Tuesday, March 29, 2011

Tax bonuses for some couples, penalties for others

Few people marry or divorce to change their tax status, but the federal income tax code does treat married couples and single people differently. Each group has its own tax brackets, standard deductions, credits, and phaseouts. As a result, two people can face very different tax bills if they are married and file jointly than if they are single and file either as individuals or heads of household. Couples who pay more than singles bear a “marriage penalty.” Those who pay less enjoy a “marriage bonus.”
Bonuses occur because couples pay tax on their combined income, no matter how much each spouse earns. If you’re married, in a progressive tax system like ours, taxing combined incomes rather than separate ones lowers your tax bill if you and your spouse have substantially different earnings. With tax brackets for couples exactly twice as wide as those for single people (and other tax provisions applying equally), a couple’s tax bill can be no greater than what they’d pay as individuals. Either they’d pay the same tax as two individuals or get a marriage bonus.
But tax brackets for couples aren’t all twice as wide as those for singles. Before the 2001 tax act passed, tax brackets were 67 percent wider for joint filers than singles. As a result, couples often paid more tax than if each spouse paid at singles’ rates on half their combined income. Thus, spouses with incomes in the same ballpark still paid marriage penalties.
Debate over the 2001 tax act riveted attention on marriage penalties. It was wrong, some policymakers asserted, to tax married folks more than those who—as people said when I was much younger—“live in sin.” The 2001 law tried to fix this by setting both the standard deduction and the widths of the 10-percent and 15-percent brackets for couples equal to twice those for single taxpayers. But Congress it didn’t fix the problem for the other four tax brackets. In particular, the 35-percent top rate began at the same level of taxable income for joint, single, and head of household filers. And nothing was done about other provisions that affect singles and couples differently.
Two years later, President George W. Bush proclaimed that “My tax relief package eliminated the marriage penalty [in the federal income tax].” The act did spell relief for many couples, but it hardly eliminated the penalty. Still on the books: the enormous penalties that the earned income tax credit (EITC) levies on low-income couples with children and the penalties that occur when tax benefits phase out over income ranges for couples that are less than twice those for single taxpayers. And marriage penalties live on in the basic tax structure because the higher brackets for joint filers are less than twice as wide as for single filers. Couples in which each spouse would have the same taxable income if they filed individual tax returns can pay up to $15,000 more than if they were single.
Most couples won’t feel this pinch from the tax brackets: Only those whose taxable income exceeds $137,300 would face a higher tax bill by getting married. Just one-quarter of couples have income that high, and many of those have earnings divided unequally between spouses. But for those power couples where each spouse earns about the same, the penalty rises quickly. Their taxes can go up by as much as 9 percent when their taxable income approaches $350,000.
Marriage penalties lurk elsewhere in our tax code as well.
But we don’t need much analysis to conclude that marriage penalties remain very much part of our current federal income tax.

Saturday, March 26, 2011

Tips for filing your income tax returns

Most  find that the federal tax code is too complicated for them to prepare their own taxes. If you decide to hire someone to prepare your federal return, make sure that your preparer has the proper background and experience.

Here are some of the most important considerations follow:

• If you have a complicated return, you should consider using a CPA, enrolled agent or attorney. Such preparers will likely be more expensive than others; however, they are also required to demonstrate continued education in order to maintain their credentials.

• If you have a relatively straightforward return -- even if you itemize -- you should consider using AARP volunteer preparers. This program is available throughout the United States.

The IRS monitors the training of AARP volunteers, and none of them can prepare taxes unless they undergo the proper training and pass a comprehensive test prepared by the IRS. Moreover, AARP uses very sophisticated software that ensures consumers that all proper deductions and credits are taken into consideration.

There is no cost for this service. You do not have to be an AARP member, and there is no age limitation. The only disadvantage is that because the program is so popular, you may have a long wait during the day to have your return prepared. Call your local AARP chapter to find out where and when you can use this service. Ask them what restrictions apply. You don't want to wait all day and find out your return cannot be prepared by AARP.

• You should make sure that there are no complaints made against your preparer. Check with the Better Business Bureau.

• If your preparer is not a CPA, enrolled agent or lawyer, you should ask whether he has any professional designation, and what the requirements are for that designation.

• Avoid any preparer who bases his compensation on the size of your refund. Don't be afraid to ask how he computes his fee. Is it a fixed price based on the type of return? You should not employ a preparer without having a pretty good idea as to what the cost will be. Don't hesitate to ask for references.

• Ask the preparer if he has a Preparer Tax Identification Number (PTIN). This is a new IRS requirement. Do not use a preparer without one.

• Before you meet with the preparer, you should be well organized. Have all your records specifying income, amounts withheld, brokerage statements, deductions, past year return (if applicable), and the Social Security numbers of all your dependents. The less organized you are, the more it will cost to have your return prepared, and the result is much more likely to be inaccurate.

One important tax change for 2010 is related to traditional IRA conversions to Roth IRAs. There are no longer any income limitations for this conversion, starting in 2010.

The entire amount of the conversion you made in 2010 has to be reported as taxable income; however, you can elect to report half the income in 2011 and half in 2012. In order for you to make a conversion for 2010, you would have had to make it by December 31, 2010.

However, you should consider making conversions in the future. Roth IRAs provide significant long-term advantages. Specifically, after a five-year holding period, and after age 59 1/2, all withdrawals, including earnings, are tax-free; moreover, you have no restrictions on when you can make withdrawals.

Roth IRAs have significant advantages for retirement and estate planning. You should discuss these options with your financial planner or attorney.

Friday, March 25, 2011

Eighteen Ways To Get Tax-Free Income

A two-year tax cut extension? That compromise between Congress and the president was nice, but you can do better. You can get a 0% tax rate on many kinds of income.
It’s pretty hard to avoid paying taxes on your paycheck. But there are all kinds of ways to pick up money that the Internal Revenue Service can’t touch—such as from inheritances, fringe benefits, airline miles and rebates.

Sweat equity is tax free, if you know what you’re doing. Buy a fixer-upper and live in it for at least two years. If you’re talented at painting and carpentry, you’ll make a nice profit when you sell, and you can take advantage of the $500,000 exemption on capital gains for your principal home. For singles, the exemption is $250,000.
The first couple of thousand dollars a year you pocket from outside jobs is likely to be tax free. Reason: You probably have all sorts of expenses, such as for continuing education, a home office, professional association dues and a computer, that you can write off against freelance income.  Since these are expenses that you usually can’t otherwise deduct, your early freelance dollars are pure gravy.
Get reimbursed
Ask your employer to cover more of your work expenses (like those professional dues) in lieu of giving you a raise. So long as your expenses are documented, the reimbursement is not income to you. Your company will save on payroll taxes, too. But don’t mess with country-club dues; these aren’t deductible.
Earn airline miles
If you pick these up by taking deductible business trips and then use them on a vacation, they should, in principle, be taxable. But they aren’t. This is a political hot potato, and the IRS gives frequent fliers a free ride.
Take the bus
You can pull up to $230 a month out of your paycheck, pretax, to cover mass transit, vanpooling and commuter parking.
Hustle rebates
Those grocery-store coupons may not be worth your time. But the $50 rebates you get on phones and computers definitely are. As a reduction in the cost of an item for personal use, a rebate is not considered taxable income.
Be nice to Uncle Joe
If he leaves you money in his will, you don’t owe a dime of income tax on it.
Pay off credit cards
Where else are you going to earn 18% on your money? To top it off, this 18% dividend is totally tax free.
Rent your house out
If you rent out a house for 14 or fewer days, the income is scot-free. Not only that, you don’t have to prorate or reduce your otherwise deductible mortgage interest and property taxes. Unlike the remodeling gambit, this one works on vacation homes, too.
House sit
You get a rent-free place to stay by keeping watch in a house whose owner is off on an overseas assignment. The $20,000 you save on rent is like getting a $20,000 raise, except that it’s tax free.
Get a cash-back card
The best of the breed give you 2% back, and the rebate is tax free if the charge was for a personal purchase. For more, read this.

