Articles

Is It Time to Enhance Your Annual Report?

2012-02-10T17:28:11Z

In an economic climate where everyone is trying to stretch their dollar, what you have to say and how you say it in your annual report could make a difference in the eyes of your donors. There is so much information available and it is easier than ever for donors and watchdog groups to access that information. As a result, there is a growing trend for organizations to present a well-rounded picture of their accomplishments and challenges in their annual reports.

In “A Charity Takes Cues From Business in Overhauling Its Annual Report” in The Chronicle of Philanthropy (October 20, 2011), one organization developed an extensive report with detailed descriptions about the organization’s financial performance, policies, and goals.

While the analysis included some key financial information, it primarily focused on narratives that would provide context to the underlying numbers. The report included information about the organization’s progress on its strategic plans and reported its governance standards and financial stewardship, all while keeping an objective viewpoint.

Striking a balance between business like thinking and social values is not a foreign concept to not-for-profits. Organizations have been faced with tough decisions and often have a story to tell about their struggles, successes, and plans for the future. An annual report is one way an organization could communicate its story, focusing on the information that people will need when determining whether to support the organization.

The following are some questions to consider when deciding what to include in an annual report:

How is the organization fulfilling its mission?
How does the organization compare to others in the same sector?
Did the operating results meet, exceed, or fall short of management’s expectations?
What are the organization’s short-term and long-term goals?
What do the leaders have to say about the organization?

For more information on what to include in your annual report please contact Toni Diprizio at tdiprizio@BlackmanKallick.com or 312-980-3227 or your Blackman Kallick representative.

Benefits of Conducting a Fraud Risk Assessment — Part Two

2012-02-10T17:28:02Z

Read "Benefits of Conducting a Fraud Risk Assessment — Part One"

Fraud is a risk to every organization whether large or small. Organizations should periodically assess their potential exposure to fraud and determine if their exposure is mitigated through their internal controls. As auditors, we are often asked (1) what is involved in a fraud risk assessment and (2) how an organization should conduct a fraud risk assessment. In Part One of this series, we explained what a fraud risk assessment is and the benefits of conducting a fraud risk assessment. In Part Two, we discuss how to plan and conduct a fraud risk assessment. In Part Three, we will discuss how to execute a plan to address risks identified in a fraud risk assessment.

Getting Started

Before beginning a fraud risk assessment, it should be understood that an effective fraud risk management program:

Requires board input and oversight
Is performed on a systematic and recurring basis
Identifies instances where fraud may occur within the organization
Involves appropriate personnel to consider relevant potential fraud schemes and scenarios
Links potential fraud schemes and scenarios to mitigating controls

As mentioned in Part One of this series, oftentimes the CFO drives the fraud risk assessment process. Whoever is selected to lead the process should be someone who can ensure cooperation across the entire organization. After an individual has been identified to drive the process, the first step to conducting the risk assessment is to understand where potential fraud risk occurs within the organization by gathering information.

Information Gathering

Organizations can use a variety of methods to gather information related to fraud risks.

One method is to organize brainstorming sessions with the board of directors and key senior leadership. Brainstorming sessions should be conducted in an open forum, using one or two individuals acting as facilitators to ensure the conversation stays on point and to document fraud risks identified by the participants. Questions in the brainstorming session should revolve around the theme “what could go wrong?”

The following questions may generate some fraud risk concerns in the brainstorming process:

Who has access to the vendor master file?
Who maintains custody of check stock?
Who has the ability and authority to sign a contract with a vendor?
Who can legally bind the organization into contracts?
Who receives cash receipts?
Who uses petty cash?
Who has corporate cards and what are their limits?
Who has signing authority on disbursements and checks?
Who has access to the banking software?
Who has the ability to view customers' credit card or banking information?

In situations where brainstorming sessions would not be effective or efficient, host small group or one-on-one meetings with individuals to identify their perceived risks of fraud to the organization.

An organization could also distribute confidential fraud risk questionnaires to individuals within the organization to gather information on potential fraud risks to the organization.

Assessment

Once an organization has gathered information about what could go wrong, the next step would be to identify the likelihood and significance of each fraud risk identified. In this phase, the organization would assess whether there are any existing controls in place that may detect or prevent the selected risks. The overall risk rating should be documented.

The fraud risk assessment could be documented by utilizing a matrix. The following are examples of components that could be summarized in the matrix during the information-gathering phase:

Risk type (information technology, financial, operational)
Fraud risk schemes identified
Existing controls (processes and controls in place to “catch” fraud)
Likelihood of fraud occurring (chance it could happen — remote, likely, etc.)
Significance to organization (quantitative and qualitative)
Fraud risk assessment rating (high, moderate, low)

By conducting and documenting a fraud risk assessment, organizations will be able to improve their internal controls and mitigate the potential risk of fraudulent activity. Part Three of this series will address executing and monitoring the fraud risk assessment.

For further information please contact Chris Cutrara, Senior Manager, at ccutrara@BlackmanKallick.com or 312-980-3341 or your Blackman Kallick representative.

