TaxMasters, Inc. - FORM 10-Q

Attached files

file	filename
EX-32.1 - TaxMasters, Inc.	ex32-1.htm
EX-31.2 - TaxMasters, Inc.	ex31-2.htm
EX-32.2 - TaxMasters, Inc.	ex32-2.htm
EX-31.1 - TaxMasters, Inc.	ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 33-11986-LA

TAXMASTERS, INC.

(Exact name of registrant as specified in its charter)

NEVADA	91-2008803
(State or other jurisdiction of	(I.R.S. Employer Identification
incorporation or organization)	No.)

900 Town & Country Lane, Suite 400, Houston, TX 77024

(Address of principal executive offices)

(281) 497-5937

(Registrant’s telephone number)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]

No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes [ ] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a small reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ]	Accelerated filer [ ]
Non-accelerated filer [ ]	Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

As of May 16, 2011, the registrant had 140,699,899 shares of common stock, $0.001 par value, outstanding and 1,000 shares of Control Series Preferred stock outstanding.

TAXMASTERS, INC.

QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED MARCH 31, 2011

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1 - Financial Statements (unaudited)

Balance Sheets as of March 31, 2011 and December 31, 2010	1
Statements of Operations for the three months ended March 31, 2011 and 2010	2
Statements of Cash Flows for the three months ended March 31, 2011 and 2010	3
Notes to Financial Statements	4

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

Item 4 - Controls and Procedures	16

PART II. OTHER INFORMATION

Item 1 - Legal Proceedings	17
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds	17
Item 3 - Defaults Upon Senior Securities	17
Item 4 - Submission of Matters to a Vote of Security Holders	17
Item 5 - Other Information	17
Item 6 - Exhibits	17

SIGNATURES	18

CERTIFICATIONS

PART I - FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

TaxMasters, Inc. BALANCE SHEETS (Unaudited)

	March 31, 2011			December 31, 2010
ASSETS

CURRENT ASSETS
Cash and cash equivalents	$	1,139,540		$	945,505
Accounts receivable		753,014			-
Short-term investments		318,163			317,204
Deferred tax asset		1,506,193			699,607
Prepaid expenses		7,750			34,250
Other current assets		966,667			708,713

Total current assets		4,691,327			2,705,279

Property and equipment, net		2,725,834			2,883,722
Investments		431,025			429,779
Deferred tax asset, net of current		1,954,244			2,835,411
Other assets		17,000			17,000

TOTAL ASSETS	$	9,819,430		$	8,871,191

LIABILITIES AND STOCKHOLDERS' DEFICIT

CURRENT LIABILITIES
Accounts payable	$	5,862,426		$	4,359,766
Accounts payable related parties		86,187			145,440
Accrued liabilities		6,387,766			4,103,719
Deferred revenue		3,481,782			6,113,438
Current portion of capital lease obligation		517,491			543,800
Note payable to related party		4,212,283			4,360,912
Total current liabilities		20,547,935			19,627,075

LONG TERM DEBT
Capital lease obligations, net of current portion		1,170,391			1,284,048

Total liabilities		21,718,326			20,911,123

COMMITMENTS AND CONTIGENCIES

STOCKHOLDERS' DEFICIT
Preferred stock, $0.001 par value,
500,000,000 shares authorized, 1,000 shares issued and outstanding		1			1
Common stock, $0.001 par value, 1,000,000,000
authorized, 340,699,899 shares issued and
140,699,899 shares outstanding		340,700			340,700
Additional paid-in capital		930,744			930,744
Accumulated deficit		(13,170,341	)		(13,311,377	)

Total stockholders' deficit		(11,898,896	)		(12,039,932	)

TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT	$	9,819,430		$	8,871,191

See accompanying notes to unaudited financial statements.

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TaxMasters, Inc. STATEMENTS OF OPERATIONS (Unaudited)

	For the three months ended March 31,
	2011			2010

REVENUES, net	$	12,928,732		$	11,346,527

OPERATING COSTS AND EXPENSES:
Selling, general and administrative expenses		7,970,416			5,178,695
Compensation		4,474,514			4,490,098
Depreciation		206,310			192,752

Total operating costs and expenses		12,651,240			9,861,545

NET INCOME FROM OPERATIONS		277,492			1,484,982

OTHER INCOME (EXPENSE):
Interest income		2,233			12,688
Interest expense		(64,108	)		(71,363	)

Total other income (expense)		(61,875	)		(58,675	)

NET INCOME BEFORE INCOME TAXES		215,617			1,426,307

INCOME TAX EXPENSE NET		74,581			486,860

NET INCOME	$	141,036		$	939,447

EARNINGS PER COMMON SHARE
Basic and diluted	$	0.00		$	0.00

WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Basic and diluted		140,699,899			339,675,899

See accompanying notes to unaudited financial statements.

