Ethics On The Front Lines

by Larry Goldsmith, CPA, JD, CFF, MAFF

I want to share three quick stories where ethical considerations were considered when accepting or continuing engagements.

Case #1:  A Partnership Dispute, or, The Devil and Larry Goldsmith

The Forensic Accounting portion of my business was uncharacteristically slow. Cases had been settled, and depositions and trials were delayed for months.

Then the devil presented me with the opportunity of a large new case which involved disputing business partners. The engagement required an analysis of expenditures, bank accounts, and the use of business proceeds.  Reading the complaint, I was mystified how the basic facts of the case could be presented so differently by the two parties.

During the interview process for the engagement, as I sat with the referring attorneys and listened as they explained to me their visions of the case, my mental calculator was adding up the staff hours that would be required from my firm. My hands were sweating with excitement.

The more I looked into the matter, the more I became concerned. The accounting records and general bookkeeping was weak. The prospective client took sizable amounts of cash from the company, allegedly to pay sub contractors. No Form 1099’s were issued and only some of the contractors would be willing to sign affidavits that they received the cash. It was explained to me that the company saved money by hiring contractors at a discount by paying cash. The prospective client asked me if I could simply accept his affidavit that the cash was properly spent for business purposes – even though this could not and would not be verified by anyone. Did I mention that the accounting records and the bookkeeping were weak?

Though I suggested alternative techniques where I could quantify the non-verified cash, it seemed that the prospective client only wanted me to investigate the egregious acts of his former partner. The whole thing seemed fraught with potential problems.

I was left with the question: should I accept this proposed engagement? If I answered entirely based on the size and cost of the engagement the answer would likely be yes. But I was concerned about possible ethical issues which seemed very likely to arise. The American Institute of Certified Public Accountants (AICPA) has published various professional standards to provide guidance in cases such as the one that confronted me.

The professional standards say:

Rule 102 of the AICPA professional standards.

In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.

This is further discussed in the Litigation Services and Applicable Professional Standards publication 03-1 by the AICPA; “The expert does not serve as an advocate for the client’s position and, therefore should not subordinate his or her judgment to the client. The expert’s function is to assist the trier of fact in understanding complex or unfamiliar concepts after having applied reliable principles and methods to sufficient relevant data.”

Rule 201, General Standards, of the AICPA Code of Professional Conduct requires that engagements be conducted with “Due Professional Care” using “Sufficient Relevant Data.” According to AICPA Publication 03-1, “Due care requires diligence and critical analysis of all work performed.”  Furthermore, the AICPA requires that the practitioner “Obtain relevant data that is sufficient to provide a reasonable basis for conclusions or recommendations for any professional services performed.”

“The practitioner should consider analyzing key assumptions to determine whether they are reasonable. In several recent cases, experts had their testimony excluded because their opinions were based on assumptions that were deemed not reasonable.”

And finally, Rule 501-01, Acts Discreditable of the AICPA Code of Professional Conduct, states that a, “Member shall not commit an act discreditable to the profession.” Rule 501-04 states that a member shall be considered to have committed an act discreditable to the profession when, by virtue of his or her negligence the member, “Signs, or permits or directs another to sign, a document containing materially false and misleading information.”

Do I accept an engagement with my hands tied?  Do I accept an engagement where my objectivity is being compromised?  You’ll find my decision at the end of this article.

Case #2:

What to Do When Independence is Compromised?

An attorney referred me to provide financial forensic analysis to a woman going through a divorce. In discussions with her I quickly realized that, not only did I know her husband personally, but I had invested in some of her husband’s projects. The wife was impressed with my knowledge of her husband’s complex business structure and sources of revenue. And she was eager for my help. Though I had not been an investor in any of the husband’s projects/deals in the last ten years, I felt that questions concerning personal and professional integrity, independence and objectivity were sure to come up.

Again, I turned to the AICPA for guidance. The AICPA requires objectively rather than independence as a standard. Objectivity is a soul searching determination. Independence is fact driven.

I called the husband. I laid my cards on the table and told him that his soon to be ex-wife wanted to hire me to investigate his finances. Then I asked him if he found there to be a conflict.

