Sunday, February 19, 2012

Expect a tougher income tax season, with smaller refunds and more audits


Tax filing season this year will be even a little less enjoyable than usual.
Many people will get smaller refunds than they expected, and federal and state tax authorities are stepping up enforcement to get more revenue out of existing taxes.
The biggest change for most taxpayers will be the increase in what they pay as a result of the expiration of the Making Work Pay Tax Credit.
Michael Merlino, president of Atlantic Accounting Associates with offices in Egg Harbor Township and Tuckerton, said that in 2009 and 2010 the credit was enough to offset changes in tax brackets and boost people's refunds.
"This year, they did away with it, so people are seeing less in refunds, especially if they're married," said Merlino, 57, of Egg Harbor Township.
Terry Shellock, of Camp and Shellock in Linwood, said just about everyone got the Making Work Pay Tax Credit, which was a form of stimulus under the American Recovery and Reinvestment Act of 2009.
"It was $400 if you're single and worked and made less than roughly $100,000, and $800 if married and filing jointly, earning less than $200,000," said Shellock, 54, of Ocean City.
And as a credit, the $400 or $800 came off the federal income tax due. Deductions, which reduce the income to which the tax rate is applied, are worth far less.
Debbie Camp, a CPA and Shellock's partner, said even those above the income threshold received a reduced Making Work Pay Tax Credit.
"Everybody got something, that was the whole point of it," said Camp, 44, of Egg Harbor Township. "The first three returns I did this year, their refunds were lower than last year."

Disappearing credits
The Making Work Pay Tax Credit is the most important federal tax break disappearing, but not the only one.
A federal tax credit of up to $3,400 for the purchase of a hybrid electric vehicle has been phased out, and purchasers of hybrids in 2011 will get no tax relief.
There is still a federal tax credit of as much as $7,500 for the purchase of a plug-in hybrid electric vehicle such as the Chevrolet Volt, or a plug-in electric vehicle such as the Nissan Leaf. Those, too, are on a schedule to be phased out, but there is a proposal in Washington to extend or even increase the credit for the so-far very slowly selling vehicles.
Shellock said another energy-related credit that helped many homeowners also has lost much of its value.
"We've had Residential Energy Credits the last couple of years, for energy improvements such as new roofs, upgraded doors and insulation, all kinds of heaters, and that's greatly reduced," Shellock said, and the eligible period for making improvements ended Dec. 31, 2011.
The tax credit to encourage first time homebuyers also is gone for everyone except military personnel, he said.
And for many businesses, a beneficial treatment of the deduction for improvements is disappearing.
"For restaurants and retail stores for the last couple of years, if you made improvements you could depreciate them over 15 years instead of the usual 39 years," Shellock said. "As of 2012 that's no longer available. You had to have done the improvements before the end of the year."

More, tougher audits
Federal and state governments want more revenue, but raising taxes is unpopular, so they're making a bigger effort to collect more of what is owed.
That effort is twofold, said Thomas J. Fitzpatrick, a CPA and partner in Fitzpatrick, Bongiovanni & Kelly, which has offices in Upper Township and Linwood.
First, the Internal Revenue Service is increasing the number of audits it performs on tax returns, in particular those of businesses, said Fitzpatrick, 55, of Ocean City.
"Audits have definitely increased on the federal level and also on the state level," he said.
After conducting 1,385,000 audits in both 2007 and 2008, the IRS bumped up the number of audits to 1,426,000 in 2009 and 1,580,000 in 2010.
Figures aren't out for last year, but Fitzpatrick said the number of audits has kept increasing, especially for businesses. "They're now ramping up big time."
"I've been a CPA since 1986 and I've seen very few business audits, probably a total of 15 in my entire career," he said. "Our firm likewise hasn't had many audits the last 10 years for businesses. But over the last 12 months, we've seen a significant increase in the industry, with 10 to 15 ourselves."
The second part of the tax collectors' extra efforts is conducting more aggressive, comprehensive audits - with the help of digital record keeping and information gathering and processing.
The IRS said that last year it began requiring tax preparers filing 100 or more returns to file them electronically. This year, any tax preparer filing more than 10 returns must file them electronically, which presumably is the vast majority of tax preparers.
That has put a lot more information about taxpayers in the hands of the federal and state governments, Fitzpatrick said, and they're learning how to use it to make tax collection more effective.
"In the past, a government clerk would keypunch in the main numbers from a tax return, a half dozen numbers or so. Now they're figuring out how to use computers to improve the audit system," he said.
For example, most businesses use QuickBooks to track and report their finances and taxes, which makes a far more rigorous audit easy, he said.
"Both the IRS and New Jersey know that, and have hired staff to understand QuickBooks inside and out, and now they're demanding the taxpayer or accountant provide the actual QuickBooks file," Fitzpatrick said. "That has thousands of times more information than they would have gotten before, and they can determine who did what, when and why."
Another segment of taxpayers getting special attention is the working poor, Merlino said.
"A lot of due diligence is being required of tax preparers in regard to the Earned Income Tax Credit, which is available to those with low income. There's so much fraud with the Earned Income Credit," Merlino said.
As a result, the IRS is compelling preparers to ensure people are actually eligible for the credit, "more or less making them do the job of the IRS," he said.
Fitzpatrick said the IRS sent 22,000 letters in November to tax preparers (his firm not among them), "warning them that the IRS is watching them and they'd better start doing things right."
He said the massive amounts of data now gathered and crunched allows the IRS to compare firms - for example, seeing if the tax returns prepared by one firm have a higher level of charitable contributions than others - and also compare individual preparers within firms.

Prepare to be audited
The IRS is trying to shrink the "tax gap," between the amount Americans owe and the amount they paid.
In January, it released its study of the tax gap for 2006, showing it had grown to $450 billion from $345 billion in 2001, the previous year studied. Most of the gap increase resulted from the increase of total federal taxes due to $2.7 trillion, but the compliance percentage - the share voluntarily paid - shrank about half a percentage point as well to 83 percent.
The IRS offset some of that weaker compliance by increasing the revenue from enforcement and late payments by $10 billion to $65 billion in 2006. The strengthening of the audit function, while intended to improve compliance, will probably increase that revenue further.
While the chance of being audited is increasing, it is still relatively small, at least at ordinary income levels - from about 1 percent for those earning less than $25,000, to 2 percent for those earning $200,000 to $500,000 (or reporting no adjusted gross income), to 10 percent for those earning $10 million a year or more.
All taxpayers are much more likely, though, to have the analysis of their returns or earnings result in a letter from the IRS pointing out discrepancies in reported income, errors on the return, or money owed. In 2010, 9.2 million people received such letters, according to an analysis by the Taxpayer Advocate Service.
The best way to handle an audit, Fitzpatrick said, is to get ready for it in advance.
"Once you've filed and are audited, there's not much you can do," he said. "To prepare for it properly, you need to make sure you understand the tax laws as they apply to you and what documentation will be required, before filing the tax return."
The IRS makes that easier for businesses, he said, by putting online descriptions of programs targeting various areas of compliance.
"For many industries, the IRS has publications that tell everything about that industry, and what kinds of things they think the public is getting away with," Fitzpatrick said.
He said his firm makes sure business clients are fully aware of what's in the publications relevant to their sector and what the IRS will be looking for.
"If you do things right, at least are trying to do things right, usually the government will allow for stupid mistakes or you just missing something," he said. "But if they think you're bending the rules, they can get nasty."