Forbes' 12th annual ranking of the largest public charities.
Go to Guidestar and search its large database of nonprofits for the keyword "poverty." The query leads to 5,432 nonprofits. Look for "cancer," and 7,258 charities come up. Both are dwarfed by results for "museum": a whopping 17,250 organizations.
There are more than 1.4 million registered nonprofits in the country, many of them operating locally rather than nationally. You can get a tax deduction by giving to just about any of them. But how do you figure out the ones that will make best use of your dollars?
We can't help you pick your causes. But we can suggest a few pointers about how to evaluate charities in a very Forbesian way--by their financial efficiency.
To that end, we present the 12th edition of our annual list of America's 200 Largest Charities, as ranked by private donations. The Forbes Charity 200 is a flush group; the top 10 alone received $45 billion in contributions during their most recent reported year.
Still, with the economy ailing, average donations to the 200 fell a sharp 11%--to $211 million each. Average revenues per charity were flat at $611 million, with the difference made up by government grants, sales of services or products and investments.
OK, you say, but how is data on the biggest charities going to help me figure whether the local food bank is using my dollars well? Easy. Our data includes financial efficiency evaluations and trends for all kinds of charities--including five food banks, which redistribute donated goods to the needy. Look at similar operations to get a sense of financial efficiency norms for the kind of charity you're evaluating. Sure, smaller, out-of-the way nonprofits might not be as efficient as the giants. But then again, their salaries and overhead expenses should be lower too.
As always, we advise against comparing efficiency ratios for different categories of charities. There's no valid way to size up a hospital vs. a foreign disaster relief outfit vs. a museum.
Financial efficiency is hardly the end-all. But before making a charitable contribution you should be doing your own due diligence, and you have to start your research somewhere. Our list will provide plenty of food for thought.
Our list is based on numbers and oriented toward donors, so we exclude from consideration certain categories of nonprofits. These include academic institutions (which solicit mainly from their alums); donor-advised funds (gifts from you to your own quasi-foundation); and religious groups, which don't have to report numbers to the Internal Revenue Service (we can't list what we don't know). We also ignore nonprofits with few direct donors, such as Ted Turner's United Nations Association; most private foundations (they don't solicit from the general public); charities that get most of their gifts from other charities that solicit; and a few whose data we question.
Key to our display are three financial efficiency ratios, and the trend in those ratios. The higher, the better. Here's what they are and what they mean:
Charitable Commitment
This calculates how much of a charity's total expense went directly to the charitable purpose (also known as program support or program expense) as opposed to management, certain overhead expenses and fundraising. The average this year is 86%, unchanged. At the low end are the Smithsonian Institution (58%), Paralyzed Veterans of America (63%), Northern California Broadcasting (64%), Operation Smile (66%) and Veterans of Foreign Wars of the U.S. (67%). At the top, all at 100%: Brother's Brother Foundation, Christian Blind Mission International, Gifts in Kind International and Operation Compassion. The four are gift-in-kind charities, receiving most of their donations as large gifts of goods, which entails far lower overhead.
Fundraising Efficiency
A much scrutinized number, this ratio shows the percentage of gifts left after subtracting the cost of getting them. The average this year: 90%, a little less than last year's 91%. We long have recommended a harsh look at any charity with a fundraising efficiency below 70%. The five on our list below that cutoff: Educational Broadcasting Corp., which operates New York City public TV station WNET (56%), Veterans of Foreign Wars of the U.S. (58%), Girl Scouts of the USA (62%), World Wildlife Fund (66%) and Paralyzed Veterans of American (68%). At the top end, 20 charities, mostly gift-in-kinds, share a 100% rating.
Donor Dependency
This measures how badly a nonprofit needs your contribution to break even. We subtract the annual surplus or deficit from gifts, then divide this figure by the gifts. The higher the percentage, the more the charity needed your charity. A result above 100% means the nonprofit ran a deficit. A rating below zero means the charity would have broken even without any contributions at all. This ratio is tremendously affected by investment performance and is the most volatile of our measures. This year's average is 92%. That's down from 95% last year. In the salad days a few years ago when markets were roaring, the ratio was in the 60s.
Our database also lists each charity's top total compensation to a single employee. This includes salary, benefits, one-time payments and deferred compensation, and may be for a previous fiscal year. The average is $624,225, down 5% from last year--in Forbes' 12 years of tracking, a first-time drop. But 26 nonprofits still listed someone getting upward of $1 million. That recipient is usually the top person, although not necessarily the current one.
Monday, November 22, 2010
Mutual fund investors: Capital gains can hurt you at tax time
Mutual fund companies are revealing their estimated capital gains payouts for 2010 — and if you're considering buying a fund now, be sure to wait until after it has made its distribution.
This year's distributions aren't as bad as they have been in other years. "A lot of funds still have losses built up from the 2007-2009 bear market that they can use to offset gains," says Dan Culloton, associate director of fund analysis at Morningstar.
But some sectors have done well enough that shareholders will have to give part of their gains to the tax man.
• Gold funds. They have a searing 34% gain this year, and several will make capital gains distributions. Fidelity Select Gold, for example, will pay an estimated $1.71 a share in short-term and $2.25 in long-term gains, about 7% of its current price.
• Energy funds. Vanguard Energy fund's Admiral shares will pay an estimated $3.28 a share in capital gains, about 2.7% of the fund's current share price.
• International and emerging markets funds. BlackRock Pacific will pay $1.10 a share in long- and short-term capital gains. Its total distribution, with dividend income, is 6.9% of its share price.
Some bond funds, too, are doling out capital gains distributions this year, because the bond market has been so hot the past few years. For example, Pimco 7-10 Year U.S. Treasury Index fund will pay $1.05 per share in short-term capital gains this year. That's about 1.3% of the fund's share price.
Funds don't pay capital gains taxes when they sell a stock or bond for a profit. Instead they pass gains on to investors, usually in a year-end distribution. If you're thinking of buying a fund in a taxable account, wait until after the fund has made its distribution. "You don't want to have to pay taxes on gains you didn't receive," Culloton says.
Distributions can be costly. Dividends paid on holdings the fund owned for less than a year are taxed the same as income. Qualified dividends — those on stocks held for more than a year — are taxed at a maximum 15%. Most dividends from real estate investment trusts are taxed as ordinary income. Short-term capital gains, from securities held less than a year, are taxed at your income tax rate. Long-term gains are taxed at a maximum 15%.
When you receive a dividend or capital gains distribution, your fund's share price drops by the amount of the distribution. Most people reinvest the distribution. If you own your shares in a tax-sheltered retirement fund, you don't have to worry about capital gains or dividend distributions.
This year's distributions aren't as bad as they have been in other years. "A lot of funds still have losses built up from the 2007-2009 bear market that they can use to offset gains," says Dan Culloton, associate director of fund analysis at Morningstar.
But some sectors have done well enough that shareholders will have to give part of their gains to the tax man.
• Gold funds. They have a searing 34% gain this year, and several will make capital gains distributions. Fidelity Select Gold, for example, will pay an estimated $1.71 a share in short-term and $2.25 in long-term gains, about 7% of its current price.
• Energy funds. Vanguard Energy fund's Admiral shares will pay an estimated $3.28 a share in capital gains, about 2.7% of the fund's current share price.
• International and emerging markets funds. BlackRock Pacific will pay $1.10 a share in long- and short-term capital gains. Its total distribution, with dividend income, is 6.9% of its share price.
Some bond funds, too, are doling out capital gains distributions this year, because the bond market has been so hot the past few years. For example, Pimco 7-10 Year U.S. Treasury Index fund will pay $1.05 per share in short-term capital gains this year. That's about 1.3% of the fund's share price.
Funds don't pay capital gains taxes when they sell a stock or bond for a profit. Instead they pass gains on to investors, usually in a year-end distribution. If you're thinking of buying a fund in a taxable account, wait until after the fund has made its distribution. "You don't want to have to pay taxes on gains you didn't receive," Culloton says.
Distributions can be costly. Dividends paid on holdings the fund owned for less than a year are taxed the same as income. Qualified dividends — those on stocks held for more than a year — are taxed at a maximum 15%. Most dividends from real estate investment trusts are taxed as ordinary income. Short-term capital gains, from securities held less than a year, are taxed at your income tax rate. Long-term gains are taxed at a maximum 15%.
When you receive a dividend or capital gains distribution, your fund's share price drops by the amount of the distribution. Most people reinvest the distribution. If you own your shares in a tax-sheltered retirement fund, you don't have to worry about capital gains or dividend distributions.
Why Your State Income Tax Bill Could Change In 2011
Republican gains in states could mean an end to new millionaire taxes and possibly rate cuts.
Do you know if your state income taxes are going up or down next year? The results of the midterm elections provide some clues and one clear answer--wealthy residents of no-income-tax Washington State won't be facing a new tax, since voters there nixed a ballot initiative, backed by Bill Gates Sr. (and his son Bill Gates, the cofounder of Microsoft ( MSFT - news - people )) that would have imposed a 9% tax on income over $1 million per couple. (The initiative was opposed by Microsoft itself, Microsoft CEO Steve Ballmer, Amazon.com ( AMZN - news - people ) CEO Jeff Bezos, and such major corporations as Boeing ( BA - news - people ) and Weyerhaeuser ( WY - news - people ).)
Clues as to what might be in store for tax rates elsewhere come from Republicans' sweeping gains in state capitols and from the promises of some of the governors-elect. Pay close attention if you're thinking of retiring to another state, if you live in a multistate metropolis, or if you're self-employed, independently wealthy, or otherwise have options as to where you live. Before you make any retirement moves, check out the special rates some states offer retirees. For more tips for tax refugees, click here.
-- Maine's Republican Governor-elect Paul LePage has said he'd like to cut the state's top income tax rate from 8.5% to 5%. (Maine's legislature flipped from Democratic to Republican too.)
--Illinois incumbent Democratic Governor Pat Quinn (who narrowly beat Republican Bill Brady) is calling to increase the state's flat 3% income tax, but Democratic House Speaker Michael Madigan is skeptical that a tax hike has enough support to pass.
--Minnesota Democratic Governor-elect Mark Dayton (unless a pending recount reverses the results) ran on a platform of higher taxes, saying in his campaign ads, "We're going to make the rich pay their fair share of taxes." That's despite the fact that Minnesota, with a top rate of 7.85%, is already on Forbes' list of the highest state income tax rates for 2011.
To be sure, Dayton's tax the rich rhetoric echoes what's happened in other states during the last three years of state budget crisis and tax hikes. Just this past January, Oregon voters approved (over the opposition of Nike ( NKE - news - people ) founder Philip Knight) an increase in the tax on income over $500,000 per couple from 9% to 11%.
But with Republicans increasing their control of both governorships and state houses (they will have single party control in 20 states), that trend has likely peaked.
"In light of the election results, with more Republicans controlling state legislatures you're more likely to see spending cuts rather than tax increases," in the coming year, predicts Jamie Yesnowitz, a senior manager in Grant Thornton's state and local tax group in Washington, D.C.
Still, Yesnowitz notes, some East Coast states with temporary millionaires' taxes, could extend them for additional years. In Maryland, where Democrats control the governor's mansion and the statehouse, a millionaire's tax expires at the end of this year. New York's millionaires' tax expires at the end of 2011. There, Democrats will control the governorship and the house, with control of the state senate still up in the air.
On the other hand, New Jersey's wealthiest residents got a reprieve when Republican Gov. Chris Christie in May vetoed the legislature's attempt to put in a 10.75% top rate for incomes above $1 million for 2010. (New Jersey had a one-year rate increase in 2009 with a 10.25% rate on incomes over $500,000 and a 10.75% rate on incomes above $1 million, signed into law by Democratic Gov. Jon Corzine.)
That leaves New Jersey with a top 8.97% rate on income over $500,000 for all filers for both 2010 and 2011, the same rate as in neighboring New York State. "People are always looking to leave New Jersey and New York," says Wayne Berkowitz, a CPA with Berdon LLP in New York City. "There isn't much you can do other than leave."
Just how high state politicians set their top income tax rate is a bit of a psychological game--played the same way retailers like Wal-Mart ( WMT - news - people ) set prices at $45.99 or folks selling their homes list them at $499,000. Often, they're trying to stay just below a round number or below a neighbor's rate.
In the case of Minnesota's Dayton, he has said he would go up to 10.9%, just shy of Hawaii and Oregon's top rate of 11%. "We wouldn't have to bear the burden of saying 'We're the highest,'" observes Phil Krinkie, president of the Taxpayers League of Minnesota. (Not that Krinkie approves of a rate hike.) In any case, Dayton will have to contend with a newly Republican-controlled legislature.
State politicians keen on bringing down rates without losing too much revenue might look to outgoing Rhode Island Gov. David Carcieri's playbook. The Republican reduced the state's top rate from 9.9% to 5.99% as of Jan. 1, and simplified things by replacing five brackets with three. That took Rhode Island off our dreaded top 10 list for 2011.
"Rhode Island needs to be competitive with our neighbors," Carcieri told Forbes. For folks making between $75,000 and $100,000, the new effective rate is about 4%, so that compares favorably with Massachusetts, with its flat tax at 5.3%. The trick? Carcieri brought down rates by broadening the state's tax base--cutting the number of tax credits and limiting itemized deductions.
But don't expect any reform plan--or tax cut--to be easy or to be passed without some trade-offs. "Getting any tax cut through this year was a battle," says Carcieri. And he did make compromises. "If I were to wave a magic wand, in addition to the income tax changes I would have eliminated the estate tax and the capital gains tax,'' he says. Instead, the reform package (which will cut state revenues by a modest $40 million a year) only raised the state estate tax exemption amount from $675,000 to $850,000, and it also retained Rhode Island's capital gains tax at ordinary income rates. (Rhode Island was one of a few states that gave preferential treatment to capital gains; the capital gains tax rate for 2008 was 1.67%; it was set to expire in 2009 but the legislature set the capital gains tax rates to match ordinary income rates instead.) Capital gains will be taxed next year at the same top 5.99% rate ordinary income.
Do you know if your state income taxes are going up or down next year? The results of the midterm elections provide some clues and one clear answer--wealthy residents of no-income-tax Washington State won't be facing a new tax, since voters there nixed a ballot initiative, backed by Bill Gates Sr. (and his son Bill Gates, the cofounder of Microsoft ( MSFT - news - people )) that would have imposed a 9% tax on income over $1 million per couple. (The initiative was opposed by Microsoft itself, Microsoft CEO Steve Ballmer, Amazon.com ( AMZN - news - people ) CEO Jeff Bezos, and such major corporations as Boeing ( BA - news - people ) and Weyerhaeuser ( WY - news - people ).)
Clues as to what might be in store for tax rates elsewhere come from Republicans' sweeping gains in state capitols and from the promises of some of the governors-elect. Pay close attention if you're thinking of retiring to another state, if you live in a multistate metropolis, or if you're self-employed, independently wealthy, or otherwise have options as to where you live. Before you make any retirement moves, check out the special rates some states offer retirees. For more tips for tax refugees, click here.
-- Maine's Republican Governor-elect Paul LePage has said he'd like to cut the state's top income tax rate from 8.5% to 5%. (Maine's legislature flipped from Democratic to Republican too.)
--Illinois incumbent Democratic Governor Pat Quinn (who narrowly beat Republican Bill Brady) is calling to increase the state's flat 3% income tax, but Democratic House Speaker Michael Madigan is skeptical that a tax hike has enough support to pass.
--Minnesota Democratic Governor-elect Mark Dayton (unless a pending recount reverses the results) ran on a platform of higher taxes, saying in his campaign ads, "We're going to make the rich pay their fair share of taxes." That's despite the fact that Minnesota, with a top rate of 7.85%, is already on Forbes' list of the highest state income tax rates for 2011.
To be sure, Dayton's tax the rich rhetoric echoes what's happened in other states during the last three years of state budget crisis and tax hikes. Just this past January, Oregon voters approved (over the opposition of Nike ( NKE - news - people ) founder Philip Knight) an increase in the tax on income over $500,000 per couple from 9% to 11%.
But with Republicans increasing their control of both governorships and state houses (they will have single party control in 20 states), that trend has likely peaked.
"In light of the election results, with more Republicans controlling state legislatures you're more likely to see spending cuts rather than tax increases," in the coming year, predicts Jamie Yesnowitz, a senior manager in Grant Thornton's state and local tax group in Washington, D.C.
Still, Yesnowitz notes, some East Coast states with temporary millionaires' taxes, could extend them for additional years. In Maryland, where Democrats control the governor's mansion and the statehouse, a millionaire's tax expires at the end of this year. New York's millionaires' tax expires at the end of 2011. There, Democrats will control the governorship and the house, with control of the state senate still up in the air.
On the other hand, New Jersey's wealthiest residents got a reprieve when Republican Gov. Chris Christie in May vetoed the legislature's attempt to put in a 10.75% top rate for incomes above $1 million for 2010. (New Jersey had a one-year rate increase in 2009 with a 10.25% rate on incomes over $500,000 and a 10.75% rate on incomes above $1 million, signed into law by Democratic Gov. Jon Corzine.)
That leaves New Jersey with a top 8.97% rate on income over $500,000 for all filers for both 2010 and 2011, the same rate as in neighboring New York State. "People are always looking to leave New Jersey and New York," says Wayne Berkowitz, a CPA with Berdon LLP in New York City. "There isn't much you can do other than leave."
Just how high state politicians set their top income tax rate is a bit of a psychological game--played the same way retailers like Wal-Mart ( WMT - news - people ) set prices at $45.99 or folks selling their homes list them at $499,000. Often, they're trying to stay just below a round number or below a neighbor's rate.
In the case of Minnesota's Dayton, he has said he would go up to 10.9%, just shy of Hawaii and Oregon's top rate of 11%. "We wouldn't have to bear the burden of saying 'We're the highest,'" observes Phil Krinkie, president of the Taxpayers League of Minnesota. (Not that Krinkie approves of a rate hike.) In any case, Dayton will have to contend with a newly Republican-controlled legislature.
State politicians keen on bringing down rates without losing too much revenue might look to outgoing Rhode Island Gov. David Carcieri's playbook. The Republican reduced the state's top rate from 9.9% to 5.99% as of Jan. 1, and simplified things by replacing five brackets with three. That took Rhode Island off our dreaded top 10 list for 2011.
"Rhode Island needs to be competitive with our neighbors," Carcieri told Forbes. For folks making between $75,000 and $100,000, the new effective rate is about 4%, so that compares favorably with Massachusetts, with its flat tax at 5.3%. The trick? Carcieri brought down rates by broadening the state's tax base--cutting the number of tax credits and limiting itemized deductions.
