KLR Tax Blog - Providence, Rhode Island, Newport, Boston, Massachusetts

in this section

Oct 27

Got Incentive Stock Options? Beware of the AMT

By Dave Desmarais

In recent blogs we’ve discussed why the alternative minimum tax (AMT) is a significant risk for high-income taxpayers and strategies for addressing this risk . One of the most dangerous AMT triggers is the exercise of incentive stock options (ISOs). If you’ve been awarded ISOs as part of your compensation package, they demand special AMT-planning attention.

Are Your Options ISOs?

Before you start worrying about the AMT, you need to check whether your options are indeed ISOs — or if they’re non-qualified stock options (NQSOs), which are treated differently for tax purposes and don’t trigger the AMT.

With ISOs, you don’t owe any regular income tax until you sell the stock you purchased through exercising the option. But, for AMT purposes, the exercise creates a tax “preference” item equal to the bargain element (the difference between the stock’s fair market value when purchased and the exercise price). This amount is included in your AMT income and thus can trigger the AMT.
You may be able to take an AMT credit in the future to offset this liability. But you’ll still have to pay the AMT now, which could create a cash flow challenge because the ISO exercise doesn’t generate any cash to pay the tax.

Minimizing AMT Consequences

Why not avoid the AMT preference item by selling the stock shortly after exercising the ISOs? Because this could ultimately cost you more taxes.

When you sell stock from an ISO exercise after holding the shares at least one year from the exercise date (and two years from the grant date), the gain will be taxed at your long-term capital gains rate. However, if you sell the stock earlier, the gain will be considered compensation income and subject to your ordinary-income rate — potentially around 20 percentage points higher than your long-term gains rate.

There are, however, strategies that can help you maximize the benefit of ISOs while minimizing the AMT consequences. For example, with careful planning you can exercise just the right number of ISOs each year to hit a breakeven point between regular tax and AMT.

Disqualifying Disposition on Exercise Isn’t Always a Bad Thing

It’s also important to note that you could end up having less in your wallet even if you hold the stock from an ISO exercise properly to get the long-term capital gains treatment.  It wasn’t that long ago when a lot of employees got hit by the tech bubble collapse. During the year-long holding period after exercise, companies’ stock prices plummeted — in some cases, the employees’ gross proceeds on disposition a year after exercise weren’t even the amount they paid in AMT on the exercise. 

They would have been far better off had they just made a disqualifying disposition on exercise (immediate exercise and sell). This is a great example of why tax planning shouldn’t be the only consideration when performing your overall financial planning. 

Comprehensive Planning Needed

The rules surrounding both ISOs and the AMT are complex. If you’ve received

ISOs, please contact us to discuss what strategies are appropriate for your particular situation. Investment, Estate, Retirement, and Tax planning should all be considered in these types of transactions, and working with a CPA who has a Personal Financial Specialist (PFS) designation is a great place to start.

Oct 27

2014-2015 U.S. Treasury and IRS Priority Guidance Plan

By Paul Oliveira, CPA

A Priority Guidance Plan for 2014-2015 was recently released by the U.S. Treasury and Internal Revenue Service that will be given special attention through this coming year (12 months that began July 2014).

What does the plan include?

The plan is divided into the major areas of U.S. taxation and addresses many topics including:

  • Transfer pricing- There are many projects intended to address treatment and allocation of risk, the Advance Pricing Agreement (APA) program and the Advance Pricing and Mutual Agreement (APMA) program.
  • Foreign Tax Credits (FTCs)- There are a number of other projects working to address issues like overall foreign losses and foreign tax redeterminations.

Stay tuned for periodic updates from the Treasury and IRS. Copies of the plan are available on the IRS website. For more information please read our article “U.S. Treasury and IRS identify 2014-2015 International Tax Priorities”.

