Do I have to make estimated tax payments to the IRS?

Article Source: http://www.wwwebtax.com/payments/estimated_payments.htm

Tax must be paid as income is earned or received. Tax is generally withheld from your wages or salary before you get it, and tax may also be withheld from other types of income such as pensions and unemployment compensation if requested. Paying estimated tax is the method of paying tax on income not subject to IRS withholding and on other income from which not enough IRS tax is withheld.If you are going to owe the IRS tax for 2010 you can either increase the amount of tax withheld from your pay or make estimated tax payments. You may change the amount of tax withheld from your pay by filing a new Form W-4, Employee's Withholding Allowance Certificate. Form 1040-ES, Estimated Tax for Individuals, has a worksheet to see if you need to make estimated tax payments. Tax is generally not withheld from income such as alimony, interest, dividends, rental income, self employment income, and capital gains. You may be required to pay estimated tax on these types of income.  You do not have to make estimated tax payments if your 2010 tax return will show a tax refund, or a balance due of less than $1,000. Generally, you should make estimated tax payments for 2010 if you will owe the IRS tax of $1,000 or more, after tax withholding and tax credits, and the total amount of tax withheld and your tax credits will be less than the smaller of: 90% of the tax to be shown on your 2010 tax return; or 100% of the tax shown on your 2009 tax return, if your tax return covered all 12 months of the tax year. However, if your 2009 adjusted gross income exceeded $150,000, or $75,000 if you filed a separate tax return from your spouse, then you must pay 110% instead of 100% of last year's tax. The percentage for those with income that exceeds $150,000 in the tax years 1997 and thereafter is as follows : For tax year 1997 110 percent For tax year 1998 100 percent For tax year 1999 105 percent For tax year 2000 105 percent For tax year 2001 105 percent For tax year 2002 112 percent For tax year 2003 and later 110 percent You may have to pay a tax penalty if you do not pay enough tax paid through withholding or estimated tax payments to the IRS, or if you fail to make required estimated tax payments to the IRS by the estimated tax due dates below. Estimated tax payments can be used to pay federal income tax, self employment tax, and household employment tax. The underpayment tax penalty will not apply if you had no tax liability for 2009 and you were a U.S. citizen or resident for all of 2009 and your tax year included all 12 months of the year. Also, the tax penalty may be waived if: The failure to make estimated tax payments to the IRS was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the tax penalty; or You retired (after reaching age 62) or became disabled during the tax year a payment was due or during the preceding tax year, you had reasonable cause for not making the estimated tax payments, and the tax underpayment was not due to willful neglect. For estimated tax payments due on or before August 21, 1998, the tax penalty is waived to the extent your tax underpayment was created or increased by the IRS Restructuring and Reform Act of 1998. Get Form 1040ES to help you figure your estimated tax liability for 2010. A tax underpayment can be reduced or eliminated by making an additional tax payment to the IRS at any time during the tax year. Alternatively, request that your employer withhold additional tax from your wages for the remainder of the tax year. Any additional withholding tax will be treated as having been paid equally throughout the tax year for purposes of determining the tax underpayment penalty. If you choose this option, the increased tax withholding will continue until your employer is notified to revise the amount. Your first estimated tax payment to the IRS for 2010 is due April 15th. You may pay the entire year's estimated tax at that time, or you may pay your estimated tax in four payments. The four payments are due April 15th, June 15th, September 15, and January 15, 2011. Underpaying any tax installment may cause a tax penalty to be assessed, even though the total estimated tax payments for the tax year are adequate. If you made unequal estimated tax payments because your taxable income was received unevenly during the tax year, you may be able to avoid or lower the tax penalty by annualizing your income. Use Form 2210, Underpayment of Estimated Tax by Individuals and Fiduciaries, to see if annualizing would reduce or eliminate the tax penalty. Estimated tax payment requirements are different for farmers and fishermen. Estimated tax payments should not be sent with or be included in checks or money orders for payment of federal income tax with your tax return. Mail your estimated tax payments separately to the address shown in Where should I send my estimated payments?

Top Ten Facts About the Child and Dependent Care Credit

Article Source: http://www.irs.gov/newsroom/article/0,,id=106189,00.html

IRS Tax Tip 2010-46
Did you pay someone to care for a child, spouse, or dependent last year? If so, you may be able to claim the Child and Dependent Care Credit on your federal income tax return. Below are the top 10 things the IRS wants you to know about claiming a credit for child and dependent care expenses.

1. The care must have been provided for one or more qualifying persons. A qualifying person is your dependent child age 12 or younger when the care was provided. Additionally, your spouse and certain other individuals who are physically or mentally incapable of self-care may also be qualifying persons. You must identify each qualifying person on your tax return.
2. The care must have been provided so you – and your spouse if you are married filing jointly – could work or look for work.
3. You – and your spouse if you are married filing jointly – must have earned income from wages, salaries, tips, other taxable employee compensation or net earnings from self-employment. One spouse may be considered as having earned income if they were a full-time student or they were physically or mentally unable to care for themselves.
4. The payments for care cannot be paid to your spouse, to someone you can claim as your dependent on your return, or to your child who will not be age 19 or older by the end of the year even if he or she is not your dependent. You must identify the care provider(s) on your tax return.
5. Your filing status must be single, married filing jointly, head of household or qualifying widow(er) with a dependent child.
6. The qualifying person must have lived with you for more than half of 2009. However, see Publication 503, Child and Dependent Care Expenses, regarding exceptions for the birth or death of a qualifying person, or a child of divorced or separated parents.
7. The credit can be up to 35 percent of your qualifying expenses, depending upon your adjusted gross income.
8. For 2009, you may use up to $3,000 of expenses paid in a year for one qualifying individual or $6,000 for two or more qualifying individuals to figure the credit.
9. The qualifying expenses must be reduced by the amount of any dependent care benefits provided by your employer that you deduct or exclude from your income.
10. If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer. If you are a household employer, you may have to withhold and pay social security and Medicare tax and pay federal unemployment tax. For information, see Publication 926, Household Employer's Tax Guide.

Beginning with 2009 tax returns, Schedule 2, Child and Dependent Care Expenses for Form 1040A Filers, has been eliminated. Form 1040A filers will now use Form 2441, Child and Dependent Care Expenses. For more information on the Child and Dependent Care Credit, see Publication 503, Child and Dependent Care Expenses. You may download these free forms and publications from IRS.gov or order them by calling 800-TAX-FORM (800-829-3676).

Links:

• Publication 503, Child and Dependent Care Expenses (PDF 167K)
• Form W-10, Dependent Care Provider’s Identification and Certification (PDF 31K)
• Form 2441, Child and Dependent Care Expenses (PDF)
• Form 2441 Instructions (PDF 32K)
• Publication 17, Your Federal Income Tax (PDF 2,075K)
• Tax Topic 602

Accounting and Consulting Simplifying FAS 109

Article Source: http://www.sbnonline.com/Local/Article/15166/80/125/Simplifying_FAS_109.aspx

How communication demystifies the process

By Arthur G. Sharp

Smart Business Northern California | August 2008

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Jim Parks
Tax Partner
Burr, Pilger & Mayer LLP

