.McQuade.Brennan.LLP.

By Adam Freedenberg

Corporations structured under sub-chapter S of the Internal Revenue Code enjoy certain tax advantages over their C corporation cousins. In addition to not being subject to federal income taxes, taxable income distributed to shareholders as dividends is not subject to self-employment tax.

So naturally, S corporation shareholders prefer dividend distributions rather than W-2 compensation. Paying shareholder dividends rather than compensation benefits the S corporation as well. Because dividends are not compensation, the corporation avoids paying payroll taxes.

The Internal Revenue Service has been challenging S corporations and examining the compensation of shareholder-employees who provide substantial services to S corporations. There have been numerous cases in which district courts have held in favor the IRS’ calculation of “reasonable compensation,” forcing the S corporation to reclassify certain distributions as compensation payments and subject to all applicable payroll taxes.

S corporations should review the reasonableness of compensation paid, versus distributions made to shareholder-employees who provide substantial services to the corporation. There are numerous factors to consider. S corporations should have a thorough understanding of the recent court cases and the IRS’ approach to determining what is reasonable.

Let us know if you have any questions on your corporation’s compensation policy.

Friends, clients and golf partners often ask the same question. How is the firm doing? Or how are things for CPA’s these days?
Well, like most businesses, our greatest challenge is growth. And growth for CPA firms, like other professionals, is largely dependent on the growth and economic health of our clients.
And the financial health of our clients runs from poor to OK. Our clients in the real estate sector (commercial and residential builders) are still fighting the great recession. Our clients in the mortgage brokerage industry are doing better and our non-profit clients are facing numerous challenges, and in general are very concerned about the future.
But I tell friends and clients what concerns me most is the lack of “start up” business. By that I mean three or four people looking to develop 100 acres in Loudon, or a couple of engineers leaving a large tech firm to start a new tech company. There is clearly a “risk off” environment on small business formation. Banks want nothing to do with commercial or construction loans, and entrepreneurs are laying low.
From our perspective, the debt ceiling debate has paralyzed capital investment in the Washington, DC marketplace, and I think it caused a lot of damage to the confidence of the business community in general. So we think our clients growth, and McQuadeBrennan’s growth will be challenged for the next 12 months, at a minimum.

Women are leading men in finding ways to increase cash flow during retirement as well as cut costs, according to a recent study commissioned by investing firm Scottrade Inc.

The study, distributed to 1,000 respondents in January of this year, found that women’s confidence in their ability to plan for retirement has reached a three-year high, with 69 percent of women rating their confidence level as good or very good. And, for the first time in three years, women’s confidence is on par with their male counterparts – as 71 percent of men rate their confidence as good or very good.
Why the change?

Women’s savings tactics differ from men’s. The study found that more women are finding ways to increase their cash flow during retirement. Forty percent of women have structured their portfolios to include investments that will generate income during retirement, compared to 30 percent of men. And 51 percent of women say that generating income during retirement is more important to them now that it was one year ago.
Seventy-nine percent of women polled in the study were already saving for retirement as compared to 74 percent of men and women were more likely to feel like they were saving enough.

Women’s spending habits are also contributing to their positive retirement planning and saving momentum. While more than a quarter of men are concerned about controlling their urge to spend, only 17 percent of women share that concern – and that number is down from 27 percent of women in 2009.

In general, women are spending less than men, able to compare prices to get the better deal and are cutting back on purchases such as clothing and electronics, as well as, eating out.

These strategies, combined with their investment choices, have put women in a very good position as they prepare for retirement.

In what should be viewed as the economic policy equivalent of a train wreck for Maryland and the District of Columbia, the past two weeks confirmed what the business community has known for years. The state of Virginia is the hands down victor in the tri state area in creating jobs and economic growth and prosperity for its citizens. Here were the June headlines:

-The Small Business & Entrepreneurship Council ranked the District of Columbia dead last (51st) in terms of the costs of its tax policies to entrepreneurs.