But don't expect any reform plan--or tax cut--to be easy or to be passed without some trade-offs. "Getting any tax cut through this year was a battle," says Carcieri. And he did make compromises. "If I were to wave a magic wand, in addition to the income tax changes I would have eliminated the estate tax and the capital gains tax,'' he says. Instead, the reform package (which will cut state revenues by a modest $40 million a year) only raised the state estate tax exemption amount from $675,000 to $850,000, and it also retained Rhode Island's capital gains tax at ordinary income rates. (Rhode Island was one of a few states that gave preferential treatment to capital gains; the capital gains tax rate for 2008 was 1.67%; it was set to expire in 2009 but the legislature set the capital gains tax rates to match ordinary income rates instead.) Capital gains will be taxed next year at the same top 5.99% rate ordinary income.
Friday, November 19, 2010
More information will be posted as it becomes available.
Several people have asked for more information regarding the post "Baucus Introduces Bill To Repeal Expanded Information Reporting". I will post more information regarding this bill as it becomes available.
Thursday, November 18, 2010
Employment Law Tips to Help Avoid Hefty Legal Costs
As employment law issues grow increasingly complex each year, CPA firms’ owners and managers are struggling to comply with state and federal laws.
As employment law issues grow increasingly complex each year, CPA firms’ owners and managers are struggling to comply with state and federal laws. Everyone’s goals are to reduce claims and liabilities, if not prevent them outright. But oftentimes it’s the most fundamental of issues that get employers in trouble with the law. In today’s economy where litigation has become commonplace for the slightest infraction, CPA firms’ human resources managers, company owners and other high-level management are advised to get ‘back to basics’ on the top issues that could cost their firms millions.
When looking at the basic employment law issues, the number one goal for every employer in the accounting industry should be to eliminate repetitive practices that could be found unlawful and could give rise to a class action lawsuit. Employers have the money and the power, and there’s an automatic bias towards them. Make sure every policy is followed through consistently and that everything is properly documented. Above all, firm leaders must look reasonable and fair.
CPA firms are advised to consider the following tips to help employers stay out of the courtroom and create fair work environments:
Employee handbooks — There are several misinterpretations about the purpose of employee handbooks. Some items absolutely have to be included, such as meal and rest periods, to ensure employees are aware of the rules and expectations. Without a handbook, it’s difficult to prove a policy was in place and understood by your professionals and staff members.
Compensation plans — Every employee who begins work for a CPA firm has an implied contract for compensation, and employers must share what their rate is before they start working. Such written policies are usually put in employee compensation plans, which detail specific information that must be in writing for them to be binding. In particular, CPA firms with a bonus offering must have compensation plans presented to employees. It’s actually just as important as the job application, but is often overlooked. Employers also must ensure modifications to compensation plans are in writing, and that employees understand that oral agreements are not valid.
Job applications — Applications are often outdated, asking questions that could trigger liability for firms. For example, if a college degree is an essential qualification for a certain position, in order to avoid a possible age discrimination claim, employers should ask candidates whether or not they graduated instead of asking when they graduated. Perhaps more importantly, many companies don’t require applications and instead opt for resume submissions—which are advocacy pieces in comparison to applications. With a well-drafted application, employers elicit "just the facts." In addition, applications allow employers to obtain approval to conduct various background checks. It’s also important that employers obtain a signature and affirmation from the applicant confirming that the information is accurate and complete. Doing so may provide grounds for termination if applicants misrepresent themselves. Employers should ensure the information submitted by the applicant is verified, consistently conducting background checks for every applicant to ensure discrimination claims are avoided. Finally, employment applications and a well-executed pre-hire due diligence program will help prevent and defend against claims for negligent hiring and negligent retention.
Arbitration agreements — It’s recommended that firms utilize a binding arbitration agreement as part of their employee handbook and personnel policies—and note that arbitration agreements are necessary for all prospective employees, not just those applicants that are actually hired at the company. For example, some applicants may claim that they were not hired due to alleged discrimination. Including an arbitration provision in all job applications ensures that those who are not hired by the company will have to arbitrate claims for "failure to hire." While some states like California require the employer to pay for the arbitration, it remains a smart strategy for CPA firms and could save big bucks in some instances.
Performance evaluations — It’s no secret that today’s reduced workforce has created packed daily schedules for both employees and their supervisors. With that in mind, many performance evaluations don’t take place at their scheduled date. But if employers don’t conduct performance reviews when they’re supposed to be done—or they’re skipped altogether—it will be difficult to terminate problem employees when there’s a lack of notice regarding issues that need to be improved, or if there are inconsistent patterns of providing performance evaluations (which could be perceived as a bias). In addition, performance evaluations, including self-evaluations for exempt employees, can prove helpful in preventing misclassification claims.
Exit interviews — If the firm decides to conduct exit interviews, they need to ensure that they are done every time a professional or staff member leaves the organization. Aside from providing information about the industry and market conditions, exit interviews can help companies defend a lawsuit if a disgruntled employee decides to sue. Specifically, if a departing employee signs an exit interview document saying everything was fine, it will be difficult for him to claim otherwise in support of a later lawsuit. However, exit interviews also pose their own risks sometimes the questions incentivize employees to make claims where there weren’t any. Thus, exit interviews have pros and cons, and firms need to make an informed business decision about whether they are appropriate for them.
Exemption issues for salaried accountants — Accounting firms or other employers who misclassify their work force as exempt could suffer significant exposure (sometimes in the million-dollar range) for unpaid overtime and other penalties. Some states take a very narrow view regarding what jobs qualify for the white-collar salaried employee exemptions, including jobs taken by trained accountants. Under California’s traditional professional exemptions, for example, a licensed accountant may qualify for one of the eight professional exemptions if they satisfy a few other prerequisites. Unlicensed accountants have been subjected to close scrutiny in California, although they may qualify for the learned professional, executive, or administrative exemptions depending on the accountant’s actual job duties and/or educational background. In Campbell v. Pricewaterhousecoopers LLP (2009, E.D. Cal) 602 F.Supp.2d 1163, the federal court, applying California law, denied an employer’s motion for summary judgment, holding that certain unlicensed accountants were entitled to overtime because they could not qualify for the administrative exemption under the test set forth in the Industrial Welfare Commission Wage Order. The court noted, among other things, that these jobs failed to require the regular performance of exempt functions, such as supervision or the regular exercise of discretion or independent judgment. This case provides a wake-up call to employers who may fail to carefully evaluate the job duties and functions of employees classified as "salaried exempt."
Timekeeping — It’s the employer’s obligation to track hours worked for nonexempt salaried or hourly employees, and these records are imperative to an employer’s compliance with wage and hour laws. Employers should document employees’ meal and rest periods in writing each day, including when they were taken, how long they lasted, whether they were waived, and if so, why they were waived. Additionally, at the end of every pay period, the total hours worked for each employee should be verified. One prominent problem facing companies is employees refusing to take their meal period. Employers must monitor those situations and ensure that these employees are taking and documenting the proper breaks to avoid class action lawsuits that can reach millions of dollars in settlements. Know your state’s meal/rest period requirements, as they differ state to state. "Stolen" hours from manipulated time cards is outright theft, and dishonest employees will take advantage if employers are not watchful. Create documents that are irrefutable in court, and be fair and respectful to your staff—they should return the sentiment. If supervisors and their staff trust each other, a level of integrity is much easier to maintain.
State and federal wage/hour laws — Although both state and federal wage/hour laws are operating simultaneously, the most favorable one to the employee always applies. Employers must understand the interaction between state and federal laws, and know when to refer to the appropriate rules. For example, there are exemptions from overtime under federal laws that don’t apply to certain states, which may have stricter exemption requirements. Both federal and state law may apply depending on the situation and locality. Firms can be sued for federal law in one state, and sued for the same thing elsewhere under a state law. Firms can also be sued in one court (state or federal court) for violations of both state and federal law.
Termination — Many CPA firms, in an attempt to save money, don’t seek the proper legal advice when terminating employees. One of the biggest mistakes employers make is to involve legal counsel after an employee has already been terminated. Sometimes it may just be a five-minute phone call to the qualified legal expert that saves the company from a lawsuit. Even at-will employment has its risks with termination. A poorly administered termination containing little or no documentation can present a very serious problem for employers who later seek to show that a termination was for legitimate non-discriminatory reasons. Specifically, an employer should document the reasons for the employee’s termination. For example, if the employer simply states "at will employment," the employee can allege whatever unlawful reason he chooses, and the employer may have a heavy burden to establish after the fact that the reason for the termination was not an unlawful one.
John K. Skousen and Christopher J. Boman are both partners with the management-side labor and employment law firm of Fisher & Phillips LLP (www.laborlawyers.com) in its Irvine, Calif., office.
This article was originally published in IOMA's monthly newsletter, "Partner's Report for CPA Firm Owners", and is republished here with the express written permission of IOMA, Copyright(c) 2010. For more information, visit www.ioma.com or for copyright permissions please call 212-576-8747 or email content@ioma.com.
As employment law issues grow increasingly complex each year, CPA firms’ owners and managers are struggling to comply with state and federal laws. Everyone’s goals are to reduce claims and liabilities, if not prevent them outright. But oftentimes it’s the most fundamental of issues that get employers in trouble with the law. In today’s economy where litigation has become commonplace for the slightest infraction, CPA firms’ human resources managers, company owners and other high-level management are advised to get ‘back to basics’ on the top issues that could cost their firms millions.
When looking at the basic employment law issues, the number one goal for every employer in the accounting industry should be to eliminate repetitive practices that could be found unlawful and could give rise to a class action lawsuit. Employers have the money and the power, and there’s an automatic bias towards them. Make sure every policy is followed through consistently and that everything is properly documented. Above all, firm leaders must look reasonable and fair.
CPA firms are advised to consider the following tips to help employers stay out of the courtroom and create fair work environments:
Employee handbooks — There are several misinterpretations about the purpose of employee handbooks. Some items absolutely have to be included, such as meal and rest periods, to ensure employees are aware of the rules and expectations. Without a handbook, it’s difficult to prove a policy was in place and understood by your professionals and staff members.
Compensation plans — Every employee who begins work for a CPA firm has an implied contract for compensation, and employers must share what their rate is before they start working. Such written policies are usually put in employee compensation plans, which detail specific information that must be in writing for them to be binding. In particular, CPA firms with a bonus offering must have compensation plans presented to employees. It’s actually just as important as the job application, but is often overlooked. Employers also must ensure modifications to compensation plans are in writing, and that employees understand that oral agreements are not valid.
Job applications — Applications are often outdated, asking questions that could trigger liability for firms. For example, if a college degree is an essential qualification for a certain position, in order to avoid a possible age discrimination claim, employers should ask candidates whether or not they graduated instead of asking when they graduated. Perhaps more importantly, many companies don’t require applications and instead opt for resume submissions—which are advocacy pieces in comparison to applications. With a well-drafted application, employers elicit "just the facts." In addition, applications allow employers to obtain approval to conduct various background checks. It’s also important that employers obtain a signature and affirmation from the applicant confirming that the information is accurate and complete. Doing so may provide grounds for termination if applicants misrepresent themselves. Employers should ensure the information submitted by the applicant is verified, consistently conducting background checks for every applicant to ensure discrimination claims are avoided. Finally, employment applications and a well-executed pre-hire due diligence program will help prevent and defend against claims for negligent hiring and negligent retention.
Arbitration agreements — It’s recommended that firms utilize a binding arbitration agreement as part of their employee handbook and personnel policies—and note that arbitration agreements are necessary for all prospective employees, not just those applicants that are actually hired at the company. For example, some applicants may claim that they were not hired due to alleged discrimination. Including an arbitration provision in all job applications ensures that those who are not hired by the company will have to arbitrate claims for "failure to hire." While some states like California require the employer to pay for the arbitration, it remains a smart strategy for CPA firms and could save big bucks in some instances.
Performance evaluations — It’s no secret that today’s reduced workforce has created packed daily schedules for both employees and their supervisors. With that in mind, many performance evaluations don’t take place at their scheduled date. But if employers don’t conduct performance reviews when they’re supposed to be done—or they’re skipped altogether—it will be difficult to terminate problem employees when there’s a lack of notice regarding issues that need to be improved, or if there are inconsistent patterns of providing performance evaluations (which could be perceived as a bias). In addition, performance evaluations, including self-evaluations for exempt employees, can prove helpful in preventing misclassification claims.
Exit interviews — If the firm decides to conduct exit interviews, they need to ensure that they are done every time a professional or staff member leaves the organization. Aside from providing information about the industry and market conditions, exit interviews can help companies defend a lawsuit if a disgruntled employee decides to sue. Specifically, if a departing employee signs an exit interview document saying everything was fine, it will be difficult for him to claim otherwise in support of a later lawsuit. However, exit interviews also pose their own risks sometimes the questions incentivize employees to make claims where there weren’t any. Thus, exit interviews have pros and cons, and firms need to make an informed business decision about whether they are appropriate for them.
Exemption issues for salaried accountants — Accounting firms or other employers who misclassify their work force as exempt could suffer significant exposure (sometimes in the million-dollar range) for unpaid overtime and other penalties. Some states take a very narrow view regarding what jobs qualify for the white-collar salaried employee exemptions, including jobs taken by trained accountants. Under California’s traditional professional exemptions, for example, a licensed accountant may qualify for one of the eight professional exemptions if they satisfy a few other prerequisites. Unlicensed accountants have been subjected to close scrutiny in California, although they may qualify for the learned professional, executive, or administrative exemptions depending on the accountant’s actual job duties and/or educational background. In Campbell v. Pricewaterhousecoopers LLP (2009, E.D. Cal) 602 F.Supp.2d 1163, the federal court, applying California law, denied an employer’s motion for summary judgment, holding that certain unlicensed accountants were entitled to overtime because they could not qualify for the administrative exemption under the test set forth in the Industrial Welfare Commission Wage Order. The court noted, among other things, that these jobs failed to require the regular performance of exempt functions, such as supervision or the regular exercise of discretion or independent judgment. This case provides a wake-up call to employers who may fail to carefully evaluate the job duties and functions of employees classified as "salaried exempt."
Timekeeping — It’s the employer’s obligation to track hours worked for nonexempt salaried or hourly employees, and these records are imperative to an employer’s compliance with wage and hour laws. Employers should document employees’ meal and rest periods in writing each day, including when they were taken, how long they lasted, whether they were waived, and if so, why they were waived. Additionally, at the end of every pay period, the total hours worked for each employee should be verified. One prominent problem facing companies is employees refusing to take their meal period. Employers must monitor those situations and ensure that these employees are taking and documenting the proper breaks to avoid class action lawsuits that can reach millions of dollars in settlements. Know your state’s meal/rest period requirements, as they differ state to state. "Stolen" hours from manipulated time cards is outright theft, and dishonest employees will take advantage if employers are not watchful. Create documents that are irrefutable in court, and be fair and respectful to your staff—they should return the sentiment. If supervisors and their staff trust each other, a level of integrity is much easier to maintain.
State and federal wage/hour laws — Although both state and federal wage/hour laws are operating simultaneously, the most favorable one to the employee always applies. Employers must understand the interaction between state and federal laws, and know when to refer to the appropriate rules. For example, there are exemptions from overtime under federal laws that don’t apply to certain states, which may have stricter exemption requirements. Both federal and state law may apply depending on the situation and locality. Firms can be sued for federal law in one state, and sued for the same thing elsewhere under a state law. Firms can also be sued in one court (state or federal court) for violations of both state and federal law.
Termination — Many CPA firms, in an attempt to save money, don’t seek the proper legal advice when terminating employees. One of the biggest mistakes employers make is to involve legal counsel after an employee has already been terminated. Sometimes it may just be a five-minute phone call to the qualified legal expert that saves the company from a lawsuit. Even at-will employment has its risks with termination. A poorly administered termination containing little or no documentation can present a very serious problem for employers who later seek to show that a termination was for legitimate non-discriminatory reasons. Specifically, an employer should document the reasons for the employee’s termination. For example, if the employer simply states "at will employment," the employee can allege whatever unlawful reason he chooses, and the employer may have a heavy burden to establish after the fact that the reason for the termination was not an unlawful one.
John K. Skousen and Christopher J. Boman are both partners with the management-side labor and employment law firm of Fisher & Phillips LLP (www.laborlawyers.com) in its Irvine, Calif., office.
This article was originally published in IOMA's monthly newsletter, "Partner's Report for CPA Firm Owners", and is republished here with the express written permission of IOMA, Copyright(c) 2010. For more information, visit www.ioma.com or for copyright permissions please call 212-576-8747 or email content@ioma.com.
Baucus Introduces Bill To Repeal Expanded Information Reporting For Businesses
On Nov. 15, Senate Finance Committee Chair Max Baucus (D-MT) formally introduced the “Small Business Paperwork Relief Act.” The bill would repeal Sec. 9006 of the Patient Protection and Affordable Care Act (Affordable Care Act, P.L. 111-48).
In general, under current law, information returns must be made to IRS by every person engaged in a trade or business who makes payments for services, aggregating $600 or more, in any tax year to another person (other than corporations) in the course of the payor's trade or business. Effective for payments made after 2011, Sec. 9006 of the Patient Protection and Affordable Care Act would add payments of amounts in consideration for property and gross proceeds—i.e., it would add payments for goods—to the list of payments subject to reporting. In addition, it provides that starting in 2012, payments to corporations (that are not tax-exempt)—which had previously been exempt from the reporting requirement—would be subject to information reporting.
Observation: A bill along the lines of the “Small Business Paperwork Relief Act” stands a good chance at being enacted. Even the President is on board. During a Nov. 3rd press conference, he said: “The 1099 provision in the health care bill appears to be too burdensome for small businesses. It just involves too much paperwork, too much filing. It's probably counterproductive. It was designed to make sure that revenue was raised to help pay for some of the other provisions, but if it ends up just being so much trouble that small businesses find it difficult to manage, that's something that we should take a look at” [White House website, Press Conference by the President, 11/3/10].
It's unclear whether an attempt will be made to offset the cost of repealing Sec. 9006 of the Patient Protection and Affordable Care Act (there is no offset in the Baucus bill). When Congress took up the health care legislation, the Joint Committee on Taxation estimated that Sec. 9006 would raise $17.6 billion over ten years.
In general, under current law, information returns must be made to IRS by every person engaged in a trade or business who makes payments for services, aggregating $600 or more, in any tax year to another person (other than corporations) in the course of the payor's trade or business. Effective for payments made after 2011, Sec. 9006 of the Patient Protection and Affordable Care Act would add payments of amounts in consideration for property and gross proceeds—i.e., it would add payments for goods—to the list of payments subject to reporting. In addition, it provides that starting in 2012, payments to corporations (that are not tax-exempt)—which had previously been exempt from the reporting requirement—would be subject to information reporting.
Observation: A bill along the lines of the “Small Business Paperwork Relief Act” stands a good chance at being enacted. Even the President is on board. During a Nov. 3rd press conference, he said: “The 1099 provision in the health care bill appears to be too burdensome for small businesses. It just involves too much paperwork, too much filing. It's probably counterproductive. It was designed to make sure that revenue was raised to help pay for some of the other provisions, but if it ends up just being so much trouble that small businesses find it difficult to manage, that's something that we should take a look at” [White House website, Press Conference by the President, 11/3/10].
