DOMA case could bring pro-gay tax rules

 Matthew S. Bajko for Bay Area Reporter writes:  Same-sex couples across the country could benefit at tax time should the U.S. Supreme Court allow the federal government to recognize their marriages and other legal unions.  The court is expected to rule this month on whether Section 3 of the federal Defense of Marriage Act is unconstitutional. That portion of the anti-gay law passed by Congress and signed by former President Bill Clinton bars federal agencies from granting numerous rights heterosexual married couples receive to those same-sex couples in state sanctioned marriages, as well as domestic partnerships or civil unions.

This prohibition is particularly felt during tax season, as legally coupled same-sex partners cannot file joint tax returns with the Internal Revenue Service, causing some couples to pay higher taxes. They are also fiscally dinged tax-wise if one spouse's employer covers the health care for the other spouse, as the IRS considers those medical benefits as taxable income.

Some employers have increased the pay of their LGBT employees to offset the increased federal taxes on their benefits, but the higher income triggers additional taxes owed to the state. (San Francisco instituted a law this year to gross up the pay of LGBT city workers impacted by the unfair tax rules while legislation is pending in Sacramento not to have the state view the benefits as taxable.)

"The Defense of Marriage Act imposes undue and unequal tax burdens on married same-sex couples and their children, and this decision would be a significant advancement in remedying the economic inequity facing these families," Andrew Cray, a policy analyst on the LGBT Research and Communications Project with the Center for American Progress, told the Bay Area Reporter.

Several years ago the IRS did implement a rule covering those same-sex couples living in states with community property laws, such as California, in order to try to provide some equitable treatment to LGBT households. The IRS required the couples to divide their income from wages as well as from a business or real estate holdings they co-owned equally among themselves and then file separate returns.

Rather than being a simple solution, the rule change resulted in overly complicated tax preparation procedures for many same-sex couples. It was so confusing that the online tax preparer TurboTax no longer was equipped to handle the tax returns for those couples impacted by the rule change.

Many found out that splitting their community property resulted in their need to start seeing professional tax preparers rather than do their taxes themselves. Those who had been using accountants saw increased fees as now it took creating three different federal returns and one for California couples, as the state allows same-sex couples to file jointly for state tax purposes, to figure out if they owed additional federal taxes or were due refunds.

In some instances, couples who had been filing separate federal tax returns and received refunds now owed thousands of dollars in unpaid taxes once a portion of their spouses' pay was added to their income.

Many of these unfair taxation issues would disappear, predict LGBT advocates, due to a ruling by the U.S. Supreme Court striking down Section 3 of DOMA.

"It is expected that following the decision, the IRS will instruct married same-sex couples to file their taxes as 'married' rather than as 'individual' or 'head of household.' This brings with it two significant benefits," Cray wrote in an emailed response to questions.

The first, explained Cray, is that complications that have faced same-sex couples around the process of filing taxes, claiming children, or claiming various deductions "may be reduced or eliminated through the ability to file a joint return."

Second, if married same-sex couples are able to file jointly, they could owe less taxes, added Cray, because "their income tax levels will be calculated appropriately based on their household income, rather than being treated differently from other married couples, and potentially resulting in a greater tax payment than for other couples."

On a recent conference call to discuss the possible outcomes of the case, known as U.S. v. Windsor, Nicole M. Pearl, a Los Angeles-based partner at the law firm McDermott Will and Emery LLP with extensive experience in estate and tax planning for gay, lesbian, and unmarried couples, said a decision against DOMA's Section 3 would be retroactive, meaning that same-sex couples could amend their prior tax returns going back to 2010 to see if they overpaid their federal taxes.

"So all same-sex couples that have already married, because they live in states that allow that, can go back and amend prior tax returns for the years that are still open," said Pearl, the author of The Effect of Same-Sex Marriage Laws on Estate Planning. "This is generally going to be three years, their past three years of returns, and this can be a benefit or a detriment depending on their financial situation, but there is no duty to amend the returns."