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TaxMasters, Inc. STATEMENTS OF CASH FLOWS (Unaudited)
	For the three months ended March 31,
	2011			2010
				As Restated
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	141,036		$	939,447
Adjustments to reconcile net income to net cash provided by
operating activities:
Change in deferred tax asset		74,581			486,860
Depreciation and amortization		206,310			192,752
Deferred rent		(25,410	)		147,044
Changes in operating assets and liabilities:
Accounts receivable		(753,014	)		-
Prepaid expenses		26,500			86,250
Other current assets		(257,954	)		(63,599	)
Accounts payable and accrued liabilities		3,812,117			(1,604,343	)
Accounts payable to related parties		(59,253	)		(117,674	)
Interest accrued on note recievable		-			(4,551	)
Deferred revenue		(2,631,656	)		1,437,426

Net cash provided by operating activities		533,257			1,499,612

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments, net		(2,205	)		(4,113	)
Purchase of fixed assets		(48,422	)		-

Net cash used in investing activities		(50,627	)		(4,113	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of capital lease obligations		(139,966	)		(131,943	)
Repayment, net of accrued interest, of note payable to related party		(148,629	)		(114,876	)

Net cash used in financing activities		(288,595	)		(246,819	)

NET CHANGE IN CASH AND CASH EQUIVALENTS		194,035			1,248,680

CASH AND CASH EQUIVALENTS—Beginning of year		945,505			2,892,895

CASH AND CASH EQUIVALENTS—End of year	$	1,139,540		$	4,141,575

Supplemental schedule for cash flow information
Cash paid for interest	$	64,108		$	71,363
Cash paid for taxes		-			-

NON CASH INVESTING AND FINANCING ACTIVITIES
Purchase of property and equipment by seller financing	$	-		$	27,464

See accompanying notes to unaudited financial statements.

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TaxMasters, Inc.

NOTES TO THE FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2011

(Unaudited)

Note 1 - Basis of Presentation

The accompanying financial statements information reflects financial information of TaxMasters, Inc. (“Company” or “TaxMasters”).

The Company primarily engages in resolution of complicated Internal Revenue Service tax problems for customers located in the USA and other parts of the world with USA operations. The Company also assists customers with state and local tax problem resolution. The Company headquarters is located in Houston, Texas.

The accompanying unaudited interim financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with the audited financial statements of TaxMasters and related notes thereto contained in the Company’s Form 10-K for the year ended December 31, 2010 filed with the SEC on April 15, 2011. Certain information and note disclosure normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

Note 2 – Summary of Significant Accounting Policies

Revenue Recognition

The Company’s revenue is generated from the sale of our proprietary tax resolution products and services. These services are Consultations, Tax Returns, Automated Collection Service (ACS), Revenue Officer Case (ROC), Collection Due Process (CDP), and Settlement Analysis. These products and services may be sold individually or in combination with any of the products and services. Effective January 1, 2010, the Company recognizes revenue under ASC 605-25, Revenue Arrangements with Multiple Deliverables and retroactively adopted ASU 2009-13, Multiple-Deliverable Revenue Arrangements, (amendments to FASB ASC Topic 605, Revenue Recognition) (“ASU 2009-13”).

ASC 605-25, as amended by ASU 2009-13, provides guidance on accounting for arrangements that involve the performance of multiple products, services and/or right to use assets. In accordance with the guidance, the Company allocates revenue for transactions or collaborations that include multiple elements to each unit of accounting based on its relative fair value and recognized revenue for each unit of accounting when revenue recognition criteria have been met. The price charged when the element is sold separately generally determines the fair value.

The Company may receive advance payments that are refundable or nonrefundable depending on the individual contract. These advance payments are recorded as deferred revenue on the balance sheet and are reclassified as revenue on the statements of operations only after services have been provided and such revenue has been earned.

Earnings Per Share

Basic earnings per share are computed using the weighted-average number of common shares outstanding. Diluted earnings per share include additional dilution from common stock equivalents, such as stock issuable pursuant to the exercise of stock options and warrants. Common stock equivalents are not included in the computation of diluted earnings per share when the Company reports a loss because to do so would be anti-dilutive for the periods presented. Contingently issuable shares where the shares are not certain to be issued are also be excluded from the EPS calculation. As of March 31, 2011, the Company has 200,000,000 contingently issuable shares that were not deemed as outstanding and were excluded from the calculation of both basic and diluted EPS. There were no common stock equivalents outstanding as of March 31, 2011 and 2010.

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TaxMasters, Inc.

NOTES TO THE FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2011

(Unaudited)

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Actual results may differ from those estimates.

Financial Instruments

The carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate their fair values due to their short term maturities. The carrying values of the Company’s long-term debt approximate their fair values based upon a comparison of the interest rate and terms of such debt to the rates and terms of debt currently available to the Company.

