The IRS under the Cost Segregation Audit Techniques Guide addresses cost segregation in the following:

In recent years, increasing numbers of taxpayers have submitted either original tax returns or claims for refund with depreciation deductions based on cost segregation studies. The underlying incentive for preparing these studies for federal income tax purposes is the significant tax benefits derived from utilizing shorter recovery periods and accelerated depreciation methods for computing depreciation deductions. The issues for Service examiners are the rationale used to segregate property into its various components, and the methods used to allocate the total project costs among these components.

The benefits of cost segregation can be substantial for taxpayers; however, the Tax Court decision in AmeriSouth XXXII, Ltd. v. Commissioner of Internal Revenue has determined a new standard for eligibility. In 2003 one of the AmeriSouth Texas partnerships, AmeriSouth XXXII, Ltd., purchased an apartment complex for $10.25 million. Immediately after making the purchase AmeriSouth began a $2 million dollar renovation of the existing apartment buildings. AmeriSouth, trying to take advantage of accelerated depreciation methods, hired MS Consultants to do a cost segregation study. In all AmeriSouth separated the asset components into 12 categories, attempting to depreciate more than 1,000 building components over five or 15 year spans. AmeriSouth’s accelerated depreciation method generated hundreds of thousands of dollars in tax deductions. The Commissioner argued that the apartment complex should be classified as one asset and therefore must be depreciated over 27.5 years, a timeframe established under the Modified Accelerated Cost Recovery System (MACRS). Because of this discrepancy the IRS audited AmeriSouth, denying over $1 million in deductions from 2003 to 2005, leading to the previously mentioned case in the Tax Court.

Complicating the situation further, at the time the case came to trial AmeriSouth sold the apartment complex and stopped all communication with the IRS, the court, and even their attorneys. The court therefore found “any factual matters not contested to be conceded by AmeriSouth.” Looking closer at the 12 categories AmeriSouth had identified for accelerated depreciation, the court sided with the Commissioner in all but a couple of components. They determined that most of the components were structural components, integral to the building’s operation and maintenance, and must be depreciated over the full 27.5 years. The court based its findings off the definition established for “structural component” of a building and determined that for an asset to be a structural component, it must be essential to the operation or maintenance of a typical apartment building. By defining the building as an “apartment” building much of the classified assets broken out by AmeriSouth now became essential components, and therefore did not qualify for shorter life spans.

This case sets a new standard for the cost segregation method in depreciating assets. It makes the process harder by being more specific in its definition of what assets are deemed essential to the structure of the type of building. Although benefits for tax payers are still possible under this method, businesses must be more careful in how they break down the various categories of a building when depreciating under this method.

In the world of “Small Businesses”, your best friend is not your dog, it is your bookkeeper. While you run around acquiring new clients, and then spend every waking hour making sure the work is completed and delivered on time, your bookkeeper keeps the administrative portion of the business moving. From processing the mail, invoicing, paying and filing bills, handling payroll, and making deposits; they have relieved your workload so you can concentrate on the important stuff.

The reliance that a business owner places on the bookkeeper is enormous. Unfortunately, one of the positions that commit the most fraud is…the bookkeeper. Over 24% of all fraud committed is by the one who processes your internal accounting. Check tampering accounts for over 33%, False Billing is over 30%, Skimming is over 18%, and Payroll Fraud is over 15%.

Clearly, the importance of a good bookkeeper cannot be underestimated; however, it is clear that while we place great reliance on them, we forget to also place oversight on what they do. While it is impossible to eliminate the possibility of all fraud, there are some commonsense and inexpensive procedures that you can implement to help reduce the likelihood of fraud occurring in your business.

All too often, the businesses that are most concerned with taking preventative fraud measures are the businesses that have previously been exposed to fraud.  The reality is that every business, whether it has historically experienced fraud or not, should have fraud procedures in place.  CPAs with backgrounds in small business, audit, and fraud or Certified Fraud Examiners (CFEs) can be a great resource for the business owner.

You will want to consider what you have at risk if a fraud were to occur, and we encourage you to take steps now to protect the money you have worked so hard to earn.

The Internal Revenue Service receives numerous reports every year from taxpayers who receive suspicious emails, phone calls, faxes or notices claiming to be from the Internal Revenue Service. Many of these scams use the Internal Revenue Service name to make the fraudulent communications appear more authentic. The goal of these scams – known as phishing – is to trick you into revealing your personal and financial information.

