New Resources for Small Businesses

A permanent exclusion for qualified SMB stock means big change

APRIL 29, 2016

The extension of the exclusion for gains on qualified small-business stock by the Protecting Americans from Tax Hikes Act of 2015 may change the way some small businesses are funded.

Although the exclusion has existed in a variety of forms since 1993, it was in 2010 that it came to the forefront of startup planning when the exclusion rate was increased to 100 percent. And despite the 100 percent exclusion rate, it has not been widely used as a vehicle to fund startup businesses because of its uncertainty — it was one of the extenders that were periodically re-enacted, sometimes retroactively. The enactment of PATH has changed that by making permanent the Section 1202 exclusion, adding certainty to the planning for new ventures and small businesses, according to CohnReznick partners Dave Logan and Asael Meir.

“Now, founders and investors can plan their investment activities with this in mind,” said Logan. “Until now, the vehicle typically used by investors was convertible debt.”

 “Historically, in the early stages, investors would come in with formal convertible debt,” Meir said. “It takes the form of a loan to the company with the right to convert it into stock at a discount. If an investor holds convertible debt for four years and then converts it, they won’t be able to take advantage of the exclusion, but if they had bought it as stock from Day One and then sell it more than five years later, it will meet one of the qualifications for the exclusion. It’s important to be in equity from Day One.”

“For example, an investor comes in with $10 million as convertible debt,” Meir said. “Five years later the company sells, and the investor will receive $100 million. The investor will be taxed on capital gain at a 25 percent rate.”

But take the same scenario, except that from Day One the investor put in $10 million for stock and sells for $100 million. “Potentially, the whole $100 million is excluded,” said Meir.



“Section 1202 encourages holding and not speculating,” noted Marty Davidoff, of E. Martin Davidoff and Associates. “This is good for small businesses, and small businesses are the economic locomotive.”

“What’s really good is that Congress is starting to add certainty throughout the Tax Code,” he added. “The constant rush to legislate extenders at the end of the year has been silly — making these permanent is a good thing.”

“Although this is not targeted at the mom-and-pop businesses, at some point when a business becomes large enough that outside investors may be interested in it, any benefit helps,” observed Roger Harris, president of Padgett Business Services.

The excludible amount is the greater of $10 million or 10 times the aggregate adjusted bases of qualified small-business stock issued by the corporation and disposed of by the taxpayer during the tax year.

In order to qualify for the exclusion, the stock must be qualified small-business stock, and it has to be held for more than five years, Logan noted.

“The company has to be a C corp, and the stock has to be acquired by the taxpayer at original issue, and at all times prior, including the transaction when the acquisition takes place, the gross assets of the corporation have to be $50 million or less,” he said. “That includes the transaction, so when you acquire the stock, that funding is included. It can grow afterwards, but at the date of the acquisition, the assets have to be $50 million or less, including the amount contributed.”

Specifically, the requirements under Code Sec. 1202 to qualify for the exclusion include:

  • The qualified small-business stock must be from a C corporation.
  • The taxpayer must be a non-corporate taxpayer.
  • The qualified small-business stock must be held for more than five years.

The stock must have been acquired by the taxpayer at original issue, either directly or through an underwriter, in exchange for money or property, not including stock or as pay for services provided to the corporation (other than services performed as an underwriter of the stock).

The C corporation must have total gross assets of $50 million or less at all times after August 9, 1993, and immediately after it issues the stock.

In addition, there is an active business requirement. During the taxpayer’s holding period of the stock, at least 80 percent of the corporation’s assets must be used in the active conduct of one or more qualified trades or businesses.

“It can’t be a service organization, such as an accounting firm, or a law firm relying on members’ expertise to provide to clients,” Logan said. “It has to be held for more than five years, and the entity that owns the stock must be a non-corporate owner. There’s a special rule for partnerships, but it is limited to what happens afterwards. If you’re in a partnership and the partnership buys stock, it can qualify, but the exclusion would not work for any new partner.”

Other businesses that are not “qualified trades or businesses” are banking, insurance, financing, leasing, investing, or similar businesses; any farming business; any business involving the production or extraction of products for which percentage depletion can be claimed; or any business of operating a hotel, motel, restaurant, or similar business, Logan indicated.

To preserve the possibility of the exclusion, care should be taken in the form that the financing takes, he noted. “Equity should be considered versus other forms because of the potential exclusion. Often, founders are not aware that they’re holding qualified stock. They’re not aware of the exclusion,” he said. “On exit planning, make sure it is the stock that is being sold for value, as opposed to selling the assets in the C corporation.”

“For example, if I own a software company and sell the code, I pay tax on it as an asset sale, but if I sell the stock in the corporation it can quality for the exclusion,” Meir said. “This provision has been under the radar, so it’s important to advise your clients that may have such holdings to see if the stock would qualify. If they sell if after four and one-half years, they won’t get the exclusion, but if they hold it for an additional half year they could possibly exclude all their gain.”

