DATA SECURITY by John Ratcliffe

On October 30, 2009 the Massachusetts Office of Consumer Affairs and Business Regulation filed its final amended regulation for 201 CMR 17.00 (aka "The Massachusetts Data Security Regulation"). The regulation requires persons (including out of state persons) who "own or license personal information about a resident of the Commonwealth" to comply with strict requirements to safeguard such personal information. Information includes:

• social security numbers
• drivers license or state-issued identification numbers
• financial account numbers, credit or debit card numbers, (with or without any security code that would permit access to a resident's financial account).

The regulation does not discriminate between a small business and a large business but must be implemented by all who store, transmit or have access to the aforementioned personal information. The regulation was required to be implemented in 2010.

In anticipation of the proposed regulation we at Pavento, Ratcliffe, Renzi & Co., LLC completed our implementation in 2009 and continue to refine the process. In my opinion regardless if you meet the criteria it is a good business practice to implement some of the key areas of the regulation, if for no other reason than to allow you to sleep better at night. There is not a week that goes by that you do not hear about another data security breach.

So for the small business what does the regulation entail? The first step in the process is to look at the data you maintain both in paper and electronic form to determine if are required to implement the data security regulation. Once you have identified the data, you must design procedures to ensure that data is secure. Most businesses have both paper and electronic records. Here are some areas that I feel are key areas to review:

1) Paper file storage and data destruction policies
2) Paper files in employee possession both inside and outside of the office
3) E-mail policies
4) Network password policies
5) Network security policies
6) Network firewall and related policies
7) Electronic file transmission policies
8) Electronic data storage and achieving policies
9) Laptop and Desktop security policies (passwords and encryption)
10) Smart phone data and e-mail policies

Next you begin the process of implementing a plan. Address the areas of highest risk first. As an example, if you allow remote access to your network and have an outdated firewall appliance, consider upgrading that first.

Then look at what types of data are being transmitted via e-mail. Data transmission is an area that everyone in our firm is very cautious about as tax returns include social security numbers. We have two ways that we transmit files 1) we utilize an email encryption service which is used for any transmission of files that meet the criteria that we have set forth as sensitive data; 2) we maintain a client portal with multi-layer security to allow for a secure exchange of data. Our clients seem to prefer the portal over the e-mail encryption as the portal does not slow their e-mail down with large file transmissions.

As you go through the process of implementing a solution for each area that impacts your business, document the process. Once you have all areas documented, write a formal data security plan and update it frequently as your situation changes.

Finally, the most important step in any plan is to monitor and test the policies you have implemented. As an auditor I cannot stress enough the importance of this step.

Whatever you decide to do is a personal business decision. Doing something is better than doing nothing and may very well prevent you from being the next company in the news! Pavento, Ratcliffe, Renzi & Co., LLC is available for guidance in the development of your data security plan.

6 Tax-Smart Ways to Help your Kids (or Grandkids) by Karla Hopkins

Uncle Sam (and some states) will reward you for helping your children or grandchildren. Several tax-smart ways are:

 Contribute to a 529 Plan. Money in a 529 Plan can be used tax-free for college costs. It is good idea for parents and grandparents to open separate accounts for a child. There is no limit on the number of 529 Accounts that can be open for one child.
 Get a gift tax break from 529 contributions. You can generally only gift up to $13,000 per person in 2011 but you can make 5 years' worth of 529 contributions all in one year without triggering the gift tax.
 Get a tax credit for tuition payments. The American Opportunity Credit can cut your tax bill by up to $2,500 per student. There are certain income limitations and other specifics for this credit but it is a dollar-for-dollar reduction in your tax liability.
 Pay tuition directly to a college. Direct payments to educational institutions are excluded from the annual $13,000 gift limit. This rule applies to anyone and is particularly popular with grandparents. Only tuition qualifies, NOT room and board.
 Help your kids or grandkids contribute to a ROTH IRA. As long as they have earned income, they qualify for a ROTH. Since most kids don’t want to stash away all their paychecks for the future, you can give them the money for their contributions. While there is no tax break to you, the kids will reap the benefit in the future.
 Open a custodial account for a child. This is not a big tax break strategy but is a great tool for teaching kids about money and savings. The child will take over the account when they turn 18 but until them, you can manage it together.

With all of these areas, it is important to consider the impact any or all of these have on various forms of financial aid and your ability to pay for college. Contact your tax and financial advisors to coordinate an effective savings plan.

