How to Amend Your Federal Tax Return

Here are some additional thoughts, based on reader questions and interviews with tax pros, on what to do when you discover mistakes—or even honest omissions—on a tax return you've filed. The answer varies depending on your situation and the size of the change.

Suppose you get a revised form from a brokerage house or some other financial institution changing the amount of dividend income reported for last year. Often, the change is just a few dollars. In such cases, tax pros say many clients routinely ignore it, even if the change would mean a slightly larger refund. It may not be worth the cost of paying your tax preparer to file amended returns.

But the answer would be different if you receive a notification involving a substantial amount. "You usually should file an amended tax return if you made an error claiming your filing status, income, deductions or credits on your original return," the IRS said in a "tax tip" in April. Use Form 1040X, and check on your state's rules, too. (Most states have their own income tax.)

When should you file an amended return? This can be tricky. "If you are due a refund from your original return, wait to receive that refund before filing Form 1040X to claim an additional refund," the IRS said. "Amended returns take up to 12 weeks to process." You may cash your original refund while awaiting the additional refund.

If you owe more tax because of something you just discovered, "file your Form 1040X and pay the tax as soon as possible," the IRS said. "This will reduce any interest and penalties."

How do you find out what's happening on your amended return? You can check three weeks after you file by clicking on "Where's My Amended Return?" on the IRS website (irs.gov). You can also call 866-464-2050. The IRS says you can use this to track an amended return for the current year and up to three years back.

Time to Think About Taxes, Again!

Yes, I know we're just past last year's tax season, but good tax planning works only if we start early enough for the current year. Having last year's tax return still fresh in memory gives us a great start for next year's tax planning.


Understand how your income is being taxedDo you know what your effective tax rate is? Do you have more than one income source? Do you know how each of your income sources is taxed? Income can be broadly classified as:

• Ordinary — Income from a regular job, self-employment and freelancing; interest income and non-qualified dividends.
• Capital — Qualified dividends, income from the sale of an asset (stock, real estate, etc.)
• Passive — Income from sources like real estate and business investments where participation is not required.

Each of these types of income is taxed at a different rate. A tax-savvy individual minimizes the income from the highest taxed source and moves his earnings toward the lowest taxed source. Before you dismiss this advice thinking you can't quit your job, think of other ways you can achieve the goal.

• If you have a large amount of money sitting in a savings account that you won't require for at least 5 years, can you move it to dividend-paying stocks?
• If you paid the higher rate for selling a stock too soon, can you plan better on when you buy and sell stocks to pay the capital gains rate instead of the ordinary rate?
• If you don't have more than one source of income, especially if your job is your only source of income, consider diversifying by earning income on the side.

Are you leaving any money on the table?For each deduction you took this year, is there a better way to save money?
For example, if you had dependents and paid for child care, have you looked at your employer's benefits to see if they offer a dependent care account? A lot of employers also offer discounts toward a variety of businesses. One of my past employers offered a discount and extended hours at a nearby day care, but no one knew about it because it was only mentioned in an online benefits brochure which didn't get many views.
Did you contribute at least enough to your retirement plan to get the employer match?


Can you optimize your deductions?Did you itemize or take the standard deduction? What is the difference in your return when choosing between itemized and standard deduction? If you donated to charity and the difference between your standard and itemized deductions was small, you might want to consider donating every other year. Here is an example to explain this better:
Let's say you donated $12,000 to charity in 2012 and again in 2013. Let's additionally assume that both years you opted to take itemized deductions. The total deduction for 2012 and 2013 is $24,000.
Now, instead, let's assume you set aside $1,000 each month in 2012 and donated the entire $24,000 in 2013. You take the standard deduction for 2012 ($11,900 if you are married and filing jointly) and itemized deduction for 2013 ($24,000). This makes the total deductions for 2012 and 2013 a whopping $35,900. You can deduct an extra $11,900, which, depending on your tax bracket, can be a substantial saving.
Of course, this is an over-simplified illustration; there are other deductions like state taxes and property taxes to consider. These cannot be skipped every other year, but it is definitely worth doing the calculations both ways to determine which is more beneficial.


Are you placing your investments in a tax-smart vehicle?Taxes should not be the only concern for any investment; you should evaluate your risk tolerance and do careful asset allocation. After you have made your investment decision, it is essential to choose the right vehicle to make it tax efficient. Should you invest in a taxable account or a tax-sheltered account? For example, if you are going to hold a stock for a very long time, it can be in a taxable account as it will be taxed as capital gains; but if you are going to be generating a lot of short-term gains, it might be better to place it in a tax-sheltered account.


Have a strategy in placeAfter going over your tax return with the goal of planning for next year, is there anything you can do now to make next year's return more efficient and less time-consuming? Think of all the potential expenses this year and figure out if any of them are deductible. For example, if you are planning to send your kids to summer camp, it might be a deductible expense. Knowing what you are going to deduct this year will make it easier to save the receipts and will also make sure you won't miss it due to last-minute lapses in memory.


Set up a system for next year's deductionsReceipts, receipts and more receipts. Anything that can be deducted, file it. Set up a system that works for you whether it's a folder for each month or a folder for each category or alternatively scanning the receipt and recording it in Excel. Pick a system and work on it throughout the year.


Get helpI wanted to have an accountant prepare my taxes for 2013; but I procrastinated and, by the time I contacted potential accountants, they were all too busy to take new clients. This year, I am looking for an accountant right now. Finding the right person can also be a time-consuming process. I want to get referrals, talk to the accountant, and develop a relationship. Doing it now, when the accountant is not drowning in client files, will help me find the best accountant for my situation.
What is your tax-planning strategy?

