california – Arrache CPA

Posts

Deadline Alert: California Small Businesses and the CalSavers Mandate

December 13, 2025/0 Comments/in Uncategorized /by mrarrache

If you are a California small business owner, especially one who manages your own corporation or LLC, you need to mark December 31, 2025 on your calendar. This is the final deadline for companies with 1–4 employees to comply with the state-mandated CalSavers Retirement Savings Program.

Ignoring this law is not an option, as non-compliance can lead to financial penalties.

Here is your clear, step-by-step guide on what CalSavers is, what it requires of you, and the critical action you must take by the end of the year.

1. What is the CalSavers Retirement Savings Program?

The California state law requires that all eligible employers who do not currently offer a qualified, private-market retirement plan (like a 401(k), SEP IRA, or SIMPLE IRA) must do one of two things:

Facilitate the state-run CalSavers Retirement Savings Program for their employees, OR
Report an exemption because they already offer a qualified private-market plan or meet other specific criteria.

The law’s primary goal is to address the over 7 million private-sector workers in California who lack access to any workplace retirement savings option.

2. The Critical Distinction: Sole Owner vs. One Employee

This is the most crucial part for the smallest businesses. Your compliance action depends entirely on your status:

Your Status	Compliance Requirement	Action Needed
Sole Owner/Employee (You are the only W-2 employee, and you own the business)	EXEMPT from participation.	You MUST register and formally Report Your Exemption on the CalSavers website.
One or More W-2 Employees (Other than the owner/owner’s spouse)	MANDATED to comply.	You MUST either facilitate CalSavers or establish a qualified private-market plan.

The bottom line: Even if you are a sole owner and are exempt from setting up the payroll deduction system, the state requires you to register and officially report that exemption to avoid compliance notices and potential fines.

3. Your Required Action Steps

To avoid penalties of up to $750 per eligible employee, you must take action before the December 31, 2025, deadline.

Step 1: Gather Your Credentials

Before you visit the website, you will need:

Your Federal Employer Identification Number (FEIN) or Tax Identification Number (TIN).
Your California Payroll Tax ID (from the Employment Development Department, or EDD).
Any CalSavers Access Code you may have received in the mail.

Step 2: Go to the CalSavers Employer Portal

You must navigate to the official CalSavers employer website.

Step 3: Register or Report Your Exemption

Follow the on-screen prompts. You will be guided to either:

Register to begin facilitating the program for your employees, OR
Report Your Exemption and select the reason (e.g., “Company has no employees other than the owner(s) or the owner’s spouse”).

Policy Insight: Is This Mandatory Saving?

Many small business owners question the ethics or policy behind a state-mandated retirement program. While it may feel like government overreach, it’s important to understand the structure:

It’s Not Forced Participation: CalSavers is voluntary for employees. Any employee can opt out at any time. The employer’s role is strictly administrative—simply facilitating the option.
It’s Not a State Investment Fund: The contributions are automatically deposited into an Individual Retirement Account (IRA)—either a Roth IRA or Traditional IRA—that is owned and controlled by the employee. The state is only requiring access to a savings vehicle, not mandating a specific investment or propping up the market.
The Goal is Social Wellness: The program is designed to reduce future reliance on state public assistance by ensuring more Californians have a basic retirement nest egg.

The final takeaway is this: The law is a compromise. It mandates access, but respects individual choice (the opt-out feature).

Secure Your Compliance

The December deadline is firm. If you are unsure about your exact exemption status or need assistance in establishing a compliant private retirement plan (like a SEP IRA) to bypass the CalSavers mandate entirely, we can help.

Don’t risk penalties. Contact us today for a quick review of your small business status to ensure you meet the compliance requirements for 2025.

Schedule Consultation

About Mr. Smart Tax

Mr. Smart Tax is your helpful, accessible, “Retail Expert” resource for all things related to tax compliance. We provide clear, tactical, and educational content on “How-to” guides, standard deductions, corporate minutes, filing tips, and small business tax requirements. Our goal is to give small business owners and individuals the specific, step-by-step answers they need to navigate the tax landscape confidently.

When Your Business Closes: What Happens to That “Large UI Balance” with the EDD?

November 18, 2025/0 Comments/in Articles & Publications /by mrarrache

So, you’re winding down your business in California, tying up all the loose ends, and you notice something on your Employment Development Department (EDD) statement: a significant “UI Balance.” You might think, “Great! I’ve been paying into this, and now that I’m closing, I’ll get that money back, right?”

Not so fast. This is a common misconception, and understanding the difference between a UI credit and a UI reserve balance is key. Let’s break it down.

The Two Types of “UI Balance”

When we talk about a “UI balance,” there are two distinct scenarios:

Actual Cash Credit / Overpayment: This is rare, but it happens. If your business genuinely overpaid its unemployment insurance contributions, resulting in a true cash credit in your account, then yes, you may be eligible for a refund after filing a claim with the EDD. This is like getting money back from the IRS if you overpaid your income taxes.
The UI Reserve Account Balance: This is what most businesses refer to when they see a “large UI balance.” This is a record-keeping balance, not a literal bank account with your business’s money sitting in it.

Your UI Reserve Account: An Insurance Policy, Not a Savings Account

Think of your Unemployment Insurance contributions less like a savings account and more like an insurance premium.

Every quarter, you pay UI taxes to the EDD. This money goes into a large, statewide Unemployment Fund.
Your individual “UI Reserve Account” tracks how much you’ve paid into the system versus how much in unemployment benefits has been paid out to your former employees.
This balance is used by the EDD to calculate your experience rating, which in turn determines your specific UI tax rate for the following year. A positive balance generally means you’ve paid more than your former employees have claimed, which can help keep your tax rate lower.

