Net investment income. Net investment income, for purposes of the new 3.8 percent Medicare tax, includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property that is not used in an active business and income from the investment of working capital are treated as investment income as well. However, the tax does not apply to nontaxable income, such as tax-exempt interest or veterans’ benefits. Further, an individual’s capital gains income will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home. However, contemplated sales made before 2013 would avoid the tax.

The tax applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute.

Deductions. Net investment income for purposes of the new 3.8 percent tax is gross income or net gain, reduced by deductions that are “properly allocable” to the income or gain. This is a key term that the Treasury Department expects to address in guidance, and which we will update you on developments. For passively-managed real property, allocable expenses will still include depreciation and operating expenses. Indirect expenses such as tax preparation fees may also qualify.

For capital gain property, this formula puts a premium on keeping tabs on amounts that increase your property’s basis. It also puts the focus on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers’ fees, may increase basis or reduce the amount realized from an investment. As such, you may want to consider avoiding installment sales with net capital gains (and interest) running past 2012.

Thresholds and impact. The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately. MAGI is AGI increased by foreign earned income otherwise excluded under Code Sec. 911; MAGI is the same as AGI for someone who does not work overseas.

Example. Jim, a single individual, has modified AGI of $220,000 and net investment income of $40,000. The tax applies to the lesser of (i) net investment income ($40,000) or (ii) modified AGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8 percent of $20,000, or $760. In this case, the tax is not applied to the entire $40,000 of investment income.

The tax can have a substantial impact if you have income above the specified thresholds. Also, don’t forget that, in addition to the tax on investment income, you may also face other tax increases proposed by the Obama administration that could take effect in 2013. The top two marginal income tax rates on individuals would rise from 33 and 35 percent to 36 and 39.6 percent, respectively. The maximum tax rate on long-term capital gains would increase from 15 percent to 20 percent. Moreover, dividends, which are currently capped at the 15 percent long-term capital gain rate, would be taxed as ordinary income. Thus, the cumulative rate on capital gains would increase to 23.8 percent in 2013, and the rate on dividends would jump to as much as 43.4 percent. Moreover, the thresholds are not indexed for inflation, so a greater number of taxpayers may be affected as time elapses. Congress may step in and change these rate increases, but the possibility of rates going up for upper income taxpayers is sufficiently real that tax planning must take them into account.

Exceptions. Certain items and taxpayers are not subject to the 3.8 percent tax. A significant exception applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans. At the present time, however, there is no exception for distributions from nonqualified deferred compensation plans subject to Code Sec. 409A, although some experts claim that not carving out such an exception was a Congressional oversight that should be rectified by an amendment to the law before 2013.

The exception for distributions from retirement plans suggests that potentially taxed investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs, or to 409B Roth accounts. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Small business owners may want to set up retirement plans, especially 401(k) plans, if they have not yet established a plan, and should consider increasing their contributions to existing plans.

Another exception covers income ordinarily derived from a trade or business that is not a passive activity under Code Sec. 469, such as a sole proprietorship. Investment income from an active trade or business is also excluded. However, SECA (Self-Employment Contributions Act) tax will still apply to proprietors and partners. Income from trading in financial instruments and commodities is also subject to the tax. The tax does not apply to income from the sale of an interest in a partnership or S corporation, to the extent that gain of the entity’s property would be from an active trade or business. The tax also does not apply to business entities (such as corporations and limited liability companies), nonresident aliens (NRAs), charitable trusts that are tax-exempt, and charitable remainder trusts that are nontaxable under Code Sec. 664.

Please contact our office if you would like to discuss the tax consequences to your investments of the new 3.8 percent Medicare tax on investment income.

Source: CCH

Class size for the seminar is limited to eight people in order to make it as personal as possible. The cost of the seminar is $100 with the proceeds being donated to the Atlanta Ronald McDonald House Capital Campaign. Our receipt of your check (made payable to Atlanta Ronald McDonald House Charities) will confirm your reservation. The seminar will begin at 9 a.m. and finish no later than 4 p.m.