Changes to Accounting for Accrued Medical Malpractice Claims and Expenses

2012-02-06T22:24:21Z

The accounting related to recording malpractice claims and the related insurance recoveries recently changed with Accounting Standards Update 2010–24, Health Care Entities: Presentation of Insurance Claims and Related Insurance Recoveries, which made significant alterations to current practices. Prior to the year ended December 31, 2011, healthcare entities (hospitals, physician practices, etc.) generally netted malpractice insurance claims against malpractice insurance recoveries on the balance sheet. The impact of this method of accounting generally understated malpractice-related assets and malpractice-related liabilities accordingly.

During 2010, the FASB decided to end this practice by updating Accounting Standards Codification Topic 954 to eliminate the industry exception enjoyed by the healthcare industry allowing the netting treatment of these assets and liabilities. For years beginning after December 15, 2010, with early adoption permitted, healthcare entities no longer have this exemption and must record the related assets and liabilities associated with malpractice claims at their gross amounts.

What this means for most healthcare entities is they will increase the receivables due from their related third-party malpractice insurers and re-insurers and, additionally, the total amount of claim liabilities to be paid will also need to be increased accordingly. The impact on the organization in most cases will be a balance sheet “gross up” (e.g., increasing current assets and liabilities); however, the entity recording the claims and related recoveries will also need to assess the related recoveries for collectability.

To read further regarding these topics and to see the actual related standard updates as well as changes to the codification, visit fasb.org.

For more information contact Paul D. Smith, Jr. at psmith@BlackmanKallick.com or 312-980-2901 or your Blackman Kallick representative.

Beware: New Form 8938 - Statement of Foreign Financial Assets

2012-02-03T16:28:18Z

Effective for tax years starting after March 18,2010, individual U.S. taxpayers (as well as bona fide residents of American Samoa and Puerto Rico) are required to include Form 8938, “ Statement of Specified Foreign Financial Assets”, in their income tax returns if they have " specified foreign financial assets" with an aggregate value exceeding an applicable reporting threshold. In effect, this new form is applicable for calendar year 2011. This form does not replace Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts (FBAR)”, but is in addition to it.

For 2011, Only Individuals Are Required To File:

Under Code Sec. 6038D, only specified persons are required to file Form 8938 if their interests in specified foreign financial assets exceed an applicable reporting threshold. Specified persons cover basically individual taxpayers who may file a U.S. tax return --- U.S. citizens, U.S. residents, nonresidents who elect to be treated as residents for filing a joint tax return, and residents of American Samoa or Puerto Rico. Bona fide residents of American Samoa or Puerto Rico are included as specified persons because they may be required to file a U.S. income tax return.

Proposed regulations (Prop. Reg. 1.6083D -6), issued on Dec. 19, 2011, require specified domestic entities to file Form 8938. These proposed regulations are not effective until finalized. Temp. Reg. 1.6038D-1T(a)(12) reserves the definition of a specified domestic entity. Therefore, the filing requirements for 2011 are only applicable to individual taxpayers.

The applicable reporting threshold for an individual taxpayer varies based on whether an individual lives in the United States or files a joint income tax return. Once the applicable threshold is met, Form 8938 is required regardless whether or not the interests in the specified foreign financial assets have any income tax effect. However, an individual is not required to file Form 8938 if he / she is not required to file an income tax return for the tax year.

In short, whether an individual taxpayer is required to file Form 8938 depends on his/her filing status , residency and the total value of interests in specified foreign financial assets held by the individual. The following provides an overview of 1) an interest in a specified foreign financial asset, 2) the reporting thresholds and 3) the value of specified foreign financial assets.

Interests in Specified Financial Assets:

Under Temp. Reg. 1.6038D -3T, specified foreign financial assets are broadly defined and include assets that one may not believe to be “foreign assets”. The term generally includes, but is not limited to the following assets:

Any financial account maintained by a foreign financial institution. Besides obvious financial institutions such as foreign banks, a foreign financial institution includes investment vehicles such as foreign mutual funds, foreign hedge funds, and foreign private equity funds.
To the extent held for investment (and not in an account maintained by a financial institution), any stock, securities, financial instrument or contract that is issued by a person (or has a counterparty) that is not a U.S. person. Examples of such financial assets include:
- stock of a foreign corporation,
- a capital or profits interest in a foreign partnership,
- a note, bond debenture, or other form of indebtedness issued by a foreign person,
- an interest in a foreign trust or foreign estate,
- an interest rate swap, currency swap, basis swap, and any notional principal contract with a foreign counterparty,
- an option or any derivative instrument with respect to any currency, commodity or other financial asset that has a foreign counterparty,
- an interest in a foreign retirement plan or foreign deferred compensation plan, and
- any foreign life insurance products.

In accordance with Temp. Reg. 1.6038 D-3T (a) (3) (ii), a financial account is not a specified foreign financial asset if all of the holdings in the account are marked-to-market under Code Sec. 475 (a), (e) or (f). Similarly, a foreign asset not held in a financial account is also not a specified foreign financial asset if it is marked-to market under Code Sec. 475 (a), (e) or (f). Temp. Reg. 1.6038D-3T (b) (2).

