Here’s the latest State and Local (SALT) tax news from several states, including: tax amnesty programs in Arizona and Massachusetts, Ohio Domicile ruling and taxing New York tax credits.

Arizona Amnesty

As part of its 2015/2016 budget bill Arizona has enacted a “Tax Recovery Program” (amnesty) for taxpayers with an outstanding liability. The logistics of the amnesty program stills needs to be addressed but as of right now, tax recovery is scheduled to take place from 9/1/2015 through 10/31/2015. Currently, as it stands, Arizona will waive penalties and interest under the tax recovery program. As the state of Arizona provides additional information on the amnesty provisions, Skoda Minotti will disseminate the information.

Massachusetts Amnesty

Massachusetts’ tax amnesty runs from 3/16/2015 through 5/15/2015. Amnesty will apply to tax years or periods to which a Notice of Assessment was received before 1/1/2015. The state of Massachusetts will notify taxpayers who are eligible to participate in amnesty. This amnesty program is geared toward the taxpayer who has already received an assessment from Massachusetts has not been paid it. If taxpayers participate in this amnesty program they will not be able to participate in another Massachusetts amnesty program for 10 years. Some of the taxes covered by the amnesty program are: corporate excise, estate taxes, fiduciary income taxes and individual use tax on the purchase of automobiles. This program is not designed for taxpayers that have undiscovered tax liabilities with the state. This link will take you to the state’s website where you can secure more information on the amnesty program.

Ohio Domicile

The Ohio Supreme Court is addressing the issue of Ohio Domicile in a case recently heard by the court. The case in question involves Kent and Sue Cunningham and whether or not they were domiciled in Ohio for the tax year in question (See Cunningham case). The Cunninghams did have another abode outside of Ohio for the year in question and Mr. Cunningham filed the required non-resident affidavit, but Mrs. Cunningham did not. The Tax Commissioner determined both parties were domiciled in Ohio and treated them as residents of Ohio. The Board of Tax Appeals disagreed and said Mr. Cunningham had fulfilled his obligations to be entitled to the presumption that he wasn’t domiciled in Ohio since he had filed the required affidavit, but Mrs. Cunningham was not entitled to the same presumption.

The issue in the case is domicile, which is the key in determining Ohio residency. Is it the place where a person has a fixed and permanent home that continues to their home until it is either abandoned or the person intends to abandon it? It is not known when the Ohio Supreme Court will render its decision but Skoda Minotti will continue to monitor the case until a decision is rendered.

New York Credits with Federal Tax Ramifications

The U.S. Tax Court recently ruled that a portion of any New York tax credits that were refundable to the taxpayer were taxable income and includable in federal adjusted gross income. At issue were New York EZ Investment Credits, EZ Wage Credits and QEZE Real Property Tax Credits. The state classified the credits as overpayment of state taxes but the Tax Court did not agree with that classification. The QEZE Real Property Tax credit was limited to the amount of past real property tax actually paid so the IRS did not treat these credits as taxable income. The EZ Investment credit and the EZ wage credit were not limited to past tax payments made. The credits reduced the taxpayers state income tax liability and any excess credits were refunded. The IRS contended that unless the credits were based on previous tax liabilities, the refundable portion of the credit must be classified as taxable income. Will this decision impact other states with refundable tax credits? Only time will tell.

For more information on the latest tax updates or Skoda Minotti’s State and Local Tax Advisory services, contact Mary Jo Dolson by leaving a message here or at 888-201-4484.

On July 31, 2015, President Obama signed into law the “Surface Transportation and Veterans Health Care Choice Improvement Act of 2015”.  Although primarily designed as a three-month stopgap extension of the Highway Trust Fund, the Act includes a number of important tax provisions, including revised due dates for partnerships and C corporation returns and revised extended due dates for many other returns.

Revised due dates for Partnership and C Corporation returns

Partnerships

Prior: Under prior law, partnerships were required to file their returns by the 15^th day of the 4^th month after the end of the partnership’s tax year.  For calendar year partnerships, returns were due by April 15 of the following year.

Since the partnership return date is the same as for individuals, those taxpayers holding partnership interests often must file for an extension to file their returns because their Schedule K-1s don’t arrive until the last minute.

NEW: Effective generally for returns for tax years beginning after Dec. 31, 2015, the due date for partnership tax returns will be 15^th day of the 3^rd month after the end of the partnership’s tax year.  Therefore, the filing deadline for partnerships will be accelerated by one month.

C Corporations

Prior: Under prior law, C corporations were required to file their returns by the 15^th day of the 3^rd month after then end of the tax year.

NEW: C corporations will now have until the 15^th day of the 4^th month after the end of the tax year.  Therefore, the filing deadline for C corporations will be deferred for one month.

FinCEN Report Due Date Revised

Prior: FinCEN Form 114, Report of Foreign Bank and Financial Accounts, is used to reporting a financial interest in, or signature authority over, a foreign financial account.