If you are interested in having someone attend this seminar, please contact Kim Glaze by May 18th. Kim will also be glad to help with hotel reservations at Hawthorn Suites if needed. The room rate at the hotel is $99 per night. If we have more participants register than space permits, a second seminar will be scheduled

New legislation signed by President Barack Obama in November expands tax incentives to businesses that hire military veterans. The new law enhances the Work Opportunity Tax Credits for hiring qualified veterans. The credit available depends on the length of time the veteran was out of work:

• New hires that were jobless for at least six months are eligible for a credit of up to $5,600;
• New hires that were jobless for less than six months are eligible for a credit of up to $2,400; and
• New hires with service-connected disabilities that were jobless for more than six months can receive a credit of up to $9,600.

A veteran is an individual who is certified as having either served on active duty in the U.S. Armed Forces for more than 180 days or else has been discharged or released from active duty for a service-connected disability. These credits only apply to newly hired veterans who began working after Nov. 21, 2011, but prior to Jan. 1, 2013. Note that the new law does not extend the Work Opportunity tax Credits for other targeted groups. It remains to be seen if they will be extended.

In our March 31 newsletter, we discussed working capital, which is the difference between the amount of current assets and current liabilities. When working capital is positive, current assets exceed current liabilities and there is a good chance the business can pay its liabilities. When working capital is negative (“working capital deficit”), the current liabilities exceed current assets.

When a business has a working capital deficit, it will need future sales to cover its working capital deficit. The Number of Days of Current Liabilities, also known as the Liability Turnover Ratio, measures the number of days future sales needed to cover the previous month’s working capital deficit.

The Number of Days of Current Liabilities is computed by dividing the working capital deficit by annual average daily sales. It measures the short-term health of a business. The target number of days future sales needed to cover the previous month’s working capital deficit is less than seven. The lower the number of days, the stronger the businesses ability to pay its current expenses.

Need another reason to maintain or work toward financially strong ratios for your business? If your children want to become owner/operators, one of the requirements of McDonald’s Next Generation program is that the parent’s organization be eligible for growth and rewrite. McDonald’s uses ratios and computations such as the Number of Days of Current Liabilities and Cash Flow Coverage Ratio (please see our March 31, newsletter on our Web site) as a way to measure the organization’s financial situation.

In summary, the Cash Flow Coverage Ratio indicates cash available to service debt. The target is 1.2, which means a businesses cash flow should equal 1.2 time its debt service. In other words, if you have annual debt service (interest plus principal) of $100,000, you should budget for cash flow of at least $120,000.

It is very important you monitor the financial health of your business. Should you have any questions, please feel free to contact Amy Williams, CPA, CVA.

A tax credit of up to $1,000 per qualified employee is available in 2011 to employers who retain the eligible New Hire Employees for a consecutive 52 weeks. The retention credit does not require an outside service to certify the employee or calculate the credit. It will be reported on the 2011 corporate tax return.

A qualified individual is one who:

• Commences employment with the employer after Feb. 3, 2010, and before Jan. 1, 2011;
• Certifies using Form W-11 or similar signed affidavit that he or she has not been employed for more than 40 hours during the 60-day period ending on the date employment begins with the qualified employer;
• Does not replace an employee that was laid off without cause;
• Is not related to the qualified employer;
• Remains on the payroll for 52 consecutive weeks; and
• Earned wages for employment during the last 26 weeks equal to at least 80 percent of wages for the first 26 weeks.

An employer may claim the retention credit for a qualified employee even if the employer has also claimed the Work Opportunity Tax Credit for the same employee. In order to claim the credit on the 2011 income tax return, employers will need to provide the following information for each retained qualified employee:

• The employee’s Social Security number;
• The date the employee began employment;
• The employee’s wages during the first 26 weeks of consecutive employment; and
• The employee’s wages during the second 26 weeks of consecutive employment.

This information can be obtained from the payroll company or employer’s records and will be used to determine the employer’s eligibility and to calculate the amount of the credit. We recommend that the employer also sends in a copy of the Form W-11 for each retained qualified employee to be maintained in permanent records.