An asset is held for investment if the asset is not used in, or held for use in, the conduct of a trade or business. Under Temp . Reg. 1.6038D -3T (b) (4), an asset is used in, or held for use in, the conduct of a trade or business if the asset is: 1) held for the principal purpose of promoting the current trade or business, 2) acquired and held in the ordinary course of a trade or business (e.g., account or note receivables arriving from the trade or business), or 3) held in a direct relationship to the trade or business. For the purpose of determining whether an asset is held in a direct relationship to a trade or business, principal consideration is given on whether the asset is needed for the present needs of the trade or business. An asset is not considered needed in the trade or business if , for example, it is held for the purpose of providing for future diversification into a new trade or business, future plant replacement, or future business contingencies. Stock is never considered used or held for use in a trade or business.

An individual is generally considered to have an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross receipts, or distributions attributable to the specified foreign financial asset would be reported or otherwise reflected on an annual income tax return of such individual. The individual is considered to have an interest in the specified foreign financial asset even if there were no income, gains, losses, deductions, credits, gross receipts, or distributions for the tax year. Temp. Reg. 1.6038D -2T (b)(1)

An individual is generally not treated as having an interest in any specified foreign financial assets held by a partnership, corporation , trust, or estate solely as a result of his/her status as a partner, shareholder, or beneficiary. However, an individual is considered to have an interest in specified foreign financial assets if he/ she is the owner of a disregarded entity (e.g., single member LLC) which owns such assets. Unless an exception specified in Temp. Reg. 1.6038D-2T(b)(3) applies ,a grantor of a grantor trust is also treated as owning interests in specified foreign financial assets held by such trust. A parent that makes an election under Code Sec. 1(g)(7) to include unearned income of a child is considered to have an interest in the specified foreign financial assets held by the child. Temp. Reg. 1.6038D-2T (b) (2)

Reporting Thresholds:

The reporting threshold varies depending on an individual taxpayer's filing status and residency. Following is a table showing that an individual taxpayer must file Form 8938 when the total fair market value (FMV) of specified foreign financial assets exceeds one of two thresholds (i.e., amount at year end or maximum amount anytime during the year) in accordance with his/ her filing status and residency.

Under Temp. Reg. 1.6038D-2T (3) and (4), an individual is considered living abroad if he/she is a qualified individual under Code Sec. 911(d)(1) for the foreign earned income exclusion.

Value of Foreign Financial Assets:

Generally, FMV is used for the purpose of determining if the specified foreign financial assets exceed an applicable reporting threshold. Specific rules are set forth in Temp. Reg.1.6038D-5T for the purpose of determining the FMV of certain assets. For example, if the value of a specified foreign financial asset is less than zero, the value is treated as zero.

If the foreign asset is denominated in foreign currency, the value is first determined in the foreign currency and then converted to U.S. dollars using the foreign currency exchange rate on the last day of the taxable year. In most cases, the U.S. Treasury Department’s Financial Management Service foreign currency exchange rate for purchasing the U.S. dollars must be used (find rate at www.fms.treas.gov/intn.html). If a U.S. Treasury Financial Management Service foreign currency exchange rate is not available, another publicly available foreign currency exchange rate may be used as long as it is disclosed on Form 8938.

If an asset is jointly owned, the value that an individual uses to determine the total value of all specified foreign financial assets depends on whether the other owner is a spouse, and if so, whether the spouse is a specified individual and whether a joint or separate return is filed. See Temp. Reg. 1.6038D-2T(c).

Joint ownership with spouse filing joint return
- File one combine Form 8938 for the tax year, if required.
- Include the value of the assets jointly owned with the spouse only once to determine the total value of all specified foreign financial assets.
Joint ownership with spouse filing separate return
- Each spouse files a separate Form 8938, if required.
- Include one-half of the value of the assets jointly owned with the spouse to determine the total value of all specified foreign financial assets.
Joint ownership with others, or with a spouse who is not a specified individual
- Each owner files a separate Form 8938, if required.
- Include the entire value of the jointly owned assets to determine the total value of all specified foreign financial assets.

Penalties

Failure to file a complete Form 8938 will result in a $10,000 penalty. Although the penalty may be waived when there is reasonable cause, a taxpayer must make an affirmative showing of all the facts alleged as reasonable cause.

Other penalties, including accuracy-related penalty, fraud, and criminal penalties, may also apply.

For further information, please contact Paul C. Lau at plau@BlackmanKallick.com or 312-980-2935, Amanda Zhong at azhong@BlackmanKallick.com or 312-980-3324, or your Blackman Kallick representative. This alert was originally published on icpas.org.

You’ve Got Two More Days to File Your Tax Return

2012-02-02T22:37:36Z

For Tax Season 2012, the due date for “April 15 returns” for Tax Year (TY) 2011 is April 17, 2012.

April 15 falls on a Sunday in Tax Season 2012, which under most circumstances would push the due date to Monday, April 16. However, Washington, DC will observe Emancipation Day on the sixteenth, and all federal and municipal offices will be closed. Consequently, April 17 is the official IRS due date for all returns normally due on April 15.

Emancipation Day, a legal holiday in DC, is observed annually on April 16.

Under §7503 of the IRC, when the last day for “performing any act” falls on a Saturday, Sunday, or legal holiday, the performance of that act is considered timely if it is performed on the next weekday that is not a legal holiday. “Legal holiday” refers to a legal holiday in Washington, DC. Thus, individual tax returns and all returns that are normally due on April 15 will be considered timely if they are filed on or before April 17, 2012. Many states are expected to comply with the due date change but not all have confirmed. Illinois will be recognizing the April 17 due date.