Sanders Paid $27,653 in 2014 Taxes on Income of $205,271



(Bloomberg) Vermont Senator Bernie Sanders and his wife earned $205,271 in adjusted gross income in 2014 and paid $27,653 in taxes—an effective rate of about 13.5 percent, according to documents released Friday.

The Democratic presidential candidate, who has said Jane Sanders files the couple’s federal income taxes, provided paperwork listing $56,377 in 2014 deductions. They paid $24,509 in state and local income taxes and property taxes and $22,946 in home mortgage interest while making $8,350 in charitable contributions.

Sanders earlier had released the first two pages of his 2014 tax return last year but had provided no detail about the deductions.

Sanders’s taxes have become an issue in his campaign for the Democratic presidential nomination. He has released information for the 2014 tax year only, far less than front-runner Hillary Clinton.

Jane Sanders told Bloomberg Television’s “With All Due Respect” on Monday that she does the couple’s taxes using tax-preparation software and that the 2015 version—“a pretty simple return”—would be released as soon as it’s ready. Monday is the annual deadline for filing individual income-tax returns in most of the U.S.

The couple’s return is “remarkable for just how unremarkable it is,” said Tony Nitti, a partner in the Aspen, Colorado, office of the accounting firm WithumSmith+Brown. The return may add to Sanders’s image as an “everyman” candidate, Nitti said. Given the lack of explosive detail, he added: “What was the problem? What was the delay in getting this thing out there?”

Sanders’s campaign didn’t immediately respond to questions about his taxes.

Most of the couple’s 2014 income was attributable to Sanders’s salary of $174,000 a year as a U.S. senator. They also reported $46,213 in Social Security benefits that year, $39,281 of which was taxable income, and $4,982 in taxable pension income that Sanders receives for having been mayor of Burlington, Vermont. The 2014 form also listed $4,900 in business income that Jane Sanders received as a member of a commission on the management of low-level radioactive waste disposal.

Trump’s Taxes
Among the 2016 major-party presidential candidates, Sanders’s lack of transparency regarding his taxes had been second only to Republican front-runner Donald Trump before Friday’s release. Trump has said he’s under an audit, and won’t release any returns until it’s over. The other Republican candidates—Senator Ted Cruz of Texas and Governor John Kasich of Ohio—have posted several years’ worth of partial returns online.

Clinton has disclosed eight years of full returns, including detailed schedules, on her campaign website, and there are decades of returns for her and Bill Clinton available online. The Clintons’ 2014 return, which is the most recent her campaign has released, showed that the couple reported $27.9 million in adjusted gross income—about 136 times the amount reported by Sanders and his wife that year.

Tad Devine, a political adviser to Sanders, said the candidate would release returns from previous years “soon” after this year’s filing is finished by Jane Sanders. “Bernie is happy to be transparent,” Devine said in an interview on CNN.

In 2014, the senator and his wife reported $2 in income from ordinary dividends and $11 in taxable interest. Their $56,377 in deductions for the year is higher than average for their income level, according to a 2014 Congressional Research Service report, which found that in 2011, taxpayers reporting adjusted gross income from $200,000 to $250,000 claimed an average of $39,470 in itemized deductions.


IRS Exposed Taxpayer ID Numbers on Offers in Compromise


The Internal Revenue Service failed to fully redact Social Security Numbers and Employer Identification Numbers from hundreds of its Offer in Compromise files that are available to the public, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, found that files available for public review contained visible Taxpayer Identification Numbers, such as SSNs and EINs. TIGTA identified and documented more than 300 instances of visible Taxpayer Identification Numbers in files accessible to the public. TIGTA provided the IRS with photographs of the redaction omissions and advised IRS management to suspend public inspections until a full review could be completed. The report noted that ineffective redaction practices put sensitive and legally protected taxpayer information at risk.

The IRS took immediate action during the evaluation, according to TIGTA, so it did not make any recommendations in the report. However, TIGTA plans to conduct a follow-up review to see whether the issues have been addressed.

In response to the report, IRS officials pointed out that public viewing requests of Offers in Compromise are rare, so the risk that sensitive taxpayer information was exposed was minimal. Nevertheless, the IRS said it is pursuing safeguards and enhancements of Offer in Compromise public inspection file redaction procedures.

“Your investigation revealed instances in which certain taxpayer information had not been fully redacted from public inspection file,” wrote Karen Schiller, commissioner of the IRS’s Small Business/Self-Employed Division. “When TIGTA alerted IRS to this issue, the IRS immediately removed the files from availability for public inspection until the required redactions were completed.”