The husband emailed me, his attorneys and her attorneys. In the email he stated that he and I (the two of us) had a previous business relationship; he welcomed my retention by his wife, but wanted his wife to be comfortable that we had a past financial relationship.

The husband told me that my professionalism and my fairness were comforting to him. He had heard stories of experts who performed needless analysis to increase fees and experts who would be an obstacle to any settlement.

During the engagement, we cut the husband no slack; we verified all business and personal assets including sources of income. My past relationship with the husband allowed my firm’s team to ask the right questions and know where to look for future income sources. This experience and knowledge saved the parties money, and gave the wife comfort that there was complete disclosure.

Case #3: An Unexpected Meeting…

I arrived at the charitable golf outing dressed in the height of sporting fashion, wearing my pink plaid golf shorts, my white gym shoe golf shoes and my pink polo golf shirt. To my surprise, the gentleman I was paired with had the same name as the attorney I was retained to testify against in an upcoming malfeasance case.

Maybe it was a coincidence, I thought. People often do have the same names.

I returned to the golf cart after practicing my putting and shanking some drives off the practice tee.  In the cart sat a disheveled man in his sixties who was lifting his glasses past his nose to read his cell phone.

After the introductions, handshake and chit chat, I realized that the man next to me, who looked like Mr. Magoo, was the subject of the malfeasance and he was the individual whom I would be testifying against.

I initially wondered if our golf game was an ethical violation. And my next thought was, did he know who I was and would he kill me?

The fact is, there was no violation of ethics in playing golf with the gentleman. We did not discuss his case and there was no disclosure on either part of our professional situations.

I was fortunate; he did not have a clue who I was. In fact three months later when I deposed him, Mr. Magoo failed to remember that we had ever previously met.

So… did I accept the engagement in Case #1…? 

One engagement can make or break a career. The grim thought of handcuffs being placed on me and seeing my career in tatters was all I needed to make my decision to walk away. This was one of those gut wrenching times when you just need to bite the bullet and say No.

I believe that our professional standards, were created to be a guide.  Sometimes our soul searching will provide the needed guidance.  Sometimes the engagement that we turn down is a blessing.

Questions or comments? E-mail me at larry@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

Larry Goldsmith is an experienced Financial Forensic expert and CPA who investigates and verifies financial income and assets in matrimonial matters. CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. 

House Passes Child Tax Credit Improvement Bill

Michael Blitstein, CJBS

Michael Blitstein, CJBS

by Michael W. Blitstein, CPA

Married couples with children would no longer face a tax penalty when claiming the child tax credit under a House bill passed on July 25, 2014. House lawmakers voted 237 to 173 to approve the Child Tax Credit Improvement Bill of 2014.  The bill would eliminate the marriage penalty in the child tax credit by increasing the income phase-out threshold for couples filing joint tax returns from $110,000 to $150,000 ($75,000 for individuals and married taxpayers filing separately).

The bill would also index for inflation the phase-out threshold for the $1,000 credit beginning in calendar year 2015. To combat fraud, taxpayers would be required to include their Social Security numbers on tax returns in order to receive the Additional Child Tax Credit (ACTC), which is refundable.

Ways and Means Chairman Dave Camp noted that the Treasury Inspector General for Tax Administration has reported that the number of filers for the ACTC without a Social Security number grew from 62,000 filers (claiming $62 million in benefits) in 2000 to 2.3-million filers (claiming $4.2 billion in benefits) in 2010. “This is a common-sense provision that will help safeguard taxpayer dollars from fraud, and put it in line with other refundable tax credits, like the Earned Income Tax Credit, which require a Social Security number,” he said.

House Rules Committee Chairman Pete Sessions said Republicans are fighting to make sure that hardworking American families keep more of their paychecks. “That’s why today the House passed legislation to provide common-sense reforms to ensure that the child tax credit keeps up with the rising cost of living,”” he said.

According to the Joint Committee on Taxation (JCT), eliminating the marriage penalty in the child tax credit and adding the inflation adjustment would cost $114 billion over the next decade. Part of that cost would be offset, in the amount of $24 billion, by requiring the use of Social Security numbers for the ACTC. In total, the JCT estimates that would cost $90.3 billion.