Pearl recommended that all same-sex couples, either married or in registered domestic partnerships, speak to their accountants or other advisers to determine if amending their returns would make sense for them. Those who are not married, for whatever reason, should also ask themselves if they are now interested in marrying, she added.

"Maybe some couples haven't even thought about that and couples who have registered as domestic partners in states that allow that or entered into civil unions are probably going to want to obtain a formal marriage license because even if the Supreme Court goes all the way and says that it's unconstitutional to deny same-sex couples the right to marry, that doesn't necessarily convert every existing domestic partnership or civil union into a valid legal marriage," said Pearl.

The Windsor case specifically had to do with the issue of estate taxes. When Edith Windsor's wife, Thea Spyer, died the IRS would not allow Windsor to take the routine marital estate tax deduction that allows for heterosexual married widows to delay paying the tax until after they die. Instead, the agency demanded that Windsor pay more than $360,000 in taxes on the estate she shared with her spouse.

If the court rules favorably in the case, then Pearl recommends that same-sex couples review and possibly amend their estate plans to ensure they qualify for all of the available tax exemptions.

She pointed out that since same-sex couples did not qualify for the federal marital deduction and were not focused on delaying the taxes owed until the death of the second partner, "estate planners for same-sex couples were focusing instead on making sure that there's no double tax so that assets aren't taxed once when the first spouse passes away and then again at the second death."

Couples may also want "to relook at any premarital cohabitation or domestic partnership agreement," added Pearl, "because most of those were probably drafted at a time that we didn't know what the income tax effect of divorce would have on same-sex marriages."

A decision against DOMA would likely take effect immediately, said Pearl, though she predicted the IRS would need some time to issue new regulations to deal with the tax implications of such a ruling.

Cray predicted that any guidance from the IRS would come before the deadline for filing 2013 taxes next April. He advised same-sex couples thinking about getting married, particularly if the court also strikes down California's voter-approved ban against same-sex marriage in a separate case it will decide, to wait to see what the IRS's response to the DOMA ruling is and to seek personalized advice on their tax filings.

"While federal taxes should not be a barrier to entering into a marriage or expressing commitment and love, marriage may bring with it some changes to what the couple will owe in taxes," he noted. "Every couple's financial situation is unique, and identifying the best steps to take for these couples and their families will require an individualized assessment of their income and economic situation."

When Can I Deduct My Food?

Nellie Williams writes: Nothing is deductible. Unless Congress says it is, of course. It is our elected Senators and Representatives, our Congress, that make the tax laws. It is the Internal Revenue Service that is charged with enforcing the tax laws.

All income is taxable. The IRS expects you to report all of your income. When you take a deduction, you are subtracting that deduction from you income and you pay less tax. I want you to pay your lowest legal tax, not a penny more. And to do that well, I think you need to know the rules of this tax game.

Generally, the cost of food is not deductible. We all have to eat. Food is a personal expense. But food can sometimes be a business expense. And business or job-related expenses can be deductible. You just need to structure the circumstances.

Most of the time my husband does the cooking. He loves to cook. He is a good cook. I can cook too. But when I cook now, I make reservations. 

Not long ago we went to dinner at a popular restaurant. The food is always good but this night it was very noisy. I was thinking how hard it would be to have a business conversation in such a noisy place.

When you want to deduct the cost of your meals, you need to do certain things. First, there must be a business purpose for this meal. How do you conduct business over a meal? There are several different ways you might have a deductible meal.

Is this a business meeting in your place of business? Are you the business owner feeding your employees at a meeting? That meal could be 100% deductible. Are you the business owner entertaining customers at a get-together? Are you a business person entertaining a client at a restaurant. Are you taking a customer or a client to a social event? Those meal expenses could be 50% deductible.

Why only 50%? Because the cost of your own meal is not deductible. The cost of your guest’s meal is. But you are not looking at who ordered what, just the whole bill, including tax and tip.

How do you make these expenses deductible? DOCUMENTATION is the key! Recordkeeping is what protects your deduction. The expense must be directly related to conducting business. Your objective must be to generate income. After all, this is INCOME tax we are talking about.