More income, more taxes - Upper-income earners face a gantlet with this year's changes

SOURCE: Detroit Free Press

Some well-to-do taxpayers won't be thrilled when they're hit with extra tax increase — which can add several hundred or several thousand dollars to the bill.

We're talking about higher tax rates for upper-income taxpayers, as well as a higher capital-gains tax rate and a new investment surtax that was included in the Affordable Care Act.

MORE TAX HELP:

See Form 8960 for the 3.8 percent tax that could apply to net investment income. The tax can apply to individuals, estates and trusts. You'd pay an additional 3.8 percent tax on the lesser of your net investment income, or the excess of modified adjusted gross income over $200,000 ($250,000 married filing jointly, $125,000 married filing separately).

• Some new tax strategies can apply because of that extra 3.8 percent surtax. For example, tax experts warn that someone in a higher-income household might think twice about making a large conversion from a traditional IRA into a Roth IRA. That's because the required inclusion of income from that conversion would drive up your adjusted gross income. Better planning over a few years could avoid triggering the tax.
• Financial planners are suggesting that investors review some strategies to help avoid or mitigate the 3.8 percent surtax. Some might ideas include reducing taxable income by contributing to 401(k) plans and IRAs; and looking into life insurance and charitable remainder trusts.

"Between the increased tax brackets that went into effect in 2013, and the new 3.8 percent Medicare surtax on net investment income, many upper-income taxpayers are seeing a significant bump in their taxes," said Patricia Bojanic, certified public accountant and tax partner at Gordon Advisors in Troy, Mich.

"It's made tax and investment planning that much more important," Bojanic said.

Some higher-income households, she said, could end up seeing an increase of 24 percent or more in the taxes on their investment income.

First, let's look at the new, little-understood 3.8 percent surtax that took effect in 2013.

Now, some taxpayers could be subject to an extra tax on net investment income. Investment income includes interest, dividends, royalties, rents, capital gains and passive activity income.

More people could be talking about the 3.8 percent surtax this season because of the relatively lower income threshold, said Bernie Kent, chairman of Schechter Investment Advisors in Birmingham, Mich.

"This is the one new tax that applies to the most people," said Kent, who has worked more than 40 years with high-net worth individuals and families.

The 3.8 percent surtax would apply to married couples when modified adjusted gross income exceeds $250,000 if filing jointly, and singles when modified adjusted gross income exceeds $200,000. The surtax would apply to married couples filing separately who individually earn more than $125,000.

On top of that, an added Medicare tax of 0.9 percent on gross income from wages and self-employment would be imposed on taxpayers earning more than $200,000 single or $250,000 for joint filers, too.

Alan Semonian, certified public accountant at Ameritax Plus in Berkley, Mich., said he has seen some higher-income households this season getting hit by the 3.8 percent surtax after receiving significant capital gains distributions from mutual funds.

One married couple, both physicians, had to report $50,000 in capital gains distributions from their mutual funds, he said. For that particular couple, the gains helped to trigger about $5,000 in extra taxes relating to the surcharge.

Mutual funds that aren't in tax-sheltered accounts, such as IRAs or 401(k)s, are required to pass profits from capital gains, interest or dividends to individual investors. You'd owe tax on that distribution, even if you did not sell off your shares in the fund.

The 3.8 percent tax does not apply to money taken out of a qualified retirement plan or IRA. It also does not apply to interest income from municipal bonds. Net investment income would not include wages, jobless benefits, Social Security benefits and alimony, either.

Though there are not many ways to reduce this 3.8 percent tax hit in 2013, a few options can exist for some people who are slightly above the $200,000 or $250,000 thresholds, Kent said.

Kent noted that someone who works for an employer who doesn't provide a 401(k) plan or other type of retirement plan, such as a traditional pension, still could contribute now through April 15 for the 2013 tax year to a deductible IRA, which would reduce taxable income. For 2013, a taxpayer could contribute up to $5,500. Or someone age 50 or older last year could contribute up to $6,500.

Someone who is self-employed could consider contributions to a Simplified Employee Pension IRA, and that could reduce 2013 taxable income.

The way the 3.8 percent surtax is calculated can be a bit confusing. For example, a single person with $225,000 in modified adjusted gross income could face an extra tax of $950 if wages were $100,000 and net investment income was $125,000. The surtax in that case is applied to $25,000 of net investment income.

For those with even higher incomes, more tax hits are taking place this year.

The highest tax rate jumps back to 39.6 percent for taxable income more than $400,000 for singles and more than $450,000 for married couples. That's up from 35 percent.

Investors in the top bracket now must pay 20 percent on long-term capital gains and dividends, instead of the 15 percent that most other taxpayers pay.

Higher-income taxpayers also face a potential phase-out of itemized deductions and personal exemptions, if their adjusted gross income is $250,000 or more if single or $300,000 or more for married couples.

James Jenkins, president of Jenkins accounting firm in Southfield, Mich., said self-employed business people are doing more planning. Many of these upper-income people, he said, "aren't accidentally rich" and they are not likely to just stand still as rates climb higher.

The real tax rate is closer to 44 percent, not 39.6 percent, for some higher-income taxpayers who have taxable income above the $450,000 threshold, Jenkins said.

"You know what a phase-out is? It's called higher tax rates," Jenkins said.

Revisiting the myth of tax deferral

By Tom Sedoric


I’m puzzled why there are not more discussions and articles about tax efficiency and investments, particularly when it comes to the issue of tax deferral.


Of course, tax planning is far from “sexy.” The lead story in the most recent IMCA (Investment Management Consultants Association, ) research quarterly was titled,  “Increased Tax Rates and Investment Strategy.”