Be a good neighbor
You babysit the neighbor’s children, and in return he paints your garage. You’re both earning money, in effect, by providing services. While the IRS can assess taxes on people in barter exchanges that involve account books and transactions with strangers, there’s no way to levy a tax on helping out a friend.
Have a charity tag sale
You were going to send $500 to Doctors Without Borders anyway. Do it this way. Have a tag sale, unloading tchotchkes from your attic, and advertise that 100% of the proceeds will go to the worthy cause. If you haul in $490, that sum becomes, in effect, tax free income for your day of labor.
Own a house
You get a dividend in the form of not having to pay rent. This dividend is tax free. It has nothing to do with mortgage interest. You have a tax free dividend even if you pay cash for the home.
Take up plumbing
…or electricity or carpentry or car repair. When you work overtime at your company in order to have the bucks to pay pros to do various chores, you owe taxes. But when you hire yourself to do chores, there’s no income to tax.
Set up an HSA
In combination with a high-deductible health insurance policy for your family, you set up a health savings account and put $6,150 a year ($7,150 if you’re over 55) of tax-deductible money into it.
You can use the bucks right away to pay uncovered medical costs. But you don’t have to eat into the account in this fashion. Instead, pay your doctor bills out of your checking account. Then let the $6,150 compound tax free until you are retired.
If you use the HSA later in life for medical costs (which will be considerable; Medicare is going bankrupt) then both the principal and the earnings come out tax free.
Hire the kids
If you own your own business, make your teenage children into employees. If the pay is reasonable for what they do, you can deduct the payroll, lowering your high-bracket net income. On the receiving end a child laborer owes no federal income tax on earned income below the $5,700 standard deduction.
If the kid also has investment income, the exact value of the freebie gets more complicated. But, in round numbers, $5,000 of summer job income is going to be free of income tax.
You will, however, have to cough up for Social Security and Medicare taxes.
Get paid in lodging
If part of your compensation is a free apartment, and if your presence on the premises has a business purpose, then you don’t owe tax on the benefit. This works for hotel managers, apartment supes and roustabouts on offshore rigs.
Clergy members get a better deal: Their housing allowance is tax-free even if paid in cash.

Thursday, March 24, 2011

What to Do if You Can’t Afford to Pay Your Taxes

With tax season winding down, millions of taxpayers may be looking at tax bills they can’t afford to pay but can’t afford to ignore either.
“If you can’t pay what you owe, still file a tax return and make payment arrangements with the IRS,” said Terrence Rice, CPA. “Otherwise, you’re immediately facing a failure-to-file penalty as well as interest, additional costs and potentially a tax lien or levy down the road.”
In February, the IRS issued new rules to help soften the blow for taxpayers who can’t afford to pay their taxes when owed. These new rules include increasing the threshold at which the IRS files a tax lien and expanding the installment and offers in compromise programs to allow more taxpayers to qualify.
Despite the changes, taxpayers still face a host of consequences for not paying taxes when owed and need to understand the options available to address their tax debt.
Ramifications of Ignoring Tax Deadlines 
If a taxpayer does not file a tax return and pay the taxes owed when due, the IRS can take several steps, including:
• Failure-to-file penalty. The taxpayer faces a penalty of 5 percent of the tax due for every month or any fraction of a month that the return is overdue, capped at 25 percent. Additionally, failing to file a federal tax return is a misdemeanor and carries a maximum fine of $25,000 for individuals or a one-year prison term.
• Substitute tax return. The IRS can file a substitute tax return for the taxpayer based on information it has from other sources. The substitute tax return will not include exemptions or expenses to which the taxpayer may be entitled. So, it may overstate the actual tax liability.
• Levies and liens. Next, the IRS will start a collection process. This can include a tax levy or tax lien. With a tax levy, the IRS can seize your property – for example, your house, car, bank account or wages – to pay your taxes if you failed to make arrangements to settle your debt. A tax lien is a claim used as security for a tax debt and can have a direct impact on a taxpayer’s credit rating. If a tax liability remains unpaid after the IRS issues a notice and demand for payment, a tax lien is automatically filed to record a claim by the IRS to all property owned by the taxpayer.
Under the new IRS procedures, liens will not be filed until a taxpayer owes more than $10,000 in taxes (up from $5,000). Additionally, the new rules make it easier for a taxpayer to have a tax lien withdrawn from their record after paying their tax debt. However, they need to make a formal request to the IRS for the withdrawal. Also, if the taxpayer enters into a direct debit installment agreement with the IRS, they can have the tax lien withdrawn while they are paying off the debt.
“You want to avoid having a tax lien,” Rice said. “It’s a costly and disruptive experience. Your credit rating will be affected, you can have difficulty buying or selling a home and it could even affect your ability to get a job.”
Three Main Tax Debt Payment Options
Steps taxpayers can take to help avoid a tax lien include either finding a way to pay the taxes owed outright or working with the IRS to arrange a payment schedule and possibly agree to reduce the amount owed.
1. Borrow, liquidate assets or charge to pay the debt. Taxpayers who owe and can’t pay their entire tax bill when it’s due, but can pay the full amount within 120 days, can ask the IRS for a short-term administrative extension.
Taxpayers who need more time have just a few options: They can try to secure a bank loan, such as a home equity loan, cash out a retirement account or use their credit card.
While going into debt to pay off a debt may not seem the best option, the interest rate and fees assessed by a bank or credit card issuer may be lower than the interest and penalties assessed by the IRS. Credit card payments must be made electronically, through personal tax software, a paid tax preparer or through credit card service payment providers.
Penalties for withdrawing from a retirement account may be more substantial. However, taxpayers may also want to explore this option with their tax advisor if other resources are unavailable.
2. Enter into an installment agreement with the IRS. The IRS is required to accept installment payments if a taxpayer has a good filing and payment record over the past five years, the amount owed is not more than $10,000 and it can be paid off in full within three years.
Under the new rules, the agency also is allowing small businesses to enter into “streamlined” installment agreements if their debt is below $25,000 (up from $10,000) and they agree to pay it off in 24 months. The new streamlined installment agreement is available to small businesses that file as an individual or as a business. To participate, the small business must enroll in a direct debit installment agreement.
3. Reach an offer in compromise with the IRS. In some instances, the IRS may accept less than the full amount due. This typically occurs if the taxpayer can show that the full tax debt could never be collected or they have a dispute with the IRS as to how much is owed, but neither party wants to enter into a legal battle to resolve the issue.
Under the new rules issued in February, more people may be eligible to participate in offers in compromise. Taxpayers with incomes of up to $100,000 (up from $50,000) and who have a tax debt below $50,000 (up from $25,000) can now request an offer in compromise from the IRS.
There’s a $150 fee charged for offers in compromise. Certain low-income individuals can ask for a waiver. Additionally, an initial non-refundable payment must be made with an offer in compromise.

Wednesday, March 23, 2011

Minimizing Capital Gains Taxes

March is one of my favorite months of the year. Winter’s just about over, NCAA March Madness is around the corner, the NBA the playoffs are coming up, flowers are getting ready to bloom and topping the list is the fact that most of us get to spend time preparing to pay taxes.

How great is that?
Although I’m certain the government is going to put our tax payments to good use, I prefer to minimize the amount I pay and that’s why I pay attention to how I might lower them, especially on things such as capital gains.

Capital gains are certainly nothing new to CPAs but to many, capital-gains distributions remain one of the great mysteries of accounting. For this reason I thought a quick column on what they are and how to potentially reduce them could be of some help.

Capital Gains 101
As an investor, sometimes you sell shares of an investment, such as a stock or a mutual fund. When you make money on that sale, you realize a capital gain.
But that’s not the only type of capital gain that exists. Each year, a mutual fund must distribute to its shareholders a portion of any net capital gains it earned when it sold securities in its portfolio. (Net capital gains are what remain after capital losses are subtracted from capital gains.) As a shareholder, you must pay taxes on those gains. So, even if you didn’t actually sell any of their fund shares,you could end up paying capital-gains taxes.
As unfair as it sounds, this is what I often refer to as the Mutual Fund Twilight Zone Paradox: sometimes funds pay out capital gains distributions in years that they’ve actually lost money. In 2002, for example, the performance of many funds was down. But at the same time, to meet redemption requests, many fund managers were forced to sell profitable growth stocks they’d held during the run-up of the 1990s. As a result, many shareholders were stuck with funds that lost money, yet still owed taxes on capital-gains distributions from the funds.
In addition and unbeknownst to some, “tax free” municipal-bond funds may realize capital-gains tax from selling bonds at a profit, even though the funds are managed for tax-exempt income.