The Internal Revenue Service lists five things they want taxpayers to know about phishing scams.

1. The IRS never asks for detailed personal and financial information.

2. The IRS does not initiate contact with taxpayers by email, if you receive an e-mail from someone claiming to be the IRS.

• Do not reply to the message.

• Do not open any attachments.

• Do not click on any links.

3. The address of the official IRS website is www.irs.gov. Do not be confused or misled by sites claiming to be the IRS but ending in .com, .net, .org or other designations instead of .gov.

4. If you receive a phone call, fax or letter in the mail from an individual claiming to be from the IRS but you suspect they are not an IRS employee, contact the IRS at 1-800-829-1040 to determine if the IRS has a legitimate need to contact you. Report any bogus correspondence.  You can forward a suspicious email to phishing@irs.gov.

5. You can help shut down these schemes and prevent others from being victimized. Details on how to report specific types of scams and what to do if you’ve been victimized are available at www.irs.gov. Click on “phishing” on the home page.

With the declining economy and unemployment rates near the highest level in decades, many people are now using part of their home for business purposes. The individual income tax return due date of April 17, 2012 is just around the corner, and it is a great time to review and understand the criteria for claiming a home office deduction for your business.

Generally, deductions for a home office are based on the percentage of the area you use specifically for the business. It is the taxpayer’s responsibility to figure out the percentage of the home devoted explicitly to the business activities. The home office deduction is available for renters and homeowners, and applies to all types of homes, even mobile homes. Deductions may include insurance, mortgage interest, real estate taxes, utilities, depreciation, repairs, etc. For a full explanation of tax deductions for your home office, please refer to IRS Publication 587, which can be found at www.irs.gov/publications/p587/index.html

There are two basic requirements for your home to qualify; the business use must be regular and exclusive, and it must be a principal place of your business.

Regular and Exclusive Use – You must regularly use a room or any part of your home exclusively for conducting business. If you use the area for both the business and personal use, you will not meet the requirement under the IRS guidelines. For example, if an accountant uses his kitchen table to prepare tax returns, he/she can not claim the home office deduction for the kitchen.

Principal Place of Your Business – You must show and be able to prove that you use your home as your principal place of business. You may also qualify for the home office deduction if you conduct business outside of your home, but also use your home on a regular basis. The structure does not have to be attached to the home, such as in the example of a barn, garage, or greenhouse. For example, if a taxpayer grows plants, flowers, and trees in the greenhouse a mile away from the principal place of business, the taxpayer is eligible to deduct the expenses related to the greenhouse because it is used exclusively and regularly for the business purpose.

It is also important to understand that if you choose to work from home, and your employer does not require you to work from home and provides an office or workspace elsewhere, it is considered to be a convenience for an employee rather than a home office, and therefore, you can not deduct expenses for the business use of your home.

Recent figures released by the IRS shows that individuals whose income is over a million dollars are more likely to be audited. In 2011, 12% of millionaires were audited, compared to 8% in 2010 and 6% in 2009.

Overall the IRS has doubled the amount of audits conducted within the last 10 years, but does acknowledge that individuals with higher incomes are more likely to be subjected to an audit. The IRS decision to increase audit rates for those in the higher tax bracket is intended to reflect the progressive tax system. Recently IRS commissioner, Steven Miller, stated that the increased audit rates show lower level earners that everyone is subject to the same basic tax rules. Meanwhile the IRS has left the audit rate for those earning $200,000 or less the same at about 1%, and has only slightly increased the rate of those earning between $200,000 and a million dollars (up slightly to 4%).

Not only are audit rates higher for individuals that net more income but rates are also higher for corporations with higher net incomes. Those corporations who have assets valued over $250 million have a 28% chance of getting audited by the agency compared to companies under $10 million in total assets who have a 1% chance.

With over 140 million individual returns and millions more corporate returns filled in 2011 the IRS has collected $2.3 trillion in revenue. Out of this only $55 billion more was recovered through audits, compared to $58 billion in 2010. It is clear that higher earners, individuals or corporations, are subject to increased audit rates and will end up contributing more money as a result.