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Search the Federal Accounting Standards Board (FASB) Web site for information about FAS 109 and you will find 14 pages of technical bulletins, accounting pronouncements, interpretations, opinions and assorted topics. No wonder accountants think it is so complicated. Yet, FAS 109 can be made easier for those who do not work with it consistently — and, at times, for those who do.
Satisfying FAS 109 requirements can be simplified, especially if the parties involved listen to one another’s concerns, work together to boil the standard down to its nuts and bolts, and resolve any inconsistencies that exist in the reporting process.
Smart Business spoke to Jim Parks of Burr, Pilger & Mayer LLP about how to demystify FAS 109, access experts and employ effective communications as a tool for the tax provision process.
What is FAS 109?
FAS 109 is an accounting standard that requires that financial statements reflect the tax consequences of all book/tax differences. Its primary objective requires companies to recognize the amount of taxes payable or refundable for the current year and compute deferred income taxes for future tax consequences of events that have been recognized in their financial statements or tax returns.
Why is meeting those requirements so complicated?
It doesn’t have to be. There is no doubt that FAS 109 can be frustrating even for people who work with it regularly. But, satisfying its requirements lies in distilling the tax preparation process into five separate and distinct steps for calculating tax provisions: identify permanent and temporary differences, calculate current income tax expense, calculate deferred income taxes, determine the need for a valuation allowance, and record the calculations on the financial statements.
Following these steps enables someone reasonably proficient in accounting and tax matters to prepare a tax provision. Virtually all tax provisions and software follow these steps in some fashion.
How can companies navigate through the calculations and required documentation?
One way is to follow Edmund Burke’s advice: ‘Good order is the foundation of all great things.’ Building on that premise means including in the process the proper tools and worksheet templates. But they won’t do the trick alone. Tax preparers need a little more to be successful! One path is to partner with trained and experienced preparers, utilize state-of-the-art technology and apply well-defined processes and procedures.
What benefits accrue from following that advice?
Tax provisions prepared by experienced personnel with the proper procedures in place yield better results. Regarding the people process, tax provisions should be prepared by trained and qualified individuals familiar with the local jurisdictions. The preparers could include in-house personnel and outside professionals. It is highly recommended that personnel familiar with the applicable jurisdiction prepare and/or have input on a tax provision. This is particularly important for foreign and state jurisdictions.
What role do technology and processes and procedures play in satisfying requirements?
Adequate technology is essential to a well-prepared tax provision. Companies and their outside accountants demand it. There are several good software programs available to preparers. Many companies, however, use Excel-based programs very efficiently. A world-class software template should be able to address downloading of company financial statements, automatic book/tax difference updates, jurisdictional issues, currency conversions, foreign tax credits, valuation allowances, etc. Additionally, documentation supporting the calculations and technical conclusions reached should be clearly presented and understandable to the reader.
The processes and procedures applied should be used with a high degree of integrity. Any deviation will likely produce unsatisfactory results. Through strict adherence to the tax provision processes and procedures companies can consistently ensure quality. This often entails the use of checklists, flowcharts and internal and external reviews.
Should the tax preparation process be done independently by internal personnel and advisers?
No. Companies need significant coordination among their auditors, outside service providers and internal personnel. Everyone is better served if they are talking ‘on the same page’ two to three times a year. This is one of most important elements of the tax preparation process. It’s also where professionals can excel and provide better services.
The tax preparation process should include a series of meetings among the practitioners that clearly lay out the expectations, time-lines and deliverables, and measure against desired results. A planning meeting maps out expectations. A post-review meeting is essential to obtain feedback, which enables everyone involved to adjust accordingly and learn.
Systemic coordination of the tax provision process is a key element to success. It’s a function of consistently improving upon what works the best. And, it doesn’t hurt to listen to what others have to say.
JIM PARKS is a tax partner with Burr, Pilger & Mayer LLP (www.bpmllp.com). Reach him at jparks@bpmllp.com or (408) 961-6383.

FIN 48 Implications - LMSB Field Examiners' Guide

Article Source: http://www.irs.gov/businesses/corporations/article/0,,id=171859,00.html

