Volume 27 Number 2, Spring 2006
SEK&Co Completes Ninth Successful Peer Review
Changes in the "Kiddie Tax"
Health Savings Accounts--Are They One Size Fits All?
IRS Audit Spotlight
PA Use Tax Voluntary Compliance Program
The Better Way
Beware of "Phishing" Scams
SEK&Co Completes Ninth Successful Peer
Review
Smith
Elliott Kearns & Company, LLC was recently notified by the Center for
Public Company Audit Firms Peer Review Committee of the American Institute
of Certified Public Accountants
(AICPA) that it has successfully completed an
independent peer review of its accounting and auditing practice.
The reviewers concluded that the firm complies with the stringent quality
control standards established by the AICPA, the national professional
organization of CPAs.
“Peer reviews are required for membership in AICPA’s Center for Public Company
Audit Firms and are
conducted every three years,” according to Edward L. Buchanan IV, CPA,
managing member of SEK&Co. “We are certainly pleased with successfully
completing our ninth peer review, especially with the ongoing scrutiny of the
accounting profession.”
The peer review was conducted
by the national firm of Cherry Bekaert & Holland under guidelines established
by the AICPA. The reviewers made an independent assessment of the firm’s
quality control policies and procedures and inspected the working papers and
reports on a representative sample of accounting and auditing engagements.
They also inspected the firm’s administrative files and records and
interviewed professional personnel.
Michael P. Manspeaker, CPA,
SEK&Co’s Director of Accounting, Auditing and Quality Control, stated,
“Considering the attention that has been focused on the quality of audits
during the past year, it is gratifying to know that an extensive review of SEK&Co’s
accounting and auditing practice resulted in a successful peer review report.”
A copy of the report is
available from Smith Elliott Kearns & Company, LLC or the American Institute
of Certified Public Accountants.
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Changes in the "Kiddie
Tax"
What does the recent change in
the “kiddie tax” (effective 2006) do for college savings? The short answer
to that question is: new tax law raises the age for which the “kiddie tax”
applies from under 14 to under 18 years of age. That means that investment
income for children ages 14 through 17 are now suddenly taxed at their
parent’s tax bracket. Without planning, this can wreck havoc to a college
savings plan.
Plans to sell appreciated
securities set aside for college when a child turned 14, especially in cases
of stock with low carryover basis in gift situations, need to be revised.
Especially painful is the loss of an anticipated non-kiddie tax sale when the
capital gains tax rate for lower income taxpayers will be zero percent in
2008, 2009 and 2010. (Taxpayers in either the 10 or 15 percent income tax
bracket in 2008 through 2010 pay $zero on long-term capital gains recognized
in those years.)
Those who are most impacted
by the new law are those 14 to 17 year olds who had their appreciated
securities sold earlier in 2006, before the kiddie tax law was changed.
Planning techniques to cope with the changes are
complicated and tricky. Call your local SEK&Co office to discuss the best way
to plan for your children's college education.
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Health Savings Accounts--Are
They One Size Fits All?
The
President’s State-of-the-Union speech on January 31 highlighted his
Administration’s focus on high deductible health plans (HDHPs) coupled with
health savings accounts (HSAs) as a device to control the high cost of health
care. Supporters of HSAs say that the HDHP/HSA offerings provide
“consumer-driven” health care. Premiums for an HDHP will be lower than for
ordinary health insurance, but out-of-pocket costs will be greater.
The requirement to pay costs
not covered by the deductible is supposed to encourage consumers to spend
their medical dollars more wisely and allow them to play a more direct role in
their health care decisions.
Critics of HSAs counter that
individuals covered by an HDHP will forgo necessary medical expenses to avoid
having to pay for expenses not covered by the high deductible. Opponents are
also concerned that the HDHP/HSA system will drive up the cost of health care
for the poor, the aged and less healthy individuals, because healthy and
well-to-do individuals will drop out of the pool of individuals covered by an
ordinary plan.
Operation of HSAs.
An individual can have an HSA only if he or
she is covered by a “high deductible health plan.” An HDHP must have a minimum
annual deductible of at least $1,050 for individual coverage and $2,100 for
family coverage. Only the individual’s actual coverage is relevant, so it does
not matter if the individual could have chosen another type of health plan.
Contributions to an HSA are
deductible, whether or not the individual itemizes deductions. Contributions
by an employer to an HSA are excluded from income and are not subject to
Social Security taxes.
For 2006, the limits are
$2,700 for an individual and $5,450 for a family. Individuals can make
contributions for 2006 up to April 16, 2007, the deadline for filing Form
1040.
