“They that can give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety.” — Benjamin Franklin

Business Loss Prevention Tips (i.e., “Stealing”)

Here is a brief and excellent summary of some basic ways to help prevent business thefts:

• Right now perform a background check on all employees working in check preparation and signing — and on all new employees in the future.
• Segregate duties. Ideally, different individuals should perform check preparation; check signing and bank reconciliations.
• Have someone other than the check preparer open bank statements and review them. (For very small firms we recommend that the bank statements be sent directly to the owner’s home.)
• Require all individuals involved in check preparation services to take time off.
• On a surprise basis, have a higher level individual or owner review check preparation and signing services.
• Have a two-signature requirement for all checks over a certain amount. (Not foolproof, they can write multiple checks that are each under that trigger amount.)
• Require written authorizations or approved documentation for all disbursements.
• Cross train employees to review each other’s work.
• Restrict access to check register and bank statements.

When reviewing canceled checks, look for such things as: checks missing from the sequence; strange signatures or endorsements; multiple endorsements on checks; if payee on check does not match name in check register; anything else that looks strange, suspicious, or untoward. Begin the review with a suspicious attitude and a chip on your shoulder — you may be surprised!*

High Risk Employees

Another list from CAMICO — employees most likely to go for your money are those with these characteristics:

• Unresolved financial problems.
• Compulsive gambling.
• Alcohol or drug abuse.
• Close relationship with suppliers in which collusion may occur.
• Never take a vacation.
• Work late all the time.
• Constantly seem to live beyond their means.
• Are secretive about their work.
• And one we added: Going through a bitter and contested divorce.

Unmarried Couples

Among numerous other differences, as we are advised by many lawyers, unmarried couples (of different or the same sex — doesn’t matter) usually do not have the automatic right to inherit property, as a spouse does. This is not a social commentary about such arrangements, but rather just an overview of some of the special problems. Among others for which there are no automatic rights are:

• The IRS does not permit the filing of joint tax returns.
• Any decisions regarding a deceased or incapacitated partner’s financial affairs or medical problems.
• Who will inherit retirement plans’ assets? Or any other assets?
• Care for any children.
• Disposition of joint assets in the event of dissolution — or death of one partner.
• Similar decisions, always requiring documents that can only be covered in advance with competent legal advice.

A few general suggestions, although state-by-state laws regarding unwed couples vary (and some state laws are in a state of flux):

A “domestic partnership agreement.” Typically may cover such items as: separate assets of each; joint assets later acquired; dissolution of their “association”; death; joint ownership of real estate; and other similar difficult issues.

A financial power of attorney if one partner is incapacitated. It can be in favor of the other partner or any other individual or financial institution. Also containing a description of exactly what specific conditions will activate this document.

A will. As stated, there are generally no automatic rights of inheritance to a surviving unmarried partner — while there are many for a surviving spouse and other family members.

A “living will” that spells out the medical care desired by an incapacitated partner, which can guide the decisions of the individual holding (also necessary) a “health care power of attorney.”

Beneficiary designations for life insurance policies, retirement accounts, investment accounts, etc.

Ownership designations for jointly owned real property, such as “joint tenancy with right of survivorship,” or “tenancy-in-common,” or a number of other ways of holding title to such property. Each designation has a different effect when one owner dies. In some case the survivor automatically inherits full ownership of the property. In other cases the survivor does not.

As you can see, the best overall advice for all unmarried couples is to see your lawyer — like yesterday!

Mortgage Offers

One of our clients with a very large mortgage recently got an offer to cut his monthly mortgage payment in half. Sounds great — right? He currently has a fixed rate and fixed payment, 30-year mortgage at about 6%. On the back of the letter were some additional details:

• The offered mortgage had a variable percentage rate.
• The initial payment quoted was for the first 12 months only — and would result in negative amortization (That means your total loan balance goes up).
• Prepayment penalty was required.
• Lifetime interest rate cap was 9.95%.