FIN 48 Implications LMSB Field Examiners’ Guide May, 2007 On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FASB Statement No. 109 regarding the calculation and disclosure of reserves for uncertain tax positions. The implementation of FIN 48 is causing significant activity in the taxpayer community regarding the handling of uncertain tax positions. In other words, it is possible that taxpayers may use new approaches in managing their examinations. For example, taxpayers and their representatives may want to more tightly control the statute of limitations, especially if there is a motivation to release the contingent tax liabilities into earnings. As another example, taxpayers may request additional closing agreements on specific subject matters on a more regular and expedited basis. Given the significant activity regarding the implementation of FIN 48, this field guide has been created to provide an awareness and examples of expected taxpayer behavior and the considerations in responding in light of existing tax law, process and procedure. FIN 48 – Summary of Requirements As stated earlier, FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006, is applicable to all enterprises subject to US GAAP (including non-profit enterprises), and applies to all income tax positions accounted for in accordance with FASB Statement No. 109. Evaluation of Reserve for Uncertain Tax Positions: The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step in the evaluation process is recognition. The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. The second step in the evaluation process is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which: (a) the threshold is met (for example, by virtue of another taxpayer’s favorable court decision); (b) the position is “effectively settled” by virtue of the closing of an examination where the likelihood of the taxing authority reopening the examination of that position is remote; or (c) the relevant statute of limitations expires. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. Disclosure of Reserve for Uncertain Tax Positions: The disclosure provisions of FIN 48 provide more information about the uncertainty in income tax assets and liabilities. Besides requiring an enterprise to accrue interest and penalties (where warranted) in the financial statements with respect to unrecognized tax benefits the following disclosures are required: (a) A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include at a minimum: 1. The gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period. 2. The gross amounts of increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period 3. The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities 4. Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations (b) The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate; (c) The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position; (d) For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date: 1. The nature of the uncertainty; 2. The nature of the event that could occur in the next 12 months that would cause the change; 3. An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made; and (e) A description of tax years that remain subject to examination by major tax jurisdictions The provisions of FIN 48 shall be applied to all tax positions upon its initial adoption. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 shall be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for the year of adoption, presented separately. Potential Taxpayer Concerns and Questions – Implications of FIN 48 on IRS Examinations Under FIN 48, one occasion when the remaining benefits of uncertain tax positions can be fully and finally recognized in US GAAP financial statements is when an enterprise determines that “effective settlement” of the uncertain position occurs. FIN 48 states: An enterprise shall evaluate all of the following conditions when determining whether effective settlement has occurred: a. The taxing authority has completed its examination procedures including all appeals and administrative reviews that the taxing authority is required and expected to perform for the tax position. b. The enterprise does not intend to appeal or litigate any aspect of the tax position included in the completed examination. c. It is remote that the taxing authority would examine or reexamine any aspect of the tax position. In making this assessment management shall consider the taxing authority’s policy on reopening closed examinations and the specific facts and circumstances of the tax position. Management shall presume the relevant taxing authority has full knowledge of all relevant information in making the assessment on whether the taxing authority would reopen a previously closed examination. In the tax years under examination, a tax position does not need to be specifically reviewed or examined by the taxing authority to be considered effectively settled through examination. Effective settlement of a position subject to an examination does not result in effective settlement of similar or identical tax positions in periods that have not been examined. In general terms, this means that when an IRS examination is closed there has been effective settlement of all uncertain tax positions for the examined year, whether such uncertainties are known to the IRS and examined or not, so long as the conditions in the immediately preceding quote are present. As an example, assume a taxpayer did not report dividend income on its tax return based on an ambiguous tax law. Furthermore, assume the position meets the requirements of FIN 48 and accordingly, the taxpayer creates a reserve for uncertain tax positions related to this item. The tax year is audited by the Service, but the Service does not propose an audit adjustment and closes the case. Assume also that the issue is not likely to meet any of the exceptions to the Service’s policy against reopening examinations. Since the examination is closed and it is remote that the Service would reopen an examination of the issue, the taxpayer can reverse that contingent tax liability and record the tax benefit at this point in time on the US GAAP financial statements because the uncertainty is now effectively removed. Another occasion when the remaining benefits of uncertain tax positions can be fully and finally recognized in US GAAP financial statements is when the statute of limitations terminates on those positions. Therefore, it should be anticipated that taxpayers and their representatives will use various approaches to reach and document effective settlement of specific issues and entire examinations as early as possible, and that they may be less willing than previously to extend the statute of limitations to points beyond an expected examination closing date. Listed below are some common questions and answers related to the requirements of FIN 48. Many of the questions and answers relate to approaches taxpayers may use to quickly gain certainty about the final outcome of uncertain tax positions in light of the requirements of FIN 48. Note that each approach should be handled in a manner appropriate to the taxpayer based on the facts and circumstances of the case, considering the Service’s need to fully examine and properly resolve tax issues, as well as taxpayer burden. In addition, the Service’s response to these possible approaches should coincide with current initiatives set out by LMSB. Question #1: Are FIN 48 Disclosures a Roadmap for the IRS? Answer #1: The disclosures required under FIN 48 should give the Service a somewhat better view of a taxpayer’s uncertain tax positions; however, the disclosures still do not have the specificity that would allow a perfect view of the issues and amounts at risk. For example, there may be a contingent tax liability listed in the tax footnotes of a large multi-national taxpayer with a description called “tax credits”; however, tax credits could be US, foreign, or state tax credits. So the “tax credits” in this example may or may not in this case have a US tax impact. Even with the lack of specificity, tax footnotes included in financial statements, including FIN 48 disclosures, should be carefully reviewed and analyzed as part of the audit planning process. For example, if a taxpayer reflecting a contingent tax liability in the year under audit for Subpart F income does not reflect Subpart F in the tax return, questions could develop about why Subpart F income does not appear in the tax return, but is mentioned in the tax footnotes as creating a contingent tax liability. Revenue Agents should not be reluctant to pursue matters mentioned in FIN 48 disclosures, but should be mindful of our policy of restraint on Tax Accrual Workpapers (TAW) and not cross over the boundaries contained there. If for example, there is discussion in the tax footnotes about a contingent tax liability being reversed because the statute of limitations related to the transfer of an intangible asset has expired, even though the statute may have run on that particular issue, this provides insight into how the taxpayer may be treating other intangible assets in other years where the statute of limitations is still open. In this example, this is public information that can be used without violating the TAW’s policy. Question #2: What is the impact of FIN 48 on the Service’s tax accrual workpaper (“TAW”) policy? Answer #2: The Service’s TAW policy may be found at IRM 4.10.20. Since FIN 48 is new, we will have to experience and study FIN 48 disclosures as they are published. However, FIN 48 workpapers are tax accrual workpapers, and they are subject to the policy of restraint covering TAW. On the other hand, FIN 48 Disclosures reported in quarterly and/or annual financial statements, and any other public documents, are not subject to the policy of restraint, and should be considered by examiners and others when conducting risk assessments. These FIN 48 disclosures might lead into discussions with appropriate taxpayer personnel during an examination, a CAP engagement, a PFA process or other taxpayer interaction. Question #3: Is it permissible to sign restricted consents to extend the statute of limitations? Answer #3: The Service has a policy regarding restricted consents: IRM 25.6.22.8.3 – Situations when the Service may Request Restricted Consents: (1) Generally, the Service will not solicit restricted consents. (2) The Service may request a restricted consent to one or more issues where, in light of reasonable tax administration, resolution of such issue or issues requires establishment of a Service position through court decision, regulation, ruling or other Headquarters action, or where other equally meritorious circumstances exist. See Rev. Proc. 68-31 (modified by Rev. Proc. 77-6 for other matters). IRM 8.9.1.2.3 – Period of Limitation on Joint Committee (JC) Cases (10-22-2001) Do not use restricted consents in Joint Committee cases. Restricted Consents – If an issue has been identified by the agent and the assessment period is about to expire, the taxpayer has the right to request a consent to extend the assessment period restricted to specific issue(s) only, while the statute of limitation is allowed to expire on all other issues. Although the taxpayer has the right to request a restricted waiver, and indeed the Service must notify the taxpayer of the opportunity, the Service has the right to limit the circumstances in which it will agree to enter into a restricted consent. Restricted waivers will only be entered under certain conditions, which are as follows: (1) the number of unresolved issues must not make it impractical for the Service to enter into a restricted waiver; (2) the specific unresolved issues covered in the restricted consent must be clearly described so that there will be no later dispute about what issues are covered in the restricted consent; (3) the issues on which the statute of limitations will be allowed to expire must be agreed, and the assessment of any deficiency or, under certain circumstances, the scheduling of refund or credit of the amount of an overassessment provided for; (4) the agent’s use of a restricted consent is approved by the agent’s group manager; and (5) the language of the restricted consent must be approved by Area Counsel. Whether it is acceptable in a particular case depends on all the facts and circumstances involved. Determining factors include but are not limited to: (a) what our working relationship has been like; (b) the nature of the issues involved; (c) whether the taxpayer has been forthcoming in identifying its uncertain tax positions; (d) where we are in the audit plan timeline; (e) how many issues are left to examine; whether Notices of Proposed Adjustments are signed when they are agreed to or left to linger until the end of the exam. While we understand that unrecognized tax benefits present contingent liabilities on balance sheets for which interest must be regularly accrued, and perhaps penalties, and while that may have an impact on loan covenants and net worth, we have to protect the government’s right to having the time necessary to adequately examine returns for compliance. We have processes in place to speed up examination and resolution of issues, both on a pre-filing and post-filing basis, and taxpayers who use those processes will undoubtedly conclude their examinations more quickly, allowing for speedier cleanup of contingent tax liabilities. Taxpayers should be encouraged to use our programs and processes to gain speed in resolving tax issues. See question #7 below. Counsel should be consulted if a taxpayer insists on the use of a restricted consent. Question #4: What is the Service’s policy regarding the use of Closing Agreement(s)? Answer #4: The Service has the discretion to decide whether to sign a closing agreement. The Service is generally reluctant to enter into closing agreements. As a matter of policy, the Service will enter into a closing agreement only if there appears to be an advantage in having the case “permanently and conclusively” closed, or “good and sufficient reasons” are shown by the taxpayer for entering into a closing agreement and it is determined that the U.S. Government will suffer no disadvantage by entering into the agreement. IRC Section 7121 is not a mandate by Congress, but is rather an authorization to enter into closing agreements. Although Congress authorized the Service to enter into these agreements, it allowed the Service the discretion to reject a taxpayer’s request for an agreement or to impose conditions on a taxpayer before executing the agreement. Similarly, it is left to the Service to determine whether the U.S. Government will sustain a disadvantage as a result of a closing agreement. Question #5: Can a closing agreement contain a stipulation by the IRS that, although the statute of limitations has not legally expired, it is deemed to be expired and further examinations of the subject year(s) is consequently barred? Answer #5: No. Counsel has stated that we have no authority to make such agreements. Question #6: Is it permitted to close a case by executing a Form 866, Agreement as to Final Determination of Tax Liability, if the taxpayer requests that be done? Answer #6: This action would completely bar the Service and the taxpayer from later changing the tax liability for that tax year for any reason. This Form has rarely been used by the field and the field avoids the issuance of qualified liability determinations in a Form 866. Counsel should be consulted if a taxpayer insists on the use of this Form. Question #7: How can we help taxpayers gain certainty more quickly in regard to their FIN 48 unrecognized tax benefits? Answer #7: We have witnessed through our FIN 48 initiative that some taxpayers do want certainty sooner because of FIN 48. We have also proven through our FIN 48 initiative that we can examine and resolve issues very speedily when taxpayers are transparent about the details of the issues that matter greatly to them. Accordingly, we anticipate that taxpayers will desire to have certainty regarding otherwise uncertain tax positions much sooner on average than in the past since the financial statements can be negatively affected much more than was the case in the past by continuing uncertainty. We can remind taxpayers that candor, transparency and the right motivations, coupled with programs and processes we have in place today can quickly generate certainty on tax issues. Those programs and processes include: (a) Pre-filing: 1. Industry Issue Resolution 2. Pre-filing Agreements 3. Advance Pricing Agreements 4. Compliance Assurance Program (b) Post-filing: 1. Joint Audit Planning 2. LIFE 3. Advanced Issue Resolution 4. Appeals Fast Track Program 5. Accelerated Issue Resolution 6. Early Referral to Appeals Question #8: There is an interesting thing about FIN 48 and undisclosed Listed Transactions. Under the Jobs Creation Act, the statute of limitations is extended until one calendar year after the IRS receives proper disclosure of Listed Transactions. So if a closed transaction should become a Listed Transaction, until one year after proper disclosure to the IRS, interest must be accrued in the P&L on the unrecognized tax benefit (perhaps all of the benefit because the “more likely than not” threshold may not have been met) under the rules of FIN 48, and the tax benefit taken on the return will never be recognizable in the financial statements. So, in that circumstance, each year the accrued interest gets larger and the P&L is negatively impacted. Has the Service considered this issue? Answer #8: LMSB has consulted with FASB on this point and they agree that that is the result. As good taxpayer service, and in order to ensure that we obtain disclosure about Listed Transactions, it may be a good practice to remind taxpayers about this provision affecting Listed Transactions and the way they impact on the application of FIN 48 in their financial statements. Question #9: Will the IRS reopen an examination cycle that has been closed because of disclosures that are made in financial statements in accordance with FIN 48? Answer #9: Our longstanding policy is that we do not reopen tax years that have been examined and closed. IRM 1.2.1.4.1, P-4-3 (12-21-1984). However, there are exceptional circumstances stated in this policy, the existence of which would allow us to reopen an examination for a tax year that was previously examined and closed. The Service has no plans to modify its policy against reopening examinations. However, since FIN 48 does require more information to be disclosed about uncertain tax positions than was the case before FIN 48 was issued, it is possible that reopenings will occur more frequently because of the potentially increased availability of information warranting reopening. Question #10: Where can one learn more about FIN 48? Answer #10: In general – Further information is available on the websites of the FASB, the AICPA and numerous research services. IRS FIN 48 Internet Site