Minimizing Capital Gains — and Taxes

Here are some tips that could help:
  1. Minimize your capital gains: This one is simple, my favorite and the one I’d have to say is most often missed. Those planning on selling shares of stock or a mutual fund can potentially reduce their taxable gains by selling shares they bought at the lowest or highest price (which to sell depends on a number of factors too lengthy to explain here).
  2. Make all gains long-term gains: Short-term capital gains are gains from sales of property held one year or less; long-term capital gains are gains from sales of property held for more than one year. In tax year 2010, short-term capital gains are taxed at an investor’s ordinary income rate, which may be as high as 35 percent, depending on your client’s income level. Long-term capital gains, on the other hand, are taxed at a maximum rate of 15 percent: In tax-year 2010, investors in the two lowest tax brackets (10% or 15%) pay zero percent in long-term capital gains tax while everyone else pays 15 percent. So unless you are in the lowest income tax bracket, you will pay lower taxes on capital gains if they hold securities for more than one year.
  3. Use capital losses to offset capital gains: Both long-term and short-term capital losses can be used to offset capital gains on a dollar-for-dollar basis. A taxpayer can carry forward “unused” losses into future years until the losses are deducted, but no more than $3,000 can be deducted in any given year. For example, if an investor has a capital loss of $30,000 and no capital gains, it would take 10 years to deduct that loss ($30,000 ÷ $3,000 = 10 years).
  4. Replacing the losers: If you take a taxable loss on a depressed stock or mutual fund and feels it has the potential to rebound, you will want to wait more than 30 days after the date of sale before buying it back. That’s because if you buy identical securities within a period of 30 days before or after the date of sale, the so-called “wash-sale” rule comes into effect. Essentially, the wash-sale rule prevents an investor from claiming a loss on a sale of stock if they buy replacement stock within the 30 days before or after the sale. 
  5. Replacing the winners: The wash-sale rule doesn’t apply when an investor realizes a profit on the sale of a stock or mutual fund: Investors can sell a winner to balance a loss and then buy it back immediately. An added benefit: you will also have the added tax bonus of a higher cost basis for your new shares. It might help to explain that cost basis is the original cost of an investment: investors may want their cost basis to be as high as possible because their investment will have appreciated less, and you will  then likely pay fewer taxes when you sell it.
  6. Not all funds are created equal: Finally, when buying a mutual fund, it could help to encourage you to check its tax-efficiency ratio, which is the fund’s tax-adjusted return divided by its pretax return. This is the percentage of total return an investor actually keeps after taxes. The higher the tax-efficiency ratio, the more tax-efficient the fund has been. Tax-efficiency ratios for mutual funds are available on some financial web sites, such as Morningtar.com.
As you can likely tell by now, minimizing capital-gains taxes is not the easiest endeavor but hopefully some of the thoughts above can be of help.

Tuesday, March 22, 2011

How to Collect Social Security and Keep Working

When it comes to retirement, the average American age 65 and older generates nearly two-thirds of their total income from a combination of earned income and Social Security, with the rest coming from pensions and personal assets.
But despite the fact that millions are earning income and collecting at the same time, there's still plenty of confusion over how Uncle Sam goes about taxing and reducing Social Security benefits for workers. Consider, for instance, some of the reasons why it can be confusing:
First, if you retire before the normal retirement age and start collecting Social Security benefits early, your benefits are reduced not only for starting early, but also as your earnings rise. In fact, if you work and collect before the so-called full retirement age, you'll lose $1 of Social Security benefit for every $2 earned over $14,160 in 2011.

Second, in the year that you reach full retirement age, your benefits are reduced $1 for every $3 earned over $37,680 in 2011, or least that's the case until the month you reach full retirement age.

Finally, once you're at full retirement age, your benefits are not reduced, but as much as 85% of the benefits could be taxed if your income is above a certain amount.

According to the Social Security website, if you file a federal tax return as an individual and your combined income is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. And if your combined income is more than $34,000, up to 85% of your benefits may be taxable. If you file a joint return, and you and your spouse have a combined income that is between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. And if your combined income is more than $44,000, up to 85% of your benefits may be taxable. If you are married and file a separate tax return, you probably will pay taxes on your benefits.

Even though all this might be confusing, there are some ways to increase your after-tax income from all your sources of income — be it earned income, Social Security, dividends, interest income, capital gains, pension income and the like. What's more, there are some ways to think differently about the interaction between earned income and Social Security benefits.

Never a net negative to work and to collect

"I find there are a lot of myths and misconceptions out there about what it means to have earned income still in retirement, and what the tax implications are," said Terrence Rice, CPA. "And frankly, I've never seen a situation where there was actually a net loss for working. There are a lot of folks who have this idea of 'I can't work in retirement because it may make my taxes go up and I may have more of my Social Security taxed or I may have to impact IRAs or do something else, so maybe I won't work.'"
And so the first thing that you have to realize, according to Rice, is that you never get a net negative for working and collecting Social Security. "If you work and you bring additional earned income into the household, there is more money there," he said. "You don't get to keep all of it, Uncle Sam will take a piece, and you may impact a couple other parts of the retirement pie as well, but it's never a net negative."

"It always pays to work," said Rice. "People are under the impression that if they earn more than $14,160 a year that they're going to be penalized. Well, it's really important, when you get into your 60s, to understand what the earnings test really is."
For starters, if you're over full retirement age, there is no earnings test, Rice said. The earnings test comes into play only if you apply for Social Security before you turn full retirement age. And for those who have to deal with the earnings test, where for every two dollars you make over $14,160, one dollar of your Social Security will be withheld, it's important to understand what happens to that amount that's withheld, she said.
"Some people have heard that you get it back," she said. "You don't really get it back. You do, however, get a credit, and it's important to understand that credit for the actuarial reduction."
Rice used this example during the roundtable discussion: If you start Social Security at 62, she said, you'll get 75% of your primary insurance amount and get a 25% reduction. "So let's say you get a job and you receive one Social Security check and then you make enough after that to have all of your benefits withheld," she said. "What happens when you turn 66 is that your benefit will be recalculated, and it will be nearly the full $2,000, so you're getting that 25% actuarial reduction that they took away, you're getting that back, basically. So that's really important for people to understand — that if you apply early, if you end up having an opportunity to work, take that opportunity and work and not worry about the Social Security."
Never earn delayed credits
Rice said another point to consider when taking Social Security before full retirement age, or what is also called normal retirement age, is this: "The fact that you applied before full retirement age means that you can never earn delayed credits, so you will, at full retirement age, get your full benefit amount, but no delayed credits. So this is why it's really, really important for people to think hard about applying for Social Security before full retirement age, because it really limits your options."
For his part, Rice said you should think about paying taxes and reduced benefits this way:
"The taxation of Social Security essentially creates a rule," he said. "If your income is high enough, a portion of your Social Security benefits will be taxed, and in essence, the higher your income is, the greater the percentage is."
"So once we reach an initial threshold, which varies depending on whether you're single or married, you start increasing the taxation of your benefits 50 cents on the dollar. When we get to an upper threshold, we start increasing the taxation of our benefits at 85 cents on the dollar.
And what does that means in practice? "If we earn an extra thousand dollars and we're at the upper threshold, not only do we have another thousand dollars of income we have to report on, but now we have to take $850 of Social Security benefits, and put that on our tax return, and we're going to have to pay taxes on a portion of the Social Security benefits as well," said Rice.
At some point, "We're taxing 85% of the entire amount of Social Security benefits, which is the cap, and that's as high as we can go," Rice said. "And from that point forward, there's, in essence, no further impact for higher earnings on causing more of your Social Security benefits to be taxed."
And that, he said, is where some of the confusion exists about earning income and Social Security benefits. "The worst-case scenario is I'm paying taxes on the dollars I earn and I'm paying some taxes on the Social Security benefits that are now also being taxed because my income is higher," he said. "And for most folks at that level, your tax bracket is probably going to be 15% and maybe 25%, and so your worst-case scenario is still I'm going to pay 25% on my income, I'm going to pay another 25% on the Social Security benefits that I just phased in, which was only 85% of them, so I only pay a portion of that 25, and the net point that we get to is still nothing close to taking home less income than you would have had, had you not worked. It simply means you get a little bit of a higher tax burden for a chunk of income as you're causing some Social Security benefits to become taxed."
To be sure, you don't want to pay more than your fair share of taxes if you are working while collecting. So  there are tactics to consider. For instance, you consider adjusting your IRA withdrawals. Or you might consider investing in municipal bonds, since the interest income from taxable bond could cause more of your Social Security benefits to be taxed than otherwise.
You shouldn't let the tax tail wag the earning income dog while collecting Social Security benefits. "We might do other things around the margins to help not make that tax situation impact it even further, but we're still at the point where a dollar you earn puts a bunch of money in your pocket that you didn't have before," said Rice. "Whether you end up paying tax rates of 15% or 20% or 25% or 30% or 35% or 40%, if we add everything in, and there's estate tax liability and all of it is coming on your income and 85% of your Social Security, you still never get close to the point of 'I just wish I hadn't earned the dollar.'"

Friday, March 18, 2011

There is an App for Your Tax Refund

Okay smart phone users; they say that there is an App for almost everything.  Whether that is true or not, who knows, but there is a brand new App from the IRS that can allow you to check on your tax refund status and obtain other useful information.  The all new IRS2GO App is a free download that can be found by visiting your phone’s local App store or marketplace.  All this comes from the IRS’s commitment to modernize and help taxpayers to become more engaged in up-to-date tax information.  So what are the benefits of having this new App?  Well, here are a few good reasons to perhaps try it out.

• Refund Status:  Taxpayers can now check on their refund status using the new App with just a few simple pieces of information.  For e-filers information could be available as early as 72 hours after the IRS acknowledges receiving your return.  Paper filers will require some additional processing time, possibly three or four weeks.  Overall it is a great added convenience that can assist you in knowing where your refund is.

• Tax Updates:  The IRS2Go App allows users to enter their email address and automatically receive tax tips and updates on all the latest information that can help with the planning and preparing of taxes.  Some of these topics might include information on free tax planning or help, tax credits, and even changes in the laws as they happen.