Under the bill, a married couple making $160,000 with two children would get an additional $2,200 in their 2018 tax refund, according to a study by the Center on Budget and Policy Priorities (CBPP).  The CBPP study estimates that a single mother of two making $14,500 would see her refund cut by $1,750 under the legislation.

The White House has threatened to veto the bill if it passes Congress. The measure would raise taxes for millions of struggling working families while enacting expensive new tax cuts without offsetting their costs, reflecting fundamentally misplaced priorities, the administration said. “If Republicans want to show they are serious about helping working families through the Child Tax Credit, they should start by extending current provisions past 2017,” the statement reads.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at michael@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

www.cjbs.com

The 10 “Must Dos” After A Divorce

by Larry Goldsmith, C.P.A., J.D., C.F.F., M.A.F.F.

The court room drama has ended, yet too often the newly divorced fail to separate financially from their ex.  Failure to separate yourself and the ex’s credit cards, bank accounts and your financial plans may have undesired consequences.

Now that your divorce is finished, please consider the following as suggested actions:

  1. Review all bank accounts and brokerage accounts and IRA’s verify who the owner and beneficiary of each account is.
  2. Review all credit cards verify that only you are on these credit cards as an authorized user
  3. Send letters to former joint credit card companies informing them that you are divorced and no longer responsible for  liabilities on the old card
  4. Contact the insurance companies notify them of the divorce and that you did not want them to contact your ex and you do not want the ex as a responsible party.
  5. Verify the life insurance beneficiaries and owners.
  6. Verify all life insurance coverage
  7. Change your financial representatives, tax professionals, insurance agents etc. when appropriate so tat you have a loyal professional who will not disclose or work for your ex
  8. Notify the health insurance company, that you want your own account, your ex does need to get copies of your medical issues by logging onto the insurance company’s website
  9. Notify the school of the joint parenting agreement. While it may not apply to you, there are issues with parental kidnappings.
  10. Revisit your will and your financial plan. You may want to consider a change to the executor of your will, beneficiaries, or your health care agents.

Larry Goldsmith is an experienced Financial Forensic CPA who investigates and verifies financial income and assets in matrimonial matters.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at larry@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

My Perspective of Accountants and CPAs

Larry Goldsmith

by Larry Goldsmith, JD, CPA, MAFF, and Julieann Chaet, CPA, MAFF

I’ve always looked at accountants, CPAs or not, as instruments or tools to be used by the IRS or the banks, or buyers and sellers of businesses. What I mean by that is, accountants working in public accounting firms complete the tasks for the Internal Revenue Service to collect its taxes. We provide the measuring stick used by bankers to lend money. We are the instrument that verifies income and assets for the buyers and sellers of businesses. We are important because we produce the tax returns the IRS looks for and the financial statements the banks require. We provide the verification to business that the company is profitable.

To our clients, we become the trusted individuals they depend on to prepare their tax returns or to prepare their company’s financial statement. But all too many times clients will make financial decisions without asking for their accountant’s opinion. I have to say my favorite clients are the ones who call me up to say “Are you busy?” or “Do you have a minute?”  The truth is, I was busy, but that interruption when they ask for my opinion or ask me a question, can save them hundreds or even thousands of dollars.

It usually takes only minutes to answer a client’s question when they call or e-mail. It’s when clients don’t ask the questions, that it can cause problems that can cost more than money.

I prepared very few tax returns this tax season because I was thankfully busy with my forensics work. However, one of the tax returns that I did prepare was absolutely gut-wrenching. A month later, I still think about these particular clients who I’ve never personally met. As I was sorting through their data and inputting the numbers into our tax program, I became curious. I thought I must be missing something. I finished preparing the tax return. The couple owed what was for them a lot of money – thousands of dollars.

So I asked the partner whose name is on the return, “what’s the deal?” Apparently, this 62 year old couple was making over $100,000 a year for at least the last 5 years. Both husband and wife had their own careers. They owned a home. The husband had even gone back to school to further his professional degree while maintaining his career.

