Tax and Business Alert - 

September 2005

Timely Tax Tips

As we approach the final quarter of the year, you probably have a pretty good idea of what your 2005 income will look like, and some planning to reduce your taxes might be appropriate. Following are some potential tax saving issues to consider before year-end.

Deducting State and Local Sales Tax. If you itemize deductions, you can deduct either state and local sales taxes or state and local income taxes. While this option clearly benefits individuals who live in states that don't impose a significant income tax, even taxpayers subject to state income tax may find that the sales tax deduction exceeds their state income tax deduction. This is especially true if you make significant purchases this year. Therefore, it's a good idea to save receipts (at least for certain big-ticket items, such as motor vehicles, aircraft, and home-building supplies, which are added to the standard sales tax deduction amount provided in the IRS tables) showing sales tax paid, to be sure you get the benefit of the largest deduction possible.

Maximize the Benefit from Your Itemized Deductions. If your itemized deductions are just at or below the standard deduction (currently $10,000 for joint and $5,000 for single filers) they don't generate any tax benefit for you. Instead, you can bunch itemized deductions into a single tax year (e.g., by pre-paying certain deductible expenditures for 2006 in 2005), to exceed the standard deduction that year. Then, you can take the standard deduction the next year. Following this two-year pattern results in greater deductions overall. Deductions that work well for this strategy include charitable contributions, property taxes, the fourth quarter estimated state income tax payment, and your January mortgage payment.

Consider a Health Savings Account (HSA). Although this tax-favored vehicle for paying medical expenses has been around a while, the insurance products needed to qualify for an HSA are now beginning to hit the market. This is a good time to revisit whether an HSA makes sense for you.

Take Another Look at Electing S Corporation Status. Favorable changes starting in 2005 increase the permitted number of S corporation shareholders from 75 to 100 and add an election to treat family members as a single shareholder. These developments may make electing S status an option for corporations previously prevented from doing so.

Generally, the best time for tax planning is prior to year-end. Call us to discuss these tax-saving ideas as well as any other personal or business tax planning issues you might have.

IRS Approves Facsimile Signatures

Corporate officers and authorized agents are now allowed to use facsimile signatures to· sign employment tax forms. The IRS recently issued rules allowing the use of alternative signature methods including computer software programs or mechanical devices.

The new rules are applicable for:

- Any form in the 940 series, including Form 940, Employer's Annual Federal Unemployment Tax Return (FUTA); Form 941, Employer's Quarterly Federal Tax Return; Form 943, Employer's Annual Federal Tax Return for Agricultural Employees; and Form 945, Annual Return of Withholding Federal Income Tax;

- Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons;

- Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips;

- Form CT-l, Employer's Annual Railroad Retirement Tax Return; and

- Any variant of these forms, such as Form 941-C, Supporting Statement to Correct Information; and Form 941-SS, Employer's Quarterly Federal Tax Return.

As you know, it is wise to have disability insurance coverage to protect you and your spouse from the loss of earnings in the event you become unable to work. The benefits paid under a disability insurance policy can be 100% tax-flee to the recipient; totally taxable to the recipient; or partially taxable to the recipient. The tax treatment depends on the type of policy, who pays the premiums and whether or not they are paid with pre-tax dollars.

If the employee pays the disability insurance premiums directly to the insurance company or through payroll deduction with after-tax dollars, the premiums are not deductible. However, the benefit of paying one's own disability insurance premiums is that any benefit payments received under the policy qualify as "tax-free" amounts. But if the recipient pays the disability insurance premiums with pre-tax dollars through a cafeteria plan, the benefit payments are taxable because the premiums are considered to be paid by the employer.

Employer payments for disability insurance premiums are not taxable to employees. However, any policy benefits received by an employee are fully taxable. Benefits received by employees under an individual or group policy where the premiums are split by the employer and employees are generally tax-free to the extent the premiums were paid by the employee.

Employers Can Verify Social Security Numbers Over the Internet

Employers can now verify Social Security numbers over the Internet using the Social Security Number Verification Service (SSNVS). You can access SSNVS through the Social Security Administration's Business Services Online (BSO) at www.socialsecurity.gov/bso/bsowelcome.htm. BSO offers Internet services for businesses and employers who exchange information with the Social Security Administration (SSA) including registration, electronic wage reporting, and Social Security number verification services.

Employee Buyouts

Sometimes private business owners prefer to sell their business to a third party instead of an employee group because they don't think their employees can run the company without them. With this pessimistic view, the owners would rather depart by striking a deal with an outside company than to count on their employees providing them a secure and prosperous retirement.