• Follow the IRS:  Some may ask who would want to follow the IRS.  But in reality there are many who rely on up to the minute information regarding the tax laws and changes.  The new App allows you to sign up and follow the IRS on Twitter and YouTube, so you can stay in tune with all of these changes that take place.
Of course this is only the first release of this App and the IRS is hinting that more features are likely to come.  But whether you are just looking for your refund information, or trying to keep up on changes in the tax laws.  The IRS2GO App looks to be a useful tool in assisting many.

Deductible Business Meals and Entertainment

You may be able to take a tax deduction for certain meals and entertainment expenses incurred for a client, customer, or employee.  For costs to be deductible, they must either be directly related to your trade or business or associated with your trade or business.  To be directly related, the main purpose of the event should be for business or you should expect to receive income or other business benefit in the future from the event.  For the expense to be associated with your trade or business, you must provide a meal or other form of entertainment directly before or after a significant business discussion.  It isn’t necessary to spend more time on business than to entertainment, but the taxpayer should be able to prove the business objective.
Meals can include food, beverage, tax and tip.  Entertainment includes activities to provide amusement or recreation.  Some examples are nightclubs, social or athletic clubs, theaters, sporting events, yachts, fishing trips, or other similar events.  However, the cost of renting or owning the entertainment facility is generally not deductible.  The meals or entertainment deducted must not be considered lavish or extravagant.  The expenses must be reasonable considering the facts and circumstances.

Once you have figured what expenses are deductible as meals and entertainment, the deduction is limited to 50% of these expenses.  There are a few exceptions to the 50% rule.  Some transportation workers are subject to an 80% limit.  Meals provided on the employer’s premises and for the benefit of the employer are not subject to any limit, as long as more than 50% of the employees are provided meals for the employer’s convenience.  Generally, holiday parties and picnics for employees are fully deductible.  Promotional activities made available to the general public are also not subject to any limit.  For example, wine merchants may fully deduct the cost of food and wine at a wine tasting event.

You can find more information regarding meals and entertainment deductions in IRS Publication 463.  Like all tax deductions, make sure you have adequate records to support your deduction.  Under audit, the IRS would expect to see records of the cost, date, place, and business purpose for all expenses.

Seniors Stung by IRS Tax Credit Errors

The tax credit, a provision of the 2009 stimulus legislation, was advanced to taxpayers in 2009 and 2010 in the form of higher payroll and pension checks, due to lower federal income tax withholdings being deducted from them. Eligible people qualified for a credit of up to $400. But millions of taxpayers were either advanced the tax credit without being eligible for it, or they were advanced more of the credit than they were entitled to under the law.
One glitch affected working seniors who also received Social Security, Supplemental Security Income, railroad retirement or veterans' disability compensation, according to the Senior Citizens League. Seniors qualified for a separate $250 economic stimulus payment that should have reduced their maximum Making Work Pay tax credit to $150. But the IRS withholding tables used by employers did not adjust for those payments.
In a provision of the 2009 stimulus legislation, was advanced to taxpayers in 2009 and 2010 in the form of higher payroll and pension checks, due to lower federal income tax withholdings being deducted from them. Eligible people qualified for a credit of up to $400. But millions of taxpayers were either advanced the tax credit without being eligible for it, or they were advanced more of the credit than they were entitled to under the law.
One glitch affected working seniors who also received Social Security, Supplemental Security Income, railroad retirement or veterans' disability compensation, according to the Senior Citizens League. Seniors qualified for a separate $250 economic stimulus payment that should have reduced their maximum Making Work Pay tax credit to $150. But the IRS withholding tables used by employers did not adjust for those payments.
Seniors receiving pensions were affected as well, because the IRS tables allowed reduced withholdings for pensions — even though such income was not even eligible for the credit, which only applied to income earned from a job.
Married couples who worked and also received a pension are at greatest risk and could potentially owe as much as $1,600.
Because the faulty tax tables caused many people to owe taxes they didn't expect to owe, the IRS has allowed penalties to be waived for the 2009 and 2010 tax years. But the waivers are only given if taxpayers explicitly request them. According to the Treasury Inspector General for Tax Administration, last year virtually no taxpayer surveyed knew they could request a waiver.
The Senior Citizens League said it supports efforts to repeal or reform the way Social Security benefits are subject to taxation. Even though retirees already paid taxes during their working years to fund the Social Security system, their benefits are also taxed once they rise above $25,000 a year. Every year the benefits of more retirees are subject to tax, because the federal government does not adjust the income levels annually as is routinely done with income tax brackets.
Social Security recipients are also required to compute their taxes using a special formula that factors in "provisional" income, including supposedly "tax-free" money such as tax-free municipal bonds or proceeds from ROTH retirement accounts.
"Many seniors will be surprised to find they owe money on their tax returns for 2010 because of the way the IRS implemented the Making Work Pay tax credit," said Senior Citizens League chairman Larry Hyland in a statement. "We urge affected seniors to file their penalty waivers. We also urge the government to eliminate what amounts to double taxation of Social Security benefits, by removing taxes on those benefits."
In response to the report that TIGTA issued last December on taxpayers who owed money last year as a result of the credit, IRS management said the agency planned to continue to do outreach efforts, but declined to contact taxpayers who owed any penalty based on the Making Work Pay credit. When asked about the claims by the Senior Citizens League, an IRS spokesperson cited the IRS response in that TIGTA report, along with a Web page on the IRS site containing information on how to adjust the withholding for the Making Work Pay credit.

Wednesday, March 16, 2011

How to Land an SBA Loan

With all of the uncertainty around maintaining a predictable flow of capital to businesses, a commercial loan provided by a bank but guaranteed by the federal government almost sounds too good to be true. Standing behind such loans is one of the responsibilities of the U.S. Small Business Administration’s (SBA) Guaranteed Loans Program.
So, why do many businesses intentionally bypass the SBA and take their chances through the normal commercial bank underwriting process? This article examines the pros and cons of major SBA loan programs and helps CPAs determine if an SBA loan is the best alternative.

Understanding SBA Loan Programs
The SBA offers several primary loan programs geared toward supporting different aspects of the small business community. To qualify as a small business under current law, a business must demonstrate that it has less than $15 million in tangible net worth and two years’ net income after taxes of less than $5 million. From this point, various SBA programs have other qualification criteria. Here are summaries of the most popular programs:

7(a) Loan Program
This is the SBA’s primary and most flexible loan program, with financing guaranteed for a variety of general business purposes. Under this program, the SBA guarantees loans made by participating commercial lending institutions. Possible loan maturities are available up to 10 years for working capital and generally up to 25 years for fixed assets.

504 Loan Program
This program provides long-term, fixed-rate financing for expansion or modernization. It is backed by the SBA but delivered by Certified Development Companies (CDCs) — private, nonprofit corporations set up to contribute to the economic development of their communities.
Proceeds from 504 loans must be used for fixed-asset projects, such as:
  • Purchasing land and improvements, including existing buildings, grading, street improvements, utilities, parking lots and landscaping.
  • Constructing new facilities or modernizing, renovating or converting existing facilities.
  • Purchasing long-term machinery and equipment.
The 504 program cannot be used for working capital or inventory, consolidating or repaying debt or refinancing. Interest rates on 504 loans are pegged to an increment above the current market rate for five-year and 10-year U.S. Treasury issues. Maturities of 10 years or 20 years are available. Fees total approximately three percent of the debenture and may be financed with the loan. Generally, the project assets being financed are used as collateral. Personal guarantees from the principal owners are required.

Microloan Program
This program provides small, short-term loans for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery and/or equipment. It is designed for small businesses and nonprofit child care centers and is delivered through specially designated intermediary lenders (nonprofit organizations with experience in lending and technical assistance).
Loan terms vary according to the size of the loan, the planned use of the funds, the requirements of the intermediary lender and the needs of the small business borrower. The maximum term allowed for a microloan is six years. Interest rates vary, depending on the intermediary lender and costs to the intermediary from the U.S. Treasury. Generally, these rates will be between eight percent and 13 percent. Each intermediary lender has its own lending and credit requirements. Generally, intermediaries require some type of collateral and the personal guarantee of the business owner.
In recognition of the important role small business plays in a healthy economy, lawmakers passed the Small Business Jobs Act of 2010 (PL 111–240), which expands loan programs through the SBA, strengthens small business preference programs for federal government projects, provides incentives for exporters, offers a variety of small business tax breaks and includes some revenue raisers.

Why Consider an SBA Loan?
For many businesses, the benefits of an SBA-guaranteed loan include having access to capital where traditional commercial loans may not be available. Startups and young businesses without a sustained history of financial performance may find an SBA-guaranteed loan especially attractive. For businesses with cash flow issues, an SBA loan can restructure debt at better terms by providing longer loan maturities and lower payments. Businesses without sufficient collateral to obtain a traditional commercial loan may find an SBA loan particularly useful.
It is very difficult at this time for lenders to underwrite the strength and long-term viability of a borrower’s ability to repay the proposed debt. In this unusually challenging economic cycle where real estate values are declining, it is also difficult to ascertain the future value of collateral,” said Terrence Rice, CPA.  “SBA provides the backup ‘insurance’ in order to be able to service the borrower’s loan needs.”