The problem started with a stroke – a stroke had debilitated the husband at the age of 59. The husband could no longer care for himself so a full-time nurse was brought in to care for him. After a couple years the wife could no longer afford the full-time nurse so she quit her job to care for her husband. They sold their house and moved into their daughter’s apartment.

By the time I was preparing the couple’s tax return, most of the couple’s savings including IRAs and proceeds from the house had been spent on living expenses and the husband’s medical care.

So what did I do?  I saw Larry Goldsmith, the head of CJBS’s Financial Group’s litigation, asset protection and tax practices team walking past my desk. “Larry, you need to do something!”, I said. I didn’t care that he was just walking in from the polar vortex that we were having outside, and that maybe he wanted to take off his hat and defrost. This woman was going to live probably for another decade or two. Her husband could live years in his current condition, and all their money was squandered on medical bills. Where would the money come from to pay the tax return?

Unfortunately, even with his vast experience and resources for this sort of thing, Larry wasn’t able to provide a solution. It was too late. The truth is the couple was financially bankrupt and didn’t know it. Their liabilities (the monies they owed) far exceeded the monies and assets they possessed. They spent their savings along with their IRA’s that she would one day need because she didn’t know that there were taxes to pay on the IRAs.

Thousands of dollars of her savings were spent caring for her husband that didn’t need to be. The wife did not know about different agencies that could’ve helped or the benefits of financial planning. She did not know that creditors cannot seize her IRAs from her.

You see she never asked the questions of her accountant so the accountant wasn’t aware of all that was happening.

We became aware the day we called her to try to make sense of the documents in front of me.  There is a solution, but it requires planning.

Julieann Chaet, CPA, MAFF

Julieann is the Manager of CJBS’ forensic accounting and litigation services practice.

Call Julieann at 847.580.5449, or e-mail: jc@cjbs.com

 

Larry Goldsmith, JD, CPA, MAFF

Call Larry at 847.580.5427, or e-mail: Larry@cjbs.com

Tax Reform Proposals Released From White House, Congress; Next Steps Uncertain

Michael Blitstein

Michael Blitstein

by Michael W. Blitstein, CPA

Shortly before President Obama unveiled his proposed fiscal year 2015 Federal budget on March 4th, House Ways and Means Chair Dave Camp (R-Mich.), introduced a sweeping tax reform bill. While President Obama did not call for such a mammoth overhaul of the Tax Code as Camp did, the President did include many tax proposals in his budget, affecting individuals, businesses and tax administration.

In Camp’s bill, two greatly affected groups are taxpayers in high-tax states, who would be impacted by elimination of the deduction for state and local taxes, and corporations, which would benefit from a corporate tax cut, but one that would be partially paid for by higher taxes on small and mid-size businesses that are generally structured as pass-through entities.

Both the President and Camp quickly took to social media to promote their proposals. At a news conference, House Speaker John Boehner (R-Ohio), indicated it was unlikely Camp’s bill would come before the House for a vote. Republican support for many of the President’s proposals remains even less likely before mid-term elections.

Obama’s proposals

As in past budgets, President Obama proposed tax incentives for manufacturing, research, energy, and job creation. The President called for Congress to make permanent the research tax credit and expand incentives for employers to hire veterans. Carried interest would taxed as ordinary income and payroll taxes would be extended to cover distributions from certain pass-through entities engaged in a professional service business.

President Obama signaled a willingness to reduce the corporate tax rate but would require the elimination of some business incentives, particularly tax preferences for fossil fuels, in exchange. The President also proposed a number of international and insurance taxation reforms.

For individuals, President Obama proposed to enhance the earned income credit (EIC) for individuals without children and noncustodial parents, and make permanent the American Opportunity Tax Credit. The President also proposed to reduce the value of certain tax expenditures for higher income individuals.

Camp’s bill

Camp’s bill would replace the current seven individual income tax rate brackets (10, 15, 25, 28, 33, 35, and 39.6 percent) with three rates: 10, 25 and 35 percent. In addition, many incentives for individuals would be repealed, including the state and local tax deduction, the itemized deduction for medical expenses, the adoption credit, deduction for alimony payments, the deduction for higher education tuition, and residential energy credits. A few incentives would be enhanced, such as the child tax credit.