The FBAR must be received by the Department of Treasury on or before June 30^th of the year immediately following the calendar year being reported.  The June 30 filing date may not be extended.

NEW: Under the new law, for tax years beginning after December 31, 2015, Treasury is directed to modify appropriate regulations to provide that the due date of FinCEN 114 will be April 15, with a maximum extension for a six-month period ending on October 15.

Have a question about the change in filing deadlines? Our Tax Planning and Preparation Group can help. Contact Jim Forbes, CPA at 440-449-6800 or jforbes@skodaminotti.com.

So far we have covered some key contributors to a manufacturer’s bottom line performance. Having a firm grasp on tax savings tactics will also help ensure that you hit those performance numbers you need to further grow your operation. In this final chapter, we offer five of them.

1) Export Tax Savings through an IC-DISC

If you own a profitable business that is exporting items that are at least 50% manufactured in the U.S., you could be eligible for significant tax savings through a separate entity called an Interest Charge Domestic International Sales Corporation (IC-DISC). While the IC-DISC entity classification has been around for a while, many U.S. exporters have failed to take advantage of the opportunity, or aren’t even aware that they qualify. Here are questions that will help you determine your eligibility:

• Do you export or sell to a U.S. customer that exports product manufactured with the U.S.?
• Does the export have less than 50 percent of its value made of imported components?
• How much are your export sales? Are they profitable and if so, what is the approximate profitability of those sales?

As a separate legal entity acting as a “selling agent” for your operating business, the IC-DISC has multiple tax-savings benefits:

• Sales commissions paid to the IC-DISC are tax deductible to the operating business
• The IC-DISC is a tax-free entity , so the taxable income it earns escapes taxation
• Dividends paid to the shareholders are taxed at favorable dividend rates—20%
• Profits may be accumulated for estate planning
• Income can be shifted to lower tax bracket taxpayers
• IC-DISCs can work with C-corps, S-corps, LLCs or partnerships

One last note—if your product is a component that you sell to a distributor, as long as that distributor sells the final product to a foreign country under the rules described above, you can still create take advantage of IC-DISC tax savings

2) Research and Development (R&D) Tax Credit

The federal R&D Tax Credit helps boosts competition by allowing companies to take a dollar-fordollar reduction of federal and state income taxes for qualified expenditures associated with the development of or improvement of a product, process, formula, invention or software.

R&D tax credits are available to your company if you increase your qualified research spending for new products and services. This includes new companies, existing companies embarking on R&D for the first time and established companies expanding their R&D budget. You can carry forward any unused R&D tax credits for up to 20 years.

Business entities that do not pay federal income tax, such as S corporations and partnerships, are permitted to “pass-through” their tax credits to shareholders or partners, who can use the federal R&D credit as long as their tax liability doesn’t dip below the Alternative Minimum Tax (AMT).

Many states, including Ohio, offer the R&D Tax Credit which generally follows the federal regulations and IRS guidance on what constitutes qualified research expenditures (QREs). Each state uses a different approach to calculate the R&D credit;

If you’re filing a Form 6765 (Credit for Increasing Research Activities) for your business entity, you are most likely eligible for an R&D credit against your CAT as well. Keep in mind that the CAT is a tax based on Ohio gross receipts, not net income. Therefore, even if you are not able to use the R&D credits on a federal level due to net operating losses, you may still have an Ohio CAT liability and can use the credit against this tax. Any R&D credit in excess of your current period CAT can be carried forward seven years.

3) InvestOhio: Investment Support for Ohio Manufacturers

Ohio’s Development Services Agency made it easier for manufacturers to grow by developing the InvestOhio program, creating a 10% nonrefundable income tax credit up to $100 million that provides investors support for their investment.

If you are considering one of the following actions this year, you may qualify for the InvestOhio tax credit program:

• Purchases of fixed asset
• Hiring new employees
• Expanding your business

Requirements to qualify for the InvestOhio tax credit include:

1. The small business is required to invest new equity into the business and spend it on one of five categories of allowable expenses within six months of its receipt.

a. Tangible Personal Property, excluding personal use vehicles, used by the small business

b. Motor vehicles registered in Ohio and used primarily for business purposes by the small business

c. Real property located in the state used in the small business

d. Intangible personal property (i.e., trademarks, patents, licenses, etc.) used by the small business

e. Compensation for new or retained employees subject to Ohio withholding tax

2. The investor must retain his or her equity contribution in the business for a two-year holding period before the tax credit may be claimed

3. The small business must similarly retain the property that it purchased from the cash infusion for the entire two-year holding period

Once approved, the credit can be carried forward over the following five tax years. InvestOhio is funded through June 30, 2017.