Why You Won’t Get Your Large UI Reserve Balance Back

Here’s the crucial point: You do not get a refund of a positive UI reserve account balance when you close your business.

It’s a Pooled Fund: The money you contributed goes into a general fund that pays unemployment benefits to all eligible workers in California, not just your specific former employees.
Insurance Analogy: It’s exactly like paying for car insurance. If you never get into an accident and then sell your car, you don’t get all your past premiums back. Those premiums covered the risk for the period you were insured. The same principle applies here.

Critical for Business Acquisitions: The Successor in Interest Rule

For sellers, buyers, and advisors involved in a business acquisition, the UI Reserve Account Balance is a key due diligence item because the tax rate can be transferred.

When a business is sold, the buyer (the “Successor in Interest”) typically has the option to apply to inherit the seller’s entire UI Reserve Account Balance and the associated tax rate.

Positive Balance Scenario: If the seller has a large positive reserve balance, the buyer will want to inherit it, as it allows them to immediately start paying a lower UI tax rate, potentially saving thousands in payroll costs. This is often factored into the negotiation and valuation of the business.
Negative Balance Scenario: If the seller has a large negative reserve balance (meaning their former employees claimed far more in benefits than the seller contributed), the buyer may try to avoid inheriting the account, as doing so would immediately saddle them with a high tax rate.

Therefore, the value of that “large balance” is not realized as a cash refund, but rather as a transferable reduction in future tax liability for the new owner.

Example: The Impact of Transferring the UI Account

Let’s look at a concrete, simplified example based on California’s tax structure (Note: New employers in CA start at a rate of 3.4% for a few years, and the taxable wage limit is currently $7,000). This example clearly demonstrates that the UI Reserve Account Balance is an intangible asset that transfers as a lower tax rate, not as a cash refund. The buyer’s due diligence should always include securing that favorable experience rating.

Scenario Variable	Value	Notes
Predecessor (Seller) Status	Positive UI Reserve Balance	Excellent employment history.
Predecessor’s UI Tax Rate	1.5% (The lowest experience rate available)	Due to the positive balance.
Successor (Buyer) Status	New Employer	No prior experience history.
New Employer UI Tax Rate	3.4% (Standard starting rate)	Assigned by the EDD to all new businesses.
Estimated Annual Payroll (Taxable)	$1,000,000	$7,000 taxable wage base times approx. 143 employees.

Case 1: Buyer CHOOSES to Roll Over the UI Account

In this scenario, the buyer (the Successor) files the necessary paperwork with the EDD to inherit the seller’s positive UI Reserve Account Balance.

Buyer’s New Rate: 1.5% (They keep the seller’s low rate).
Annual UI Tax Cost: $1,000,000 times 1.5% = $15,000
Result: The buyer immediately saves $19,000 per year in UI taxes compared to the new employer rate, making the business more profitable from Day 1. This tax savings is the real value of the positive UI balance.

Case 2: Buyer DOES NOT Roll Over the UI Account

This might happen if the buyer misses the filing window, or if the seller simply closes the account.

Buyer’s New Rate: 3.4% (The default new employer rate).
Annual UI Tax Cost: $1,000,000 times 3.4% = $34,000
Result: The benefit of the seller’s good employment history is lost. The buyer pays $19,000 more per year in UI taxes, effectively punishing them for not taking the critical step to transfer the low-rate experience.

So, What Does Happen to That Large Positive Balance when a business simply closes?

When your business formally closes its EDD account:

No Refund: The positive balance in your UI reserve account is not returned to you.
Account Cancellation: After a period (typically three consecutive years) during which your business no longer pays wages, your UI reserve account is generally canceled by the EDD.
Redistribution: The positive balance from your canceled account is then prorated and distributed among the reserve accounts of other employers who have positive balances. Essentially, it helps stabilize the overall Unemployment Fund and can potentially benefit other businesses by contributing to lower statewide UI tax rates.

California vs. Other States: Is This the Universal Rule?

The California rule that the UI Reserve Account Balance is non-refundable is the overwhelming norm across the United States. Almost every state uses a similar experience rating system, and the contributions are considered premiums for a pooled trust fund.

Category	States (Examples)	Disposition of Positive Reserve Balance
The Vast Majority (Pooled Fund States)	California, Texas, New York, Georgia, Wisconsin, Kentucky	Non-Refundable. The balance is typically canceled and reallocated to the state’s general UI fund to benefit all remaining employers.
The Exception	No state currently offers a direct cash refund of the positive UI reserve account balance to the closing employer.	The entire system is built on pooled risk.
The Successor Rule (A Key Option)	All States	If the business is sold (not just closed), the buyer (the successor) can often apply to inherit the positive (or negative) UI Reserve Account Balance and the associated low (or high) tax rate.

The Key Difference is Not the Refund, but the Account Transfer

The biggest distinction between states isn’t whether they offer a refund (they don’t), but how they handle the transfer of the reserve account when a business is sold or acquired.

In California, if you sell your business, the new owner may apply to take over your favorable UI Reserve Account Balance to keep their tax rate low. If they don’t, the balance is canceled and eventually distributed.
In states like New York or Texas, similar successor rules apply. The benefit of that positive balance can only be realized if it is transferred to a new, ongoing employer account.

The Essential Step: Formally Close Your EDD Account

Even though you won’t get a refund on your reserve balance, it is absolutely critical to formally close your business’s account with the EDD when you cease operations.

Why?