Two popular individual incentives—the home mortgage interest deduction and the charitable contribution deduction—would survive under Camp’s plan but in modified form.

Camp’s bill would gradually reduce the corporate tax rate to 25 percent. Few targeted business tax incentives would survive. Camp’s plan eliminates the Work Opportunity Tax Credit, many energy-related incentives, the rules for like-kind exchanges, and more. However, Code Section 179 small business expensing would be enhanced. The research tax credit would be retained but modified.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at michael@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

www.cjbs.com

Forensics is About Teamwork…

Larry Goldsmith

by Larry Goldsmith, JD, CPA, MAFF, and Julieann Chaet, CPA, MAFF

So much is always happening in each of our own lives.  We have our kids, our parents, our friends, our jobs.  We have the maintenance of our homes, our cars, and even ourselves, if we allow that.

The Forensics Team at CJBS can be broken down into these smaller pieces.  Each of us has our family, friends, and homes.  In addition each of us has our own unique experiences in our education, skills, and knowledge.

The bigger picture of the Forensics Team at CJBS is that we are a piece of our client’s team.  The Forensics Team at CJBS works with our clients and their attorneys.  We collaborate to bring our own unique skill set to solve problems and create solutions.

I was at a seminar last week, and received an e-mail informing me that a client needed to talk.  I called the client back thinking that it had something to do with the case.  Maybe there was new evidence that was found.  Maybe the soon-to-be ex-spouse decided to do the right thing and turn over all the information we were pursuing.  Or maybe the client needed reassurance that we were progressing and discovering hidden money or property.  The phone call was neither of those things.  It was a client who was going to her divorce hearing the next day and was scared.  It was a client that just needed to talk.  It was a client who needed to know that we, her forensic team, was doing everything possible to make her next day, the day of her hearing, as successful as possible.  We spoke for about a half hour.  I had been in those shoes in a divorce, and it’s not a nice place to be.  At that moment I was more than her forensic accountant.  I was her friend.   I was part of the team of professionals who would together make her next days as successful as possible with the least anxiety as possible, if that’s even possible.

The Forensics Team at CJBS is a group of people working together with our client and her/his attorney to achieve the best result possible for our client.  We are passionate for both our client and the quality of our work product.

Julieann Chaet, CPA, MAFF

Julieann is the Manager of CJBS’ forensic accounting and litigation services practice.

Call Julieann at 847.580.5449, or e-mail: jc@cjbs.com

 

Larry Goldsmith, JD, CPA, MAFF

Call Larry at 847.580.5427, or e-mail: Larry@cjbs.com

The Need to Invest in a Forensic CPA

Larry Goldsmith

Larry GoldsmithJulieann Chaet

by Larry Goldsmith, JD, CPA, MAFF, and Julieann Chaet, CPA

So, there I am stuck in traffic attempting to get home from my day at the office, and I cannot find anything on the radio that I want to listen to. One commercial after another, or one not necessarily bad song, just not what I care to listen to, and this commercial comes on about investing in gold.  You’ve probably heard the commercial a 1000 times, and either acted on it, thereby making an investment in gold, or thought, when is this commercial going to end?  That’s when this blog was born.  The same gold commercial that I’ve listened to 1000 times, for whatever reason in that particular moment on that particular day, was a brainstorm.  That is to say the investment in gold can be comparable to the investment in a forensic accountant.

Give me a moment while I explain.  Darrell D. Dorrell and Gregory A. Gadawski are the authors of many forensic accounting textbooks. Their definition of forensic accounting is “the art and science of investigating people and money”.  This is precisely what we at CJBS do in the forensic department.  Our team investigates any documents that relate to someone’s behavior and habits.  For example, whether a corporate case or a personal divorce case, two of the first items we ask for are the known bank account statements and the credit card statements.  Bank statements and credit card statements show the habits of the company or the habits of an individual.  For example, were the appliances purchased for the work place or were they for the home? Why does the company credit card show a down payment on an auto when the company that s/he is employed for pays the lease of the auto that the employee is driving? Why is the business doing so poorly that they are increasing the line of credit if sales are on the rise?