Oct 16

Timing Strategies to Help Avoid or Reduce AMT

By Dave Desmarais

One of the common tax issues facing many high-income taxpayers is the alternative minimum tax (AMT). (See “Don’t wait until year end to take the AMT into account in your tax planning”) for some basics on how the AMT works and a list of common triggers.) Fortunately, you can take steps now that may allow you to avoid the AMT, or at least reduce your AMT liability. You might even be able to use its lower maximum rate (28% vs. 39.6%) to your tax advantage.

  1. The first step is to total your income and deductible expenses year-to-date and project what they’ll be through the end of the year.
  2. Next, you need to see whether you have any expense or income items that might trigger the AMT. You also need to consider what your AMT risk is for next year.

You then may be able to implement tax-saving timing strategies based on whether:

You’re at AMT risk for 2014. For many taxpayers, what happens in the last few months of the year can make the difference between avoiding the AMT and being subject to it. To avoid the AMT, you’ll need to avoid AMT triggers (like property taxes and miscellaneous itemized deductions subject to the 2% floor) between now and Dec. 31. 

You likely will be subject to the AMT for 2014. If the AMT appears inevitable, you’ll want to focus on preserving deductions. This means deferring to 2015 both expenses you can’t deduct for AMT purposes (because you’ll otherwise lose their benefit) and expenses you can deduct for AMT purposes (because they’ll be less valuable in 2014). You also may want to take advantage of the AMT’s lower rate by accelerating ordinary income (such as exercising vested non-qualified stock options) into 2014.

You aren’t at AMT risk for 2014 but are for 2015. In this case you’ll want to accelerate deductible expenses into 2014 and defer ordinary income to 2015, for the same reasons noted above.

One of the biggest AMT triggers that we haven’t gone into here is incentive stock option exercises. We’ll cover those in a future blog post. In the meantime, please contact us if you’d like more information on the AMT and the strategies we’ve discussed.

Oct 14

Automated IRS Examinations

By Paul Oliveira, CPA

The difference between the taxes actually collected by the IRS and the taxes that should have been reported and paid is referred to in Congress as the tax gap.  The IRS indicates that there are three reasons for the tax gap:  underreporting, underpayment and non-filing.  One of the tools available to the IRS to combat under reporting is automated IRS examinations. These usually take the form of either a correspondence examination (vs. an IRS office or field audit) or the automated under-reporter program.

In 2013 the IRS conducted 5.7 million correspondence examinations resulting in $40.4 billion in additional taxes.  This has boosted the examination coverage rate for individuals with incomes below $100,000 from about 1% to 6.9% and from 0.6% to 7.3% for individuals reporting incomes between $100,000 and $200,000.  These are substantial increases in the probability of your return being reviewed and additional explanation or information being requested from you.

The focus of a correspondence examination is well defined and is usually on a specific schedule or line item on the tax return rather than on the entire return.  However, if something unusual is identified, the scope can be expanded or the case referred to a field or office audit agent.  The issues are usually less complex than those involved in office or field audits, typically involving requests for records and supporting documentation.

Various notices are used to contact the taxpayer.  We always advise that whenever and however you are contacted by the IRS you should immediately contact us.  Regardless of the type of IRS examination, you have the right to be represented by a CPA or enrolled agent and we establish this representation by completing a Power of Attorney and Declaration of Representative form with you for this purpose.  Once we are engaged, we can use the Practitioner Priority Services line to contact the IRS on your behalf and resolve questions and issues as fast as possible.

The IRS automated under-reporter program produces correspondence indicating a potential miss-match of information the IRS has received from information returns such as 1099 forms and the individual’s income tax return.  This program usually results in contact 12 months or more after the individual filed their return and requests a response within 30 days of the notice date. This is a very short amount of time for you to look through financial records that are over a year old and likely filed away.  You should not assume that if you and the IRS could not find an item on your return that it was not reported. 

As with the correspondence examination, we will likely have you execute the appropriate form to name us as your representative and, with your help, we will address the IRS concerns to hopefully eliminate or mitigate the amount of additional taxes and penalties you may owe. For more information on IRS examinations, please contact us.