Tuesday, March 15, 2011

Understanding and planning for the kiddie tax

The kiddie tax has been around since 1986. When it was first enacted, the tax applied to children under age 14 at calendar year end. This continued for almost 20 years. For 2006 and 2007, the tax was changed to apply to children who were under age 18-years old at year-end. Changes to the age requirement were made again in 2008, which are still in effect for 2010. Under these new rules a full-time student might be subject to the kiddie tax through age 23.

What Is the Kiddie Tax?
The purpose of the kiddie tax is to prevent parents in high income tax brackets from shifting income to their lower-income tax bracket children. The kiddie tax is calculated and reported on Internal Revenue Service (IRS) form 8615 and taxes the unearned income of the child at the parent’s rate, if it is higher than the child’s. In cases where there is more than one child subject to the tax, the unearned income of other children in the family must also be considered in the calculation. With the different tax rates for qualified dividends and capital gains, these amounts also need to be recalculated. For example a child may be in the zero-tax bracket for capital gains and qualified dividends, yet their parents are in the 15 percent bracket. Net-capital gains and qualified dividends need to be calculated separately in computing the kiddie tax as they have a maximum 15 percent tax rate. This must be calculated for the parents, child and any other children of the parents who are subject to the kiddie tax.

How Does It Work?
A child must file form 8615 and be taxed on unearned income at their parent’s tax rate if all of the following conditions are met:
  • Investment income exceeds a certain dollar amount. For 2010, this is $1,900.
  • They are required to file a return.
  • At least one parent is alive at the end of the year.
  • The child does not file a joint return.
  • They are either:
    • Under age 18 at the end of the year
    • Age 18 at the end of year but their earned income was not more than one-half of their support
    • Between the ages of 19 and 23 at the end of the year and a full-time student and their earned income was not more than one half of their support.
Investment income represents most income other than earned income and includes taxable interest, dividends and capital gains.
Whether a child is required to file a return depends on how much earned and unearned income they have during the year. They are required to file a return if any of the following conditions apply for 2010:
  • Unearned income exceeds $950;
  • Earned income exceeds $5,700;
  • Total unearned and earned income exceeds the greater of $950 or earned income (up to $5,400) plus $300.
However, If the child is under 19 (24 if a full time student) as of December 31st and their only income is from interest or dividends totaling less than $9,500, the income may be reported directly on the parent’s return, using form 8814 . Although this option would prevent the need to file a return for the child it may affect the parents return in other areas. First of all, the parents may pay $95 more tax, for the $950 standard deduction on the child’s return, which would be taxed on the parent’s return at 10 percent. More importantly is the potential phase out or disallowance of various deductions on the parents return for the increase in their income due to inclusion of the child’s income. Some of these areas are student-loan interest, individual retirement account (IRA) contributions, child tax credit, education credits or making work pay credits.
When considering the child’s age at the end of the year, a birthday on January 1, does bring the child to the next age level. For example, a child born on January 1, 1987 is considered to be 24 for purposes of a 2010 return and is not subject to the kiddie tax.
If a child is filing their return before the parent’s return is finalized, estimates may be made and the return amended, if necessary upon finalization of the parent’s return.

Ways to Minimize
There are several planning tools that may be used by taxpayers who have unearned income that could trigger the kiddie tax.
If a child between the age of 18 and 23 has earned income that is more than one half of their support, they are not subject to the kiddie tax. Support includes all amounts spent on food, lodging, clothing, medical expenses, education, recreation, transportation and similar necessities. Student loans in the name of the student are also considered to be support for which the child pays. However, if a child receives a scholarship, it is not considered support. With some planning, earned income could be maximized to be greater than half of the child’s support, whether or not it is used for the support. This includes reasonable wages that self-employed parents pay to the student for services he or she performs.
Amounts subject to kiddie tax cannot exceed taxable income. A contribution to an IRA by a child who has earned income could reduce taxable income and thereby reduce or eliminate the kiddie tax.
The education credits may be used by some students to offset the kiddie tax. This is only the case when the parent cannot claim a student as a dependent.
Students could invest in tax-free investments, including section 529 plans, which are not included in income.

The kiddie tax provides for taxing unearned income of children at their parent’s higher tax brackets. There are options related to reporting this income that taxpayers and preparers should be aware of, along with tax-planning options to reduce the kiddie tax.

Friday, March 11, 2011

Can Same-Sex Couples Finally File Jointly?

Last month, the Obama Administration announced it would no longer fight constitutional challenges to the Defense of Marriage Act (DOMA) by same-sex couples who are legally married under state law
However DOMA is still on the books and must be enforced by the Feds (at least theoretically) until it is amended, repealed, or overturned in the courts. That may not happen anytime soon. House Speaker John Boehner has said he would initiate Congressional action to defend DOMA .
Trying to make sense of this muddled situation is difficult, but here is my take: Expect the government to half-heartedly say the DOMA rules still apply to legally married same-sex couples until the rules are challenged in court. At that point, the White House will punt. I doubt the Republicans can do anything to change that as long as Obama is president.
Now for the question of the day: assuming my analysis is correct, what impact (if any) does the administration's new DOMA position have on a legally married same-sex couple's federal tax situation? Before answering, let's briefly review why it matters.

Impact of being married (for tax purposes)

From a tax perspective, DOMA is important because it says same-sex couples who are considered married under state law are not considered married for federal tax purposes. With one big exception, the federal tax rules generally treat married folks better than singles. Here are the specifics.
In the scenario where one spouse earns most or all of the income and it is a healthy amount, being allowed to file a joint Form 1040 will cut the couple's federal income tax bill. That is because more of the higher-earning spouse's income gets taxed at lower rates and because married couples are entitled to bigger standard deductions than singles. This is the so-called "marriage bonus" in action.

Advantage: Tax-free employer benefits
When you are considered married for federal tax purposes, your spouse can receive certain tax-free benefits from your employer. The two most common examples are tax-free health insurance and tax-free payouts from flexible spending arrangements (FSAs).

Advantage: Better treatment for inherited retirement account balances
Another benefit for federal tax purposes is that your surviving spouse can roll over qualified retirement plan balances inherited from you into his or her own IRA. The surviving spouse is not required to start taking annual required minimum distributions (RMDs) from the rollover IRA until after he or she turns 70½. In contrast, when a non-spouse inherits a qualified retirement plan balance and transfers it to an IRA, he or she will usually have to start taking RMDs sooner and in larger amounts. Since RMDs are taxable, spouses are allowed to collect more tax-deferral benefits than non-spouses.
When you are considered married for federal tax purposes, your surviving spouse also can roll over IRA balances inherited from you into his or her own IRA. Once again, the RMD rules that apply in this situation allow spouses to collect more tax-deferral benefits than non-spouses.

Advantage: Better gift and estate tax rules
When you are considered married for federal tax purposes, you can make unlimited gifts to your spouse while you are still alive without any federal tax consequences (assuming your spouse is not a non-resident alien). When you die, you can leave your surviving spouse an unlimited amount free of any federal estate tax, thanks to the so-called unlimited marital deduction privilege (assuming your spouse is a U.S. citizen).
If you die in 2011 or 2012, you also can leave any unused federal estate tax exemption to your surviving spouse. That way, your spouse will have a bigger estate tax shelter if he or she also dies (after you) in 2011 or 2012. While federal gift and estate tax issues are not a big concern for most folks (thanks to the current $5 million gift and estate tax exemptions), wealthy couples who are considered married for federal tax purposes still have big advantages over those who are not.

Disadvantage: "Marriage penalty" can apply
The one big disadvantage of being considered married for federal tax purposes occurs when both spouses earn healthy incomes. In this scenario, a married couple can wind up with a bigger federal income tax bill than if they were single. This is the so-called "marriage penalty" in action. So a same-sex couple in this situation can actually benefit from being considered unmarried for federal tax purposes.

Have your tax-filing options changed?

I don't think so. Because DOMA is still the law of the land (however weakly it might be enforced), a married same-sex couple is still considered unmarried for federal tax purposes. Therefore, for 2010, I advise same-sex married individuals to file separate federal returns as singles. Then to protect your tax position in the event that DOMA is overturned, consider filing an amended joint return for 2010 using Form 1040X. You also can consider filing amended joint returns for earlier tax years that are still "open" (a year is generally "open" for up to three years after the date you filed your Form 1040 for that year). Talk to your tax pro about the advisability of filing amended returns. The potential tax savings may or may not be worth the trouble.

The last word

Some tax pros may disagree with my conservative take on your tax-filing options. Fair enough, because we are all on shaky ground here. That said, you certainly won't be charged any extra taxes or penalties if you follow my advice. Finally, one thing is completely clear: Nothing has changed for same-sex couples who are not legally married under state law. They must continue to file their federal returns as singles -- period.

