Details

Written by: CPA Magazine

Published: 08 January 2018

The most comprehensive tax act in 31 years is described as a 23% cut for the middle class. There are two sweeping changes, five major changes and several other important changes.

The sweeping changes are the reduction of the corporate rate from 35 to 21% and the increase in the standard deduction which almost doubles to $24,000 for taxpayers filing jointly.

The bill repeals personal exemptions, doubles childcare credits, caps interest tax deductions and creates at 20% pass-through deduction.

The home mortgage interest deduction reduces the limit on acquisition indebtedness to $750,000 from the current limit of $1 million.

The bill increases the child tax credit to $2,000 per qualifying child.

Under the bill the limit for state and local income or property tax deductions is $10,000.

The take away for CPAs is: 2018 will be a busy tax year for CPAs handling taxes and a reduced market for itemized tax returns in 2019 and beyond.

Details

Written by: Steven T. Miller

Published: 07 December 2017

Avrahami v. Commissioner: What’s Next for Captive Insurance? On August 21, the Tax Court issued its long awaited opinion in Avrahami v. Commissioner. Many in the micro-captive industry had been waiting for Judge Holmes to issue this opinion, in part, due to the IRS’ own anticipation. What many had hoped for was bright line guidance from the Court on an area of law highly scrutinized by the IRS with little prior IRS, Treasury or judicial direction. What we received fell short of our aspirations, containing some guidance but raising many questions. What we will try to do in this article is walk you through what the court found and what it portends for the future. And we need to remember that this is part one of a trilogy of cases that have been tried before Judge Holmes and await his irascible pen.

The Avrahamis ran a successful jewelry and real estate business. They created a captive insurance company named Feedback, which made the section 831(b) election. While they were unlucky enough to be early in line for IRS attention, the issues raised by the IRS are the same as have been raised now hundreds of times since—that is, was Feedback an insurance company and were the policies it issued insurance. In addition, there was the issue of whether Pan American, which was the reinsurance “pool” in this case, was a successful mechanism to distribute insurable risk amongst unrelated parties.

Judge Holmes did not spare words and the opinion ran 105 pages. Of those, 90 were not so good for the taxpayer and the captive manager. The issue the Court considered in this case is whether amounts paid to Feedback (the captive) and Pan American Reinsurance Company were deductible as insurance payments for Federal Tax Law purposes. The Government argued that Feedback’s policies included uninsurable risks, it failed to distribute risk because it had an insufficient pool of insureds, risk was not shifted and that the arrangements did not embody common notions of insurance because Feedback and Pan American did not operate like insurance companies and their premiums were not determined at arm’s length. The Court agreed with some of these arguments, but did so in a very fact specific manner. Ultimately, the Court did not make findings as to risk shifting or what constitutes insurable risk. It decided it did not need to in order to find for the government.

First, the Court opined on whether risk distribution was satisfied. The Avrahamis had argued they met this requirement in two ways. First, they argued that they had enough related party risk. Second, they contended that the risk pool for unrelated risk (Pan American) was sufficient. The Court dealt with each in turn. As to insuring related entities, while the government’s expert stated 35 related entities are needed to meet risk distribution and the plaintiff’s expert, citing Rev. Rul. 2002-90, stated only 12 is necessary (and argued maybe as few as seven), the Court did not opine on the total number of related affiliates it believed would actually be needed. Rather, it held that because the captive only insured three to four related entities, it did not meet the minimum stated by either expert. Therefore, we are not sure of whether the Tax Court will respect the 12 insured rule created by Rev. Rul. 2002-90, or adopt its own rule when it comes to risk distribution. Judge Holmes’ next case, Caylor, may provide us with a better sense in this regard as it relies solely on affiliate risk. However, the Court here was very clear that the number of affiliates insured was not a magic number. Instead, the Court indicated that it wanted to see diverse and numerous “independent risk exposures.” What are these? Think cars, employees, properties, etc. Judge Holmes cited to the recent Rent-A-Center case in this regard, noting he recognized that fewer such exposure units must exist in the micro-captive setting but he needed more than what the Avrahamis had.

Second, the Court decided whether risk distribution was met through the Pan American program. Under the Pan American program, an insured would pay a premium for terrorism coverage in a pool arrangement, and the captive would reinsure the pool for all the risks assumed by the pool for that insured. The Court held that risk distribution was not met due to a series of adverse factual findings, including: the seemingly circular flow of funds that left Pan American with no funds and all obligations, “utterly unreasonable” premiums, and a lack of arm’s length dealings. It found for these reasons, Pan American was not a bona fide insurance company, so the policies it was issuing were not insurance, and therefore the captive’s reinsurance of those policies did not distribute risk. But let’s think about what the Court did not say. The Court’s analysis here is telling in that it found that it had to look at the actual facts of the pool – the Court did not prohibit or even speak negatively of risk pools, but instead focused on the totality of the facts.

