Year-End Tax-Planning Moves for Businesses

By Mayer Nazarian

In our last post, we discussed advisable year-end tax-planning moves for individuals under current tax laws. Here, we’ll discuss actions businesses may consider before the end of the year to minimize their own tax obligations. This is by no means an exhaustive list, but it should provide some jumping-off points for your conversations with your tax planning professional. 

• Employers must withhold additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take this into account when figuring their estimated tax. And, there could be situations where an employee is required to have more withheld toward year-end to cover the tax.  For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax, since wages from each employer do not exceed $200,000. 

• A business should consider accelerating income from 2015 to 2014 where doing so would prevent the business from moving into a higher bracket next year.  Conversely, it should consider deferring income until 2015 where doing so will prevent the business from moving into a higher bracket this year.

• A corporation should consider deferring income until next year if doing so will preserve the corporation's qualification for the small corporation alternative minimum tax (AMT) exemption for 2014.

• A corporation (other than a "large" corporation) that anticipates a small net operating loss (NOL) for 2014 (and substantial net income in 2015) may find it worthwhile to accelerate just enough of its 2015 income (or to defer just enough of its 2014 deductions) to create a small amount of net income for 2014. This will permit the corporation to base its 2015 estimated tax installments on the relatively small amount of income shown on its 2014 return, rather than having to pay estimated taxes based on 100% of its much larger 2015 taxable income.

• If your business qualifies for the domestic production activities deduction for its 2014 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies (the deduction is based upon revenue generated from qualifying activities – typically the manufacture, growth, production, or extraction of tangible property; the production of film, sound recording or software; or the performance of construction, engineering or architectural services –within the United States). If your business qualifies, consider ways to increase 2014 W-2 income, e.g., by bonuses to owner-shareholders whose compensation is allocable to domestic production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2014, even if the business has a fiscal year. 

• To reduce 2014 taxable income, consider deferring a debt-cancellation event until 2015.

• To reduce 2014 taxable income, consider disposing of a passive activity in 2014, if doing so will allow you to deduct suspended passive activity losses. 

• If you own an interest in a partnership or S corporation, consider whether you should increase your basis in the entity so you can deduct a loss from it for this year.

Don’t hesitate to contact our firm if you’re considering taking any of the above actions or would like to consider other possibilities available in your particular situation to minimize tax liabilities in 2014.

Year-End Tax Planning Moves for Individuals

By Mayer Nazarian

Your year-end tax planning may be particularly challenging this year, as Congress has yet to act on a host of tax breaks expiring at the end of 2014. The fate of these tax breaks may not be clear until the end of the year, or possibly the beginning of next year.

For individuals, these breaks include the option to deduct state and local sales and use taxes instead of state and local income taxes, the above-the-line deduction for qualified higher education expenses, tax-free IRA distributions for charitable purposes by those age 70 ½ or older, and the exclusion for up to $2 million of mortgage debt forgiveness on a principal residence.

Our firm can help narrow down the specific actions that will help you save valuable tax dollars if you act before year-end. In the meantime, the following checklist outlines possible advisable actions for individuals under the current tax rules.

• Realize losses on stock while preserving your investment position. There are several ways to accomplish this. One example is to sell the original holding then buy back the same securities at least 31 days later.

• Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $14,000 in 2014 to each of an unlimited number of individuals, but you can't carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

• Postpone income or defer a bonus into 2015 and accelerate deductions into 2014 to lower your 2014 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2014 that are phased out over varying levels of adjusted gross income. These include child tax credits, higher education tax credits, and deductions for student loan interest. Note, however, that in some cases, it may pay to actually accelerate income into 2014 and defer expenses into 2015 if your marginal tax rate is expect to be substantially higher next year. 

• Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2014 deductions even if you don't pay your credit card bill until after the end of the year.

• You may be able to save taxes this year and next by applying a bunching strategy to "miscellaneous" itemized deductions (i.e., certain deductions that are allowed only to the extent they exceed 2% of adjusted gross income), medical expenses and other itemized deductions.

• You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.