Avoid Penalties: Failing to close your account can lead to non-filing penalties, even if you’re no longer operating.
Finalize Records: It ensures all your tax and wage reporting obligations are met for your final period of operation.
Clear Your Name: It formally notifies the EDD that your business is no longer an active employer, preventing future confusion.

How to Close Your Account:

e-Services for Business: Log in to your account on the EDD’s e-Services for Business portal.
Final Returns: Submit your final payroll tax returns and wage reports.
Notify EDD: Officially inform the EDD of your business closure date and reason.

The Takeaway

While it might be disappointing to learn that a large UI reserve balance isn’t money coming back to your business, understanding its true purpose as part of a crucial social safety net is important. Focus on formally closing your account to ensure a clean and proper exit from your employer obligations.

Need Professional Guidance?

For complex business situations, especially those involving multi-state payroll questions or intricate final tax filings, it is always best to consult with a qualified professional.

Please feel free to contact us directly at info@mrarrachecpa.com for assistance.

About the Author

Michael R. Arrache, CPA, EA, DRE

As a Certified Public Accountant (CPA), Enrolled Agent (EA), and licensed Realtor, I am a tax expert who works closely with small business owners and real estate investors. My firm, Arrache CPA, Inc. dba Mr. Smart Tax, provides a range of specialized financial and real estate services, including tax planning, business transactions, and real estate advisory. With over 15 years of experience, my mission is to help clients achieve their financial and business goals by providing strategic advice and tailored solutions. I write these articles to serve as a starting point to guide you through the business or real estate process, and I am committed to providing the strategic guidance you need to help preserve and grow your wealth.

The $Mistake: Why Your “Charity” is Actually a Taxable Business

November 14, 2025/0 Comments/in Articles & Publications /by mrarrache

The Line in the Sand: Nonprofit vs. Business

Every founder with a mission dreams of tax-exempt status. But the path to becoming a recognized public charity 501(c)(3) is fraught with strict legal and financial tests. The true cost of seeking nonprofit status isn’t the filing fee—it’s the risk of having a profitable business structure that fails the charity test entirely.

If you started your organization hoping for tax-exempt status but were denied, or if you realize your current operations would likely lead to a denial—you are running a compromised entity. Your organization is legally exposed, and you need an immediate strategy shift.

The case study of “Organization A“, an entity attempting to navigate the complex world of state-funded specialized care, illustrates this perfectly. They learned the hard way that if the company’s primary function is private benefit or not related to public charity, the IRS will deny its mission—forcing a dramatic and costly pivot.

Establishing a Compliant Nonprofit (The 5 Key Steps)

Before all else, you must define your public charity mission. This mission will guide every legal and financial step that follows.

State Incorporation (CA SOS): File the Articles of Incorporation (e.g., Form ARTS-PB) with the California Secretary of State (SOS). This legally creates the corporation as a Nonprofit Public Benefit entity.
Federal EIN: Obtain an Employer Identification Number (EIN) from the IRS. This number is required for all bank accounts, tax filings, and payroll.
CA Charitable Registration (CA AG): Register with the California Attorney General’s (AG) Registry of Charities and Fundraisers. This is mandatory within 30 days of first receiving charitable assets (donations, grants).
Federal Tax Exemption (IRS): File IRS Form 1023 (Application for Recognition of Exemption Under Section 501(c)(3)) or Form 1023-EZ. Approval here grants federal tax-exempt status.
State Tax Exemption (FTB): File Form 3500 or Form 3500A with the California Franchise Tax Board (FTB). This is the California equivalent of the Form 1023, granting exemption from state corporate income tax.

Three Fatal Flaws that Kill a Nonprofit Application

The IRS operates on two core principles: Prohibition of Inurement and the Operational Test. Any public charity must pass both. “Organization A” failed spectacularly on multiple fronts, exposing the following “fatal flaws”:

1. The Indefensible Insider Salary (Prohibited Inurement)

The single quickest way to ensure denial is to pay a founder or insider an excessive salary. Prohibited private inurement occurs when a charity’s net earnings are used to unjustly enrich an insider.

The “Organization A” Case Study: The Founder was paid excessive compensation for providing services. Since the organization operated without a robust public program, this payment was deemed unjustified and not substantiated by market rates for the service rendered.
The CPA’s Warning: Compensation must be reasonable—meaning it must be comparable to what a similar professional in a comparable organization would be paid. Without this proof, the IRS classifies the excessive payment as an Excess Benefit Transaction, which leads to denial and potential personal penalties for the founder.

2. The 100% Private Benefit Trap (The Operational Test)

A 501(c)(3) must be operated exclusively for charitable purposes, meaning its public activities must be substantial.

The “Organization A” Case Study: A high percentage of the organization’s total revenue came from a single private funding stream linked to the care of a Related Adult Beneficiary. This proved the organization’s primary function was to sustain a private, familial employment arrangement, not serve the general public.
The Rule: Even with volunteer work, if all the organization’s paid resources are concentrated on a private interest, the IRS concludes the charitable mission is merely a “pretext”.

3. Structural Non-Compliance

The nonprofit organization’s failure to establish basic operating procedures sank the application:

The organization could not provide documentation, detailed Program Policies, or a budget for its stated charitable missions.
The high-hour compensation claimed lacked essential labor law justification, exposing the directors to personal liability for wage and hour disputes under state law.

The Only Two Viable Paths for Mission-Driven Entities

If your organization has already been denied tax-exempt status or is preparing to apply but is currently compromised because its operations involves related party revenue, specialized services, or high founder compensation, you must choose one of the following compliant paths:

Path A: The Clean Break (Recommended)

This strategy separates the profitable, high-risk operational business from the clean, public charitable function. This is the ultimate lesson learned by “Organization A”.

