department are trying to determine if private collection is efficient and how well it works.

8. In some cases, the IRS is actually required to use private collectors, where:

• The tax bill is not being collected because of a lack of IRS resources or the IRS’ inability to locate the taxpayer.

• More than 1/3 of the statute of limitations has expired, and no IRS employee has been assigned to collect it; and

• The tax bill has been assigned for collection, but more than a year has passed without any interaction.

9. Some tax bills cannot go to private collectors, as where:

• There is a pending or active offer-in-compromise or installment agreement;

• It is an innocent spouse case;

• The taxpayer is deceased, under age 18, in a designated combat zone, or is a victim of identity theft;

• The taxpayer is under IRS audit, in litigation, criminal investigation, or levy; or

• The taxpayer has gone to IRS Appeals.

Revocation or Denial of Passports

The passport provision became official, when President Obama signed the 5-year infrastructure spending Bill. It added a new section 7345 to the Internal Revenue Code. It is part of H.R. 22 – Fixing America’s Surface Transportation Act, the “FAST Act.” The law says the State Department can revoke, deny or limit passports for anyone the IRS certifies as having a seriously delinquent tax debt in an amount in excess of $50,000.

IRC § 7345 authorizes the IRS to certify that to the State Department. The department generally will not issue or renew a passport to you after receiving certification from the IRS.

Upon receiving certification, the State Department may revoke your passport. If the department decides to revoke it, prior to revocation, the department may limit your passport to return travel to the U.S.

Certification Of Individuals With Seriously Delinquent Tax Debt

Seriously delinquent tax debt is an individual’s unpaid, legally enforceable federal tax debt totaling more than $50,000* (including interest and penalties) for which a:

• Notice of federal tax lien has been filed and all administrative remedies under IRC § 6320 have lapsed or been exhausted or;

• Levy has been issued.

Some tax debt is not included in determining seriously delinquent tax debt even if it meets the above criteria. It includes tax debt:

• Being paid in a timely manner under an installment agreement entered into with the IRS.

• Being paid in a timely manner under an offer in compromise accepted by the IRS or a settlement agreement entered into with the Justice Department.

• For which a collection due process hearing is timely requested in connection with a levy to collect the debt.

• For which collection has been suspended because a request for innocent spouse relief under IRC § 6015 has been made.

Before denying a passport, the State Department will hold your application for 90 days to allow you to:

• Resolve any erroneous certification issues.

• Make full payment of the tax debt.

• Enter into a satisfactory payment alternative with the IRS.

There is no grace period for resolving the debt before the State Department revokes a passport.

Taxpayer Notification - Notice CP 508C

The IRS is required to notify you in writing at the time the IRS certifies seriously delinquent tax debt to the State Department. The IRS is also required to notify you in writing at the time it reverses certification. The IRS will send written notice by regular mail to your last known address.

Reversal Of Certification - Notice CP 508R

The IRS will notify the State Department of the reversal of the certification when:

• The tax debt is fully satisfied or becomes legally unenforceable.

• The tax debt is no longer seriously delinquent.

• The certification is erroneous.

The IRS will provide notice as soon as practicable if the certification is erroneous. The IRS will provide notice within 30 days of the date the debt is fully satisfied, becomes legally unenforceable or ceases to be seriously delinquent tax debt.

A previously certified debt is no longer seriously delinquent when:

• You and the IRS enter into an installment agreement allowing you to pay the debt over time.

• The IRS accepts an offer in compromise to satisfy the debt. • The Justice Department enters into a settlement agreement to satisfy the debt.

• Collection is suspended because you request innocent spouse relief under IRC § 6015.

• You make a timely request for a collection due process hearing in connection with a levy to collect the debt.

The IRS will not reverse certification where a taxpayer requests a collection due process hearing or innocent spouse relief on a debt that is not the basis of the certification. Also, the IRS will not reverse the certification because the taxpayer pays the debt below $50,000.

Judicial Review Of Certification

If the IRS certified your debt to the State Department, you can file suit in the U.S. Tax Court or a U.S. District Court to have the court determine whether the certification is erroneous or the IRS failed to reverse the certification when it was required to do so. If the court determines the certification is erroneous or should be reversed, it can order reversal of the certification.