• If you expect to owe state and local income taxes when you file your return next year, consider increased withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2014, if doing so won't create an alternative minimum tax (AMT) problem.

• You may want to pay contested taxes to be able to deduct them this year, while continuing to contest them next year.

• If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA, if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2014.

• If you converted assets in a traditional IRA to a Roth IRA earlier in the year and the assets in the Roth IRA account declined in value, if you leave things as is you will wind up paying a higher tax than is necessary. You can back out of the transaction by re-characterizing the conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA. You can later reconvert to a Roth IRA, if doing so proves advantageous.

• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70- 1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. 

Don’t hesitate to contact our firm if you’re considering taking any of the above actions to minimize your payments in 2014. In our next article, we’ll discuss specific considerations and advisable actions for businesses under current tax rules.

Can a California Employee Waive the Right to a Labor Commission Hearing as a Condition of Employment? The Jury is Still Out…

By David Kroll

If a California employer fails to pay wages, an employee may not want to file a lawsuit. Instead, he or she might seek administrative relief by filing a wage claim with the California Labor Commissioner.  An employee who files such a claim is entitled to a "Berman" hearing, which is conducted by a deputy labor commissioner. 

For employees, a Berman hearing is an attractive alternative to litigation.  The hearing is informal, so the rules of evidence don't apply.  That can help employees who represent themselves at the hearings— and the presiding deputy labor commissioners as well.  Indeed, those commissioners are required to interpret and apply state and related federal law, but don't need college degrees, let alone a law degree or any legal training.  And employers who think the deck is stacked against them may be right:  a 2012 analysis determined that commissioners routinely find in the employee’s favor at Berman hearings. 

There are other advantages to the Berman hearing procedure.  If the employee prevails, the employer must post a bond in the amount of the award.  Any "appeal" will be heard in the Superior Court, but the employee (and the employer) can introduce entirely new evidence.  The Labor Commission also represents indigent employees in court for free.  If the employer loses the appeal, the employer must pay the employee's attorney fees, but the employee is only liable for the employer's attorneys' fees if the court awards the employee zero. 

Because Berman hearings favor employees, employers may justifiably want prospective employees to waive Berman hearing rights in employment arbitration agreements.  It's not altogether clear if those waivers are enforceable, however. 

In 2011, the California Supreme Court held that the right to a Berman hearing can never be waived, but reversed itself two years later, after the United States Supreme Court rejected a similar California rule barring enforcement of class-action waivers in employment arbitration agreements. In reversing itself, the California Supreme Court expressed discomfort with Berman hearing waivers, noting that they'll be unenforceable if the arbitration agreement is "unconscionable" as a whole. This would occur if "the arbitral scheme imposes costs and risks on a wage claimant that make the resolution of the wage dispute inaccessible and unaffordable."  In other words, the waiver itself must be taken into account in deciding whether the agreement is unconscionable. 

Courts have already begun wrestling with this decision.  Earlier this year, the Fourth District Court of Appeal was able to duck the issue entirely, because the employment agreement excluded arbitration of "any matter within the jurisdiction of the California Labor Commissioner." In July, in an unpublished opinion issued after a Berman hearing occurred and the employee had received a substantial award, the First District Court of Appeal granted an employer's petition to compel arbitration, thus necessarily determining that a Berman hearing could be waived – without analyzing unconscionability at all.

Given the uncertainty in the law, employers should carefully review their arbitration agreements and employment handbooks with counsel, before considering whether or not they wish to provide for Berman hearing waivers.

Streaming for Dollars

By Michael R. Morris

I recently moderated a panel for the California Copyright Conference entitled “Streaming for Dollars,” that addressed the music industry’s current evolution from an “ownership” model to an “access” model.  Instead of purchasing CDs or permanently downloading songs via iTunes, Amazon, etc., a vastly increasing share of music listeners are choosing to stream music over the Internet via services such as Pandora, Spotify, and Sirius XM.  While these streaming services still pay royalties to artists, songwriters, music publishers, and record companies, the rates can be miniscule compared to the revenue artists receive from permanent CD and download purchases.  Understandably, this seismic shift in consumer consumption of music is a hot topic in the music industry.