Close the Compromised Entity: Dissolve the old nonprofit entity (“Organization A”) immediately. File final corporate tax returns (Form 1120/100) to clear all tax history and obtain tax clearance, avoiding the complex conversion process.
Form a Taxable Business: Create a new, taxable S-Corporation to handle all fee-for-service work (like contract administration and payroll). This structure provides the necessary corporate liability protection and allows the founder to receive a salary without violating inurement laws.
Form a Pure Nonprofit: Create a separate, new public charity with a new EIN immediately. This entity must have zero financial history with the founder’s business dealings. Its sole purpose is to raise funds and run the public programs.

Path B: The Correct Nonprofit Structure

If an entity absolutely must be a nonprofit to function (e.g., a hospital or university), all compensation must be carefully managed.

Third-Party Benchmarking: Compensation for insiders must be determined by a disinterested board based on external, third-party salary surveys of comparable positions.
Zero Related-Party Revenue: The organization must demonstrate its financial support comes primarily from the public (donations, grants, public program fees) and that services provided to any insider or their family member are incidental to the overall mission.

Final Advice: Never Let Operations Go Uncertified

The key takeaway from this case study is to know your operations. You must be able to certify all your business practices in order to clearly identify and avoid risks.

If you’re concerned that your nonprofit structure is a high risk, do not guess or stall, reach out to us today for a free introductory discovery consultation.

About the Author

Michael R. Arrache, CPA, EA, DRE

As a Certified Public Accountant (CPA), Enrolled Agent (EA), and licensed Realtor, I am a tax expert who works closely with nonprofits, small business owners and real estate investors. My firm, Arrache CPA, Inc. dba Mr. Smart Tax, provides a range of specialized financial and real estate services, including tax planning, business transactions, and real estate advisory. With over 15 years of experience, my mission is to help clients achieve their financial and business goals by providing strategic advice and tailored solutions. I write these articles to serve as a starting point to guide you through the business or real estate process, and I am committed to providing the strategic guidance you need to help preserve and grow your wealth.

From a Panera Table to a Global Reach: Celebrating 12 Years of Growth

September 21, 2025/0 Comments/in Articles & Publications /by mrarrache

Twelve years ago, our business began with a simple idea and a lot of determination.

Our office wasn’t a sleek corporate space; it was a kitchen table, a public library, and sometimes, a quiet corner at Panera Bread with free Wi-Fi. Our client list was humble—one dedicated restaurant owner and a handful of individuals who put their trust in us.

Today, as we celebrate our 12th anniversary, we are humbled and incredibly proud to say we serve hundreds of business owners and real estate investors not just across the country, but around the world. That small handful of clients has grown into a thriving community, and we wouldn’t be here without each and every one of you.

A Landmark Year of Service

The past year has been a landmark for our firm. We’ve invested heavily in our team, focusing on new skill training and bringing on new talent to ensure we provide the highest level of expertise. As we continue to grow, we’ve formalized our expertise into a set of services designed to help you succeed.

Our Real Estate Expertise

We’ve honed our expertise to offer a unique, comprehensive real estate service. We can act as your trusted financial consultant, providing essential guidance on everything from tax implications and cash flow analysis to accounting and long-term planning. We can also serve as your dedicated realtor, offering full-service representation for buying, selling, or leasing properties. Our hands-on experience ranges from revitalizing major residential properties to spearheading new property developments and navigating the sale of commercial buildings, allowing us to serve you with real-world knowledge and seamless, integrated advice.

Embracing the Future: Technology and AI

We were at the forefront of the new tax laws under OBBBA, providing our clients with early-stage guidance and implementation to help them navigate the changes successfully. As we look ahead, we are embracing the coming AI-powered revolution by implementing new software and technology that will improve our capabilities and allow us to serve you even more efficiently.

This year, we have implemented new client facing technology, which offers better user experience and helps us serve you more efficiently. While this implementation has been beneficial in streamlining our work, we understand that with every new software, there is a learning curve. Please know that we are here to help you with any questions and to find the best way to communicate with you, ensuring a smooth and productive experience.

Introducing a New Resource for Restaurant Owners

Our journey began with a single restaurant owner, and that community remains at the heart of what we do. In 2025, we had the privilege of helping clients in a variety of ways: guiding a San Diego restaurant through a complex lease exit and asset sale, assisting another with a successful rebranding strategy, and providing the crucial financial planning and operational strategies needed to build out a new space and thrive in seasonal markets.

Now, we’re thrilled to give back to this community with the upcoming release of our self-published guide, The Bean Counter’s Bible for Restaurants. This guide is the ultimate source for all things financial and operational, providing restaurant owners with the knowledge they need to successfully start, run, grow, or sell their business.

Our journey from that first client to a global presence is a testament to our commitment to your success. We are dedicated to continuing to grow our team and our capabilities to better serve you as your trusted CPA professionals and real estate advisors.

Thank you for being a part of our story. We can’t wait to see what the next 12 years bring.

Newport Beach Investors Caught in Diamond Ponzi Scheme: Tax Implications of Their Loss

September 12, 2025/0 Comments/in Articles & Publications /by mrarrache

Newport Beach, California, a hub of affluent investors, has recently seen several individuals fall victim to a sophisticated diamond investment scheme that has since been exposed as a multi-million dollar Ponzi. (full article here) The elaborate fraud, perpetrated by a local dealer, promised exorbitant returns on high-value diamond acquisitions, luring unsuspecting investors with the allure of a seemingly tangible and exclusive asset. As the dust settles and the true nature of the operation comes to light, many victims are now grappling with significant financial losses. However, there may be a silver lining in the form of tax relief, specifically the ability to write off these losses against ordinary income.