For further information please contact Jennifer Perfect Toyloy at jtoyloy@BlackmanKallick.com or 312-980-3280 or your Blackman Kallick representative.

1099-MISC Requirements for Landlords

2012-02-02T22:26:20Z

In the past couple of years Congress has been active in modifying filing requirements for informational returns, especially 1099s. All of these changes have left informational return filing requirements misconstrued, especially in the case of landlords on their individual tax returns.

The Patient Protection and Affordable Care Act (PPACAP), enacted in 2010, increased the 1099 filing requirements to include any payment of $600 or more for goods or services rendered from any single vendor. On September 27, 2010, the Small Jobs Business Act (SBJA) was passed reclassifying any individuals receiving rental income as engaging in the business of renting property, and as a result, expanded the 1099 filing requirement by the PPACAP to all landlords.

In the spring of 2011 both the extensive 1099 filing requirements sanctioned by the PPACAP and the extension of these requirements to landlords under the SBJA were repealed by the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011. This repeal has caused the misunderstanding that landlords are no longer required to file 1099s for services paid.

Although the act repealed the extensive reporting requirements in which landlords were included, the historical rules still apply, causing some landlords to still be obligated to file Form 1099. Section 6041(a) states all persons engaged in a trade or business and making payment of rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable gains, profits, and income of $600 or more in the course of such trade or business to another service provider who is not incorporated, must report the amount, and the name and address of the recipient of such payment. Because this statute has not been overturned, landlords engaging in the business of renting property are still required to issue 1099s for vendors paid $600 or more. A person engaging in a trade or business is defined as a person who is involved in the activity continuously and regularly and whose main motive in engaging in the activity is for income or profit. Thus these filing requirements will not apply to the owner of property who turns over management duties to an outside source, as he is not regularly and continuously involved in the activity.

To emphasize the matter of filing requirements, the IRS has modified Schedule E. At the top of Schedule E there are now two new questions, A and B. Question A asks, “Did you make any payments in 2011 that would require you to file Form(s) 1099?” Question B asks, “If ‘yes,’ did you or will you file all required Forms 1099?” In the case of these questions the rules stated in 6041(a) apply. For example, if a landlord pays $1,000 to a handyman for various repairs in a rental unit over the course of 2011, the landlord would have to answer “yes” to both questions since it is a payment in the course of a trade or business and the payment amount is above the $600 threshold.

It is also important to note that although the extensive filing requirements were alleviated with the repeal, the increase in penalties for not filing 1099s still pertains. Taxpayers are penalized $250 for each 1099 intentionally not filed.

For further information, please contact Kristin Bonnett at kbonnett@BlackmanKallick.com or 312-980-3327, Louis Sands at lsands@BlackmanKallick.com or 312-980-3219, or your Blackman Kallick representative.

Where Do You Live? The Illinois Tax Edition

2012-02-02T22:06:17Z

And why does it matter? It seems that Illinois residents have been asking this question more often since Illinois increased its individual income tax to five percent.

How does Illinois define a resident?

Illinois defines "resident" as:

(A) an individual (i) who is in this state for other than a temporary or transitory purpose during the taxable year, or (ii) who is domiciled in this state but is absent from the state for a temporary or transitory purpose during the taxable year.¹

A regulation goes on to define "domicile" that shows it is the intent of the taxpayer that leads the residency claim:

Domicile has been defined as the place where an individual has his true, fixed, permanent home and principal establishment, the place to which he intends to return whenever he is absent. It is the place in which an individual has voluntarily fixed the habitation of himself and family, not for a mere special or limited purpose, but with the present intention of making a permanent home, until some unexpected event shall occur to induce him to adopt some other permanent home.²

The code and regulations make it very clear that there are no hard-and-fast rules that define residency. The best the state has to offer are presumptions — the following two to be specific:

If an individual spends in aggregate more than nine months of any tax year in Illinois it will be presumed that he is a resident of Illinois.
An individual who is absent from Illinois for one year or more will be presumed to be a nonresident of Illinois.

So are you an Illinois resident?

If you've truly moved out of state, the answer is you're not an Illinois resident. But if you do something short of abandoning your Illinois residence, there’s a chance Illinois could still continue to deem you a resident. As the old saying goes, home is where the heart is, and the Illinois Department of Revenue sometimes asserts that individuals may claim a "home" just to save taxes.

What happens when I die?

Individuals may be subject to federal and state estate tax where they are domiciled. For Illinois purposes, the Illinois estate tax exemption was $2 million for residents dying before January 1, 2012 and increased to $3.5 million for residents dying in 2012. For residents dying on or after January 1, 2013, the exemption is further increased to $4 million. Fewer Illinois residents will be paying Illinois estate tax.

What does this mean to me?

If you’re an Illinois resident, it means your estate tax has decreased.

If you’re moving out of Illinois, it means be careful. Illinois rules are very subjective and taxpayers can potentially find themselves being residents of two states. For instance, New York has a hard-and-fast 183-day rule — if you have a New York place of abode and are present in New York more than 183 days, you are a New York resident.³ In a worst-case scenario, an Illinois resident could move to New York and think he's abandoned his Illinois residence since he was in New York more than 183 days. Unfortunately, an auditor could take exception to this and the individual could be considered a resident of both states. Talk about going from bad to worse!