Fair Value Measurements

The Company adopted Statement of ASC No. 820, “Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 clarifies that fair value is an estimate of the exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (i.e., the exit price at the measurement date). Under ASC 820, fair value measurements are not adjusted for transaction cost. ASC 820 provides for use of a fair value hierarchy that prioritizes inputs to valuation techniques used to measure fair value into three levels:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities

Level 2: Input other than quoted market prices that are observable, either directly or indirectly, and reasonably available. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the Company.

Level 3: Unobservable inputs. Unobservable inputs reflect the assumptions that the Company develops based on available information about what market participants would use in valuing the asset or liability.

An asset or liability’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Availability of observable inputs can vary and is affected by a variety of factors.

The Company uses judgment in determining fair value of assets and liabilities and Level 3 assets and liabilities involve greater judgment than Level 1 and Level 2 assets or liabilities. See Note 3, “Fair value of Financial Instruments”, for additional information regarding the Company’s financial assets and liabilities measured at fair value on a recurring basis.

Accounts Receivable

As of March 31, 2011, the Company had accounts receivable of $753,014 and had no trade receivable as of December 31, 2010. The Company’s policy is to recognize an accounts receivable only if (and when) the Company completes the services due under the contract at the amount it expects to collect. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic and industry trends, and changes in customer payment terms. As of March 31, 2011, management has determined that an allowance for doubtful accounts is not required.

The Company’s trade receivables are generally unsecured. The Company has no concentration of revenue with any one customers that the loss of any one or a few customers could impact its operations materially unless such a loss of customers were a general loss of customers.

Reclassifications

Certain reclassification of prior period amounts has been made to conform to the current presentation. The reclassification had no impact on stockholders’ deficit and net income.

Recently Adopted Accounting Pronouncements

Management does not believe that any recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the accompanying condensed consolidated financial statements.

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TaxMasters, Inc.

NOTES TO THE FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2011

(Unaudited)

Note 3 - Fair Value

ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs.

The following tables set forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value as of March 31, 2011 and December 31, 2010. As required by ASC 820, a financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. There were no transfers between fair value hierarchy levels for the twelve months ended December 31, 2010.

Balance at March 31, 2011	Level 1		Level 2		Level 3		Total

Assets
Investments- short-term	$	318,163		-		-	$	318,163
Investments- long-term		431,025						431,025
Total Assets	$	749,188		-		-	$	749,188

Liabilities – N/A		-		-		-		-

Balance at December 31, 2010	Level 1		Level 2		Level 3		Total

Assets
Investments- short-term	$	317,204		-		-	$	317,204
Investments- long-term		429,779						429,779
Total Assets	$	746,983		-		-	$	746,983

Liabilities – N/A		-		-		-		-

All short-term investments were in bank CD’s at March 31, 2011 and December 31, 2010, and have a maturity range from six to twelve months .

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TaxMasters, Inc.

NOTES TO THE FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2011

(Unaudited)

Note 4 – Capital Lease Obligations

The Company acquired equipment under long-term leases with two to five year terms, generally bearing interest rates from 2% to 26%. For financial reporting purposes, the present value of the minimum lease payments has been capitalized.

		March 31		December 31
Year		2011		2010
2008	The Company entered into various capital leases for computer equipment and office equipment. The terms range from 24 to 48 months and the monthly lease payments are approximately $10,159 including interest, with maturity dates ranging from January 2011 to March 2012.		25,705		45,872
2009	The Company entered into various capital leases for computer equipment, office equipment and phone system equipment. The terms range from 24 to 60 months and the monthly lease payments are approximately $41,702, with maturity dates ranging from February 2011 to December 2014		1,581,198		1,692,730
2010	The Company entered into various capital leases for computer equipment, office equipment and phone system equipment. The terms of 36 months and the monthly lease payments are approximately $3,757, with a maturity date of September 2013.		80,979		89,246
	Total lease obligation		1,687,882		1,827,848

	Less: current portion		517,491		543,800

	Capital lease obligation, net of current portion	$	1,170,391	$	1, 284,048

Future payments under these capital lease arrangements are as follows:

2011	$	431,707
2012		510,742
2013		420,604
2014		405,840
2015		10,727
Total future payments	$	1,779,620
Less: amount representing interest		91,738
Present value of net minimum lease payments	$	1,687,882

Note 5 – Income Taxes

As part of the process of preparing the financial statements, the Company is required to estimate its income taxes. The process incorporates an assessment of the current tax exposure together with temporary differences resulting from different treatment of transactions for tax and financial statement purposes. Such differences may result in deferred tax assets and/or liabilities, which are included within the balance sheet.

Our provision for income taxes at March 31, 2011 and 2010 consisted of the following:

Current:	2011		2010
Federal	$	-	$	-
State		-		-
State
Deferred:
Federal		74,581		486,860
State		-		-

	$	74,581	$	486,860

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TaxMasters, Inc.