4) Domestic Production Activity Deduction (DPAD; Sect. 199 Deduction)

When the American Jobs Creation Act of 2004 was enacted, it included a tax relief provision for domestic manufacturers with the intent of stimulating U.S. manufacturing activity. A business that is profitable that does any manufacturing, with a significant part of its taxable income generated from “production” activities in the United States, may qualify for a deduction equal to 9% of its qualified production activity income (QPAI). As a safe harbor, the significance requirement can be met if the taxpayer’s direct labor and overhead for the qualified production within the U.S. is 20% or more of the product’s total cost.

Understanding the complex rules that govern the QPAI calculation is critical in maximizing available tax deductions. If your business has claimed the Domestic Production Activity Deduction (DPAD or Section 199 Deduction), check the Form 8903 filed with your tax return. If the amount on line 10b is less than taxable income there may be opportunities for more DPAD than claimed. Even if your business passes that simple test, there may be even more deduction lurking under the surface of the calculation itself.

If you are a partner or S-corporation shareholder in a manufacturing business and your Form K-1 does not show information for you to compute the DPAD on your personal tax return there also may be an opportunity for the business to claim the DPAD.

5) Last In First Out Inventory Valuation (LIFO)

LIFO has been around for ages, yet many manufacturers do not take advantage of this beneficial accounting method. LIFO is especially beneficial in environments of rising inventory levels raw material experiencing constant inflation. When using the LIFO method, inventory is valued at prior year amounts, which could be decades old, and significantly lower than today’s dollars. When inventory levels are lower, cost of goods sold expense is increased, thereby lowering taxable income. The only additional requirement for using LIFO to decrease your tax bill is that it must be used for financial statement purposes as well.

Looking to take the next steps in your manufacturing business? Download our free e-book, Overcoming the Challenges of Today’s Manufacturer, for more great insights on how you can improve your bottom line.

For more information about how to save on your taxes or grow your manufacturing business, please contact Jon Shoop at 440-605-7107 or jshoop@skodaminotti.com.

While the overall economy is improving, state finances have been much slower to recover from the loss of funding and programs. States with a need to raise revenue have become more aggressive in enacting tax measures and have intensified the enforcement of these tax laws.

In recent years, state and local taxes (SALT) have become more prevalent with increasing impact on business decisions and strategies. How does a business stay in compliance while also looking for ways to minimize exposure/risk? It’s first helpful to understand what SALT is and what factors define it.

What’s Nexus?

It’s impossible to discuss SALT without talking about nexus, for it is nexus that creates a state and local filing obligation for a business entity. Simply put, nexus means a business entity has established a direct or representational presence within a particular state or jurisdiction. There are different definitions of nexus, depending on whether it is associated with sales tax or income tax. Both will be covered in more detail in upcoming blogs in this series.

Sales Tax Nexus

Nexus is the determining factor of whether an out-of-state business selling products into a state is liable for collecting sales or use tax on sales into the state. This presence gives the state the right to require a company to pay or collect and remit certain taxes. Say you have an employee travel into a state to call on a customer. In many states, that will create a “sufficient physical presence”

In addition to physical presence, there are two new standards that states are enacting to address the nexus issues created by remote sellers. We’ll address “click-through nexus” and “affiliate nexus” and other Internet tax issues in a future blog.

Income Tax Nexus Income tax nexus is not as straightforward as sales tax nexus. Let’s say your business solicits sales in a state for tangible personal property purposes—federal law will protect you from having to pay taxes there. However, the same does not hold true if your business provides a service in various states. Many states have begun adding to the physical presence nexus standard by adopting an economic nexus standard. So, if you have a certain amount of property, payroll and /or sales in a state, the business would be determined to have a nexus. We’ll cover this in more detail in an upcoming blog.

Because of the ever-changing nexus standards, it is important for a multistate business to take the time each year to determine if nexus has been created with any new states and if so, what steps are required to be in compliance.

The increase in the state and local tax burden can impact an organization’s competitive position. As states become more driven to find streams of revenue, it becomes more important than ever for business owners to stay up to speed with changes in compliance requirements and be ever vigilant of risk.

Staying aware of state and local taxes is crucial to growing your business. Take the next steps with our free e-book: State and Local Tax Issues That Affect Your Business.

Banking, Economics and Trade

Canada’s banking system is one of the most stable and developed in the world, and it forms the foundation for the country’s advanced economic stability. ConsiderCanada.com notes the system is divided into three schedules, classified by ownership and size.

• Schedule I banks are domestically owned. Deposits in Schedule I banks may be eligible for deposit insurance provided by the Canada Deposit and Insurance Corporation.
• Schedule II banks are foreign bank subsidiaries, which may be eligible for deposit insurance from the Canada Deposit and Insurance Corporation.
• Schedule III banks are bank branches of foreign institutions that have been authorized by the Canadian government to do banking business in Canada, but with certain restrictions.

