4 IRS hot buttons. Defending your business against tax audits

Transcription

1 Manufacturer Winter IRS hot buttons Defending your business against tax audits Made in the USA makes a comeback Spotlight on final tangible property regs Wage increases: Look before you leap

2 4 IRS hot buttons Defending your business against tax audits Everyone has at least one pet peeve. The IRS has many. Here are some items that the tax agency may target on a manufacturer s 2014 tax return and ways to help safeguard against an IRS audit. 1. Owners compensation A privately held C corporation may try to overpay its owners in lieu of paying dividends to avoid double taxation. Conversely, an S corporation that s not subject to corporate-level taxes might try to underpay its owners to minimize payroll taxes and, instead, make higher distributions. The IRS is on the lookout for whichever ploy applies to your company and may compare your owners compensation to that of other manufacturers or distributors in your area. How much should an owner get paid? There s no right answer for every company. It depends on what unrelated third parties with the same responsibilities, schooling and experience receive for performing the same functions. Outside sources, such as headhunters and various compensation surveys, can be used to substantiate your owners compensation expenses. 2. Travel expenses Private business owners sometimes push the envelope when it comes to combining business and personal travel expenses. But the IRS has strict rules on what qualifies as deductible business travel expenses. For instance, suppose you attended the International Manufacturing Technology Show in Chicago last September. You visited the conference for two days but extended your stay an extra week to visit family in the Chicago area and your wife and kids tagged along. How much of the trip can you deduct as a legitimate business expense? You generally can deduct up to 50% of business-related meals and entertainment expenses incurred for the purpose of entertaining a client, customer or employee. In order to deduct travel expenses, the primary reason for the trip must be business, rather than personal pleasure. To validate the business purpose of a trip, the IRS usually considers whether your business travel days including travel days to and from the destination, working days and standby days exceed your personal travel days. When this happens, you can usually deduct all your transportation costs, such as airfare, rental car fees and hotel costs, but not those incurred by the rest of your family. If the threshold isn t met, you can t deduct any travel costs, even if you conduct substantial business during your trip. 3. Meals and entertainment Likewise, excessive meals and entertainment expenditures are likely to catch the IRS s attention. You generally can deduct up to 50% of business-related meals and entertainment expenses incurred for the purpose of entertaining a client, customer or employee. Maintaining detailed records is the key to protecting your meals and entertainment deductions. 2

3 Managing IRS inquiries The IRS wants to make up for a tax gap that s estimated at more than $300 billion. So, it s become more efficient and targeted in its audit efforts. If you receive a notice from the IRS in the mail, contact your tax professional immediately. He or she can help you respond to the notice or question, which is often all the IRS needs to satisfy its inquiry. A tax professional can manage your ongoing correspondence with the tax agency. When an outside tax professional gets involved, it can limit your direct interaction with IRS agents. Your company s expense reimbursement forms should require the following information: Amount of the expense, Time and place, Business purpose, and Name and business relationship of any person entertained. Hold onto records supporting the items claimed until the statute of limitations runs out. (The statute of limitations usually runs out three years from the due date or the filing date, whichever is later.) However, the IRS can go back more than three years if it suspects a substantial omission of income or a tax fraud. 4. Net operating losses When expenses exceed revenues, a business may incur a net operating loss (NOL). Businesses may elect to carry back (or forward) NOLs to offset income in other years. The IRS may ask your company to substantiate the loss, not only in the year it s incurred, but also when a refund is claimed for an earlier (or later) year. So, proper record retention is essential with NOLs. IRS If you request it, your tax advisor s office may also serve as an offsite location for the IRS field audit. This may prevent an agent from inadvertently stumbling upon another unrelated tax deficiency while on your premises. Also, beware that the IRS never initiates contact with taxpayers via telephone, social media or . If you receive an , text or phone call from the IRS, it may be fraudulent. Contact the IRS or Federal Trade Commission immediately. instructions recommend saving records until NOLs no longer have an effect, plus seven years. Tax pros lower audit risks A small percentage of tax returns are audited by the IRS. Sometimes a business is randomly selected. But in many cases, high-risk or excessive deductions trigger an audit. The IRS keeps norms on how much manufacturers under each industrial classification code typically deduct for each line item but unfortunately it doesn t publish industry norms to the general public. IRS auditors often have a field day with do-ityourself returns. An advisor who specializes in the manufacturing niche can evaluate your deductions line-by-line and help minimize your audit risks. n 3