How to Substantiate Deductible Mileage by Karla Hopkins

The Internal Revenue Service designates standard mileage rates for tax deductions for individuals. The standard business rate was recently increased to 55.5 cents a mile for all business miles driven from July 1, 2011, through Dec. 31, 2011. This is an increase of 4.5 cents from the 51 cent rate in effect for the first six months of 2011. The intent of the standard rate is to simplify the amount of record keeping that must be done to accurately reflect the vehicle expenses.

Individuals have the option to use the standard mileage rate OR to track all vehicle expenses. You can NOT deduct both. Therefore you must choose a method of accounting for your vehicle expense and then apply it consistently. If using the standard mileage rate, you MAY NOT deduct gas, repairs, insurance etc. When electing to use actual expenses (i.e. gas, repairs, insurance), the business use percentage is applied to the costs to determine the deductible amount.

The business use percentage is found by comparing total business miles to total vehicle miles for the period. Business miles are those driven from one job to another, but NOT commuting between a house and a job. The first leg of your daily journey and your last are generally defined as commuting miles and therefore not deductible.

Standard rates are also established for other driving purposes. For example:

The distance driven to perform charitable work is deductible at the 2011 rate of 14 cents a mile.

If you drive for medical care, you can deduct the mileage at a 2011 rate of 19 cents a mile from 1/1 to 6/30/11 and 23.5 cents per mile from 7/1 to year end 2011.

Tolls and parking fees are also deductible.

To claim the standard rate deduction, you must keep an accurate record of where you have driven, the purpose for driving and the date of the driving. Pursuant to IRS statute, if the IRS finds that the documentation is inadequate, they can deny 100% of the deduction regardless of whether you incurred transportation costs. Therefore it is important to know the substantiation rules and to maintain complete and timely records of vehicle usage. The IRS considers the following as adequate documentation:

For the amount of a vehicle expense such as a repair, you need to have the cancelled check and the receipt from the vendor that includes the date of the service.

For the mileage, you need a log book for each mile that the car is used during a given day, week, and year which includes the mileage from one place of business to another and the purpose of the business trip. If you make multiple stops on a given day, the log should list each trip separately. On an annual basis this log should be totaled to calculate the total business and personal usage for the year which can be applied to the actual costs if you choose that method for deductions.

Many office supply companies such as Staples, have IRS approved log books available and we highly recommend you use them and keep them in your vehicle at all times. There are also electronic devices now available to track your vehicle miles using technology similar to a GPS device.

RED FLAGS FOR AN IRS AUDIT by Karla Hopkins

Why are some tax returns audited by the IRS? There are a whole host of reasons but only about 1% of all returns actually are audited. So the odds are pretty low for most taxpayers. However, the chances of audit or questions from the IRS can increase based on various factors including omitting income that has been reported to the IRS directly by third parties like a 1099 or a W-2, certain types of deductions and credits, foreign holdings and math errors.

Although there is no sure way to avoid an audit, here are 12 red flags to be aware of:

• Failure to report all taxable income. Make sure that you have included all income from 1099s and W-2s. If you receive an incorrect form from a third party, ask them to correct it BEFORE filing your tax return.
• Returns that have claimed the home buyer credit. There has been a lot of fraud in this area. Make sure you attach your settlement statement to your return if you claim this credit. The IRS is also monitoring the recapture of this credit by following real estate transactions reported in public records.
• If your charitable contributions are comparably high in relation to your income, this could be a red flag and if you do not file a form 8283 for noncash donations over $500 the chances for audit increase.
• The IRS likes to audit the home office deduction because they often make an adjustment to a tax return when they do. For this deduction the space must be used exclusively and on a regular basis as your principal place of business. This can make it difficult to claim the guest bedroom or the family's TV room.
• Business meals, travel and entertainment on schedule C is a gold mine for IRS audits. Large write offs here will set off alarm bells to the IRS. Agents know that many taxpayers fail to satisfy the strict substantiation rules for these expenses. You must keep detailed records of the amount, place, persons attending and business purpose for all expenses.
• Another area the IRS is successful in auditing is the business use of an automobile. Again, taxpayers are aggressive with their claim and often do not have the required substantiation. It is extremely rare for a vehicle to be 100% business. Detailed documentation and a less aggressive approach are key in this area.
• If your schedule C is a loss generating activity, you may have trouble with the IRS. The IRS can sniff out a hobby that is really not a trade or business. If you are trying to make your hobby into a business, your intention from the beginning must be to make a profit. So make sure you run your business in a business-like manner.
• Cash intensive businesses are often at risk. The IRS has developed a new guide for agents to use when auditing cash businesses and looking for unreported income.
• Failure to report a foreign bank account can lead to severe penalties and the IRS has made this a top priority. Make sure you report all income from these accounts such as interest and dividends on your returns.
• Currency transactions, like gambling winnings, are a valuable source of audit adjustments for unreported income. If you are a person who makes large cash purchases or deposits be prepared for IRS scrutiny.
• Math errors are rare if you are using a tax preparation software but if you are preparing your own return they are common. If you make a math error, you will definitely hear from the IRS about it and it can often lead into a tax audit.
• If any deduction on your return is disproportionately large compared to your income, the IRS takes notice. It has formulas that it uses in processing returns. Screeners of returns pull out returns that don’t meet the norm. If you have proper documentation, no need to worry but be prepared for IRS questions.