It's unclear whether an attempt will be made to offset the cost of repealing Sec. 9006 of the Patient Protection and Affordable Care Act (there is no offset in the Baucus bill). When Congress took up the health care legislation, the Joint Committee on Taxation estimated that Sec. 9006 would raise $17.6 billion over ten years.
IRS Explains When Partnerships Must Disclose Their Participation In Loss Transactions
Chief Counsel Advice 201045022
In Chief Counsel Advice (CCA), IRS has provided guidance on when taxpayers who participated in certain loss transactions are obligated to disclose their participation to IRS. The CCA also supplied information and illustrations on what constituted adequate disclosure for purposes of Reg. §1.6011-4.
Background. Every taxpayer that has participated in a “reportable transaction” within the meaning of Reg. §1.6011-4(b) and is required to file a tax return must attach a completed Form 8886, Reportable Transaction Disclosure Statement, to its return for the tax year. (Reg. §1.6011-4(a)) For this purpose, the term “taxpayer” includes an individual, trust, estate, partnership, association, company, or corporation (including an S corporation), and also includes an affiliated group of corporations that joins in the filing of a consolidated return. (Reg. §1.6011-4(c)(1))
A reportable transaction is a transaction described in Reg. §1.6011-4(b)(2) through Reg. §1.6011-4(b)(7). The term “transaction” includes all the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and also includes any series of steps carried out as part of a plan.
Under Reg. §1.6011-4(b)(5)(i), a loss transaction is any transaction resulting in the taxpayer claiming a loss under Code Sec. 165 of at least:
... $10 million in any single tax year, or $20 million in any combination of tax years for corporations;
... $10 million in any single tax year, or $20 million in any combination of tax years for partnerships that have only corporations as partners (looking through any partners that are themselves partnerships), whether or not any losses flow through to one or more partners;
... $2 million in any single tax year or $4 million in any combination of tax years for all other partnerships, whether or not any losses flow through to one or more partners;
... $2 million in any single tax year or $4 million in any combination of tax years for individuals, S corporations, or trusts, whether or not any losses flow through to one or more beneficiaries or shareholders; or
... $50,000 in any single tax year for individuals or trusts, whether or not the loss flows through from an S corporation or partnership, if the loss arises with respect to a Code Sec. 988 transaction (i.e. relating to foreign currency transactions).
In determining these threshold amounts, the amount of a Code Sec. 165 loss is adjusted for any salvage value and insurance or compensation received. However, a Code Sec. 165 loss does not take into account offsetting gains or other income or limitations. The full amount of a Code Sec. 165 loss is taken into account for the year in which the loss is sustained, regardless of whether all or part of it enters into the computation of a net operating loss (NOL) or net capital loss carried to another year, and it does not include any portion of a loss attributable to a capital loss carried from another year that is treated as a deemed capital loss under Code Sec. 1212. A Code Sec. 165 loss also includes an amount deductible under a provision that treats a transaction as a sale or other disposition, or otherwise results in a deduction under Code Sec. 165. Rev Proc 2004-66, 2004-50 IRB 966 provides that certain losses aren't taken into account in determining whether a transaction is a reportable transaction for purposes of the disclosure rules.
A taxpayer is treated as having participated in a loss transaction if the taxpayer's tax return reflects a Code Sec. 165 loss in an amount that equals or exceeds the above threshold amounts. A taxpayer who is a partner, S corporation shareholder, or trust beneficiary and who had a Code Sec. 165 loss that flowed through to the taxpayer from the entity has participated in a loss transaction if the loss reflected on the taxpayer's tax return equals or exceeds the applicable threshold amount.
In order to meet Reg. §1.6011-4 's disclosure requirements, the Form 8886 must describe the expected tax treatment, potential tax benefits, and tax result protection associated with the transaction, and it must provide sufficient details for IRS to understand the tax structure and identify the parties involved. Under Reg. §1.6011-4(f)(2), a taxpayer who is uncertain as to whether a transaction must be disclosed may file a Form 8886 on a protective basis. Protective disclosures are treated the same by IRS as other disclosure statements, and they must satisfy the same disclosure requirements in order to be considered effective. Although the instructions to Form 8886 indicate that only one transaction may be reported per form, multiple transactions may be reported on a single form if they are the same or substantially similar.
Facts. IRS provided four hypothetical situations that were intended to reflect common situations and information routinely included by taxpayers on Forms 8886. In two of the situations, IRS provided guidance on whether the taxpayers had disclosure obligations under Reg. §1.6011-4 as a result of claiming losses under Code Sec. 165. In the other two situations, IRS considered whether the hypothetical taxpayers' disclosure statements were complete under Reg. §1.6011-4(d).
Situation 1. In Year 1, Partnership X, which had two corporate partners that each have equal interests in the partnership, entered into four transactions, which were not part of a series of steps carried out as part of a plan, that yielded Code Sec. 165 losses of $30 million, $9 million, $12 million, and $30 million. Only the first $30 million loss was a loss described in Rev Proc 2004-66, Sec. 4, and none of the losses arose with respect to a Code Sec. 988 transaction. The results of these transactions are reflected both on the taxpayer's and partners' returns for Year 1.
The losses from each transaction were considered separately, and weren't aggregated for purposes of determining whether the threshold amount was met or exceeded, since the transactions weren't a series of steps carried out as part of a plan. The first $30 million loss wasn't taken into account since it was a loss described under Rev Proc 2004-66, Sec. 4. As such, the transaction giving rise to that loss wasn't a reportable transaction to Partnership X and didn't need to be disclosed on a Form 8886. The $9 million loss fell under the threshold amount applicable to partnerships with corporate partners, so it wasn't from a reportable transaction. The $12 million and other $30 million losses were both reportable transactions with respect to Partnership X because they exceeded the applicable $10 million, single-year threshold amount. With respect to the corporate partners, the $12 million loss transaction wasn't a reportable transaction because their respective $6 million shares fell under the threshold amount; but the second $30 million loss transaction was a reportable transaction since their $15 million shares exceeded the threshold amount.
If the 3rd and 4th transactions were the same or substantially similar, Partnership X can disclose them on a single Form 8886. Otherwise, the taxpayer must file two forms.
Situation 2. Partnership Y has two individual partners, A with a 90% interest, and B with a 10% interest. Items of income, gain, loss, deduction and credit are allocated in accord with their interests. In Year 2, Partnership Y enters into two transactions and incurs Code Sec. 165 losses of $3 million and $2 million. Neither of the losses were described in Rev Proc 2004-66, Sec. 4, nor did they arise with respect to a Code Sec. 988 transaction. The results of these transactions were reflected on Partnership Y's return and the individual partners' returns for Year 2.
Both of these losses exceed the $2 million, single-year threshold amount applicable to partnerships with individual partners, so they were both reportable transactions with respect to Partnership Y. Again, the transactions can be disclosed on a single Form 8886 only if they are the same or substantially similar. A's $2.7 million loss from the first transaction exceeds the $2 million threshold amount for individuals and was accordingly a reportable transaction, and A's $1.8 million loss from the second transaction falls under the threshold amount and wasn't a reportable transaction. B's $300,000 and $200,000 losses both fell under the threshold amount, so neither transaction was a reportable transaction for B.
Situation 3. Partnership Z is the top-tier entity of a tiered investment partnership with some partners that were not corporations. Put another way, the taxpayer was a partnership that was a partner in another partnership that was a partner in yet another partnership. In Year 3, Partnership's Z's lower-tier entities engaged in several transactions that yielded Code Sec. 165 losses in excess of $2 million. Some, but not all, of the transactions resulted in losses that were losses described in Rev Proc 2004-66 (i.e. not subject to the disclosure requirements). Partnership Z attached a protective disclosure form to its return for Year 3 in which it stated, without providing any further details, that “due to the nature and volume of Taxpayer's activities, it is not practical to determine whether the applicable reportable loss thresholds are exceeded for any specific transaction or to determine with certainty whether any specific transaction has met any of the exceptions provided in Rev Proc 2004-66.” Partnership Z's lower-tier entities attached similar disclosures to their returns.
Partnership Z's disclosure statement failed to describe the expected tax treatment and potential tax benefits associated with the transaction(s) or provide sufficient details for IRS to understand the tax structure and identify the parties involved. So, neither Partnership's disclosure form nor those of its lower-tier entities satisfied the requirements of Reg. §1.6011-4(d).
Situation 4. Partnership W is a partnership with no corporate partners. In Year 4, Partnership W incurred a $50 million Code Sec. 165 loss on the sale of property that wasn't excluded under Rev Proc 2004-66. Partnership W attached a Form 8886 to its Year 4 tax return that merely stated that it “claimed losses under Code Sec. 165 in excess of the $2 million threshold,” without disclosing the actual amount of the loss or filling out lines 5 through 8 of the form.
Partnership W's disclosure statement failed to describe the full extent of the tax benefit claimed from the Code Sec. 165 loss or identify and describe the transaction in sufficient detail. So, Partnership W's disclosure failed to comply with the requirements of Reg. §1.6011-4(d).
References: For information on disclosure requirements and reportable transactions, see FTC 2d/FIN ¶S-4427.1 et seq.; United States Tax Reporter ¶60,114.02; TaxDesk ¶817,002; TG ¶71808.
In Chief Counsel Advice (CCA), IRS has provided guidance on when taxpayers who participated in certain loss transactions are obligated to disclose their participation to IRS. The CCA also supplied information and illustrations on what constituted adequate disclosure for purposes of Reg. §1.6011-4.
Background. Every taxpayer that has participated in a “reportable transaction” within the meaning of Reg. §1.6011-4(b) and is required to file a tax return must attach a completed Form 8886, Reportable Transaction Disclosure Statement, to its return for the tax year. (Reg. §1.6011-4(a)) For this purpose, the term “taxpayer” includes an individual, trust, estate, partnership, association, company, or corporation (including an S corporation), and also includes an affiliated group of corporations that joins in the filing of a consolidated return. (Reg. §1.6011-4(c)(1))
A reportable transaction is a transaction described in Reg. §1.6011-4(b)(2) through Reg. §1.6011-4(b)(7). The term “transaction” includes all the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and also includes any series of steps carried out as part of a plan.
Under Reg. §1.6011-4(b)(5)(i), a loss transaction is any transaction resulting in the taxpayer claiming a loss under Code Sec. 165 of at least:
... $10 million in any single tax year, or $20 million in any combination of tax years for corporations;
... $10 million in any single tax year, or $20 million in any combination of tax years for partnerships that have only corporations as partners (looking through any partners that are themselves partnerships), whether or not any losses flow through to one or more partners;
... $2 million in any single tax year or $4 million in any combination of tax years for all other partnerships, whether or not any losses flow through to one or more partners;
... $2 million in any single tax year or $4 million in any combination of tax years for individuals, S corporations, or trusts, whether or not any losses flow through to one or more beneficiaries or shareholders; or
... $50,000 in any single tax year for individuals or trusts, whether or not the loss flows through from an S corporation or partnership, if the loss arises with respect to a Code Sec. 988 transaction (i.e. relating to foreign currency transactions).
In determining these threshold amounts, the amount of a Code Sec. 165 loss is adjusted for any salvage value and insurance or compensation received. However, a Code Sec. 165 loss does not take into account offsetting gains or other income or limitations. The full amount of a Code Sec. 165 loss is taken into account for the year in which the loss is sustained, regardless of whether all or part of it enters into the computation of a net operating loss (NOL) or net capital loss carried to another year, and it does not include any portion of a loss attributable to a capital loss carried from another year that is treated as a deemed capital loss under Code Sec. 1212. A Code Sec. 165 loss also includes an amount deductible under a provision that treats a transaction as a sale or other disposition, or otherwise results in a deduction under Code Sec. 165. Rev Proc 2004-66, 2004-50 IRB 966 provides that certain losses aren't taken into account in determining whether a transaction is a reportable transaction for purposes of the disclosure rules.
A taxpayer is treated as having participated in a loss transaction if the taxpayer's tax return reflects a Code Sec. 165 loss in an amount that equals or exceeds the above threshold amounts. A taxpayer who is a partner, S corporation shareholder, or trust beneficiary and who had a Code Sec. 165 loss that flowed through to the taxpayer from the entity has participated in a loss transaction if the loss reflected on the taxpayer's tax return equals or exceeds the applicable threshold amount.
In order to meet Reg. §1.6011-4 's disclosure requirements, the Form 8886 must describe the expected tax treatment, potential tax benefits, and tax result protection associated with the transaction, and it must provide sufficient details for IRS to understand the tax structure and identify the parties involved. Under Reg. §1.6011-4(f)(2), a taxpayer who is uncertain as to whether a transaction must be disclosed may file a Form 8886 on a protective basis. Protective disclosures are treated the same by IRS as other disclosure statements, and they must satisfy the same disclosure requirements in order to be considered effective. Although the instructions to Form 8886 indicate that only one transaction may be reported per form, multiple transactions may be reported on a single form if they are the same or substantially similar.
Facts. IRS provided four hypothetical situations that were intended to reflect common situations and information routinely included by taxpayers on Forms 8886. In two of the situations, IRS provided guidance on whether the taxpayers had disclosure obligations under Reg. §1.6011-4 as a result of claiming losses under Code Sec. 165. In the other two situations, IRS considered whether the hypothetical taxpayers' disclosure statements were complete under Reg. §1.6011-4(d).
Situation 1. In Year 1, Partnership X, which had two corporate partners that each have equal interests in the partnership, entered into four transactions, which were not part of a series of steps carried out as part of a plan, that yielded Code Sec. 165 losses of $30 million, $9 million, $12 million, and $30 million. Only the first $30 million loss was a loss described in Rev Proc 2004-66, Sec. 4, and none of the losses arose with respect to a Code Sec. 988 transaction. The results of these transactions are reflected both on the taxpayer's and partners' returns for Year 1.
The losses from each transaction were considered separately, and weren't aggregated for purposes of determining whether the threshold amount was met or exceeded, since the transactions weren't a series of steps carried out as part of a plan. The first $30 million loss wasn't taken into account since it was a loss described under Rev Proc 2004-66, Sec. 4. As such, the transaction giving rise to that loss wasn't a reportable transaction to Partnership X and didn't need to be disclosed on a Form 8886. The $9 million loss fell under the threshold amount applicable to partnerships with corporate partners, so it wasn't from a reportable transaction. The $12 million and other $30 million losses were both reportable transactions with respect to Partnership X because they exceeded the applicable $10 million, single-year threshold amount. With respect to the corporate partners, the $12 million loss transaction wasn't a reportable transaction because their respective $6 million shares fell under the threshold amount; but the second $30 million loss transaction was a reportable transaction since their $15 million shares exceeded the threshold amount.
If the 3rd and 4th transactions were the same or substantially similar, Partnership X can disclose them on a single Form 8886. Otherwise, the taxpayer must file two forms.
Situation 2. Partnership Y has two individual partners, A with a 90% interest, and B with a 10% interest. Items of income, gain, loss, deduction and credit are allocated in accord with their interests. In Year 2, Partnership Y enters into two transactions and incurs Code Sec. 165 losses of $3 million and $2 million. Neither of the losses were described in Rev Proc 2004-66, Sec. 4, nor did they arise with respect to a Code Sec. 988 transaction. The results of these transactions were reflected on Partnership Y's return and the individual partners' returns for Year 2.
Both of these losses exceed the $2 million, single-year threshold amount applicable to partnerships with individual partners, so they were both reportable transactions with respect to Partnership Y. Again, the transactions can be disclosed on a single Form 8886 only if they are the same or substantially similar. A's $2.7 million loss from the first transaction exceeds the $2 million threshold amount for individuals and was accordingly a reportable transaction, and A's $1.8 million loss from the second transaction falls under the threshold amount and wasn't a reportable transaction. B's $300,000 and $200,000 losses both fell under the threshold amount, so neither transaction was a reportable transaction for B.
Situation 3. Partnership Z is the top-tier entity of a tiered investment partnership with some partners that were not corporations. Put another way, the taxpayer was a partnership that was a partner in another partnership that was a partner in yet another partnership. In Year 3, Partnership's Z's lower-tier entities engaged in several transactions that yielded Code Sec. 165 losses in excess of $2 million. Some, but not all, of the transactions resulted in losses that were losses described in Rev Proc 2004-66 (i.e. not subject to the disclosure requirements). Partnership Z attached a protective disclosure form to its return for Year 3 in which it stated, without providing any further details, that “due to the nature and volume of Taxpayer's activities, it is not practical to determine whether the applicable reportable loss thresholds are exceeded for any specific transaction or to determine with certainty whether any specific transaction has met any of the exceptions provided in Rev Proc 2004-66.” Partnership Z's lower-tier entities attached similar disclosures to their returns.
Partnership Z's disclosure statement failed to describe the expected tax treatment and potential tax benefits associated with the transaction(s) or provide sufficient details for IRS to understand the tax structure and identify the parties involved. So, neither Partnership's disclosure form nor those of its lower-tier entities satisfied the requirements of Reg. §1.6011-4(d).
Situation 4. Partnership W is a partnership with no corporate partners. In Year 4, Partnership W incurred a $50 million Code Sec. 165 loss on the sale of property that wasn't excluded under Rev Proc 2004-66. Partnership W attached a Form 8886 to its Year 4 tax return that merely stated that it “claimed losses under Code Sec. 165 in excess of the $2 million threshold,” without disclosing the actual amount of the loss or filling out lines 5 through 8 of the form.
Partnership W's disclosure statement failed to describe the full extent of the tax benefit claimed from the Code Sec. 165 loss or identify and describe the transaction in sufficient detail. So, Partnership W's disclosure failed to comply with the requirements of Reg. §1.6011-4(d).
References: For information on disclosure requirements and reportable transactions, see FTC 2d/FIN ¶S-4427.1 et seq.; United States Tax Reporter ¶60,114.02; TaxDesk ¶817,002; TG ¶71808.
S Corporation Can Deduct Legal Expenses And Restitution Paid As Result Of Employee's Misconduct
PLR 201045005
IRS has privately ruled that legal expenses and restitution paid by an S corporation on behalf of its employee for his failure to timely inform the government of a client corporation's ongoing criminal activities were deductible under Code Sec. 162(a). The expenses arose as a proximate result of the employee's ordinary business activities and were paid by Taxpayer under an indemnification clause, and their deduction wasn't barred by Code Sec. 162(f).
Background. Under Code Sec. 162(a), a taxpayer can deduct all the ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. However, no deduction is available for personal expenditures, capital expenditures, or fines or similar penalties paid to a government for the violation of any law. Generally, amounts paid to settle lawsuits are currently deductible if the acts which gave rise to the litigation were performed in the ordinary conduct of the taxpayer's business.