The employee or individual
sets up the account with a bank or other financial entity and is the owner of
the account, like an IRA. Funds in an HSA can be invested like an IRA. Both
the employer and the employee can contribute to an account. The individual
controls investments and withdrawals from the account. Funds from an HSA or
from an Archer Medical Savings Account can be rolled over into another HSA.
Funds withdrawn from the
account are tax-free if used to pay medical expenses. Funds can be withdrawn
for nonmedical reasons but are taxable and subject to a 10 percent penalty.
Once the employee turns 65,
funds can be withdrawn without penalty, but are still taxable if not used for
medical expenses.
Administration proposals.
The tax benefits of an HSA are very costly
to the government. Congress may be reluctant to approve proposals that drive
up the cost of the program, unless there are budgetary offsets.
President Bush has proposed
to increase the contribution limit to the maximum out-of-pocket expense for
the HDHP, which for 2006 can be as much as $5,250 for individual coverage and
$10,500 for family coverage. Employees would be able to take an above-the-line
deduction for the employee’s cost of an HDHP provided by the employer.
Employees using after-tax dollars to contribute to their HSA (whether
employer-sponsored or individually obtained) could claim a 15.3 percent credit
for payroll taxes paid. In addition, a refundable credit would be provided to
lower-income individuals for premiums paid for an HDHP. The credit would cover
up to 90 percent of the premium, up to $1,000 for individuals and $3,000 for
families.
Comparability.
Employers do not have to contribute to
HSAs, but any employer contributions are subject to a comparability
requirement. The penalty for violating the comparability rules is 35 percent
of the contributions made to employee HSAs.
Contributions must be the
same amount or the same percentage of the employee’s deductible, for employees
in the same coverage category. Different treatment is allowed for full-time
and part-time employees, for retirees, and for self-only and family coverage.
ERISA and COBRA.
The Department of Labor has determined that
HSAs are not an ERISA employee welfare benefit plan. Therefore, employers are
not bound by ERISA’s reporting requirements and do not have a fiduciary duty
to monitor the investment of an HSA’s assets.
An employer can terminate its
contributions to the employee’s HSA and can reserve in an HDHP’s plan
documents the right to terminate the HDHP. COBRA rules that require employers
to offer health insurance after an employee terminates employment do not apply
to HSAs.
Employer considerations.
Employers are beginning to offer HDHPs
coupled with the incentive of employer contributions to an HSA. For now, they
continue to offer other health insurance coverage, but over time, many
employers may consider replacing all comprehensive coverage with HDHPs and
HSAs.
Smaller employers offering an
HDHP have less control over the marketplace and will find it harder to
negotiate a favorable price from the HDHP provider. On the other hand, the
self-employed entrepreneur will find HSAs more attractive than a health
reimbursement account (HRA) because they can be used to build up tax-free
savings.
Health reimbursement
accounts. As the law presently
exists, larger employers may prefer health reimbursement accounts (HRAs) to
HSAs.
The rules, benefits and
pitfalls of various plans are quite complicated. Contact your local SEK&Co
office to explore the best solution for your business.
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IRS Audit Spotlight
The
IRS’s recently released 2005 Data Book gives taxpayers a glimpse at where the
agency is focusing its audit priorities. Individuals and small businesses have
strong chances of being audited. Statistics from the IRS’s 2005 fiscal year
(FY) show a 20 percent increase in individual audits and a similar jump in
small business examinations.
Drawing conclusions from
audit statistics must be measured by the various types of audits conducted.
Not all audits, indeed very few, are full-blown, highly intrusive audits.
Correspondence audits are the most common. In FY 2005, only about 20 percent
of all audits were conducted in person by revenue agents or examiners.
Individual audit rate
continues to climb. The overall audit rate for all individual
returns continues to climb. In FY 2005, the audit rate for all individual
returns was 0.93 percent, up from 0.77 percent for FY 2004.
The overall audit rate for
all individuals is now about where it was 10 years ago before audit rates
started falling. After Congress passed the IRS Restructuring and Reform Act of
1998, the IRS pulled employees off enforcement and into customer service.
Since 2003, the IRS has been refocusing on enforcement.
The IRS assessed
approximately $1.8 billion in civil penalties against individuals and $1
billion in interest in FY 2005. However, for about 40,000 taxpayers, the
outcomes of their audits were better. They received refunds.
Targeting Schedule C
filers. Schedule C is traditionally a gold mine for the IRS. In
FY 2005, the IRS targeted Schedule C’s showing receipts of $100,000 or more.