NOTES TO THE FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2011

(Unaudited)

The U.S. federal statutory income tax rate is reconciled to the effective rate at March 31, 2011 and 2010 as follows:

	2011			2010
Income tax expenses at U.S. federal statutory rate		34.0	%		34.0	%
Permanent differences		0.6	%		0.1	%
Effective tax rate		34.6	%		34.1	%

The components of the net deferred tax assets (liability) at March 31, 2011 and December 31, 2010 are as follows:

	2011		2010
Deferred tax assets
Net operating loss carryover	$	2,370,736	$	3,179,790
Deferred rent		340,628		349,267
Accrued expenses		1,159,513		518,576
Customer refund		249,281		83,632
Other		97,399		97,399
		4,217,557		4,228,664
Deferred tax liability
Property and equipment		757,120		693,646
	$	3,460,437	$	3,535,018

The Company periodically assesses the likelihood that it will be able to recover its deferred tax assets and determines if a valuation allowance is necessary. As a result of this analysis the Company concluded that it is more likely than not that its deferred tax assets will ultimately be recovered and, accordingly, no valuation allowance was recorded as of March 31, 2011 and December 31, 2010.

Note 6 – Related Party Transactions

The Company incurs certain business development and entertainment expenses related to brand image development, employee retention, necessary entertainment, and certain expenses related to its community relations activities that are paid to companies owned by one or more of the corporate executives. It is believed that these costs are reasonable and approximate the costs of similar activities with unrelated parties.

The Company is affiliated, through common ownership, with another company that provides the Company with advertising. The affiliated company charged approximately $37,750 and $419,000 for the three months ended March 31, 2011 and 2010, respectively, for advertising costs incurred. In addition, the outstanding balance due to the affiliated company as of March 31, 2011 and December 31, 2010, $41,786 and $112,138, respectively.

In addition, the Company has marketing services provided by a related entity that is owned by the Company’s management. Marketing expenses were approximately $0 and $92,000 for the three month period ended March 31, 2011 and 2010, respectively. There were no outstanding balances due to this related entity as of March 31, 2011 and December 31, 2010.

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TaxMasters, Inc.

NOTES TO THE FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2011

(Unaudited)

Note 7 – Commitments and Contingencies

Leases

The Company has two separate lease agreements. The Company leased its main office space in Houston, Texas under a lease agreement that commenced in December 2006 and expires February 2014. In addition, there were two expansion leases entered into for this property in January and March 2008 which both expire in May 2014. The aggregate monthly lease payments are $25,162. In July 2009, The Company entered into an additional lease agreement for additional office space in Houston, Texas through December 31, 2015, this agreement was amended in June 2010. Monthly lease payment under this agreement are $0 for the first six months, $74,804 for the months seven through twenty–six, $83,795 for months twenty-seven through forty-six, and $92,785 thereafter.

The future minimum lease payments are as follows:

Year Ended:
2011	$	907,824
2012		1,279,397
2013		1,325,556
2014		1,178,996
Thereafter		835,069
Total	$	5,526,842

Total rent expense for three months ended March 31, 2011 and 2010 was $323,451 and $273,036, respectively.

Deferred Rent

The Company recognizes rent, including rent holidays, and escalating rent provisions, on a straight-line basis over the terms of the lease. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. The current portion of deferred rent is included in accrued expenses. Cash reimbursements received from landlords for leasehold improvements and other incentives are also recorded as deferred rent and amortized on a straight-line basis over the lease term as an offset to rent expense. The amounts at March 31, 2011 and December 31, 2010 are $1,001,846 and $1,027,256, respectively, and are included in accrued liabilities.

Legal Proceedings

On May 13, 2010, the Texas Attorney General’s (AG) office filed a suit against the Company and its Chief Executive Officer in state district court for Travis County, Texas. In the suit, styled as The State of Texas v. TaxMasters, Inc., TMIRS Enterprises, Ltd., GP Services, LLC, d/b/a TaxMasters, and Patrick R. Cox, the AG alleges, the Company violated certain provisions of the Texas Deceptive Trade Practices Act (“DTPA”) and the Texas Debt Collection Act and is seeking (i) injunctions against the Company from further violations of the applicable Texas statutes, (ii) restitution, and (iii) civil penalties of up to $20,000 per violation for each violation of the DTPA. The Company denies the allegations and is vigorously defending the AG’s claims.

On May 25, 2010, as part of the same proceeding, the court granted and agreed temporary injunction which requires the Company to more clearly and conspicuously disclose to potential customers prior to their purchase of tax resolution services from the Company that (i) the Company’s contract provides that the Company is entitled to its full fee regardless of the Company’s success or failure in resolving the customer’s tax issues, (ii) the Company’s contract provides that the Company is not obligated to perform services for the customer until the Company’s fee has been paid in full, (iii) if the customer is paying in installments, the Company may not be working on the customer’s tax issues until the Company has received its entire fee and (iv) the Company’s contract provides that any and all fees paid to the Company for its services are non-refundable.