The origin of the claim test, first set forth by the Supreme Court in U.S. v. Gilmore, (S Ct 1963) 11 AFTR 2d 758, 372 U.S. 39, controls how to distinguish deductible business expenses from personal or capital expenditures. Under this test, the substance of the underlying claim or transaction out of which the expenditure in controversy arose governs whether an item is deductible, regardless of the motives of the payor making the payment or the consequences that may result from the failure to defeat the claim.
Facts. An indirect owner/employee of Taxpayer provided various operational services to an investment corporation on Taxpayer's behalf. While providing such services, the employee became aware that the investment corporation was engaging in fraudulent investment activities. Taxpayer subsequently ceased providing services to the investment corporation, and the employee later notified the Office of the U.S. Attorney of the corporation's fraudulent activities. The government's investigation showed that the investment corporation in fact defrauded numerous clients and that neither Taxpayer nor the employee participated in this scheme, but the government also determined that the employee's notification to the U.S. Attorney was untimely. The employee was charged with, and ultimately pled guilty to, misprison (i.e., failure to timely inform the government of an ongoing felony and the concealment of such felony). The employee received a prison sentence and was held jointly and severally liable with the investment corporation for restitution equal to the investment corporation clients' losses resulting from the misprison. These amounts were paid by Taxpayer under an indemnification clause. Taxpayer and its employee also incurred legal fees in the ensuing civil actions that were brought against them.
Deduction allowed. IRS concluded that Taxpayer was entitled to deduct the legal expenses and restitution as ordinary and necessary business expenses. Applying the origin of the claim test, IRS determined that the employee's delay in reporting the investment corporation's illegal activities arose from his provision of operational services to the investment corporation on Taxpayer's behalf. Taxpayer was contractually obligated to indemnify the employee since these operational services were within the employee's normal course of business activities, so the restitution payments were considered valid business expenses. IRS also determined that the restitution payments were compensatory in nature, so Taxpayer's deduction wasn't barred by Code Sec. 162(f). The legal fees were similarly deductible since they were connected to Taxpayer's business activities and incurred to protect its corporate assets.
References: For deduction of legal expenses, see FTC 2d/FIN ¶L-2902; United States Tax Reporter ¶1624.040; TaxDesk ¶305,004; TG ¶16163. For origin of the claim doctrine, see FTC 2d/FIN ¶L-2501; TaxDesk ¶305,001; TG ¶16161.
IRS has privately ruled that legal expenses and restitution paid by an S corporation on behalf of its employee for his failure to timely inform the government of a client corporation's ongoing criminal activities were deductible under Code Sec. 162(a). The expenses arose as a proximate result of the employee's ordinary business activities and were paid by Taxpayer under an indemnification clause, and their deduction wasn't barred by Code Sec. 162(f).
Background. Under Code Sec. 162(a), a taxpayer can deduct all the ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. However, no deduction is available for personal expenditures, capital expenditures, or fines or similar penalties paid to a government for the violation of any law. Generally, amounts paid to settle lawsuits are currently deductible if the acts which gave rise to the litigation were performed in the ordinary conduct of the taxpayer's business.
The origin of the claim test, first set forth by the Supreme Court in U.S. v. Gilmore, (S Ct 1963) 11 AFTR 2d 758, 372 U.S. 39, controls how to distinguish deductible business expenses from personal or capital expenditures. Under this test, the substance of the underlying claim or transaction out of which the expenditure in controversy arose governs whether an item is deductible, regardless of the motives of the payor making the payment or the consequences that may result from the failure to defeat the claim.
Facts. An indirect owner/employee of Taxpayer provided various operational services to an investment corporation on Taxpayer's behalf. While providing such services, the employee became aware that the investment corporation was engaging in fraudulent investment activities. Taxpayer subsequently ceased providing services to the investment corporation, and the employee later notified the Office of the U.S. Attorney of the corporation's fraudulent activities. The government's investigation showed that the investment corporation in fact defrauded numerous clients and that neither Taxpayer nor the employee participated in this scheme, but the government also determined that the employee's notification to the U.S. Attorney was untimely. The employee was charged with, and ultimately pled guilty to, misprison (i.e., failure to timely inform the government of an ongoing felony and the concealment of such felony). The employee received a prison sentence and was held jointly and severally liable with the investment corporation for restitution equal to the investment corporation clients' losses resulting from the misprison. These amounts were paid by Taxpayer under an indemnification clause. Taxpayer and its employee also incurred legal fees in the ensuing civil actions that were brought against them.
Deduction allowed. IRS concluded that Taxpayer was entitled to deduct the legal expenses and restitution as ordinary and necessary business expenses. Applying the origin of the claim test, IRS determined that the employee's delay in reporting the investment corporation's illegal activities arose from his provision of operational services to the investment corporation on Taxpayer's behalf. Taxpayer was contractually obligated to indemnify the employee since these operational services were within the employee's normal course of business activities, so the restitution payments were considered valid business expenses. IRS also determined that the restitution payments were compensatory in nature, so Taxpayer's deduction wasn't barred by Code Sec. 162(f). The legal fees were similarly deductible since they were connected to Taxpayer's business activities and incurred to protect its corporate assets.
References: For deduction of legal expenses, see FTC 2d/FIN ¶L-2902; United States Tax Reporter ¶1624.040; TaxDesk ¶305,004; TG ¶16163. For origin of the claim doctrine, see FTC 2d/FIN ¶L-2501; TaxDesk ¶305,001; TG ¶16161.
Don't Overlook Tax Breaks For Grandparents
Recently-released IRS Publication 4694 highlights various tax breaks that may be available to an individual who is raising a grandchild. These include head of household filing status, exemption for the child, earned income credit (EIC), child tax credit (CTC), credit for child and dependent care expenses, credits or deductions for qualified education expense, and deductions for medical and dental expenses. Because it is increasingly common for practitioners to have clients in this situation, this Practice Alert explains the key details of these tax breaks, which are only briefly summarized in the publication.
Head of household filing status. An individual who is considered unmarried and has a qualifying child may be eligible to use head of household as his or her filing status. It generally is more favorable than the single filing status.
An unmarried taxpayer may qualify as a head of household by maintaining as his home a household that is the principal place of abode for more than half the year of a qualifying child of the taxpayer (as defined in Code Sec. 152(c), see below). (Code Sec. 2(b)(1)(A)(i)) However, the taxpayer won't qualify as a head of household if the qualifying child is married at the close of the taxpayer's tax year (Code Sec. 2(b)(1)(A)(i)(I) and isn't a dependent of the taxpayer because he filed a joint return (Code Sec. 152(b)(2)), or because he isn't a U.S. citizen or resident (Code Sec. 152(b)(3)), or both. (Code Sec. 2(b)(1)(A)(i)(II))
A “qualifying child” is an individual who: (1) bears a specified relationship to the taxpayer including being a grandchild of the taxpayer; (2) has the same principal place of abode as the taxpayer for more than one-half of that tax year; (3) hasn't attained a specified age (see below); and (4) hasn't provided over one-half of his or her own support for the calendar year in which the taxpayer's tax year begins. (Code Sec. 152(c))
An individual meets the age requirement in (3), above, if he:
... hasn't attained the age of 19 as of the close of the calendar year in which the tax year of the taxpayer begins;
... is a student who hasn't attained the age of 24 as of the close of that calendar year; or
... is permanently and totally disabled at any time during the calendar year. (Code Sec. 152(c))
Exemption for the child. A grandparent who has a child living with him or her may be able to claim the child as a dependent and, if so, qualify for other tax breaks, as noted below.
A taxpayer is entitled to a deduction equal to the exemption amount for each person who qualifies as his “dependent.” (Code Sec. 151(c)) A person generally qualifies as the taxpayer's dependent if the person is the taxpayer's qualifying child (see above) or qualifying relative. (Code Sec. 152(a))
Earned income credit. A grandparent who is working and has a qualifying child living with him or her may be able to take the EIC, even if the grandparent is 65 years of age or older. This could generate a refund even if the grandparent owes little or no tax.
An eligible individual (see below) is allowed an EIC equal to the credit percentage of earned income (up to an “earned income amount”) for the tax year. (Code Sec. 32(a)(1)) The EIC for a tax year (determined under IRS tables) can't be more than the excess (if any) of (1) the credit percentage of the earned income amount, over (2) the phaseout percentage of AGI (or earned income, if greater) over a phaseout amount. (Code Sec. 32(a)(2))
An individual who has a “qualifying child” for the tax year is an eligible individual. (Code Sec. 32(c)(1)(A)(i)) A “qualifying child” for EIC purposes means a qualifying child of the taxpayer, as defined for the dependency exemption in Code Sec. 152(c) (see above), but without the requirement that the child didn't provide more than half of his own support. (Code Sec. 32(c)(3)(A))
Child tax credit. A grandparent who is raising a grandchild may be able to take the CTC and, under specific circumstances, the additional CTC. The latter may provide a refund even if no federal income taxes are owed.
For 2010, individuals may claim a maximum $1,000 CTC for each qualifying child (see above) the taxpayer can claim as a dependent. (Code Sec. 24(a)) The child must be under 17 and a U.S. citizen or resident alien. (Code Sec. 24(c))
The amount of the allowable credit is reduced (not below zero) by $50 for each $1,000 (or fraction thereof) of modified AGI (AGI increased by excluded foreign, possession, and Puerto Rico income) above: $110,000 for joint filers; $75,000 for unmarried individuals; and $55,000 for marrieds filing separately. (Code Sec. 24(b))
The CTC is refundable, but only to the extent of the greater of: (1) 15% of taxable earned income above $3,000 for 2010; or (2) for a taxpayer with three or more qualifying children, the excess of his social security taxes for the tax year over his EIC for the year. (Code Sec. 24(d)) IRS calls the amount of the CTC that's refundable (on Form 8812) the “additional child tax credit.”
Credit for child and dependent care expenses. This credit may be available if a grandparent pays someone to care for a qualifying individual, i.e., a dependent under age 13, or his or her spouse or a dependent who is physically or mentally not able to care for himself or herself, while the grandparent works or looks for work. (Code Sec. 21(a))
The credit for 2010 is 35% of employment-related expenses for taxpayers with AGI of $15,000 or less. The percentage decreases by 1% for each $2,000 (or fraction thereof) of AGI over $15,000, but not below 20%. (Code Sec. 21(a)(1), Code Sec. 21(a)(2); Reg. §1.21-1(a)) The maximum amount of employment-related expenses that may be used to compute the credit for 2010 is $3,000 for one qualifying individual, or $6,000 for two or more qualifying individuals. (Code Sec. 21(c); Reg. §1.21-2(a)(1))
Qualified education expense. There are several tax breaks that may be available to a grandparent who pays his or her grandchild's education costs. These include:
... Education credits. An individual taxpayer may claim an income tax credit for the Hope scholarship tax credit (renamed the American opportunity tax credit (AOTC) for 2010) and the Lifetime Learning credit for higher education expenses at accredited post-secondary educational institutions paid for themselves, their spouses, and their dependents. The AOTC is available in 2010 for qualified expenses of the first four years of undergraduate education; the Lifetime Learning credit is available for qualified expenses of any post-high school education at “eligible educational institutions.” Both credits can't be claimed in the same tax year for expenses of any one student, and it phases out for higher-income taxpayers. For tax years beginning in 2010, individuals may elect a personal, partially refundable tax credit equal to 100% of up to $2,000 of qualified higher-education tuition and related expenses plus 25% of the next $2,000 of expenses paid for education furnished to an eligible student in an academic period. (Code Sec. 25A(a)(1), Code Sec. 25A(i)(1)) Taxpayers may elect a Lifetime Learning credit equal to 20% of up to $10,000 of qualified tuition and related expenses paid during the tax year. The maximum credit is $2,000. (Code Sec. 25A(a)(2), Code Sec. 25A(c)(1)) Unlike the AOTC/Hope credit, which is available for the qualifying expenses of each qualifying student, the Lifetime Learning credit is available only per taxpayer.
... Coverdell Education Savings Accounts (CESAs). Taxpayers can contribute up to $2,000 per year to CESAs in 2010, formerly called education IRAs, for beneficiaries under age 18 (and, in 2010, special needs beneficiaries of any age). The account is exempt from income tax, and distributions of earnings from CESAs are tax-free if used for qualified education expenses. (Code Sec. 530)
... Qualified Tuition Programs (QTPs) —529 Plans. A person can make nondeductible cash contributions to a QTP/529 plan on behalf of a designated beneficiary. The earnings on the contributions build up tax-free, and distributions from a QTP are excludable to the extent used to pay for qualified higher education expenses. (Code Sec. 529)
... Higher Education Exclusion for Savings Bond Income. Qualified U.S. savings bond income is excluded if redemption proceeds don't exceed qualified higher education expenses. The exclusion phases out at higher levels of modified adjusted gross income. Qualified higher education expenses are tuition and fees required for the enrollment or attendance of taxpayer, taxpayer's spouse or any dependent for whom taxpayer is allowed a dependency exemption, at an eligible educational institution, e.g., most colleges, junior colleges, nursing schools and vocational schools. (Code Sec. 135)
... Above-the-Line Deduction for Higher-Education Expenses (before 2010). For tax years beginning before 2010, eligible individuals may deduct higher education expenses—i.e., “qualified tuition and related expenses” of the taxpayer, his spouse, or dependents—as an adjustment to gross income to arrive at adjusted gross income. (Code Sec. 222(a)) The higher education deduction can't exceed: $4,000 for taxpayers whose modified AGI for the tax year doesn't exceed $65,000 ($130,000 for a joint return); $2,000 for taxpayers whose modified AGI exceeds $65,000 ($130,000 for a joint return), but doesn't exceed $80,000 ($160,000 for a joint return); and zero for other taxpayers. (Code Sec. 222)
... Deduction for Interest on Qualified Education Loans. Qualifying individuals may claim an above-the-line deduction for up to $2,500 of interest paid on a qualified higher education loan, i.e., any debt incurred by the taxpayer solely to pay qualified higher education expenses that are: (1) incurred on behalf of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the debt was incurred; (2) paid or incurred within a reasonable period of time before or after the debt is incurred; and (3) attributable to education furnished during a period when the recipient was an eligible student (as defined for the AOTC/Hope credit purposes, i.e., at least a half-time student). (Code Sec. 221)
Medical and dental expenses An individual who itemizes can deduct the amount by which certain unreimbursed medical and dental expenses paid during the year for himself or herself, his or her spouse, and his or her dependents exceed 7.5% of his adjusted gross income. (Code Sec. 213)
Head of household filing status. An individual who is considered unmarried and has a qualifying child may be eligible to use head of household as his or her filing status. It generally is more favorable than the single filing status.
An unmarried taxpayer may qualify as a head of household by maintaining as his home a household that is the principal place of abode for more than half the year of a qualifying child of the taxpayer (as defined in Code Sec. 152(c), see below). (Code Sec. 2(b)(1)(A)(i)) However, the taxpayer won't qualify as a head of household if the qualifying child is married at the close of the taxpayer's tax year (Code Sec. 2(b)(1)(A)(i)(I) and isn't a dependent of the taxpayer because he filed a joint return (Code Sec. 152(b)(2)), or because he isn't a U.S. citizen or resident (Code Sec. 152(b)(3)), or both. (Code Sec. 2(b)(1)(A)(i)(II))
A “qualifying child” is an individual who: (1) bears a specified relationship to the taxpayer including being a grandchild of the taxpayer; (2) has the same principal place of abode as the taxpayer for more than one-half of that tax year; (3) hasn't attained a specified age (see below); and (4) hasn't provided over one-half of his or her own support for the calendar year in which the taxpayer's tax year begins. (Code Sec. 152(c))
An individual meets the age requirement in (3), above, if he:
... hasn't attained the age of 19 as of the close of the calendar year in which the tax year of the taxpayer begins;
... is a student who hasn't attained the age of 24 as of the close of that calendar year; or
... is permanently and totally disabled at any time during the calendar year. (Code Sec. 152(c))
Exemption for the child. A grandparent who has a child living with him or her may be able to claim the child as a dependent and, if so, qualify for other tax breaks, as noted below.
A taxpayer is entitled to a deduction equal to the exemption amount for each person who qualifies as his “dependent.” (Code Sec. 151(c)) A person generally qualifies as the taxpayer's dependent if the person is the taxpayer's qualifying child (see above) or qualifying relative. (Code Sec. 152(a))
Earned income credit. A grandparent who is working and has a qualifying child living with him or her may be able to take the EIC, even if the grandparent is 65 years of age or older. This could generate a refund even if the grandparent owes little or no tax.
An eligible individual (see below) is allowed an EIC equal to the credit percentage of earned income (up to an “earned income amount”) for the tax year. (Code Sec. 32(a)(1)) The EIC for a tax year (determined under IRS tables) can't be more than the excess (if any) of (1) the credit percentage of the earned income amount, over (2) the phaseout percentage of AGI (or earned income, if greater) over a phaseout amount. (Code Sec. 32(a)(2))
An individual who has a “qualifying child” for the tax year is an eligible individual. (Code Sec. 32(c)(1)(A)(i)) A “qualifying child” for EIC purposes means a qualifying child of the taxpayer, as defined for the dependency exemption in Code Sec. 152(c) (see above), but without the requirement that the child didn't provide more than half of his own support. (Code Sec. 32(c)(3)(A))
Child tax credit. A grandparent who is raising a grandchild may be able to take the CTC and, under specific circumstances, the additional CTC. The latter may provide a refund even if no federal income taxes are owed.
For 2010, individuals may claim a maximum $1,000 CTC for each qualifying child (see above) the taxpayer can claim as a dependent. (Code Sec. 24(a)) The child must be under 17 and a U.S. citizen or resident alien. (Code Sec. 24(c))
The amount of the allowable credit is reduced (not below zero) by $50 for each $1,000 (or fraction thereof) of modified AGI (AGI increased by excluded foreign, possession, and Puerto Rico income) above: $110,000 for joint filers; $75,000 for unmarried individuals; and $55,000 for marrieds filing separately. (Code Sec. 24(b))
The CTC is refundable, but only to the extent of the greater of: (1) 15% of taxable earned income above $3,000 for 2010; or (2) for a taxpayer with three or more qualifying children, the excess of his social security taxes for the tax year over his EIC for the year. (Code Sec. 24(d)) IRS calls the amount of the CTC that's refundable (on Form 8812) the “additional child tax credit.”