What we find lacking here – and not in any way to the Court’s fault – is clarity on what the Court would do with a more diverse and well operated risk pool. As in, just what is necessary between Pan American and the size and breadth of the risks in Rent-A-Center?

After finding that there was no risk distribution, the Court began to disassemble Feedback, the Avrahami’s captive. The Court found Feedback was not an insurance company and the arrangement was not insurance in the commonly accepted sense. Why? Again, let us count the ways. While the Court found no quarrel with St. Kitts as a domicile for organizing a captive (though it did make a few snarky comments), the Court found the operation of Feedback sadly lacking. The key reasons include: no claims until initiation of the IRS audit, and when they showed up they were dealt with on an ad hoc basis, claimed late and without substantiation; operations and formalities were lacking; policy terms were unclear; investments were in illiquid assets such as long term unsecured loans to related parties/insureds; and failure to receive regulatory approval for loans. One line the Court did draw for us: do not have 65% of your assets in related party loans that are unsecured.

The Court was somewhat confusing on the level of capitalization required. The Court chose to follow precedent and interestingly sided with the Avrahamis in holding that Feedback was adequately capitalized because it met the minimum requirements of St. Kitts. However, it held that Pan American—even though it met the minimum capitalization requirements of its jurisdiction—was not adequately capitalized, because it would not be able to cover the nearly $308 million in potential losses and that it would likely not be able to collect payment from the captives.

Regarding premiums, in holding that the arrangement did not constitute insurance in the commonly accepted sense, the Court spent many pages on the work of the actuary for the captive and Pan American. It found that his explanations “were often incomprehensible” and that “the premiums were utterly unreasonable.” The Court spent time in its opinion analyzing the details of the actuary’s methodology, and found error in the way he selected and utilized variables to artificially inflate premiums. We think that the methodology employed by actuaries will continue to be an issue raised by the IRS and Courts. We have, in fact, attended an interview where an actuary spent hours with an IRS team walking them though the actuarial science. Not an easy task and not an easy interview. As a result, it is important to make sure that the actuary pricing premiums for a captive is well qualified and relies on actuarially sound principles.

In the last pages of the opinion, the Court did award the Avrahamis a valuable win in granting relief on most penalties. The Court found that the Avrahamis had relied on a tax advisor and had relied in good faith. What this relief tells us is that the Court will continue to respect reasonable reliance on a professional advisor, even in a micro-captive context. What is less clear, is whether the Court will also find that reliance to be in good faith. The Court was sympathetic to the Avrahamis, finding good faith due to the lack of IRS or judicial guidance on micro-captives. However, now with this opinion available, it may be slightly more difficult for newly formed captives to assert good faith, especially in instances where facts are in line with those of Avrahami. Arguably, this good faith should apply for all years before the opinion but we shall see.

The two major issues the Court did not address are risk shifting and what constitutes an insurance risk. While Judge Holmes did not opine on these issues, he and the IRS did offer a little insight on insurance risks. In the facts section of his opinion, it was made clear that the IRS agreed that coverage for Administrative Actions and Employee Fidelity were insurance risks. On the flip side, the Court stated Tax Indemnity is the “most peculiar policy of all.” Further guidance will be needed on other types of coverages common to micro-captive arrangements.

And further guidance on insurance risks, risks shifting and for other fact specific issues may be coming soon. Judge Holmes has two fully tried captive cases on his docket – Caylor v. Commissioner and Wilson v. Commissioner. Caylor is similar in some ways to Avrahami, specifically in that it involves terrorism insurance through Pan American. Caylor, on the other hand, does not involve a risk pool, but instead is an arrangement where a captive provides insurance to 12 related construction/real estate entities. Caylor may offer valuable insight as to whether Rev. Rul. 2002-90 will be respected by the Court.

What Avrahami provides is a set of facts where the Court will not find insurance present. What it does not provide is guidance on what it would find acceptable. We have but one point of data in many areas. While Avrahami only answers a few questions due to the fact specific nature of the opinion, we sincerely hope that further guidance comes from Caylor and Wilson. Further, guidance from the IRS would go a long way. In an ideal world, the IRS would take the general findings that come from these cases to create both an audit resolution program for those already under audit and also a safe-harbor describing permissible behavior concerning major issues. Time will tell.

Steven T. Miller is alliantgroup’s National Director of Tax and former IRS Acting Commissioner. He spent 25 years with the IRS serving the agency in a number of diverse and increasingly important roles.

Details

Written by: Joshua Fluegel

Published: 07 December 2017

Write-Up Software Roundtable

Write-up software is all about bringing together all the information. Making a mistake when selecting the software that is right for your firm can be exasperating. For this reason, CPA Magazine asked the leading minds in write-up software how to avoid these problems and provide recommendations to assure a perfect meeting of man and machine.

Chandra Bhansali Co-Founder and CEO of AccountantsWorld

What is a mistake you have seen CPAs make when selecting a write-up solution?

The biggest mistake CPAs make is to run their write-up practice on desktop-based accounting systems created for small businesses. These systems introduce a tremendous amount of inefficiencies and that’s one reason why most write-up practices are low-margin services.

