Fall 2014 Volume XIX, No. 1 Newsletter

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Fall Notes:

winterSince our last newsletter, we’ve enjoyed our busiest tax season to date and have worked diligently to complete any outstanding tax returns. On the corporate side, things have gone very smoothly – our fabulous bookkeepers, Becky and Robin, continue to provide their expertise with QuickBooks. Ellen Silverstein has been my right-hand associate for over twenty years and continues to assist in tax preparation and review. On the individual tax side, I have reached out to many of you this summer in order to make some important changes. While the individual tax returns we have issued have resulted in no inquiries, no IRS letters, and no audits, I was not particularly happy with the turn-around times which we try to keep at no more than ten days. By reaching out to individual tax clients, I was able to fix what I perceived as a problem over this summer.

One of our goals for 2014 is to increase our business in the area of personal financial planning, and to that extent, I invite each of you to visit with me and explore how we can help you to meet your goals and increase the quality of your life. I would like to thank the many individuals who have come in to visit with us – I think you’ll agree that it has been time well spent.

I am happy to report that we will be hosting another fabulous dinner seminar on Thursday, September 18th at 6:00 p.m. The location once again will be the private room at Eggspectation in Ellicott City. Titled “Investing in Uncertain Times”, our colleagues from Scott & Stringfellow/Choice Portfolios will look at current world events & market conditions in order to advise you as to what the next twelve months should hold for individual investors. There is no cost to attend and you may RSVP at our number below anytime. We would love to have you…

On a personal note, we have a new college graduate – Eric has graduated from the University of Maryland, College Park. Lisa is just beginning her sophomore year at Emory University in Atlanta, where she carries a perfect grade point average. Michele continues to excel at the Federal Finance Housing Agency, where her responsibilities include regulating Fannie Mae & Freddie Mac. She has just passed her 25th year in government service.

S-Corporations — Reasonable Compensation:

Mr. David Watson, a CPA, formed a professional corporation, elected to be a Sub-S corporation and employed himself, receiving $24,000 annually in W-2 wages. The entity’s net income however, was in excess of $200,000. The remaining amount was paid to Watson as a non-wage distribution. Upon audit, the IRS asserted that most of the income realized by the entity should be re-characterized as wages to Watson, as his salary of $24,000 wasn’t a reasonable wage. The courts affirmed the IRS position in the most recent example in a long line of similar decisions (Watson P.C. vs. United States), also (Radtke, S.C. vs. United States).

Although the S-Corporation structure is sometimes motivated by a desire to minimize employment taxes, S-Corporations must pay a reasonable wage compensation to a shareholder-employee in return for services that the employee provides to the corporation, before non-wage distributions may be made to the shareholder-employee. In the event the IRS determines that reasonable wages are not being paid, distributions may be re-characterized as wages (Joly vs. Commissioner).

Since most of our corporate clients are S-Corps, we begin by asking the owner(s) how much they would require in wages to perform the same services, with the same responsibilities, for another company. This allows us to determine whether there is a good chance that their salary is set unreasonably low. In our practice, we constantly check officer salaries to ensure their conformance with generally accepted
IRS guidelines.

Thirsty for Income? Try Dividend Growth:

Chasing yield has become a challenging mission for investors in recent years. As yields collapsed in fixed income, investors flocked to bond-like substitutes such as high dividend yielding stocks. Now that these stocks have become pricey, companies with strong dividend-growth potential offer a better way to source equity income.
There are many ways to look at dividends. Dividends can help raise returns and lower investment volatility. Financial professionals typically measure volatility by standard deviation. Put simply, investments with a low standard deviation historically have been less volatile than investments with a high standard deviation. Also a history of paying dividends can tell us a great deal about a company. For example, companies that regularly pay dividends often are:

Aligned with shareholder interests. Dividends are the ultimate proof that stocks are not just pieces of paper. They represent ownership in real businesses.

Managed with discipline. If a company is committed to paying a specific percentage of earnings (or cash flow) every year as a dividend, it requires the firm’s officers to be better stewards of capital.

Expressing management’s confidence in its future prospects. Paying dividends can send a powerful signal to the market. It suggests that a company has confidence in its earnings, balance sheet and cash flow.

A good starting point for the novice investor is a company’s payout ratio, which measures the proportion of net income that a company pays out to shareholders. At the end of 2013, U.S. companies were only paying out one third of their earnings as dividends, well below the average of the past 60 years. Payout ratios matter. When they’re low, the ratios tell us that many companies have lots of room to raise dividends. And since U.S. companies have record cash positions and solid balance sheets today, it’s easy to envision how dividend payouts can increase.

Finding income is still high on the agenda of many investors. Yet traditional sources of yield in fixed-income & equity markets have simply become overpriced. It’s definitely possible to find stocks with higher dividend yields today. But we believe that companies with low payout ratios and high dividend-growth potential can provide investors with a better way to earn income over the long term (Examples: Intel, Conoco Phillips, T. Rowe Price, Visa).

2014 Standard Mileage Rates:

The Internal Revenue Service issued the 2014 standard rates used to calculate the deductible costs of operating an automobile for business, medical or moving purposes. Beginning on January 1, 2014 the standard mileage rates for the use of a vehicle are:

  • 56 cents per mile for business miles driven
  • 23.5 cents per mile driven for medical or moving purposes
  • 14 cents per mile driven in service of charitable organizations

The business, medical, and moving expense rates decreased one-half cent from the previous year, based on an IRS assessment of the fixed costs to operate a motor vehicle. Taxpayers always have the option of calculating the actual costs of using their vehicles for business, or using the standard mileage rates. We find in our practice that the IRS approved standard mileage rates are fairly easy to track, simple to transfer onto tax forms, have reduced audit risk and compensate taxpayers fairly for their auto usage.

IRA Rollovers — Beware!

In late January 2014 the Tax Court ruled on a case involving a taxpayer who made two IRA rollovers, each from a different IRA. The Tax Court concluded that the second IRA rollover was a taxable event because only one rollover is permitted per year, even though this contradicted the IRS’s own Publication 590. Taxpayers should be forewarned – regardless of what the IRS’s own publication says, performing more than one IRA rollover within a 12-month period results in unintended taxable income.
In our practice, we have been warning our clients for years about this possible conflict. What we recommend in this situation is a direct custodian-to-custodian transfer. Because the funds do not pass through the taxpayer’s hands in direct transfers, this is not considered a rollover (Rev. Ruling 78-406).

Closing:

During the course of the year, we have many Baltimore Orioles baseball tickets and Maryland Terrapin & Washington Wizards basketball tickets. If you are interested in attending a game, please don’t hesitate to call.

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Matthew R. Horowitz, C.P.A.
(410) 312-7622 • email
10015 Old Columbia Rd. Suite B-215, Columbia, Maryland 21046