Determining a “Reasonable” Compensation for an S-Corp Owner-Employee

S-Corps must pay reasonable 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. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.

The instructions state "Distributions and other payments by an S-Corp to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."

If payments by an S-Corp to a corporate officer are not reasonable in comparison to the services provided, several court cases support the authority of the IRS to reclassify other those payments to a shareholder-employee as a wage expense which are subject to employment taxes.

The key to establishing reasonable compensation is determining what the shareholder-employee did for the S-Corp. As such, we need to look to the source of the S-Corp's gross receipts.

The three major sources are:

1.      Services of shareholder,

2.     Services of non-shareholder employees, or

3.     Capital and equipment.

If the gross receipts and profits come from items 2 and 3, then that should not be associated with the shareholder-employee's personal services and it is reasonable that the shareholder would receive distributions along with compensations.

On the other hand, if most of the gross receipts and profits are associated with the shareholder's personal services, then most of the profit distribution should be allocated as compensation.

In addition to the shareholder-employee direct generation of gross receipts, the shareholder-employee should also be compensated for administrative work performed for the other income producing employees or assets. For example, a manager may not directly produce gross receipts, but he assists the other employees or assets which are producing the day-to-day gross receipts.

Some factors in determining reasonable compensation:

· Training and Experience
· Duties and Responsibilities
· Time and Effort Devoted to the Business
· Dividend History
· Payments to Non-Shareholder Employees
· Timing and Manner of Paying Bonuses to Key People
· What Comparable Businesses Pay For Similar Services
· Compensation Agreements
· The Use of a Formula to Determine Compensation

CHRIS HEAD | CPA/ CDFA/ CFP/ ESQ/

ATTORNEY | ACCOUNTANT | ADVISER
Office: (612) 405-2192 | Fax: (612) 568-4946
Email: chrishead@jamesdaeh.com

JAMES DAEH pllc (pronounced "JAMES DAY")

TAX | LEGAL | FINANCIAL

Qualifying for Medicaid & Transferring Assets

Ineligible Transfers

For anyone considering long-term medical care with the hope of Medicaid picking up the bill, be aware of the asset transfer trap. Congress imposed a period of Medicaid ineligibility for applicants who transfer assets during the five (5) years prior to receiving any benefits.

For transfers made prior to February 8, 2006, state Medicaid officials would look only at transfers made within the 3 years prior to the Medicaid application (or 60 months if the transfer was made to or from certain kinds of trusts). But for transfers made after February 8, 2006, the so-called "look-back" period for all transfers is five (5 year or 60 months). What this means is that any transfer of assets greater than $1,000 or multiple transfers totaling more than $1,000 will most likely be penalized for Medicaid eligibility purposes.

Penalty Period

While the look-back period determines what transfers will be penalized, the length of the penalty depends on the amount transferred. The penalty period is determined by dividing the amount transferred by the average monthly cost of nursing home care in the state. For instance, if the nursing home resident transferred $100,000 in a state where the average monthly cost of care was $5,000, the penalty period would be 20 months ($100,000/$5,000 = 20). 

The 20-month period will not begin until (1) the transferor has moved to a nursing home, (2) has spent down to the asset limit for Medicaid eligibility, (3) has applied for Medicaid coverage, and (4) has been approved for coverage but for the transfer. Therefore, if an individual transfers $100,000 on April 1, 2013, moves to a nursing home on April 1, 2014, and spends down to Medicaid eligibility on April 1, 2015, that is when the 20-month penalty period will begin, and it will not end until December 1, 2016.

Consequently, transfers should be made carefully, with an understanding of all the consequences. People who make transfers must be careful not to apply for Medicaid before the five-year look-back period elapses without first consulting with an elder law attorney. This is because the penalty could ultimately extend even longer than five years, depending on the size of the transfer.

Old Rule and Asset Transfer Strategy 

One of the prime planning techniques used before the enactment of a 2005 law (the Deficit Reduction Act of 2005 or DRA), often referred to as "half a loaf," was for the Medicaid applicant to give away approximately half of his or her assets. 

It worked this way: before applying for Medicaid, the prospective applicant would transfer half of his or her resources, thus creating a Medicaid penalty period. The applicant, who was often already in a nursing home, then used the other half of his or her resources to pay for care while waiting out the ensuing penalty period. After the penalty period had expired, the individual could apply for Medicaid coverage.

Example: Mrs. Jones had savings of $72,000. The average private-pay nursing home rate in her state is $6,000 a month. When she entered a nursing home, she transferred $36,000 of her savings to her son. This created a six-month period of Medicaid ineligibility ($36,000/$6,000 = 6). During these six months, she used the remaining $36,000 plus her income to pay privately for her nursing home care. After the six-month Medicaid penalty period had elapsed, Mrs. Jones would have spent down her remaining assets and be able to qualify for Medicaid coverage.