We recommend that you review the employees that you hired after Feb. 3, 2010, and before Jan. 1, 2011, to verify who worked for a consecutive 52 weeks. This credit could be significant for you. If you have any questions or would like any additional information please contact Erna Cehic in our office.

By Amy Williams, CPA, CVA
Sparkmon & Associates, CPAs

When deciding to purchase or sell a McDonald’s restaurant, you will need to determine how much the restaurant is worth.  A number of valuation methods are available and there are many factors to consider when determining the value of a McDonald’s restaurant.

The most common method used in valuing a McDonald’s restaurant for an arm’s length buy/sell transaction is the discounted cash flow method. This method projects the restaurant cash flow for the next 20 years and discounts that cash flow back to today’s dollars at an appropriate discount rate (typically from 18 to 22 percent). This values the business based on its cash-generating ability, taking into consideration future events and the time value of money.

A starting point for establishing a frame of reference to determine the projected 20-year cash flow is the restaurant’s actual trailing 12-month cash flow. Consider the following factors when projecting the next 20 years’ cash flow:

• Sales and Growth Impact – Review a five-year sales history, if available, and ask:  Are sales growing and at what pace?  Are sales declining and if so, why?  Is there potential for future impact on sales due to competitors, other McDonald’s restaurants nearby, weather, construction, or changing demographics?
• Profit After Controllable (PAC) – You will need to determine the appropriate PAC to use when valuing the restaurant. For example, should you use top 50 percent FFS, top 25 percent FFS, or actual FFS. The store’s value may be impacted if it is performing at a PAC well below that of the top 50 percent FFS. Some additional factors to calculate are:
• Analyze costs (such as labor, food, health insurance and maintenance and repairs) that tend to rise and have an impact on the profit margin.  Keep an eye on whether commodity prices are rising.
• Those who are considering selling should review their P&L Opportunity Reports and identify areas that need improvement and take measures to improve profitability without compromising customer service.
• Reinvestment needs – Answer the following: What type of building is the restaurant (freestanding, Oil Alliance, Wal-Mart, mall, or other) and what are the typical ongoing reinvestments? What is the age of the restaurant? When was the store last remodeled? Are there any required reinvestments that were identified on a recent walk-thru by McDonald’s Corporation as stated on the NRBES report? Is the restaurant scheduled to have a major long-term remodel, a rebuild, or a relocation in the near future? Here’s a tip for those considering selling: To help increase value, keep restaurant reinvestments up to date. Any needed reinvestments as of the date of sale will reduce the value of the restaurant.
• Real Estate Tenure – Does McDonald’s Corporation own or lease the land? Is real estate tenure assured? In order to secure real estate tenure will store rents be increased?
• Rents – Are there any rent escalations?  Is the store on a tiered rent?
• License Term – What is the remaining term on the existing franchise? Are there any deferred franchise fees that will be due in later years?
• NEP Restaurants – Is the building loan assumable? Do prepayment penalties exist on the loan?

All the above factors should be considered when valuing a McDonald’s restaurant. In addition to purchase and sale transactions, we prepare valuations for estate and gift planning, divorce settlements, retirement and financial planning purposes. Please contact our office if we can assist you with your valuation needs.

The recordkeeping provision required businesses to file Form 1099 for all transactions valued at $600 and more and drew a firestorm of criticism from small businesses for being an excessive paperwork burden. The new law offsets the cost of repeal by increasing the amount of overpayment subject to repayment of premium assistance tax credits for health insurance coverage purchases through the exchanges established under the health care law.

By Kim Janssen
Chicago Sun Times

You’ve heard of Big Macs, McNuggets, McMansions and McJobs – now meet the McRunner.

Palatine dad Joe D’Amico plans to run the Los Angeles Marathon on March 20 after training for 30 days on a diet of McDonald’s fast food alone.
It may sound more like a recipe for getting the runs than running fast. But ultra-lean D’Amico aims to beat his personal best time of two hours and 36 minutes – a six-minute-mile pace that should put him among the top 50 finishers.

“My wife told me I was crazy,” D’Amico, 36, said. “But I love McDonald’s and I love running, and this was a great way to combine the two.”
D’Amico, who has been blogging about his progress at McRunner.com, has been eating three meals a day at the golden arches for the last two weeks.