Canada has a service-dominated economy — as is the case with most developed nations. The service sector employs approximately 75 percent of the workforce.

Canada is also rich in natural resources, particularly its vast evergreen forests, and massive oil and natural gas deposits in Alberta and off the shore of the Atlantic Provinces. The oil deposits alone account for 13 percent of the world’s oil reserves, behind only Saudi Arabia and Venezuela.

Those factors make the country unusual among developed nations in its reliance on its primary-sector businesses. Logging and petroleum are two of the most prominent primary-sector industries in Canada, making it one of the few developed nations that is a net exporter of energy.

Canada also has large grain production, mineral exporting and manufacturing industries serving as pillars of the nation’s economy. Its abundance of natural resources and its thriving manufacturing sector have made the country one of the most active international trade partners in the world, although the U.S. is by far its biggest, accounting for 75 percent of Canadian exports. The U.K., Mexico, China and Japan serve as other major trade partners, accounting for a combined 12 percent of total exports.

Canada does have a sizable trade deficit, with imports exceeding exports by approximately 25 percent annually. Once again, the U.S. is Canada’s biggest partner, accounting for about 50 percent of Canadian imports.

Socioeconomics

Because so much of Canada is composed of arctic and subarctic lands, much of the country is sparsely inhabited or uninhabited. Though Canada is the second-largest country in the world by land area, it’s only the 37th most populated country, according to ConsiderCanada.com.

Canada has a population of about 35.7 million, or about 3 million fewer than California. Ontario and Quebec account for nearly 62 percent of the country’s population, while British Columbia and Alberta are the next two most populous provinces.

• Ontario – 38.5 percent
• Quebec – 23.2 percent
• British Columbia – 13.0 percent
• Alberta – 11.4 percent
• Remaining provinces and territories – 13.9 percent

Canada has sophisticated welfare, retirement, medical and unemployment programs aimed at creating a socioeconomic safety net that aids disadvantaged citizens. However, as the population has grown, so has the cost to support those programs, and it is now common for health, family and social services to make up more than 50 percent of a province’s annual budget. And that’s with federal support. Because Canada is a federation, many province-administered programs are supported in part by transfer payments from the federal government.

As in the U.S. and other developed countries, health care takes one of the biggest bites out of government program funding. All provinces in Canada provide universal, publicly funded health care for services deemed by the government as medically necessary. Costs are partially subsidized by the federal government in those cases.

Services that are not listed, or that have been delisted — that is, services that are not covered by, or have been removed from, provincial insurance plans — may be purchased privately. ConsiderCanada.com notes that the Canadian government bans the purchase of private insurance or care for any services that are listed, a move meant to prevent a system of two-tiered health care, allowing those who can pay for private health care to receive treatment above and beyond what the government will pay for. However, in the 2005 Chaouli v. Quebec ruling, the Supreme Court of Canada created an exception, ruling that the private-care ban on listed services could be considered unconstitutional if it creates unreasonable delays for patients.

Education

In Canada, provinces and territories administer primary and secondary education, which is compulsory up to age 16, 17 or 18, depending on the province. Public elementary and secondary education is provided at a nominal cost. Private education is available but is much less popular than in other developed countries such as the U.S. and the U.K., due to its comparatively high cost and the relative high quality of public education. Post-secondary schooling is subsidized by the federal and provincial governments, and financial assistance is available through student loans and bursaries.

Click here to download the full whitepaper: Business in Canada

Considering doing business internationally? Learn more about how Skoda Minotti’s International Tax group can grow your business.

Sellers of C Corporations often want to structure the transaction as a stock deal in order to receive personal capital gain tax treatment and pay a single level of tax. Stock deals also allow the seller to pass along any liabilities (both known and unknown) to the buyer. Purchasers of C Corporations, however, prefer structuring acquisitions as asset deals in order to receive a step up in the basis of the acquired assets (particularly intangibles and goodwill) and to shield themselves from legal liabilities that arose from the sellers’ actions prior to the transaction date.

The significant financial gap that must be bridged in negotiating between an asset deal and a stock deal when selling a C Corporation is much smaller (and sometimes almost non-existent) when the selling company is taxed as a pass-through entity. The term “stock” deal will be used throughout this section – just note that “stock” deals for LLCs and partnerships would instead be called member or partnership interest purchases (which is effectively the same as a stock deal, but with a different name because these entities do not have stock). Regardless of whether an asset or stock deal structure is used when selling a pass-through entity, the sellers avoid double-taxation and typically are able to receive capital gain treatment on any intangible/goodwill value. In addition, buyers may also be able to receive a step-up in basis of the acquired assets regardless of the deal structure. How is it that both parties seem to get the best of both worlds? Here is how:

Asset Deals – Pass-through entities enjoy special tax treatment that allows for only a single level of tax in an asset sale. While a portion of the sale price allocated to current and fixed assets may be taxable at ordinary income tax rates, all intangible value is typically taxed at personal capital gain rates (unless there are built-in gains that were present upon conversion to an S corporation). This is a far superior tax result compared to the two levels of tax encountered by C Corporation owners, the first of which may be up to 35% at the corporate level, followed by a dividend tax levied on the owners if the remaining proceeds are distributed to them as a dividend. At the same time, the buyer receives a step-up in the basis of the acquired assets, just as in an asset acquisition of a C Corporation.