One of the main goals of the 2005 law was to eliminate this kind of planning. To determine whether it is still an available strategy in your state, you will have to consult with a local elder law attorney.

Be very, very careful before making transfers. Any transfer strategy must take into account the nursing home resident's income and all of his or her expenses, including the cost of the nursing home. Bear in mind that if you give money to your children, it belongs to them and you should not rely on them to hold the money for your benefit. However well-intentioned they may be, your children could lose the funds due to bankruptcy, divorce, or lawsuit. Any of these occurrences would jeopardize the savings you spent a lifetime accumulating. Do not give away your savings unless you are ready for these risks.

In addition, be aware that the fact that your children are holding your funds in their names could jeopardize your grandchildren's eligibility for financial aid in college. Transfers can also have bad tax consequences for your children. This is especially true of assets that have appreciated in value, such as real estate and stocks. If you give these to your children, they will not get the tax advantages they would get if they were to receive them through your estate. The result is that when they sell the property they will have to pay a much higher tax on capital gains than they would have if they had inherited it.

As a rule, never transfer assets for Medicaid planning unless you keep enough funds in your name to (1) pay for any care needs you may have during the resulting period of ineligibility for Medicaid and (2) feel comfortable and have sufficient resources to maintain your present lifestyle.

Remember: You do not have to save your estate for your children. The bumper sticker that reads "I'm spending my children's inheritance" is a perfectly appropriate approach to estate and Medicaid planning.

Even though a nursing home resident may receive Medicaid while owning a home, if the resident is married he or she should transfer the home to the community spouse (assuming the nursing home resident is both willing and competent). This gives the community spouse control over the asset and allows the spouse to sell it after the nursing home spouse becomes eligible for Medicaid. In addition, the community spouse should change his or her will to bypass the nursing home spouse. Otherwise, at the community spouse's death, the home and other assets of the community spouse will go to the nursing home spouse and have to be spent down.

Permitted Transfers

While most transfers are penalized with a period of Medicaid ineligibility of up to five years, certain transfers are exempt from this penalty. Even after entering a nursing home, you may transfer any asset to the following individuals without having to wait out a period of Medicaid ineligibility:

• Your spouse (but this may not help you become eligible since the same limit on both spouse's assets will apply)
• Your child who is blind or permanently disabled.
• Into trust for the sole benefit of anyone under age 65 and permanently disabled.
• In addition, you may transfer your home to the following individuals (as well as to those listed above):
• Your child who is under age 21.
• Your child who has lived in your home for at least two years prior to your moving to a nursing home and who provided you with care that allowed you to stay at home during that time.
• A sibling who already has an equity interest in the house and who lived there for at least a year before you moved to a nursing home.

CHRIS HEAD | CPA/ CDFA/ CFP/ ESQ/
ATTORNEY | ACCOUNTANT | ADVISER
Office: (612) 405-2192 | Fax: (612) 568-4946
Email: chrishead@jamesdaeh.com

JAMES DAEH pllc (pronounced "JAMES DAY")

TAX | LEGAL | FINANCIAL

5 Things Every Woman Should Know About Social Security

There are many things a woman should know about Social Security. Here are five of the most important Social Security messages every woman should know.

If You’re Divorced And Were Married More Than 10 Years, You’re Eligible For Some Of Your Ex-Husband’s Social Security Benefits

·       Divorced women married more than 10 years are eligible for Social Security benefits on the ex- husband’s record if they are unmarried at the time they become eligible for Social Security benefits (age 62).

·       Some women sign divorce decrees relinquishing their rights to Social Security on their ex-husband’s record; however, so long as you were married more than 10 years, those clauses in divorce decrees are worthless and are never enforced.

·       Any benefits paid to a divorced spouse DOES NOT reduce payments made to the ex-husband or any payments due the ex’s current spouse if he remarried.

·       Generally, the same payment rules apply to divorced wives and widows as to current wives and widows. That means most divorced women collect their own Social Security benefits while their ex-husband is alive, but can apply for higher widow’s rates when he dies.

When Ex-Husband Dies, You’re Probably Due A Widow’s Benefit

·       Widows are due between 71 percent (at age 60) and 100 percent (at full retirement age) of what their husband or ex-husband was getting before he died.

·       But Social Security must pay your own retirement benefit first, then supplement it with whatever extra benefits you are due as a widow to take your Social Security benefit up to the widow’s rate.

·       Social Security can also pay you a $255 one-time death benefit if you were living with your husband when he died.

·       If you made more money than your husband, then he might be due a widower’s benefit on your record if you die before he does.