Like the remarkable underestimation of the potential long-term power of compound interest in creating one’s fortune, there are too few discussions about the potential shortcomings of tax deferral and the significance of tax-efficient investment strategies.


I’ve beaten this drum for a long time. It was nearly three decades ago, when the transition to 401(k) plans was taking off, that I wrote a column that drew the ire of many of my fellow advisers and friends in the accounting profession. The abridged version goes like this: beware the myth of tax deferral. My point was to take a hard look at the long-term implications of tax-deferral plans and to recognize the potentially serious drawbacks in the future.


The future is here for some. There is often confusion about the benefits and mathematics of tax deferral, as well as pretax savings, because sometimes a tax-deferred account or investment only defers one from paying potentially more down the road. This may not always be to an investor’s advantage.


Owning a tax-deferred asset, like the stock of a good company or fund, in a taxable account is often wiser than holding the same fund or company in a tax-deferred account like an IRA or 401(k). If held in an IRA, that growth company or fund will eventually be taxed as ordinary income.  Ordinary income tax rates could be twice the level if the stock or fund had been held in a taxable account, sold, and taxed as a long-term capital gain. Remember, in investing, it is not what you make, but what you keep that matters most.
A conscious choice
Automatic savings can occur if a 401(k) is in place and can be terrific for the investor taking control of their retirement security and very profitable for mutual fund companies and insurance vendors. I think trends and events over the past three decades have given us a clearer perspective of winners and losers in the tax-deferral arrangement.


One reality has become quite apparent: People who do not create diversified tax efficiencies and who relied too much on tax-deferred investments in their long-term plans may find themselves hit with much greater tax burdens than they expected or needed to pay in later years. Individual tax rates have been largely declining for three decades, while few experts believe tax rates will be lower in the future.


The issue of tax efficiencies remains elusive because it sounds dull, dry and formidable – better left to accountants. It is anything but formidable, and I believe the matter of tax efficiencies resides in the same category as compound interest. It is considered dull and unexciting when compared to the latest investment scheme.


In truth, tax efficiencies should be an integral part of any sound investment plan.
Here’s a frequent example of mine, and it has to do with my favorite hypothetical company, XYZ:
Investor A has a $1 million investment in company XYZ, with a zero cost basis, held in a tax-deferred IRA savings account. Investor A also has $1 million directly invested in company XYZ stock in their personal trust or investment account, also with a zero cost basis.
On paper, both assets are worth the same, except for the significant difference of future tax liability. And if the client dies with a significant IRA, the tax burden on future generations may even be higher.


The obligation of the tax-deferred IRA is set at the income tax rate, which could currently be over 40 percent, or higher if ordinary income tax rates increase again. The sales of stock in a taxable account would be subject to a much lower long-term capital gains tax of barely 20 percent for even the highest-income investor.


Assuming a zero cost basis for this hypothetical example, the IRA investment could have an after-tax value of an estimated $600,000 while the stock investment in a taxable account could be worth as much as $800,000 – a $200,000 difference.


Some would call this found money, but in reality it’s a conscious choice to weigh long-term risks and benefits – and naturally unique to every investor. If investors are blinded or distracted by the allure of tax deferrals, they may miss out on the opportunity to have greater flexibility for future earnings.
I don’t believe that tax-deferred plans are inherently unhealthy, though the late Sy Syms said, “An educated consumer is our best customer,” and the same may be true in the realm of tax deferral. After all, why should people pay more taxes than they need to?

Planning for Social Security

Social Security recently announced its new figures for 2014.

Benefits for the 57 million monthly receipts will increase 1.5 per cent. The average check will be $1,294 per month.

 

People who receive the maximum benefit will receive $2,642 per month. These are people who paid in the maximum for 35 years.

 

People who receive disability payments will get an average of $1,294 per month. Cost-of-living increases are based on the consumer price index from the third quarter of 2012 through the third quarter of 2013. In the last 25 years, they have averaged 2.74 percent.

The maximum amount that can be taxed on Social Security will increase up to $117,000. That means that a worker at the top level will pay about $205 more this year. You must continue to pay the Medicare premium even above this level. In addition to that, people earning more than $200,000 have to pay an extra Obamacare tax of 0.9 percent.

Many people do not realize that you must give up some of your Social Security income if you start collecting before full retirement age.

 

For 2014, the figure is $15,480. For every $2 you earn above this amount, you must re-pay Social Security $1. There is a special rule for the year until you reach full retirement age. That year only, you can earn up to $41,400 and then you must give back one dollar for every three you earn. This only applies until the month of your birthday when you reach full retirement age.

After full retirement age you can earn any amount of income without a penalty. People often do not take this into consideration when they start Social Security at age 62.

Remember, every day 10,000 people reach retirement age. Because of all of this volume, Social Security is moving more functions online.

Many middle class taxpayers might get hit with the alternative minimum tax. This was created in 1969 to make sure that everyone paid taxes. Originally it got the very rich who maybe only owned tax-free investments such as muni-bonds. Today the rich are paying a lot more regular income taxes so that is often more than the alternative minimum. You have to pay whichever is higher. Low-income taxpayers do not earn enough to worry about the alternative minimum. This year it is estimated that some 3.9 million people or 4.2 percent will get hit with AMT. The average for individuals is $6,600. For a couple filing jointly the limit could be $80,800 and for individuals $51,900.

Whether you will be affected depends on your particular deductions. People at the most risk live in states with high local taxes, exercise stock options, report large investment options, have lots of children, use home equity loans, have many miscellaneous deductions or are claiming business depreciation.