Stock Deals – Just as in selling the stock of a C Corporation, when pass-through entity investors sell their ownership interests, they will generally pay tax at personal capital gain rates based on the difference between the sales price and their basis in the investment. Rather than the buyer inheriting the tax basis of the acquired assets (“carryover basis”), however, there are two elections that can be made that actually allow for a step-up in the basis of the acquired assets:

338(h)(10) Election (for S Corporations) – If this election is made jointly by the buyer and seller in a transaction, it effectively treats the sale of stock as an asset deal for tax purposes (i.e., the buyer receives a stepped-up basis in the acquired assets, and the seller receives capital gain treatment on any intangible/goodwill value), while still retaining the characteristics of a stock deal for legal purposes. It should be noted that there are certain requirements that must be met for the transaction to be considered a qualified stock purchase (“QSP”) under Section 338(h)(10).

754 Election (for LLCs and partnerships) – If a group of buyers purchase the LLC member interests or partnership interests of an entity, a 754 Election can be made to provide the buyers
with a step-up in the basis of the acquired assets while still retaining “stock” sale treatment for the LLC members or partners. In the event that a single buyer is making the acquisition of an LLC or partnership, no 754 Election is necessary, and the buyer still receives a step-up in basis of the acquired assets, while the seller retains “stock” sale treatment. Similar to an asset deal, a portion of the sale price allocated to current and fixed assets may be taxable at ordinary income tax rates, while all intangible value is typically taxed at personal capital gain rates.

To summarize, there is a significant amount of flexibility afforded to buyers and sellers in an acquisition when the target company is a pass-through entity. While there are still differences in the proceeds that a seller will receive depending upon whether a transaction is structured as an asset deal or stock deal (as well as what tax elections are made and the tax basis in the various assets of the business), this impact is often significantly less than if the selling company was a C Corporation. This also creates further incentive for C Corporations to consider a C-to-S conversion (although there are certain holding periods that must be satisfied in order to avoid double-taxation in the event of a sale after the conversion). Given some of the unique and complex tax considerations that can arise in choosing between asset and stock deals for pass-through entities, as well as the related tax elections, it is important to involve your tax advisor in the planning process as early as possible to allow you to make an informed decision as to deal structure.

Learn more about the important topics you should be aware of during M&As in our free e-book: Valuation Considerations When Buying or Selling a Business – Part 2. For more information on the various approaches to valuation or our Valuation and Litigation Advisory Services, contact Dan Golish via email or by calling 440-449-6800.

Do you find yourself treading water financially even with a relatively healthy household income? Even with your new higher-paying job and your spouse’s promotion, do you still find it difficult to get ahead, despite carefully counting your pennies? Does your friend or relative halfway across the country have a better quality of life on less income? If so, the cost of living might be to blame.

The cost of living refers to the cost of various items necessary in everyday life. It includes things like housing, transportation, food, utilities, health care, and taxes.

Single or family of six?

Singles, couples, and families typically have many of the same expenses–for example, everyone needs shelter, food, and clothing–but families with children typically pay more in each category and have the added expenses of child care and college. The Economic Policy Institute (epi.org) has a family budget calculator that lets you enter your household size (up to two adults and four children) along with your Zip code to see how much you would need to earn to have an “adequate but modest” standard of living in that geographic area.

What areas have the highest cost of living? It’s no secret that the East and West Coasts have some of the highest costs. According to the Council for Community and Economic Research, the 10 most expensive U.S. urban areas to live in Q3 2015 were:

Factors that influence the cost of living

Let’s look in more detail at some of the common factors that make up the cost of living.

Housing.

When an area is described as having “a high cost of living,” it usually means housing costs. Looking to relocate to Silicon Valley from the Midwest? You better hope for a big raise; the mortgage you’re paying now on your modest three-bedroom home might get you a walk-in closet in this technology hub, where prices last spring climbed to a record-high $905,000 in Santa Clara County, $1,194,500 in San Mateo County, and $690,000 in Alameda County. (Source: San Jose Mercury News, Silicon Valley Home Prices Hit Record Highs, Again, May 21, 2015)

Related to housing affordability is student loan debt. Student debt–both for young adults and those in their 30s, 40s, and 50s who either took out their own loans, or co-signed or borrowed on behalf of their children–is increasingly affecting housing choices and living situations. For some borrowers, monthly student loan payments can approximate a second mortgage.

Transportation.