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TaxMasters, Inc.

NOTES TO THE FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2011

(Unaudited)

Management believes that the Company has complied with all the requests from the Texas Attorney General’s office and has made appropriate changes to its current business model. The Company is vigorously defending itself against these allegations but the Company also recognizes that it is probable it will incur some civil penalties and have to make restitution. Company’s management has determined that the amount of client penalties and restitution cannot be reasonably estimated and any estimate would be so uncertain as to impair the integrity of these financial statements. Per FASB ASC 450-20-25; recognition of a contingency loss may only be made if the event is (1) probable and (2) the amount of the loss can be reasonably estimated. Since the amount cannot be reasonably estimated, no accrual for this contingent loss has been made to these financial statements. The Company estimates restitution to the Texas Attorney General of $2 million to cover legal costs, penalties and fees. This amount has been accrued under Accrued Liabilities in the balance sheet at March 31, 2011. An amount has been accrued under accrued liabilities to cover estimated costs of legal fees, penalties, fees, and other costs in this matter.

On December 16, 2010, the Minnesota Attorney General’s (AG) office filed a suit against the Company in state district court for the Fourth Judicial District of Hennepin County, Texas. In the suit, styled as State of Minnesota by its Attorney General, Lori Swanson vs. TaxMasters, Inc. a Nevada corporation, d/b/a TaxMasters, the AG alleges, the Company violated certain provisions of the Minnesota Consumer Fraud Act and the Uniform Deceptive Trade Practices Act. The AG further alleges that the Company was unjustly enriched. The AG is seeking to have the court (i) enjoin the Company from engaging in deceptive practices or making false or misleading statements, (ii) award civil penalties, (iii) award restitution for all persons injured by Company’s acts; and (iv) award costs, including costs of investigation and attorneys’ fees. The Company denies the allegations and is vigorously defending the AG’s claims. Company’s management has determined that the amount of penalties and restitution cannot be reasonably estimated and any estimate would be so uncertain as to impair the integrity of these financial statements. Per FASB ASC 450-20-25; recognition of a contingency loss may only be made if the event is (1) probable and (2) the amount of the loss can be reasonably estimated. Since the amount cannot be reasonably estimated, no accrual for this contingent loss has been made to these financial statements.

Deferred Bonus

On December 31, 2009, the Chief Executive Officer of the Company earned a bonus of $1,008,333 per the terms of his employee contract. This bonus is payable within the next twelve months provided the Company meets certain covenants per the agreement. As of March 31, 2011 no payments have been made,

Note 8 – Restatement of Previously Issued Financial Statements

On January 3, 2011, the Company concluded that previously issued financial statements for the three months ended March 31, 2010 should no longer be relied upon. Previously, the Company accounted for the unpaid and incomplete portion of its customer contracts as accounts receivable and deferred revenue. The Company has determined that the balance of the amount due under the contract should have been accounted for as an account receivable only if (and when) the Company completes the services due under the contract without receiving the payment of the balance due.

As a result of the above error, the Company has determined that accounts receivable and deferred revenue as of March 31, 2010 were overstated by $14,135,010. The Company concluded that accounts receivable should be zero since, as a matter of policy, the Company does not complete any work unless payment has been received.

The above error resulted to a corresponding overstatement in current deferred tax assets and an understatement in non-current deferred tax assets of $571,481 as of March 31, 2010. There were no adjustments impacting the statements of operations for the three months ended March 31, 2010. The adjustments to the Statements of Cash Flows for three months ended March 31, 2010 did not result in any changes to the amounts previously reported for net cash from operating activities, investing activities or financing activities.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the financial statements and the related notes thereto included in this document.

Forward Looking Statements

The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. The words or phrases "would be," "will allow," "expect to", "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements". Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) our ability to retain and add qualified personnel with the proper tax and IRS experience and business acumen, (b) our ability to execute our business plan, (c) our ability to successfully compete against numerous competitors, some of whom are larger and better financed than us, (d) the amount and timing of operating costs and capital expenditures relating to the expansion of our business, (e) the implementation of our marketing programs and (f) general economic conditions specific to our industry.

Unless otherwise required by applicable law, the Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

The following discussion should be read in conjunction with our consolidated financial statements and related notes included as part of this report.

Overview

History

We are TaxMasters, Inc., a Nevada corporation formerly known as Crown Partners, Inc. (the “Company” or “we”, “our” or “us”). On August 4, 2009, the Company acquired all of the outstanding shares of common stock of TaxMasters, Inc., (the "Target"), a Nevada corporation, in an exchange of shares of its common stock and certain preferred stock for all of the issued and outstanding shares of the Target under Section 368(a)(1)(B) of the Internal Revenue Code (the “Share Exchange”). As a result of the Share Exchange the sole stockholder of the Target acquired control of the Company through the receipt of approximately 99.1% of the Company’s 303,712,899 then-issued and outstanding shares of common stock. As a result of the Share Exchange, the Target became a wholly-owned subsidiary of the Company.

