You may not have caught the news that the rate used to calculate Social Security withholding taxes from your employees has been reduced for 2011. It goes back up on January 1, 2012. The rate is now 4.2% rather than 6.2%. So, in effect, your employees are getting a raise and you are not paying for it. The Medicare tax rate has not changed.

The rate that a company contributes for Social Security taxes has not changed. It is still 6.2%. You should take this into account when you calculate the payment of taxes each month. You should multiply the gross payroll by 13.3% to calculate the Social Security and Medicare payment that you make.

You don’t need to worry about this if you are using a payroll service. They should take care of it.

The IRS is also changing the rules for paying the taxes. Starting January 1, 2011 you are required to pay the taxes using the Electronic Federal Tax Payment System (EFTPS). See my blog posted on December 21, 2011 for more details. http://www.thomstaxtalk.com

IRS Requirement to pay your business taxes electronically

If you are in business you probably got a notice from the IRS recently telling you that you must pay your taxes electronically. This new rule takes effect January 1, 2011.

Up to now, businesses could pay most of their taxes by completing Form 8109 and paying their taxes at their bank. This system has been in effect for decades and worked well. The Internet has changed all that. It is now easier, and cheaper, for the government to have you use the Electronic Federal Tax Payment System (EFTPS) than to have you go to your bank to make the payments.

Use of the EFTPS system is required for business taxes. So if you must remit payroll taxes, income taxes, and various excise taxes, this system must be used starting January 1, 2011. Individuals may use the system to pay their federal income taxes and estimates.

Here is a link to some basic information about the system:

https://www.eftps.gov/eftps/direct/HelpAboutMain.page


The system is fairly easy to sign up for and to use. Here is the link to sign up:

https://www.eftps.gov/eftps/enrollment/new-enrollment-flow?execution=e1s1

You can always go to the IRS website at http://www.irs.ustreas.gov/ and search for information.

Massachusetts has required businesses to remit taxes electronically for several years. Information can be found at:

https://wfb.dor.state.ma.us/webfile/business/Public/Webforms/Login/Login.aspx

These systems are reasonably easy to use and will save you the time of driving off to the bank when you have to make these payments.

Health Insurance and Our S Corporation

Health insurance is a benefit that most companies offer. It is a great way to attract and keep good employees, and it provides some tax benefits as well. Even the share of the premiums that the employee pays can be treated as a pre-tax deduction and save the employee and the company significant money. What becomes a little more complicated is if you are the owner of an S Corporation and you participate in the health insurance program.

IRS regulations require that you report the company paid portion of health insurance as compensation for anyone who owns more than 2% of the company stock. This is the case for more than 99% of owners of S Corporations. Massachusetts also follows this rule.

Here is an example: Suppose your salary is $50,000 and you also paid $10,000 for your health insurance. (I know, you wish it were only $10,000.) Your W-2 should show federal taxable wages of $60,000. It also should show this amount as state wages in Massachusetts and probably others states as well. The Social Security and Medicare wages should only be $50,000. This add back to your income is not subject to Social Security or Medicare taxes.

You might be about to panic because you think you will be paying more in income taxes because of this adjustment. I have good news. It is true that you will report $60,000 on line 7 of your personal tax return. But you will get to deduct the $10,000 on line 29 of your return and thus pay tax only on the $50,000 of salary.

If it does not have any impact, why do it? Reason one: The IRS requires it. Why challenge them? Reason two: If you do not put the health insurance on your W-2, you will have to report it as income anyway and then you can deduct it as a medical expense on Schedule A of your return. Medical expenses are subject to a 7.5% of income floor and you may lose some or all of the deduction. It could cost as much as 40% of the cost of the health insurance in additional taxes. Now that’s a great reason to do it.

I’d be happy to talk with anyone who has any questions about this.

IRS Scams

My spam filter intercepted three emails allegedly from the IRS telling me that a payment to them had been rejected because of a problem with my employer identification number. I also have been receiving calls and emails from my clients on the same topic.