Do you have access to reliable public transportation or do you need a car? Younger adults often favor public transportation and supplement with ride-sharing services like Uber, Lyft, and Zipcar. But for others, a car (or two or three), along with the cost of gas and maintenance, is a necessity. How far is your work commute? Do you drive 100 miles round trip each day or do you telecommute? Having to buy a new (or used) car every few years can significantly impact your bottom line.

Utilities.

The cost of utilities can vary by location, weather, usage, and infrastructure. For example, residents of colder climates might find it more expensive to heat their homes in the winter than residents of warmer climates do cooling their homes in the summer.

Taxes.

Your tax bite will vary by state. Seven states have no income tax–Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. In addition, property taxes and sales taxes can vary significantly by state and even by county, and states have different rules for taxing Social Security and pension income.

Miscellaneous.

If you have children, other things that can affect your bottom line are the costs of child care, extracurricular activities, and tuition at your flagship state university.

To move or not to move

Remember The Clash song “Should I Stay or Should I Go?” Well, there’s no question your money will go further in some places than in others. If you’re thinking of moving to a new location, cost-of-living information can make your decision more grounded in financial reality.

There are several online cost-of-living calculators that let you compare your current location to a new location. The U.S. State Department has compiled a list of resources on its website at state.gov.

Stay up-to-date with the latest business trends, tips and revenue-generating ideas affecting you and your business by subscribing to the Skoda Minotti Blog or by following us on LinkedIn, Twitter @skodaminotti, and Facebook.

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Fraud and embezzlement cost local organizations millions of dollars annually. Consistent with national trends, organizations with fewer than 100 employees are the primary targets.

And, nationally and locally, there is an increase in financial crimes in which people are colluding with internal or external partners.

Cooperation increases their chances of success, because collusion cases are more difficult to detect, as the perpetrators tend to be more creative than those who work solo. But, they can be exposed if organizations are diligent about curbing fraud and embezzlement.

Statistics show that companies that institute effective fraud policies experience a material reduction in financial losses should economic crimes occur. There are ways to reduce those losses, maximize earnings and save embarrassment.

What should we be doing to prevent fraud?

One of the most effective ways a company can minimize risk is by continuously reviewing and testing internal controls. Even though many executives believe their company’s internal controls are adequate, that might not always be the case. The material discrepancies between what management thinks is in place versus what employees are actually doing can be significant. That explains why constantly reviewing internal controls is a major deterrent to fraud and embezzlement.

Organizations should also educate their employees and vendors about what is expected of them regarding fraud and implement a fraud hotline outside the company through which employees and vendors can anonymously report real or perceived fraudulent activity. This hotline can be tied in with the American Institute of Certified Fraud Examiners (ACFE), local CPAs or law firms, or a multitude of other sources. The hotline should not be tied directly to company sources, though, because the people receiving the fraud alerts might be involved in the fraud.

Another step is to implement and enforce fraud policies. A surprising number of organizations have such policies in place but do not enforce them. Also, providing economic incentives to employees to encourage them to report fraud is helpful, as is the willingness to follow up on tips. Often managers will dismiss tips as hearsay and find out after they have been victimized that they were accurate. That is too late to prevent their losses. A clearly written fraud policy can reduce the chances of that happening.

What is a fraud policy?

A fraud policy is a “thou shalt not steal” document that allows companies to communicate with their employees on the reporting procedures they should follow if they suspect that fraud is going on. Importantly, the policy should be written and signed on an annual basis by all employees, from the top down. It sets the tone by specifying that fraud will not be tolerated at any level of the workforce and lays out the consequences to employees.

All employees who sign the policy acknowledge that they have not perpetrated economic crimes and do not intend to in the future. The signed document is a valuable tool should they commit such a crime and fall back on an excuse like they were only “borrowing” the money, as unauthorized “borrowing” is a fraudulent act.

What makes up an effective fraud policy?
An effective fraud policy outlines specifically what constitutes fraud and explains what the consequences will be, e.g., perpetrators will be prosecuted and, of course, terminated, and the company will seek restitution. It should include what activities are considered inappropriate and provide examples of fraud, such as misappropriation of checks, paying personal bills with company funds or using company property without permission. Ideally, it should be disseminated to outside vendors and customers in light of the increase in collusion cases that involve people outside the companies. That makes outsiders aware of the company’s firm position on fraud and may lead to alerts from them about the occurrence of internal fraud.

Is it costly to implement an effective fraud policy?

No, and it’s money well spent. Some of the anti-fraud recommendations have a dollar tag associated with them. Others do not, since they are nothing more than changes to policies that are already in place. Setting up a “whistle-blower” program or a hotline is relatively inexpensive. There might be fees associated with steps like changing where customer deposits are sent. It might be advisable for small business owners to have their company’s bank statements sent to their houses. That way, they can personally monitor every check or wire transfer to make sure it is appropriate. About 85 percent of all fraud that occurs is done through checkbooks and cash. So, simple mechanisms like reconciling every bank statement or setting up a physical lockbox for cash can deter fraud.