However, there are occasions where an employee buyout (EBO) may be the best available option for the current owner. Clearly, if the company has been offered for sale and no serious buyers have come forth, the owner will have little choice but to consider this option. Moreover, the long-time employees may have the most serious commitment to make the deal work because they want to keep their jobs. In addition, employee groups typically lack the cohesiveness or expertise to drive a hard bargain with their bosses. Thus, even when serious third-party offers are on the table, the current owners may get their best price by selling to their employees.

There are also those entrepreneurial owners whose business plan from day one has been to sell their business to their employees. They base hiring and retention decisions on who is the most capable of running the company. Then, after waiting to see if an employee is a keeper, these owners deliberately groom these employees to take over the business.

Regardless of the reason, an employee-led buyout can be a viable method of transferring ownership in a business. Whether structured as an asset or stock purchase, an employee buyout transaction can involve virtually any size of business. Typically, the business involved is closely held. An EBO is a practical alternative that should be considered when the owner has groomed a capable management team that believes it can improve the operations and profitability of the company. The arrangement offers the owners the opportunity to dispose of their interests in the business to a group of people who will maintain their positions in the company and preserve their authority. An EBO also offers the employee buyout group greater control over its destiny and the opportunity to profit from its collective knowledge of company operations. Thus, an employee buyout can provide a practical solution to the diverse interests of the retiring owner and the current management team. As such, it can be used to fulfill an owner's succession plan for transferring the business to a talented group of employees whether they are family or nonfamily.

In an employee-led buy-out, a management group normally is the key participant in the acquisition and is usually aided by a primary and secondary lender The buyer and seller understand the business and the circumstances that led to the proposed buyout, which often makes negotiations easier Successful employee-led buyouts almost always require the owner's full support and cooperation. Very often this cooperative spirit leads to a continuing relationship between the new and former owners in such areas as consulting about customers, suppliers, products, sales, and services.

The financing may be provided by a financial institution, a venture capital or pension fund or (in very large transactions) by issuing debt securities to the public through an investment banker. In other cases, the selling shareholders simply take a note back for the balance of the purchase price. The borrowed funds are repaid with the cash flow generated by the business or the proceeds from the sale of unwanted business assets. In almost all cases, the borrowed funds are secured by the assets of the acquired business. In the case of third-party debt, the lender may require the selling shareholders to personally guarantee that debt.

The real struggle with an employee buyout is coming up with a smooth transition plan for transferring the business from the founding owners to the key employees. The most common characteristic of successful employee buyouts is early planning. If the founders have been steadily laying the foundation for an employee takeover, the likelihood of success is much greater than if a sudden decision is made at the eleventh hour of the last day.

Qualifying for Medicare

Medicare Part A generally covers medical costs of a hospital, skilled (not custodial) care in a skilled nursing facility (following certain hospital stays), home health agency, or hospice that participates in Medicare. Medicare Part B covers certain physician's services (including surgery), clinical laboratory services, durable medical equipment, and certain other items and services not covered under insurance.

Individuals (and spouses) who are age 65 or over and eligible for social security benefits are covered under Part A of Medicare at no cost (even if they continue working). Also covered at no cost is an individual who is age 65 or over and (a) qualifies for railroad retirement benefits (whether or not retired); (b) worked for a federal, state, or local government, and would be eligible for monthly social security benefits if his or her governmental employment were covered under social security; or (c) is a dependent or survivor of an individual age 65 or over entitled to Part A of Medicare, or is a dependent of an individual under age 65 entitled to retirement benefits.

In addition, individuals who have been disabled (as defined in the Social Security Act) for 24 consecutive months and receive social security disability benefits are covered under Part A of Medicare at no cost. Also covered at no cost is a disabled individual who (a) is entitled to railroad retirement disability benefits (under certain conditions); (b) worked for a federal, state, or local government, and would have been entitled to social security disability benefits for more than 24 months if his or her governmental employment were covered under social security; or (c) is age 65 or over and a dependent of an individual under age 65 entitled to disability benefits.

Individuals of any age with end-stage renal disease who are treated by a regular course of dialysis or need a kidney transplant are covered under Part A of Medicare at no cost even if they are working.

Individuals enrolled in Part B of Medicare pay a monthly premium of $78.20 in 2005. The premiums are generally withheld from the individual's social security benefits. If the individual is not receiving social security benefits, he or she is billed by the Social Security Administration. Individuals are eligible to enroll in Part B when they are (a) entitled to Part A hospital insurance at no cost; (b) disabled and paying a monthly premium for Part A hospital insurance because they are gainfully employed; or (c) age 65 or older and not entitled to Part A hospital insurance at no cost, but only if the person is a resident who is either a U.S. citizen or an alien who is a permanent resident who has resided in the U.S. continuously for five years prior to his enrollment month.