TIGTA agreed there is limited opportunity for the disclosure of sensitive taxpayer information but pointed out that each taxpayer has a right to expect that the IRS will protect their sensitive information in all circumstances. TIGTA said it believes the IRS needs to be committed to safeguarding the identity of all taxpayers in administering programs, whether large or small, high-profile or little known. Identity theft continues to be a serious and evolving issue which has a significant impact on tax administration, TIGTA noted.

Trump’s Tax Lawyers Say 2002-2008 Returns No Longer Under Audit

NEW YORK (MARCH 31, 2016)


(Bloomberg) Republican presidential candidate Donald Trump’s income tax returns for the years 2002 through 2008 are no longer under federal audit, though more recent filings remain under review, according to an unusual letter his campaign released Wednesday night.

The campaign didn’t say whether it’s prepared to release any of the documents, a standard practice for presidential candidates. Trump, a billionaire real estate developer and former reality TV show host, has refused to release his returns, citing what he described as a 12-year-long Internal Revenue Service audit.

The letter, dated March 7 and written by two lawyers at law firm Morgan, Lewis & Bockius LLP, says the Internal Revenue Service has ended its scrutiny of the tax years 2002 through 2008. The agency is continuing to examine returns from 2009 forward, according to the letter.

Trump has been under pressure from political opponents to release his returns. The 2012 Republican presidential nominee, Mitt Romney, in February called on Trump to release the documents, saying they may contain a “bombshell.” Trump is the only remaining major-party candidate for president who hasn’t made at least some portion of his tax returns public.

Trump campaign spokeswoman Hope Hicks didn’t immediately respond to requests for comment.

It’s unclear why the campaign posted the letter Wednesday night, more than three weeks after it’s dated.

The three-paragraph letter says that Trump’s returns had been “under continuous examination by the Internal Revenue Service since 2002.” It also said that examinations of returns for 2002 through 2008 had been closed “without assessment or payment, on a net basis, of any deficiency.” The letter’s authors, tax lawyers Sheri Dillon and William Nelson, don’t explain in the letter what they mean by “on a net basis.” Nelson is a former IRS chief counsel.

Elliot Frieder, a spokesman for the Morgan Lewis firm, said last night that the firm doesn’t discuss clients’ business.

‘Complex Businesses’
Trump disclosed in July that he is the sole or principal owner in roughly 500 business entities—most of them partnerships. As a result, his “personal federal income tax returns are inordinately large and complex for an individual,” according to the letter by Dillon and Nelson. It says the continuous audits of Trump’s personal returns are “consistent with the IRS’s practice for large and complex businesses.”

The letter’s last paragraph also says that in a sense, the IRS examinations for 2009 forward “are continuations of prior, closed examinations.” That’s because Trump’s later returns “report items that are attributable to continuing transactions or activities that were also reported on returns for 2008 and earlier.” However, it’s unclear whether the returns include new sources of income or other disclosures that might have also drawn IRS scrutiny.

Dennis Brager, a tax lawyer in Los Angeles and former senior IRS trial attorney, told Bloomberg after reading the letter that its references to examinations for 2002 through 2008 that were closed and to later examinations that concerned matters in 2008 and earlier “contradict each other.”

Brager said it’s possible the issue under scrutiny involves a so-called timing loss, meaning that Trump might have declared a tax-deductible loss in one year that the IRS disallowed, then claimed it again in another year.

“The letter appears to be internally inconsistent,” Brager said.

Democratic front-runner Hillary Clinton released full tax returns for the years 2007 through 2014 last year. Combined with earlier releases from her 2008 presidential campaign, and with returns released earlier by her husband, former President Bill Clinton, she has released tax information for every year since the late 1970s.

On the Republican side, Trump’s rivals, Texas Senator Ted Cruz and Ohio Governor John Kasich, have each released a number of partial returns, excluding schedules that would provide such details as their itemized deductions and business income.

Young, Broke, and Scared of the IRS: The Millennial Tax Trap

NEW YORK (MARCH 28, 2016)



It wasn’t a very nice way to begin a letter, but then, it was from the Internal Revenue Service, and it got Greg’s attention.

The Athens, Georgia, veteran said the notice, which arrived earlier this year, cited three months of taxes he had failed to pay two years ago—and was the first he’d heard of it.

After leaving the military, Greg , then 27, had taken a job in information technology. “I guess when I filled out my taxes for 2013 I messed something up, so I didn’t get my private-sector job included into the taxes owed,” he said. Now he was into the Treasury Department for more than $1,700.

The IRS doesn’t keep track of how many millennials incur tax debt, but a survey by personal finance adviser NerdWallet found they are more afraid of filing their taxes than any other generation. Eighty percent of millennials, defined by the survey as 18 to 34 years old, fear they will make a mistake, underpaying or overpaying.

Putting aside outright tax cheats, young workers are financially inexperienced and, increasingly, part of a gig economy—driving for Uber, funding their creative work through Patreon—that requires more care with taxes than some are able, or willing, to take. For example, people who work in contract jobs typically don’t have their taxes withheld automatically and need to set up a program of quarterly estimated tax payments on their own.