Credit for child and dependent care expenses. This credit may be available if a grandparent pays someone to care for a qualifying individual, i.e., a dependent under age 13, or his or her spouse or a dependent who is physically or mentally not able to care for himself or herself, while the grandparent works or looks for work. (Code Sec. 21(a))
The credit for 2010 is 35% of employment-related expenses for taxpayers with AGI of $15,000 or less. The percentage decreases by 1% for each $2,000 (or fraction thereof) of AGI over $15,000, but not below 20%. (Code Sec. 21(a)(1), Code Sec. 21(a)(2); Reg. §1.21-1(a)) The maximum amount of employment-related expenses that may be used to compute the credit for 2010 is $3,000 for one qualifying individual, or $6,000 for two or more qualifying individuals. (Code Sec. 21(c); Reg. §1.21-2(a)(1))
Qualified education expense. There are several tax breaks that may be available to a grandparent who pays his or her grandchild's education costs. These include:
... Education credits. An individual taxpayer may claim an income tax credit for the Hope scholarship tax credit (renamed the American opportunity tax credit (AOTC) for 2010) and the Lifetime Learning credit for higher education expenses at accredited post-secondary educational institutions paid for themselves, their spouses, and their dependents. The AOTC is available in 2010 for qualified expenses of the first four years of undergraduate education; the Lifetime Learning credit is available for qualified expenses of any post-high school education at “eligible educational institutions.” Both credits can't be claimed in the same tax year for expenses of any one student, and it phases out for higher-income taxpayers. For tax years beginning in 2010, individuals may elect a personal, partially refundable tax credit equal to 100% of up to $2,000 of qualified higher-education tuition and related expenses plus 25% of the next $2,000 of expenses paid for education furnished to an eligible student in an academic period. (Code Sec. 25A(a)(1), Code Sec. 25A(i)(1)) Taxpayers may elect a Lifetime Learning credit equal to 20% of up to $10,000 of qualified tuition and related expenses paid during the tax year. The maximum credit is $2,000. (Code Sec. 25A(a)(2), Code Sec. 25A(c)(1)) Unlike the AOTC/Hope credit, which is available for the qualifying expenses of each qualifying student, the Lifetime Learning credit is available only per taxpayer.
... Coverdell Education Savings Accounts (CESAs). Taxpayers can contribute up to $2,000 per year to CESAs in 2010, formerly called education IRAs, for beneficiaries under age 18 (and, in 2010, special needs beneficiaries of any age). The account is exempt from income tax, and distributions of earnings from CESAs are tax-free if used for qualified education expenses. (Code Sec. 530)
... Qualified Tuition Programs (QTPs) —529 Plans. A person can make nondeductible cash contributions to a QTP/529 plan on behalf of a designated beneficiary. The earnings on the contributions build up tax-free, and distributions from a QTP are excludable to the extent used to pay for qualified higher education expenses. (Code Sec. 529)
... Higher Education Exclusion for Savings Bond Income. Qualified U.S. savings bond income is excluded if redemption proceeds don't exceed qualified higher education expenses. The exclusion phases out at higher levels of modified adjusted gross income. Qualified higher education expenses are tuition and fees required for the enrollment or attendance of taxpayer, taxpayer's spouse or any dependent for whom taxpayer is allowed a dependency exemption, at an eligible educational institution, e.g., most colleges, junior colleges, nursing schools and vocational schools. (Code Sec. 135)
... Above-the-Line Deduction for Higher-Education Expenses (before 2010). For tax years beginning before 2010, eligible individuals may deduct higher education expenses—i.e., “qualified tuition and related expenses” of the taxpayer, his spouse, or dependents—as an adjustment to gross income to arrive at adjusted gross income. (Code Sec. 222(a)) The higher education deduction can't exceed: $4,000 for taxpayers whose modified AGI for the tax year doesn't exceed $65,000 ($130,000 for a joint return); $2,000 for taxpayers whose modified AGI exceeds $65,000 ($130,000 for a joint return), but doesn't exceed $80,000 ($160,000 for a joint return); and zero for other taxpayers. (Code Sec. 222)
... Deduction for Interest on Qualified Education Loans. Qualifying individuals may claim an above-the-line deduction for up to $2,500 of interest paid on a qualified higher education loan, i.e., any debt incurred by the taxpayer solely to pay qualified higher education expenses that are: (1) incurred on behalf of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the debt was incurred; (2) paid or incurred within a reasonable period of time before or after the debt is incurred; and (3) attributable to education furnished during a period when the recipient was an eligible student (as defined for the AOTC/Hope credit purposes, i.e., at least a half-time student). (Code Sec. 221)
Medical and dental expenses An individual who itemizes can deduct the amount by which certain unreimbursed medical and dental expenses paid during the year for himself or herself, his or her spouse, and his or her dependents exceed 7.5% of his adjusted gross income. (Code Sec. 213)
Compensatory Damages Received By Exonerated Prisoner Are Excludable
Chief Counsel Advice 201045023
In Chief Counsel Advice (CCA), IRS has determined that compensatory damages received by an exonerated prisoner pursuant to state legislation enacted to compensate wrongfully incarcerated individuals for their physical injuries, sickness, and economic losses flowing from their injuries and sickness are excludable from gross income under Code Sec. 104(a)(2).
Background. Under Code Sec. 104(a)(2), non-punitive damages received by a taxpayer in a suit or agreement as compensation for personal physical injury or personal physical sickness are excluded from income. If an action has its origin in a physical injury or physical sickness, then all damages (other than punitive damages) that flow from that injury or sickness are treated as payments received on account of physical injury or physical sickness. For example, back pay and other lost income meet the requirement that damages have been received on account of a personal injury if the recovered back pay, etc., relates to a period of time during which the taxpayer was incapacitated for work as a result of the personal injury.
Facts. An individual was wrongfully convicted of a crime and incarcerated for several years before the state exonerated the individual of the crime. While incarcerated, the individual suffered physical injuries and sickness. The state enacted legislation to compensate individuals who were wrongfully convicted and incarcerated for their injuries, sickness, and economic losses flowing from their injuries and sickness, such as lost wages and future medical bills. The exonerated prisoners were allowed to receive their compensation either in a lump sum and/or in periodic payments.
IRS's analysis. IRS stated that compensatory damages for physical injuries and physical sickness that the individual receives from the state for wrongful conviction and incarceration, including damages received for economic losses flowing from the physical injury or physical sickness, are excluded from gross income under Code Sec. 102(a)(2). These compensatory damages are excludable regardless of whether the individual receives them in a lump sum or in periodic payments. But, IRS noted that if an individual receives title to, constructive receipt of, or economic benefit of the corpus or assets used to fund future periodic payments, then some portion of the future periodic payments may not be excludable. Also, IRS emphasized that punitive damages and interest don't qualify for exclusion and are included in gross income.
Conclusion. IRS concluded that, consistent with its analysis, the individual was entitled to exclude from gross income compensation received from the state for wrongful conviction and incarceration.
References: For exclusion of income for damages received for personal physical injury, see FTC 2d/FIN ¶J-5801; United States Tax Reporter ¶1044.02; TaxDesk ¶182,001; TG ¶13201.
In Chief Counsel Advice (CCA), IRS has determined that compensatory damages received by an exonerated prisoner pursuant to state legislation enacted to compensate wrongfully incarcerated individuals for their physical injuries, sickness, and economic losses flowing from their injuries and sickness are excludable from gross income under Code Sec. 104(a)(2).
Background. Under Code Sec. 104(a)(2), non-punitive damages received by a taxpayer in a suit or agreement as compensation for personal physical injury or personal physical sickness are excluded from income. If an action has its origin in a physical injury or physical sickness, then all damages (other than punitive damages) that flow from that injury or sickness are treated as payments received on account of physical injury or physical sickness. For example, back pay and other lost income meet the requirement that damages have been received on account of a personal injury if the recovered back pay, etc., relates to a period of time during which the taxpayer was incapacitated for work as a result of the personal injury.
Facts. An individual was wrongfully convicted of a crime and incarcerated for several years before the state exonerated the individual of the crime. While incarcerated, the individual suffered physical injuries and sickness. The state enacted legislation to compensate individuals who were wrongfully convicted and incarcerated for their injuries, sickness, and economic losses flowing from their injuries and sickness, such as lost wages and future medical bills. The exonerated prisoners were allowed to receive their compensation either in a lump sum and/or in periodic payments.
IRS's analysis. IRS stated that compensatory damages for physical injuries and physical sickness that the individual receives from the state for wrongful conviction and incarceration, including damages received for economic losses flowing from the physical injury or physical sickness, are excluded from gross income under Code Sec. 102(a)(2). These compensatory damages are excludable regardless of whether the individual receives them in a lump sum or in periodic payments. But, IRS noted that if an individual receives title to, constructive receipt of, or economic benefit of the corpus or assets used to fund future periodic payments, then some portion of the future periodic payments may not be excludable. Also, IRS emphasized that punitive damages and interest don't qualify for exclusion and are included in gross income.
Conclusion. IRS concluded that, consistent with its analysis, the individual was entitled to exclude from gross income compensation received from the state for wrongful conviction and incarceration.
References: For exclusion of income for damages received for personal physical injury, see FTC 2d/FIN ¶J-5801; United States Tax Reporter ¶1044.02; TaxDesk ¶182,001; TG ¶13201.
Wednesday, November 17, 2010
Customizing QuickBooks for Nonprofit Organizations
There are many types of nonprofit organizations—health and welfare, religious, education, research, social organizations, and professional associations. Each type needs to collect for services, products, dues, grants, donations, and pledges; pay expenses; pay employees; and generate internal financial statements. Because nonprofit organizations can be subject to a high level of public scrutiny, maintaining accurate accounting records is essential for them. 1
Company Setup
The “EasyStep Interview” discussed in PPC’s QuickBooks Solutions Guide guides users through the process of creating a company in QuickBooks and offers setup hints for the type of business selected. To tailor QuickBooks to specifically handle a nonprofit organization, consider enabling the following preferences: (See section 207 of PPC’s QuickBooks Solutions Guidefor further discussion of preferences.)
• Inventory. Nonprofit organizations may need to track inventory if they sell products like clothing, books, or other items. To turn on inventory preferences, answer “Yes” during the “EasyStep Interview” to the question “Do you want to track inventory?” Inventory also can be enabled by selecting “Edit,” “Preferences” from the menu, then by choosing the “Items & Inventory” icon from the list of icons appearing on the left side of the “Preferences” window and checking the “Inventory and purchase orders are active” checkbox in the “Company Preferences” tab. Setting up inventory items, accounts, and opening balances is discussed beginning in paragraph 203.35, and an inventory setup checklist is provided in Appendix 2F of PPC’s QuickBooks Solutions Guide.
• Sales Tax. Nonprofit organizations may need to collect sales tax if products are sold. Sales tax preferences are enabled in QuickBooks by answering “Yes” during the “EasyStep Interview” to the question “Do you charge sales tax?” Sales tax preferences can also be enabled by selecting “Preferences” from the “Edit” menu and then choosing the “Sales Tax” icon from the list of icons appearing on the left side of the “Preferences” window. Answer “Yes” to the question “Do You Charge Sales Tax?” in the “Company Preferences” tab. Even if the sales tax feature is turned on in the “EasyStep Interview,” additional information should still be entered in the “Preferences” window (for example, when sales tax is paid, when sales tax is owed, most common sales tax, and whether to mark taxable amounts with “T” when printing). Sales tax items, sales tax codes, groups, and opening balances are discussed beginning in paragraph 203.26, and a sales tax setup checklist is provided in Appendix 2E of PPC’s QuickBooks Solutions Guide.
• Time Tracking (QuickBooks Pro, Premier, Premier-Accountant, and Premier-Nonprofit). Nonprofit organizations may need to track time by employee, donor, or volunteer for specific projects. To use time tracking, enable the QuickBooks preference during the “EasyStep Interview” by answering “Yes” to the question “Do you want to track time in QuickBooks?” Time tracking also can be enabled by selecting “Preferences” from the “Edit” menu. Select the “Time & Expenses” icon and the “Company Preferences” tab. Answer “Yes” to the question “Do you Track Time?” The user also should enter the first day of the work week in this screen.
• Classes. FASB ASC 958-205 (formerly SFAS No. 117, Financial Statements of Not-for-Profit Organizations) requires nonprofit organizations to report amounts for three classes of net assets—unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets. Thus, revenues and expenses may be grouped in QuickBooks using those classifications so that those amounts can be determined, or classes can be used to group functional expense classifications (that is, Programs, Administration, and Fundraising) and subclasses can be used to group specific location or program expenses (such as Westside Clinic, Southside Clinic, and Mobile Lab or Foodbank, Night Shelter, and Soup Kitchen) and to designate restrictions. To use classes, enable the QuickBooks preference by selecting “Preferences” from the “Edit” menu, choosing the “Accounting” icon from the list of icons appearing on the left side of the “Preferences” window, and checking “Use class tracking” in the “Company Preferences” tab. QuickBooks also allows users to require a class to be entered before a transaction is recorded. (Section 206 of PPC’s QuickBooks Solutions Guidediscusses using classes further. Also see paragraph 702.12.)
Member, Donor, and Client Setup The organization’s members, donors, and clients should be entered in the “Customer:Job List” so that information about them can be tracked. To set up members, donors, and clients, go to the “Customer Center” by clicking on the “Customer Center” icon. Click the “New Customer & Job” button, and enter the client data. The “Add/Edit Multiple List Entries” window can be used to add and/or edit multiple clients. (See the discussion at paragraph 206.12 of PPC’s QuickBooks Solutions Guide.) Notes can be kept on each client and are entered on the “Edit Customer” window. (Click the button on the right side labeled “Notes.” The “Customer:Job List” will display an icon indicating notes are available.) Custom fields can be added in the “Additional Info” tab to track birthday, spouse, administrative assistant, fiscal year end, or any other meaningful data. Keep in mind, however, that an individual list is limited to seven custom fields with a maximum of fifteen custom fields for all lists. The same field (e.g., birthday) that applies to customers, vendors, and employees counts as one field.
Setting up Members, Donors, and Clients by Type Nonprofit organizations may find it useful to track and report members, donors, and clients by type. Some useful types might be type of contributor or member (sponsor, donor, patron, or subscriber), location of contributor or member, industry represented by donor or member, or type of services provided to clients. For example, a nonprofit shelter may set up contributors with types (e.g., business and corporate, foundation, government, and private). Each customer type may have up to five levels of subtypes. Reports, labels, and summary statements may print by customer type.
To group members, donors, or clients by type, first create the types by selecting “Customer & Vendor Profile Lists” and then “Customer Type List” from the “Lists” menu. Click on the “Customer Type” menu button on the screen that appears, and select “New.” Once types have been created, assign members, donors, or clients to the types by double-clicking each name on the “Customer:Job List,” selecting the “Additional Info” tab, and choosing the appropriate type from the drop-down list under “Type.”
Note: Types can be added “on the fly” as member, donor, or client information is entered. Simply choose “” from the drop-down list of types on the “Additional Info” tab.
Setting up Services, Products, Dues, and Pledges Nonprofit organizations collect for services, products, dues, donations, and pledges. This can be accomplished in QuickBooks by setting up items for each service or product provided as follows:
a. Service items should be used for dues, pledges, memberships, or sponsorships. Service items are set up by choosing “Item List” from the “Lists” menu. Click on the “Item” button and select “New.”
b. Miscellaneous charges should be set up as other charge items. For example, a monthly breakfast meeting with a fee of $10 could be set up as an other charge item called “Meetings.” Other charge items are set up by choosing “Item List” from the “Lists,” menu. Click on the “Item” button and select “New.”
c. Sales of products (t-shirts, books, or other items) should be set up as noninventory or inventory part items. Inventory and noninventory part items are set up by choosing “Item List” from the “Lists” menu. Click on the “Item” button and select “New.” (The inventory preference must be enabled in “Items & Inventory.” See paragraph 203.35 and Appendix 2F of PPC’s QuickBooks Solutions Guide.) Using inventory part items will update quantities on hand, cost of goods sold, and inventory values automatically when the items are entered on an invoice or statement charge. If sales tax is charged on products sold, ensure the sales tax preference is enabled (see paragraph 203.26 and Appendix 2E of PPC’s QuickBooks Solutions Guide) and select the “Tax Code” on the “Edit Item” or “New item” window. Subitems can be created for up to five levels. An example of sponsorship subitems might be Diamond Circle, Gold Circle, and Silver Circle.
The “Add/Edit Multiple List Entries” window can be used to add and/or edit multiple items. (See the discussion at paragraph 206.12 of PPC’s QuickBooks Solutions Guide.)
Nonprofit organizations typically are run based on budgets, so reports of actual results versus budgeted amounts are important tools for them. Budgets are created in QuickBooks by selecting “Planning & Budgeting” and then “Set Up Budgets” from the “Company” menu. QuickBooks will display the “Create New Budget” wizard. 2
Note: If a month-by-month budget is not needed, set up the budget by entering the annual budget amount in the first month’s amount field.
Follow the onscreen instructions to create the budget. For further information on creating a budget, see paragraph 203.2 of PPC’s QuickBooks Solutions Guide.
Nonprofit organizations frequently experience periods of limited cash flow. QuickBooks allows users to forecast their cash flows for the next six weeks based either on the organization’s experience during the previous six weeks or amounts inputted by the user. An in-depth discussion of the feature is located in section 403 of PPC’s QuickBooks Solutions Guide.
Chart of Accounts Consistent, quality financial reporting has long been a goal of nonprofit organizations and those that are interested in their financial results. To aid nonprofit organizations in reaching that goal, CompassPoint Nonprofit Services, a nonprofit consulting and training organization, helped develop the book, Unified Financial Reporting System for Not-for-Profit Organizations—a Comprehensive Guide to Unifying GAAP, IRS Form 990, and Other Financial Reports Using a Unified Chart of Accounts. The book assists the reader in either developing a nonprofit organization’s new chart of accounts or cross-referencing a nonprofit organization’s existing chart of accounts so that various financial reports are quickly and easily prepared. Nonprofit organizations that have multiple reporting responsibilities may wish to consult this book. Contact CompassPoint at www.compasspoint.org or (415) 541-9000.
QuickBooks Premier-Nonprofit includes a copy of the Unified Chart of Accounts (UCOA) for nonprofit organizations. It is used automatically if the company file is created using the “EasyStep Interview” and Nonprofit is selected as the industry type. If the “EasyStep Interview” was not used, the user can import the UCOA by selecting “Import Nonprofit Chart of Accounts (UCOA)” from the “Nonprofit” menu.
Practitioners using QuickBooks Premier-Accountant can import the UCOA for their nonprofit clients that are not using QuickBooks Premier-Nonprofit by using the “Toggle” feature. As discussed in paragraph 700.4 of PPC’s QuickBooks Solutions Guide, practitioners can toggle between other editions of QuickBooks with Premier-Accountant by selecting “Toggle to Another Edition” from the “File” menu. They should select QuickBooks Premier-Nonprofit and select “Toggle.” QuickBooks closes Premier-Accountant and reopens with the QuickBooks Premier-Nonprofit. Using the QuickBooks Premier-Nonprofit menu, practitioners can import the UCOA as discussed in paragraph 702.10 of PPC’s QuickBooks Solutions Guide. When clients open their files in their edition of QuickBooks, the chart of accounts will be available to them. Appendix 7A-3 of PPC’s QuickBooks Solutions Guideillustrates a sample chart of accounts for a social service organization.