He plans to keep up the regime until the race.

He usually starts the day with a plate of hot cakes, an Egg McMuffin and an orange juice. He eats a grilled chicken sandwich for lunch, washed down with a large Coke, then enjoys a hamburger and fries for dinner, with cookies for desert. His only deviation from the McDonald’s menu is a daily multivitamin, tap water, and an energy gel he takes while on the road.

It is, his doctor says, a less than ideal preparation for the 26.2-mile ordeal. But D’Amico insists, “I’ve been feeling really good.”

Unlike filmmaker Morgan Spurlock, who gained 24 pounds and saw his health rapidly deteriorate while eating at McDonald’s for a month for his hit 2004 documentary “Super Size Me,” D’Amico won’t order large fries, and he’s never had a Big Mac. He did try an Angus deluxe burger, though, as part of his training.

“I can do it because I’m running 100 miles a week,” he said.

A more traditional runner’s diet centered on pasta, bananas and other whole foods fueled him to the finish line in the 14 marathons he’s previously run.

He isn’t sponsored by or connected to McDonald’s in any way, he says, but he is raising funds for Ronald McDonald House Charities because “It seemed a natural fit.”

“I’m not trying to prove anyone wrong or make any kind of political statement,” he added. “But I’ve been eating McDonald’s since I was a kid. In a way I’ve been practicing for this my whole life.”

Source: Chicago Sun Times, March 10, 2011

The future of the new and highly unpopular 1099 reporting regulations remains murky as the U.S. Senate and House of Representatives haggle over how to make up revenue that would be lost as a result of repeal bills that have passed both chambers.

The new federal healthcare law — referred to informally as Obamacare and formally as the Patient Protection and Affordable Care Act — includes a provision that expands 1099 reporting requirements.

Under the law, businesses will be required beginning in 2012 to issue a 1099 for each recipient paid more than $600 in a calendar year, whether that recipient is an individual or an incorporated business. The requirements for issuing 1099s have also been expanded to include essentially any product or service that is purchased. For a single store operator, this could easily mean issuing over 100 1099s each year. Landlords likewise are subject to the new rules. The Small Business Jobs Act enacted a requirement that individuals who receive rental income must issue 1099 forms to service providers for payments of $600 or more made during 2011 and for payments made for property and to corporations beginning in 2012.

On March 3, the House of Representatives voted 314-112 to repeal the 1099 reporting provisions mandated through the healthcare law, as well as the expanded 1099 regulations for owners of rental property. The Senate voted earlier this month on a bill to repeal portions of the 1099 reporting rules. The two repeal bills, however, differ over what portions of the new 1099 reporting law should be eliminated and what should be kept in place.

While the House bill seeks to eliminate all of the changes to 1099 reporting put in place in the 2010 health care legislation, the Senate version keeps the portion of the new rules that relates to 1099 requirements on landlords.

PAYGO rules in both chambers require that all legislation that lowers taxes must account for a cut in expenses or an increase in revenue somewhere else to offset the revenue the government would have received. In this case, it is estimated to be about $19 billion in lost revenue.

To pay for repeal, the House in its version voted to increase the amount consumers would be required to repay if they are overpaid tax subsidies in health reform’s insurance exchanges.

The Senate bill would pay for the repeal by rescinding $44 billion of discretionary government spending.

The House and the Senate will have to reach agreement on a revenue offset before a bill can be sent to President Barack Obama. White House opposition to the revenue offsets contained in both bills makes the road to final passage unclear.  Until the president agrees to sign this proposal, Benson Goldstein, senior technical manager at the AICPA, cautions that those “with rental properties should continue to keep the necessary records so that they will have the records that would be needed to file 1099s in 2012.”

We again encourage you to contact your representatives to strongly encourage their support of this repeal for the 1099 rules.

Sources: AccountingWeb (http://www.accountingweb.com/topic/tax/house-and-senate-spar-repeal-1099-reporting-rule); Politico (http://www.politico.com/news/stories/0311/50609.html); and Journal of Accountancy (http://www.journalofaccountancy.com/Web/20113926.htm)