The Anatomy of the Diamond Ponzi

The fraudulent scheme, reportedly orchestrated by a well-known local diamond dealer, capitalized on the perceived stability and value of diamonds. Investors were presented with meticulously crafted prospectuses detailing opportunities to purchase rare and investment-grade diamonds, with promises of substantial profits upon resale within a short timeframe. The dealer allegedly used funds from new investors to pay off earlier investors, creating the illusion of a legitimate and profitable enterprise. This classic Ponzi model inevitably collapsed, leaving a trail of shattered dreams and depleted bank accounts. Investigations are ongoing, and legal proceedings are anticipated against the alleged perpetrator.

Understanding Tax Deductions for Ponzi Scheme Losses

For victims of Ponzi schemes, the Internal Revenue Service (IRS) offers specific guidance and relief regarding the tax treatment of their losses. Generally, investment losses are treated as capital losses, which have limitations on how much can be deducted against ordinary income in a given year. However, for losses stemming from a theft, such as a Ponzi scheme, the IRS provides a more favorable treatment, allowing for a deduction against ordinary income.

Theft losses are not subject to the $3,000 annual limit that typically applies to capital losses, making this deduction significantly more valuable for Ponzi scheme victims. Also, for tax years 2018 through 2025, an individual can only deduct theft losses if the loss is from a transaction entered into for profit, which a fraudulent investment scheme qualifies as.

Two Paths to Claiming Your Loss

The IRS provides two primary ways for victims of this scheme to claim their deduction.

Path 1: The IRS Safe Harbor (The Easiest Method)

Recognizing the difficulty in proving the exact nature and timing of a Ponzi scheme loss, the IRS created a “safe harbor” in Revenue Procedure 2009-20. This simplifies the process for victims. To use this safe harbor, you would generally claim the loss in the year the scheme’s lead figure is indicted or a criminal complaint is filed against them.

Under the safe harbor, you can deduct a percentage of your “qualified investment”. The deductible amount is calculated as follows:

95% of your qualified investment if you do not pursue any recovery from a third party (like an accountant or lawyer).
75% of your qualified investment if you are pursuing or plan to pursue third-party recovery.

The qualified investment includes the total amount of cash or property you invested, plus any fictitious income you reported on past tax returns, minus any cash or property you received back.

This deduction is filed on Form 4684, Casualties and Thefts, and you must include a statement with your tax return that you are electing the safe harbor.

Path 2: The 100% Deduction (The More Complex Method)

If you want to deduct 100% of your loss, you must forgo the safe harbor and claim the loss under the general tax rules of Internal Revenue Code (IRC) Section 165. This method is more complex and has a higher burden of proof.

You can only deduct the loss in the year you discover it and also determine there is no reasonable prospect of recovery. Proving this to the IRS can be very difficult, as it requires you to show with certainty that you will not recover any funds from the scheme’s assets or any legal claims. The IRS safe harbor was specifically created to bypass this difficult process by allowing an immediate deduction (at 95% or 75%) without requiring proof of a lack of recovery.

Comparison of the Two Methods

Feature	IRS Safe Harbor (Rev. Proc. 2009-20)	General Rules (IRC § 165)
Deduction Amount	95% or 75% of qualified investment.	Up to 100% of the qualified investment.
Required Proof	Relatively simple; requires an indictment or criminal complaint against the lead figure.	Highly complex; requires you to prove “no reasonable prospect of recovery”.
Deduction Timing	Claimed in the year of the promoter’s indictment or complaint.	Claimed only when it can be determined there is no reasonable prospect of any recovery. This could be years later.
Filing Process	Simplified with specific instructions on Form 4684 and a signed statement.	Requires detailed documentation and proof to support a 100% loss.

Next Steps

Given the complexities of this type of tax deduction, it is crucial to ensure you are following the correct procedures to maximize your recovery. If you have been a victim of the Lugano Diamonds scheme or a similar fraudulent investment, I can help you:

Determine your qualified investment and the correct deductible loss amount.
Properly document and file your tax return with the required forms.
Navigate the process of carrying back a Net Operating Loss to get a refund.

Please feel free to contact me for a confidential consultation to discuss your specific situation and ensure you receive the tax relief you are entitled to. Michael@mrarrachecpa.com or 949-877-3143

Bean Counter’s Bible: Choosing the Right Workers’ Comp Policy for Restaurants and Construction

September 3, 2025/0 Comments/in Articles & Publications /by mrarrache

For both restaurant owners and construction companies, selecting the right workers’ compensation policy is crucial for managing cash flow and risk. The best choice often depends on your business’s specific payroll fluctuations.

Payment Methods: A Comparison

1. Monthly Payroll Reports (MPR) 📊

This method is perfect for businesses with fluctuating payrolls, especially those in the restaurant and hospitality industry.

How it works: You pay an upfront deposit (e.g., two months’ worth of estimated premium) and then submit a report of your actual payroll each month. Your premium is calculated and paid based on these real-time numbers.
Pros for Restaurants: Restaurants often hire extra staff for seasonal rushes (summer patios, holiday parties) and special events. The MPR method ensures your premium payments adjust with your payroll, so you only pay for the coverage you need, when you need it. This helps prevent a large, unexpected bill after a busy season.

2. Installment Method with an Annual Audit 🗓️

This method offers predictable, equal monthly payments, which can be attractive for construction companies with a more stable, long-term workforce.