Nothing Keeps You From Getting Own Social Security Benefit

·       If you’ve worked for at least 10 years and earned a minimum of 40 work credits, you are vested in the Social Security system.

·       Once you reach age 62, you will be eligible for your own Social Security benefit whether you’re married or not and whether your husband collects Social Security or not.

·       Your retirement benefit is figured the same way a man’s retirement benefit is figured. It’s based on a percentage of your average monthly wage using a 35-year base of earnings.

·       If you become disabled before your full retirement age, you might qualify for Social Security disability benefits if you’ve worked and paid Social Security taxes in five of the preceding ten years.

·       If you also get a pension from a job where you didn’t pay Social Security taxes (e.g., a civil service or teacher’s pension), your Social Security benefit might be reduced.

There Is No Penalty Or Limit To Benefits Paid To A Married Couple

·       If you are married and both you and your husband have worked, you will each be paid your own Social Security benefit.

·       A working woman is not limited to one-half of her husband’s Social Security. (That rate applies to women who never worked outside the home.)

·       So, for example, if you are due a Social Security benefit of $1,200 per month and your husband is due a Social Security benefit of $1,400 per month, you will be paid $2,600 per month in retirement benefits.

If You’re Due Two Benefits, You Get The One That Pays The Most

·       Most women are potentially due two benefits: your own retirement benefit and wife’s benefit on your husband’s record.

·       But you only get the one that pays the higher rate, not both.

·       A wife is due between one-third and one-half of her husband’s Social Security.

·       Most working women who reach retirement age get their own Social Security benefit because it’s more than one-third to one-half of the husband’s rate.

·       But if your husband dies before you, you can apply for the higher widow’s rate. 

Seven Tax-Smart Ways to Educate Your Kids

Tax-smart education planning is all about putting dollars in the hands of that student in your life, to pay for an education in a manner that results in tax savings to you, no tax to the student, or both.

In these cases, you’re causing the taxman to partner with you in paying for that education. Here are seven creative ideas to consider.

1. Scholarship dollars. Last week I talked about the fact that scholarship dollars can be tax-free for a student – and won’t come from your pocket. Encourage your child to apply for various scholarships up to one year ahead of attending school. As a start, take a look at the following websites for specific scholarships available: www.scholarshipscanada.com,www.yconic.com, and www.canlearn.ca.

2. Wages from a family business. If you happen to own a business – full- or part-time – and are looking for ways to save tax, consider paying your child to work in the business. You can pay reasonable wages which are deductible against your business income. If your child’s total income is under $11,474 (the basic personal amount in 2016), she won’t pay any tax on those wages. These dollars can be used to pay for education. Effectively, you will have deducted the costs of education from your business income. Don’t have a business? Consider starting one part-time to create the opportunity to claim deductions like this.

3. Loans from a parent’s corporation. If you have a corporation, it’s possible for your company to lend money to your child to pay for an education. The amount will be taxed in the hands of your child if it’s not repaid within one year of the company’s year-end. No problem. If your child’s total income is under $11,474 in 2016, including the amount of the loan, then your child won’t face tax. Here’s the best part: When your child has graduated and is working, he can repay the loan at that time and will receive a deduction for the amount repaid. That’s right. No tax when the loan is made, in my example, but a valuable deduction later when your child can use it.

4. Helping in a family move. If you plan to move in the near future and are eligible to deduct the costs (such as for work, etc), consider paying a child who is 18 or older to help in the move. If you’re otherwise eligible to deduct moving expenses, you’ll be able to deduct these wages. Your child can then use those dollars to contribute toward an education. Your child will have to report the wages as income, but won’t face tax if his taxable income is less than $11,474 in 2016.

5. Looking after younger siblings. Pay your adult child (18 or older) to look after the younger ones (16 or younger) and you may be able to claim the amount paid as child-care expenses if you otherwise qualify to deduct child-care costs. Your child can use those dollars to help pay for school, and won’t face tax if her taxable income is under $11,474 in 2016.

6. Investing gifts from mom and dad. Consider a registered education savings plan (RESP) to set aside funds for your child. Contributions can come with a Canada Education Savings Grant (CESG), which I’ve written about before. Also, consider setting up in-trust accounts for your minor children and invest for growth in those accounts. Any capital gains over time will be taxed in the hands of your child, who will likely pay little or no tax. Your child can use those funds for education later (although she won’t be obligated to do that; still, you likely carry some moral suasion on that point).

7. Transferring certain tax credits to a parent. A student is entitled to tuition, education and textbook tax credits (the latter two disappear in 2017 and later years). These can be transferred to a parent (or spouse) if the student doesn’t need them to reduce taxes to zero.