– The US Department of Labor reported Maryland came in dead last in the nation for its pace of job creation over the past year.

- CNBC ranked Virginia as the best state in the union to do business

The above rankings come as no surprise. In January 2009, Kate Carr and I, in an op-ed piece for the Washington Post, (“How to Make D.C. and Economic Powerhouse (Hint: Tax Less)”) predicted the tax policies being pursued by the District of Columbia and Maryland were costing both states the most important thing they need… jobs. We also recognized the tax advantages Virginia had over both jurisdictions. While other states are shedding or reducing their state corporate income taxes, DC and Maryland are looking for new sources of tax revenue from business’ and individual taxpayers. Maryland is attempting to position itself as a biotech/research hub. Unfortunately, most of the biotech outfits setting up shop in Maryland do it primarily for Maryland’s research tax credits, which in effect are state subsidies of private business. When and if they ever make money, they, and their jobs, are gone.

But as bad as Maryland’s tax and economic policies are, it cant hold a candle to the job killing policies of DC. The District’s corporate tax rate (9.975%) says to business: If you operate here, you will not be competitive. The lost opportunities both jurisdictions have squandered, given their proximity to the Federal government spending machine, is hard to understand. Virginia doesn’t even have to be very good, (which it is), just better than these failing municipalities.

They say Virginia is for lovers, but more realistically, it’s for residents of Washington, DC and Maryland trying to dodge their state’s estate tax.

Though the federal estate tax exemption is currently set at $5 million, tax policies in Maryland and DC target residents who have estates valued at $500,000 or higher.

Virginia repealed its estate tax five years ago, which has prompted many financial advisors in the DC metro area to tell their clients to move across the state line.

And there’s good reason: back in 2008 when Maryland legislators created a “millionaire” tax bracket (I wrote about it in more detail here) raising the top income tax rate to 6.25 percent from 5.5 percent on taxable income over $1 million, legislators were hoping the increase would fill in the state’s expanding deficit. Just the opposite occurred – the State Comptroller’s office revealed they received 1,000 less tax returns from that qualifying tax bracket. Where did those upper income families go? They chose to leave the state.

Though the 6.5 tax rate expired at the beginning of the year, those with income greater than $500,000 are still taxed at 5.5 percent. And millionaires aren’t off the hook yet – in March legislators discussed making the 6.5 tax rate permanent. It’s part of $827 million package in potential state tax increases.

It’s not only the estate tax that gets the wealthy moving. The District has the third highest state or local corporate tax rate in the country. It’s not news that higher tax rates often result in higher unemployment rates and lower tax revenue. For companies looking to set up shop in the District, it’s a deal breaker.

Virginia from an economic performance perspective is knocking the socks off Maryland and DC – it’s more business friendly, and more jobs have been created. The legislative policies pursued by Maryland and DC are job killers and the estate tax is just another nail in the coffin.

March 17th for our tax professionals is just another day, like the occasional sunny, 70 degree day in early spring.  Our staff knows our clients need answers to their tax issues and they are anxious to know the amount of their 2010 tax liabilities or refunds. So, St. Patrick’s Day is largely celebrated by the “wearing of the green” and the exchange of “Happy St. Patrick’s Day” to our clients and each other. (I was excused early to attend the annual Friendly Sons of St. Patrick event at the Hilton. The Friendly Sons dinner is one of Washington’s great events.)

Most of our clients are coming to grips with e-filing their returns, as opposed to filing paper copies.  It’s largely a generational hesitation on the part of certain clients who object to e-filing.  However when we note tax refunds have a two week turnaround with e-filing, they warm up to the idea.

Our firm’s computer system allows 24/7 remote access to our databases and software and coupled with BlackBerrys and Smartphones; there is always the pressure for MB professionals to continue their work after they arrive home. And, some do. Like many professionals, it’s important for our tax professionals to seek a balance, stay fresh and keep the innovative and fresh ideas coming for our clients.