If you have questions or would like assistance in minimizing the likelihood of being a resident of more than one state, contact Jason Parish at jparish@BlackmanKallick.com or 312-980-2959, Deb Rood at drood@BlackmanKallick.com or 312-980-2995, or your Blackman Kallick representative.

¹§1501(20)(A)
²Ill. Admin. Code 100.3020(d)
³New York Tax Law Sec. 605(b)(1)

Specialty Snapshot: Home Healthcare Services

2012-01-11T19:55:14Z

There are approximately 33,000 home care providers across the US with combined total projected revenues in 2009 of approximately $72.2 billion. This industry is highly fragmented, and the 50 largest companies generate less than 25 percent of the total revenue associated with this business segment of the healthcare marketplace. The average revenue per worker is estimated at approximately $50,000.

FTE - Full-time Equivalent
Click table to enlarge

Services include traditional home health care, home hospice care, and home nursing care. Home healthcare services include medical and skilled nursing services; medical equipment, supplies, and medication services; personal care (such as bathing and transportation); therapeutic services (such as physical and respiratory therapy), and psychosocial services (including counseling and spiritual care).

Items to keep in mind regarding the current home healthcare industry:

The population of individuals who generally utilize the services provided by the home healthcare industry is going to expand over the next 20+ years by 50 percent or approximately 40 million more people entering this age segment of the population.
Pediatric home healthcare for pediatric patients with long-term conditions is preferred by both doctors and parents, and is more profitable than services to geriatric patients, as the required technical skill level and reimbursement rates are higher.
With approximately 65 percent of reimbursements for services coming from Medicare and Medicaid, the significant cuts pending with the recent Patient Protection and Affordable Care Act of 2010 (Healthcare Reform) will have a negative impact on the industry.
There are proposed measures to change Medicare’s reimbursement rules for home therapy visits that would alter the way providers are reimbursed, decreasing the number of allowed home visits and additionally negatively impacting revenues.
The industry is labor intensive and the profitability of individual companies depends on effective marketing and efficient operations.

With the population aging and the cost of home healthcare lower compared to hospitalization or institutionalization, opportunities for industry growth are significant through the expansion of additional services. The increased willingness of managed care organizations to pay for home care is an opportunity for home healthcare providers to expand their services.² The following example analyzes the costs associated with different types of healthcare services.

SNF - Skilled Nursing Faculty
Click table to enlarge

Selected Benchmarking Data:

EBITBA - Earnings before interest, taxes, depreciation, and amortization
Click table to enlarge

Industry websites:

If you have any questions on home healthcare services, please contact Paul D. Smith, Jr. at psmith@BlackmanKallick.com or 312-980-2901 or your Blackman Kallick representative. Our thanks to Beth Carpenter of Beth Carpenter and Associates for her contribution to this article. For more information and resources visit bethcarpenterandassociates.com.

¹Source - Hospice Salary & Benefits Report, 2009-2010, Hospital & Healthcare Compensation Service in cooperation with Hospice Association of America, October 2009.
²Data from Hoovers, Inc. FirstSearch Industry Profile and National Association of Home Care & Hospice, © 2011. All rights reserved.
³Source - 2005-2007 are from the Annual Statistical Supplement, 2008, to the Social Security Bulletin, Social Security Administration. 2008-2009 are updated using the Bureau of Labor Statistics’ (BLS) General medical and surgical hospitals Producer Price Index (PPI).
⁴Source - 2005 from the Annual Statistical Supplement, 2006, to the Social Security Bulletin, Social Security Administration. 2006-2009 are updated using the BLS Nursing care facilities PPI.
⁵Source - 1999-2007 are from the Health Care Financing Review, Statistical Supplement, Centers for Medicare & Medicaid Services, 2008. 2008-2009 are updated using the BLS Home health care services PPI.
⁶Source - First Research - Averages and data for 14,371 agencies.

Is Your Healthcare Entity a Personal Service Corporation?

2012-01-10T23:08:47Z

A qualified personal service corporation (PSC) is a specific type of C Corporation, providing personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting. Many entities currently classified as PSCs could see substantial tax savings if they elect to convert to a flow-through S Corporation. The IRS classifies a PSC as a C Corporation where 95 percent of the work performed is in personal services, and 95 percent or more of the stock by value is held directly by employees providing these services or by retired employees who provided these services during their tenure.

The PSC rules are a result of the tax structure prior to the Tax Reform Act of 1986, when individual tax rates were much higher than corporate rates. At that time, many individuals performing personal services formed corporations so that income was taxable to the corporation and therefore subject to the substantially lower corporate tax rate. To mitigate the tax savings by personal service professionals incorporating, PSC restrictions were put into place and a flat 35 percent tax imposed on PSC income. This flat PSC tax differs from the graduated tax rates normally levied on a C Corporation. In general a flat tax is seen as unfavorable however during the 1970s and 1980s, the 35 percent PSC flat rate was still very favorable versus the high individual income tax rates at the time.

This situation changed in the following decade, as the maximum individual income tax rate dropped from 70 percent in 1980 to 28 percent in 1990. The top rate has stayed level for the last eight years at 35 percent. As a result of this trend toward lower individual tax rates, the incentive for personal-service-provider owners to continue as a PSC in order to benefit from a material income tax rate differential has been eliminated. There are many tax implications that should be reviewed by the PSC owners and their advisers to ascertain if the PSC structure still makes financial sense or if an S election should be made to create a flow-through entity going forward.