Oct 13

Global Forum’s Latest Compliance Ratings

By Paul Oliveira, CPA

The Global Forum on Transparency and Exchange of Information for Tax Purposes has released 13 peer review reports outlining plans to implement an international standard for exchange of tax information on request.

Important Updates

In addition to the above mentioned plan, the forum also issued compliance ratings for ten jurisdictions.
Other updates:

  • The country of Georgia now qualifies for the next stage of the review process, which will assess the country’s exchange of information practices.
  • Mexico received an overall rating of “Compliant”.

On October 28th and 29th of this year the Global Forum will be meeting in Berlin to discuss completion of additional peer reviews.

For more information, please read our article, “Global Forum releases compliance ratings on tax transparency for 10 jurisdictions”.


Oct 8

Understanding New Withholding Reporting Requirements with FATCA

By Elizabeth Colagiovanni

Companies have known for a while that they need to be compliant with the Foreign Account Tax Compliance Act (“ FATCA”), but effective July 1, 2014 there is no hiding from the fact that companies need to understand their corporate structure in order to properly identify their entities for FATCA reporting requirements.

There are two types of entities that FATCA identifies: a foreign financial institution (“FFI”) and a non-financial foreign entity (“NFFE”). FFI’s are usually banks, investment companies, trusts/fiduciary companies, hedge funds, and private equity companies. All those companies that are not considered as participating in some sort of financial investment are identified as NFFEs. Moreover, for reporting purposes, NFFEs are considered either active (an operating company) or passive (generally a holding company with investments in active companies).

Although it may be easy to identify whether an entity itself is a FFI or a NFFE, it may not be easy to understand how to report these entities when it comes to the new W-8 series of forms and Form W-9, or for withholding agents to understand if they received a proper withholding form from a vendor. First, the IRS has finally released the new Form W-8BEN-E, which is for foreign entities, while the new Form W-8BEN is for foreign individuals only. An individual is considered an actual person, where an entity is any corporation or certain types of trusts that are treated for tax purposes as the beneficiary of the income on which withholdings will be required. A disregarded entity must be looked at to determine whether the owners of the entity are corporations or individuals that are the beneficial owners of the income in question. It is those owners that will have to submit one of the W-8 series or a W-9 if the owner is a U.S. person.

Once the beneficial owner of the income is identified, and the correct form is chosen, then it is important to understand how to fill out the form in order to be compliant with the FATCA rules. The new Form W-9 for U.S. persons (individuals and entities)  is still the most straight-forward of these withholding reporting forms, but it does have a new “Exemptions” box which requires the payee to report if they are an exempt entity, or exempt from FATCA reporting, and codes must be placed in this box if the payee is exempt.

The most complex of these forms is the new W-8BEN-E which requires that once the entity is identified as either a FFI or NFFE, it then must check off a box that further identifies the type and status of FFI or the type of NFFE the entity is and requires the payee to complete additional parts of the form depending on the box they choose. There are over thirty boxes to choose from and once a box is chosen to identify the entity, the payee must then complete the section the box directs them to. These sections require the payee to make specific certifications regarding their status as an FFI or NFFE. Some of these certifications are quite detailed. For example, one of these certifications asks the payee to confirm that revenues or assets meet specified thresholds, and another asks for the submission of the names, addresses and TINs for substantial U.S. owners of a passive NFFE (which are usually foreign holding companies).

The new withholding reporting requirements for Form W-8BEN-E are quite detailed, and if filled out improperly could result in an entity not being in compliance with FATCA as well as the withholding agent also being considered non-compliant. If you are the payee or the payor and have any questions regarding the proper completion of these forms please, contact us.

Oct 6

OECD Proposes first Steps to Combat Tax Base Erosion and Profit Shifting

By Paul Oliveira, CPA

In an ongoing effort to end tax base erosion and artificial profit shifting to avoid taxes, the Organization for Economic Cooperation and Development (OECD) has released its first recommendations for an international corporate tax renovation. The plan is based on the BEPS (Base Erosion and Profit Shifting) action plan which is looking to help governments protect their tax bases.

What is included in the plan?