For the 2011 tax season at MB: so far, so good.

On July 1^st, I commented on Apollo Group’s 34% increase in earnings (The Next Big Short: Part 3 – The Apollo Group Announces Third Quarter Earnings).  I also noted that Apollo Group was the largest recipient of federal student aid (to the tune of $1.8 billion in 2008), so the earnings report was no surprise.  What prompted my commentary were the analyst reports from Barrington and FBR.  Even a cursory review of the legislative activity last summer, particularly that of the Senate Committee on Health, Education, Labor and Pensions, should have  alerted the analysts at both firms that the game was about to drastically change for the for-profit higher education industry.  I noted the industry will soon be facing new standards that many schools will fail to comply with.  I also suggested that Barrington and FBR review their target prices for Apollo ($65 for Barrington and $49 for FBR), which were bizarre even back in July.

Today, FBR downgraded Apollo to “underperform”, and gave a target price of $40.  Thanks.  As of this writing, I have no information for Barrington.  However, investors should not expect an upgrade.

Check out the price action of the following publicly traded for-profit/internet schools over the past five months:

On Monday, October 11, 2010, Thomas Heath commented on “The Intelligent Entrepreneur: How Three Harvard Business School Graduates Learned the 10 Rules of Successful Entrepreneurship”, a book written by Bill Murphy, a former Washington Post reporter and aspiring entrepreneur. 

Murphy’s 10 rules for success include:

1.) Be committed to entrepreneurship, the act of creating something, rather than a single idea.

2.) Solve a problem.

3.) Think big. Think new. Think again.

4.) You can’t do it alone.

5.) You must do it alone. Be decisive.

6.) Manage risk.

7.) Lead.

8.) Learn to sell.

9.) Persistence is everything.

10.) Time, not money, is the key resource.

I work with many small- and medium-sized businesses.  I’ve seen the bad, the good and the ugliest of outcomes from entrepreneurship.  Murphy is right “you can’t do it alone”.  Your support team should not only consist of a business partner and trusted friends, but also a trusted financial advisor to help you construct a business plan.  A lot of entrepreneurs have good ideas, but formulating a business plan is outside their skill set.   A financial advisor can give a clear description of how one will make money, including a time table of when the cash flow is going to start and what is the expected rate of return.  You need to have an advisor that’s going to explain to you the facts of life – not tell you what you want to hear.  They’ve got to tell you the bad news and the good news. 

Lastly, you must work hard and hire the best and brightest people you can find.

On September 8, 2010, Obama proposed a 100 percent bonus depreciation tax incentive for 2011 and asked Congress to make the research-and-development (R&D) tax credit permanent.

Obama proposes to increase the current 50% bonus depreciation deduction to 100%, retroactive to September 8, 2010. This deduction applies to purchases of equipment such as vehicles, solar panels, and computers.

The Administration hopes to encourage business investment and support the business community by making the R&D tax credit permanent and increasing bonus depreciation.

Don’t buy any equipment just yet. We’ll inform you once Congress has voted.

I picked up an Apple iPad about a month ago. It’s great. I strongly recommend you give it a test drive when you get chance. For business types like me, the ability to toss the iPad in my briefcase is extremely convenient. It’s a truly portable device. You can actually read attachments to emails without a microscope, unlike my Blackberry. Newspapers are in color and the presentation is light years better than the Kindle. A friend of mine was in the grill room at Columbia CC the other day having a beer, reading his iPad – an interesting sight. It was obvious to me that the “tablet” computer is going to change how we do a lot of things. When Apple adds a phone and camera to the iPad, watch out.

(c) ISAMU SANADA

The iPad and its successors will probably accelerate the demise of the print version of newspapers, because they provide such a good reading experience and offer the same portability. Textbooks are next. The tablets are going to be game changers.