Forensic accounting is about finding the gold. Of course gold can be the gold bar that you think of when you hear the commercial for investing in gold, but gold can come in not-so literal packages. How about a real estate property that one spouse never knew existed?  Or receiving monthly child support payments without going back to court each month to fight for what was already determined to be your lawful right? How about the company that is continually just breaking even only to discover that company’s monies was used to pay for an employee’s personal expenditures?

Sometimes there is one working spouse that controls all the money of the household.  The other spouse is at home to raise the children, while trusting his/her partner to invest the monies for their collective benefit and ownership. Years later the marriage may be at a breaking point, and the spouse that stayed home may not be aware of what assets were purchased or where the monies have gone during the marriage. Many times the stay at home spouse lacks the knowledge of which bank accounts exist.

It is the forensic CPA that can discover unknown assets such as real estate properties or bank accounts. Attorneys went to law school to study the law. CPAs like numbers and they have the education to understand the flow of these numbers. Forensic CPAs differ from ordinary CPAs in that Forensic CPAs utilize specialized techniques to find the hidden assets and income.

As forensic CPAs at CJBS, our team is trained to find the gold.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail Larry at larry@cjbs.com or Julieann at jc@cjbs.com if you have any questions about this posting or if we may be of assistance in any way.

Julieann Chaet, CPA

Call Julieann at 847.580.5449, or e-mail: jc@cjbs.com

 

Larry Goldsmith, JD, CPA, MAFF

Call Larry at 847.580.5427, or e-mail: Larry@cjbs.com

House will not consider tax extender legislation in 2013

by Michael W. Blitstein, CPA 

Legislation to extend the group of expiring provisions commonly known as “tax extenders” will not be considered by Congress in 2013.  House lawmakers will begin their winter district work period on December 13th, but tax extender legislation is not on the legislative floor schedule and no markup is planned in the Ways and Means Committee.

The House is likely to consider legislation dealing with Medicare payment rates for physicians, a fiscal year 2014 budget conference agreement and, possibly, a conference report on the farm bill.

Rather than following its typical pattern of passing a one or two-year extension of tax incentives in late December, Congress could approve an extenders bill in 2014 that applies retroactively, possibly as part of larger comprehensive tax reform legislation.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at michael@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

www.cjbs.com

Divorce and I.R.S. Trouble for the Innocent Spouse

by Larry Goldsmith, CPA, J.D., M.A.F.F.

As a Financial Forensic CPA traveling down the road of hidden assets and hidden income, I often observe bad behavior meant to intentionally punish a former spouse.  More than once, I have seen fear in the eyes of an innocent spouse who simply signed her name to a joint tax return and is now being relentlessly pursued by the Internal Revenue Service collection division.

We all know how this happens; in preparation for a separation or divorce, some spouses seeking a better settlement will decrease their business profits by diverting income or by claiming improper business expenses. The trouble for the innocent spouse who has agreed to file a joint income tax return before or during the separation is that when the Internal Revenue Service or the State of Illinois discovers the unreported income, the taxing agencies will hold both the innocent and guilty spouse ‘jointly and severably’ liable for the under reported income taxes, tax penalties, and accrued interest. ‘Joint and severably’ liable simply means that the Internal Revenue Service will take the money from either spouse, without concern as to fairness.

Unfortunately, it is often the case that the guilty party who is hiding assets will allow the innocent spouse to be burdened by paying 100% of the tax debt. Last year a woman was referred to me. Her husband of three years was cheating on his income taxes and his business was audited by the IRS. The young woman was told by an IRS collections officer that since she filed a joint tax return she owed $220,000. The IRS garnished her wages, placed a lien on her pre-marital real estate and levied her bank accounts. Her husband told her it was a mistake and “not to worry”.

How can you be protected?

Both the Internal Revenue Service and the State of Illinois recognize that there are innocent spouses who:

  1. Filed a joint income tax return not knowing the guilty spouse failed to report on the income tax returns, gross income, deducted improper deductions, or took improper tax credits.
  2. The innocent spouse, like a reasonable person in a similar circumstance, would have not known of the under reporting. The government will consider the innocent spouse’s education, business experience, the nature of the under reporting and the individual’s financial condition.