The business can be conducted immediately before, during or immediately after the meal. The meal cannot be lavish or extraordinary if you want the government to pay for it. Isn’t that what we’re asking when we reduce the income we pay tax on by taking an allowable deduction? Meals with co-workers or associates are generally not deductible.

The IRS says you don’t need an actual receipt for meals under $75, but I still encourage my clients to keep all of the receipts you can for any tax deductible expenses. You do still need records to substantiate your deductions.

Your records do still need to show for each separate expense: the date, the name of the place, the business purpose (who you entertained), and the amount spent. This amount can include the cost of the meal including tax and tip. I ask my clients if the remember the 5 “w”s of journalism? Write down WHO your entertained, WHAT was the purpose of your meal or event, WHEN (the date) you did this, WHERE you went, WHY this is going to help your business and finally, How Much did you spend?

If you do not keep adequate records, you can lose you deduction. So you decide. Is your deduction worth the extra time to protect it, to save it?

Audit-Proofing Your Tax-Deductible Medical Expenses

SPW writes: It will be difficult to accrue tax-deductible medical expenses in 2013. The ceiling just rose an additional 2.5% of Adjusted Gross Income (AGI), bringing the percentage up to 10%. If you do cross this threshold, then you want to ensure your tax return is audit proof. Documentation is integral for claiming any of the 3 Major tax-deductible medical expenses below.

Nursing Home Costs as a Tax-Deductible Medical Expense

Later in life, claiming deductions on nursing home expenditures can help offset most of your income and save a significant percentage of your money. The cost of the nursing home – including meals and lodging – can be written down as an itemized deduction. If you are helping a parent or grandparent with their taxes, be sure to take advantage of the opportunity. But standing up to an audit would require documentation that will prove the nursing home is necessary primarily for medical reasons. It does not matter how obvious the need may be, the IRS will require physical proof.

Weight Loss Programs as a Tax-Deductible Medical Expense

Approximately 2/3 of the adults in the U.S. are either overweight or obese, making weight loss programs increasingly common. It is also generally accepted that weight gain can lead to hypertension, diabetes, and high cholesterol. With a physician’s documentation of need for weight loss, you can claim deductions for:

• Attendance at meetings and weight-loss groups
• Weight-loss programs
• Special gym fees associated with your weight-loss program
• Food costs – This is the most difficult category to prove and will only be deducted if the food a) alleviates/treats an illness; or b) is not part of a normal nutritional need.

Showing a picture is not enough for the IRS. You need to have a medical opinion outlining the need for weight loss, and the programs you are engaged in.

Medical Massage as a Tax-Deductible Medical Expense

If you throw out your back, your doctor will often suggest medical massage as a component of physical rehabilitation. But you need official documentation from the healthcare provider in order to claim the therapeutic treatment as a deduction. We suggest treatment from a medical office that offers massage, as opposed to a general spa. It will be much easier to convince the IRS the expense was for treatment and not for pleasure.

Commonly Missed Small Business Tax Deductions

From iacprofessionals.com/Zimbio we read: Although many tax deductions are well known, there are also many that get forgotten or overlooked by business owners. These deductions can save hundreds or even thousands of dollars in taxes each year, yet often are left off tax returns. Although most tax professionals will hunt down deductions for their clients, sometimes even the most meticulous professionals and business owners miss some deductions.

Fees
There are many fees that are paid out as part of doing business. It is important that all these applicable fees, big and small, are deducted at the end of year. Some fees that business owners can usually deduct are:

• Legal fees, for business legalities in the current year
• Consultant fees
• Bookkeeping and accountant fees
• Credit bureau fees
• Bank fees
• Business association dues or fees

Education
Keeping up with new trends in industry requires that business owners often have continuing education, seminars and trainings to attend. These expenses when related to the business are often deductible. This can include the cost of tuition or fees for classes, software, training videos and other forms of education. Even some books, magazines and audiotapes may be deductible as long as they are used for continued learning purposes that are related to business.