How it works: You pay a larger upfront deposit (e.g., three months’ worth) and then make nine equal monthly payments based on an estimated annual premium.
Pros for Construction: Construction crews may work on long-term projects with a consistent number of employees. This method allows for easier budgeting because you know your monthly insurance cost upfront. However, this is only a “pro” if your workforce and payroll are stable.
Cons for Both: The major drawback is the annual premium audit. If your actual payroll was higher than the estimate, you’ll receive a bill for the difference, which can be a significant surprise. This can be especially risky for construction companies that win a large new project mid-year and hire more workers than originally planned.

Bonus Section: Workers’ Comp Laws by State for Your Industry

Workers’ comp laws are highly state-specific, and the requirements for restaurants and construction can differ.

California & Arizona: Workers’ compensation is mandatory for all employers with at least one employee. This is a “no-fault” system. In construction, these laws are strictly enforced, given the high-risk nature of the work.
Washington: As a monopolistic state, employers, including those in construction and restaurants, must purchase workers’ comp from the state fund (L&I). This is a crucial distinction from states that allow private insurers.
Texas: Texas is unique as the only state where private workers’ comp is voluntary. This means a restaurant or construction company can choose to “non-subscribe” to the state system, but they lose legal protections from employee lawsuits. Given the high-risk environment of construction, this is a dangerous choice.
Tennessee: Workers’ comp is generally mandatory for employers with five or more employees, but for construction and coal mining, it’s mandatory if you have just one employee. This highlights the state’s specific risk assessment for the industry.
District of Columbia: Workers’ comp is mandatory for nearly all employers. A restaurant or construction company must secure coverage through a private carrier.

Disclaimer: The Dangers of Not Having Workers’ Comp ⚠️

While some states, like Texas, allow you to opt out, the financial and legal risks for both a restaurant and a construction company are enormous.

For Restaurants: An employee falling in the kitchen or slipping on a wet floor could result in a serious injury. Without workers’ comp, the restaurant owner is personally and financially liable for all medical bills and lost wages. A single claim could bankrupt the business.
For Construction: Given the inherent dangers of the job—falls from heights, heavy machinery accidents, etc.—a serious injury is not a matter of “if,” but “when.” Not having workers’ comp leaves a construction company vulnerable to a ruinous lawsuit that could put them out of business forever.

The only “pro” of not having a policy is avoiding premiums, but for both of these industries, the security and peace of mind provided by workers’ compensation are essential investments.

Have Questions? We’re Here to Help

Navigating workers’ compensation can be complex, and the right choice for your business depends on many factors. We’re here to help you understand your options and make an informed decision. If you have any questions about which policy is best for your business, or about workers’ comp laws in your state, please don’t hesitate to reach out to us. We look forward to working with you.

Naming the New Year: 2025 “Screeching Hawk”

August 26, 2025/0 Comments/in Articles & Publications /by mrarrache

A Tradition of Naming the New Year

Like many people, I enjoy a good tradition. Whether it’s a familiar tradition like a family vacation or nightly family dinners, one of our favorites is naming the new year.

The New Year Name is chosen before the year begins and reflects the important plans, challenges, and opportunities ahead. We typically use a simple format: action + animal. This has led to some memorable names over the years:

2019 – Riding Tiger
2020 – Running Bear
2021 – Soaring Eagle
2022 – Hanging Man
2023 – Hungry Hummingbird
2024 – Bucking Bull
2025 – Screeching Hawk

The Value of a Name

In my experience, this tradition has been inspirational, accurate, and at times, even foreboding. For example, 2023’s “Hungry Hummingbird” was incredibly accurate for the volatile housing markets and the unexpected but awesome rebound of the stock markets. Hummingbirds are fiercely protective of their small territories and need to constantly feed to survive, much like entrepreneurs had to stay nimble and seize every opportunity in the market.

For us as entrepreneurs and business owners, it’s important to work in our business as well as work on our business. The New Year’s name helps us associate an idea that is larger than any one person, while at the same time allowing us to focus 100% on the work at hand.

Our name for 2024, “Bucking Bull,” was a year of energy, enthusiasm, and competition. Much like riding a bucking bull, smart businesses had to navigate an uncertain economy and avoid getting dragged into uncontrolled situations. It was more important than ever to stay enthusiastic and align your journey with your competitive advantages.

This brings us to our name for the coming year: 2025’s “Screeching Hawk.”

Embracing the “Screeching Hawk”

A hawk is a powerful predator known for its patience and keen eyesight. It soars above the landscape, surveying its surroundings with a clarity and perspective that few others possess. Its screech is a sharp, confident sound—a declaration of its presence and a warning to others.

The “Screeching Hawk” will be a year of strategic planning and decisive action. We anticipate a year where a broad perspective will be key to spotting opportunities from a distance. The most successful businesses will be the ones that have a clear vision and the confidence to act quickly and boldly when the time is right.

For many, this may sound like a year of challenges, but for those of us who appreciate tradition, we see it as a year of clarity and purpose. We wish you a happy and safe New Year, and we extend our best wishes for success in 2025.

Info@mrarrachecpa.com

The Smart Family Loan: Why a Promissory Note is Essential (Even for Family!)

August 26, 2025/0 Comments/in Articles & Publications /by mrarrache

That moment when a relative steps in to help their family business is truly special. It’s a testament to family support, trust, and love. Recently, I had a client, whose relative generously lent them a large amount of money to help open their business. While the gesture was heartwarming, my immediate advice was clear: Get a promissory note signed.

You might be thinking, “It’s family! Does it really need to be so formal?” And my answer as a CPA is an unequivocal yes. A promissory note isn’t about distrust; it’s about smart financial planning, clear communication, and protecting both parties.

Let’s break down why this simple document is a must for any family loan:

The Promissory Note Checklist: What Needs to Be in It?

