Insider. Construction. Identity Theft Tax Returns an Emerging Trend. Go Green with the Construction Insider

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1 Construction Insider Insights & Observations for the Construction Industry Volume 7 :: Issue 1 Go Green with the Construction Insider In order to be more ecofriendly, we are converting to an electronic newsletter and we need your help! To switch from a printed version to an electronic format, please send an to jgallo@uhy-us.com and insert Green Newsletter in the subject line. Thank You! Identity Theft Tax Returns an Emerging Trend An identity theft return is a criminal act in which a tax return is filed using another individual s identity, primarily for the purpose of generating a fraudulent refund. Last year, the IRS reported about 940,000 returns totaling $6.5 billion of fraudulent refunds were related to identity theft. It is important to understand that a return filed by an identity thief does not represent a valid return, because it is not filed by the true taxpayer and it does not contain a valid signature of the taxpayer. Therefore, if the true taxpayer establishes that he or she did not submit the fraudulent return, any issuance of a notice of deficiency (demand for payment) is considered an administrative error. Continued on Page 2...

2 The Next Level Of Service UHY LLP Identity Theft Tax Returns an Emerging Trend Continued from Page 1... Being aware of this threat and knowing what to do if you are a victim of an identity theft return could save you time and money. Indications that your identity may have been stolen include receiving a letter from the IRS stating that: You filed more than one tax return or someone has already filed using your information You have a balance due, refund offset or have had collection actions taken against you for a year you did not file You received wages from an employer you have not worked for If you receive a notice from the IRS, it is important to respond immediately. If you believe someone may have used your Social Security Number fraudulently, notify the IRS immediately by responding to the name and number printed on the notice letter. You will need to fill out the IRS Identity Theft Affidavit, Form For victims of identity theft who have previously been in contact with the IRS and have not achieved a resolution, contact the IRS Identity Protection Specialized Unit at Reversing the effects of a fraudulent return is not a process that you want to go through on your own. If you think you may have been a victim of an identity theft return, contact your advisor within UHY as soon as possible. With an executed power of attorney, your advisor can help you through the process and work with the IRS to correct the situation in a timely manner. Should circumstances dictate, it may be beneficial to involve the services of attorney with a background in IRS practice. Volume 7 :: Issue 1 Construction Insider UHY LLP 2

3 UHY LLP The Next Level Of Service Court Case: Masons Were Employees, Not Independent Contractors A recent Tax Court case held in favor of the Internal Revenue Service, finding that a masonry contractor was treating workers as independent contractors when they should have been classified as employees. The contractor argued that the workers were hired to perform a specific job and free to work for other contractors at any time. The IRS position was that workers were controlled by the contractor when they were on the job, and they had no investment in facilities or equipment other than what was provided by the employer. The government has recognized that employers have many incentives to want to treat workers as independent contractors rather than employees. Independent contractors bear most of the tax-reporting and tax-filing burden in the employer-worker relationship. The extent of the employer s obligation is to provide them with Form 1099 documenting amounts paid to them. Classifying workers as independent contractors allows employers to avoid paying the employer share of payroll taxes such as FICA, Medicare, federal unemployment, and state unemployment. That burden is transferred to the independent contractor. The IRS has stepped up enforcement of this issue in its audit programs. It employs a 7-step test to determine whether an individual should be classified as an employee stated by the following: 1. The degree of control exercised by the principal 2. Which party invests in work facilities used by the individual 3. The opportunity of the individual to realize a profit or loss 4. Whether the principal can discharge the individual 5. Whether the work is part of the principal s regular business 6. The permanency of the relationship 7. The relationship the parties believed they were creating In the Tax Court case mentioned earlier, laborers provided their own tools and equipment for the job and were hired on a per-job basis. The company failed to maintain accurate written contracts and agreements regarding the workers employment status, and the ones that did exist were often incomplete and contradictory. The company also failed to file its S corporation income tax returns for multiple years. Upon applying the 7-step test described above, the Tax Court ruled in favor of the IRS as follows: 1. Even though the laborers reported to independent contractors, the vice president had the authority to tell them what jobs to perform and how to perform them (Employees) 2. Although the workers used their own tools, they did not have significant investment in facilities (Employees) 3. The workers had no opportunity for profit or loss (Employees) 4. The company had the right to fire the workers at will (Employees) 5. The workers were and integral part of the company s business (Employees) 6. The workers were hired on a per-job basis and free to work elsewhere (Independent contractors) 7. There was no testimony on the relationship the parties created Employers can avoid this same problem under the Voluntary Classification Settlement Program (VCSP) in place with the IRS. The VSCP allows employers to prospectively reclassify its workers that have been improperly classified as nonemployees. Under the program, the IRS offers generous settlement terms and audit relief for previous years when the employees may have been misclassified as independent contractors or other non-employees. Volume 7 :: Issue 1 Construction Insider UHY LLP 3