The IRS does not use email to make initial contacts with taxpayers. These emails are a phishing scam trying to get information from you that can be used to steal your money. Do not respond and do not open any links. You will regret it if you do.

Where’s My Refund?

Right about now I get a lot of calls from clients who have not received their federal refunds. There is an easy way to find out where it is.

First, go to this link

https://sa2.www4.irs.gov/irfof/lang/en/irfofgetstatus.jsp

You will need to enter the following information

* Your Social Security Number (or Individual Taxpayer Identification Number)
* Your Filing Status
* The exact whole dollar amount of your refund

And VOILA you will get information on what is happening with your refund.

Just remember, if the IRS says they mailed the check last Friday, it probably means that it actually got to the post office next Friday. This is a great argument for having the IRS do a direct deposit your refund.

Take Your Business Electronic

For years the Commonwealth of Massachusetts has required businesses to pay their taxes electronically. The Department of Revenue has a web site designed to accomplish this. And the web site is actually fairly easy to use. Here is the website:

https://wfb.dor.state.ma.us/webfile/business/Public/Webforms/Login/Login.aspx

You take a few minutes to register and then it goes live a couple of days later. Then you can use its full capabilities.

You would use this to pay essentially any tax that you owe to the Commonwealth. The most common ones would be state tax withholdings, sales and meals taxes collected, and corporate excise taxes. You are required to pay even the more obscure taxes electronically.

The Massachusetts unemployment office has set up the QUEST system for employers to file and pay returns and process unemployment claims. It is located at

https://wfb.dor.state.ma.us/webfile/business/Public/Webforms/Login/Login.aspx

Again you need to register with them and this can be a difficult process. You need a user name and password and can call 617-626-5075 for assistance. Expect a wait.

The QUEST system is not as user friendly as other government sites.

The IRS is getting into the game of requiring direct payments rather than using paper checks. The system is relatively easy to use and it is required for all but the smallest business starting in 2011.

Here is the registration site
https://www.eftps.gov/eftps/

Good luck.

Why Have a Mortgage?

Most people have a mortgage because that is the only way they can afford to own a home. Although the real estate market is having a very tough time right now, over the long run your house is often your biggest asset and will help fund your retirement. Plus you get a tax benefit from paying the interest on the mortgage.

Some people are fortunate to have significant financial assets. One of the more important questions for these lucky people is “Why do you have a mortgage?” The answer often is “Its my only tax deduction.”

That’s nice but is it worth it? If you have a $200,000 mortgage at 4% you are paying the bank interest of $8,000. The IRS will give you back about $2,000 in reduced taxes so $6,000 is coming out of your pocket. That is not a very good result for your pocket.

Investment advisors argue that you can invest the money and earn more than 4% but they are hesitant to guarantee that you will earn more than the interest rate on your mortgage. My suggestion is to pay off your mortgage and then invest the monthly payment with your investment advisor. You will be amazed how quickly that money will pile up.

You can’t pay it off? Add a little extra to the principle you pay every month so that you will pay your mortgage off in a shorter time period. This will save you a lot of money.

Convertin Your IRA to a Roth

A lot of clients have asked about converting regular IRAs to Roth IRAs. This is a complicated question.

Let’s start with the basics. You usually get to deduct the money you contribute to your regular IRA while there is no deduction for contributions to a Roth IRA. You pay taxes on the money you take out of your regular IRA. There may be some adjustments but the distributions are a taxable event. If you meet the requirements for a Roth IRA you do not pay tax on money you take out of it. So Roth distributions generally are tax-free.

You are allowed to convert a regular IRA to a Roth IRA. Here is the problem: you pay taxes on the amount you move from your regular IRA to a Roth IRA. You need to pay these taxes out of money that is not in the IRA. So if you have a $10,000 tax liability for making one of these conversions, it must come out of other investments or savings account. If you use the IRA money to pay the taxes you might end up paying some penalties and taxes.

Why do a conversion? You do not have to pay taxes on future earnings in the Roth IRA assuming you meet the requirements of having it in the account for five years and being over 59-1/2. There are some exceptions to these rules.