Think of a promissory note as the blueprint for your loan. It should clearly lay out all the terms to prevent any future confusion. Here’s what it should include:

Lender and Borrower Information: Full legal names and addresses for both your relative (the lender) and you (the borrower).
Principal Amount: The exact loan amount, written in both numbers and words.
Interest Rate: This is crucial! To avoid the IRS classifying the loan as a gift, the rate must be at least the Applicable Federal Rate (AFR), which changes monthly. We can look up the current rate together.
Repayment Schedule: Details on how and when payments will be made – monthly, quarterly, or a single lump sum, and specific due dates.
Maturity Date: The final date by which the entire loan, including interest, must be repaid.
Signature and Date: Both parties need to sign and date the note to make it legally binding.
Default Clause: What happens if payments are missed? This clause protects your relative and clarifies the process.
Prepayment Clause: Allows you to pay off the loan early without penalty – a common and fair clause for family loans.

The Pros of a Promissory Note: More Than Just Paperwork

Now, let’s talk about the significant benefits this document provides:

1. Legal and Financial Protection for Everyone

Avoids Nasty Tax Surprises: Without a note, the IRS might consider the money a gift from your relative. This could trigger gift tax liabilities for them on any amount over the annual exclusion limit. A promissory note provides undeniable proof it’s a loan.
The “Bad Debt” Lifeline: This is a big one! If, for unforeseen reasons, you are unable to repay the loan, the promissory note becomes critical documentation for your relative. It allows them to potentially claim a non-business bad debt deduction on their taxes. Without the note, the IRS would likely view the unpaid amount as an unrecoverable gift, and they’d lose out on that deduction.
Legal Enforceability: It’s a legally binding agreement. While no one wants to think about legal action against family, having this in place protects your relative’s assets.
Asset Protection for Both: In unfortunate events like bankruptcy or divorce, a promissory note clearly establishes the funds as a legitimate debt, protecting both your relative’s claim and your financial standing.

2. Crystal-Clear Clarity and Accountability

No More “He Said, She Said”: The note meticulously spells out all the terms – interest, payments, dates. This eliminates those awkward, “I thought we agreed on…” conversations that can damage relationships.
Fosters Responsibility: Formalizing the loan encourages the borrower to treat it with the same seriousness as a bank loan, fostering financial discipline and accountability.

3. Preserves Your Precious Family Relationship

Business is Business, Family is Family: A written agreement compartmentalizes the financial transaction. It allows you to keep the loan on a professional footing, preventing it from bleeding into and potentially straining your personal bond.
Head Off Disputes Before They Start: By defining the rules of engagement upfront, a promissory note removes the primary source of conflict in family money matters: misunderstandings, forgotten details, or differing expectations.

Potential Drawbacks and Tax Implications

While promissory notes offer many benefits, it’s also important to be aware of potential tax implications for both parties:

Interest Income for the Lender: For your relative (the lender), any interest received on the loan is considered taxable interest income that must be reported to the IRS. Even if the interest is not actually paid but is required by the note (especially if using the AFR), it may still need to be reported as “imputed interest.”
Cancellation of Debt (COD) Income for the Borrower: If for some reason the loan is partially or entirely forgiven, the amount forgiven can be considered Cancellation of Debt (COD) income for you (the borrower). This is generally taxable income to the borrower, unless specific exceptions or exclusions apply (e.g., insolvency, bankruptcy).

🏠 Bonus Section: A Special Note on Real Estate Loans

If a family loan is for a real estate purchase or is secured by a home in California, it’s considered a residential loan and requires extra steps for the lender’s protection. A promissory note is still essential, but it is not enough on its own.

In this scenario, the loan must also be formalized with a trust deed that is recorded with the county recorder’s office. This crucial step legally attaches the debt to the property, turning your relative into a secured lien holder. This protects their interest and establishes their priority over other potential liens. This is a critical legal process that an attorney must handle. They will ensure all documents are prepared and filed correctly to fully protect the lender and make the loan enforceable.

How to Record Real Estate Family Loans in Other States

The legal instrument used to secure a real estate loan varies by state, but the principle of recording the document is the same.

Arizona: In Arizona, the instrument is a Deed of Trust. It must be signed by the borrower and recorded with the county recorder’s office where the property is located.
Texas: In Texas, the instrument is a Deed of Trust. It must be signed by the borrower and recorded with the county clerk’s office where the property is located.
Tennessee: Like Texas, Tennessee uses a Deed of Trust. It must be recorded with the Register of Deeds in the county where the property is located.
Washington: In Washington, the instrument is also a Deed of Trust. It is recorded with the county auditor’s office where the real estate is situated.

The Bottom Line for Families

A family loan is a wonderful act of support. But to truly protect that generosity, that relationship, and everyone’s financial well-being, a promissory note isn’t just a good idea – it’s an essential one.

Disclaimer: As a CPA, I can help you with the financial and tax implications of this loan. However, the information provided here is for general educational purposes and is not legal advice. When dealing with any legally binding document, it is best practice to consult with your attorney.

If you or your family are considering a loan, let’s connect. I can help you navigate the financial and tax considerations of the loan, ensuring all parties are protected. Don’t let a kind gesture turn into a future headache; plan wisely from the start.

#FamilyLoan #PromissoryNote #CPA #FinancialPlanning #FamilyFinance #RealEstateLoan #TrustDeed #LegalAdvice #TaxPlanning #MoneyManagement

Did your spouse leave you real estate? 💡

August 18, 2025/0 Comments/in Articles & Publications /by mrarrache

A client recently asked a crucial question: “If Spouse A deeds their portion of a home to Spouse B who is terminally ill, and then inherits it back after Spouse B passes away, does Spouse A get a full step-up in basis?”