4 UHY LLP The Next Level Of Service Proposed IRS Regulations Clarify Loss Deductibility Using Shareholder Loans In June 2012, the IRS issued proposed regulations clarifying the requirements for when shareholder loans to an S corporation may be used as the basis for deducting tax losses. Under these regulations, loans from a shareholder to an S corporation must meet the test of being bona fide in order to qualify for debt basis. The ability to deduct tax losses directly impacts the personal income tax returns of S corporation owners by allowing them to generate refunds and create Net Operating Losses for current and future use. The issue of loss deductibility is one of the IRS s highest priorities for tax return examination, and should not be taken lightly. Unbeknownst to many, the IRS has an intricate series of rules in place to prevent S corporation shareholders from deducting losses on their personal income tax returns unless they have sufficient basis in the corporation. In general, if the losses incurred in an S corporation were losses of capital invested or accumulated by the stockholders, that loss will be deductible. Failure to meet the requirements for deducting these losses can create the unfavorable result of having those losses suspended and carried forward to future years, rather than providing immediate benefit. There are two types of basis that allow for S corporation losses to be used in the current year, stock basis and debt basis. Stock basis is essentially a tax-basis measure of retained earnings from the date the company elected to be an S corporation, through the current date. This figure cannot be found in your GAAP financial statements. It must be calculated by your controller or tax advisor. If your stock basis is positive, you can deduct business losses up to that amount. Once stock basis has been eroded to zero, the IRS permits the deduction of tax losses to the extent of debt basis. This rewards shareholders that have loaned personal funds to the corporation by allowing them loss deductibility to the extent of the loan amount. The proposed IRS regulations issued in June seek to clarify what types of shareholder loans qualify for purposes of creating debt basis. When a shareholder does not have funds readily available to loan to his S corporation, it is possible for him to borrow those funds from a third party (bank, related party, etc.) and loan them to the corporation personally to create debt basis. Typically, the loan to the shareholder must be recourse in nature for it to qualify as debt basis when those funds are loaned to the corporation. There have been several court cases concerning whether the shareholder has made an economic outlay or has been made poorer in a material sense by funds he is loaning to the S corporation he owns especially when the funds were obtained from a related party for which repayment may not be expected. The IRS has determined that loans owed to a shareholder for purposes of creating debt basis must meet the test of being bona fide. The proposed regulations do not specify conditions for meeting the test of a bona fide loan. From the context of the proposed regulations, several factors will be used, including valuing the substance of a transaction over its form. There are a few tactics that will increase your chances of meeting the bona fide threshold: Shareholders should consummate the loan by writing a personal check to the corporation, rather than having a third party write a check directly to the entity Determine a stated rate of interest, make sure interest is charged on the loan at that rate Actually pay the interest each period and issue a Form 1099-INT to the shareholder annually Document all loan transactions in a signed agreement between the shareholder and the corporation, including face amount, maturity date, repayment provisions, and interest rate If repayment of the loan is not an option, consider contributing the loan into additional paid-in capital, which increases stockholders equity In an IRS examination, the determination of stock basis, debt basis, and loss deductibility may very well hinge on the facts and circumstances of the case, not just IRS law. Taking the above steps will help protect you from an unfavorable result. Volume 7 :: Issue 1 Construction Insider UHY LLP 4