Transportation
Business use of a personal vehicle as well as other costs of transportation such as taxis, buses and trains can often be deducted. Even parking fees and metered parking can be deducted if it was for a business purpose. If a personal vehicle is used to run business errands or to meet with clients, it is important to track the mileage. Keeping a journal in the car or entering the mileage on a smart phone or tablet each time a vehicle is used for business is a good habit to get into. For 2012, the standard mileage deduction was over 50 cents per mile, which can add up to hundreds if not thousands of dollars saved throughout the year.

By scouring the deduction list that businesses can use, many business owners may find that they have missed opportunities to write off certain expenses. Every dollar adds up over the year, so taking the time to ensure that every legitimate business expense is used is worth the effort.

The Best Mobile Payment Systems: Small Businesses Weigh In

Anisha Sekar for Forbes writes: Many small merchants, from food truck vendors to hair stylists, use mobile payments to process their transactions. They’re convenient, simple and often come with handy features like receipt delivery and reports. But should small businesses always turn to the first processor they see? Even though companies like Square and PayPal Here dominate the conversation, they’re not always the best choice.

The tangled web

A NerdWallet study found that the best payment processor varied greatly by type of transaction, amount, total sales volume and type of card. In the end, though, certain processors carried the day.

Breadcrumb by Groupon GRPN -2.45% wins out for merchants who:

• Key in a significant number of transactions OR
• Have many transactions over $400 OR
• Do less than five or more than six figures in monthly sales volume, AND
• Have an average transaction over $26 OR

• Have an average transaction over $17 and under $26, but do not take American Express AXP -2.35%

PayPal Here is ideal for merchants who:

• Do less than five figures in sales a month AND

• Have an average transaction under $17 OR
• Have an average transaction under $26 and take American Express cards

Square’s monthly subscription plan is best for merchants who:

• Do 5-6 digits in sales every month AND
• Have very few transactions over $400 AND
• Key in very few transactions
• There are a few other tips available to businesses:
• Dwolla is one of the best processors out there, but it requires both customer and merchant to have signed up for an account, adding friction to the transaction process.
• Online donations from companies like Frendo or through portals like American Express Members Give can offer transaction discounts for registered nonprofits.
• American Express can be costly: Bank of America BAC -0.46%’s Mobile Pay on Demand, Breadcrumb by Groupon and Intuit INTU +0.09% GoPayment all charge extra to take the high-end cards.

Watch for the fine print

There can be some crazy things hidden in terms and conditions. For example, Intuit GoPayment’s subscription service comes with hidden surcharges that significantly jack up the price. As CardFellow reports, only non-rewards credit card transactions (“qualified transactions”) get the lowest rate; others cost significantly more. According to NerdWallet analysis, such transactions make up only about 60% transactions – a hidden detail that can take a significant chunk from already-thin margins.

In the end, though, a merchant is best served by doing the math and finding the best payment processor for her own needs.

Juggle College Savings With Multiple 529 Plans It may make more sense to open a new 529 account after moving out-of-state than to move college funds.

 REYNA GOBEL for US News World Report writes: When Jacek and Laura Lazarczyk had their son Luke in 2002, they opened a tax-advantaged 529 college savings account for him through their state, Illinois.

Then friends told them about Upromise, a rewards program for online, retail and credit card purchases that allows parents to put those rewards into a different, Nevada-based 529 plan account. They opened one of those for Luke as well.

In 2005, the couple had their second son, Adam – and opened a state 529 plan account for him, as well as a Upromise account.

Now, the couple juggles multiple 529 plans, but they have a strategy. As the children age, the plans will automatically adjust to reduce stock-based investments in favor of safer investments.

Jacek Lazarczyk relies on the plan managers to make the investment choices. "I don't think I can ever be smarter than the market, so I don't pretend," he says. The couple contributes regularly to their state plan, which offers a tax deduction.

The Lazarczyks are far from the only family with multiple 529 plan accounts. Joe Hurley, founder of Savingforcollege.com, says, "The most common reason for having multiple accounts is believing an out-of-state plan works best for the investor, but the in-state plan offers a state tax deduction or credit."