How many poor souls will fall for this “great” offer, or something similar? Some just react to the fact they could cut their monthly payment in half — but oh, the price!

Auto Expense Rules

Probably the three most favorite tax deductions of the average small business (in order of priority) are payments for:

1. Auto expenses.
2. Entertainment.
3. Accounting fees (we hope).

Substantiation — standard mileage rate: A mileage log should be maintained (the IRS prefers daily) showing (a) miles traveled; (b) destination; (c) business purpose. For salespersons making repetitive sales calls, the “business purpose” is obvious and does not have to be repeated over and over. The 2007 standard business mileage rate is 48.5¢ (or less if you prefer) and may be used instead of the actual cost method for both reimbursement or deduction purposes.

Substantiation — actual cost method: Receipts, invoices, canceled checks and other documentation are needed to verify expenses. Also required in order to claim depreciation: the original cost of the car and date placed in service for business use. Repair invoices can be used to establish total mileage (but not business mileage — which may end up being calculated as a percentage of the total).

Calculating the business portion deduction: The cost of travel between your home and your regular place of business is not deductible. Visiting customers (or principals); attending business meetings away from the office; traveling from one workplace to another; or similar and logical “business” use is deductible. Obviously, personal travel and personal weekend use does not qualify.

As a practical matter, the typical method is to calculate total business mileage (using the above standards) compare it to total mileage using repair and other documentation — and arrive at a business use percentage. Then, apply that business use percentage to the total actual costs of operating the vehicle — to arrive at the tax-deductible amount of the total actual expenses.

Under the actual cost method, if your business has paid the entire amount of auto expenses, the non-deductible balance (see above) becomes “personal use of business auto(s).” That amount can either be repaid the company by each business auto user; or charged as additional compensation (Form W-2); or against his/her loan or other account on the books of the company.

Employee Expense Reimbursements

It’s always a great tax advantage for an employee to receive tax-free expense reimbursements, rather than those that are considered additional (taxable) compensation; and it also benefits the employer as well. To refresh your memories, it requires an “accountable plan” to achieve this favorable result.

To qualify as an accountable plan, the expense reimbursement or allowance must meet all three of these rules:

1. Expenses must have a business connection. While performing services as your employees, they must have paid or incurred (what are classified as) tax-deductible expenses.
2. The employees must adequately account (substantiation and receipts) to you, the employer, for these expenses, within a reasonable period of time.
3. The employees must return any excess reimbursement or allowance within a reasonable period of time

But what if you meet the first two out of the three conditions — and they appear to be the two major ones? How will you fare with the IRS? Can you win a partial victory?

To simplify the conditions of this tax case: (a) the employer paid the employee more than the amounts that met the first two conditions above, and (b) the employee did not return the excess as required by condition three. In court the employer made two claims to try and salvage most of the reimbursements as accountable:

• Allow the amounts actually substantiated and reimbursed as paid under an accountable plan.
• Only tax the excess paid over those amounts as additional compensation.

First the Tax Court ruled that the entire total of reimbursements was taxable compensation and then the Eighth Circuit Court of Appeals affirmed the Tax Court’s decision. Why? The arrangement flunked condition (3) that the excess reimbursements must be returned. They ruled: “…because the plan as a whole did not meet the requirements of an accountable plan, all the payments received by the taxpayer were includible in gross income.” (S.J. Namyst, CA-8, 2006-1 USTC)

The lesson, of course, is that every employee must meet all three of the accountable conditions, or the entire amount of reimbursements will be taxable income to the employee! You just can’t be “a little bit pregnant.”

To further emphasize all this, the IRS announced (Rev. Rul. 2006-56) that they are starting a new crackdown on “excessive employee expense reimbursements,” as well as “lax recordkeeping.” Agents will look for mileage-based travel allowances where employers don’t require employees to account for their daily business mileage and/or don’t tax them on reimbursements in excess of the standard IRS maximum rates. In any of these cases the entire allowance will be taxed!