What is a recommendation you would give CPAs who are selecting a write-up solution?

Make sure that the system offers a simple method for clients to upload invoices using their smartphone and also has workflow capabilities to help staff perform at peak efficiencies. Bank feed is a must to reduce data entry by 70-80% for those clients who still write manual checks in their business. To help you offer virtual CFO services, the system you select should include tools like cash flow manager, alerts, dashboards, performance analysis, financial ratios, and fully customizable financial statements.

Ken Garen President of UBCC

What is a mistake you have seen CPAs make when selecting a write-up solution?

Not finding out how performance will be as they add data and not finding out how easy it is to construct a financial statement.

What is a recommendation you would give CPAs who are selecting a write-up solution?

Talk to your peers to find out the pluses and minuses of the software that they use. Run the software on a trial basis for at least a month or two to see how it fits with their practice. Find out how easy it is to import and/ or export information. Find out if all of their data (including PDF files) can be exported and used by other software programs they may use now or in the future.

Louie Calvin Product Manager, Accounting & Payroll of Thomson Reuters

What is a mistake you have seen CPAs make when selecting a write-up solution?

Any top-grade professional solution will integrate with many SMB (small to medium business) products and financial institutions, and have generic importing capabilities. Fortunately, the newest software can all but eliminate manual information gathering and data entry by using a single, online platform that is accessible to both the accountant and the client through a secure, online meeting place. When the client enters data as part of day-to-day bookkeeping, that data is immediately available to the accounting firm. Many applications also offer advanced security features and the ability to tailor the software to fit each client’s business needs and level of sophistication. Accounting software must be flexible enough to handle diverse client needs in a variety of industries. Technology should facilitate quick client setup so that you can move on to revenue-generating activities and valued deliverables. Client setup can be a lengthy process that requires a significant amount of data entry, a fact that is often surprisingly overlooked when making a major software investment. Firms should verify that there are features for automated setup and ways to maintain consistency within your firm across clients.

What is a recommendation you would give CPAs who are selecting a write-up solution?

Automated information gathering can be an immense timesaver for clients, as well as the firm, so convincing them to make the switch may not be as difficult as you think. Sophisticated accounting applications can accept source documentation from a wide variety of third-party software applications, banks and financial institutions, and even fetch credit card transactions. Here is a checklist I recommend – today’s most progressive write-up software, for professional accountants, will accept data from a wide range of small business software, including:

• QuickBooks (versions, editions, including QuickBooks Online)
• Chart of accounts, transactions, customers, vendors and more from Microsoft Excel
• Bank and credit card statement information
• Real-time financial datafeeds

Details

Written by: Adam Fayne J.D.

Published: 07 December 2017

At the time this article was published, Donald Trump’s Unified Framework For Fixing Our Broken Tax Code (UFFOBT) has been known to the public for only a few weeks. The main principals are as follows:

Individual Taxes

The UFFOBT reduces the number of tax rates to three (from the seven in place today). The proposed rates are 12%, 25% and 35%. It is unknown what income will fall into each rate structure.

Increased Standard Deduction

UFFOBT increases the standard deduction for married couples to $24,000 and for single filers to $12,000. This increase will reduce the number of people who itemize their deductions on Schedule A.

Increased Child Tax Credit

It is unclear what this increased credit will be. UFFOBT requires the lawmakers to determine what amount this credit will provide. It will likely be higher than the $1,000-per-child credit provided today.

Limit or Eliminate Deductions, AMT, and the Estate Tax

UFFOBT proposes to eliminate the state and local tax deduction, personal exemption allowances, abolish the Alternative Minimum Tax, and abolish the Estate Tax.

Business Tax Changes

Corporate rates would be reduced from today’s 35% rate to 20%. Pass-through entity profits would be taxed at a rate of 20%, reduced from highest individual rate today of 39.6%.

Foreign Earnings

United States business, today, pay a 35% tax on overseas profits when they repatriate them to the United States. UFFOBT would reduce this rate to equal the tax rate where the funds are earned abroad with a minimum foreign tax (to avoid shifting income to low tax jurisdictions). UFFOBT would also propose a one-time “tax holiday” whereby companies may repatriate their foreign profits at a very low tax rate.

2017 Tax Planning

It is difficult to plan around the UFFOBT since it is unclear what, if anything, will become final law. We anticipate this proposal to be very fluid and it is highly unlikely that any tax reform will be identical to what is proposed today under UFFOBT. With that said, we all know there will not be any change for the worse in 2018. As a result, our advice is to sit-tight and hope for the best.

The one item to be delicate with is estate planning. We certainly want to plan to take advantage of yearly allowances and exemptions in planning, but we would be reluctant today to establish any long term vehicles, unless absolutely necessary, since there is the chance that the estate tax will be abolished.

Adam Fayne is an attorney with the law firm of Arnstein & Lehr LLP. He may be reached at 312-876-7883 or This email address is being protected from spambots. You need JavaScript enabled to view it..