One reason the out-of-state plan might work better is if a family moved and there's a cost for transferring funds to a new plan, says Mike Fitzgerald, chairman of the College Savings Plans Network. The state parents moved from could expect tax deductions and credits to be repaid, he says.

For instance, if someone saved $1,000 on their annual taxes because of 529 plan contributions, this amount could be recaptured on a future tax return. "That's the way we do it in Iowa; that's the way they do it in most states," Fitzgerald says.

Then, for future contributions, open a plan in the new state, Fitzgerald says. This way, state tax deductions and credits aren't reclaimed by the old state, and families can benefit from state tax deductions and credits in the new state.

For the Lazarczyk family, the out-of-state plan is their Upromise 529 plan. They don't make regular contributions, but they leave the reward earnings – from online purchases and a percentage of their credit card charges – in the Upromise 529 account. The family has saved $3,000 between the two boys' accounts from Upromise rewards.

The family hasn't planned which account to withdraw money from first for future qualified education expenses. Lazarcyk says they're just trying to accumulate as much as possible.

Financial expert Hurley recommends using the plan with the most earnings first, in case there are leftover funds after all qualified educational expenses are paid.

If a student doesn't use all the money for education, the account owner would have to pay federal taxes on the earnings, and the IRS would charge a tax penalty of 10 percent on the withdrawal.

For example, the student is going to a college that costs $16,500. The student's family opened two 529 plan accounts 10 years ago. One was opened with $10,000 and earned 5 percent annually; the other account was opened with $5,000 and grew 3 percent annually. The first account is now worth about $16,300. The other account is worth more than $6,700.

Since the degree only costs $16,500, the family should withdraw money from the plan with the greater earnings, with a total of $16,300, to avoid taxes on withdrawals from that account. Then they could cash out the second account and pay less in taxes because of lower earnings and a smaller tax penalty because of the account's overall lower value.

While there are reasons to open more than one 529 plan account per child, Hurley doesn't recommend opening dozens.

"I have had 529 accounts in 33 different states," he says. "I don't recommend it. One or two is sufficient for anyone else."

Wave Partners With Box, MailChimp, General Assembly And More To Launch One-Stop Shopping Tool For Startups

Darrell Etherington for TechCrunch writes:  A new convergence of startups and Internet companies has come together to provide other early-stage companies with the tools required to get up and running quickly, and most importantly, cheaply. It’s sort of like a Humble Indie Bundle, except instead of gaming,GetStartupTools.com offers software from Wave, Box, MailChimp, Zendesk, Uberflip and General Assembly that most brand new internet companies would need or at least appreciate.

Toronto-based Wave operates its free accounting platform, and now also does payroll, as well as invoicing and tracking receipts via mobile apps. As part of the package, they’ll be offering three free months of payroll in the U.S. in Canada, which is normally a paid service on their freemium SaaS model. General Assembly offers online education and courses, with a lot of focus on subjects startups will benefit from. Box is offering 10GB of free storage for current sign-ups, MailChimp is doing an exclusive $50 credit for new sign-ups to its newsletter service, and Zendesk is doing a $1,000 credit with a free year of subscription for its customer support tool. Finally, Uberflip is offering two months of free use for its content marketing platform.

Of course, Get Startup Tools isn’t something that these companies have just put together out of the goodness of their hearts – each enjoys a very healthy influx of customers from startup clients, and early-stage companies, especially those in tech but also beyond, are a key target demographic for each, especially given that most are low-cost alternatives to more traditional and complex enterprise software. Joining forces, especially since no company on the list really steps on the toes of any other in terms of their service areas, makes a lot of sense for each party involved.

Wave and the others might be more or less self-interested in setting this up, but that doesn’t mean it’s not also a convenient resource for startup companies, either. Wave CEO Kirk Simpson said that putting together a bundle is a way of making it easier and cheaper to launch a company, and that’s true in this case, especially given the special discounts some of the participants are offering. Plus it shows a renewed interest in the startup market by each of those companies involved, which is refreshing because often you see businesses go after more established customers as their own company matures.