IRC § 7345 does not provide the court authority to release a lien or levy or award money damages in a suit to determine whether a certification is erroneous. You are not required to file an administrative claim or otherwise contact the IRS to resolve the erroneous certification issue before filing suit in the U.S. Tax Court or a U.S. District Court.

Payment Of Taxes

If you can’t pay the full amount you owe, you can make alternative payment arrangements such as an installment agreement or an offer in compromise and still keep your U.S. passport. If you disagree with the tax amount or the certification was made in error, you should contact the phone number listed on Notice CP 508C. If you’ve already paid the tax debt, send proof of that payment to the address on the Notice CP 508C. If you recently filed your tax return for the current year and expect a refund, the IRS will apply the refund to the debt and if the refund is sufficient to satisfy your seriously delinquent tax debt, the account is considered fully paid.

Passport Status

If you need to verify whether your U.S. passport has been cancelled or revoked, you should contact the State Department by calling the National Passport Information Center at 877-487-2778. If you need your U.S. passport to keep your job, once your seriously delinquent tax debt is certified, you must fully pay the balance, or make an alternative payment arrangement to keep your passport. Once you’ve resolved your tax problem with the IRS, the IRS will reverse the certification within 30 days of resolution of the issue.

Travel

If you’re leaving in a few days for international travel and need to resolve passport issues, you should call the phone number listed on Notice CP 508C. If you already have a U.S. passport, you can use your passport until you’re notified by the State Department that it’s taking action to revoke or limit your passport.

If the Secretary of State decides to revoke a passport, the Secretary of State, before making the revocation, may:

(a) Limit a previously issued passport only for return travel to the United States;

or

(b) Issue a limited passport that only permits return travel to the United States.

If your passport is cancelled or revoked, after you’re certified, you must resolve the tax debt by paying the debt in full, making alternative payment arrangements or showing that the certification is erroneous. The IRS will notify the State Department of the reversal of your certification within 30 days of the date the tax debt is resolved.

Robert E. McKenzie of the law firm of Arnstein & Lehr LLP of Chicago, Illinois, concentrates his practice in representation before the Internal Revenue Service and state tax agencies. He previously served as a member of the IRS Advisory Council (IRSAC) which is a group appointed by the IRS Commissioner from 2009 to 2011.

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Written by: Lauren Clemmer

Published: 31 July 2017

That does it take for a small firm to be on the path to growth? It takes vision and the willingness to do things differently. If you want different results, you can’t rely on the status quo. You should question the tried and true and create a new path. Firms experiencing the most growth are running their businesses in a different way. They are finding areas for focus that provide a competitive advantage. And they all put the client at the center of what they do, ensuring needs are met and they are helping them succeed. The following details the ways firms are driving growth from their own perspective.

Intentionally Establish Your Culture

Firms that are able to do things differently have a culture that supports growth at their core. MiddletonRaines+Zapata (MRZ) set out from its inception to think outside the box, even looking outside the industry for best practices.

“Growth starts with culture,” said Wesley Middleton, managing partner. “It has to be intentional.”

Culture has helped the firm grow from one office four and half years ago to four offices today. Known for energy, responsiveness and providing innovative solutions, MRZ is a place people want to work.

“Transparency is at the core of our business model. It’s how we build trust,” Middleton said. “Not only is innovation encouraged, but it is okay for someone to fail. That’s how they learn to do things better.”

Firm success also stems from:

• Investing in marketing and business development.

• Embracing digital marketing.

• Making client relationship managers the center of the client service model.

• Allowing partners to be great CPAs and not sales people.

• Trusting everyone to excel at what they are good at.

• Encouraging staff to become true advisors.

• Listening to what the client needs and delivering it.

By having a culture that puts the client first, plays upon individual strengths and focuses on the importance of the marketing and business development process, MRZ has created a winning business model.

Narrow Your Focus

High growth firms are twice as likely to be specialists according to Lee Frederiksen of Hinge Marketing. These firms experience 13.1% growth compared to 6.6% growth seen by generalist firms.

Family friendly and tech savvy firm Bohlmann Accounting Group wanted to build a firm that was “not your father’s CPA firm,” said Stehli Krause, office manager.

Bohlmann has a laser focus – specializing in international tax. Their staff is culturally diverse and representative of the industry they serve.

“Staff members are encouraged to promote our services in their home countries,” Krause said. Their focus is on serving the client and bringing services to them that help them manage their lives.”