 

People with extensive municipal bond holding also could be at risk.

If you are subject to this tax, you need to do substantial tax planning. Congress finally indexed the levels for exposure to this tax last year. That should make planning possible. Tax planning is important for all of your investment whether you are subject to this tax or not.

IRS Previews Instructions for New Net Investment Income Tax Form

The Internal Revenue Service has released draft instructions for Form 8960, the Net Investment Income Tax that was mandated as part of the Affordable Care Act.

The 3.8 percent Net Investment Income Tax applies to certain net investment income above the statutory threshold amounts of individuals, estates and trusts, beginning with their first tax year beginning on or after Jan. 1, 2013. But it does not affect income tax returns for the 2012 taxable year filed in 2013.

The threshold amounts are $250,000 for married filing jointly returns, $125,000 for married filing separately, $200,000 for singles, $200,000 for heads of household with a qualifying person, and $250,000 for a qualifying widow or widower with a dependent child.

The IRS released a draft version of the form in August after much anticipation and has finally released the draft instructions.

They include instructions for U.S. citizens and residents, as well as nonresidents, dual-resident individuals and dual-status individuals. The instructions also describe an election to file jointly with a nonresident spouse.

In terms of estates and trusts, the IRS provides instructions and exceptions for domestic estates and trusts as well as special computational rules for qualified funeral trusts and for bankruptcy estates, along with distributions from foreign estates and trusts.

The instructions also cover numerous other areas, including rules for passive activities, trade or business activities, rental activities, a safe harbor for real estate professionals, recharacterization of passive income, special rules for certain rental income, disclosure requirements for the disposition of a partnership interest or S Corporation stock, and special rules for traders in financial instruments and commodities.

138 shopping days until April 15

You will want to do some tax planning right now so that you can not only prevent a big surprise but prepare for it if need be.

You need to sit down and project your income and income tax withholding to year-end. Then if you used tax software to prepare your returns, you can enter this information and any other anticipated taxable transactions into the tax software along with your new filing status to see if you will owe or not.

Better yet, visit a tax professional with your projections and a copy of your 2012 income tax return and get an assessment – there may be factors that play in that you are not aware of. After all, the tax code is 73,000 pages long and incomprehensible to the average lay person. Plus a tax professional may guide you to some tax saving transactions that you can implement before year-end.

Listed below are tax-impacting situations that require the help of a professional:

Change in marital status. If you divorced this year or have a divorce that will be final by December 31, 2013, you will transition from the advantageous married filing jointly tax status to single or perhaps head of household if you have dependents or others who will qualify you for that filling status. You may end up owing, so it’s a good idea to find out now so you can adjust your withholdings or otherwise plan for the liability. If you got married this year, you will want to analyze the impact of joint finances on your tax liability. It’s a good idea to combine your finances in a spreadsheet then visit your tax pro to determine if there will be a liability or a refund. Take along your copies of your prior year tax return.

Buying or selling a home. Many folks think that they can write off the down payment, or take deductions for improvements made to their primary residence. Not so. However, if you go from being a renter to being a homeowner, you will enjoy a deduction for property taxes and mortgage interest. So rather than taking the standard deduction, you will be allowed to itemize deductions which will allow for additional write offs such as charitable contributions, DMV fees, state income taxes paid, investment expenses, employee business expenses, and medical, to name a few.

If you sell your home, part of your profit may be taxable. Consult with a tax professional to determine if you will end up owing due to a home sale. Bear in mind that the first $250,000 (single) or $500,000 (married filing joint) of profit is not includable in income for tax purposes. If you went from being a homeowner to a renter, you will likely lose the advantage of itemized deductions and may need to adjust your withholdings accordingly.

Job change. If you change jobs, you will be required to complete Form W4 to declare the number of exemptions you will claim. Depending upon whether there are other financial changes and if you are substantially increasing or decreasing your income, you may want to do some projections to see where you will stand next April 15. Your tax pro can help you determine how many exemptions to claim in order to align your withholdings to your liability.

Retirement. Many baby boomers are retiring and that generally changes their tax picture completely. Running the new numbers will help retirees determine how much should be saved toward taxes and whether or not to have withholdings on their retirement pay or social security benefits.

So before the holiday season hits and you get busy partying, think about and plan for your 2013 tax liability. Come next April you will be glad you did.

Are You Ready For The 2013 Obamacare Investment Tax?

Obamacare is first and foremost a health insurance regulation, but investors would be mistaken if they believe it won't affect them if they don't invest in that sector and they already have health insurance. One of the major features of the regulation that has not been discussed much is the tax on investment income that is being levied to pay for the regulation. This tax is likely to be particularly important to retirees.

The tax I am referring to, which took effect starting January 1, 2013, is a flat 3.8% tax on "net investment income" (i.e. all income from investments) for investors with $200,000 a year in total income ($250,000 for couples). This tax is a flat tax, which is levied in addition to other taxes owed by the investor (e.g. capital gains taxes, federal income taxes, etc). So if you make $200K a year total from capital gains, dividends and coupon payments, your job salary, business profits, and all other income sources, you will be exposed to this tax. (There are select income exemptions that I discuss below.)

Now $200,000 a year in income may seem like a lot. And for many people it is - at least if they earn $200K each and every year. But this tax is likely to hit a lot more people than just that group. Most people know that stocks have returned about 9-11% annually for the last century or so. However, that average is dragged down by bad years and up by good years. As a result, there are a lot of years where the stock market averages gains of 15-20% or more.