Page Last Reviewed or Updated: June 05, 200

Employee Stock Purchase Plans

Article Source: http://turbotax.intuit.com/tax-tools/tax-tips/investments-and-rental-property/5595.html

Get information about how your employee stock purchase plan can impact your taxes.

Buying company stock at a discount

Many large companies offer an Employee Stock Purchase Plan (ESPP) that lets you buy your employer's stock at a discount. These plans are offered as an employment incentive, giving you an opportunity to share in the growth potential of your company's stock (and by implication, work hard to keep the stock price moving ahead).
Usually, you make contributions to a stock purchase fund for a certain period of time through payroll deductions. At designated points in the year, your employer then uses the accumulated money in the fund to purchase stock for you.
In many plans, the price that you pay for the stock is the stock price at the time you started contributing to the fund, or the stock price at the time your employer purchases the shares on your behalf, whichever is lower, with a discount of up to 15 percent. Either way, you get to buy the stock at a price that's lower than the market price. Your discounted price is known as the offer or grant price, because your employer has offered it to you, or granted it to you.
The company keeps the stock in your name until you decide to sell it. At that point you have to begin thinking about taxes.

But what about taxes?

When the company buys the shares for you, you do not owe any taxes. You are exercising your rights under the ESPP. You have bought some stock. So far so good.
When you sell the stock, the discount that you received when you bought the stock is generally considered additional compensation to you, so you have to pay taxes on that as regular income.
Also, depending on when you were granted the right to purchase the stock (the grant date), and how long you have held the stock, any profit that you make, over and above the compensation, may be considered a long-term capital gain, which can be taxed at lower rates than the compensation.
If you've participated in one of these plans, you probably know how it works. Come tax time, though, trying to figure out how to report the stock you sold through your plan can be daunting. You may wonder what gets reported and where on your return.

How much of the sales price is compensation?

That depends on whether your sale of the stock is a qualifying disposition or a disqualifying disposition. Selling the stock is thought of as disposing of it, but the question is, what makes the sale qualify as a capital gain, at least in part?

• Qualifying Disposition:

  You sold the stock at least two years after the offering (grant date) and at least one year after the exercise (purchase date). If so, a portion of the gain (the “bargain element”) is considered compensation income (taxed at regular rates) on your Form 1040. Any additional gain is considered capital gain (which may be taxed at lower rates if they are long-term gains) and should be reported on Schedule D, Capital Gains and Losses. Depending on the holding period the gain is either long-term or short term. If the gain is long-term gain, it will be taxed at a preferential rate.
  

• Disqualifying Disposition:

  You sold the stock within two years or less after the offering (grant date) or within one year or less from the exercise (purchase date). In this case, your employer will report the bargain element as compensation on your Form W-2, so you will have to pay taxes on that as ordinary income. The bargain element is the market price at the exercise date minus the actual price you paid for the stock, multiplied by the number of shares. Any additional appreciation is considered capital gain and should be reported on Schedule D.
  

Situation 1: Disqualifying Disposition

In this situation, you sell your ESPP shares within one year of purchasing them.
Example:

Offering date: 1/01/2008	Market price: $30
Exercise (purchase) date: 6/30/2008	Market Price: $25
15 percent discount	Actual cost: $21
Actual sale date: 1/20/2009	Market price: $50
Commission paid at sale $10
Number of shares: 100

This is a disqualifying disposition (sale) because you sold the stock less than two years after the offering (grant) date and you sold the stock less than a year after the exercise date.
Because this is a disqualifying disposition, your employer should include the bargain element in Box 1 of your 2009 Form W-2 as compensation. The bargain element is calculated this way:

1. Subtract the actual price paid from the market price at the exercise date
2. Multiply the result by the number of shares: ($25 - $21.25) x 100 = $375

Even if your employer didn't include the bargain amount in Box 1 of Form W-2, you must report this amount as compensation income on line 7 of your Form 1040.
You must also show the sale of the stock on your 2009 Schedule D, Part I for short-term sales because there was less than one year between the date you acquired the stock (6/30/2008) and the date you sold it (1/20/2009).
The sales price you report on Schedule D is $4,990 and the cost is $2,500. Your net gain is the difference between these two, or $2,490. As a short-term capital gain, it is fully taxable.
How did we come up with these amounts?
The sales price is the market price at the date of the sale ($50) times the number of shares sold (100), or $5,000. You then subtract any commissions paid at the sale ($10 in this example), arriving at $4,990. Your broker will show this amount on Form 1099-B that you'll receive at the beginning of the year following the year you sold the stock.
The cost is the actual price you paid per share (the market price times the discount) times the number of shares ($21.25 x 100 = $2,125), plus the amount reported as income on line 7 of your form 1040 (the $375 bargain element we calculated above), for a final cost of $2,500. 

Situation 2: Disqualifying Disposition

In this situation, you sell your ESPP shares more than one year after purchasing them, but within two years of the offering date.
Example:

Offering date: 6/30/2007	Market price: $30
Exercise (purchase) date: 1/01/2008	Market price: $25
15 percent discount	Actual cost: $21.25
Actual sale date: 1/20/2009	Market price: $50
Commission paid at sale $10
Number of shares: 100

This is a disqualifying disposition because you sold the stock less than two years after the offering (grant) date. As in the previous example, your employer should include the bargain element in your wages on your 2009 Form W-2. The bargain element is the same as in the first example ($375). You must report this amount as compensation income on line 7 of your 2009 Form 1040.

You must show the sale of the stock on your 2009 Schedule D. It's considered long-term because more than one year passed from the date acquired (1/01/2008) to the date of sale (1/20/2009). That is good, because long-term capital gains are taxed at a rate that is usually lower than your regular tax rate.
In this example, as in the previous one, the sales price you report on Schedule D is $4,990 and the cost basis is $2,500. The long-term gain is the difference of $2,490.