You are paying current taxes to save future taxes. If you left the money in the regular IRA you would eventually pay taxes on all the earnings when you withdrew it from the account. You do not pay these taxes on the Roth.

Here is the big problem. You can pay as much as 40% in taxes on the value of the IRA that you convert to a Roth. This happens if you are in a high tax bracket. Even if your income were about $100,000 you would pay about 33% in taxes on the conversion. That’s a lot of money.

I have analyzed this conversion for several clients. The results have consistently come in that doing the conversion does not result in significant savings for the client. After taxes were considered the clients would end up with the same amount of money whether or not they did the conversion.

The one kicker that investment advisors keep throwing on the table is that tax rates are probably going up so pay the taxes now. I have a problem with paying a lot of taxes now based on what Congress might do in the future.

A conversion like this could benefit a low-income taxpayer, perhaps someone who lost a job and had very low income this year but expects to re-enter the workforce soon. This could result in some future benefit. Analyze your situation carefully if you are thinking about doing this type of transaction.

If your business is organized as an S-Corporation and it pays for your health insurance you could have a problem.

A corporation that has elected to have its profits or losses passed through to its shareholders, rather than paying its taxes directly, is an S-Corporation. If your corporation pays for your health insurance, you are required to add the value of any company paid premiums to the gross wages on your W-2 form.

For example, if your wages are $100,000 and you pay health insurance premiums for yourself of $12,000 (you wish they were that low) your gross wages on the W-2 form should be $112,000. These premiums are not subject to Social Security or Medicare Taxes.

There is some good news. After going through these gyrations you are allowed to deduct the health insurance premiums on the face of your personal federal tax return and Massachusetts tax return. In effect, it does not cost any additional taxes when you follow these rules.

If it has no effect, why do it? First, it’s the law. Second, if you do not put the premiums on your W-2, you are not allowed to deduct them on your corporate tax return. Third, they become an itemized deduction on your personal return that is subject to a floor of 7.5% of your gross income. So you would not get the full benefit of deducting the health insurance premiums.

Please note that this applies only to 2% or more shareholders. It does not apply to any employee who is not an owner.

Please pay attention to this problem. The IRS is getting more and more active in reviewing these transactions and assessing penalties if you fail to follow them.

Question of the Day

A client called to ask if the State of Massachusetts was willing to forgive penalties on sales taxes that were paid late.

Here is one of the unfortunate facts about sales taxes. No matter what the business structure, the owner of the business is personally liable for sales taxes plus the penalties and interest on them. So the corporate structure will not shield the owner from paying these taxes out of personal funds.

There is a possibility that the state will abate penalties if it is the first time they have been imposed and the person can give a good reason for not paying them on time. This abatement is requested using form CA-6. Here is a website where you can find the forms. http://bit.ly/MassForms

It will take the state a minimum of two months to process the request, they will continue to bill you, and you will still accrue the penalties and interest on the balance due.

The best policy is to pay your taxes on time.

More Time to File Your Tax Return

Floods can be a good thing. The IRS and Massachusetts have extended the deadline to file and pay your 2009 income taxes to May 11. They also have extended the time to pay some of your payroll taxes. Here is a link to get all the details. That is still due on April 15th. However, they may change this as well. I will keep you posted.

Correction 9:30Am 4-2-10 Estimates also are extended

Click on the title to see the IRS notice.

Whistle Blower Policy

We had some big business scandals in the early part of the new millennium. Accounting fraud at companies like Enron and Worldcom, and theft from companies like Tyco were in the headlines almost daily. Business executives were treated to the “perp walk” on a regular basis, partly to prove that the government was doing something about them. The end result was a lot of people lost a lot of money because of a few arrogant #$%^&*.

Non-profits were directly affected by these scandals. There is now more scrutiny of how non-profits do their work, and concern when any individual at the non-profit gets a salary over $150,000. (Maybe the big banks should get some of this scrutiny. But that’s off topic.) There has always been a concern when a non-profit spends more than 20% of its revenue on administration and fund raising.