In addition to the flat tax rate of 35 percent, PSCs have many tax disadvantages in comparison with S Corporations. Dividends paid to the employee-owners are subject to double taxation; income is first taxed at 35 percent for the corporation, and then taxed again on the individual’s return as a dividend (currently 15 percent for qualified dividends). As a result, PSC owners want to decrease the potential pool of doubled-taxed income to close to zero, often by increasing the amount of salaries paid to the employee-owners. If there is a large amount of compensation with little or no dividends paid to employee-owners, the IRS may recast some of the compensation as taxable dividends, which would then be subject to double taxation. Interest and possibly penalties would also be added to this amount.

Conversion from a PSC to an S Corporation may provide considerable tax advantages while maintaining the limited liability advantages of incorporation. By electing to become a flow-through entity, the issue of double taxation is eliminated. Also, the personal-service-provider owners would be taxed using graduated individual income tax rates as opposed to the flat 35 percent PSC tax.

One of the most often overlooked tax-planning issues related to PSCs is the tax implications of selling the entity at a future date. In addition to the previously mentioned issue of double taxation, there is also not a favorable long-term capital gains rate for C Corporations as there is for individuals. If a C Corporation has an asset sale, any capital gain is taxed at 35 percent, and the remaining cash distributed out to the owners will be taxed again at dividend rates. Any capital gain for an S-Corporation asset sale would be taxable to the individual owners, allowing for a favorable (currently 15 percent) long-term capital gains rate.

When converting from a C Corporation to an S Corporation, the advantages are not all immediately available; judicious tax planning now can reap substantial benefits in the coming years. Corporations that convert to an S Corporation from a C Corporation are subject to a built-in gains tax, which is applicable for 10 years after conversion. Any gain on sale is taxed as though the Corporation were a C Corporation up to the value in place at conversion. Any residual value would then be taxed as an S Corporation that flows through to the owners. The built-in gain would be zero if the S election had been made at the time of incorporation. To start the clock on built-in gains, it is best to convert to an S Corporation earlier rather than later, and ideally to wait until the built-in gains tax is no longer applicable before the entity is sold.

There are many advantages to converting from a PSC to an S Corporation. Please consult your tax advisor to see if an S Corporation election is right for your PSC.

For further information, please contact Leslie Shoemaker at lshoemaker@BlackmanKallick.com or 312-980-3303, Gina Mastrangeli at gmastrangeli@BlackmanKallick.com or 312-980-3355, or your Blackman Kallick representative.

Donations of Conservation Easements

2012-01-04T16:02:50Z

A new Internal Revenue Service Audit Techniques Guide (ATG) on conservation easements gives taxpayers an outline for how IRS examiners will view charitable contributions of conservation easements. The purpose of a conservation easement is to preserve and protect property from future development or subdivision.

Acknowledging the need to preserve our natural resources, Congress allows a charitable deduction for property owners who give up certain rights of ownership to preserve their land or buildings for future generations. However, having seen abuses of this tax provision in the past, Congress is issuing guidance for the deductibility of this type of donation.

To qualify for this income tax deduction, the easement must be legally binding and must permanently restrict use and development of the property. It must be made to a qualified organization and serve a conservation purpose, meaning the property must have an appreciable natural, scenic, historic, scientific, recreational, or open-space value.

Qualified Real Property

Examples of real property qualifying for the deduction are parks, wetlands, farmland, forest land, scenic areas, and historic land or structures.

Qualified Organization

Qualified organizations include a federal or state governmental unit or a public charity described in section 501(c)(3) of the Internal Revenue Code. A conservation easement must be received by an eligible donee to be deductible. (Not all qualified organizations are eligible to accept deductible conservation easements.) Furthermore, a qualified organization must have a commitment to protect the conservation purpose of the easement. Such organizations will generally have a monitoring system in place to enforce the restrictions of the easement.

Conservation Purpose

IRC § 170(h)(4)(A) defines “conservation purpose” as one of the following:

Preservation of land for the outdoor recreation of, or education of, the general public
Protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem
Preservation of open space either for the scenic enjoyment of the general public or pursuant to a clearly delineated governmental conservation policy (both purposes must yield a significant public benefit)
Preservation of a historically important land area or a certified historic structure

The ATG further explains each of the four qualifying purposes in detail.

Perpetuity of Restrictions

A deductible conservation easement must be made in perpetuity, permanently restricting the use of the property. This means that the deed of conservation easement must state the following:

The restriction remains on the property forever
The restriction is binding on current and future owners of the property

If a conservation-easement deed only imposes restrictions for a specific period such as 10 years, it is not deductible since it does not meet this requirement. In addition, an easement is not considered to be in perpetuity if it allows for future amendments that would change the nature of the restrictions.

Substantiation

The burden of proof is on the taxpayer to demonstrate that the transfer of property to a qualified organization is deductible. For all donations of $250 or more, written acknowledgment must be received from the charity. Specifically, the taxpayer must keep records of pertinent expenses, and the charity must write a letter acknowledging the gift. The letter must include the description (but not the value) of the easement and a statement that nothing was received in return. If anything was received in return, a good-faith estimate of the value of the goods received must be subtracted from the charitable deduction. Finally, Form 8283 must be properly completed and attached to the taxpayer’s Form 1040 for all donations greater than $5,000.

