Good client relations: independent contractors, tax forms and more - California Tax

California CPA, May, 2003 by Leonard W. Williams

Guilty? Have you ever walked your client through an increased federal tax liability as the result of an audit or CP-2000 Notice, but forgotten to warn them of the impending Franchise Tax Board increase?

If you have--and many CPAs are guilty of this lapse--you know your client will be upset.

Or suppose that an IRS audit results in a lot of changes, but because of AMT, the client's federal tax liability will not change. Should the client be warned of a coming FTB change?

You betcha.

When federal taxable income changes, the IRS sends a report to the FTB, which in turn, adjusts for California purposes and bills the taxpayer accordingly.

EDD and Independent Contractors

The independent contractor issue with the EDD is an endless battle. A TaxTalk participant relayed several incidents involving dentists and optometrists and their "colleagues" or dental assistants.

The EDD says these colleagues are employees. The hanging hat seems to be whether or not the "contractor" has a business license.

Next, the EDD checks for a yellow pages business listing, which indicates that they are holding themselves out to the general public as they claim.

The EDD also has done reference checks by asking for client contact information and interviewing them by phone.

In one war story, a dental assistant worked for 10 dentists and the EDD claimed that she was an employee for each of them because she didn't have a business license. The EDD won.

Another participant said dental hygienists can never be contractors because they may not set up shop by themselves. They almost always must work under a dentist's supervision.

Deciding a Corporation's Future

The subject of letting a corporation die or formally dissolving it has been bandied about many times before, but it has returned with another viewpoint. The following war story related by a participant seems to favor dissolving the corporation instead of letting it die.

An attorney set up--but didn't use--a corporation, and more or less forgot about it. He eventually received a notice from the FTB for $19,693.49, plus penalties, fees and interest, which bumped his total proposed assessment to $35,407.

The figure wasn't based on 1099s or any other direct data. Rather, it was based on the "average income amounts reported by businesses in this industry."

If the person to whom the notice is sent continues to pitch the envelopes, it winds up in a field collection group.

It is hard enough to calm down clients when they get notices in the mail. Just think what happens when clients get a phone call from an FTB collection agent over that kind of money!

Tax Season Happenings

This column will be published after tax season, but is being written at the end of February when many CPAs are mildly upset about a surprise item on Form 541, the income tax form for estates and trusts.

The new item is Question 5 on the second page of Form 541, where it asks for the fair-market value of the trust's assets at the end of the trust's taxable year.

According to word received from various sources, failure to answer the question doesn't constitute an incomplete return.

The thing that has most people upset is that there was no advance warning--and most CPAs didn't realize it until they were doing the returns.

Community Property

A lot of the questions posted on the listserve stem from misunderstandings about California community property.

For many years the California CPA Education Foundation has offered a course in the rudiments of California community property. You can search for upcoming courses and locations at www.educationfoundation.org.

Here's an area of concern that comes up frequently in the listserve postings:

A married couple--living together for the entire year, with no separate assets and no agreement that their earnings are separate--may only file MFS by splitting their income and deductions 50-50 for the year.

Clue: This results in no income tax savings.

There is a common misconception among the public that they may file as MFS by working from their respective W-2s and allocating their dental expenses, for example, toward the spouse who actually incurred the expenses. That won't work in the common situation just outlined.

However, when a married couple separates and one of them moves out, their earnings become separate and are no longer considered community.

In the year of separation, trying to file separate returns can be a problem, especially if the two aren't speaking. However, for frazzled CPAs trying to prepare returns in these circumstances, Prop. Reg. 1.66-1 through 5 says, in effect, to do the best you can with the information available, and do not get bogged down in an insolvable situation.

Thanks to the following Tax Talk Listserve participants for their news and views: Steve Kramer, CPA; Michael Chambers, CPA; Johanna Sweeney Salt, CPA; Don Yamagishi, CPA; and John Hoag, CPA.

Leonard W. Williams, CPA, is a Sunnyvale-based sole practitioner. A member of Ca/CPA's Committee on Taxation, the A/CPA Tax Division and a former Peninsula Chapter president, he can be reached at williams@lwwilliamscpa.com.