Overall, the costs associated with instituting an effective fraud policy depend on how inclusive a company wishes to make it.

Do Embezzlers Have to Pay Taxes on the Funds They Steal?

While this last question may seem like a joke, failing to report – and pay income taxes – on stolen funds happens to be a criminal offense.  Believe it or not, gains arising from illegal activities such as extortion, prostitution, gambling, illegal drug trafficking, embezzlement and fraud are all taxable for federal income tax reporting purposes. Al Capone was convicted and sentenced to 11 years in prison in 1931 for failing to report the illegal income associated with the bootlegging of alcohol during Prohibition!

If someone steals from your business, which is a crime in itself, the perpetrator is also likely committing a second criminal offense of failing to report their theft income on their personal income tax returns. While you may think that such a charge is comical, it’s a very clear cut case to prosecute once the theft of funds has been established. The IRS can be alerted of the illegal activity – even anonymously – by telephone, or by submitting Federal Form 3949 A.

Have a question about fraud? Frank Suponcic would be happy to help. Or, contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

Every year, the Trustees of the Social Security and Medicare Trust Funds release reports to Congress on the current financial condition and projected financial outlook of these programs. The newest reports, released on July 13, 2017, discuss the ongoing financial challenges that both programs face, and project a Social Security cost-of-living adjustment (COLA) for 2018.

What are the Social Security and Medicare Trust Funds?

Social Security: The Social Security program consists of two parts. Retired workers, their families, and survivors of workers receive monthly benefits under the Old-Age and Survivors Insurance (OASI) program; disabled workers and their families receive monthly benefits under the Disability Insurance (DI) program. The combined programs are referred to as OASDI. Each program has a financial account (a trust fund) that holds the Social Security payroll taxes that are collected to pay Social Security benefits. Other income (reimbursements from the General Fund of the U.S. Treasury and income tax revenue from benefit taxation) is also deposited in these accounts. Money that is not needed in the current year to pay benefits and administrative costs is invested (by law) in special Treasury bonds that are guaranteed by the U.S. government and earn interest. As a result, the Social Security Trust Funds have built up reserves that can be used to cover benefit obligations if payroll tax income is insufficient to pay full benefits.

Note that the Trustees provide certain projections based on the combined OASI and DI (OASDI) Trust Funds. However, these projections are theoretical, because the trusts are separate, and generally one program’s taxes and reserves cannot be used to fund the other program.

Medicare: There are two Medicare trust funds. The Hospital Insurance (HI) Trust Fund pays for inpatient and hospital care (Medicare Part A costs). The Supplementary Medical Insurance (SMI) Trust Fund comprises two separate accounts, one covering Medicare Part B (which helps pay for physician and outpatient costs) and one covering Medicare Part D (which helps cover the prescription drug benefit).

Trustees Report highlights: Social Security

• The combined trust fund reserves (OASDI) are still increasing, but are growing more slowly than costs. The U.S. Treasury will need to start withdrawing from reserves to help pay benefits in 2022, when annual program costs are projected to exceed total income. The Trustees project that the combined trust fund reserves will be depleted in 2034, the same year projected in last year’s report, unless Congress acts.
• Once the combined trust fund reserves are depleted, payroll tax revenue alone should still be sufficient to pay about 77% of scheduled benefits for 2034, with the percentage falling gradually to 73% by 2091.
• The OASI Trust Fund, when considered separately, is projected to be depleted in 2035, the same year projected in last year’s report. Payroll tax revenue alone would then be sufficient to pay 75% of scheduled OASI benefits.
• The DI Trust Fund is expected to be depleted in 2028, five years later than projected in last year’s report. Both benefit applications and the total number of disabled workers currently receiving benefits have been declining. Once the DI Trust Fund is depleted, payroll tax revenue alone would be sufficient to pay 93% of scheduled benefits.
• Based on the “intermediate” assumptions in this year’s report, the Social Security Administration is projecting that beneficiaries will receive a cost-of-living adjustment (COLA) of 2.2% for 2018.

Trustees Report highlights: Medicare

• Annual costs for the Medicare program exceeded tax income annually from 2008 to 2015. The Trustees project surpluses in 2016 through 2022 and a return to deficits thereafter.
• The HI Trust Fund is projected to be depleted in 2029, one year later than projected last year. Once the HI Trust Fund is depleted, tax and premium income would still cover 88% of estimated program costs, declining to 81% by 2050, and then gradually increasing to 88% by 2091. The Trustees note that long-range projections of Medicare costs are highly uncertain.

Why are Social Security and Medicare facing financial challenges?