4 Made in the USA makes a comeback The trend of outsourcing to overseas suppliers and contractors may be losing some of its luster. Many businesses are returning to U.S. manufacturers also known as reshoring to obtain goods faster and at lower costs than foreign suppliers can offer. What s more, Made in the USA tags can win over domestic customers who want to feel good about their purchases. Complying with FTC rules In order to claim a product is Made in the USA, you must comply with strict regulations set forth by the Federal Trade Commission (FTC). These rules require that final assembly take place on U.S. soil and the majority of total manufacturing costs be spent on U.S. parts and processing. Complex labeling standards may also apply if an American flag or map is used on packaging to imply the country of origin. To claim a product is Made in the USA, final assembly must take place on U.S. soil and the majority of total manufacturing costs must be spent on U.S. parts and processing. A company can make a qualified claim when a product is made in several countries, however. For example, it may specify the percentage of a product s domestic content or label a product as Assembled in the USA instead. modify packaging to comply with the FTC regulations, which can be another costly expenditure. Touting the benefits The Made in the USA resurgence is a welcome boon to domestic manufacturing. You can prepare by investing staff, inventory and equipment to meet increasing demand for domestic-made products. But first, you may need to remind your customers about the benefits of using domestic manufacturers, including: Cheaper, more reliable shipping. The United States offers lower labor, natural gas and electricity costs than some other developed countries in Europe and Asia, including the United Kingdom, Germany, France and Japan. Tariffs and high shipping costs can also make overseas production cost-prohibitive. And volatile foreign political environments may prevent products from shipping on time, leading to production delays. Fewer business risks. Intellectual property theft and devaluation of the U.S. dollar are just some of the risks companies face when they outsource production to other countries. Additionally, important instructions such as product specifications or shipping terms may be lost in translation when communicating with foreign suppliers. 4 Compliance with these rules is essential. False claims are likely to attract an FTC investigation, which could lead to enforcement actions and negative publicity. Violators also may need to Safer products. News stories about contaminated plastic and pet food products from China have led to recalls, illnesses and even deaths. Products made under the scrutiny of the U.S. Food and Drug

5 Administration and Departments of Commerce and Agriculture are typically held to higher quality standards than many foreign-made products. Safer materials and products give customers peace of mind that they re not exposing end-users to unsafe products and themselves to liability claims. Environmental concerns. The U.S. Environmental Protection Agency also requires manufacturers to adhere to strict environmental standards that limit emissions and pollutants. Other countries, including China and India, are making huge carbon footprints today that will harm the environment for many years. Humanitarian aspects. People feel patriotic when they support the U.S. economy and create jobs for American workers. They also want to know that factory workers aren t subjected to unsafe conditions, low wages or other forms of exploitation that the U.S. Department of Labor and domestic labor unions protect against. Whether you sell to businesses or consumers, you might consider implementing a marketing campaign that positions your products as American-made. This may include new advertising programs and repackaging with the Made in the USA label. Preparing for a comeback As manufacturers and distributors budget for 2015, they should consider whether the reshoring trend will attract more business, both domestically and abroad. Proactive businesses will position themselves as all-american and have extra capacity to meet increasing customer demand for U.S.-manufactured products. n Spotlight on final tangible property regs Manufacturers and distributors typically spend significant amounts of money to acquire and improve tangible property, such as buildings, machinery, vehicles, furniture and equipment. Many of these costs are capitalized on the balance sheet for 5, 10, 15 or 20 years or longer. But certain qualifying expenditures may be deducted in the current year, thereby lowering the company s taxable income. Last winter, the IRS released long-awaited final regulations (IRS T.D. 9636) on the tax treatment of tangible property expenditures that apply to the current tax year. Here s an overview of these rules, including several safe harbors, to help you file an accurate 2014 tax return. Material and supplies The final regulations increase the dollar threshold for materials and supplies that are exempt from capitalization from $100 to $200. They allow you to elect to capitalize certain materials and supplies but limit them to rotable, temporary or standby emergency spare parts. The final regulations clarify an optional method that allows taxpayers to treat the rotable and temporary spare parts as used or consumed in the year 5

6 of disposition or elect to treat them as depreciable assets. Taxpayers are no longer required to employ this method for all pools of rotable spare parts used in that trade or business they can opt not to use it for those pools for which they don t use it on their books and records. Capitalizable building improvements A cost that results in an improvement to a building structure or its systems (for example, the plumbing or electrical system) must be capitalized. An improvement occurs if there was a betterment, restoration or adaptation of a unit of property. The final regs require you to capitalize amounts that are reasonably expected to materially increase the productivity, efficiency, strength, quality or output of a unit of property or are a material addition to a unit of property. They also include a new definition to help determine whether an amount spent on replacement constitutes a restoration. A building expenditure is for the replacement of a major component or substantial structural part if the replacement includes a part or combination of parts that comprises: 1) a major component or a significant portion of the building structure or any building system, or 2) a large portion of the physical structure of the building or any building system. Safe harbors Under the safe harbor provisions, an expenditure isn t considered a capitalizable improvement if the taxpayer expected to incur it as a result of its use of the property or to keep the property in its ordinarily efficient operating condition. The activity is considered routine if, at the time the property was placed in service, the taxpayer reasonably expected to perform the activity more than once during the property s life. The final regulations extend this safe harbor to buildings. The taxpayer must reasonably expect to perform the building-related activities more than once in 10 years. These activities include property inspection, cleaning and testing, as well as replacement of worn or damaged parts. The regulations add another safe harbor for qualified small business taxpayers (generally, those with gross receipts of $10 million or less). For property that initially cost $1 million or less, taxpayers may elect to deduct the lesser of $10,000 or 2% of the adjusted basis of the property for repairs, maintenance, improvements and similar activities each year. The final regulations allow a taxpayer that expensed the purchase price of tangible property for financial reporting purposes on an applicable financial statement to deduct the amount for tax purposes, as long as the amount paid for property doesn t exceed $5,000 per invoice or per item. If you elect this safe harbor, it must be applied to all eligible amounts paid in the taxable year for tangible property that meets the requirements, including amounts paid for materials and supplies. 6 Help with 2014 taxes As calendar year 2014 wraps up, manufacturers and distributors should review the final tangible property regs to ensure they ve properly distinguished between capital expenditures and deductible business expenses. Your tax advisor can help answer any questions you have regarding these regulations and how to best proceed. n