Qualified Appraisal

Qualified appraisals are required for all deductions of conservation easements greater than $5,000. The rules for an appraisal to be considered “qualified” are fairly intuitive and are specifically set out in the ATG.

The value of the easement is generally the fair market value at the time of the contribution. If there is a substantial record of sales of easements comparable to the donated easement, the fair market value (FMV) is based on the sales price of such comparables. If there is no substantial record of marketplace sales, the value is generally determined using the “before and after” method which takes into account the decrease in the FMV of the underlying property after the easement is transferred and compares it to the value of the property before it was transferred. The difference is the value of the contribution. If there is no decrease in the property value after the easement has been given, there is no charitable donation allowed. If the taxpayer owns contiguous property, that property is included in the “before and after” FMV amounts as well.

View the conservation easement audit technique guide at irs.gov

For further information, please contact Patti Benaissa at pbenaissa@BlackmanKallick.com or 312-980-3290, Nora Stapleton at nstapleton@BlackmanKallick.com or 312-980-2933, or your Blackman Kallick representative.

Illinois Tax Change: More Than Sears and CME

2012-01-04T15:06:21Z

The passing of SB 397 and SB 400 in December has brought a lot of publicity to the tax breaks for Sears and CME Group. However, there are some significant changes for all Illinois residents and businesses. Most notably, the change in the estate exclusion will be increasing starting with the 2012 tax year. As of January 1, 2012 the exclusion will increase from the current $2 million to $3.5 million. Starting with the 2013 tax year the exclusion will be $4 million dollars, putting it closer to the current federal exclusion of $5 million. While a death is something no one can plan for or wants to think about, it is nice to know that the gap between federal and state exclusions will be reduced. This should mean less of a headache when it comes to estate planning.

Businesses also got a little good news — the Net Loss Deduction (NLD) carryforward suspension was lifted in favor of a limit. C corporations with NLD carryforwards will now be allowed to use up to $100,000 of NLD in 2012 and 2013 instead of having them suspended until 2014 as was originally introduced in 2010. This means a savings of up to $9,500 of Illinois tax liability for each of those two years.

Not included in either bill but still important was Illinois's treatment of 100% bonus depreciation. The state has not decoupled from the federal bonus depreciation and no addition will be necessary for 2011. This is not a change from the last part of 2010 but allows taxpayers who have placed new fixed assets in service in 2011 a full deduction in the current year.

Other changes to be aware of include the following:

5-year extension of R&D credit
Extension of replacement-tax investment credit through 2018
Increase of personal exemption to $2,050 for 2012 — indexed for inflation going forward
Extension of the Earned Income Credit (EIC)
Extension of all credits set to sunset in 2011–2013

While this is not an exhaustive list of the changes in the two bills, it does bring to light the many taxpayer-friendly addendums to the Illinois tax laws.

If you have any questions regarding these changes please contact Jason Parish at jparish@BlackmanKallick.com or 312-980-2959, Deb Rood at drood@BlackmanKallick.com or 312-980-2995, or your Blackman Kallick representative.

2012 Standard Mileage Rates

2012-01-03T18:36:37Z

On December 9, 2011 the IRS released the standard business, deductible medical, and moving mileage rates effective January 1, 2012. The rate for business miles has remained unchanged since the 2011 mid-year adjustment. The medical and moving rate has decreased by .5 cents.

The new rates are contained in Announcement 2011-116

Taxpayers may use the optional standard rates to calculate the deductible costs of operating an automobile for business and other purposes. The optional business standard mileage rate is used in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

New rates Beginning January 1, 2012:

Standard Business Rate	55.5 cents per mile
Medical and Moving Rate	23 cents per mile
Charitable Rate	14 cents per mile

Please contact Kim Haumann at khaumann@BlackmanKallick.com or 312-980-3249 or your Blackman Kallick advisor with any questions.

Congress Extends the Reduced Social Security Rate for Employees

2012-01-03T18:24:31Z

On December 23, 2011 Congress passed and President Obama signed into law the "Temporary Payroll Tax Cut Continuation Act of 2011." The two percent social security tax rate cut has been extended through February 29, 2012 for the employee side of payroll taxes and self-employed individuals.

The law also added a recapture provision applying to employees earning more than $18,350 in wages during the first two months of 2012. This provision adds back the two percent savings on earnings between $18,350 and $110,100 (2012 social security wage base) received by February 29, 2012. The additional tax is to be reported on the individual's 2012 income tax return and will be payable in 2013.

A House-Senate Committee will be convening to consider extending this temporary payroll tax cut to all of 2012, which may remove the provision for recapture.

Please contact Corey Crane at ccrane@BlackmanKallick.com or 312-980-3377, Cara Hoffman at choffman@BlackmanKallick.com or 312-980-3274, or your Blackman Kallick tax advisor for further details.