Every year, we are asked by clients how long they have to keep tax returns and tax records. Below is a simple summary of IRS requirements on which records to keep and for how long.

Individual Tax Returns – 3 years from filing.

For example, if you filed your 2010 tax return on April 18, 2011, you should keep it until April 15, 2014. With the tax return, you should keep any records to support income, deductions or credits that you report on the tax return. Income items include W-2’s, bank and brokerage statements, K-1’s and 1099’s. Deduction items include 1098 mortgage statements, property tax bills, charitable contribution acknowledgements, mileage logs, and receipts for business deductions. Credit items include child care expense bills, and tuition payments.

Records relating to property you own should be kept at least 3 years after you sell or otherwise dispose of the property. Examples of property are stocks, IRA’s, rental property records, your home purchase and major improvements.

Small business owners must keep all of the employment tax records for at least 4 years after the tax is due or paid. Business owners should keep items related to gross receipts, such as bank deposit slips, register tapes, invoices, credit card slips and Forms 1099-Misc. The back up documents for items related to purchases and expenses such as canceled checks, invoices, account statements, credit card receipts, and petty cash slips should also be kept for 4 years. Finally, any document needed to verify your assets, such as purchase and sales invoices, cancelled checks and real estate closing statements should be kept at least 4 years after the assets is disposed of.

These guidelines are only if you have not significantly “understated” your tax returns. If you have, the IRS has the ability to go back indefinitely and audit you.

For more detailed information, please refer to IRS publications 552, 583 and 463, available at www.irs.gov.

However, in this digital age, it is becoming easier to save and store tax returns and the records that support them on computers and flash drives. Invest in a scanner and save all of your old tax returns and records in a file on your computer. Then the information is always available.

An often overlooked employer benefit, flexible spending accounts are sponsored by the employer and allow you to pay for eligible medical expenses on a pre-tax basis.

If you have items such as insurance deductibles, co-pays, medical expenses not covered by insurance to pay out of pocket you should consider participating in your employer’s flexible spending account if one is offered.

The advantage of a flexible spending account is it reduces your income taxes.  The contributions made to your account are deducted from your pay before federal and state income taxes and social security taxes are calculated.  The result is your taxable income decreases and ultimately you have higher take home pay.

Enrollment occurs on an annual basis and at the beginning of the plan year (usually a calendar year).  Once you have enrolled your election remains in effect for the entire plan year.  There are provisions which allow you to change your election, change in employment status or family status as is provided for in the employer’s plan document.

Now that you have decided to enroll in the plan you need to decide how much you would like to contribute to your account.  To determine how much to contribute make a list of all expected out of pocket expenses you expect for yourself and your dependents during the plan year.  The amount that you determine you want to contribute for the year is taken out of your paycheck over the course of the year in equal installments.

For an expense to be considered eligible under a flexible spending account it needs to be considered eligible as a deductible medical expense under the Internal Revenue Service. Some examples include:

-  Fees paid to doctors, dentists and surgeons

-  Fees for hospital services

-  Co-payments on eligible expenses

-  Insurance deductibles

-  Prescription drugs

Flexible spending accounts are “use it or lose it” plans.  This means that any account balance at plan year end is not carried over to the subsequent plan year.  It is important to spend some time determining the amount you decide to contribute to a flexible spending account.  If the amount you contribute during the year exceeds the claims you submit the excess money remaining in the account by law, is forfeited.

If your employer’s plan provides for it there can be a grace period of up to 2 ½ months beyond the end of the plan year.  The grace period allows for any qualified medical expenses incurred in that time period to be reimbursed from the prior years remaining balance.

Staffing decisions are at the core of every business.  The decision of how large a workforce is needed to perform the services and produce the products that generate revenues for an entity is a complex and ongoing process that may well determine whether or not a business is profitable.

The composition and classification of this workforce will depend upon different factors, some of which may be unique to a particular business or industry.  Is the business seasonal, such as construction? Does it need advanced technical assistance which would be difficult to develop and/or maintain in-house?  Or perhaps it has a short-term project requiring additional resources.  How to classify individuals engaged to provide services will be determined by the amount of control the business is able to exercise, and the independence of the individual engaged to perform services.  The three factors that the IRS uses to make this determination are:

• Behavioral control – who has the right to direct and control how the work is performed.
• Financial control – who controls the economic aspects of the job
• Type of relationship – how the worker and business perceive the relationship

Let’s look at these factors in more detail.