Situation 3: Qualifying Disposition and Market Price Decreased

In this situation, you sell your ESPP shares more than one year after purchasing them, and more than two years after the offering date, and the market price decreased during the period from the offering date to the exercise date. You have a qualifying disposition here.
Example:

Offering date: 1/01/06	Market price: $35
Exercise (purchase) date: 6/30/07	Market price: $25
15 percent discount	Actual cost:$21.25
Actual sale date: 1/20/2009	Market price: $50
Commission paid at sale $10
Number of shares: 100

This sale is a qualifying disposition because over two years have passed between the offering date and sale date, and more than one year has passed between the date of purchase and the date of sale. But the price per share decreased from the offering date to the purchase date.

Because this is a qualifying disposition, your employer might not report anything on your 2009 Form W-2. If not, you will still need to report some compensation income on line 7 of your 2009 Form 1040, as "compensation." You report the lesser of:

• The sales price per share minus the actual price paid per share times the number of shares. ($50-$21.25) x 100 shares = $2,875, or
• The offering price per share times the company discount, if any, times the number of shares. ($35 x .15) x 100 shares = $525

You report $525 on line 7 on the Form 1040 as "ESPP Ordinary Income."
Report the sale of your stock on your 2009 Schedule D, Part II, as a long-term sale. It's long term because there was over one year between the date you acquired it (6/30/07) and the date you sold it (1/20/2009).
For reporting on Schedule D, the sales price is $4,990, and the cost basis is $2,650. The long-term gain is the difference of $2,340.
The sales price is computed as in the previous examples. The cost, however, is the actual price paid per share times the number of shares ($21.25 x 100 = $2,125) plus the amount ($525) that you're reporting as compensation income on line 7 of your Form 1040. Thus, your total cost is $2,650.

Situation 4: Qualifying Disposition and Market Price Increased

In this situation, you sell your ESPP shares more than one year after purchasing them, and more than two years after the offering date and the market price actually increased from the offering date to the exercise date.
Example:

Offering date: 1/01/07	Market price: $15
Exercise date: 6/30/07	Market price: $25
15 percent discount	Actual cost: $12.75
Actual sale date: 1/20/2009	Market price: $50
Commission paid at sale $10
Number of shares: 100

This, is also a qualifying disposition (sale) because over two years have passed between the offering date and the sale date, and over one year has passed between the date of purchase and the date of sale. And this time, the price per share increased from the offering date to the purchase date.

Again, your employer might not report anything on your 2009 Form W-2 as compensation. But you will still need to report some ordinary income on line 7 of your 2009 Form 1040, as "compensation." You report the lesser of:

• The sales price per share minus the actual price paid per share times the number of shares. ($50-$12.75) x 100 shares = $3,725, or
• The offering price per share times the company discount, if any, times the number of shares. ($15 x .15) x 100 shares = $225

So you must report $225 on line 7 on the Form 1040 as "ESPP Ordinary Income."
You must also report the sale of your stock on Schedule D, Part II as a long-term sale. It's long term because there is over one year between the date acquired (6/30/07) and the date of sale (1/20/2009).
For reporting on Schedule D, the sales price is $4,990 and the cost basis is $1,500. The long-term gain is the difference of $3,490.
The sales price is computed as in the previous examples. The cost, however, is the actual price paid per share times the number of shares ($12.75 x 100 = $1275), plus the amount ($225) that you're reporting as compensation income on lien 7 of your Form 1040. Your total cost is $1,500.

Bottom line

Your employer is not required to withhold Social Security (FICA) taxes when you exercise the option to purchase the stock. Also, your employer is not required to withhold income tax when you dispose of the stock. But you still owe some income tax on any gain resulting from the sale of the stock.

Updated for tax year 2009

Alimony - Frequently Asked Questions

Article Source: http://www.ftb.ca.gov/individuals/faq/alimony.shtml

1. What is alimony? Money paid from one spouse to another for day-to-day support of the spouse with fewer financial resources is alimony (sometimes also referred to as "spousal support"). The law allows courts to award "alimony" or spousal support to one of the former spouses when a married couple divorces.
2. What are other examples of alimony payments? Payments made to a third party are considered alimony. Indirect alimony may include cash payments to a third party to provide a residence for a former spouse (i.e., rent, mortgage, utilities, etc.) medical cost payments or other such expenses incurred by the recipient.
3. What types of payments do NOT qualify as alimony?

• Property settlement payments, even if required by the divorce decree or other written instrument or agreement.
• Retirement benefits that the other spouse is entitled to receive are actually from community property.
• Any voluntary payments made before they are required by a divorce decree or agreement.
• Child support payments.

4. Can I deduct alimony paid? The law requires alimony payments to be reported as income by the recipient. The person who pays alimony may take a deduction for these payments. Alimony payments you make are deductible if all of the following requirements are met:

• You pay in cash, checks or money orders.
• The divorce or separation instrument does not say that the payment is NOT alimony.
• You and your former spouse are not members of the same household when you make the payment.
• You have no liability to make any payment after the death of your spouse or former spouse.
• Your payment is not treated as child support.

Generally, alimony deductions appear on line 31 of the federal Form 1040.
5. Are alimony payments considered taxable income? Alimony and similar payments from your spouse or former spouse are taxable to you in the year received. Taxpayers report alimony income on line 11 of the federal Form 1040, and this figure carries through to the California return.
6. I get family support from my former spouse. Is that considered taxable income? If the divorce decree or separation instrument provides for "family support" but no amount of the family support is designated as child support, then the entire payment is considered alimony.
7. Can I deduct child support payments? No. Child support is not considered alimony. If your divorce decree or other written instrument or agreement calls for alimony and child support, and you pay less than the total required, the payments apply first to child support. Any remaining amount is then considered alimony.
8. How can I distinguish alimony from child support? Distinguishing whether payments are alimony or child support may be difficult. Consult a tax advisor if you are uncertain. Payments that are fixed, in terms of an amount of money or a part of a payment as payable for the support of the payor's children are not alimony but rather non-deductible child support.
9. What are common mistakes made by taxpayers? Many taxpayers mistakenly consider all payments made to their ex-spouses as deductible alimony payments. For example, taxpayers frequently include non-deductible child support payments as alimony deductions. On the other hand, many alimony recipients do not consider the payments from their ex-spouses as taxable income, and fail to report it. Some recipients make the common mistake of not reporting income designated as "family support" by the divorce decree. This type of support is considered alimony income in most cases.
10. Can Registered Domestic Partners (RDPs) claim alimony payments on their federal and state returns? IRC section 71 defines "alimony" or "separate maintenance payment" as any payment in cash if such payment is received by (or on behalf of) a spouse under a divorce or separation agreement. Because federal law specifically identifies alimony as a payment to a spouse under a divorce and a separation agreement, for federal purposes IRC section 71 may not apply to RDPs. How the IRS treats alimony payments between RDPs remains unclear, therefore please contact the IRS, a federal tax practitioner, or competent counsel for the proper treatment of this issue on your federal returns.
California treats an RDP the same as a spouse. Consequently, we treat alimony payments between RDPs the same as alimony payments between spouses.
11. Why did FTB contact me? We contacted you because you claimed an alimony deduction as a payor or you under reported income from alimony payments as a recipient.
12. Will I be assessed any penalties if I owe additional taxes? The law allows us to assess the Accuracy-Related Penalty on the portion of any understatement of tax that should be shown on the return (CR&TC §19164). The penalty is equal to 20% of the portion of the underpayment caused by one or more of the following:

• Negligence or disregard of rules or regulations.
• Substantial understatement of income tax.
• Substantial valuation misstatement.

The law provides relief provisions or exceptions for each of these situations. We consider the relief provisions for each situation prior to assessing the penalty. We consider three common defenses (relief provisions) by taxpayers to avoid assessment of the penalty, depending upon the basis of the penalty. List of defenses are:

1. Substantial authority – Substantial Authority exists for the tax treatment of an item on the return.
2. Adequate disclosure – The original return contains Adequate Disclosure of the transaction and a reasonable basis for the position taken exists.
3. Reasonable Cause – Treasury Regulations §1.6664-4 also states that no penalty shall be imposed under IRC §6662 with respect to any portion of an understatement if the taxpayer shows that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion. We determine whether a taxpayer acted with reasonable cause and in good faith on a case–by–case basis, taking into account all pertinent facts and circumstances.