Social Security and Medicare are funded primarily through the collection of payroll taxes. Because of demographic and economic factors, fewer workers are paying into Social Security and Medicare than in the past, resulting in decreasing income from the payroll tax. The strain on the trust funds is also worsening as large numbers of baby boomers reach retirement age, Americans live longer, and health-care costs rise.

What is being done to address these challenges?

Both reports urge Congress to address the financial challenges facing these programs soon, so that solutions will be less drastic and may be implemented gradually, lessening the impact on the public. Combining some of these solutions may also lessen the impact of any one solution.

Some long-term Social Security reform proposals on the table are:

• Raising the current Social Security payroll tax rate. According to this year’s report, an immediate and permanent payroll tax increase of 2.76 percentage points would be necessary to address the long-range revenue shortfall (3.98 percentage points if the increase started in 2034).
• Raising the ceiling on wages currently subject to Social Security payroll taxes ($127,200 in 2017).
• Raising the full retirement age beyond the currently scheduled age of 67 (for anyone born in 1960 or later).
• Reducing future benefits. According to this year’s report, scheduled benefits would have to be reduced by about 17% for all current and future beneficiaries, or by about 20% if reductions were applied only to those who initially become eligible for benefits in 2017 or later.
• Changing the benefit formula that is used to calculate benefits.
• Calculating the annual cost-of-living adjustment for benefits differently.

According to the Medicare Trustees Report, to keep the HI Trust Fund solvent for the long-term (75 years), the current 2.90% payroll tax would need to be increased immediately to 3.54% or expenditures reduced immediately by 14%. Alternatively, other tax or benefit changes could be implemented gradually and might be even more drastic.

You can view a combined summary of the 2017 Social Security and Medicare Trustees Reports and a full copy of the Social Security report at ssa.gov. You can find the full Medicare report at cms.gov.

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A will is often the cornerstone of an estate plan. Here are five things you can do with a will.

Distribute property as you wish

Wills enable you to leave your property at your death to a surviving spouse, a child, other relatives, friends, a trust, a charity, or anyone you choose. There are some limits, however, on how you can distribute property using a will. For instance, your spouse may have certain rights with respect to your property, regardless of the provisions of your will.

Transfers through your will take the form of specific bequests (e.g., an heirloom, jewelry, furniture, or cash), general bequests (e.g., a percentage of your property), or a residuary bequest of what’s left after your other transfers. It is generally a good practice to name backup beneficiaries just in case they are needed.

Note that certain property is not transferred by a will. For example, property you hold in joint tenancy or tenancy by the entirety passes to the surviving joint owner(s) at your death. Also, certain property in which you have already named a beneficiary passes to the beneficiary (e.g., life insurance, pension plans, IRAs).

Nominate a guardian for your minor children

In many states, a will is your only means of stating who you want to act as legal guardian for your minor children if you die. You can name a personal guardian, who takes personal custody of the children, and a property guardian, who manages the children’s assets. This can be the same person or different people. The probate court has final approval, but courts will usually approve your choice of guardian unless there are compelling reasons not to.

Nominate an executor

A will allows you to designate a person as your executor to act as your legal representative after your death. An executor carries out many estate settlement tasks, including locating your will, collecting your assets, paying legitimate creditor claims, paying any taxes owed by your estate, and distributing any remaining assets to your beneficiaries. As with naming a guardian, the probate court has final approval but will usually approve whomever you nominate.

Specify how to pay estate taxes and other expenses

The way in which estate taxes and other expenses are divided among your heirs is generally determined by state law unless you direct otherwise in your will. To ensure that the specific bequests you make to your beneficiaries are not reduced by taxes and other expenses, you can provide in your will that these costs be paid from your residuary estate. Or, you can specify which assets should be used or sold to pay these costs.

Create a testamentary trust or fund a living trust

You can create a trust in your will, known as a testamentary trust, that comes into being when your will is probated. Your will sets out the terms of the trust, such as who the trustee is, who the beneficiaries are, how the trust is funded, how the distributions should be made, and when the trust terminates. This can be especially important if you have a spouse or minor children who are unable to manage assets or property themselves.

A living trust is a trust that you create during your lifetime. If you have a living trust, your will can transfer any assets that were not transferred to the trust while you were alive. This is known as a pourover will because the will “pours over” your estate to your living trust.

Caveat

Generally, a will is a written document that must be executed with appropriate formalities. These may include, for example, signing the document in front of at least two witnesses. Though it is not a legal requirement, a will should generally be drafted by an attorney.

There may be costs or expenses involved with the creation of a will or trust, the probate of a will, and the operation of a trust.

Want to make the most out of your will? Contact Bob Coode at bcoode@smcofinancial.com or call us at 440-449-6800.

Advisory Services offered through Investment Advisors, a division of ProEquities, Inc., a Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker-Dealer, Member, FINRA & SIPC. Skoda Minotti is independent of ProEquities, Inc.