Behavioral Control

Factors indicating an employee relationship:

• Business controls when and where the work is performed, which tools are used and order or sequence used for work
• Detailed instructions given for work performance
• Evaluation of work performed, rather than results
• Training provided

Factors indicating independent contractor status:

• Business does not control schedule
• Individual determines how work is performed
• Results of work evaluated rather than details of work performed

Financial Control

Independent contractors are more likely to:

• Have significant financial investments in tools and equipment
• Not receive reimbursement for out of pocket expenses
• Have a profit motive and the opportunity for a loss
• Work for multiple businesses
• Advertise
• Maintain a separate business location

Employees are more likely to:

• Be guaranteed a regular payment amount, based on a period of time rather than an amount of work
• Work for only one business

Type of Relationship

One important fact to note is that the ultimate classification of a worker is not dependent upon the existence of a contract between parties stating whether or not an individual is an independent contractor.  The actual facts and circumstances of the relationship will determine the status, and the IRS will be guided by those facts and circumstances, rather than the contract.  Other aspects that determine the type of relationship are:

• Benefits such as pension plan contributions, health insurance and paid time off are generally offered to employees, not independent contractors
• Workers hired on a permanent basis, rather than for a specific period of time, are generally considered employees
• Services provided represent the core activity of the business, such as medical or legal services; this will make it more likely that the business will seek to direct and control these activities

Businesses often seek to classify workers as independent contractors in order to save the employer portion of the social security taxes assessed on the worker’s salary.  Workers may also have a preference to be treated as either an employee or independent contractor for various reasons.  As we have noted here, the classification of a worker depends upon the facts and circumstances of the relationship, not the desires of the parties involved.

As a result of recent legislation, the federal government is now requiring third parties such as brokerage firms, banks and mutual fund companies for tax year 2011 to report information on the subject of cost basis of securities that are sold or liquidated, such as stocks, bonds and mutual funds. The purpose of this legislation is to ensure that taxpayers report appropriate cost basis information on their tax returns.

It is important to note that cost basis is nothing new, but it is the reporting requirement that is changing. Up to now, financial institutions have provided some cost basis information to investors. As of January 2011, for individual stocks, or after January 2012, for mutual funds, most exchange traded funds (ETFs), bonds, options and other securities, financial institutions are required to report cost basis to both the Internal Revenue Service as well as to the investor.

The President recently signed into law two new tax credits aimed at getting unemployed veterans back into the work force.  The new credits are The Returning Heroes Tax Credit and The Wounded Warrior Tax Credit.  These credits give businesses generous incentives to hire unemployed veterans.

The Returning Heroes Tax Credit:

• Employers who hire veterans that have been unemployed for at least 4 weeks can get a credit of 40% of the first $6,000 of wages paid.
• Employers who hire veterans who have been unemployed longer than 6 months can get a credit of 40% of the first $14,000 of wages paid.

The Wounded Warrior Tax Credit:

• Employers who hire veterans with service-connected disabilities who have been unemployed longer than 6 months can get a credit of 40% of the first $24,000 of wages.

These credits were signed into law and are effective as of November 21, 2011.  The credits are available through December 31, 2012.

To take advantage of these credits, employers need to check and certify the prospective employee’s eligibility.   The individual’s eligibility must be certified by the State Workforce Agency.  In Illinois this certification is done through the Illinois Department of Employment Security (IDES).  The Prescreening Form is IRS Form 8850, “Pre-Screening Notice and Certification Request for Work Opportunity Credit”  http://www.irs.gov/pub/irs-pdf/f8850.pdf.  The employer will also need to complete ETA Form 9061, “Individual Characteristics Form” http://www.uses.doleta.gov/pdf/Appendix_II/Appendix_II__1_ETA_9061.pdf.  These forms need to be mailed to IDES no later than 28 days after the individual starts work.  The address is:

WOTC Unit

33 S. State St. 8^th Floor

Chicago, IL 60603

Employers can call IDES at (312) 793-2913, visit http://www.ides.illinois.gov/page.aspx?item=652 or call their BSD client account manager for more information.

These new credits can save employers money and also assist in getting veterans back into the workforce.  Consider Hiring a Hero.