Advance Premium Tax Credit

As part of a series of COVID-19-related audits, the Treasury Inspector General for Tax Administration (TIGTA) has completed its evaluation of how the IRS handled advance premium tax credit (APTC) issues. TIGTA has found that the IRS “took immediate steps to remove excess APTC repayment” from 2020 tax returns. But it also identified 30,231 taxpayers who may now qualify for additional child tax credits totaling $16.4 million (and will need to take action to claim their benefits).

TIGTA also says that the IRS failed to develop processes and procedures to verify the accuracy of premium tax credit claims based on unemployment compensation. To read the report:


How Inflation Could Affect Your Financial Statements

Business owners and investors are understandably concerned about skyrocketing inflation. Over the last year, consumer prices have increased 8.3%, according to the latest data from the U.S. Bureau of Labor Statistics. The Consumer Price Index (CPI) covers the prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. This was a slightly smaller increase than the 8.5% figure for the period ending in March, which was the highest 12-month increase since December 1981. Meanwhile, the producer price index (PPI) is up 11% over last year. This was a smaller increase than the 11.2% figure for the period ending in March, which was the largest increase on record for wholesale inflation. PPI gauges inflation before it hits consumers.

Key impacts for your business, inflation may increase direct costs and lower customer demand for discretionary goods and services. This leads to lower profits — unless you’re able to pass cost increases on to customers. However, the possible effects aren’t limited to your gross margin.

Here are seven other aspects of your financial statements that might be impacted by today’s high rate of inflation.

1. Inventory.  Under U.S. Generally Accepted Accounting Principles (GAAP), inventory is measured at the lower of 1) cost and 2) market value or net realizable value. Methods that companies use to determine inventory cost include average cost, first-in, first-out (FIFO), and last-in, first-out (LIFO). The method you choose affects profits and the company’s ending inventory valuation. There also might be trickle-down effects on a company’s tax obligations.

2. Goodwill. When estimating the fair value of acquired goodwill, companies that use GAAP are supposed to apply consistent valuation techniques from period to period. However, the assumptions underlying fair value estimates may need to be revised as inflation increases. For instance, market participants typically use higher discount rates during inflationary periods and might expect revised cash flows due to rising expenditures, changes in customer behaviors and modified product pricing.

3. Investments. Inflation can lead to volatility in the public markets. Changes in the market values of a company’s investments can result in realized or unrealized gains or losses, which ultimately impact deferred tax assets and liabilities under GAAP. Concerns about inflation may also cause a company to revise its investment strategy, which may require new methods of accounting or special disclosures in the financial statement footnotes.

4. Foreign currency. Inflation can affect foreign exchange rates. As exchange rates fluctuate, companies that accept, hold and convert foreign currencies need to ensure they’re capturing the correct rate at the appropriate point in time.

5. Debts. If your company has variable-rate loans, interest costs may increase as the Federal Reserve raises interest rates to counter inflation. The Fed already raised its target federal funds rate by 0.5% in May and is expected to increase rates further over the course of 2022. Some businesses might decide to convert variable-rate loans into fixed-rate loans or apply for additional credit now to lock in fixed-rate loans before the next rate hike. Others may restructure their debt. Depending on the nature of a restructuring, it may be reported as a troubled debt restructuring, a modification or an extinguishment of the debt under GAAP.

6. Overhead expenses. Long-term lease agreements may contain escalation clauses tied to CPI or other inflationary measures that will lead to increased lease payments. Likewise, vendors and professional service providers may increase their prices during times of inflation to preserve their own profits.

7. Going concern disclosures. Each reporting period, management must evaluate whether there’s substantial doubt about the company’s ability to continue as a going concern. Substantial doubt exists if it’s probable that the entity will be unable to meet obligations as they become due within 12 months of the financial statement issuance date. Soaring rates of inflation can be the downfall of companies that are unprepared to counter the effects, causing doubt about their long-term viability.

We can help. Inflation can have far-reaching effects on a company’s financial statements.

Contact us for help anticipating how inflation is likely to affect your company’s financials and brainstorming ways to manage inflationary risks. © 2022

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Recent Court Decision Reaffirms Importance of Adequately Documenting Deductible Management Fees

In October 2021, the Internal Revenue Service (IRS) formally launched the Large Partnership Compliance (LPC) Pilot Program. The LPC program represents a focused effort on the part of the U.S. Treasury Department and IRS to improve partnership compliance. Not surprisingly, we are beginning to see an uptick in the number of partnerships under IRS exam.

One area of focus for these examinations that the IRS has identified is the deductibility of management fees paid by portfolio companies to their private equity fund owners. Although not specifically dealing with private equity funds, a recently decided case nonetheless highlights the relevant issues and presents a cautionary tale for funds and their portfolio companies when structuring these arrangements. Moreover, the court’s decision provides an implicit documentation and substantiation framework for taxpayers looking to enter into similar management fee arrangements.