Given that the average investor holds a stock for about 11 months and investors tend to cash out after markets have had a big run, these years of 15-20% gains in the stock market are likely to generate about that much in capital gains. What this means is that investors with total portfolio values of anywhere from perhaps $750K to $1 million are likely to face this Obamacare tax at some point in the next few years, particularly after dividend income is considered. (For example, $750K * 15% capital gains + 5% dividends + $50K salary/pension = $200K in annual income, and $5,700 in additional taxes from this Obamacare tax.)

Data from Federal Reserve studies and the IRS suggest that many retirees or upper middle class individuals nearing retirement have portfolios of this size, suggesting that they need to be very concerned with the tax.

MLPs and direct resource investments  will face less of a tax hit because part of their income should be sheltered by resource depreciation allowances, but the high level of income these stocks throw off is unlikely to be completely protected, so if possible moving them to a tax-advantaged retirement account is also wise.

Most investors with a sizable portfolio won't be able to and won't want to move all of their assets to an IRA or other tax-favored account. For these investors, timing gains and losses will be even more important than before. Investors should try and spread large gains out over multiple years (which I know is easier said than done after stocks have had a big run-up and one is nervous about a pullback), and when facing losses that are unlikely to be recouped, investors should try to sell these securities within the first year so that the losses qualify as short-term capital losses.

Finally, investors can avoid the Obamacare taxes by investing in traditional tax-exempt municipal bonds (though there has been some talk of the administration trying to reverse this exemption). The interest on these bonds is exempt from the Obamacare tax as well as federal income taxes, but investors still may owe the Obamacare tax on any capital gains from trading in munis as well as from interest on "Build America" Bonds.

11 Changes You Must Know Before Filing Your Tax Return for 2012

FROM FORBES.COM -

With so many changes looming for 2013, it’s easy to forget that there were some significant tweaks to the Tax Code for 2012. Here’s a list of eleven changes to keep in mind before you file your 2012 tax return, due April 15, 2013:
1. Payroll tax credit will still affect self-employed taxpayers. The expiration of the payroll tax credit for 2013 was big news – but don’t forget that the credit was still in place for 2012. While that means nothing for employees subject to withholding (no additional breaks on your federal income tax return since you’ve already received the benefit of the payroll tax credit in your withholding), if you were self-employed you will receive an adjustment on your self-employment (SE) taxes when you file your federal income tax return. Your SE tax will be reduced by 2%; the SE tax rate of 12.4% is reduced to 10.4%.
2. Forms W-2 have more information this year. Under the Affordable Health Care Act, most employers are required to report the value of health care benefits received by an employee on a 2012 federal form W-2 (a few small businesses are still exempt from reporting under the transitional relief offered by IRS). The amount will be reported in box 12 with Code DD and should include both the portion paid by the employer as well as any amount paid in by an employee. Even though it appears on a W-2, this amount remains federal income tax free for 2012.
3. Roth Conversions May Be Taxable. Taxpayers who converted or rolled over amounts to a Roth IRA in 2010 and did not elect to include the entire amount in income in 2010 may need to report half of that taxable income on their 2012 returns. Favorable tax treatment made conversions in 2010 more appealing than normal: specifically, taxpayers had a three year window to pay the taxes due. That window expires with tax year 2012.
4. Relief For Underwater Taxpayers. With record numbers of taxpayers in foreclosure, Congress enacted the Mortgage Forgiveness and Debt Relief Act of 2007 to provide limited tax relief for taxpayers facing financial difficulties. Under the Act, qualified homeowners who were forced into foreclosure or mortgage restructuring on a principal residence could exclude income of up to $2 million ($1 million for married taxpayers filing separately) on the mortgage forgiveness (the difference between the lower amount received and the higher amount owed to the mortgage company). The fiscal cliff tax deal extended that tax relief through 2013 making it possible for taxpayers to avoid a huge tax bill on 2012 short sales.
5. Increased Standard Deduction.The amount of the standard deduction increased for all taxpayers in 2012. The rates for 2012 were:

• Single: $5,950, up $150 from 2011
• Married Filing Separately: $5,950, up $150 from 2011
• Head of Household: $8,700, up $200 from 2011
• Married Taxpayers Filing Jointly and Qualifying Widow(er): $11,900, up $300 from 2011

This is good news for most taxpayers since two out of every three taxpayers will claim the standard deductionin 2012.