Thursday, March 10, 2011

IRS to Examine Rental Losses More Closely

The Internal Revenue Service has agreed with recommendations in a newly released government report urging the agency to increase its examinations of individual tax returns that report losses from rental real estate activity.
The report, by the Treasury Inspector General for Tax Administration, was conducted because a Government Accountability Office report in August 2008 found that at least 53 percent of individual taxpayers with rental real estate activity for tax year 2001 misreported their rental real estate activity, resulting in an estimated $12.4 billion of net misreported income.
The objectives of TIGTA’s review were to evaluate the IRS’s scrutiny of individual tax returns with rental real estate activity and to recommend changes to help identify, select and examine tax returns with rental real estate activity.
TIGTA found that during fiscal years 2008 and 2009, the IRS’s rental real estate Compliance Initiative Program examined only a small percentage of the 318,339 examinations conducted by revenue agents and tax compliance officers. TIGTA projected that if the IRS were to increase the percentage of rental real estate CIP tax returns it examined, it could increase potential tax assessments by $27.3 million over a five-year period.
“Given the magnitude of underreporting in our voluntary system of tax compliance, even small improvements in the IRS’s examination of tax returns with rental real estate activity could increase taxpayer compliance and generate substantial additional revenue to the federal government, helping reduce the tax gap,” said TIGTA Inspector General J. Russell George in a statement.
IRS management agreed with all of TIGTA’s recommendations, disagreeing only with the report’s proposed monetary outcome measures.
In its report, TIGTA recommended that IRS officials conduct an analysis to determine the population of tax returns with rental real estate activity that meets the criteria for inclusion in the CIPs. The IRS should also revise the instructions for Form 8582 to require all taxpayers with prior-year unallowed passive activity losses to submit the form with their tax return. The report also recommended that the IRS ensure that the information taxpayers provide to report the net amount of income earned or losses incurred from being a real estate professional is transcribed.
IRS management agreed with all three recommendations. The IRS, in connection with the development of compliance strategies, plans to consider whether additional CIP examinations are appropriate. In addition, the IRS plans to revise the 2011 instructions for Form 8582 and transcribe the information taxpayers provide to report the net amount of income earned, or losses incurred, from being a real estate professional.
“We will ensure the information taxpayers provide to report the net amount of income earned, or losses incurred, from being a real estate professional is transcribed,” wrote Christopher Wagner, the commissioner of the IRS’s Small Business/Self-Employed Division. “These changes will assist in selection of the most high-risk returns for audit.”
However, the IRS disagreed with the proposed monetary outcome measures. “Since the dollars per hour figures were calculated based on actual examinations that were ranked and selected for examination based on their potential yield, the characteristics of these cases are not necessarily an accurate representation of the entire remaining population,” Wagner wrote. “Therefore, because the results of the cases examined do not necessarily represent results from cases not selected, projecting differences in revenues across unexamined cases does not produce accurate revenue estimations.”
TIGTA said it computed the outcomes conservatively using historical data from the examination program. TIGTA officials maintained that the potential $27.3 million of increased revenue over a five-year period is reasonable considering the assumptions used to calculate the estimate.

Tuesday, March 8, 2011

Test drive highlights tax software limits

Like Watson, the IBM computer that stumped the champions on Jeopardy, tax-preparation software uses sophisticated technology to perform a task previously done by a human — in this case, your neighborhood tax preparer.
For taxpayers with straightforward returns, tax software gets the job done, at a fraction of the cost of a tax preparer. If you file a 1040-EZ, there's simply no reason to pay someone to do your taxes for you when you can do it online for less than $20 (or free if you qualify for the IRS Free File). Most tax software programs are also adept at handling returns that claim common tax breaks, such as the deduction for mortgage interest and charitable contributions.
But this year's tax software review also revealed the limitations of these programs. Taxes have grown so complex that even those of us who don't invest in individual stocks, own rental property or run a small business could find ourselves in need of advice from a flesh-and-blood tax preparer. Here's where we ran into trouble in our annual test drive:

Retirement savings

Most taxpayers with lengthy investment portfolios hire a professional to prepare their returns, with good reason. Even Watson would have a hard time figuring out the cost basis for a stock you bought in the 1980s and sold last year.
But these days, something as common as saving for retirement can create tax headaches, especially for taxpayers who converted a traditional individual retirement account to a Roth IRA.
A law that took effect last year lifted income restrictions on such conversions, allowing thousands of taxpayers to convert for the first time. In addition, the law gave taxpayers who converted in 2010 the option of splitting the income tax from the conversion between 2011 and 2012. For example, if you converted an IRA valued at $100,000 last year, you could opt to pay taxes on $50,000 of the income in 2011 and $50,000 in 2012.
For most of us, that's the obvious choice. Why pay taxes now when you can pay them later? But if you expect your income to increase in 2011 and 2012, you may want to take the tax hit now.
If you make that determination, be prepared to wrestle your tax software to the ground. TurboTax provided the easiest workaround: While it advises users that deferral is the preferred option for most taxpayers, it offered a way to pay your taxes in 2010. Still, a worksheet would have been nice. Instead, we had to use a back-of-the-envelope calculation to figure out how much it would cost to pay the tax bill in 2010.
H&R Block At Home Deluxe deferred the income, with no explanation of what it was doing, or why. To learn more, you have to advance to the "Adjustments and Deductions" section and check a box for IRA conversions and rollovers. This section provides a useful description of the pros and cons of paying taxes now vs. later, but it's so far away from the initial entry that it's easy to overlook.
CompleteTax offers a box you can check if you want to have your conversion taxed in 2010. However, the language was confusing, and when we posed a question to the help section about our options, we were told we would need to upgrade to get an answer.
The most troubling treatment of an IRA conversion occurred in our test drive of TaxAct. After we entered information about our conversion, the program treated the entire amount as taxable in 2010. This created such a large tax bill that we experienced heart palpitations and had to walk away from the computer. A TaxAct spokesman said this resulted from a data entry error on our part, but it was an easy — and expensive — mistake to make.
The bottom line: If you converted a large IRA to a Roth last year, it may be worthwhile to consult with an experienced tax preparer.

Miscellaneous income

If you're self-employed or starting a business, you're probably better off paying a tax preparer to do your return. Otherwise, you risk overlooking valuable deductions, or making errors that could attract scrutiny from the IRS.
But many people who work for an employer also earn a little extra income through consulting, freelancing or tutoring kids at the local elementary school. This income typically appears on Form 1099-MISC.
TurboTax did the best job of handling this income, although it strongly suggested we upgrade to its Home & Business version (which costs about $75). Entering miscellaneous income was more laborious with H&R Block At Home.
The bottom line: You shouldn't have to upgrade to a premium software program to report a couple of hundred bucks you earned mowing lawns last year. But you may need to root around a bit to find the right place to enter this information.
Other thoughts:
•As has been the case in past years, TurboTax provided the clearest instructions of all the programs we tested. However, if you're a longtime desktop user, you may want to consider making the leap to the online version. It's cheaper and updates automatically. In our test drive of the desktop version, we had to endure several updates, one of which lasted more than 10 minutes.
•H&R Block At Home did a workmanlike job on our tax return — and costs about 25% less than TurboTax. Block has enhanced its data-import function, which lets you electronically transfer information from your W-2, mortgage statements and other documents, but it still lags behind TurboTax in this regard.
•TaxAct continues to be the preferred choice for cost-conscious taxpayers. Its standard program is free. However, if you want any guidance, you'll need to upgrade. For that reason, it's best-suited for people with a good grasp of tax laws or those with simple returns.

Sunday, March 6, 2011

Seven Common Audit Triggers and Ways to Avoid Them

The IRS has made no secret of the fact that it is ramping up audits in order to close the "tax gap." The "tax gap" is the difference between what the IRS expects to collect and what it actually does collect. In 2005, the IRS estimated this gross tax gap, before collections efforts, to be approximately $345 billion.

The good news is that the IRS doesn't expect to shrink the tax gap with random audits. While it's true that some returns are randomly selected for examination, most of the time the IRS has a reason for plucking a form 1040 out of the pile. In other words, audits are generally triggered by a specific item or pattern of behavior on your tax return (or tax returns). Following is a brief checklist of items or behaviors that might trigger an audit:

1. Failing to Include a Form 1099 or Other Income

The IRS suggests that over 60% of underreported individual income tax is related to business and self-employment income, so ensuring compliance with those individuals is a priority. As part of their efforts, the IRS matches forms 1099 in their records to the amounts on your return, so make sure those are correct.

2. Inflating Home Office Deductions

If you use part of your home for business, you're entitled to deduct the related costs as a home office deduction. However, to qualify for the home office deduction, the IRS says you must use the part of your home attributable to business "exclusively and regularly for your trade or business." That means your home office must be your actual office, not just a spot in your home where you sometimes do work, and it must be exclusively workspace and not used for other purposes. In most cases, you'll calculate your deductions based on the size of your home office -- measure carefully and resist the temptation to overstate the size of your office.

3. Citing Too Many Losses on a Schedule C

Filing a Schedule C isn't generally enough to trigger an audit, but taxpayers who file a Schedule C may be statistically more likely to face an audit. One reason is that there is a temptation to overstate losses on your return. Keep in mind that the IRS assumes you're in business to make money. Filing a loss year after year might make the IRS question whether you're serious about your business -- and how you're getting by.