As Mac software and game creators have long known, a bundle is a good way to shift product. We’ll see if the same applies for startup-focused SaaS providers.

ZenPayroll Adds Contractors to Its Cloud-Based Payroll Service

Jason Bramwell  for AccountingWeb writes: When San Francisco–based ZenPayroll Inc. launched in December 2012, its mission was to bring the power of modern software to the payroll industry through a Cloud-based service that's simple, easy to use, comprehensive, and accessible 24/7 from any computer or mobile device.

"So much of the payroll industry today is still done manually. That's why some small businesses every year get fined for forgetting to file Form 1099, reporting wages incorrectly, or making filing errors with the government," Joshua Reeves, CEO and cofounder of ZenPayroll, told AccountingWEB. "By fundamentally rethinking how payroll works with a focus on user experience, we're able to deliver delightful payroll through automation that's easy to use, secure, and saves businesses time and money."

After raising $6.1 million and receiving the backing of CEOs from such companies as Yelp, Yammer, and Dropbox, ZenPayroll initially focused on providing businesses with its Cloud-based payroll service to pay full-time employees. However, on June 12, the company launched support for contractor payments.

According to the US Government Accountability Office, nearly forty-three million workers, or approximately one-third of the US workforce, are independent contractors. Providing support for contractor payments was one of the most requested services ZenPayroll received in the past several months, according to Reeves.

"We found that a lot of folks, including ourselves with previous companies we have run, end up doing checks or using PayPal or other various payment mechanisms to pay contractors. They track the amount paid, when it was paid, and who it was paid to in spreadsheets or in other types of systems," Reeves said. "Any business owner who uses ZenPayroll can add contractors to their existing system and, much like paying their full-time employees, the contractor's payment is direct deposited into the [contractor's] account. Rather than paying employees and contractors separately, it's all done through one system. All that data gets centralized, and companies can see in one place how much and when they paid contractors."

How It Works
Signing up to use ZenPayroll takes about ten to fifteen minutes, Reeves said. The payroll service asks for specific information from the user, and that information is entered one time only.

Companies must provide ZenPayroll with the contractor's bank account number and routing number for the contractor's payment to be direct deposited. When a contractor is scheduled to be paid, the employer clicks on a "pay contractor" button on the service's online dashboard. The employer is asked how much the contractor should be paid, and after that amount is entered, the contractor soon receives his or her payment.

Once a contractor is added to the system, an employer can also record previous payments made to the contractor prior to using the service.

ZenPayroll maintains bank-grade security, Reeves said. Data is fully encrypted at rest and in transit using 256-bit secure sockets layer (SSL) encryption. The company employs state-of-the-art firewall and backup technology, and data reside in high-security, access-controlled data centers.

"We spent all of last year building out the platform to make sure we leverage bank-grade security because it's such a business-critical task. It always has to work correctly," he said. "We've had tens of millions of dollars now come through this system, and customers love it. They tweet about it and have validated our belief that payroll can be delightful.

"If you think about it, the underlying building blocks of payroll are two of the most amazing building blocks possible," Reeves continued. "Two of the happiest moments of the month for employees or contractors is when they get paid – for contractors, they may even get paid more than twice a month. For the employer, it's how you reward your employees or contractors for all the work they've done."

Another feature of the service is that it automatically creates the contractor's Form 1099 for income tax-reporting purposes. Businesses are required to file Form 1099 with the IRS at year's end for any contractor who received more than $600 in wages from the employer.

"Because all that data is already stored in the system, the 1099 gets printed automatically. We send it to the IRS, which is what we do for all tax filings, through eFax or e-file. Then we go ahead and send a copy to the contractor," Reeves said.

Employees and contractors also receive a lifetime account to ZenPayroll, in which they can log in to the website and view their account.

"They can change the direct deposit, they can review their payment history, and they can view the 1099 that we created for them and where that data came from," he said.