6. Increased Personal Exemption. Similarly, the value of the personal exemptions for 2012 also increased. While exemptions were worth $3,700 in 2011, they rose to $3,800 for 2012.
7. Sales Tax Deduction Still An Option. Taxpayers who itemize may deduct state income taxes paid on their federal return putting those taxpayers who live in a state without an income tax arguably at a disadvantage. A federal law which allowed taxpayers the option of choosing to deduct state income taxes paid or sales taxes paid offered temporary relief for those folks – and those who made high dollar purchases but lived in low tax states. That tax break – which debuted in 2005 – expired at the end of 2011. However, the tax deal extended that option through 2013, making it still a viable option for taxpayers in 2012.
8. Tax Breaks for Charitable Donations from IRAs Extended. The new tax deal extended the qualified charitable distribution provisions which were set to expire through 2012 and 2013. Generally, distributions from an IRA are taxable when withdrawn whether payable to an individual or a charity. However, under the special rules, a withdrawal from an IRA (other than an ongoing SIMPLE or SEP) owned by an individual who is age 70½ or over that is paid directly to a qualified charity can be excluded from gross income. Up to $100,000 of distributions be distributed – and that amount can be used to satisfy a taxpayer’s required minimum distributions (RMDs) for the year. Even better? Special rules allow taxpayers to treat donations made before February 1, 2013, as qualifying distributions for 2012.
9. Education Tax Breaks Strengthened. The American Opportunity Credit (the super-charged version of the Hope Credit) was extended through 2012 for expenses paid for tuition, certain fees and course materials for higher education. The maximum credit available is $2,500 in 2012 which includes 100% of qualifying tuition and related expenses not in excess of $2,000, plus 25% of those expenses that do not exceed $4,000. Additionally, the Lifetime Learning Credit sticks around for 2012, capped at $2,000, which applies to 20% of the first $10,000 of qualifying out-of-pocket expenses (but no double-dipping: you can’t claim both credits in the same tax year for the same student). Also getting a boost? The above-the-line Tuition and Fees Deduction was extended so that taxpayers who don’t itemize can continue to benefit.
10. Alternative Minimum Tax (AMT) Relief. The tax deal passed in January 2013 provided significant AMT relief for middle class taxpayers in 2012 – and beyond. The AMT exemption for 2012 was increased to $50,600 for single taxpayers (an increase of nearly $20,000) and $78,750 for married taxpayers filing jointly (an increase of more than $30,000). Even better? Beginning with 2012, AMT relief will be adjusted for inflation each year – no more patches!
11. Adoption Credit Survives – But Is Limited. Under the new tax deal, the adoption credit was saved. Originally, the adoption credit was scheduled to sunset at the end of 2010 but was temporarily extended as part of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010; it was also made refundable (a nonrefundable credit can reduce the amount of tax you owe to zero while a refundable credit can reduce your tax liability to zero and any remaining credit will be refunded to you). The new tax deal did extend the adoption credit permanently with one significant hit: the credit is no longer refundable. The credit was only refundable in 2010 and 2011. Taxpayers in 2012 can claim the adoption credit but it is not refundable

Ever have an Embezzlement Susceptibility Probe?

All companies are candidates for embezzlement. Let’s face it, human’s work at companies, interface with companies, program computer software for companies and humans are fallible.
They can lie, cheat, steal and commit all types of anti-social and criminal behavior if the right triggers are set into motion. Many times these triggers are hidden from company view, because they happen away from the workplace. They are environmental, genetic, organic or inorganic. In other words, you just never what may cause a previously trustworthy and loyal employee to turn to the dark side.
So, have you wondered how susceptible your company is to embezzlement? Have you probed your company to see if you have an average level, a low level or a high level of probability that your company can be victimized?
Having a low or high level doesn’t mean you have been a victim of embezzlement, or for that matter will be a victim. What it does mean is that embezzlement at your company maybe harder or easier to accomplish.
The ideal is impervious to embezzlement, but this ideal is impractical. The next best solution is to get as close to that ideal as is possible, but you have to be open to seeing the pitfalls.
Think about it….

Contact Us for Free Income Tax Extension Filing

I am offering free filing of tax extensions now through the April 17 tax filing deadline, Terrence Rice,
CPA, announced today.

On average, more than 10 million taxpayers applied for an extension on their taxes each of the past few years, avoiding the 5 percent monthly penalty for failure to file. Rice noted that the extension gives taxpayers an extra six months to file a tax return, making the new filing deadline Oct. 15. If there is a balance due, Rice  will help taxpayers understand their payment options.

The additional two days to file won't have an effect on some taxpayers, though. Taxpayers who reside outside of the country (including members of the military) routinely receive an additional two months to file their tax returns, making their deadline June 15 this year.

Filing a tax return when in a rush can lead to taxpayers making mistakes that may cause them to pay more in taxes than they actually owe, said Rice.

Who Should Take a Home-Office Tax Deduction?

FROM BUSINESSWEEK.COM -

According to data compiled in tax year 2009, more than 4 million Americans claimed the home-office deduction on their tax returns. That’s about 3 percent of the total 140 million returns filed in 2010. The number is likely to increase this year, with business startup rates having increased substantially in 2011.
Kathy Pickering, executive director of the Tax Institute, research and analysis division of tax-services provider H&R Block (HRB), says the average home-office deduction is valued at more than $2,600. Yet many taxpayers are unclear about how to claim the deduction, or they worry that if they do, they’ll face an IRS audit. Pickering says that although the home-office deduction is scrutinized closely, it should be used by those who are eligible. She spoke recently about home-office deductions and other overlooked tax opportunities with Smart Answers columnist Karen E. Klein; edited excerpts of their conversation follow.

What advice do you give individuals running home-based businesses when it comes to accounting for their expenses—particularly home-office expenses?
We try to remind them of the things that are important. For instance, you have to be very precise that a hobby is not your business. A home office needs to be just that—an office. It can’t double as a kids’ playroom or a video game room where you happen to do your crafts.
Now, there’s an exception if you’re a licensed day-care operator and you have the children using the living room and the playroom. In that case, you can deduct all that space as part of operating your business.

According to the IRS, the home office has to be not only exclusively used for business but it also has to be your principal place of business. What does that mean in practical terms?
The office has to be where you conduct most of your business and it has to be in your house—or garage or guest house on your property. It can’t be at somebody else’s place. And if you primarily work in an office building but you check your e-mail at night in a room in your home, that doesn’t work. In that case, your home is not your principal place of business.
If you call on clients or conduct meetings off-site, but you administer the business from your home office and you have no other place to do that administrative work, you can take the home-office deduction. Just be aware that eligibility rules are very strict and we absolutely recommend that people err on the side of being conservative about taking this deduction.

How does it actually work?
It allows you to deduct a percentage of your home expenses, based on the square footage of the office as compared to the size of the entire home. So you can deduct a portion of your home’s expenses, including depreciation, rent, insurance, utilities, maintenance, and general repairs, based on the business use of that part of your home.