4. Claiming Disproportionately High Charitable Deductions

Charitable deductions are one of the most common deductions claimed on a personal income tax return. In fact, more than 90% of taxpayers who opt to itemize claim charitable deductions. Taxpayers who claim the charitable deduction donate, on average, about 3% of their income. Of course, many taxpayers routinely make large donations due to religious or other charitable reasons. If you're one of them, be sure and document your donations properly, especially cash donations, and make sure the values of non-cash donations make sense.

5. Using Too Many Round Numbers

You know how every now and again, your bill at a store will turn out to be $20 even, and you find that hard to believe? The IRS looks at tax returns that way, too. Your tax return isn't intended to be an estimate. You should report your actual items of income and losses, not approximations. If the IRS sees too many numbers that look like guesses, they may ask you for supporting documentation.

6. Reporting Rental Real Estate Losses When you Don't Materially Participate
As a rule, the IRS considers all rental real estate activities that aren't performed by real estate professionals to be passive activities. For tax purposes, that means expenses associated with rental real estate activities will be deductible only to the extent of rental income (some exceptions apply). However, if you're considered to be in the business of renting real property because of your active involvement, you may be entitled to deduct rental real estate losses in full.

7. Citing Too Many Business-Related Deductions

To be considered a bona fide business expense, an expense must be both "ordinary and necessary ... in carrying on any trade or business." If you have a lot of deductions that seem a bit out of the ordinary for your trade or business, you may call attention to your return. A good rule of thumb when determining whether to claim a business-related deduction is that there should be a clear connection between your expenses and your business in order to take the deduction. Don't try to make something fit that clearly doesn't qualify, and, of course, keep excellent records.

Remember that there's nothing in the tax law that says you should pay more in taxes than you have to ... so don't be afraid to take legitimate deductions on your return. Be careful, however, to report income and expenses properly and keep good records.

Friday, March 4, 2011

Business entertainment deductions can be complex

Taking a customer to lunch, dinner or the theater is part of doing business. And often, a lot of fun. But company owners may find that claiming such entertainment expenses as income tax deductions is complicated, and maybe painful.
Many owners find out when they're compiling their income tax returns that they can't deduct the full amount of a meal or event. Maybe they can't deduct any of it.
IRS Publication 463, Travel, Entertainment, Gift and Car Expenses will give you a good grounding in deductions for entertainment expenses. And, as with any tax matters, it's always a good idea to consult a tax professional like an accountant or an attorney to be sure you're following the rules.

Here's an overview of what the IRS allows, and doesn't allow, for business entertainment deductions:
If you took your client out for a $300 dinner and consoled yourself with the idea that at least you got a big deduction, the truth is, you can claim only $150 on your return. The tax code allows only 50 percent of an entertainment expense to be deducted.
And, if $300 would be considered a lavish expense considering the line of work you're in and where your company is located, the IRS might limit how much of the check you can deduct. The amount the government allows will still be subject to the 50 percent rule.
Let's say the meal takes place during a business trip. While your airfare and hotel bill may be fully deductible, only half of the restaurant check can be claimed.

It's so common for business associates, especially when they're friends, to get together for dinner or a drink and compare notes about how things are going. Or ask each other for advice. But according to the IRS, the bills for these occasions can't be deducted.
In order to claim an entertainment deduction, the government requires that the main purpose of a dinner or other form of entertainment be "the active conduct of business." And an owner must have "more than a general expectation of getting income or some other specific business benefit at some future time."
In other words, if you're getting together just to network with a client or add some goodwill to the relationship, it might not pass the IRS' test. If you talk about a specific project or contract, you've got yourself a deduction.
Here's an exception: If the entertainment takes place before or after a business discussion, then you can deduct it. So let's say you make a presentation to a client and then go out to dinner and you don't discuss business during the meal. It's still deductible.
It's common for owners to bring their spouses and a customer's spouse to a big night out. Unless the spouses are an essential part of the business discussion, their meals and/or tickets aren't deductible.

If you take a customer to the theater or a baseball game, the same rules generally apply. But there can be exceptions, and that's why you need to read Publication 463. For example, if the ticket is to an event that will benefit a charitable organization -- local golf tournaments are often held for charitable reasons -- then you can deduct the full amount.
Many business owners will treat clients to a round of golf at the club they belong to. The fees they pay for a guest are deductible. But yearly or monthly membership dues for the club are not.

Many accountants say the biggest problems their clients have with entertainment expenses is that they don't keep good enough records. Many have a pile of receipts and credit card statements at the end of the year. But that won't be good enough for the IRS if it questions your deductions.
The government and tax professionals recommend that business owners keep a log or diary where they can enter their entertainment expenses. That's where you need to keep track of the business purpose of the meal or other event. If the expense is more than $75, you also need restaurant checks, hotel bills and other receipts to document the amount you're claiming.

Thursday, March 3, 2011

Six Tax Deductions For Home Offices

In many ways, running your own business from home is a sweet deal: No commute, no boss looking over your shoulder, no dress code. You can eat what’s in the house and keep your dog company.
But it’s also expensive. You’ve got to foot the bill for everything from technology to transportation to health insurance. So it’s critical that home-based entrepreneurs take full advantage of the tax deductions that are available to them. 
Here’s what to write off, and how to do it:
Home office space. If an office or other portion of your home is designated for work, the IRS allows you to deduct a portion of your mortgage payments or rent. The use of the space for work has to be “regular and exclusive”—in other words, a laptop on the kitchen table doesn’t qualify. The deduction is proportional to the size of your workspace. Calculate the percentage of your home’s square footage that is used exclusively for work. And don’t forget that you can deduct utilities, homeowners’ insurance and real estate taxes as well.
Computer equipment, software and supplies. Deduct the full value of any computers, software and Internet service that are used only for business purposes. Other write-offs include software programs, including accounting software, and postage expenses.
Health insurance costs. Sole proprietors can write off the cost of their health insurance premiums, but remember, your family’s insurance costs are not deductible unless they work for you.
Research materials. If you subscribe to websites or print publications that focus on your industry, write them off. If you’re a writer and purchase copies of the publications you want to write for, deduct those too. Same goes for reference books.
Business phone calls. Write them off. The simplest way to keep track of your business call expenses is to have a dedicated phone line or a separate cell phone altogether.
Auto mileage and travel expenses. Whether you're traveling to meet with clients, conduct research, or for some other legitimate business purpose, all of the expenses can be deducted. Keep track of mileage, and keep receipts for cabs and air travel. They can all be written off if properly documented.

10 Tax Benefits For The Self-Employed

How would you like to reduce your taxable income while simultaneously increasing your financial independence? Starting your own business, whether on the side or full time, can be a great way to turn costs that you would incur anyway into legitimate, tax-deductible business expenses.

As an added bonus, the income you derive from your business can help make you less dependent on your employer (if not totally self-sufficient) and help you retire sooner. In this article, we’ll explore some common tax deductions available to the self-employed.

Some Common Tax-Deductible Expenses: Many self-employed tax benefits soften the blow of having to acquire things that an employer normally provides. In this way, the tax code helps to encourage entrepreneurship.

Self-Employment Tax Deduction: The self-employment tax refers to the employer portion of Medicare and Social Security taxes that self-employed people must pay. Everyone who works must pay these taxes, which for 2010 are 7.65% for employees and 15.3% for the self-employed (7.65% x 2). In 2011, taxes for self-employed filers are being reduced to 13.3%.  Many people view the self-employment tax as a discouragement to entrepreneurship, but the IRS does a couple of things to reduce the sting.First, you get to deduct half of your self-employment taxes from your net income. Essentially, the IRS treats the self-employment tax as a business expense and allows you to deduct it accordingly. Second, you only incur self-employment tax on your net business income, or what’s left over after you subtract your business expenses.Finally, you only pay self-employment tax on 92.35% of your net business income in 2010. Thus, someone in the 25% federal tax bracket ends up with an effective self-employment tax rate of only 12.36%, not 15.3%. Remember, you’re paying the first 7.65% no matter who you work for, so the self-employment tax amounts to an extra 4.71% tax for someone in the 25% federal tax bracket, not an extra 7.65%. That’s a small price to pay for being your own boss, right?

Home Office: The home office deduction is one of the more complex deductions. In short, any workspace that you use regularly and exclusively for your business, regardless of whether you rent or own, can be deducted as a home office expense. While you are basically on the honor system, you should be prepared to defend your deduction in the event of an audit. Make sure to prepare a specific map of your workspace, with the correct measurements, in case you are required to submit this information to receive your deduction. And don’t forget to include your restroom, as the government expects your home company to need facilities too. The expenses you can deduct for your home office include the business percentage of rent or mortgage, property axes, utilities, homeowners insurance and home maintenance that you pay during the year. For example, if your home office occupies 15% of your home, then 15% of your annual electricity bill becomes tax deductible.

