Masonry Magazine October 1985 Page. 12
TAX TRAPS continued
The deposit rules for withheld federal income and FICA taxes are as follows:
If the Accumulated Unpaid Liability is: $3,000 or more at the end of any "eighth- monthly period" $500 to $2,999 at the end of any month Less than $500 at the end of the calendar quarter Then the Deposit Requirement is Three banking days after the close of the eighth monthly period 15th day of the following month Due date of the quarterly return (may be paid with the return in lieu of being deposited)
Interest is also charged (currently at 13 percent per year) on delinquent payments of payroll taxes.
Records Maintenance (IRC § 274)
The Internal Revenue Code requires that books and records be maintained for all businesses. The maintenance of these records is particularly important in the area of travel and entertainment expenses where claimed tax deductions can be rejected if not properly substantiated. Such records must show the amount, time and place, business purpose, and business relationship of the person being entertained for all claimed travel and entertainment deductions. Mileage logs are generally adequate substantiation for automobile travel expenses. A receipt for the amount expended listing the above information is recommended. The Tax Reform Act of 1984 (the Act), as enacted, required that effective for 1985 and later years, these records must be maintained contemporaneously with the claimed deductions. Before 1985, sufficient non-contemporaneous corroborating evidence could be used to substantiate the deductions.
The Act also mandated that for 1985 and thereafter contemporaneous records must be maintained to substantiate investment tax credit and recovery depreciation deductions on certain properties, e.g., automobiles and home computers. However, as a result of complaints from thousands of taxpayers, the Congress is ardently working on a bill to repeal the recordkeeping requirements imposed by the Act. A joint House and Senate Tax Conference Committee drafted an agreement on May 1, 1985 which, at this writing, is expected to be adopted by the full House and Senate. This conference agreement essentially reinstates the prior law under IRC Section 274 which required taxpayers to substantiate deductions by using adequate records or sufficient evidence corroborating their own statements. If adopted, these changes would become effective in 1986 and the law in effect prior to the Act would apply through 1985.
Limitations on Certain Deductions and Credits (IRC § 168 and § 48)
The Tax Reform Act of 1984 added several provisions designed to increase the federal government's revenues while decreasing tax deductions. Automobile depreciation (Accelerated Cost Recovery Systems [ACRS] deduction) and investment tax credit limitations are probably the most widely publicized. Under the Act, automobiles purchased after July 18, 1984 are subject to the following maximum annual depreciation deductions:
Year of Purchase $4,000 Every Subsequent Year $6,000
These amounts will be adjusted for inflation annually beginning in 1985. ACRS automobile depreciation before the Act was 25 percent in the year of acquisition, 38 percent in the second year and 37 percent in the third year with no annual deduction amount limitations. The investment tax credit on automobiles was also limited under the Act to a maximum of $1,000 per automobile. To achieve full depreciation in three years and to take maximum advantage of the investment tax credit, automobiles purchased after July 18, 1984 can cost no more than $16,000 ($4,000 the first year, $6,000 the second year and $6,000 the third year). A $34,000 automobile, on the other hand, would be depreciated over six years ($4,000 in the first year, and $6,000 in the second through the sixth years). The Tax Conference Committee's agreement previously discussed includes a revenue offset provision. This provision sets lower maximum annual depreciation deductions for automobiles:
Year of Purchase $3,200 Every Subsequent Year $4,800
In addition, the annual inflation adjustments would be postponed until 1989. The investment tax credit would also be reduced from the $1,000 maximum provided by the Act to a maximum amount of $675. Therefore, to achieve full depreciation in three years under the conference agreement provisions, the purchase price of an automobile could be no more than $12,800 ($3,200 in the first year, $4,800 in the second and third years). A $34,000 automobile, under the agreement's provisions, would be depreciated over eight years ($3,200 in the first year, $4,800 in the second through seventh years, and $2,000 in the eighth year).
The lower limits on the annual depreciation deduction and investment tax credit will be applicable to automobiles placed in service or leased after April 2, 1985.
Related Party Transactions (IRC § 267)
The Tax Reform Act of 1984 also changed a heretofore widely used tax planning device. Those business owners and managers who are not aware of this change may incur unnecessary federal income tax consequences. Corporate taxpayers may either be on the accrual basis, expenses deductible when incurred regardless of when paid in cash, or the cash basis, expenses deductible when paid in cash regardless of when incurred. Individual taxpayers, including those shareholders/employees of the previously mentioned corporate taxpayer, are almost always on the cash basis-income taxed when received in cash regardless of when earned. The tax planning mechanism changed by the Act involved an accrual basis corporate taxpayer and its cash basis (shareholder/employee) individual taxpayer.
The corporation/employer would accrue and deduct, generally as compensation to the shareholder/employee, an amount in one year which would not be taxable to the shareholder/employee until the next year, within limitations. This would usually result in a substantial lowering of corporate taxes in the first year and a deferment of a portion of the (shareholder/employee) individual's taxes. This tax planning mechanism has been virtually eliminated by the Act since accrual basis taxpayers must account for these related party payments (corporation/employer to shareholder/employee) on a cash basis irrespective of the basis of accounting (cash or accrual) for tax purposes.
Conclusion
This article has attempted to identify potential tax traps which may confront the small to mid-sized business. As noted, substantial and adverse tax consequences may result from the absence of a thorough understanding of the ever-changing tax structure. Hopefully, a general awareness of these tax consequences will enable the business owner/operator to avoid many tax traps by consulting a professional tax adviser.