What caveats do you give clients on this topic?
First, the deduction for the home office cannot exceed the net annual income from the business. And second, it’s important to document. If you’re legitimately entitled to take the home office deduction, keep records that show how you use your home office and take pictures of your work space and keep them with your tax records.

What credits and tax deductions do you find are frequently overlooked by small business owners and the self-employed?
A: The small business health-care tax credit is in effect and if you’ve got 25 or fewer employees and you’re paying 50 percent of their insurance premiums, you’re eligible to take it. We have a calculator where you can go plug in your numbers and see whether it will work for you.
Unfortunately, probably a lot of small employers are not eligible for the credit the way it’s written now, because either they’re not providing insurance or they’re not paying enough of the premium.

Are there other benefits that taxpayers routinely miss out on?
We pulled in a bunch of individuals as part of a marketing campaign and looked over their previous years’ tax returns. One that we caught a lot of people missing, whether they were self-employed or not, was the American opportunity tax credit. This is the best and most generous credit for people paying higher-education costs.
You can get a credit of up to $2,500 per student for the first four years of college costs, including tuition, fees, and course materials. This can mean saving $10,000 per student and you can claim it for multiple students at the same time if you’re a parent paying for your children’s college educations.

Taxes are due on 2010 Roth IRA conversions

Fro USA Today -

Several years ago, Congress enacted a law that offered individual retirement account holders a deal that looked a lot like those "same as cash" offers you see in ads for furniture and appliances.

The law, which took effect Jan. 1, 2010, lifted income restrictions on Roth IRA conversions, allowing high-income taxpayers to convert to a Roth for the first time. It also gave IRA owners the option of delaying taxes on 2010 conversions by opting to split income from the conversion between 2011 and 2012.

Not surprisingly, a lot of people decided to defer taxes on their Roth conversions. If you chose that option, though, taxes on the first half of your conversion income are due this year. And like those "same as cash" offers, failure to pay by the deadline — which is April 17 — could leave you in a world of hurt.

Don't expect to get a notice from your IRA provider reminding you of your tax obligation. Instead, you need to refer to last year's tax records and your 2010 tax return, says Melissa Labant, tax manager for the American Institute of Certified Public Accountants. Assuming you opted to postpone your tax bill, the amount of income deferred will show up on Form 8606 of your 2010 tax return, Labant says. On line 25A, you should see the amount of income you're required to pay taxes on when you file your 2011 tax return, Labant says.

Most taxpayers will report the income on Line 16B of Form 1040, Labant says. Tax software will do this automatically. Keep in mind that the income from the conversion has been reported to the government, so if you fail to report it, "You're going to get a letter from the IRS," says Francis St. Onge, an enrolled agent in Brighton, Mich.

No turning back

Ideally, you should have prepared for this tax hit by putting aside money to pay the tax bill. Even if you did, you may be in for an unpleasant surprise when you do your taxes. A large conversion could push you into a higher marginal tax bracket, Labant says. It could also make you ineligible for some tax credits and deductions that phase out at specific income levels, she says. If you're retired, the additional income could force you to pay taxes on a portion of your Social Security benefits. "Anytime your adjusted gross income increases, there are negative consequences," Labant says.

Sadly, it's too late to negate the tax bill by reversing the conversion. Taxpayers have the option of undoing a Roth conversion through a process called recharacterization, but the deadline for recharacterizing a 2010 conversion was Oct. 15, says Maria Bruno, analyst for the Vanguard Group. "The bottom line is that the tax is due," she says. "There's not much you can do."

Another wrinkle for taxpayers who converted in 2010 is the expiration of the 2001 Bush tax cuts at the end of this year. Depending on a number of factors, including who wins the presidential election, some high-income taxpayers could end up paying higher taxes on the second portion of their 2010 conversion. Paying taxes on the entire conversion this year would protect you from that prospect, but it's not an option, Bruno says. If you elected to defer income on a 2010 Roth conversion, you're locked into a 50-50 split, she says.

Nowhere to hide

If you can't pay the taxes on your 2010 conversion, the worst thing you can do is fail to file your return, Labant says. That will trigger interest and steep failure-to-file penalties, she says.

Options for cash-strapped converters include a short-term credit card loan or an IRS installment plan. If you've run out of time and money, you can withdraw money from your Roth, but that should be your absolute last resort, says Ed Slott, author of The Retirement Savings Time Bomb and How to Defuse it in 2012. If you're under 59½, you may have to pay an early withdrawal penalty. You'll also end up paying taxes on money that's been growing tax-free, which defeats the purpose of converting to a Roth in the first place, he says.

Meanwhile, it's not too soon to start planning for next year's tax bill, St. Onge says. For example, you may want to adjust your exemptions to increase the taxes withheld from your paycheck.

IRS Gives Advice on Reporting Unemployment Benefits

FROM ACCOUNTING TODAY -

The Internal Revenue Service offered advice Wednesday to unemployed taxpayers on how they and their tax preparers should report unemployment benefits on their tax returns.

Unemployment compensation generally includes state unemployment compensation benefits, among other types of benefits, but the tax implications depend on the type of program paying the benefits, the IRS noted. Taxpayers must report unemployment compensation on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ.

Here are four tips from the IRS about unemployment benefits.

1. You must include all unemployment compensation you receive in your total income for the year. You should receive a Form 1099-G, with the total unemployment compensation paid to you shown in box 1.