Substantial understatement of income tax exists if the amount of the understatement for the taxable year exceeds the greater of: (a) 10% of the tax required to be shown on the return for the taxable year, or (b) $5,000.
If you file the original return late, you also owe a late filing penalty.
13. What happens if I move out of California? A nonresident who receives alimony does not owe tax to California even if a California resident pays the alimony and claims a deduction for the payment.
14. Where can I get additional tax information?

Website:	www.ftb.ca.gov
Phone:	(800) 852-5711

Or, contact your tax preparer.
Assistance for persons with disabilities: We comply with the Americans with Disabilities Act. Persons with hearing or speech impairments please call TTY/TDD (800) 822-6268.
15. How can I request tax forms and publications?

Website:	www.ftb.ca.gov
Phone:	(800) 338-0505
Mail:	Tax Forms Request Unit MS D120 Franchise Tax Board PO Box 307 Rancho Cordova, CA 95741-0307

16. What will happen if I do not respond to the letter from FTB? We will revise your tax liability to include alimony income based on information available to us. Interest will also be assessed. In addition, you may be subject to the Accuracy-Related Penalty at 20% of the underpayment of tax (CR&TC §19164).

How Restricted Stock And RSUs Are Taxed

Article Source:http://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp

Employee compensation is a major expenditure for most corporations; therefore, many firms find it easier to pay at least a portion of their employees' compensation in the form of stock. This type of compensation has two advantages: it reduces the amount of cash compensation that employers must pay out, and also serves as an incentive for employee productivity. There are many types of stock compensation, and each has its own set of rules and regulations. Executives that receive stock options face a special set of rules that restrict the circumstances under which they may exercise and sell them. This article will examine the nature of restricted stock and restricted stock units (RSUs) and how they are taxed.   

What Is Restricted Stock?Restricted stock is, by definition, stock that has been granted to an executive that is nontransferable and subject to forfeiture under certain conditions, such as termination of employment or failure to meet either corporate or personal performance benchmarks. Restricted stock also generally becomes available to the recipient under a graded vesting schedule that lasts for several years.

Although there are some exceptions, most restricted stock is granted to executives that are considered to have "insider" knowledge of a corporation, thus making it subject to the insider trading regulations under SEC Rule 144. Failure to adhere to these regulations can also result in forfeiture. Restricted stockholders have voting rights, the same as any other type of shareholder. Restricted stock grants have become more popular since the mid-2000s, when companies were required to expense stock option grants. (For more, read Mapping Out The Stock Options Landscape.)

What Are Restricted Stock Units?RSUs resemble restricted stock options conceptually, but differ in some key respects. RSUs represent an unsecured promise by the employer to grant a set number of shares of stock to the employee upon the completion of the vesting schedule. Some types of plans allow for a cash payment to be made in lieu of the stock, but this type of plan is in the minority. Most plans mandate that actual shares of the stock are not to be issued until the underlying covenants are met.

Therefore, the shares of stock cannot be delivered until vesting and forfeiture requirements have been satisfied and release is granted. Some RSU plans allow the employee to decide within certain limits exactly when he or she would like to receive the shares, which can assist in tax planning. However, unlike standard restricted stockholders, RSU participants have no voting rights on the stock during the vesting period, because no stock has actually been issued. The rules of each plan will determine whether RSU holders receive dividend equivalents.

How Are Restricted Stock and RSUs Taxed?Restricted stock and RSUs are taxed differently than other kinds of stock options, such as statutory or nonstatutory employee stock purchase plans (ESPPs). Those plans generally have tax consequences at the date of exercise or sale, whereas restricted stock usually becomes taxable upon the completion of the vesting schedule. Restricted stock plans are not eligible for capital gains treatment, and the entire amount of the vested stock must be counted as ordinary income in the year of vesting. (To learn more, check out Getting The Most Out of Employee Stock Options.)

The amount that must be declared is determined by subtracting the original purchase or exercise price of the stock (which may be zero) from the fair market value of the stock as of the date that the stock becomes fully vested. The difference must be reported by the shareholder as ordinary income. However, if the shareholder does not sell the stock at vesting and sells it at a later time, any difference between the sale price and the fair market value on the date of vesting is reported as a capital gain or loss.

Section 83(b) ElectionShareholders of restricted stock are allowed to report the fair market value of their shares as ordinary income on the date that they are granted, instead of when they become vested, if they so desire. This election can greatly reduce the amount of taxes that are paid upon the plan, because the stock price at the time of grant is often much lower than at the time of vesting. Therefore, capital gains treatment begins at the time of grant and not at vesting. This type of election can be especially useful when longer periods of time exist between when shares are granted and when they vest (five years or more).

Example - Reporting Restricted Stock John and Frank are both key executives in a large corporation. They each receive restricted stock grants of 10,000 shares. The company stock is trading at $20 per share on the grant date. John decides to declare the stock at vesting while Frank elects for Section 83(b) treatment. Therefore, John declares nothing in the year of grant while Frank must report $200,000 as ordinary income. Five years later, on the date the stock becomes fully vested, the stock is trading at $90 per share. John will have to report a whopping $700,000 of his stock balance as ordinary income in the year of vesting ($90-$20=$70), while Frank reports nothing unless he sells his shares, which would be eligible for capital gains treatment. Therefore, Frank pays a lower rate on the majority of his stock proceeds, while John must pay the highest rate possible on the entire amount of gain realized during the vesting period.

Unfortunately, there is a substantial risk of forfeiture associated with the Section 83(b) election that goes above and beyond the standard forfeiture risks inherent in all restricted stock plans. If Frank should leave the company before the plan becomes vested, he will relinquish all rights to the entire stock balance, even though he has declared the $200,000 of stock granted to him as income. He will not be able to recover the taxes he paid as a result of his election. Some plans also require the employee to pay for at least a portion of the stock at the grant date, and this amount can be reported as a capital loss under these circumstances. (To learn more about employee stock strategies, read Solutions For Concentrated Positions.)

Taxation of RSUsThe taxation of RSUs is a bit simpler than for standard restricted stock plans. Because there is no actual stock issued at grant, no Section 83(b) election is permitted. This means that there is only one date in the life of the plan on which the value of the stock can be declared. The amount reported will equal the fair market value of the stock on the date of vesting, which is also the date of delivery in this case. Therefore, the value of the stock is reported as ordinary income in the year the stock becomes vested.

ConclusionThere are many different kinds of restricted stock, and the tax and forfeiture rules associated with them can be very complex. This article only covers the highlights of this subject and should not be construed as tax advice. For more information, consult your financial advisor.
 