In the case, Aspro, Inc. v. Commissioner, issued April 26,  the U.S. Court of Appeals for the Eight Circuit upheld a Tax Court holding that recast a corporation’s deductible “management fees” as disguised dividends. Although the taxpayer argued that at least a portion of the fees were reasonably deductible business expenses, the circuit court agreed with the lower court that the taxpayer failed to demonstrate that any portion of the amounts paid was reasonable compensation for services provided.

‘Management fees’ paid to owners but no dividends

The taxpayer, Aspro, is an Iowa-based C corporation in the asphalt-paving business. During the years at issue, 2012–2014, it had three shareholders – two were corporations and one was an individual, who was also the president of the company. Over a twenty-year period, Aspro consistently paid its shareholders “management fees” purporting to be for services provided in connection with the overall management and growth of the business. During this same period, and despite the company’s profitability, Aspro paid no dividends.

Aspro initially sought to deduct the management fees in the three years at issue, but the IRS denied the deductions, contending they were, in fact, profit distributions. The Tax Court agreed with the IRS that the claimed management fees were not deductible as ordinary and necessary business expenses, concluding that Aspro failed, “to connect the dots between the services performed and the management fees it paid.” Instead, the court held that the payments were disguised, non-deductible earnings distributions. In reaching its decision, the Tax Court considered whether the management fees were purely for services (Payment for Services Requirement) and whether the payments were reasonable in nature and amount (Reasonableness Requirement).

Failure to establish deductibility of fees

With respect to the Payment for Services Requirement, the Tax Court concluded that the evidence presented indicated a disguised distribution rather than a deductible expense. The Tax Court based its conclusion on the following considerations:

  1. Despite its annual profitability, Aspro made no distributions to its shareholders but paid management fees each year.
  2. The management fee payments roughly corresponded with the shareholder’s ownership interests.
  3. The management fees were paid as lump sums at the end of each year rather than over the course of the year as the purported services were performed.
  4. The managements fee deductions eliminated virtually all of Aspro’s taxable income.
  5. The process of setting management fees was unstructured and had little, if any, relation to the services performed.

In addition, the Tax Court concluded that Aspro failed to satisfy the Reasonableness Requirement. Aspro failed to provide documentation supporting the existence of a service relationship between the parties. At a most basic level, there were no written management service agreements. In addition, there was no documentation outlining the cost or value of any purported service, and no bills or invoices were provided in connection with the purported management services. Additionally, Aspro failed to provide evidence showing how the amount of the management fees was determined.

To establish that the fees were actually paid for valuable services performed, Aspro offered two expert witnesses – a contractor in the taxpayer’s industry and an accountant. However, the Tax Court excluded both witnesses, concluding that neither provided expert knowledge based on scientific methods.  Instead, the court believed that each witness merely offered their personal opinions based on their familiarity with the industry and the taxpayer. The circuit court agreed that these exclusions were reasonable.

In deciding the whether the amount of management fees paid by Aspro was reflective of reasonable compensation for the services performed, the Court considered both an independent investor standard and a multi-factor standard. An independent investor standard evaluates the fee arrangement on the basis of whether an independent investor earning returns after deduction of the management fees would view the quantum of fees as reasonable; a multi-factor standard looks to various criteria such as the nature of work performed and the prevailing rates of compensation for non-shareholders providing similar services to similar businesses. Under both standards, the court noted that the management fee arrangement breached the reasonable compensation threshold, and, thus, Aspro failed to satisfy the Reasonableness Requirement.



The IRS is increasing its audit of large partnerships and is increasingly scrutinizing the validity and deductibility of management fee arrangements. The Aspro case offers a warning to taxpayers, including private equity and venture capital funds seeking to establish similar arrangements with their portfolio companies. But perhaps more importantly, this case provides a roadmap for taxpayers to follow when structuring and documenting these arrangements. Proper documentation and support, including transfer-pricing work done to support the quantum of the fees to be charged pursuant to such an arrangement, is an essential element of sound tax planning in this regard.

The circuit court’s opinion makes clear that the substantiation of such management fees arrangements requires taxpayers to satisfy the Payment for Services Requirement and the Reasonableness Requirement. To satisfy these requirements, taxpayers should base the economic terms of any such arrangement on some sort of scientific method that transcends mere industry knowledge. Moreover, even in circumstances where the level of management fees is demonstrably reasonable in light of the services provided, failure to adequately document the arrangements will leave taxpayers vulnerable to losing their deductions.

Written by David Newberry, Justin Follis and Veranda Graham. Copyright © 2022 BDO USA, LLP. All rights reserved.



Do You Have a Health Savings Account?

Do you have a Health Savings Account?
Health Savings Accounts (HSAs) are tax-advantaged savings accounts funded with pretax dollars. Funds can be withdrawn tax-free to pay for qualified medical expenses. An HSA must be coupled with a high-deductible health plan (HDHP). The IRS annually adjusts HSA and HDHP amounts based on inflation.
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Keeping meticulous records is the key to tax deductions and painless IRS audits

If you operate a business, or you’re starting a new one, you know you need to keep records of your income and expenses. Specifically, you should carefully record your expenses in order to claim all of the tax deductions to which you’re entitled. And you want to make sure you can defend the amounts reported on your tax returns in case you’re ever audited by the IRS.