Digging their tax trap deeper, fewer than 10 percent of millennials go to the IRS when they have a tax question, and only about a quarter seek help from a tax professional, the survey found, compared with 38 percent of all taxpayers who seek help from a tax pro. Instead, most young people turn to friends and family, a largely unreliable if well-meaning group. Millennial taxpayers in particular bemoan the long wait times on the phone with the IRS and the agency’s weird penchant for mail (like, mail).

“It took at least five hours of your life just getting somebody on the phone,” said Greg, who said he placed four or five calls to the agency seeking to confirm the letter’s validity before signing up for a payment plan on its website. “There needs to be more notification and communication on their part.”

This month, Greg made his first contribution to an IRS tax debt repayment plan, which he said was easy enough to set up. He’ll be making a $150 payment every month until he has repaid the debt. Starting this tax season, he’s working with a certified public accountant.

“Someone facing a tax bill they can’t pay can usually set up a payment agreement,” IRS spokesman Eric Smith said. Indeed, even if the agency isn’t so hot on the phone, it will send multiple letters urging debtors to set up plans before threatening them, if necessary, with levies and liens. Resources are available on the IRS website, agents regularly describe payment plans to those who get through on the phone, and accountants work with the agency to devise plans for their clients.

“If you don’t contact us, we can take action to collect the taxes,” Smith said.

That said, millennials are less likely to own homes than generations before them, so the threat of a property lien doesn’t carry the weight it might, and a change of rental address can cut the letters off altogether. Anthony, a 24-year-old based in Washington, D.C., incurred just over $1,000 of tax debt after he tried to claim an education credit on his 2013 taxes that his parents had already claimed. He sent in a correction of the error but then lost his job and couldn’t pay the balance.

When he moved in September of 2014, the letters stopped coming.

“It was an out-of-sight, out-of-mind thing,” he said.

In fact, the IRS was nothing compared to the creditors who were after Anthony for his student debt, he said. The following year, what would have been his tax refund was taken to pay off a portion of the outstanding debt. Employed by that time, he was able to pay the balance.

“I still don’t rank them anywhere near as scary as Sallie Mae,” Anthony said of the IRS. “They were very slow to catch on to it. …With Sallie Mae, they immediately start calling you on the phone—and start calling your parents. Sallie Mae is everything the IRS does, but on ‘roids.”

While credit card companies collecting student debt can affect a debtor’s credit scores immediately, tax debt doesn’t begin to influence them unless levies and liens are issued, and enrolling in a repayment plan won’t affect the scores either. Yet of the seven millennials facing tax debts interviewed for this article, only two were familiar with these plans, and neither of them knew that signing on to one wouldn’t affect their scores.

“I don’t think anyone should be afraid of the IRS, because as long as you’re talking to them, bad things don’t happen,” said Cari Weston, director of taxation for the American Institute of CPAs.

Erik Duemig and his brother Joe, who own a production sound company in Austin, Texas, fell into tax debt when they made what Erik described as a series of clerical errors on a 2014 filing. At 26, the twins had filed taxes only a few times before, and were previously filing as contract employees, not business owners. Eventually, they hired a certified public accountant for $1,200, but only after Joe had been audited.

Few of the Duemigs’ millennial friends hold down a traditional job with its W2 tax form, they said, citing a culture that relies heavily on the gig economy.

“For millennials who are making money on the Internet, like YouTube ad sales and things like Patreon, I imagine that kind of income stream gets really weird to deal with the IRS,” Erik said.

Millennials who find themselves in debt to the agency have more constructive options than neglecting debt letters and less expensive ones than hiring a CPA. Tax tutorials are available online, and the Society of Grownups, a Brookline, Massachusetts, financial literacy group, offers two classes, “Quarterly Schmarterly” and “Get Off Your Tax.” Each costs $30. In one class, a third of those in attendance owed money to the IRS, said Jena Palisoul, director of financial planning.

“Some people get so frightened, they take no action whatsoever,” she said, “and that’s the worst thing to do.”

Smith of the IRS acknowledged “it can be a while” on the phone but said “it’s better than it was last year, as Congress provided us with some increase in funding for the phone operations. We really encourage people to [seek help] online first.”

“I think they are trying to speak to everyone in a more technology-friendly way,” said Weston. “They’re tweeting, they’re trying to get representatives out there … but with all this identity theft they are being very cautious about communicating with taxpayers digitally.”

Even so, “it was all very poorly communicated to us by the IRS,” Duemig said.

He added: “Tax law, it almost feels, like, intentionally complicated. It just tires you out so you just pay more than you need to.”

CPA, Taxes, Bookkeeping, Payroll, Accounting Services, Insurance

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