There are several elements the Action plan focuses on, including:

  • Realigning taxation to restore the intended benefits of international standards and to end tax treaty abuse.
  • Ensuring that pricing outcomes are in line with value creation by focusing on transfer pricing and intangibles.
  • Opposing harmful tax procedures.

For more details on the plan and their goals for 2015, read our article “OECD unveils first elements of proposed global corporate tax overhaul”.

Oct 2

What Prompts an IRS Tax Audit?

By Parul Bansal

Looking to avoid an IRS tax audit? There are several items on your tax return that the IRS is likely to dissect. Be sure to carefully review all entries on your return to avoid a dreaded letter from the IRS.

What entries does the IRS examine?

For individuals specifically, recent years have shown that returns that indicate reporting income of $1 million or more stand the greatest chance of receiving a tax audit.  Apart from income, the IRS is likely to send a tax audit to both individuals and businesses to double check entries like:

  • Unreported income- Failure to report taxable income such as interest, dividends, non-employee compensation, gambling winnings will surely prompt an IRS letter or even an audit. Remember the IRS received copies of all Forms 1099s, W-2s, W-2Gs, etc.
  • Charitable contributions- Since the IRS publishes data on the standard size of charitable donations for different income levels, you could attract their attention if you take a deduction for an amount that is materially larger than the average for your income level. Charitable contributions of property often require an appraisal and specific return attachments that could be inspected by the IRS. This is not to suggest that you refrain from being charitable; the key is to maintain proper documentation/appraisals to substantiate the deductions in the event of an audit.
  • Foreign bank accounts- There are severe penalties for failure to report foreign bank accounts including signature authorities on accounts that you may not even own directly. The IRS now receives information from many foreign bank accounts. Checking off that you have one on Schedule B could heighten the chances for an audit, and not checking it off when you should, could warrant an audit as well.
  • Cash Transactions- It is mandatory for banks and merchants to report to the IRS cash transactions that exceed $10,000. If you make large cash purchases or deposits, you could be scrutinized.
  • Home business- In order to deduct the expenses and depreciation attached to a home office space, you must show that the space is used entirely for business purposes. For the most part, you stand a greater chance for an audit if you claim a significantly high percentage of your home for business purposes.
  • Losses- There are a variety of losses that the IRS will scrutinize, including but not limited to: Gambling losses- Though you are permitted to deduct losses equal to the amount of your winnings, the IRS is aware that many taxpayers do not keep the required records. Bad debt losses- It is difficult for taxpayers to win in this area, because it is tough to show the existence of a bona fide debt or the occurrence of a loss in an earlier or later year. Casualty losses- For this entry, appraisals and other outside information may be required, which could get complicated.
  • Crowdfunding- Funds raised through small donations or investments via social media/internet must be reported to the IRS as taxable income. Don’t make the mistake of reporting funding efforts as non-taxable hobbies!
  • Maintenance and repairs- Sometimes there is a difference between what property owners consider a repair and what the IRS considers a repair. You may be required to depreciate expenses that you deducted on your return.
  • Business Meals, Travel and Entertainment- Big deductions for meals, travel and entertainment are always a red flag for an audit. Make sure to keep detailed records documenting the business purpose and the client name for each item of expense.

Don’t panic when you see a letter from the IRS. Sometimes, the IRS is simply asking for more information when they request an audit. For issues involving one or two items on a return, correspondence audits are the most popular type of audit. The letter will indicate the documents taxpayers have to provide (within 30 days) to eliminate any suspicion regarding their return.

In order to rightfully claim deductions, it is important to make sure you are fully entitled. Seek advice from a tax advisor if you are unsure. Contact any member of our Tax Services Group for further guidance on tax audits and what the IRS is looking for.


Sep 30

Tax Considerations with Investments

By Loree Dubois

Though you cannot make investment decisions based entirely on tax implications, you should be aware that tax treatment of investments differs based on a number of factors. There are many ways you can ensure that you are making the most practical investment decision.