What's new with Not-for-Profits? by Carolyn Flaherty

There have been a plethora of changes in the reporting requirements for not-for-profit organizations. The most significant change being an overhaul to the Form 990 requiring extensive disclosures. Due to the complexity of the new Form 990 released in 2008, the IRS allowed for a phase in period. However, as of 2010, any organization with gross receipts of at least $200,000 or gross assets of at least $500,000 is required to file the long form. Therefore, few non-profits are able to avoid the onerous requirements this season.

An information organizer has been developed to assist Form 990 filers. However, the organizer, like the Form, is long and overwhelming.

Based on a review of the long form disclosures, it would appear the IRS is trying to create transparency and mitigate abuses in the not-for-profit sector. Yet, what it feels like to the charitable organizations is a large burden on lean staff during a difficult economic time.

For the tax preparer, the time incurred to prepare the long form creates an interesting dilemma with regard to billing. The "improved" Form 990 does not generate more value for our clients, but does cause us and the client to incur more time. Therefore expenses are increased for both the client and the preparer. That said, much of the time incurred during the initial year of implementing the redesigned Form 990 is a learning curve and information gathering process that can be leveraged on in future years. Hence, we hope subsequent years of filing to provide a more efficient, cost effective and less frustrating process.

The IRS is willing to give some extra time to figure out the complex forms and thus will grant automatic extensions of time to file. However, failure to file a proper extension may result in a late penalty of $20 per day up to the lesser of $10,000 or 5% of the organization's gross receipts. Non-profits with gross receipts in excess of $1 million can be charged $100 per day up to a maximum of $50,000!

Meanwhile, the following new or increased fees (among others), are unlikely to be cost effective on any level to charitable organizations:

• Rulings for "unusual grants" now cost $400. Whether a grant is unusual is a subjective determination. A large donation could jeopardize an organization's public charity status. A prudent organization may wish to obtain a ruling prior to accepting such a donation.
• "Set aside" approval now costs $1,000. Amounts set aside by a private foundation for a specified project may be considered a qualifying distribution in the year they are set aside instead of the year paid. Private foundations hoping to avoid tax on undistributed income may wish to obtain prior approval from the IRS.
• IRS approval of grant making procedures by a private foundation for an individuals travel, study, etc. is $1,000. Grants made under a procedure that is objective and nondiscriminatory can avoid taxation.
• Return filing determination will cost $400. Organizations that believe they are exempt from filing can seek a determination of filing status from the IRS.
• A private foundation that wishes to become a public charity must now pay $400 for an advance ruling of public status.

What common rulings and inquiries is the IRS giving out for free?

• Confirmations of exemption if the original exemption status letter is misplaced or to reflect name and address changes.
• Determinations as to whether relief will be granted in certain circumstances for late filing of an exemption application.
• Acknowledgement that a Canadian registered charity is exempt under IRC 501(c)(3) or as a private foundation.

Perhaps the increased IRS fees are necessary to cover staffing to review the redesigned Form 990. Whatever the reason, it is clear that the IRS is indeed discouraging any non-profit organizations which may be motivated by profit margins. Our experience as a firm is that the organizations we work with are simply concerned with surviving this economic time and are driven by passion for the charitable intention for which they were established. Pavento, Ratcliffe, Renzi & Co., LLC wishes well to all the honorable non-profits and the people who run them. We also wish to remind those entities that filing deadlines and final extension deadlines, dependent upon your year end are fast approaching.