5 UHY LLP The Next Level Of Service Michigan Purchaser Not Subject to Tax When Purchasing from Michigan Vendor The General Sales Tax Act imposes a tax on retail sales of tangible personal property within the state of Michigan. Sales tax is imposed on the retailer for the privilege of engaging in the business of making retail sales. Sales tax is most commonly passed onto the purchaser during a sale, but the retailer has the obligation to pay the tax due and bears the direct legal incidence of the General Sales Tax Act. The Use Tax Act is an excise or privilege tax that covers transactions not subject to sales tax. The use tax is a companion tax to the sales tax and is imposed on all taxable items brought into Michigan or purchases by mail from out-of-state retailers. In Andrie, Inc. v. Michigan Department of Treasury, Andrie purchased items from a Michigan retailer and failed to prove any sales tax was paid on the purchases. Michigan Department of Treasury then assessed Andrie use tax on those items. The trial court determined that since they were sold within the state of Michigan, the items purchased were only subject to sales tax. The seller of the items purchased by Andrie was required to be licensed under the General Sales Tax Act and was ultimately responsible to remit the sales tax. Therefore, the Department of Treasury could not assess the use tax on those items that Andrie purchased from Michigan vendors. In recent years, it was common practice by the State to assess use tax on purchases from Michigan vendors if the purchase invoice did not have any sales tax charged on the purchase. With the Andrie decision, the State will not be able to asses use tax on a Michigan taxpayer s purchases from Michigan vendors going forward. For more information please contact your professional at UHP LLP in Farmington Hills or Sterling Heights , or visit us on the Web at uhy-us.com. Volume 7 :: Issue 1 Construction Insider UHY LLP 5

6 Construction Industry Insight Our teams of experts are organized across the country by industry, which provides clients the best-in-category knowledge gained from working with similar clients in their industry or service specialty. Our construction expertise includes: In-depth knowledge of the construction industry Knowledge of the surety market Leadership and participation in rule-setting Clients with a wide range of construction activities (general contractors, underground contractors, underwater construction, casino builders, tunnel, bridge and heavy highway); sizes range from start-ups to $1 billion in annual revenue. For more information please contact Tom Callan, our national construction practice leader at or tcallan@uhy-us.com. uhyllp-us.com Georgia Maryland Michigan Missouri New Jersey New York Our Locations Atlanta Columbia Farmington Hills Sterling Heights St. Louis Oakland Albany New York White Plains Dallas Houston Chicago New York Houston Washington Our firm provides the information in this newsletter as tax information and general business or economic information or analysis for educational purposes, and none of the information contained herein is intended to serve as a solicitation of any service or product. This information does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided as is, with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose. UHY Advisors, Inc. provides tax and business consulting services through wholly owned subsidiary entities that operate under the name of UHY Advisors. UHY Advisors, Inc. and its subsidiary entities are not licensed CPA firms. UHY LLP is a licensed independent CPA firm that performs attest services in an alternative practice structure with UHY Advisors, Inc. and its subsidiary entities. UHY Advisors, Inc. and UHY LLP are U.S. members of Urbach Hacker Young International Limited, a UK company, and form part of the international UHY network of legally independent accounting and consulting firms. UHY is the brand name for the UHY international network. Any services described herein are provided by UHY Advisors and/or UHY LLP (as the case may be) and not by UHY or any other member firm of UHY. Neither UHY nor any member of UHY has any liability for services provided by other members. Texas Additional UHY Advisors Locations Illinois New York Texas Washington DC