The government recognizes that innocent spouses must be protected and has established procedures where an innocent spouse can be freed from financial pitfalls orchestrated by the guilty spouse’s tax trap. In evaluating an innocent spouse claim the government will consider the benefit the innocent spouse received and whether the spouses are separated or divorced. As the Forensic CPA who examines the spouse’s business for possible hidden income or assets, I will recommend at times to the innocent spouse that filing a separate tax return rather than a joint tax return may be financially safer.

An agreement drafted by the attorneys where the guilty spouse agrees to pay all tax liabilities should the Internal Revenue Service determine that there is income tax liability is not considered binding by the IRS and affords the innocent spouse little protection.

My experience is that if an innocent spouse presents a well documented case the government will consider the granting of innocent spouse protection. In the case I used as an example, it took several months but eventually I was able to get the woman’s money returned and her property freed of the liens. Had she listened to her now ex-husband, she would have been penniless, chasing after her ex-husband with no financial resources to pay an attorney.

The lesson is: if you are in a shaky marriage and you believe that your husband or soon to be ex-husband is improperly reporting his taxable income from his business, DO NOT SIGN a joint tax return.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at larry@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

Will You Be Paying More Tax on Similar or Less Income?

by Michael W. Blitstein, CPA 

Most taxpayers would agree that paying more tax on similar or less income does not sound appealing.  The health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010) imposes a new 3.8 percent Medicare contribution tax on the net investment income of higher-income individuals. Although this tax has a wide reach, certain steps may be taken to lessen its impact.

Net investment income. Net investment income, for purposes of the new 3.8 percent Medicare tax, includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property that is not used in an active business and income from the investment of working capital are treated as investment income as well. However, the tax does not apply to nontaxable income, such as tax-exempt interest or veterans’ benefits. Further, an individual’s capital gains income – both long-term and short-term – will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Section 121, and gains from the sale of a vacation home. Planning the sale of “big ticket items”, therefore, now often requires attention to the new 3.8 percent surtax.

The tax also applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute. Use of family trusts and other trust-based strategies now must factor in the 3.8 percent surtax in the construction and operation of the trust.  Executors must also be aware of how the 3.8 percent surtax is applied against income on assets held by the estate rather than immediately distributed.

Deductions. Net investment income for purposes of the new 3.8 percent tax is gross income or net gain, reduced by deductions that are “properly allocable” to the income or gain. This is a key term that the Treasury Department expects to address in future guidance. For passively-managed real property, allocable expenses will still include depreciation and operating expenses. Indirect expenses such as tax preparation fees may also qualify.

For capital gain property, this formula puts a premium on keeping tabs on amounts that increase your property’s basis. It also puts the focus on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers’ fees, may increase basis or reduce the amount realized from an investment.

Thresholds and impact. The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately.

The tax can have a substantial impact if you have income above the specified thresholds. Also, remember that, in addition to the tax on investment income, you may also face other tax increases that have taken effect beginning in 2013. The top marginal income tax rate is now 39.6 percent and the top tax rate on long-term capital gains has increased from 15 percent to 20 percent. Thus, the cumulative rate on capital gains for someone in the highest rate bracket has increased to 23.8 percent. Moreover, the 3.8 percent surtax’s thresholds are not indexed for inflation, so a greater number of taxpayers may be affected as time elapses.

Exceptions. Certain items and taxpayers are not subject to the 3.8 percent tax. A significant exception applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible deferred compensation plans. At the present time, however, there is no exception for distributions from nonqualified deferred compensation plans, although some experts claim that not carving out such an exception was a Congressional oversight that should be rectified by an amendment to the law.

The exception for distributions from retirement plans suggests that potentially taxed investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Business owners may want to set up retirement plans, especially 401(k) plans, if they have not yet established a plan, and should consider increasing their contributions to existing plans.

Prudent planning is necessary to create and implement efficient and effective tax strategies that will allow for goals and objectives to be met.  The new 3.8 percent Medicare contribution tax on the net investment income is no exception.  Please seek the advice from your tax professional to determine how this affects you.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at michael@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

www.cjbs.com