The law passed to deal with business ethics, Sarbanes-Oxley, now requires that non-profits have a Whistle Blower Policy. A Whistle Blower Policy details the organization’s response to someone who reports alleged inappropriate activity within the organization. It protects the Whistle Blower from retaliation and gives a process for reporting the questionable activity. Many organizations do not know that this requirement exists, but the new IRS Form 990 now has a question about this.

What’s a non-profit to do? They can spend thousands of dollars with an attorney to create a customized policy. This is appropriate for large organizations like colleges and the United Way. There even are companies that enable an organization to outsource their response to people who report inappropriate activity.

Smaller organizations have an alternative. They can use a template to establish a policy. Here is a good site where you can get such a template.

http://www.blueavocado.org/content/model-whistleblower-policy-nonprofits

Take a look and try it out.

Charity for Haiti

Who says the government cannot move quickly?

Congress passed a new law that allows you to deduct the charitable contributions you make to Haiti relief in 2010 on your 2009 tax return. President Obama has signed the bill into law.

This means write the check now and get the tax benefit on the return you will file shortly.

File Free With the IRS

This is a repeat blog from a year ago. The only thing that changed was the dollar limitation.

Do you have a simple federal tax return to file? You can do it on-line free through the IRS. You qualify if you receive a W-2 from your employer, and have some interest and dividend income. You even can own a home and qualify. The major restriction is that all of your income must be below $57,000.

You can file your return through an IRS partner, or you can complete the tax forms found on the IRS Web site at http://www.irs.gov/app/picklist/list/formsInstructions.html This is a fast, easy, and free way to file your return. Would you like to have your refund in less than 3 weeks? You can have it deposited directly into your checking account. Have a personal check in front of you when you file your return so you have the numbers they require to take advantage of direct deposit. This system is appropriate only for uncomplicated returns.

This link to the IRS Web site can help you file your return.

http://www.irs.gov/efile/article/0,,id=118986,00.html?portlet=4

Massachusetts also offers a webfile alternative. Access it here

https://wfb.dor.state.ma.us/income/Default.aspx

If the link does not work. Please copy and paste it into your browser

The Estate Tax

2010 is a great year to die.

One of the Bush administration tax cuts enacted early in his presidency was a phase out of the Estate Tax. Each year the taxes collected by the estate tax was reduced as larger and larger estates were protected by a rising exemption. Well, this is the year of the final phase out.

What is the estate tax? It is a tax on the value of all your assets less any liabilities, such as your home mortgage, when you die. So if you have a house worth $400,000 and a mortgage of $100,000 (you wish), plus some investments worth $500,000, you have an estate worth $800,000. Check my math if you wish.

Once you figure out the value of your estate, you go to a chart and calculate what your estate tax will be. Someone dying in 2009 would need a net estate of $3,500,000 before they would pay any estate tax. (Don’t you wish you had an estate that large?)

2010 is the year that the estate tax goes completely away. So no matter what the size of your estate, there will be no estate tax on it. For anyone with a taxable estate, that is good news. For someone with an estate less than $3,500,000, it is bad news.

Let me explain. Up until 12/31/09, assets you inherited got a step up in tax basis. Supposed your grandfather paid $1 per share for 1000 shares of IBM stock back in 1955. It now sells for about $130 per share. So the stock that your grandfather bought for $1000 is worth $130,000. If your grandfather died on 12/31/09and you inherited his stock, your tax basis would be stepped up from $1 per share to $130 per share. So if you sold it for $140 per share you would only pay tax on $10,000 ($140 per share minus the ‘cost” of $130 per share times 1000 shares). Under current tax law your tax would be about $2000.

If he died on 1/1/10 your tax cost would be what he paid for it or $1 per share. So you would pay tax on a $139,000 gain if you sold it for $140 per share. The tax would be about $28,000. This is quite a difference.

Back in the middle of the Great Health Care Debate, Congress considered changing the law to freeze the Estate Tax at the 2009 level. The change got lost in the GHCD. I expect some sort of change to occur this year but who knows what form it will take. Watch this blog for updates.