Health Insurance Premiums: The tax code makes it difficult for most people to deduct the cost of their health insurance premiums. However, if you are self-employed, pay for your own health insurance premiums, and were not eligible to participate in a plan through your spouse’s employer, you can deduct all of your health, dental and long-term care insurance premiums. What’s more, you can also deduct premiums that you paid to provide coverage for your spouse and dependents. This is technically considered a personal deduction, not a business deduction, but it is only available to the self-employed.

Meals and Entertainment: To deduct meals and entertainment (meals being considered the most common business entertainment expense), you must conduct business with the person you are entertaining during the meal/event or immediately before or after it. Unlike other deductions, these expenses are only 50% deductible, not 100%. Examples of deductible expenses in this category include tickets to a sporting event, the cost of a meal (with beverages, tax and tip), or the cost of a game of golf. Make sure to keep meticulous records of what business activity you conducted, when, with whom, and how it directly relates to the entertainment expense; keep your receipts. This area is audit-prone because many people try to cheat the system here.
  • Internet and Phone: Regardless of whether you claim the home office deduction, you can deduct your business phone, fax and internet expenses. The key here is to only deduct the expenses that are directly related to your business. If you have only one phone, you shouldn’t deduct its basic monthly charge, which you would likely incur whether you worked form home or not. You should only deduct costs that specifically relate to your business. If you have a second phone line that you use exclusively for business, however, you can deduct 100% of that cost. By the same token, you would only deduct your monthly internet expenses in proportion to how much of your time online is related to business – perhaps 25%.
  • Interest on Business Loans and Business Credit Card Interest: It’s a no-brainer that interest on a typical business loan from a bank is a tax deductible business expense. However, normally, credit card interest is not tax deductible. If you make business purchases on your business credit card and incur interest, however, this credit card interest is tax deductible. That said, it’s always cheaper to spend only the money you already have and not incur any interest expenses at all.
  • Car: When you use your car for local business trips, your vehicle expenses for those trips are tax deductible. Transportation expenses are considered an audit flag, however, so make sure you only take what you are entitled to and that you keep excellent records.You can either deduct the standard mileage rate (determined annually by the IRS) or deduct your actual expenses. The standard mileage rate is the easiest because it requires minimal record-keeping or calculations. Keep track of the business miles you drive and the dates you drove them. Then, multiply the total miles by the standard mileage rate (50 cents per mile in 2010). This amount is your deductible expense. To use the actual expense method, you must calculate the percentage of driving you did for business over the course of the year as well as the total cost of operating your car during the year, including gas, oil changes, repairs and car insurance.
Making Passions More Profitable: If your business happens to be in a field that you’re passionate about, a lot of things you would probably spend money on anyway become tax deductible when they are directly related to your business.
  • Publications: The cost of specialized magazines and books directly related to your business is tax deductible. For example, a daily newspaper would not be specific enough to be considered a business expense, but a subscription to the CPA Journal would be tax-deductible if you are a Certified Public Accountant (CPA). (And yes, some people are passionate about accounting.)
  • Travel: Overnight travel outside your city limits for business purposes is tax deductible.To be considered a business trip, your trip should have a specific business purpose planned before you leave home, and you must actually engage in some business activity – such as finding new customers, meeting with clients, or learning new skills directly related to your business – while you are on the road.Taxpayers should be particularly careful to maintain complete and accurate records and receipts for their business travel expenses and the business activities they performed, as this deduction often draws attention from the IRS. Deductible travel expenses include the cost of transportation to and from your destination (such as plane fare), the cost of transportation at your destination (such as a car rental or subway tickets), lodging and meals. You are even allowed to travel luxuriously, taking first class flights or staying at four-star hotels, but remember, it’s you, not the IRS, who will be paying the bulk of your travel costs.100% of your travel expenses for business are deductible, except for meals and entertainment, which are limited to 50%. If your trip does not involve an overnight stay, you can still deduct the cost of transportation, but you cannot deduct the cost of meals as a travel expense. If your trip combines business with pleasure, however, things get a lot more complicated.
  • Education: Any education expenses that you want to deduct must be related to your existing business – that is, not just any class is deductible, even a class meant to prepare you for a new line of work. If you are a real estate consultant, taking a course called “Real Estate Investment Analysis” to brush up on your skills would be tax deductible, but a class on film noir would not. 
The Best Self-Employed Tax Deduction of All: One deduction in particular can make going into business for yourself particularly profitable.
  • Self-Employed Retirement Plans: Self-employed retirement plans – such as SEP-IRAs, SIMPLE IRAs, Keogh plans and solo 401(k)s – are particularly valuable for reducing your tax bill now and racking up tax-deferred retirement savings for later. In 2010, you could feasibly contribute 20% of your net self-employment income (based on a maximum net income of $245,000 in 2010) plus a $16,500 elective salary deferral to a solo 401(k) – that’s a total maximum contribution of $49,000!Those who don’t make quite as much can contribute to both a self-employed retirement plan and an IRA (as long as you are within the IRA’s income phase-out limits). And, if you still have a day job where your employer doesn’t offer any kind of retirement plan, starting your own profitable business will get you out of the only-$5,000-a-year rut (the maximum annual IRA contribution) and allow you to start saving more for retirement.

  • Conclusion:  Most small business deductions are a bit more complicated than can be explained in this brief overview, but this is a good introduction to the basics. Remember, any time you’re not sure whether an expense is a legitimate business expense, ask yourself, “Is this an ordinary and necessary expense in my line of work?” This is the same question the IRS will ask when examining your expenses if you get audited. If the answer is no, don’t take the deduction. If you’re not sure, seek professional help with your tax return from a CPA.

Wednesday, March 2, 2011

Five Unusual Business Tax Write-Offs You've Probably Been Missing

Entrepreneurs might find tax time a bit less taxing this year and next due to some new write-offs covering a range of common expenses for growing businesses.

Here's a quick look at five breaks aimed at certain businesses that you'll want to know about:
1. New-job creators
A new-hires tax credit can give employers a break on their payroll tax if they hired new workers into new job slots between Feb. 3, and Dec. 31, 2010. These workers can't have replaced people who left. They have to add to your headcount. And they have to have been unemployed for 60 or more days prior to you hiring them.
If your business qualified for this deduction, which amounts to 6.2% of your payroll tax, you should have taken from your quarterly payroll tax estimates during 2010. But if you missed it, it's worth going back and amending those quarterly payments to account for the credit. What's more, an additional $1,000 general business tax credit may be available in 2011 if you keep these new employees for 52 weeks or longer. So if you qualified for the first credit, make sure you qualify for the second one as well,

2. Cell-phone users
Mobile phones used to be counted among items the Internal Revenue Service refers to as "listed property," such as laptops or cars that might be purchased for work or provided by an employer but that lend themselves to personal use. Users had to keep track of their business and personal use for these items and write off the former proportionally.

The IRS has removed cell phones from this onerous list, which means that if you provide employees with cell phones or use one for business yourself, "Your business can write it off directly," says Rice.

3. Large sport-utility vehicle buyers
This is a great break for entrepreneurs who need an SUV that's heavier than 6,000 pounds for their business, such as a Chevy Tahoe or Ford Explorer. If you bought or plan to buy a new one between Sept. 8, 2010, and Dec., 31, 2011, you may be able write off the full value in a single tax year, rather than having to depreciate it over a few years, as has been the case previously.
"This is a loophole for a lot of taxpayers," says Rice.
If you really do need this kind of horsepower, this credit could go a long way toward defraying the cost of owning one of these gas guzzlers.

4. New-equipment buyers
In a bid to get business owners to open the till and spend a little, the IRS is offering "bonus depreciation," which is the temporary ability to write off more equipment in a bigger way.
If a business bought or buys new equipment between Sept. 8, 2010, and Dec. 31, 2011, it may be able to write off 100% of the cost all at once. We're talking big items like computers, office furniture and manufacturing equipment. "This was enacted to help manufacturers and help to spark the economy," Rice says. For this reason, the items have to be purchased new, not used, and put into use during that same period.
Better still, the write-off has no limits on how much you spend and isn't capped by your taxable income, as is the case with the write-off rule this one temporarily supersedes, says Rice.

5. Employee health-insurance buyers

The small employer health-care credit lets very small businesses write off 35% of the premiums you pay for employees' health insurance. It sounds great, and it is, if you qualify, but there are limits, says Anderson.
To qualify, a business must have fewer than the equivalent of 25 full-time workers. So, for example, you could have 50 part-time workers. The average annual salary across your employees can't top $50,000, and you must be covering more than half of your workers' health-care costs.
The credit will rise to 50% in 2014, but it will also phase out for employers who pay an average annual employee wage between $25,000 and $50,000. "It's meant to give a tax credit to business owners who provide health insurance to lower-wage workers," says Rice, "But it's too onerous to qualify for it. It isn't going to get a lot of play [in places where wages are high]."
Even so, with the number of new tax breaks this year, many entrepreneurs are likely to find at least one that could come in handy this spring.