Accounting System/Internal Controls In Small Business

Article Source: http://www.thinkinglike.com/Small-Business-Book/accounting-record-keeping-internal-controls.html

A new small business will find that it is generating important data necessary to conduct business. For example, suppose you have a mail-order business. Incoming orders must be recorded. The amount of payment must be recorded. Which products are shipped on which shipping dates must also be recorded.
To track such information, most businesses have a database system which has been set up to record key information. Record keeping is essential to successful small business management. Without adequate records, you won't even know how well your business is doing (nor will the IRS, which could cause you other problems!).
In addition to tracking sales and payments, you will want an accounting program for your small business. Try the various programs. See which one you like the best. MYOB (Mind Your Own Business) is one popular accounting program. I also highly recommend taking an accounting class and ordering a copy of Keeping The Books: Basic Record-Keeping and Accounting For The Small Businessby Linda Pinson.
Many small business owners neglect record keeping until the end of the year, when they must file taxes. Then they bring their shoebox, full of receipts and other information, to their accountant with the hope that the accountant will be able to figure it all out!
Getting behind in the record keeping is a serious problem for some. Procrastination kills! Set up a regular schedule for entering accounting and order/fulfillment information into your record-keeping system.
When starting, when in doubt about the need to record some bit of information, go ahead and record it. If you find you really don't need the information later, you can stop recording it. But, if you later find that you need information which you haven't been recording, you might have a difficult time reproducing the information.
As your small business grows, you will find that other information which you were not recording is useful. Allow your record-keeping system to grow and change with your business. Using feedback and experience is one of the best ways to learn what information is most important to your company.
Internal controls will change as you grow your business. For example, when you were a one-person company, whenever you had a business expense, you probably just wrote a check to cover the expense. However, as you have employees, you might find it is useful for them to be able to order materials and equipment. However, you don't just want to hand them your business checking book!
One common solution is the purchase order system. Whenever an employee desires to acquire new materials for the business, he/she fills out a purchase order or gets some approval. This method allows employees to order necessary supplies, but, at the same time, effectively records all purchase transactions, so the business owner knows who is ordering what.
Internal controls make it easier to monitor what is happening within your business and to make any necessary changes. You can't change what you don't know about.
Think about your internal controls, record keeping, and accounting system. These can always be modified latter as your business grows and changes.

Internal Controls for Small Business

Article Source: http://www.whistleblowing.com.au/information/documents/InternalControls.pdf

Stock Options, Restricted Stock, Phantom Stock, Stock Appreciation Rights (SARs), and Employee Stock Purchase Plans (ESPPs)

Article Source: http://www.nceo.org/main/article.php/id/43

There are five basic kinds of individual equity compensation plans: stock options, restricted stock and restricted stock units, stock appreciation rights, phantom stock, and employee stock purchase plans. Each kind of plan provides employees with some special consideration in price or terms. We do not cover here simply offering employees the right to buy stock as any other investor would.

Stock options give employees the right to buy a number of shares at a price fixed at grant for a defined number of years into the future. Restricted stock and its close relative restricted stock units (RSUs) give employees the right to acquire or receive shares, by gift or purchase, once certain restrictions, such as working a certain number of years or meeting a performance target, are met. Phantom stock pays a future cash bonus equal to the value of a certain number of shares. Stock appreciation rights (SARs) provide the right to the increase in the value of a designated number of shares, paid in cash or shares. Employee stock purchase plans (ESPPs) provide employees the right to purchase company shares, usually at a discount.

Stock Options

A few key concepts help define how stock options work:

• Exercise: The purchase of stock pursuant to an option.
• Exercise price: The price at which the stock can be purchased. This is also called the strike price or grant price. In most plans, the exercise price is the fair market value of the stock at the time the grant is made.
• Spread: The difference between the exercise price and the market value of the stock at the time of exercise.
• Option term: The length of time the employee can hold the option before it expires.
• Vesting: The requirement that must be met in order to have the right to exercise the option-usually continuation of service for a specific period of time or the meeting of a performance goal.

A company grants an employee options to buy a stated number of shares at a defined grant price. The options vest over a period of time or once certain individual, group, or corporate goals are met. Some companies set time-based vesting schedules, but allow options to vest sooner if performance goals are met. Once vested, the employee can exercise the option at the grant price at any time over the option term up to the expiration date. For instance, an employee might be granted the right to buy 1,000 shares at $10 per share. The options vest 25% per year over four years and have a term of 10 years. If the stock goes up, the employee will pay $10 per share to buy the stock. The difference between the $10 grant price and the exercise price is the spread. If the stock goes to $25 after seven years, and the employee exercises all options, the spread will be $15 per share.

Kinds of Options

Options are either incentive stock options (ISOs) or nonqualified stock options (NSOs), which are sometimes referred to as nonstatutory stock options. When an employee exercises an NSO, the spread on exercise is taxable to the employee as ordinary income, even if the shares are not yet sold. A corresponding amount is deductible by the company. There is no legally required holding period for the shares after exercise, although the company may impose one. Any subsequent gain or loss on the shares after exercise is taxed as a capital gain or loss when the optionee sells the shares.

An ISO enables an employee to (1) defer taxation on the option from the date of exercise until the date of sale of the underlying shares, and (2) pay taxes on his or her entire gain at capital gains rates, rather than ordinary income tax rates. Certain conditions must be met to qualify for ISO treatment:

1. The employee must hold the stock for at least one year after the exercise date and for two years after the grant date.
2. Only $100,000 of stock options can first become exercisable in any calendar year. This is measured by the options' fair market value on the grant date. It means that only $100,000 in grant price value can become eligible to be exercised in any one year. If there is overlapping vesting, such as would occur if options are granted annually and vest gradually, companies must track outstanding ISOs to ensure the amounts that becomes vested under different grants will not exceed $100,000 in value in any one year. Any portion of an ISO grant that exceeds the limit is treated as an NSO.
3. The exercise price must not be less than the market price of the company's stock on the date of the grant.
4. Only employees can qualify for ISOs.
5. The option must be granted pursuant to a written plan that has been approved by shareholders and that specifies how many shares can be issued under the plan as ISOs and identifies the class of employees eligible to receive the options. Options must be granted within 10 years of the date of the board of directors' adoption of the plan.
6. The option must be exercised within 10 years of the date of grant.
7. If, at the time of grant, the employee owns more than 10% of the voting power of all outstanding stock of the company, the ISO exercise price must be at least 110% of the market value of the stock on that date and may not have a term of more than five years.

If all the rules for ISOs are met, then the eventual sale of the shares is called a "qualifying disposition," and the employee pays long-term capital gains tax on the total increase in value between the grant price and the sale price. The company does not take a tax deduction when there is a qualifying disposition.

If, however, there is a "disqualifying disposition," most often because the employee exercises and sells the shares before meeting the required holding periods, the spread on exercise is taxable to the employee at ordinary income tax rates. Any increase or decrease in the shares' value between exercise and sale is taxed at capital gains rates. In this instance, the company may deduct the spread on exercise.

Any time an employee exercises ISOs and does not sell the underlying shares by the end of the year, the spread on the option at exercise is a "preference item" for purposes of the alternative minimum tax (AMT). So even though the shares may not have been sold, the exercise requires
the employee to add back the gain on exercise, along with other AMT preference items, to see whether an alternative minimum tax payment is due.

In contrast, NSOs can be issued to anyone-employees, directors, consultants, suppliers, customers, etc. There are no special tax benefits for NSOs, however. Like an ISO, there is no tax on the grant of the option, but when it is exercised, the spread between the grant and exercise price is taxable as ordinary income. The company receives a corresponding tax deduction. Note: if the exercise price of the NSO is less than fair market value, it is subject to the deferred compensation rules under Section 409A of the Internal Revenue Code and may be taxed at vesting and the option recipient subject to penalties.

Exercising an Option

There are several ways to exercise a stock option: by using cash to purchase the shares, by exchanging shares the optionee already owns (often called a stock swap), by working with a stock broker to do a same-day sale, or by executing a sell-to-cover transaction (these latter two are often called cashless exercises, although that term actually includes other exercise methods described here as well), which effectively provide that shares will be sold to cover the exercise price and possibly the taxes. Any one company, however, may provide for just one or two of these alternatives. Private companies do not offer same-day or sell-to-cover sales, and, not infrequently, restrict the exercise or sale of the shares acquired through exercise until the company is sold or goes public.

Accounting

Under rules for equity compensation plans to be effective in 2006 (FAS 123(R)), companies must use an option-pricing model to calculate the present value of all option awards as of the date of grant and show this as an expense on their income statements. The expense recognized should be adjusted based on vesting experience (so unvested shares do not count as a charge to compensation).