Be aware that there’s no one way to keep business records. But there are strict rules when it comes to keeping records and proving expenses are legitimate for tax purposes. Certain types of expenses, such as automobile, travel, meals and home office costs, require special attention because they’re subject to special recordkeeping requirements or limitations.

Here are two recent court cases to illustrate some of the issues. Case 1: To claim deductions, an activity must be engaged in for profit

A business expense can be deducted if a taxpayer can establish that the primary objective of the activity is making a profit. The expense must also be substantiated and be an ordinary and necessary business expense.

In one case, a taxpayer claimed deductions that created a loss, which she used to shelter other income from tax. She engaged in various activities including acting in the entertainment industry and selling jewelry. The IRS found her activities weren’t engaged in for profit and it disallowed her deductions. The taxpayer took her case to the U.S. Tax Court, where she found some success. The court found that she was engaged in the business of acting during the years in issue.

However, she didn’t prove that all claimed expenses were ordinary and necessary business expenses. The court did allow deductions for expenses including headshots, casting agency fees, lessons to enhance the taxpayer’s acting skills and part of the compensation for a personal assistant. But the court disallowed other deductions because it found insufficient evidence “to firmly establish a connection” between the expenses and the business. In addition, the court found that the taxpayer didn’t prove that she engaged in her jewelry sales activity for profit. She didn’t operate it in a businesslike manner, spend sufficient time on it or seek out expertise in the jewelry industry. Therefore, all deductions related to that activity were disallowed. (TC Memo 2021-107)

Case 2: A business must substantiate claimed deductions with records A taxpayer worked as a contract emergency room doctor at a medical center. He also started a business to provide emergency room physicians overseas. On Schedule C of his tax return, he deducted expenses related to his home office, travel, driving, continuing education, cost of goods sold and interest. The IRS disallowed most of the deductions.

As evidence in Tax Court, the doctor showed charts listing his expenses but didn’t provide receipts or other substantiation showing the expenses were actually paid. He also failed to account for the portion of expenses attributable to personal activity. The court disallowed the deductions stating that his charts weren’t enough and didn’t substantiate that the expenses were ordinary and necessary in his business. It noted that “even an otherwise deductible expense may be denied without sufficient substantiation.” The doctor also didn’t qualify to take home office deductions because he didn’t prove it was his principal place of business. (TC Memo 2022-1)

We can help

Contact us if you need assistance retaining adequate business records. Taking a meticulous, proactive approach can protect your deductions and help make an audit much less difficult. © 2022

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Want to turn a hobby into a business? Watch out for the tax rules

Like many people, you may have dreamed of turning a hobby into a regular business. You won’t have any tax headaches if your new business is profitable. But what if the new enterprise consistently generates losses (your deductions exceed income) and you claim them on your tax return? You can generally deduct losses for expenses incurred in a bona fide business. However, the IRS may step in and say the venture is a hobby — an activity not engaged in for profit — rather than a business. Then you’ll be unable to deduct losses. By contrast, if the new enterprise isn’t affected by the hobby loss rules because it’s profitable, all otherwise allowable expenses are deductible on Schedule C, even if they exceed income from the enterprise.

Note: Before 2018, deductible hobby expenses had to be claimed as miscellaneous itemized deductions subject to a 2%-of-AGI “floor.” However, because miscellaneous deductions aren’t allowed from 2018 through 2025, deductible hobby expenses are effectively wiped out from 2018 through 2025.

Avoiding a hobby designation

There are two ways to avoid the hobby loss rules: Show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing or racing horses). Run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. The IRS regs themselves say that the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective.

How can you prove you have a profit-making objective?

You should run the venture in a businesslike manner. The IRS and the courts will look at the following factors: How you run the activity, Your expertise in the area (and your advisors’ expertise), The time and effort you expend in the enterprise, Whether there’s an expectation that the assets used in the activity will rise in value, Your success in carrying on other activities, Your history of income or loss in the activity, The amount of any occasional profits earned, Your financial status, and Whether the activity involves elements of personal pleasure or recreation.

Recent court case

In one U.S. Tax Court case, a married couple’s miniature donkey breeding activity was found to be conducted with a profit motive. The IRS had earlier determined it was a hobby and the couple was liable for taxes and penalties for the two tax years in which they claimed losses of more than $130,000. However, the court found the couple had a business plan, kept separate records and conducted the activity in a businesslike manner. The court stated they were “engaged in the breeding activity with an actual and honest objective of making a profit.” (TC Memo 2021-140)

Visit our small and emerging business page to learn more or contact one of our experts to discuss details on whether a venture of yours may be affected by the hobby loss rules, and what you should do to avoid a tax challenge. © 2022