7 Wage increases: Look before you leap A recent Gallup poll shows that roughly three-quarters of Americans support a minimum wage increase. Factories and warehouses tend to employ a large number of entry-level and low-wage workers. So you may be considering a wage increase for your hourly workers. Here are some important questions to factor into your decision. How do your wages compare? Many cities and states already have minimum wage rates that exceed the federal rate, which has been set at $7.25 since Others are currently considering legislation to increase their rates. Depending on where you re located, you may already be required to pay above-average wages or soon will be so it may not make sense to increase wages at this time. Also consider that a wage increase might make you less competitive globally. Right now, productivityadjusted labor costs in other developed countries (including the U.K., Germany and Japan) are 20% to 45% higher than U.S. labor costs on average, according to a recent study by the Boston Consulting Group. That gives U.S. manufacturers an edge over other developed nations. The Chinese government s five year plan has increased the minimum wage by an average of 13% per year, according to a website run by the Chinese government. As a result, China s cost advantage over the United States has been cut in half over the last decade. So, outsourcing to China is becoming less cost-effective, causing many companies to rethink their supply chain partners. Let China serve as an example of what might happen if you increase your wages. It could ultimately make you less cost-effective than global competitors, thereby lowering your sales. What s the total cost? When annualized, the federal minimum wage rate equates to $14,500 for a full-time employee, assuming 50 work weeks per year. Every $1 more you offer full-timers per hour translates into another $2,000 in wages over the next year. This doesn t include hidden costs such as higher payroll taxes, retirement plan contributions or other perks that accompany a wage increase. Moreover, an increase in the wages paid to entrylevel workers is also likely to trickle up the ranks to more experienced hourly workers and managers. It s questionable whether you can pass along these incremental costs to customers without lowering your sales demand. Do the benefits outweigh the costs? A wage increase can be a great way to show support for your workers by enhancing their buying power and sense of self-worth. But budgeting for a wage increase goes beyond simply increasing direct labor costs for your lowest-paid workers. Contact an accounting professional to guide you through this tough decision. n This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use MFGwi15 7

8 PO Box 1869 Brentwood, TN With offices in Nashville Knoxville Chattanooga Transfer Pricing - Is your company at risk? Transfer pricing is an integral part of U.S. and foreign tax compliance, planning, and risk management with a role in State level planning as well. Globally, over 60 countries have transfer pricing regulations or rules in place, most requiring specific documentation. LBMC s transfer pricing practice offers customized transfer pricing solutions with the flexibility of a regional firm. Transfer pricing enforcement has increased dramatically in the U.S., reinforcing the need to create and maintain compliance documentation: The IRS has hired over seven hundred new international specialists and now has transfer pricing economists in twenty six offices IRS audit focus has shifted to companies with assets of $10 million to $250 million increasing the audit risks of medium sized companies Industries that were hit hardest by the global recession which may still be recovering (such as automotive and housing sector linked companies) may need extra analysis to reduce risks Transfer pricing documentation makes audits go more smoothly, reduces risks, shifts the burden of proof to the tax authorities, and may provide penalty protection Some U.S. Transfer Pricing Compliance Issues U.S. transfer pricing is governed by Internal Revenue code section 482, associated regulations (transfer pricing regulations) and section 6662 (valuation misstatement penalty regulations), which require that all related party transactions be priced at arm s length. This includes: - Product (tangible goods) transactions - Intangibles - Services - Loans & leases Transfer pricing documentation is required and provides penalty protection if contemporaneous and complete (no penalty for not having documentation, but must produce it when requested by the IRS). Misstatement penalties can be large 20% or 40% of the additional tax owed. Penalty triggers are based on large dollar values, percentage differences from arm s length amount, or certain percentages of revenue. Tax preparer standards (section 6694) establish the level of assurance needed for uncertain tax positions at substantial authority or reasonable basis with disclosure; transfer pricing is an uncertain position. Get answers to your questions. Call us today. Contact Information Service Offerings: U.S. and certain foreign transfer pricing compliance documentation Transfer pricing planning and risk assessment Tax controversy services Risk assessment and/or FIN 48 tax provision reviews Emily Trader, Director, Transfer Pricing (Phone) (Direct) etrader@lbmc.com