Our Company

We are a tax resolution company engaged in the business of assisting taxpayers with matters at the Internal Revenue Service (“IRS”), especially the resolution of disputes and assessments and the settlement of tax liabilities. We are a firm of experienced tax professionals that help our clients solve their Federal tax problems, ranging from filing delinquent tax returns to settling tax debts. Our tax professionals include tax attorneys, Certified Public Accountants, Former IRS agents, Licensed Tax Preparers and other tax professionals who are authorized to practice before the IRS. Our tax professionals are experienced in analyzing and providing solutions to even the most complicated tax problems and guiding clients through the bureaucracy of the IRS.

Our tax professionals have the skill and knowledge to reduce our client’s tax liabilities and solve their IRS tax problems. We use the rules established by the Internal Revenue Code and IRS regulations to help our clients resolve matters at the IRS. Our tax professionals help our clients reduce taxes, eliminate penalties and get representation before the IRS. We help our clients understand how they developed their tax problems they have and help them fix the entire problem that caused their tax debt. We can often reduce the tax our clients owe even before attempting to develop a tax strategies with the IRS.

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Through our tax professionals, we offer the following services:

·	Get our clients into compliance with their obligation to file income tax returns and pay back taxes due;
·	educe taxes by reducing penalties and interest on tax debts;
·	Settle our client’s tax debt for the lowest amount possible under the law;
·	Stop IRS wage garnishments;
·	Stop IRS property seizure;
·	Defend our client in an IRS audit or IRS criminal investigation;
·	Recover seized funds; and
·	Remove an IRS levy or lien.

Description of Revenues

We offer our clients a no-charge initial consultation regarding their tax problems. The free initial consultation enables our tax consultants to get information from the potential client about his or her tax problem and understand the nature of the problem. From the initial consultation, we can determine what services and forms the client will need and we can present a cost estimate for the client.

We charge our clients a fee based on the type of tax problem we are addressing and the service we are providing: (i) an IRS collection matter, (ii) preparing or amending tax returns (including schedules), (iii) negotiated settlements and/or (iv) audits. In addition, some of our rates will vary depending on whether our client is an individual or a business. Built into all of our fees are the initial consultation we have with the IRS to determine all of the client’s problems and the preparation by us of a findings letter outlining the tax problems. In addition to the fee, certain services will require our tax consultants to interact with the IRS, such as a settlement negotiation or an audit, for which we charge our clients additional consulting fees. We may provide our services on a “pay-as-you-go” basis and an installment plan.

The Company may receive advance payments that are refundable or nonrefundable depending on the individual contract. These advanced payments are recorded as deferred revenue on the balance sheet and are reclassified as revenue on the statements of operations only after services have been provided and such revenue has been earned.

Refund Policy for Client’s Early Termination of Agreement

The Company’s client may terminate his or her agreements with the Company at any time, and in the client’s sole discretion, by providing notice in writing to the Company. If a client terminates his or her agreement with the Company within three business days from the date of the agreement is signed (by providing written notice to the Company) the Company will refund all fees paid by such client except for fee for services performed by the Company prior to termination plus a $350 administrative fee.

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If the client elects to terminate his or her agreement with the Company after three business days but within 18 months from the date the agreement is signed, the Company will refund the lesser of (1) all fees paid by the client except for fees for services performed by the Company prior to termination plus a $350 administrative fee or (2) all fees paid by Client less a cancellation fee in the amount of twenty five percent (25%) of the total of fees due under the contract.

Processing of refunds takes approximately 60 days from the later of date of notice of termination or the date of payment by the client. The client must execute a full release of all claims before receipt of any refund.

Description of Expenses

Our expenses include the following: (i) Costs of services, which consists primarily of salaries and benefits to our tax consultants, customer service consultants, outside services and professional fees used to provide our tax services, including associated marketing expenses; (ii) Marketing costs (a significant portion of which consists of our advertising expense); and (iii) General administrative costs, which consists of overhead expenses, such as rent, utilities and telecommunications.

We currently have no material research and development expenses.

Results of Operations

Results for the three months ended March 31, 2011 versus the three months ended March 31, 2010.

The following table sets forth selected statement of operations data as a percentage of total revenues for the periods indicated

	For three Month ended March 31,
Statement of Operations Data:	2011					2010
Total Revenue	$	12,929,000		100.0 %		$	11,347,000		100.0 %
Operating Costs and Expenses:
Selling, general and Administrative		7,970,000		61.6	%		5,179,000		45.6	%
Compensation		4,475,000		34.6	%		4,490,000		39.6	%
Depreciation		206,000		1.6 %			193,000		1.7 %
Total Operating expenses		12,651,000		97.8	%		9,862,000		86.9	%
Total Other Income / (expenses)		(62,000	)	-0.5 %			(59,000	)	-0.5 %
Net Income before taxes		216,000		1.7%			1,426,000		12.6 %
Tax Expense		75,000		0.6%			487,000		4.3 %
Net Income	$	141,000		1.1%		$	939,000		8.3 %

Revenues. Revenues increased by approximately $1.6 million, or 13.9%, to approximately $12.9 million for the three months ended March 31, 2011 as compared to approximately $11.3 million for the same three month period in 2009. This increase in our sales revenue can be attributed to our increase spending in our advertising expenses.