Pricing for the service is the same for both employees and contractors. A company pays $25 per month and $4 per month for each full-time employee and contractor. When a company grows past ten employees and contractors, the rate drops to $2 for each additional person.

"The company gets unlimited usage, so if it wants to pay a contractor six times a month, all we care about is how many people it has in the system," he said. "There are no additional fees or surcharges, nothing at the end of the year, and nothing on a quarterly basis. It's just that simple monthly price."

ZenPayroll for Accountants
Another service ZenPayroll provides, ZenPayroll for Accountants, was launched in April and allows independent accountants, independent bookkeepers, and other back-office service providers to manage the payroll needs of multiple companies from an online dashboard.

"We're really excited to empower those individuals with modern software and help build their service businesses more strongly and more successfully," Reeves said. "With the launch of contractor payments, we're enabling these independent accountants and bookkeepers to help their customers manage contractors."

Anelya Grant, founder and senior accountant for AgAccounting, which provides accounting, bookkeeping, corporate, and tax services to small and midsized businesses, told AccountingWEB that her company has used ZenPayroll since October 2012.

"It's the best payroll software on the market right now," she said. "It makes doing payroll so much easier. First of all, they take care of filing all state and federal payroll tax documents. Second of all, you can add people to the payroll and just forget about it. They have an option for automatic payroll, which makes direct deposits automatically. You just have to set up payroll and everything is delightfully easy."

ZenPayroll's Cloud-based payroll service is currently only available in California, but nationwide expansion is a top priority for the company, Reeves said.

"We'll be adding support for Florida, New York, and Texas next month, and we'll be nationwide by the end of the year. We'll be expanding into Canada next year," he concluded. "However, contractors can be located nationwide. For example, a company in California can pay their contractors who live anywhere in the United States."

Yahoo!/Tumblr Deal and the Tax Cost of Cash Acquisition Payments

McBrayer, McGinnis, Leslie & Kirkland, PLLC write: When Yahoo! recently acquired the blogging service Tumblr, the two companies structured the deal so that virtually all of the $1.1 billion price tag for Tumblr will be paid in cash. In the current economy, many companies, particularly tech companies, have a lot of cash available, making the more traditional payment in stock appear less desirable. However, tax planning during mergers or acquisitions can be invaluable because, with proper counsel, the organizations can anticipate and mitigate the tax ramifications for the companies, individuals and shareholders.

Specific information about any tax planning in the Yahoo!/Tumblr deal hasn't been released, but let's consider the potential tax consequences of an essentially all-cash deal.

Most of Tumblr’s existing shareholders likely purchased their stock for substantially less than it was valued at the time of Yahoo’s acquisition. Since capital gains taxes are levied on the difference between the purchase price and the sale price, those Tumblr shareholders may be facing a hefty capital gains tax bill that will come due as soon as the transaction is complete.

If the deal had been structured as a stock transaction, on the other hand, it might have been structured to defer the capital gains tax for those shareholders until they actually sell their stock to Yahoo! There are a number of methods, such as 1031 exchanges, Section 368 tax-free reorganizations, and or 338(h)(10) stock purchase elections, that might also be effective in mitigating the tax burden.

An all-cash deal also presents challenges for Yahoo! in that it could affect the incentives for Tumblr’s founder and senior management going forward. In a tax-free reorganization, for example, they would generally be compensated in Yahoo! stock, which automatically creates an incentive for Tumblr’s leadership to build value for Yahoo! Without stock, a different incentive plan is needed.

According to The New York Times’ DealBook blog, Yahoo! may not need to worry about incentivizing Tumblr’s leadership, however, as it plans to continue to run the blog service as a separate company with the same group of executives. That may leave the existing incentives for success in place.

In this particular case, we don’t have enough information to determine why Yahoo! and Tumblr structured the acquisition as an all-cash deal. Well-considered tax planning, however, is essential for any business considering a merger or acquisition, stock sale, or major asset sale. Anticipating and minimizing transactional taxes, including business transfer taxes and business succession taxes, can help ensure that companies garner all potential benefits of the deal.