Note: The “Toggle” feature is only available in QuickBooks Premier-Accountant.
Solutions to Common Problems
Net Asset Classification and Functional Expenses As discussed in paragraph 702.2 of PPC’s QuickBooks Solutions Guide, FASB ASC 958-205-45 (formerly SFAS No. 117) requires nonprofit organizations to report revenues and expenses as unrestricted, temporarily restricted, or permanently restricted. Many organizations also are required to report expenses by their functional classification, such as major classes of program services and supporting activities. To accomplish that in QuickBooks, set up classes for unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets, or set up classes for functional expense classifications with subclasses for specific programs and restrictions and specify the appropriate class when recording each transaction.
While QuickBooks can track revenues and expenses by class, it cannot track balance sheet 3 amounts by class. Thus, the balance sheet report produced by QuickBooks does not meet the FASB ASC 958-205 (formerly SFAS No. 117) requirement to present amounts for each of the three classes of net assets—unrestricted, temporarily restricted, and permanently restricted. To prepare a proper balance sheet presentation, export the balance sheet to Excel and manually change the net asset section to report the amounts by class. 4
Tracking Volunteers Most nonprofit organizations rely on volunteers. If volunteers need to be tracked separately from members, donors, and clients, they can be entered in the “Other Names List.” Volunteers that are already listed as members, donors, or clients will need to be entered with a slight name variation (use V for volunteer at the end of the name or enter a middle initial). Custom fields and jobs cannot be added like they can on the “Customer:Job List,” but the notes option is available. To add a volunteer to the “Other Names List” from the “Lists” menu, select “New” from the “Other Names” menu button. Enter the name and other contact information. Notes can be added from the “Edit Name” window.
Receiving Cash Donations Nonprofit organizations that receive donations that were not invoiced may enter them in QuickBooks either as a deposit or a cash sale. However, deposits do not allow users to track items (the account is entered rather than the item) or generate a cash receipt. Consequently, such donations generally should be entered as cash sales. To enter a cash sale, select “Enter Sales Receipts” from the “Customers” menu. Select the “Custom Sales Receipt” or any other sales receipt template. (See paragraph 702.22 of PPC’s QuickBooks Solutions Guidefor customizing templates.)
Recording Donated Goods and Services Nonprofit organizations often receive donated goods and services. Donated goods should be recorded as revenue and as inventory or expense (whichever is appropriate) at fair value in the period they are received. Donated services should be recorded at fair value if the services (a) create or enhance a nonfinancial asset or (b) involve specialized skills, provided by entities possessing those skills, that would be purchased if they were not donated. Donated services are recorded as revenues and as additions to nonfinancial assets (if related to a nonfinancial asset) or expense.
The best way to record donated goods and services in QuickBooks is through a journal entry. To record a journal entry, select “Make General Journal Entries” from the “Company” menu.
Recording Promises to Give (Pledges) A promise to give is a written or oral agreement by a donor to contribute cash or other assets to the organization. A promise may be conditional (that is, contingent upon the occurrence of specified future events) or unconditional. Recording promises to give in QuickBooks varies depending on whether the organization keeps its accounting records on the accrual or cash basis of accounting as follows:
a. Accrual Basis. Accrual-basis organizations recognize unconditional promises to give in their financial statements when the promises are made. Thus, they should record unconditional promises to give in QuickBooks using an invoice when the promise is made.
A conditional promise to give is recognized when the conditions upon which it depends are met (or there is only a remote possibility they will not be met). Conditional promises to give should be recorded in QuickBooks as pending invoices so that they may be tracked, but not posted as revenue. (Pending invoices are not posted to the register—and thus reported as income—until they are marked final.) To create a pending invoice, create an invoice as normal and choose “Mark Invoice As Pending” from the “Edit” menu. To review a report of conditional promises to give, choose “Reports,” “Sales,” and then “Pending Sales” from the menu bar. Once a conditional promise to give meets the criteria for recognizing it as revenue, record the invoice by simply displaying it and choosing “Mark Invoice As Final” from the “Edit” menu.
b. Cash Basis. Cash-basis organizations record promises to give when the contribution is received. However, cash-basis organizations still should create an invoice for a promise to give when the promise is made so that it may be tracked in QuickBooks. (QuickBooks does not record invoices of cash-basis organizations as revenue. Revenue is recorded only when the cash receipt is recorded.) Later, cash-basis organizations should record the receipt of the promise to give against the invoice by selecting “Customers” then “Receive Payments” from the menu bar and filling in the requested information. (Be sure to apply the receipt to the appropriate invoice.)
Tracking and Collecting Membership Dues Organizations may charge membership dues monthly, based on a rolling calendar, or based on a calendar year. Rolling calendar memberships expire in a year and are due on or near the anniversary date. Calendar year memberships are prorated for the remaining time in the year and all memberships are due at the same time.
Calendar year memberships may be set up in QuickBooks using service items for each month of the year with a prorated rate. (For example, if annual dues are $240, the amount for January’s service item would be $240, the amount for February’s service item would be $220, and so on.) Rolling calendar and monthly memberships may be set up with a single service item. (Setup of items is discussed in paragraph 702.6 of PPC’s QuickBooks Solutions Guide.)
QuickBooks can memorize an invoice and remind the user to send renewal notices. After the invoice is created, select “Memorize Invoice” from the “Edit” menu. The user can click “Remind Me” and the “How Often” drop-down list will appear. Choose the period to be reminded. (See paragraph 207.16 of PPC’s QuickBooks Solutions Guide.) Memorized transaction groups also can be created by month to track memberships due in a particular month.
Customizing Sales Forms Invoices, estimates, statements, or any sales form can be customized in QuickBooks. Fields can be added, changed, or deleted by choosing “Templates” from the “Lists” menu. A new template can be created or an existing form can be duplicated and then modified. Logos may be added by checking the “Use logo” checkbox in the “Basic Customizations” window. Click the “Use logo” checkbox, and select the path of the bitmap file (.bmp). The organization’s phone number can be added to the form by checking the “Phone Number” checkbox to display the field. Alternatively, the organization’s phone number can be added to the “Address” field by selecting “Company,” “Company Information” from the menu. Some other changes nonprofit organizations may want to make are as follows: 5
• Customizing Sales Receipts. The “Custom Sales Receipt” template may be copied, or the original template may be edited for a donation receipt. Click on the “Additional Customization” button. Then, on the “Header” tab, change the “Default Title” to “Donations Receipt,” the “Sale Number” to “Receipt No.,” and the “Sold To” to “Donor.” On the “Columns” tab, remove the “Qty” and “Rate” columns. On the “Footer” tab, uncheck the “Subtotal” and “Sales Tax” fields.
• Customizing Invoices for Pledges. If the organization sends reminders for pledges, copy the “Intuit Professional Invoice” template. Click on the “Additional Customization” button. Then, on the “Header” tab, change the “Default Title” to “Pledge,” the “Invoice Number” to “Pledge No.,” and the “Bill To” to “Donor.” On the “Columns” tab, the quantity and rate columns may be turned off the form. Statements can be customized in the same manner by duplicating and modifying the “Intuit Standard Statement” template.
Reporting Reports can be exported to Excel for modification and are discussed further beginning in paragraph 403.52 of PPC’s QuickBooks Solutions Guide. 6 A few reports that may be useful to nonprofit organizations in addition to the standard profit and loss reports are as follows:
• Overhead as a Percentage of Total Expenses. Often, nonprofit organizations will need to report overhead as a percentage of total expenses. This can be accomplished by selecting the “Profit & Loss by Class” report (select “Company & Financial” from the “Reports” menu), clicking on the “Modify Report” button, and selecting add a subcolumn for “% of Row” in the “Display” tab.
• Promises to Give (Pledges). If pledges are identified as pending invoices, select “Sales” and “Pending Sales” from the “Reports” menu.
• Donations and Grants. Donors may need a year end or periodic report. A custom report may be created that will work with the make deposit and sales receipt methods of receiving cash. Choose “Custom Summary Report” from the “Reports” menu. Modify the report to display columns by “Total only,” “Class,” “Item type,” or any other field and display “Customer” for rows. For example, selecting “Total only” will display total donations by customer.
• Revenue and Expense Classifications. All transactions should be assigned a class (see discussion beginning at paragraph 702.12 of PPC’s QuickBooks Solutions Guide). To determine whether there are unassigned transactions, create a report of transactions by class choosing “Custom Summary Report” from the “Report” menu. Choose “All” from the “Dates” drop-down list on the “Display” tab, and from the “Display columns by” drop-down list select “Total only.” Finally, select “Class” from the “Display rows by” drop-down list. Transactions appearing in the unclassified category should be investigated and assigned to a class if necessary.
• Budgeting. Budget reports are available by choosing “Budgets” (or “Budgets & Forecasts” in QuickBooks Premier, Premier-Accountant, and Premier-Nonprofit) from the “Reports” menu. Choose the report (Budget Overview, Budget vs. Actual, Profit & Loss Budget Performance, or Budget vs. Actual Graph) and use the “Budget Report” wizard to create the budget and layout. To create a “Profit & Loss Budget Overview” report, the user should select “Budget Overview” from the “Reports” menu and in the “Budget Report” wizard select “Profit & Loss by Account” for the applicable year. Next, select the report layout for the budget and click “Finish” to finish the report.
• Sales Report by Item or Customer. Amounts for services, other charges, inventory, or any other items may be printed by item or customer, in detail or summarized. From the “Reports” menu, choose “Sales” and the appropriate report.
Additional report templates are available for download for QuickBooks Pro, Premier, Premier-Accountant and Premier-Nonprofit users. Select “Lists,” “Templates” from the menu, click on the “Templates” button, and select “Download Templates” to open the Internet browser. (See the discussion beginning at paragraph 501.16 of PPC’s QuickBooks Solutions Guide.) Some of the reports that are available for nonprofit organizations are —
• Contributions by Donor. Lists the total contributions made by each donor.
• Organizational Budget by Program. Provides an overview of the organization’s budget.
• Overhead as Percentage of Total Income and Expenses. Provides an overview of how well the organization is meeting its budget goals.
Integrated Applications The prior discussion provides solutions to common problems, but nonprofits often need specific industry applications in addition to QuickBooks. Intuit realized certain industries have unique needs and opened the QuickBooks source code to software developers so that they could develop specialized industry software that integrates with QuickBooks Pro, Premier, Premier-Accountant, and Premier-Nonprofit. Integration allows data (e.g., donations, member, or financial) to be shared. When specific third-party applications are integrated with QuickBooks, the data sharing can help save time by eliminating repetitive data entry and increasing data accuracy. A list of third-party software applications for nonprofits that integrate with QuickBooks is available at http://marketplace.intuit.com. (See the discussion beginning at paragraph 504.1 of PPC’s QuickBooks Solutions Guide for further discussion of integrated applications.)
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1 The QuickBooks Premier-Nonprofit edition is designed specifically for nonprofit organizations. It has additional features that streamline accounting for fundraising efforts. It also includes specialized reports for the nonprofit industry, including a “Statement of Functional Expense” report and includes a chart of accounts designed specifically for nonprofits. It also includes a “Nonprofit” menu that gives users instant access to key activities and reports. For more information on QuickBooks Premier-Nonprofit, refer to http://quickbooks.intuit.com.
2 If a budget currently exists, the most recent budget will be displayed in the “Set up Budgets” window. To create a new budget, click the “Create New Budget” button in the right hand corner.
3 Most nonprofit organizations use the term “statement of financial position.” The authors use “balance sheet” to be consistent with the QuickBooks terminology.
4 The Intuit Statement Writer is an optional add-on included in QuickBooks Premier-Accountant. The practitioner can use the Intuit Statement Writer to format the financial statements to prepare a proper balance sheet presentation. See discussion at section 403 of PPC’s QuickBooks Solutions Guide.
5 QuickBooks has downloadable templates for various forms (e.g., email pledge forms and background color changes for some forms). See the discussion of downloading templates at paragraph 702.24 of PPC’s QuickBooks Solutions Guide.
6 The Intuit Statement Writer, an optional add-on within QuickBooks Premier-Accountant, also enables the practitioner to modify financial statements. See discussion at section 403 of PPC’s QuickBooks Solutions Guide.
Company Setup
The “EasyStep Interview” discussed in PPC’s QuickBooks Solutions Guide guides users through the process of creating a company in QuickBooks and offers setup hints for the type of business selected. To tailor QuickBooks to specifically handle a nonprofit organization, consider enabling the following preferences: (See section 207 of PPC’s QuickBooks Solutions Guidefor further discussion of preferences.)
• Inventory. Nonprofit organizations may need to track inventory if they sell products like clothing, books, or other items. To turn on inventory preferences, answer “Yes” during the “EasyStep Interview” to the question “Do you want to track inventory?” Inventory also can be enabled by selecting “Edit,” “Preferences” from the menu, then by choosing the “Items & Inventory” icon from the list of icons appearing on the left side of the “Preferences” window and checking the “Inventory and purchase orders are active” checkbox in the “Company Preferences” tab. Setting up inventory items, accounts, and opening balances is discussed beginning in paragraph 203.35, and an inventory setup checklist is provided in Appendix 2F of PPC’s QuickBooks Solutions Guide.
• Sales Tax. Nonprofit organizations may need to collect sales tax if products are sold. Sales tax preferences are enabled in QuickBooks by answering “Yes” during the “EasyStep Interview” to the question “Do you charge sales tax?” Sales tax preferences can also be enabled by selecting “Preferences” from the “Edit” menu and then choosing the “Sales Tax” icon from the list of icons appearing on the left side of the “Preferences” window. Answer “Yes” to the question “Do You Charge Sales Tax?” in the “Company Preferences” tab. Even if the sales tax feature is turned on in the “EasyStep Interview,” additional information should still be entered in the “Preferences” window (for example, when sales tax is paid, when sales tax is owed, most common sales tax, and whether to mark taxable amounts with “T” when printing). Sales tax items, sales tax codes, groups, and opening balances are discussed beginning in paragraph 203.26, and a sales tax setup checklist is provided in Appendix 2E of PPC’s QuickBooks Solutions Guide.
• Time Tracking (QuickBooks Pro, Premier, Premier-Accountant, and Premier-Nonprofit). Nonprofit organizations may need to track time by employee, donor, or volunteer for specific projects. To use time tracking, enable the QuickBooks preference during the “EasyStep Interview” by answering “Yes” to the question “Do you want to track time in QuickBooks?” Time tracking also can be enabled by selecting “Preferences” from the “Edit” menu. Select the “Time & Expenses” icon and the “Company Preferences” tab. Answer “Yes” to the question “Do you Track Time?” The user also should enter the first day of the work week in this screen.
• Classes. FASB ASC 958-205 (formerly SFAS No. 117, Financial Statements of Not-for-Profit Organizations) requires nonprofit organizations to report amounts for three classes of net assets—unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets. Thus, revenues and expenses may be grouped in QuickBooks using those classifications so that those amounts can be determined, or classes can be used to group functional expense classifications (that is, Programs, Administration, and Fundraising) and subclasses can be used to group specific location or program expenses (such as Westside Clinic, Southside Clinic, and Mobile Lab or Foodbank, Night Shelter, and Soup Kitchen) and to designate restrictions. To use classes, enable the QuickBooks preference by selecting “Preferences” from the “Edit” menu, choosing the “Accounting” icon from the list of icons appearing on the left side of the “Preferences” window, and checking “Use class tracking” in the “Company Preferences” tab. QuickBooks also allows users to require a class to be entered before a transaction is recorded. (Section 206 of PPC’s QuickBooks Solutions Guidediscusses using classes further. Also see paragraph 702.12.)
Member, Donor, and Client Setup The organization’s members, donors, and clients should be entered in the “Customer:Job List” so that information about them can be tracked. To set up members, donors, and clients, go to the “Customer Center” by clicking on the “Customer Center” icon. Click the “New Customer & Job” button, and enter the client data. The “Add/Edit Multiple List Entries” window can be used to add and/or edit multiple clients. (See the discussion at paragraph 206.12 of PPC’s QuickBooks Solutions Guide.) Notes can be kept on each client and are entered on the “Edit Customer” window. (Click the button on the right side labeled “Notes.” The “Customer:Job List” will display an icon indicating notes are available.) Custom fields can be added in the “Additional Info” tab to track birthday, spouse, administrative assistant, fiscal year end, or any other meaningful data. Keep in mind, however, that an individual list is limited to seven custom fields with a maximum of fifteen custom fields for all lists. The same field (e.g., birthday) that applies to customers, vendors, and employees counts as one field.
Setting up Members, Donors, and Clients by Type Nonprofit organizations may find it useful to track and report members, donors, and clients by type. Some useful types might be type of contributor or member (sponsor, donor, patron, or subscriber), location of contributor or member, industry represented by donor or member, or type of services provided to clients. For example, a nonprofit shelter may set up contributors with types (e.g., business and corporate, foundation, government, and private). Each customer type may have up to five levels of subtypes. Reports, labels, and summary statements may print by customer type.
To group members, donors, or clients by type, first create the types by selecting “Customer & Vendor Profile Lists” and then “Customer Type List” from the “Lists” menu. Click on the “Customer Type” menu button on the screen that appears, and select “New.” Once types have been created, assign members, donors, or clients to the types by double-clicking each name on the “Customer:Job List,” selecting the “Additional Info” tab, and choosing the appropriate type from the drop-down list under “Type.”
Note: Types can be added “on the fly” as member, donor, or client information is entered. Simply choose “
Setting up Services, Products, Dues, and Pledges Nonprofit organizations collect for services, products, dues, donations, and pledges. This can be accomplished in QuickBooks by setting up items for each service or product provided as follows:
a. Service items should be used for dues, pledges, memberships, or sponsorships. Service items are set up by choosing “Item List” from the “Lists” menu. Click on the “Item” button and select “New.”
b. Miscellaneous charges should be set up as other charge items. For example, a monthly breakfast meeting with a fee of $10 could be set up as an other charge item called “Meetings.” Other charge items are set up by choosing “Item List” from the “Lists,” menu. Click on the “Item” button and select “New.”
c. Sales of products (t-shirts, books, or other items) should be set up as noninventory or inventory part items. Inventory and noninventory part items are set up by choosing “Item List” from the “Lists” menu. Click on the “Item” button and select “New.” (The inventory preference must be enabled in “Items & Inventory.” See paragraph 203.35 and Appendix 2F of PPC’s QuickBooks Solutions Guide.) Using inventory part items will update quantities on hand, cost of goods sold, and inventory values automatically when the items are entered on an invoice or statement charge. If sales tax is charged on products sold, ensure the sales tax preference is enabled (see paragraph 203.26 and Appendix 2E of PPC’s QuickBooks Solutions Guide) and select the “Tax Code” on the “Edit Item” or “New item” window. Subitems can be created for up to five levels. An example of sponsorship subitems might be Diamond Circle, Gold Circle, and Silver Circle.