Compensation expense. Compensation expense, which is comprised of salaries and payroll taxes, health insurance and fees, for the three months ended March 31, 2011 was approximately $4.5 million, consistent with the compensation expense of approximately $4.5 million for the three months ended March 31, 2010. Salaries and payroll taxes increased slightly, approximately $54,000 versus prior three month period a year ago but this increase was offset by a reduction in healthcare costs of approximately $67,000 versus the prior three month period.

Selling, general and administrative costs (“SG&A”). Selling, general and administrative costs increased by approximately $2.8 million or 53.9%, from approximately $5.2 million for the three months ended March 31, 2010 to approximately $6.0 million for the same period in 2011. Selling expenses, which consists mainly of advertising expenses and bank fees associated with process payments increased approximately $0.9 million to approximately $4.4 million or 26.0% from approximately $3.5 million in 2010. The primary increase in selling expense was the advertising expense which was approximately $4.1 million, an increase of approximately $0.7 million or 22.4%. General and administrative (“G & A”) expenses increased approximately $1.9 million for the three months ended March 31, 2011 as compared to the prior year three month period. Decreases in G & A expenses were mainly in contracted outside labor which decline approximately $312,000, office expenses declined approximately $71,000, professional fees which include outside services, accounting and legal fees decline approximately $75,000 and an approximate reduction of $65,000 in travel and entertainment expenses for the three months period ended March 31, 2011. These cost reductions were off set in by increases in rent, building maintenance, telephone and utilities which increased approximately $400,000 or the three months ended March 31, 2011 as compared to the same three month period a year ago.

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Total Operating Expenses. Total operating expenses for the three months ended March 31, 2011 were approximately $12.7 million, an increase of approximately $2.8 million, or 28.3%, from total operating expenses of $9.8 million for the same three month period in 2010. The increase in total operating expenses for the first quarter 2011 was mainly due to increase in selling costs of approximately $0.9 million, brought about primarily by increases in advertising expenses and a decrease of approximately $0.1 million in G & A expenses as described above. Compensation costs and depreciation were basically flat compared to the prior three month period..

Total Other Income and Expenses. Total other income and other expenses consist of interest income, interest expense and other non operating related adjustments. Interest expense for the three months ended March 31, 2011 was approximately $64,000, a decrease of approximately $7,000 from the same three month period in 2010. This decrease is mainly due to lower interest expense associated with the Company’s capital leases as many of them have mature or have been paid off. Interest income for the first quarter 2011 was approximately $2,000, a decrease of approximately $10,000, from first quarter 2010.

Income Taxes Expense. Total income taxes expense was approximately $75,000 for the three months ended March 31, 2011, a decrease in the tax expense of approximately $412,000, versus the prior year three month period. This decrease in taxes expense for the three month ended March 31, 2011can be attributed to lower income before taxes of approximately $0.2 million as compared to an income before taxes of approximately $1.4 million, a decrease of approximately $1.2 million.

Net Income. The net income for the three months ended March 31, 2011 was approximately $141,000 million as compared to net income of approximately $939,000 for the same three month period in 2010, a decrease of approximately $798,000. This decrease in net income mainly was driven by an increase in operating expenses.

Liquidity and Capital Resources

At March 31, 2011, the Company had total current assets of approximately $4.7 million and total current liabilities of approximately $20.5 million, resulting in negative working capital of approximately $15.8 million. At March 31, 2011, the Company's current assets consisted of approximately $4.7 million in cash, $0.8 million in trade receivables, $0.3 million in short-term investments and approximately $2.5 million in deferred tax asset and other current assets.

At March 31, 2011, the Company has open contracts in the amount of approximately $19.1 million that are expected to be completed within the next three to nine months. Upon completion of the work by the Company’s tax experts this amount will be recognized as earned revenue.

During the fiscal year 2011, the Company expects to generate positive cash flow from its operations. We believe that our existing cash and expected cash flow from operations will be sufficient to meet our projected operating expenses at least through December 31, 2011 as well as to fund the full implementation of our P3 system to increase productivity and improve customer service. Additionally, we are currently in the process of securing funding from a group of investors which will also increase our expected cash flows for the year.