Tax saving strategies

  • Capital Gains: To cut tax on any long term capital gain, hold on to the investment until you’ve owned it for more than a year.
  • Think about selling unrealized losses to offset your gains.
  • Mutual funds: Save tax dollars by choosing funds that provide primarily long-term gains (lower long-term rates).
  • Avoid the “wash sale rule”- The wash sale rule prevents you from taking a loss on a security if you buy a substantially identical security within 30 days before or after you sell the security that created a loss. Only when you sell the replacement security can you recognize the loss. There are ways to avoid this, such as waiting 31 days to repurchase the same security.
  • The 0% rate- For a long term gain that would be taxed at 10 or 15% (depends on the taxpayer’s ordinary-income), the 0% tax rate applies.
  • Bond swaps- A bond swap involves selling a bond, taking a loss, and then immediately buying another similar bond from a different issuer. You will get a tax loss with this because the wash sale rule doesn’t apply as the bonds aren’t considered identical.
  • Losses- Be aware that if net losses exceed net gains, you can only deduct $3,000 (for married couples filing separately, the deduction is $1,500) of the net losses per year against ordinary income. Loss carryovers can be a valuable tax saving tool, but carryovers disappear once the taxpayer dies, so sell investments at a gain now in order to absorb these losses!

Besides gains and losses, you will want to consider other tax consequences on investments like:

  • Interest on investments- Since interest income is generally taxed at an ordinary income rate, it may be a better tax decision to invest in stocks that pay qualified dividends.
  • Investments that produce dividends- Instead of a higher ordinary-income tax rate, qualified dividends are taxed at a long term capital gains rate.
  • Bonds- Bonds produce interest income, but they are treated a bit differently tax wise. Corporate bond interest, for example, is entirely taxable for both state and federal purposes.

Before making an investment decision, don’t ignore the tax implications of your potential decision! It is important to be conscious of the effects of buying, holding, and selling an investment. After considering both your desired return and risk tolerance, be sure to analyze all applicable tax consequences of your investment, including whether the income will be subject to the additional net investment income tax

Questions? Contact any member of our Tax Services Group or refer to the KLR Online Tax Guide.


Sep 30

Don’t Wait Until Year End to Take the AMT Into Account in Your Tax Planning

By Dave Desmarais

The alternative minimum tax (AMT) is a separate income tax system that reduces or prohibits certain deductions and treats some income items differently. The top AMT rate is lower than the top regular tax rate: 28% vs. 39.6%. But more of your income may be subject to the AMT rate, which can result in a larger tax bill because you must pay the higher of your AMT or regular tax liability.

Some permanent AMT relief was signed into law at the beginning of 2013, but it primarily benefits middle-income taxpayers. Many high-income taxpayers are still at significant AMT risk. To reduce this risk — or to minimize any negative impact if the AMT is unavoidable — you must start planning now.

Potential Triggers

Here are some of the deductions and income items that are treated differently for AMT purposes and can trigger the AMT:

  • State and local income and property taxes (especially if you live in an area where rates are high)
  • Interest on home equity debt of up to $100,000 not used to improve your principal residence
  • Miscellaneous itemized deductions subject to a floor (such as professional fees, investment expenses and unreimbursed employee business expenses)
  • Medical expenses for taxpayers age 65 and older (this group still enjoys a lower floor for deducting these expenses for regular tax purposes than for AMT purposes)
  • Accelerated depreciation adjustments and related gain or loss differences when assets are sold
  • Tax-exempt interest on certain private activity municipal bonds
  • Incentive stock option exercises

Large amounts of long-term capital gains and dividends can also trigger the AMT, even though they aren’t treated differently for AMT purposes.

Start Planning Now

You need to start planning for the AMT now because actions you take between now and Dec. 31 could cause you to unnecessarily trigger the AMT or to lose deductions that you could have preserved. We’ll cover some AMT planning strategies in a future blog, but if you’d like some ideas now, please contact us. We also can help you project your income and deductions for the year and assess your AMT risk.

See all Tax Blog articles in the archives.