Key factors differentiate royalties generated by the digital streaming of music from revenues attributable to permanent purchases and the traditional "terrestrial" broadcasting of music.  This is driven by the business and legal relationship between the streaming companies, performance rights organizations (or "PROs," which are BMI, ASCAP, and SESAC in the United States) and the record labels in the streaming age.  In the "old world," permanent sales of music represented the bulk of the music business— music was sold either as physical product (CDs) or as permanent downloads.  Record labels would get a wholesale price per CD from a distributor or digital seller (like Apple iTunes) and pay a royalty to the artist (a percentage based on a wholesale or retail price, depending upon the label and type of sale).

But when a song is streamed on‑demand via Spotify or by a non‑interactive company like Pandora, there are no traditional royalty-based sales.  Royalties get paid solely from the performances of songs and master recordings.  Thus, Spotify will usually pay royalties for the performances of the songs to the PROs via "blanket" licenses of the entire catalogs.  The PROs negotiate a "blanket" catalog license fee and then divide it between the songwriters and publishers based on the number of streams.  So, hypothetically, if ASCAP received a "blanket" license fee of $1,000,000 for a particular quarter from Spotify, in which there were 5 billion streams of the ASCAP catalog, the per stream rate would be $.0002.  Spotify also pays a fee to stream the sound recordings (via direct licenses with labels), but unlike non‑interactive services such as Pandora, these deals are neither set by statute nor publicly disclosed.  Also, major companies like UMG, Sony Music, and the Warner Group have taken stakes in Spotify and other streaming services, raising the issue of whether the labels are trading equity for lower royalty rates, which are shared with artists.

Non-interactive companies like Pandora and Sirius XM also pay royalties for the performance of songs and the master recordings embodying them.  However, the rates paid by Pandora and Sirius XM to broadcast songs are based on consent decrees dating back to the 1940's.  When such rates came up for renewal, Pandora, ASCAP, and BMI couldn't agree on new terms.  Pandora then sued ASCAP and BMI for a judicial rate court determination.  To the dismay of the PROs, the District Court decision upheld the current ASCAP-Pandora rate (1.85% of income) until December 31, 2015.  In response to mounting criticism about royalty rates based on antiquated consent decrees, the Department of Justice ("DOJ") announced it will review these consent decrees.  Hopefully, the DOJ will address the argument that the changing conditions in the music industry should enable PROs to negotiate performance rates to reflect free market conditions.  As Representative Doug Collins succinctly stated:  "Should Congress promote more music creation through less regulation?"

Pandora and Sirius XM also pay royalties from digital streaming of master recordings to labels and artists under the Digital Millennium Copyright Act and the Digital Performance Right in Sound Recordings Act, whose rates are set by statute.  Such royalties are collected and distributed by Sound Exchange.  However, to the chagrin of labels and artists, Pandora and Sirius XM don't pay on pre‑1972 sound recordings, which are not protected by federal copyright.  As a result, both the major labels and "heritage" acts like Flo & Eddie (Mark Volman and Howard Kaylan, p/k/a "The Turtles") have sued Pandora and Sirius XM under various state copyright and related intellectual property rights laws.  In a decision with far reaching effects, U.S. District Court Judge Phillipe Gutierrez held that under California law, Flo & Eddie owned exclusive rights to the public performance of their pre‑1972 recordings of such classics as "Happy Together" and "She'd Rather Be With Me."  The economic consequences of this ruling cannot be overstated – companies like Pandora and Sirius XM could end up paying hundreds of millions of dollars in additional royalties.  Not surprisingly, Sirius XM has appealed.  In the meantime, Flo & Eddie have brought similar suits in other states, while a group of labels is pursuing its own action against Pandora in New York.

The legal battles over what rates should be paid for the digital performance of songs and pre‑1972 master recordings are hardly surprising, and the Flo & Eddie California case may open a floodgate of litigation.  This was predictable, given overall U.S. music revenue during 2013 was flat at $4.47 billion, down from a $14.6-billion peak in 1995. While consumer appetite for streaming music has grown exponentially and seems insatiable, digital revenues have not even remotely kept pace.