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Operating Activities

Net cash provided by operating activities was approximately $0.5 million for the three months ended March 31, 2011, as compared to cash provided by operating activities of approximately $1.5 million for the three months ended March 31, 2010, a decrease of approximately $1.0 million. This decrease is mainly attributable to a reduction in cash received for deferred revenue of approximately 4.1, cash received from trade receivable decline approximately $.7 million and an increase in other current assets of approximately $0.2 million. These declines were offset by reduction in cash used to pay our accounts payable in the amount of approximately $5.5 million, and cash generated by regular operations increased approximately $0.6 million mainly driven from sales.

Investing Activities

Net cash used in investing activities was approximately $51,000 for the three months ended March 31, 2011 compared to net cash used in investing activities of approximately $4,000 for the three months ended March 31, 2010, an increase in cash used of approximately $47,000. The primary reason for the change in investing activities was an increase in the purchase of property and equipment in the amount of approximately $48,000 in first quarter 2011 versus 2010.

Financing Activities

Net cash used in financing activities was approximately $289,000 for the three months ended March 31, 2011 compared to approximately $247,000 for the three months ended March 31, 2010, an increase in cash used in financing activities of approximately $42,000 or 17.0%. The repayment of a note payable from a related party within the Company increased approximately $34,000 in first quarter 2011 versus the first quarter 2010. The Chief Executive Officer of the Company loaned the Company $5.3 million at an interest rate of prime plus 1% (the “CEO Note”). The CEO Note is unsecured and is due on demand, with covenants that limit demand rights. The covenants in the CEO Note limit demand rights to $1 million annually so long as the Company is achieving certain financial targets and has the cash for repayment. Cash used to pay the Company’s capital lease payment increased approximately $8,000 for the three months ended March 31, 2011 as compared to the same three months period in 2010.

Commitments and Contingencies

We currently have two separate lease agreements for our office space under an operating lease through May 2014. Our monthly lease payment under these agreements amounts to approximately $25,162 and $74,804. Total obligation through 2015 under these agreements is approximately $5,527,000.

We also lease certain computer equipment under capital leases. Our obligation under these leases continues until July 2015. Our total obligation under these leases is approximately $1,780,000.

We currently plan to utilize both lease office spaces through the second quarter 2011 and will evaluate office space needs through the remainder of 2011 to determine if a sublet option or termination of a lease is appropriate.

On July 31, 2009, we entered into a lease agreement for approximately 107,890 square feet of office space, which we expect to occupy in late first quarter or early second quarter of 2010. This lease has a term of 66 months and expires in late first quarter or early second quarter of 2015, depending on the date we occupy the space. Under this lease, upon the commencement date we will not pay any rent until for the first six months, we will pay a monthly rent of $74,804 for months 7 to 26, which after 20 months will increase to $83,795 for the following 20 months. During the last 20 months of the lease our monthly rent will be $92,785. The Company has the right to extend the term of the lease for one additional term of five years.

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These obligations are summarized in the table below:

Contractual Obligations

The following table presents future contractual obligations due by fiscal period as of March 31, 2011:

	2011			2012-2013		2014-2015	Thereafter		Total

Operating lease commitments	$	908,000	$	2,605,000	$	2,014,000	$	0	$	5,527,000

Capital & Equipment leases		432,000		931,000		417,000		0		1,780,000

Total	$	1,340,000	$	3,536,000	$	2,431,000	$	0	$	7,307,000

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements.

Recent Accounting Pronouncements.

ITEM 4. CONTROLS AND PROCEDURES

(a) Disclosure Controls and Procedures. Our management, with the participation of our principal executive officer (chief executive officer) and principal financial officer (chief financial officer), conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of March 31, 2011 (the “Evaluation Date”). Based on this evaluation, and due to the material weaknesses in our internal control over financial reporting (as described below in the “Report of Management on TaxMasters, Inc.’s Internal Control Over Financial Reporting”), our chief executive officer and chief financial officer concluded that as of the Evaluation Date, our disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

The material weakness relates to the lack of segregation of duties in financial reporting, as our financial reporting and all accounting functions are performed by external consultants with no oversight by a professional with accounting expertise. Our CFO does not possess accounting expertise and our company does not have an accounting staff with public company audit experience. This weakness is due to the fact that TaxMasters, Inc., which we acquired on August 4, 2009, was a privately held company and its staff, overall, had minimal experience in public company matters, including public company accounting. To remedy this material weakness, we intend to engage accountant personnel to assist with financial reporting as promptly as possible.

(b) Internal Controls Over Financial Reporting. There was no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

None.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5.

OTHER INFORMATION

None.

ITEM 6.

EXHIBITS

Number	Description
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURE PAGE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	TAXMASTERS, INC.

Dated: May 23, 2011
	By: /s/ CHRISTOPHER J. KOSCINSKI
	Chief Financial Officer
	(Principal Financial and Accounting Officer and Duly Authorized Officer)

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TaxMasters, Inc. - FORM 10-Q - May 23, 2011

Attached files

TaxMasters, Inc. Reports