Roughly 3.65 percent were selected for audit.
Corporate audit rates
rise. Audit rates for all types of corporations increased in FY
2005. The audit rate for S corporations rose from 0.19 percent in FY 2004 to
0.30 percent in FY 2005. The audit rate for large corporations jumped from
16.7 percent in FY 2004 to 20 percent in FY 2005.
This year, the IRS is making
a special push to identify employers who pay their workers in cash to get
around their employment tax obligations. The agency is also focusing on
unreported tip income.
Other enforcement targets include identifying employers that
misclassify their workers as independent contractors and return preparer and
promoter fraud. The IRS has discovered an upturn in the number of bogus
medical reimbursement arrangements being marketed on the Internet.
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PA Use Tax Voluntary
Compliance Program
The
Pennsylvania Department of Revenue is ‘kicking off’ a Use Tax Compliance
Program by educating taxpayers and tax preparers about Pennsylvania Use Tax.
The number of Pennsylvania
businesses that purchase equipment and supplies from out-of-state-vendors
continues to steadily increase. Using the Internet to make purchases provides
the convenience of submitting an order today and having the requested item
delivered to the doorstep the next day. However, in many instances PA Sales
Tax is not collected and remitted by the seller, meaning that the purchaser
must report and pay PA Use Tax to the Department of Revenue.
Under the Use Tax Voluntary
Compliance Program, if a return and payment is post marked by the designated
due date, penalties will be waived. This due date can be found in the upper
right hand portion of the letter businesses received from the Department.
If businesses file and pay
Use Tax after the designated due date, the penalty is 5 percent of the unpaid
tax for each month or fraction of a month from the original filing date of the
return. The maximum penalty is 25 percent of the unpaid tax.
The Use Tax Compliance
Program will include several phases over the next year. Revenue Department
officials will work with professional and business organizations to educate
businesses about PA Use Tax and encourage greater compliance. Following this
outreach phase, the Department will directly contact many businesses and guide
them in voluntarily reviewing and self-disclosing their Use Tax obligation.
Finally, the Department is planning a Use Tax field audit initiative to
reinforce the necessity of voluntary compliance.
It’s important to note that a lack of response to the
voluntary compliance request will automatically spark a use tax review.
Accordingly, you should respond even if you believe your use tax obligation to
be zero for the periods in question.
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The Better Way
Hi Bracket had his nephew, Adam,
involved in several of his real estate partnerships. While good
investments, their tax reporting was always late, which caused Adam to
file his return at the last minute.
When Adam's CPA tried to file his return electronically, it was rejected by
IRS because his seventeen-year-old son, Junior, had already claimed himself as
a dependent, with no tax advantage to him, when he filed on-line with
supertax.com using the point & click method. This was going to cost Adam a
$1,000 tax credit (that's real money, folks) and a $3,200 tax deduction. The
other choice was to put his return on extension thereby delaying his refund,
amend Junior's return and file after the amended return was processed. This
didn't work out too well!
The Better Way is to look at the tax filings at
the family level so that all filings are coordinated. In addition to the above
example, tuition deductions, education credits, taxes for children under 14
years old, employment in a family business, interest on family member loans
and many other areas take coordination for the best income tax and estate and
gift tax results.
We work closely with families and closely held
businesses to see that the all around best results are achieved. Talk with us
early- it's so much better (and cheaper) to do it right the first time than to
fix it later!
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Beware of "Phishing"
Scams
The IRS has
launched a new electronic mailbox designed to combat a recent surge in
scam emails pretending to be from the IRS. “Phishing” or tricking
individuals into disclosing personal information through the Internet is
on the rise. The IRS has identified more than two dozen IRS-related
phishing scams, mostly originating in foreign countries.
How it works.
The IRS never sends out unsolicited emails
requesting personal information, PIN numbers, passwords or similar secret
information. It is warning taxpayers to especially watch for emails telling
them they are due a refund and directing them to what appears to be a
legitimate IRS website. The fake IRS website then prompts the taxpayer to
submit personal and financial information. These emails are not from the IRS
and are used to commit identity theft.
phishing@irs.gov.
Taxpayers who receive suspicious emails can report them to phishing@irs.gov.
For detailed instructions taxpayers should go to the IRS website (www.irs.gov),
type “phishing” in the search box, and open the article entitled “How to
Protect Yourself from Suspicious E-Mails.”
Taxpayers with an “.edu” email address should be extra
cautious, the IRS warned, since educational groups have been particularly
targeted.
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