100% Exlusion on Gains of Qualified Small Business Stock by Karla Hopkins

One of the provisions of the Small Business Jobs Act is the 100% exclusion from gross income of capital gains from the sale of certain qualified small business stock (QSBS). Generally this provision will allow taxpayers to pay no federal tax on up to $10 million in gain from the sale of certain QSBS. To qualify the stock has to be acquired after September 27, 2010, and before January 1, 2012. Taxpayers in general will be able to exclude up to $10 million in gain from gross income with no preference for AMT purposes. To be eligible for the exclusion, the taxpayer must hold the QSBS for more than five years. Thus, the earliest one can benefit from the 100% exclusion would be 2015.
How does stock qualify for the Exclusion?
For QSBS to qualify for the 100% exclusion, the following provisions must be met:
• The QSBS must be acquired after September 27, 2010, and before January 1, 2012.
• The QSBS must be held for more than five years
• The exclusion applies only to non-corporate taxpayers, including individuals and pass-through entities such as partnerships and S corporations
• The small business must be a domestic C corporation, and the stock purchased must be purchased by the investor upon original issuance from the corporation.
• The small business corporation generally must use 80% of its assets (by value) in a qualifying active business (which excludes certain types of businesses, such as financial institutions, farms, professional service firms, hotels and restaurants, and similar businesses) for substantially all of the investor’s holding period.
• Additional provisions relating to assets and active business activities exist to complicate the applicability of this provision but should be reviewed at the time of a sale of such stock

If the benefits of this provision are not available until 2015, why are we talking about it now? Since there is a specific time frame for when the stock is purchased and how long it is held, 2011 is a key year to purchase shares that would be eligible for this provision. The exclusion is designed for those who bear the entrepreneurial risk of a new company. Individuals or pass-through entities wanting to start up a new company or invest in new companies should consider taking advantage of the new 100% exclusion and acquire newly issued QSBS prior to the end of 2011. Employees or directors holding stock options in qualified small businesses should consider exercising the options before the end of the year as well.

College Students as Dependents by Karla Hopkins

College students combine many sources of funds to pay for their education, including personal savings, family savings, income from jobs, scholarships, and student loans. As the percentage of funds from the student's sources increases, parents face the risk of losing the student as a dependent on their tax return. Not only could they lose the exemption but they could also lose valuable tax benefits like the Education Credits and Tuition Deductions.

College costs continue to increase at a rate greater than inflation. Many parents began saving early for their child's education and many of these students are now entering college. The tax implications of withdrawals from education savings plans should always be considered. In addition, given the current economic times, students are borrowing more money for higher education than ever before.

One of the requirements to claim a child as a dependent on your tax return is the support test. The student cannot have provided more than one-half of his own support. To determine whether a student provided more than one-half of his support, the amount provided by the student must be compared with the total amount of support the student received from all sources.

The support test depends on two factors: the source of funds and the total expenses paid. Support includes food, shelter, clothing, medical and dental care, education and other similar items. Typical expenses for a college student might include tuition and fees, lodging and meals, transportation, clothing and personal expenses. One important item that is not included in the support calculation is scholarships. These are not counted in determining total sources of funds. Money that had been saved in a Uniform Gift to Minors Act account are considered provided by the STUDENT, not the parent. Money saved in a 529 plan or a Coverdell Education Savings Account has not yet been classified by the IRS as the student or the parent's and could make a significant difference each year in the dependency test. We await legislation that will clarify this.

When a student obtains a loan to help defray the costs of education and the student is obligated to repay that loan, the amount of the loan is considered support provided by the STUDENT, not the parent. This, in particular, may make it difficult for a parent to meet the support test.

The tax benefits of the parents claiming the student as a dependent usually warrant planning the source of funds in an effort to preserve the dependency exemption and educational credits. However, a high income family should also analyze who claims the dependency exemption in terms of potential phase outs, tax credits, alternative minimum tax, and other nontax implications.

Whether or not a college student qualifies as a dependent affects both the parents' and student's tax returns. Items such as the Exemption deduction, Hope Scholarship, American Opportunity or Lifetime Learning Credit, and Tuition and Fees Deduction depend on the status of the student as a dependent. The implications of a student no longer qualifying as a dependent extend beyond the parents' and student's tax returns to include benefits provided through the parents' employer and federal student aid calculations. Planning for the annual calculation can be complex but is wise.