The firm has uncovered a need for bookkeeping services in the international space, but they feel like they have just scratched the surface. They will continue to keep close to clients to discover other needs. This specialized focus is why the firm is up 21% over last year. Specialties level the playing field, allowing small firms to compete with larger ones, even on an international scale.

Package Services Clients Need

Rather than have a client come to you and tell you what they want to buy, try packaging and selling them what you know they need.

New Vision CPA Group takes this novel approach to selling services and keeps things simple. Every client starts with the Small Business Accounting & Tax Package which includes year-round advisory services. The firm specializes in working with small businesses, and they know what they offer and what they don’t.

“We meet with all clients four times a year, and they love it” said Jody Padar, CEO and principal, and author of The Radical CPA: New Rules for the Future- Ready Firm.

Through a customer-centric focus, Padar utilizes cloud solutions and social media to attract customers. She then provides value through a unique experience that is spelled out in her packages. As a result, the firm grew by 30% last year.

Don’t Skip the Strategy

If you want to have leverage when it comes to growing your firm, you have to start with a good strategy. But what should you include in your strategy? There is no uniform answer to that question, as there are many factors to consider. However, Frederiksen details the top four marketing plays that lead to growth:

1. Partnership marketing. Collaborate with another firm or organization to expand your reach.

2. Webinars and speaking engagements. Conduct these to promote thought leadership and get recognized.

3. Phone marketing. Conversations can provide additional information that leads to engagement.

4. Blogging and articles. Used to drive business to you.

As you look to grow your own firm, start by embracing change. Look at your culture to ensure it encourages innovation and spurs new ideas. Consider what you are doing differently from your competitors. This could be an industry and or service focus or packaging of your services. Move away from being a generalist and experience higher growth. Most importantly, have a plan. Don’t leave growth to chance.

Lauren Clemmer is the executive director of the Association for Accounting Marketing (AAM).

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Written by: CPA Magazine

Published: 25 July 2017

Crowdfunding comes in three flavors. It’s important to know the difference between Kickstarter, GoFundMe and Wefunder. Kickstarter is reward crowdfunding, GoFundMe is charitable crowdfunding and Wefunder is equity crowdfunding.

Kickstarter allows contributions to projects in exchange for a reward like a T-shirt or product. GoFundMe allows doners to give money to a good cause. Wefunder allows patrons to contribute to a company in exchange for equity at that company.

The U.S. Securities and Exchange Commission (SEC) refers to equity crowdfunding as Regulation Crowdfunding. Startups may now raise up to $1,070,000 from non-accredited as well as accredited investors per year effective May 16th, 2016. Fundraising over $100,000 requires at least a review of GAAP financial statements by an independent CPA for the past two years.

If the issuer has previously relied on Regulation Crowdfunding, a capital raise of more than $535,000 will require an audit. Remember, Form C, which is estimated to take 49 hours to complete, must be filed with the SEC before fundraising can begin.

In addition to the disclosure of GAAP financials, the number of employees, officers & directors, stakeholders with more than 20% voting power, past fundraising rounds, use of funds and all material risks must also be disclosed

With a Regulation Crowdfunding offering, you need to file an annual report once a year with financial statements and a discussion of your business, self-certified by the CEO as well as a business discussion. This must be done no later than three months after the end of the fiscal year. 

Investors are also limited in the amount of capital they may invest in Regulation Crowdfunding startups per year. To calculate your investment limit, first choose either your net income or net worth - whichever is lower. If the lower number is over $107,000, you are allowed to invest 10% of it each year. Otherwise, only 5%. For instance, if your income is $96,000 and your net worth $200,000, you'd be legally allowed to invest $4,800 per year in startups.

By law, all Regulation Crowdfunding investments must be made through a funding or a broker/dealer.

If you have more than 2,000 shareholders or 500 unaccredited shareholders, and more than $25 million in assets, you could be subject to burdensome SEC reporting requirements. If you have an S corp, you are limited to under 100 shareholders unless you convert to a C corp or LLC.

Investors confirm that startups and small businesses are very risky and they can afford a 100% loss of all investments. They also confirm they understand crowdfunded securities are not easily resold. There is no secondary market. It could take years for a return.

To learn more about crowdfunding and how the SEC is handling it, visit https://www.sec.gov/oiea/investor-alerts-bulletins/ib_crowdfunding-.html .

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