2011 and 2012 Increase to Federal Unemployment Taxes

2011-12-30T15:19:40Z

Twenty states and the Virgin Islands will see an increase in their Federal Unemployment Tax (FUTA) for 2011 and 2012. Many state unemployment insurance funds borrowed from the federal government recently due to the economic downturn. When the loans remain unpaid for two years employers in their home state are subject to a reduction in the credit that employers take against FUTA. The reduction in the credit is used to repay the state’s obligation on unemployment insurance loans. The states had until November 10, 2011 to repay the loans to avoid the FUTA credit reduction.

Employers generally pay both federal and state unemployment insurance taxes on wages paid. The Federal rate is 6 percent. State rates vary greatly. The IRS allows a credit of 5.4 percent against the 6 percent for payment of state unemployment taxes. This makes the effective rate for FUTA 0.6 percent (.006) on taxable wages up to the limit of $7,000.

The FUTA rate was reduced effective July 1, 2011 by 0.2 percent from the 0.8 percent it was in recent years. This complicated the Form 940 by assessing different rates for wages paid through June and wages paid between July and December 31, 2011. The 2011 Form 940 identifies the states that are subject to the FUTA Credit Reduction for 2011.

The 2011 Credit Reduction States

Arkansas
Connecticut
Georgia
Indiana
Michigan
Missouri
New Jersey
North Carolina
Pennyslvania
Virginia
Wisconsin

California
Florida
Illinois
Kentucky
Minnesota
Nevada
New York
Ohio
Rhode Island
Virgin Islands

All but Indiana and Michigan have a reduced credit of 0.3 percent. For everyone besides Indiana and Michigan the net FUTA rate will be 1.1 percent for wages paid up to $7,000 for the first six months of 2011 and 0.9 percent for FUTA taxable wages paid between July and December 31, 2011. The FUTA rate is higher for Indiana and Michigan since they have failed to repay their loans for two or more consecutive years. Indiana’s rate for the first six months of 2011 is 1.4 percent and 1.2 percent for the last six months of 2011. Michigan’s rate is 1.7 percent for the first six months of 2011 and 1.5 percent for the remainder of 2011.

The IRS completed their revision of the 2011 Form 940, Schedule A, Multi-State Employer and Credit Reduction Information, in December 2011. The Schedule A must be completed by employers if they pay unemployment taxes to more than one state or if they paid wages in any of the states subject to the credit reduction in 2011. Employers in these states do not have to make a federal unemployment tax deposit for the increase in their FUTA rate until the fourth quarter deposit due on January 31, 2012. When completing the Schedule A, be sure to only include taxable FUTA wages, not all wages.

The FUTA rate for 2012 is set to remain at 0.6 percent of wages, up to the $7,000 limit. Employers in credit reduction states should be on alert as most will see an increase in FUTA taxes in 2012 (payable in January 2013). Unless the state pays off its loans, or federal law changes, their FUTA Credit Reduction will increase 0.3 percent annually. Illinois authorized the issuance of bonds in 2012 to pay off the outstanding loans. If this goes through, employers will not be subject to FUTA credit reduction in 2012. Texas did the same. Additional states, such as Colorado, Delaware, Kansas, and Vermont, are expected to become credit reduction states during 2012.

Employers should be aware that they carry the burden of annual interest assessments from the outstanding loans to the states. The interest on federal loans was waived through 2010 by the American Recovery and Reinvestment Act of 2009, but that has since expired.

Please contact Kim Haumann at khaumann@BlackmanKallick.com or 312-980-3249, Cara Hoffman at choffman@blackmankallick.com or 312-980-3274, or your Blackman Kallick advisor with any questions.

Small Business Health Care Tax Credit

2011-12-27T16:22:57Z

On March 23, 2010 the government passed the highly publicized Affordable Health Care for America Act that affected most Americans. Included in this bill were specific credits aimed to help small-business owners reduce their taxes by way of a credit based on the level of employee health insurance premiums that they pay.

In order to qualify for the credit, you must cover at least 50 percent of single (not family) health care coverage for each employee. You also must have fewer than 25 full-time-equivalent employees. These employees must have an average wage of less than $50,000 a year. This credit operates on a sliding scale; therefore, the smaller the business, the bigger the credit will be.

For tax years 2010-2013, the maximum credit available is 35 percent for small-business employers and 25 percent for small tax-exempt employers. This credit is slated to jump to 50 percent and 35 percent, respectively, on January 1, 2014 but more specific information on the enhanced information will be available in the near future.

It is important to note that if small-business owners do not owe tax during the year, they can carry the credit back or forward. It is also important to recognize that the amount of health insurance premium payments is more than the total credit, so eligible small businesses can still claim a business-expense deduction for the premiums in excess of the credit.

For Example:

A dental practice has 10 full-time-equivalent employees and has wages of $250,000, or $25,000 per full-time employee. The dental practice spends $80,000 on employee health care costs. At this level, in 2010 the dental practice would receive a $28,000 credit (35%). In 2014, this same dental practice would receive a $40,000 credit (50%).

This credit could prove to be extremely beneficial to small businesses and should be taken into consideration when filing your 2011 taxes. This credit can be claimed on your income tax return by using Form 8941.

Download a PDF copy of Form 8941: Credit for Small Employer Health Insurance Premiums

Please contact Melissa Colgan at mcolgan@BlackmanKallick.com or 312-980-2982, Leslie Shoemaker at lshoemaker@BlackmanKallick.com or 312-980-3303, or your Blackman Kallick representative for more information.