The “Add/Edit Multiple List Entries” window can be used to add and/or edit multiple items. (See the discussion at paragraph 206.12 of PPC’s QuickBooks Solutions Guide.)
Nonprofit organizations typically are run based on budgets, so reports of actual results versus budgeted amounts are important tools for them. Budgets are created in QuickBooks by selecting “Planning & Budgeting” and then “Set Up Budgets” from the “Company” menu. QuickBooks will display the “Create New Budget” wizard. 2
Note: If a month-by-month budget is not needed, set up the budget by entering the annual budget amount in the first month’s amount field.
Follow the onscreen instructions to create the budget. For further information on creating a budget, see paragraph 203.2 of PPC’s QuickBooks Solutions Guide.
Nonprofit organizations frequently experience periods of limited cash flow. QuickBooks allows users to forecast their cash flows for the next six weeks based either on the organization’s experience during the previous six weeks or amounts inputted by the user. An in-depth discussion of the feature is located in section 403 of PPC’s QuickBooks Solutions Guide.
Chart of Accounts Consistent, quality financial reporting has long been a goal of nonprofit organizations and those that are interested in their financial results. To aid nonprofit organizations in reaching that goal, CompassPoint Nonprofit Services, a nonprofit consulting and training organization, helped develop the book, Unified Financial Reporting System for Not-for-Profit Organizations—a Comprehensive Guide to Unifying GAAP, IRS Form 990, and Other Financial Reports Using a Unified Chart of Accounts. The book assists the reader in either developing a nonprofit organization’s new chart of accounts or cross-referencing a nonprofit organization’s existing chart of accounts so that various financial reports are quickly and easily prepared. Nonprofit organizations that have multiple reporting responsibilities may wish to consult this book. Contact CompassPoint at www.compasspoint.org or (415) 541-9000.
QuickBooks Premier-Nonprofit includes a copy of the Unified Chart of Accounts (UCOA) for nonprofit organizations. It is used automatically if the company file is created using the “EasyStep Interview” and Nonprofit is selected as the industry type. If the “EasyStep Interview” was not used, the user can import the UCOA by selecting “Import Nonprofit Chart of Accounts (UCOA)” from the “Nonprofit” menu.
Practitioners using QuickBooks Premier-Accountant can import the UCOA for their nonprofit clients that are not using QuickBooks Premier-Nonprofit by using the “Toggle” feature. As discussed in paragraph 700.4 of PPC’s QuickBooks Solutions Guide, practitioners can toggle between other editions of QuickBooks with Premier-Accountant by selecting “Toggle to Another Edition” from the “File” menu. They should select QuickBooks Premier-Nonprofit and select “Toggle.” QuickBooks closes Premier-Accountant and reopens with the QuickBooks Premier-Nonprofit. Using the QuickBooks Premier-Nonprofit menu, practitioners can import the UCOA as discussed in paragraph 702.10 of PPC’s QuickBooks Solutions Guide. When clients open their files in their edition of QuickBooks, the chart of accounts will be available to them. Appendix 7A-3 of PPC’s QuickBooks Solutions Guideillustrates a sample chart of accounts for a social service organization.
Note: The “Toggle” feature is only available in QuickBooks Premier-Accountant.
Solutions to Common Problems
Net Asset Classification and Functional Expenses As discussed in paragraph 702.2 of PPC’s QuickBooks Solutions Guide, FASB ASC 958-205-45 (formerly SFAS No. 117) requires nonprofit organizations to report revenues and expenses as unrestricted, temporarily restricted, or permanently restricted. Many organizations also are required to report expenses by their functional classification, such as major classes of program services and supporting activities. To accomplish that in QuickBooks, set up classes for unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets, or set up classes for functional expense classifications with subclasses for specific programs and restrictions and specify the appropriate class when recording each transaction.
While QuickBooks can track revenues and expenses by class, it cannot track balance sheet 3 amounts by class. Thus, the balance sheet report produced by QuickBooks does not meet the FASB ASC 958-205 (formerly SFAS No. 117) requirement to present amounts for each of the three classes of net assets—unrestricted, temporarily restricted, and permanently restricted. To prepare a proper balance sheet presentation, export the balance sheet to Excel and manually change the net asset section to report the amounts by class. 4
Tracking Volunteers Most nonprofit organizations rely on volunteers. If volunteers need to be tracked separately from members, donors, and clients, they can be entered in the “Other Names List.” Volunteers that are already listed as members, donors, or clients will need to be entered with a slight name variation (use V for volunteer at the end of the name or enter a middle initial). Custom fields and jobs cannot be added like they can on the “Customer:Job List,” but the notes option is available. To add a volunteer to the “Other Names List” from the “Lists” menu, select “New” from the “Other Names” menu button. Enter the name and other contact information. Notes can be added from the “Edit Name” window.
Receiving Cash Donations Nonprofit organizations that receive donations that were not invoiced may enter them in QuickBooks either as a deposit or a cash sale. However, deposits do not allow users to track items (the account is entered rather than the item) or generate a cash receipt. Consequently, such donations generally should be entered as cash sales. To enter a cash sale, select “Enter Sales Receipts” from the “Customers” menu. Select the “Custom Sales Receipt” or any other sales receipt template. (See paragraph 702.22 of PPC’s QuickBooks Solutions Guidefor customizing templates.)
Recording Donated Goods and Services Nonprofit organizations often receive donated goods and services. Donated goods should be recorded as revenue and as inventory or expense (whichever is appropriate) at fair value in the period they are received. Donated services should be recorded at fair value if the services (a) create or enhance a nonfinancial asset or (b) involve specialized skills, provided by entities possessing those skills, that would be purchased if they were not donated. Donated services are recorded as revenues and as additions to nonfinancial assets (if related to a nonfinancial asset) or expense.
The best way to record donated goods and services in QuickBooks is through a journal entry. To record a journal entry, select “Make General Journal Entries” from the “Company” menu.
Recording Promises to Give (Pledges) A promise to give is a written or oral agreement by a donor to contribute cash or other assets to the organization. A promise may be conditional (that is, contingent upon the occurrence of specified future events) or unconditional. Recording promises to give in QuickBooks varies depending on whether the organization keeps its accounting records on the accrual or cash basis of accounting as follows:
a. Accrual Basis. Accrual-basis organizations recognize unconditional promises to give in their financial statements when the promises are made. Thus, they should record unconditional promises to give in QuickBooks using an invoice when the promise is made.
A conditional promise to give is recognized when the conditions upon which it depends are met (or there is only a remote possibility they will not be met). Conditional promises to give should be recorded in QuickBooks as pending invoices so that they may be tracked, but not posted as revenue. (Pending invoices are not posted to the register—and thus reported as income—until they are marked final.) To create a pending invoice, create an invoice as normal and choose “Mark Invoice As Pending” from the “Edit” menu. To review a report of conditional promises to give, choose “Reports,” “Sales,” and then “Pending Sales” from the menu bar. Once a conditional promise to give meets the criteria for recognizing it as revenue, record the invoice by simply displaying it and choosing “Mark Invoice As Final” from the “Edit” menu.
b. Cash Basis. Cash-basis organizations record promises to give when the contribution is received. However, cash-basis organizations still should create an invoice for a promise to give when the promise is made so that it may be tracked in QuickBooks. (QuickBooks does not record invoices of cash-basis organizations as revenue. Revenue is recorded only when the cash receipt is recorded.) Later, cash-basis organizations should record the receipt of the promise to give against the invoice by selecting “Customers” then “Receive Payments” from the menu bar and filling in the requested information. (Be sure to apply the receipt to the appropriate invoice.)
Tracking and Collecting Membership Dues Organizations may charge membership dues monthly, based on a rolling calendar, or based on a calendar year. Rolling calendar memberships expire in a year and are due on or near the anniversary date. Calendar year memberships are prorated for the remaining time in the year and all memberships are due at the same time.
Calendar year memberships may be set up in QuickBooks using service items for each month of the year with a prorated rate. (For example, if annual dues are $240, the amount for January’s service item would be $240, the amount for February’s service item would be $220, and so on.) Rolling calendar and monthly memberships may be set up with a single service item. (Setup of items is discussed in paragraph 702.6 of PPC’s QuickBooks Solutions Guide.)
QuickBooks can memorize an invoice and remind the user to send renewal notices. After the invoice is created, select “Memorize Invoice” from the “Edit” menu. The user can click “Remind Me” and the “How Often” drop-down list will appear. Choose the period to be reminded. (See paragraph 207.16 of PPC’s QuickBooks Solutions Guide.) Memorized transaction groups also can be created by month to track memberships due in a particular month.
Customizing Sales Forms Invoices, estimates, statements, or any sales form can be customized in QuickBooks. Fields can be added, changed, or deleted by choosing “Templates” from the “Lists” menu. A new template can be created or an existing form can be duplicated and then modified. Logos may be added by checking the “Use logo” checkbox in the “Basic Customizations” window. Click the “Use logo” checkbox, and select the path of the bitmap file (.bmp). The organization’s phone number can be added to the form by checking the “Phone Number” checkbox to display the field. Alternatively, the organization’s phone number can be added to the “Address” field by selecting “Company,” “Company Information” from the menu. Some other changes nonprofit organizations may want to make are as follows: 5
• Customizing Sales Receipts. The “Custom Sales Receipt” template may be copied, or the original template may be edited for a donation receipt. Click on the “Additional Customization” button. Then, on the “Header” tab, change the “Default Title” to “Donations Receipt,” the “Sale Number” to “Receipt No.,” and the “Sold To” to “Donor.” On the “Columns” tab, remove the “Qty” and “Rate” columns. On the “Footer” tab, uncheck the “Subtotal” and “Sales Tax” fields.
• Customizing Invoices for Pledges. If the organization sends reminders for pledges, copy the “Intuit Professional Invoice” template. Click on the “Additional Customization” button. Then, on the “Header” tab, change the “Default Title” to “Pledge,” the “Invoice Number” to “Pledge No.,” and the “Bill To” to “Donor.” On the “Columns” tab, the quantity and rate columns may be turned off the form. Statements can be customized in the same manner by duplicating and modifying the “Intuit Standard Statement” template.
Reporting Reports can be exported to Excel for modification and are discussed further beginning in paragraph 403.52 of PPC’s QuickBooks Solutions Guide. 6 A few reports that may be useful to nonprofit organizations in addition to the standard profit and loss reports are as follows:
• Overhead as a Percentage of Total Expenses. Often, nonprofit organizations will need to report overhead as a percentage of total expenses. This can be accomplished by selecting the “Profit & Loss by Class” report (select “Company & Financial” from the “Reports” menu), clicking on the “Modify Report” button, and selecting add a subcolumn for “% of Row” in the “Display” tab.
• Promises to Give (Pledges). If pledges are identified as pending invoices, select “Sales” and “Pending Sales” from the “Reports” menu.
• Donations and Grants. Donors may need a year end or periodic report. A custom report may be created that will work with the make deposit and sales receipt methods of receiving cash. Choose “Custom Summary Report” from the “Reports” menu. Modify the report to display columns by “Total only,” “Class,” “Item type,” or any other field and display “Customer” for rows. For example, selecting “Total only” will display total donations by customer.
• Revenue and Expense Classifications. All transactions should be assigned a class (see discussion beginning at paragraph 702.12 of PPC’s QuickBooks Solutions Guide). To determine whether there are unassigned transactions, create a report of transactions by class choosing “Custom Summary Report” from the “Report” menu. Choose “All” from the “Dates” drop-down list on the “Display” tab, and from the “Display columns by” drop-down list select “Total only.” Finally, select “Class” from the “Display rows by” drop-down list. Transactions appearing in the unclassified category should be investigated and assigned to a class if necessary.
• Budgeting. Budget reports are available by choosing “Budgets” (or “Budgets & Forecasts” in QuickBooks Premier, Premier-Accountant, and Premier-Nonprofit) from the “Reports” menu. Choose the report (Budget Overview, Budget vs. Actual, Profit & Loss Budget Performance, or Budget vs. Actual Graph) and use the “Budget Report” wizard to create the budget and layout. To create a “Profit & Loss Budget Overview” report, the user should select “Budget Overview” from the “Reports” menu and in the “Budget Report” wizard select “Profit & Loss by Account” for the applicable year. Next, select the report layout for the budget and click “Finish” to finish the report.
• Sales Report by Item or Customer. Amounts for services, other charges, inventory, or any other items may be printed by item or customer, in detail or summarized. From the “Reports” menu, choose “Sales” and the appropriate report.
Additional report templates are available for download for QuickBooks Pro, Premier, Premier-Accountant and Premier-Nonprofit users. Select “Lists,” “Templates” from the menu, click on the “Templates” button, and select “Download Templates” to open the Internet browser. (See the discussion beginning at paragraph 501.16 of PPC’s QuickBooks Solutions Guide.) Some of the reports that are available for nonprofit organizations are —
• Contributions by Donor. Lists the total contributions made by each donor.
• Organizational Budget by Program. Provides an overview of the organization’s budget.
• Overhead as Percentage of Total Income and Expenses. Provides an overview of how well the organization is meeting its budget goals.
Integrated Applications The prior discussion provides solutions to common problems, but nonprofits often need specific industry applications in addition to QuickBooks. Intuit realized certain industries have unique needs and opened the QuickBooks source code to software developers so that they could develop specialized industry software that integrates with QuickBooks Pro, Premier, Premier-Accountant, and Premier-Nonprofit. Integration allows data (e.g., donations, member, or financial) to be shared. When specific third-party applications are integrated with QuickBooks, the data sharing can help save time by eliminating repetitive data entry and increasing data accuracy. A list of third-party software applications for nonprofits that integrate with QuickBooks is available at http://marketplace.intuit.com. (See the discussion beginning at paragraph 504.1 of PPC’s QuickBooks Solutions Guide for further discussion of integrated applications.)
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1 The QuickBooks Premier-Nonprofit edition is designed specifically for nonprofit organizations. It has additional features that streamline accounting for fundraising efforts. It also includes specialized reports for the nonprofit industry, including a “Statement of Functional Expense” report and includes a chart of accounts designed specifically for nonprofits. It also includes a “Nonprofit” menu that gives users instant access to key activities and reports. For more information on QuickBooks Premier-Nonprofit, refer to http://quickbooks.intuit.com.
2 If a budget currently exists, the most recent budget will be displayed in the “Set up Budgets” window. To create a new budget, click the “Create New Budget” button in the right hand corner.
3 Most nonprofit organizations use the term “statement of financial position.” The authors use “balance sheet” to be consistent with the QuickBooks terminology.
4 The Intuit Statement Writer is an optional add-on included in QuickBooks Premier-Accountant. The practitioner can use the Intuit Statement Writer to format the financial statements to prepare a proper balance sheet presentation. See discussion at section 403 of PPC’s QuickBooks Solutions Guide.
5 QuickBooks has downloadable templates for various forms (e.g., email pledge forms and background color changes for some forms). See the discussion of downloading templates at paragraph 702.24 of PPC’s QuickBooks Solutions Guide.
6 The Intuit Statement Writer, an optional add-on within QuickBooks Premier-Accountant, also enables the practitioner to modify financial statements. See discussion at section 403 of PPC’s QuickBooks Solutions Guide.
IRS Updates FAQs On New Tax Return Preparer Identifying Number Requirements
IRS has updated its online FAQs explaining the new post-2010 requirement for tax return preparers to obtain and furnish a preparer tax identification number (PTIN) on tax returns and claims for refund of tax that they prepare. The FAQs supplement final regs issued on the PTIN requirement and the application process (see Final Regs Explain New Tax Return Preparer Identifying Number Requirements and Regs Set User Fee To Apply For Or Renew Preparer Tax ID; Online Registration Up And Running), and update FAQs issued earlier this year. Among the subjects covered are how applicants are "compliant" with their federal tax obligations, and whether fingerprints will be required.
Background. Under new final regs, for tax returns or refund claims filed after Dec. 31, 2010, the identifying number that a domestic or foreign tax return preparer must include with the preparer's signature on tax returns and refund claims is his PTIN or such other number as IRS prescribes in forms, instructions, or other guidance. Tax return preparers won't be able to use a SSN as a preparer identifying number unless specifically prescribed by IRS in forms, instructions, or other guidance. The regs also explain who may obtain a PTIN and who is a tax return preparer. (Preamble to TD 9501, 09/28/2010, Reg. 1.6109-2; see Final Regs Explain New Tax Return Preparer Identifying Number Requirements for details)
Separate new regs establish a new annual user fee for individuals who apply for or renew a tax return preparer tax identification number (PTIN), and a new information release explains the online PTIN registration process. (T.D. 9503, 09/28/2010; Reg. 300.9; IR 2010-99, see Regs Set User Fee To Apply For Or Renew Preparer Tax ID; Online Registration Up And Running)
Supplemental guidance on PTIN application process. The new FAQs provide additional guidance on a number of different aspects of the PTIN application process for tax return preparers, including the following information:
• All PTIN applicants must attest that they are compliant with their personal and business tax obligations, or provide an explanation if they are not. Being in tax compliance means all returns that are due have been filed (or an extension requested), and all taxes that are due have been paid (or acceptable payment arrangements have been established). (Online PTIN System, FAQ 18)
• IRS is not currently conducting fingerprint checks as part of the PTIN application process, but may do so for certain applicants in the future. (New PTIN Requirements, FAQ 11)
• Obtaining a PTIN through the new registration system does not trigger any new continuing education requirement (the beginning date for CPE has not been determined). Once the CPE requirement begins, affected preparers will have a full twelve months to meet their first year's requirement. (Attorneys, CPAs, enrolled agents, enrolled actuaries, or enrolled retirement plan agents won't need to meet the new CPE requirements due to their existing education requirements.) (CPE Requirements, FAQ 1)
• Every PTIN holder must have his or her own e-mail account. Thus an organization can't use one e-mail account to create accounts for all of its employees.
• The name to use when applying for a PTIN should be the name used on the applicant's most recent Form 1040. If applicants are married filing jointly and both spouses apply for a PTIN, each must create a user account under different mail addresses and file a separate PTIN application. Each spouse must each enter his or her own information on separate applications (name, social security number and address). The spouse's name or social security number should not be entered. (Online PTIN System, FAQ 8)
Research References: For who is a tax return preparer, see FTC 2d/FIN ¶S-1117; United States Tax Reporter ¶77,014.24; TaxDesk ¶867,002. For the return preparer penalty, see FTC 2d/FIN ¶V-2631; United States Tax Reporter ¶66,944; TaxDesk ¶867,019.