What Happens When You Flunk “Accountable”?

As a non-accountable plan, the IRS rule is clear-cut and unavoidable — all such expense reimbursements must be reported as “additional compensation” (i.e., additional payroll, in Box 1 of wage Form W-2) — subject to regular payroll taxes and withholding. This can cost the employer as much as 15%-25% in additional payroll taxes, workers’ compensation insurance and perhaps retirement plan contributions. Just to begin with, it costs the employee the other half of the social security and Medicare taxes. Also, it is the worst possible arrangement for the employee as well.

The employee is now faced with itemizing those business expense deductions and claiming them on his/her individual tax return (as a “Miscellaneous Itemized Deduction”). As such they are subject to a 2% of income disallowance; plus a further lost deduction for 50% of entertainment and business meals — and the high probability of an IRS audit as well. Also, the employee cannot claim a standard deduction and must complete additional Form 2106, “Employee Business Expenses” (a somewhat complicated two-page form) to claim those expenses on his/her individual income tax return. Finally, that entire deduction does not even count, when figuring possible liability for the Alternative Minimum Tax (AMT) and thus increases the likelihood the AMT will apply.

It’s a real “lose-lose” for everyone but the IRS.

Wesley Snipes Arrested for Tax Evasion

For those of you that missed it, he was charged with two major counts:

• Fraudulently claiming refunds of nearly $12 million in 1996 and 1997 (which he apparently got from the IRS).
• Failure to file income tax returns for all the years of 1999 through 2004.

His “accountants,” with a history of filing false tax returns (according to the IRS), convinced him to follow their advice in these matters. The firm, American Rights Litigators, would receive 20% of all refunds received by clients, according to the indictment. Snipes claims: (a) he is a scapegoat; (b) was unfairly targeted by the prosecutors; (c) and he was taken advantage of. If convicted, he faces up to 16 years in prison.

While we do not specialize in the entertainment industry as such, but (living in L.A.) over the years I have had a fair amount of contact with entertainers. I have a theory that being naïve, gullible, financially unsophisticated, somewhat “childlike” and partially “living in a dream world,” is not at all uncommon. Further, as a generalization, I also think it may actually help their acting ability to be so — and I suspect that Mr. Snipes fits this description. But where were his regular business managers, lawyers, CPAs and other advisers to protect him? And did he really believe he did not have to file income tax returns at all? How sad (P.S. I think he’s a fine actor.).

Recently Married or Recently Divorced?

Some smart tips from the IRS: They caution that in either category, make sure that the name on your tax return matches the name registered with the Social Security Administration (SSA). A mismatch could unexpectedly increase a tax bill or reduce the size of a refund.

Recently Married. If the new bride takes her husband’s last name, but does not advise the SSA, there is a problem. If the couple now files a joint tax return with her new name, the IRS computers will not be able to match that name with her social security number.

Recently Divorced. If the divorcee previously had taken her husband’s last name (and so advised the SSA), she now must reverse the procedure and contact the SSA if she reassumes a previous name.

It’s easy to inform the SSA of a name change by filing Form SS-5 at a local SSA office. The form is available by calling 800•772•1213 or on the web at socialsecurity.gov.

Real Estate Syndication

Either forming or investing in a real estate syndicate affords the opportunity to acquire larger properties, with greater leverage opportunities and the promise of higher returns. In my opinion the absolutely best and most essential guide for all those interested, is the just-published and latest revised edition, of “Principles of Real Estate Syndication” by Samuel K. Freshman. Over the past 40 years, he has sponsored over $500 million dollars in investments in real estate projects throughout the U.S.A. — and made a lot of people rich. He is an attorney and recognized as an outstanding expert in this field. Copies can be ordered at: syndicationideas.com.

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* Information provided by CAMICO Services, Inc., a major insurer of professional liability for CPA firms.