This scenario brings up a critical, but often misunderstood, tax rule: IRC Section 1014(e). This “deed-to-die” rule states that if a person gives appreciated property to a dying relative and then inherits it back within one year of the death, they do not receive a step-up in basis. This prevents the intentional use of a death to avoid capital gains taxes.

The solution to a full step-up in basis depends on how the property is owned:

Community Property States

The following are community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In these states, the entire property generally receives a full step-up in basis upon the death of the first spouse. According to IRC Section 1014(b)(6), if at least half of the community property is included in the deceased spouse’s gross estate, the entire property’s basis is stepped up to its fair market value on the date of death. This is a significant advantage, as it erases capital gains tax on the appreciation of the entire property. The strategy of deeding the property is unnecessary and could complicate the situation. For more information, refer to IRS Publication 555, Community Property.

Common Law States (Joint Tenancy)

In the majority of U.S. states, which are common law states, property is often owned as joint tenants with rights of survivorship (JTWROS). In this case, only the deceased spouse’s half of the property receives a step-up in basis. The surviving spouse’s half retains its original cost basis. The plan to deed the property in a common law state falls directly under the “deed-to-die” rule, meaning a full step-up would not be achieved. The most effective solution here for getting a full step-up would be to transfer the property to a living trust.

A revocable living trust is a key strategy for this scenario. By transferring the home to a trust, the entire property is included in the deceased spouse’s gross estate under IRC Section 2038, which allows the entire asset to receive a full step-up in basis under IRC Section 1014, effectively resetting the cost basis for the surviving spouse and eliminating capital gains on the entire home. This is not a tax loophole, but a legitimate legal and tax strategy.

California Property Tax Reassessment Exclusion

For clients in California, an important additional layer to consider is property tax. The state has an interspousal transfer exclusion which states that a transfer of property between spouses does not trigger a property tax reassessment. Additionally, under Proposition 19, a transfer of a primary residence from a parent to a child is now subject to a property tax reassessment, unless the child uses the property as their own principal residence. However, the original property tax base can be retained with an adjustment. It is critical to consult a professional to ensure this transfer is handled correctly and a reassessment is not triggered unnecessarily.

Texas Property Tax Notes

In Texas, while property is reassessed annually to market value, the homestead exemption provides a significant benefit for primary residences. For properties with a homestead exemption, the appraised value for tax purposes can only increase by a maximum of 10% per year, regardless of the increase in market value. This is known as the homestead cap. When a spouse inherits a home, they can continue to claim the homestead exemption, and the transfer generally does not reset the 10% cap. This provides a valuable, ongoing property tax benefit to the surviving spouse.

Washington Property Tax Notes

In Washington, a transfer of property between spouses or registered domestic partners does not trigger a change in ownership for property tax purposes. This means that deeding a property to a spouse will not cause a property tax reassessment. A transfer of property upon death to a surviving spouse is also exempt from reassessment. The tax basis of the property will be stepped up, but the property’s assessed value for property tax purposes remains the same. This allows the surviving spouse to avoid a potentially significant increase in their annual property tax bill.

Property Tax Reassessment Notes for Other Community Property States

In Arizona, Idaho, Louisiana, Nevada, New Mexico, and Wisconsin, the laws for property tax reassessment are similar to those in Texas and Washington. Generally, a transfer of property between spouses, including through inheritance upon the death of one spouse, is exempt from being considered a “change in ownership.” This is a key benefit that allows the surviving spouse to inherit the property without a new, and potentially much higher, tax assessment. This complements the federal full step-up in basis and helps preserve the long-term affordability of the home

It’s a reminder that sophisticated tax and estate planning requires a deep understanding of complex regulations. Always consult a professional for legal and tax advice to ensure your clients’ strategies are sound.

Please reach out if you have questions.

#CPA #TaxProfessional #TaxPlanning #EstatePlanning #IRCSection1014e #TaxLaw

Naming the New Year: 2024 “Bucking Bull”

January 1, 2024/0 Comments/in Articles & Publications /by mrarrache

Like many people, I enjoy a good tradition.

Whether it is a familiar tradition like the family vacation or nightly family dinners, One of our favorite Traditions is Naming the New Year.

The New Year Name is chosen before the new year starts and will reflect important plans, challenges, obstacles, etc. ahead in the New Year.

Typically We’ve used a simple nomenclature = action + name

For instance,

2019 – “Riding Tiger”
2020 – “Running Bear”
2021 – “Soaring Eagle”
2022 – “Hanging Man”
2023 – “Hungry Hummingbird”
2024 – “Bucking Bull”

Why is this important?

In my experience, the tradition of naming the New Year has been at times inspirational, accurate and foreboding.

2023 “Hungry Hummingbird”, for example, was pretty accurate for the volatile Housing Markets and true to form, unexpected but awesome, rebound of the Stock Markets.

As entrepreneurs and business owners, it is important to work IN your business as well as work ON your business. The New Year name helps us associate an idea larger than any 1 person and at the same time focus 100% on the work at hand.

2024 “Bucking Bull” will be a year of energy, enthusiasm and competition. Much like riding a Bucking Bull, Smart Business will navigate uncertain economy and avoid getting dragged into uncontrolled situations. It will be more important then ever to stay enthusiastic and align your journey with competitive advantages.

A lot of people probably stopped reading when I said “nightly family dinners”, but for those of you who appreciate a tradition, We wish you a happy and safe New Year and best wishes in 2024.

Info@mrarrachecpa.com