Background. Under new final regs, for tax returns or refund claims filed after Dec. 31, 2010, the identifying number that a domestic or foreign tax return preparer must include with the preparer's signature on tax returns and refund claims is his PTIN or such other number as IRS prescribes in forms, instructions, or other guidance. Tax return preparers won't be able to use a SSN as a preparer identifying number unless specifically prescribed by IRS in forms, instructions, or other guidance. The regs also explain who may obtain a PTIN and who is a tax return preparer. (Preamble to TD 9501, 09/28/2010, Reg. 1.6109-2; see Final Regs Explain New Tax Return Preparer Identifying Number Requirements for details)
Separate new regs establish a new annual user fee for individuals who apply for or renew a tax return preparer tax identification number (PTIN), and a new information release explains the online PTIN registration process. (T.D. 9503, 09/28/2010; Reg. 300.9; IR 2010-99, see Regs Set User Fee To Apply For Or Renew Preparer Tax ID; Online Registration Up And Running)
Supplemental guidance on PTIN application process. The new FAQs provide additional guidance on a number of different aspects of the PTIN application process for tax return preparers, including the following information:
• All PTIN applicants must attest that they are compliant with their personal and business tax obligations, or provide an explanation if they are not. Being in tax compliance means all returns that are due have been filed (or an extension requested), and all taxes that are due have been paid (or acceptable payment arrangements have been established). (Online PTIN System, FAQ 18)
• IRS is not currently conducting fingerprint checks as part of the PTIN application process, but may do so for certain applicants in the future. (New PTIN Requirements, FAQ 11)
• Obtaining a PTIN through the new registration system does not trigger any new continuing education requirement (the beginning date for CPE has not been determined). Once the CPE requirement begins, affected preparers will have a full twelve months to meet their first year's requirement. (Attorneys, CPAs, enrolled agents, enrolled actuaries, or enrolled retirement plan agents won't need to meet the new CPE requirements due to their existing education requirements.) (CPE Requirements, FAQ 1)
• Every PTIN holder must have his or her own e-mail account. Thus an organization can't use one e-mail account to create accounts for all of its employees.
• The name to use when applying for a PTIN should be the name used on the applicant's most recent Form 1040. If applicants are married filing jointly and both spouses apply for a PTIN, each must create a user account under different mail addresses and file a separate PTIN application. Each spouse must each enter his or her own information on separate applications (name, social security number and address). The spouse's name or social security number should not be entered. (Online PTIN System, FAQ 8)
Research References: For who is a tax return preparer, see FTC 2d/FIN ¶S-1117; United States Tax Reporter ¶77,014.24; TaxDesk ¶867,002. For the return preparer penalty, see FTC 2d/FIN ¶V-2631; United States Tax Reporter ¶66,944; TaxDesk ¶867,019.
IRS Will Ease Up On Some New Return Preparer Requirements
In an October 26 speech before the AICPA's Fall Tax Meeting in Washington, IRS Commissioner Doug Shulman revealed two important details about IRS's new return preparer initiative, which requires return preparers to meet new registration, competency testing, continuing education, and ethical standards:
(1) For the first year of implementation (namely 2011) IRS intends to waive the requirement for return preparers to meet continuing education (CE) requirements. Shulman said that the waiver will give IRS time to work through the many issues regarding CE, including working with third parties who already certify CE courses to attempt to leverage their infrastructure.
Observation: The CE requirement won't apply at all to attorneys, CPAs, enrolled agents, enrolled actuaries, or enrolled retirement plan agents due to their existing education requirements.
(2) One of the practitioner complaints about IRS's guidance was that in certain circumstances it requires PTINs to be obtained by non-signing individuals who work on tax returns under the supervision of a professional such as an accountant. (See New FAQs Shed Additional Light On New Tax Return Preparer Identifying Number Requirements, Final Regs Explain New Tax Return Preparer Identifying Number Requirements, and Regs Set User Fee To Apply For Or Renew Preparer Tax ID; Online Registration Up And Running) Acknowledging that "this is a tricky area," Shulman said that "it is highly likely that as we implement the new rules and procedures there will be some relief for testing and continuing education requirements for people who do not sign a return and work in a professional firm under the supervision of an accountant, enrolled agent or lawyer."
To read the full text of Mr. Shulman's speech, see Commissioner Of Internal Revenue Douglas H. Shulman's Keynote Speech Before The AICPA Fall Tax Meeting Washington, DC.
References: For who is a tax return preparer, see FTC 2d/FIN ¶S-1117; United States Tax Reporter ¶77,014.24; TaxDesk ¶867,002; TG ¶71753. For the return preparer penalty, see FTC 2d/FIN ¶V-2631; United States Tax Reporter ¶66,944; TaxDesk ¶867,019; TG ¶71769.
(1) For the first year of implementation (namely 2011) IRS intends to waive the requirement for return preparers to meet continuing education (CE) requirements. Shulman said that the waiver will give IRS time to work through the many issues regarding CE, including working with third parties who already certify CE courses to attempt to leverage their infrastructure.
Observation: The CE requirement won't apply at all to attorneys, CPAs, enrolled agents, enrolled actuaries, or enrolled retirement plan agents due to their existing education requirements.
(2) One of the practitioner complaints about IRS's guidance was that in certain circumstances it requires PTINs to be obtained by non-signing individuals who work on tax returns under the supervision of a professional such as an accountant. (See New FAQs Shed Additional Light On New Tax Return Preparer Identifying Number Requirements, Final Regs Explain New Tax Return Preparer Identifying Number Requirements, and Regs Set User Fee To Apply For Or Renew Preparer Tax ID; Online Registration Up And Running) Acknowledging that "this is a tricky area," Shulman said that "it is highly likely that as we implement the new rules and procedures there will be some relief for testing and continuing education requirements for people who do not sign a return and work in a professional firm under the supervision of an accountant, enrolled agent or lawyer."
To read the full text of Mr. Shulman's speech, see Commissioner Of Internal Revenue Douglas H. Shulman's Keynote Speech Before The AICPA Fall Tax Meeting Washington, DC.
References: For who is a tax return preparer, see FTC 2d/FIN ¶S-1117; United States Tax Reporter ¶77,014.24; TaxDesk ¶867,002; TG ¶71753. For the return preparer penalty, see FTC 2d/FIN ¶V-2631; United States Tax Reporter ¶66,944; TaxDesk ¶867,019; TG ¶71769.
Legislation Introduced to Repeal New 2012 Corporate Information Reporting Requirements
Senate Finance Committee Chairman Max Baucus (D-MT) has announced that he will introduce legislation that would repeal the new corporate information reporting requirements that are scheduled to go into effect in 2012 [U.S. Senate Committee on Finance News Release, Baucus to Introduce Bill to Repeal Form 1099 Income Reporting Requirements for Small Businesses, 11/12/10].
Background. The 2010 Patient Protection and Affordable Care Act (Health Care Act, P.L. 111-148) included a provision (IRC §6041(h)) that, effective for payments made after 2011, would require a person engaged in a trade or business (payors) to file an information return for all payments totalling $600 or more in a calendar year to a single payee (other than a payee that is a tax-exempt corporation). Under current law, payments to corporations, except those made for medical or health care services, are not required to be reported on an information return.
Businesses owners have raised concerns about the expense and effort that would be required to comply with the expanded information reporting requirements.
The news release. The news release that accompanied the proposed legislation included the following statement from Senator Baucus: “I have heard small businesses loud and clear and I am responding to their concerns. Small businesses are the backbone of our economy in my home state of Montana and across the country, and they need to focus their efforts on creating good-paying jobs — not filing paperwork.”
White House supports revisions to the rules. President Obama made the following comments on the new information reporting requirements during a November 3rd press conference: “The 1099 provision in the health care bill appears to be too burdensome for small businesses. It just involves too much paperwork, too much filing. It's probably counterproductive. It was designed to make sure that revenue was raised to help pay for some of the other provisions, but if it ends up just being so much trouble that small businesses find it difficult to manage, that's something that we should take a look at” [White House website, Press Conference by the President, 11/3/10].
Background. The 2010 Patient Protection and Affordable Care Act (Health Care Act, P.L. 111-148) included a provision (IRC §6041(h)) that, effective for payments made after 2011, would require a person engaged in a trade or business (payors) to file an information return for all payments totalling $600 or more in a calendar year to a single payee (other than a payee that is a tax-exempt corporation). Under current law, payments to corporations, except those made for medical or health care services, are not required to be reported on an information return.
Businesses owners have raised concerns about the expense and effort that would be required to comply with the expanded information reporting requirements.
The news release. The news release that accompanied the proposed legislation included the following statement from Senator Baucus: “I have heard small businesses loud and clear and I am responding to their concerns. Small businesses are the backbone of our economy in my home state of Montana and across the country, and they need to focus their efforts on creating good-paying jobs — not filing paperwork.”
White House supports revisions to the rules. President Obama made the following comments on the new information reporting requirements during a November 3rd press conference: “The 1099 provision in the health care bill appears to be too burdensome for small businesses. It just involves too much paperwork, too much filing. It's probably counterproductive. It was designed to make sure that revenue was raised to help pay for some of the other provisions, but if it ends up just being so much trouble that small businesses find it difficult to manage, that's something that we should take a look at” [White House website, Press Conference by the President, 11/3/10].
IRS Seeks to Return $164.6 Million in Undelivered Checks to Taxpayers; Recommends E-file and Direct Deposit to Eliminate Future Delivery Problems
The Internal Revenue Service is looking to return $164.6 million in undelivered refund checks. A total of 111,893 taxpayers are due one or more refund checks that could not be delivered because of mailing address errors.
“We want to make sure taxpayers get the money owed to them,” said IRS Commissioner Doug Shulman. “If you think you are missing a refund, the sooner you update your address information, the quicker you can get your money.”
A taxpayer only needs to update his or her address once for the IRS to send out all checks due. Undelivered refund checks average $1,471 this year, compared to $1,148 last year. Some taxpayers are due more than one check.
The average dollar amount for returned refunds rose by just over 28 percent this year, possibly due to recent changes in tax law which introduced new credits or expanded existing credits, such as the Earned Income Tax Credit.
If a refund check is returned to the IRS as undelivered, taxpayers can generally update their addresses with the “ Where’s My Refund?” tool on IRS.gov. The tool also enables taxpayers to check the status of their refunds. A taxpayer must submit his or her Social Security number, filing status and amount of refund shown on their 2009 return. The tool will provide the status of their refund and, in some cases, instructions on how to resolve delivery problems.
Taxpayers checking on a refund over the phone will receive instructions on how to update their addresses. Taxpayers can access a telephone version of “Where’s My Refund?” by calling 1-800-829-1954.
While only a small percentage of checks mailed out by the IRS are returned as undelivered, taxpayers can put an end to lost, stolen or undelivered checks by choosing direct deposit when they file either paper or electronic returns. Taxpayers can receive refunds directly into their bank, split a tax refund into two or three financial accounts or even buy a savings bond.
The IRS also recommends that taxpayers file their tax returns electronically, because e-file eliminates the risk of lost paper returns. E-file also reduces errors on tax returns and speeds up refunds. E-file combined with direct deposit is the best option for taxpayers; it’s easy, fast and safe.
The public should be aware that the IRS does not contact taxpayers by e-mail to alert them of pending refunds and that such messages are common identity theft scams. The agency urges taxpayers not to release any personal information, reply, open any attachments or click on any links to avoid malicious code that will infect their computers. The best way for an individual to verify if she or he has a pending refund is going directly to IRS.gov and using the “ Where’s My Refund?” tool.
“We want to make sure taxpayers get the money owed to them,” said IRS Commissioner Doug Shulman. “If you think you are missing a refund, the sooner you update your address information, the quicker you can get your money.”
A taxpayer only needs to update his or her address once for the IRS to send out all checks due. Undelivered refund checks average $1,471 this year, compared to $1,148 last year. Some taxpayers are due more than one check.
The average dollar amount for returned refunds rose by just over 28 percent this year, possibly due to recent changes in tax law which introduced new credits or expanded existing credits, such as the Earned Income Tax Credit.
If a refund check is returned to the IRS as undelivered, taxpayers can generally update their addresses with the “ Where’s My Refund?” tool on IRS.gov. The tool also enables taxpayers to check the status of their refunds. A taxpayer must submit his or her Social Security number, filing status and amount of refund shown on their 2009 return. The tool will provide the status of their refund and, in some cases, instructions on how to resolve delivery problems.
Taxpayers checking on a refund over the phone will receive instructions on how to update their addresses. Taxpayers can access a telephone version of “Where’s My Refund?” by calling 1-800-829-1954.
While only a small percentage of checks mailed out by the IRS are returned as undelivered, taxpayers can put an end to lost, stolen or undelivered checks by choosing direct deposit when they file either paper or electronic returns. Taxpayers can receive refunds directly into their bank, split a tax refund into two or three financial accounts or even buy a savings bond.
The IRS also recommends that taxpayers file their tax returns electronically, because e-file eliminates the risk of lost paper returns. E-file also reduces errors on tax returns and speeds up refunds. E-file combined with direct deposit is the best option for taxpayers; it’s easy, fast and safe.
The public should be aware that the IRS does not contact taxpayers by e-mail to alert them of pending refunds and that such messages are common identity theft scams. The agency urges taxpayers not to release any personal information, reply, open any attachments or click on any links to avoid malicious code that will infect their computers. The best way for an individual to verify if she or he has a pending refund is going directly to IRS.gov and using the “ Where’s My Refund?” tool.
Friday, November 12, 2010
Independent Contractor Status Granted to Massage Therapists, Cosmetologists, and Nail Technicians Working at Spa
The Tax Court has ruled that cosmetologists, nail technicians, and massage therapists (“service providers”) who performed their services at a spa were independent contractors, rather than employees [Cheryl Mayfield Therapy Center v. Commissioner, TC Memo 2010-239, Dkt. No. 9156-07, 10/28/10].
The facts. The taxpayer was the owner of a spa. The service providers who worked at the spa received no set salary, wages, or fringe benefits. As a general rule, the spa charged each service provider weekly “booth rent” equal to the greater of approximately $80 “base rent,” or 25% of the gross revenues that the service provider generated during the week. The service providers set their own hours. Some of them worked full time; others were part-time workers who were students or had jobs elsewhere. They generally provided their own supplies. Each service provider purchased his or her own work clothing. The spa's clients paid for services at a central point as they left the spa, rather than paying the service provider directly.
The spa did not file W-2 forms for any of the service providers. Nor did it report any compensation payments to employees during the years at issue on Forms 941, Employer's Quarterly Federal Tax Return, or Forms 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. The IRS issued assessments against the spa for employment taxes and penalties, as the IRS believed that the service providers should have been classified as employees.
The law. IRC §3121(d)(2) defines an “employee” for employment tax purposes as “any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee.” Under common law rules, the most important consideration in determining an employer-employee relationship is generally whether the person for whom the services are performed has the right to direct and control the method and manner in which the work is to be completed.
The 20-factor test. The IRS has published a standard list of 20 factors (commonly known as the common-law test or 20-factor test) for businesses to consider when determining whether a worker is a common-law employee or an independent contractor.
The following factors in the 20-factor test supported the spa's contention that the service providers were not employees: (1) The spa generally charged, and the service providers generally paid, weekly rent of at least $80. (2) The service providers were compensated on a straight commission basis, with no minimum guaranteed level of payment. (3) The spa did not pay service providers' business or travel expenses. (4) Many of the massage therapists made significant investments in outfitting and decorating their massage rooms. Thus, the service providers bore the risk of suffering net losses. (5) Several service providers believed that they had a non-employee relationship with the spa. (6) The spa did not tell the service providers how to provide their services to the clients. The service providers were all licensed professionals, possessing skills as required by their licensing. They set their own hours. Although the spa posted prices for various services, the service providers were free to charge less and sometimes provided services for free.
The following factors supported the IRS's contention that the service providers should have been classified as employees: (1) Their services were integrated into the spa's operations. (2) They provided their services mostly on the spa's premises. (3) The spa provided at least some informal training to new service providers. (4) There was no indication that the service providers made their services available to the general public regularly and consistently (other than when working at the spa). (5) The spa provided assistance to the service providers in booking appointments. (6) The spa's clients paid the spa rather than the service providers. (7) The spa kept the payments until it distributed the service providers' weekly checks.
Other factors in the 20-factor test did not conclusively support a finding of employee or independent contractor.
The ruling. The Tax Court said that it was a close call, but the factors supporting the service providers' autonomy predominated over those indicating the spa's control over their work. Accordingly, it held that the service providers were independent contractors, rather than employees.
The facts. The taxpayer was the owner of a spa. The service providers who worked at the spa received no set salary, wages, or fringe benefits. As a general rule, the spa charged each service provider weekly “booth rent” equal to the greater of approximately $80 “base rent,” or 25% of the gross revenues that the service provider generated during the week. The service providers set their own hours. Some of them worked full time; others were part-time workers who were students or had jobs elsewhere. They generally provided their own supplies. Each service provider purchased his or her own work clothing. The spa's clients paid for services at a central point as they left the spa, rather than paying the service provider directly.
The spa did not file W-2 forms for any of the service providers. Nor did it report any compensation payments to employees during the years at issue on Forms 941, Employer's Quarterly Federal Tax Return, or Forms 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. The IRS issued assessments against the spa for employment taxes and penalties, as the IRS believed that the service providers should have been classified as employees.
The law. IRC §3121(d)(2) defines an “employee” for employment tax purposes as “any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee.” Under common law rules, the most important consideration in determining an employer-employee relationship is generally whether the person for whom the services are performed has the right to direct and control the method and manner in which the work is to be completed.
The 20-factor test. The IRS has published a standard list of 20 factors (commonly known as the common-law test or 20-factor test) for businesses to consider when determining whether a worker is a common-law employee or an independent contractor.
The following factors in the 20-factor test supported the spa's contention that the service providers were not employees: (1) The spa generally charged, and the service providers generally paid, weekly rent of at least $80. (2) The service providers were compensated on a straight commission basis, with no minimum guaranteed level of payment. (3) The spa did not pay service providers' business or travel expenses. (4) Many of the massage therapists made significant investments in outfitting and decorating their massage rooms. Thus, the service providers bore the risk of suffering net losses. (5) Several service providers believed that they had a non-employee relationship with the spa. (6) The spa did not tell the service providers how to provide their services to the clients. The service providers were all licensed professionals, possessing skills as required by their licensing. They set their own hours. Although the spa posted prices for various services, the service providers were free to charge less and sometimes provided services for free.
The following factors supported the IRS's contention that the service providers should have been classified as employees: (1) Their services were integrated into the spa's operations. (2) They provided their services mostly on the spa's premises. (3) The spa provided at least some informal training to new service providers. (4) There was no indication that the service providers made their services available to the general public regularly and consistently (other than when working at the spa). (5) The spa provided assistance to the service providers in booking appointments. (6) The spa's clients paid the spa rather than the service providers. (7) The spa kept the payments until it distributed the service providers' weekly checks.
Other factors in the 20-factor test did not conclusively support a finding of employee or independent contractor.
The ruling. The Tax Court said that it was a close call, but the factors supporting the service providers' autonomy predominated over those indicating the spa's control over their work. Accordingly, it held that the service providers were independent contractors, rather than employees.
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