Accounting Memo John and Jane Smith Add,

Accounting Memo

John and Jane Smith

Add, NearLakes CPA Services

RE:

Tax Implications

Mr. And Mrs. Smith:

I have carefully reviewed the materials from our recent meeting and have the following information and recommendations for your situation:

Under U.S. Tax law, Gross Income is defined as compensation for fees, services, commissions and similar items (26 CFR 1,61.2) (Internal Revenue Service, 2013). In this case, the income derived from a client in a personal injury case is considered taxable income. The IRS would expect that you note this as income to the firm and would expect an estimated tax be paid. Based on a simple calculation from the IRS site, and treating this $300,000 as a bonus, we would recommend that you make a payment of $85,048 in Estimated Taxes by the end of next quarter. Failure to do so might cause the IRS to levy additional penalties when the tax return is filed for next year, their assumption being that you recovered this money now, and knew it would be taxable (Internal revenue Services, 2014).

1b. While your firm paid out $25,000 in expenses, you were reimbursed for those expenditures. They were legitimate means of preparing for trial and for materials and needs during the trial process. Those expenditures will be taken into consideration as line item expenses on the yearly tax return, and will likely expand based on additional materials for this, and other trials. For instance, certain additional expenses (meals, lodging, etc.) may not have been billed to the client, but other expenses were billed and monies received. The money received will go into your accounting line item as "Reimbursements" on an Income Account and will therefore be part of your annual income. Per IRC section 162(a) I would recommend that you set aside at least 20% of the expenses into an account in anticipation of tax liability, due to the lack of complete clarity from the above exception. However, not prepaying anticipated tax should not likely be penalized (Internal Revenue Service, 2013).

1c. You do not mention a few potential issues within your personal and professional life that might help offset tax liabilities when you have a large settlement. The new tax law requires taxpayers to reduce exemptions by 2% for every $2,500 over an income of $250,000-$300,000. You might consider making an S Corp election and being paid a reasonable salary and thus reducing net profit on your income. This would keep funds within the corporation for use, but not be subject to the same taxable percentage. You could also use a material participation exception, which can be worked out based on the distribution rights of those involved in your firm. Depending, too, on your estimate of final earnings within this fiscal year, we might look at a Zeroed-Out grantor Annuity Trust (GRATs) which would defer income as an annuity for retirement or later in life (Kilham, 2013; Bilodeau, 2011).

1d. The issue surrounds the benefits of either purchasing or leasing your building space based on tax implications for this fiscal year, and assuming the next few years. The situation is complicated by a number of factors: strength of the real estate market, tax implications and future plans. If you have solid capital and your long-term business plan supports purchasing a tangible asset, then purchasing could be a solid deal. Right now you are paying $3,500/month on your lease, or $42,000 per annum. We do not know the purchase price of your building, and you do not mention if you would utilize the entire building, or lease some of it out and retain some additional income (and responsibility for maintenance, etc.). Due to your position with excess cash, and assuming the building will be large enough for your firm (and perhaps rental space) over the next 5 years, you would need to understand this as an investment. You are able to deduct the full amount of rent, but you can only write off building repairs immediately, improvements and depreciation can only be deducted over 39 years. However, you can deduct interest on the purchase of the property, taxes, and other qualifying expenses. Again, depending on the cost of the building, the interest on your loan, etc. this would need to exceed $42,000 per annum to be a viable tax strategy -- noting of course, that you would have to include income from any tenents that may offset those deductions. When you have the actual figures available, we can review this in a spreadsheet and estimate a 5 and 10-year potential situation from purchasing or leasing (Etter & Caldwell, 2005).