Certainly Spotify, Pandora, and similar services enable more people to experience a wider variety of music, arguably providing more access to and exposure for artists than ever before.  But present music streaming models haven't materially offset lost permanent sales revenues.  In this climate, music creators have and will continue to suffer.  Consumer habits have changed, and the economics of the music industry in a streaming world must change as well.

Gold Diggers Beware

By Lynda Chung

In the world of trust and estate litigation, claims of undue influence are nothing new. These suits usually concern a caregiver, mistress, or other interloper coercing an unfair share of an inheritance from the deceased.  However, far less common are undue influence cases brought against the wife of the deceased. That is … until a case earlier this year made it clear that marriage is not a license to steal. Indeed, all would-be “gold-diggers” should take note, as this decision is a potential game changer.

In this case, the deceased took the defendant as his third wife in 1999. After divorcing six months later, the couple remarried in 2005. The deceased was a retired real estate magnate worth millions, and had multiple children and grand children from previous marriages, while the defendant had two children of her own. Needless to say, this type of blended-family can be a powder keg when it comes to inheritance.

At the time of his marriage, most of the decedent’s real estate holdings were kept in a trust, which provided for his children and grand children. However, in mid-2005 (after remarrying Wife No. 3), he began introducing a series of amendments to the trust, providing his wife with more and more of his inheritance, and finally giving her the power to disinherit his own children altogether after his death.

Upon his death, his eldest children brought a suit alleging the defendant unduly influenced the deceased into modifying his trust, and that the way in which she freely spent her husband’s money constituted a breach of fiduciary duty. The court found that the deceased “did not know the extent of [defendant’s] spending,” and that “while it is not uncommon for a spouse to spend money or purchase items of which the other is unaware, and the line between such conduct and financial abuse is not always clear, what [defendant] did in this case went well beyond the line of reasonable conduct and constituted financial abuse.”

Widespread financial conflict in blended families is already quite common, but the result of this decision could have far reaching implications for future situations in which a new spouse attempts to disinherit the rest of the family. 

Non-Profit Corporations Must Operate Pursuant to the Rules

By Arlen R. Gunner

I was recently asked to serve as an expert witness in a case that demonstrates the abuse that occurs when people form a non-profit for the sole purpose of personal gain.

As an experienced attorney representing non-profits, I was hired by the plaintiff’s attorney to testify as an expert witness against the founders of a non-profit organization. Rather than using the money raised for the mission of the organization, they were using the entity as their personal piggy bank and had already pocketed large amounts of cash.

They had no interest in running a charitable organization for the public benefit; they were out to milk the business for themselves. Ignoring even the most basic rules, they controlled everything and hired “front men” to run the charity. These individuals were highly paid and were used to front the organization.  Although they were officers of the entity, they were never allowed to review financial statements, attend board meetings, or run the business.

Over the course of my preparation to be deposed, I discovered that this wasn’t the first time they had carried out this scheme. The founders had a history of using a non-profit corporation as a vehicle to line their own pockets.  This is a serious offense, and violates both California and IRS rules for tax-exempt organizations. Finally the IRS pulled the plug on them and revoked their 501(c)(3) status.

As part of the suit against the founders for the recovery of lost funds, I was deposed by the defendants' counsel. When the nitty-gritty details were laid bare, the defendants’ legal team eventually determined they were fighting a lost cause and offered to settle.

The lesson to be learned is that there are very specific rules and requirements to operate a non-profit corporation. Non-profits are not a vehicle for personal enrichment. Business must be conducted in accordance with the mission for which the non-profit was formed.

To obtain tax-exempt status, the corporation must file an application with the IRS and, if granted, it must also obtain exemption from state taxes as well. Once a non-profit entity is formed, a trust is legally impressed upon its assets, which are held for the benefit of the public. The attorney general is responsible for preserving those assets. If you violate non-profit rules, the attorney general and/or the IRS have broad enforcement power to pursue the entity and those who violated the law, in addition, you will likely face the repercussions from those whose funds have been collected under false pretenses.