Restricted Stock

Restricted stock plans provide employees with the right to purchase shares at fair market value or a discount, or employees may receive shares at no cost. However, the shares employees acquire are not really theirs yet-they cannot take possession of them until specified restrictions lapse. Most commonly, the vesting restriction lapses if the employee continues to work for the company for a certain number of years, often three to five. Time-based restrictions may lapse all at once or gradually. Any restrictions could be imposed, however. The company could, for instance, restrict the shares until certain corporate, departmental, or individual performance goals are achieved. With restricted stock units (RSUs), employees do not actually receive shares until the restrictions lapse. In effect, RSUs are like phantom stock settled in shares instead of cash.

With restricted stock awards, companies can choose whether to pay dividends, provide voting rights, or give the employee other benefits of being a shareholder prior to vesting. (Doing so with RSUs triggers punitive taxation to the employee under the tax rules for deferred compensation.) When employees are awarded restricted stock, they have the right to make what is called a "Section 83(b)" election. If they make the election, they are taxed at ordinary income tax rates on the "bargain element" of the award at the time of grant. If the shares were simply granted to the employee, then the bargain element is their full value. If some consideration is paid, then the tax is based on the difference between what is paid and the fair market value at the time of the grant. If full price is paid, there is no tax. Any future change in the value of the shares between the filing and the sale is then taxed as capital gain or loss, not ordinary income. An employee who does not make an 83(b) election must pay ordinary income taxes on the difference between the amount paid for the shares and their fair market value when the restrictions lapse. Subsequent changes in value are capital gains or losses. Recipients of RSUs are not allowed to make Section 83(b) elections.

The employer gets a tax deduction only for amounts on which employees must pay income taxes, regardless of whether a Section 83(b) election is made. A Section 83(b) election carries some risk. If the employee makes the election and pays tax, but the restrictions never lapse, the employee does not get the taxes paid refunded, nor does the employee get the shares.

Restricted stock accounting parallels option accounting in most respects. If the only restriction is time-based vesting, companies account for restricted stock by first determining the total compensation cost at the time the award is made. However, no option pricing model is used. If the employee is simply given 1,000 restricted shares worth $10 per share, then a $10,000 cost is recognized. If the employee buys the shares at fair value, no charge is recorded; if there is a discount, that counts as a cost. The cost is then amortized over the period of vesting until the restrictions lapse. Because the accounting is based on the initial cost, companies with low share prices will find that a vesting requirement for the award means their accounting expense will be very low.

If vesting is contingent on performance, then the company estimates when the performance goal is likely to be achieved and recognizes the expense over the expected vesting period. If the performance condition is not based on stock price movements, the amount recognized is adjusted for awards that are not expected to vest or that never do vest; if it is based on stock price movements, it is not adjusted to reflect awards that aren't expected to or don't vest.

Restricted stock is not subject to the new deferred compensation plan rules, but RSUs are.

Phantom Stock and Stock Appreciation Rights

Stock appreciation rights (SARs) and phantom stock are very similar concepts. Both essentially are bonus plans that grant not stock but rather the right to receive an award based on the value of the company's stock, hence the terms "appreciation rights" and "phantom." SARs typically provide the employee with a cash or stock payment based on the increase in the value of a stated number of shares over a specific period of time. Phantom stock provides a cash or stock bonus based on the value of a stated number of shares, to be paid out at the end of a specified period of time. SARs may not have a specific settlement date; like options, the employees may have flexibility in when to choose to exercise the SAR. Phantom stock may offer dividend equivalent payments; SARs would not. When the payout is made, the value of the award is taxed as ordinary income to the employee and is deductible to the employer. Some phantom plans condition the receipt of the award on meeting certain objectives, such as sales, profits, or other targets. These plans often refer to their phantom stock as "performance units." Phantom stock and SARs can be given to anyone, but if they are given out broadly to employees and designed to pay out upon termination, there is a possibility that they will be considered retirement plans and will be subject to federal retirement plan rules. Careful plan structuring can avoid this problem.

Because SARs and phantom plans are essentially cash bonuses, companies need to figure out how to pay for them. Even if awards are paid out in shares, employees will want to sell the shares, at least in sufficient amounts to pay their taxes. Does the company just make a promise to pay, or does it really put aside the funds? If the award is paid in stock, is there a market for the stock? If it is only a promise, will employees believe the benefit is as phantom as the stock? If it is in real funds set aside for this purpose, the company will be putting after-tax dollars aside and not in the business. Many small, growth-oriented companies cannot afford to do this. The fund can also be subject to excess accumulated earnings tax. On the other hand, if employees are given shares, the shares can be paid for by capital markets if the company goes public or by acquirers if the company is sold.

Phantom stock and cash-settled SARs are subject to liability accounting, meaning the accounting costs associated with them are not settled until they pay out or expire. For cash-settled SARs, the compensation expense for awards is estimated each quarter using an option-pricing model then trued-up when the SAR is settled; for phantom stock, the underlying value is calculated each quarter and trued-up through the final settlement date. Phantom stock is treated in the same way as deferred cash compensation.

In contrast, if a SAR is settled in stock, then the accounting is the same as for an option. The company must record the fair value of the award at grant and recognize expense ratably over the expected service period. If the award is performance-vested, the company must estimate how long it will take to meet the goal. If the performance measurement is tied to the company's stock price, it must use an option-pricing model to determine when and if the goal will be met.

Employee Stock Purchase Plans (ESPPs)

Employee stock purchase plans (ESPPs) are formal plans to allow employees to set aside money over a period of time (called an offering period), usually out of taxable payroll deductions, to purchase stock at the end of the offering period. Plans can be qualified under Section 423 of the Internal Revenue Code or non-qualified. Qualified plans allow employees to take capital gains treatment on any gains from stock acquired under the plan if rules similar to those for ISOs are met, most importantly that shares be held for one year after the exercise of the option to buy stock and two years after the first day of the offering period.

Qualifying ESPPs have a number of rules, most importantly:

• Only employees of the employer sponsoring the ESPP and employees of parent or subsidiary companies may participate.
• Plans must be approved by shareholders within 12 months before or after plan adoption.
• All employees with two years of service must be included, with certain exclusions allowed for part-time and temporary employees as well as highly compensated employees. Employees owning more than 5% of the capital stock of the company cannot be included.
• No employee can purchase more than $25,000 in shares, based on the stock's fair market value at the beginning of the offering period in a single calendar year.
• The maximum term of an offering period may not exceed 27 months unless the purchase price is based only on the fair market value at the time of purchase, in which case the offering periods may be up to five years long.
• The plan can provide for up to a 15% discount on either the price at the beginning or end of the offering period, or a choice of the lower of the two.

Plans not meeting these requirements are nonqualified and do not carry any special tax advantages.

In a typical ESPP, employees enroll in the plan and designate how much will be deducted from their paychecks. During an offering period, the participating employees have funds regularly deducted from their pay (on an after-tax basis) and held in designated accounts in preparation for the stock purchase. At the end of the offering period, each participant's accumulated funds are used to buy shares, usually at a specified discount (up to 15%) from the market value. It is very common to have a "look-back" feature in which the price the employee pays is based on the lower of the price at the beginning of the offering period or the price at the end of the offering period.

Usually, an ESPP allows participants to withdraw from the plan before the offering period ends and have their accumulated funds returned to them. It is also common to allow participants who remain in the plan to change the rate of their payroll deductions as time goes on.

Employees are not taxed until they sell the stock. If the stock is held long enough, any gain, except the discount, is taxed as capital gain. The discount element is taxed as ordinary income. If the shares are not held long enough, the entire sale is taxed as ordinary income. Special tax rules apply if the shares are sold for less their fair market value at exercise but more than discounted price.

If the plan provides not more than a 5% discount off the fair market value of shares at the time of exercise and does not have a look-back feature, there is no compensation charge for accounting purposes. Otherwise, the awards must be accounted for much the same as any other kind of stock option.