2. Other types of unemployment benefits include:
•    Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund
•    Railroad unemployment compensation benefits
•    Disability payments from a government program paid as a substitute for unemployment compensation
•    Trade readjustment allowances under the Trade Act of 1974
•    Unemployment assistance under the Disaster Relief and Emergency Assistance Act
For complete information on each of the benefits listed, see chapter 12 in IRS Publication 17, Your Federal Income Tax, or Publication 525, Taxable and Nontaxable Income.
3. You must report benefits paid to you as an unemployed member of a union from regular union dues. However, if you contribute to a special union fund and your payments to the fund are not deductible, you only need to include in your income the unemployment benefits that exceed the amount of your contributions.
4. You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete Form W-4V, Voluntary Withholding Request, and give it to the paying office. Tax will be withheld at 10 percent of your payment. If you choose not to have tax withheld, you may have to make estimated tax payments throughout the year.
For more information on unemployment compensation see IRS Publications 17 and 525.  Forms and publications can be downloaded from the IRS Website at www.irs.gov or can be ordered by calling 1 (800) 829-3676.

Not the DIY type? Tips to find a tax preparer

FROM BOSTON.COM.

If your financial life is simple and you have basic computer skills, using do-it-yourself software is an “EZ’’ way to file your tax return.
But if you’re nervous about preparing your own taxes, don’t have time, had a major life or job change last year or simply think the tax laws are too complex, you’re not alone.
About 60 percent of all returns are filed by professional preparers, according to the Internal Revenue Service. Officials at H&R Block, which prepared one out of every six tax returns last year, told investors recently that the growth in the software market has come mainly from do-it-yourselfers who switched from paper to digital, not from taxpayers who switched from paid preparers.

But how do you find a tax preparer you can trust? Here are a few tips:
1. Ask around
Tax professionals say the best way to find someone is through an old-fashioned, word-of-mouth recommendation. Ask friends and family members who they use, and why they would recommend their preparer.
If you’re expecting to claim a lot of business-related expenses, ask colleagues from work or professional organizations if they know a preparer who focuses on your industry. If you have a small business make sure, at a minimum, that the person has worked a lot with small businesses, preferably within your field, advised Melissa Labant, the director of tax advocacy for the American Institute of Certified Public Accountants.

2. Make a few calls
Before committing, speak to two or three candidates and ask about their experience and their approach. Get a list of their base fees, but remember that fees may change depending on the complexity of your return and the training and education of the preparer.
Also confirm that the individual or the firm will be able to represent you before the IRS, if there are questions about your return or if you’re audited.

3. Check credentials and history
Make sure any preparer you consider has a Preparer Tax Identification Number, or PTIN, which is required by the IRS to file as a professional.
Check for complaints filed with the Better Business Bureau and your city or state consumer protection agency. And check out disciplinary issues and license status with your state board of accountancy for CPAs, state bar associations for attorneys, or the IRS Office of Professional Responsibility for enrolled agents.
Most importantly, make sure you’re comfortable with the preparer. It’s important because, even if you hire someone to prepare your return, you’re still ultimately responsible for what it says.

4. Be prepared for questions

Minkow noted that once you find the right preparer, you will likely establish a relationship that lasts for years. Accountants and other professionals may also provide advice on other aspects of your financial life, including long-term planning, investments and home buying.

 

5. Look for warning signs
If your preparer does any of the following, it’s a sign of a problem that should make you think twice about filing the return:
— Asks you to sign a blank return.
— Indicates that it is OK to include false or misleading information to boost your refund.
— Refuses to sign your return or include his or her PTIN.
As Minkow put it, “You do not want that person who’s working in the back of the bowling alley and telling you to go file yourself.’’

The tax law that could make your grandchildren super-rich

FROM THE WASHINGTON POST -

Sometimes Congress hands out a break that is so generous it seems it must be a mistake. This one’s a doozy: the ability to receive a tax-free inheritance of $400 million or more.
Thanks to two recent changes in the tax code, investors with huge 401(k) accounts have a way to turn them into tax-free income for their grandchildren’s lifetimes.
This is by far the biggest estate-planning break on record, created even as lawmakers debate over which tax giveaways should be killed to help shore up the federal budget.
“I call this tax break the government’s going-out-of business sale,” says IRA guru Ed Slott, who travels the country teaching advisers and accountants how to squeeze benefits out of the Roth IRA. “This is a tax break you could drive 10 Mack trucks through. It’s an incredible opportunity to do a totally tax-free transfer of wealth.”
This massive estate-tax break was created last year in two steps. First Congress lifted a $100,000 income restriction on who can convert a 401(k) or IRA to a Roth IRA, allowing even the wealthiest investors to convert. Then late in the year, it raised the generation-skipping transfer tax exemption (GST) to $5 million until 2013. The exemption was previously $3.5 million, and was scheduled to drop to $1 million this year before Congress stepped in.
Both of these provisions on their own create possibilities for significant tax savings. But used in combination, the results are exponentially greater.
The Roth IRA has always been on a different playing field compared with alternatives because it allows gains to be withdrawn tax free. Money taken out of a 401(k), regular IRA or other retirement accounts are subject to income-tax rates.
Also, the Roth doesn’t require that minimum distributions be taken after turning age 70½, as other plans do. So if you don’t need retirement plan assets to live on, the Roth preserves it best for heirs.
Not everyone jumps at the chance to convert to a Roth IRA because you have to pay income taxes on the assets moved into the account. So if you plan to live off of retirement account assets, a conversion might not make sense. But from an estate planning perspective, when there are decades of gains ahead, the tax bill can be a small price to pay for big benefits down the road.
With the new GST exemption, the estate planning benefits that can be wrung out of a Roth are eye-popping. Consider an extreme case: A wealthy individual converts a large 401(k) account to a Roth IRA and names a grandchild as the beneficiary. The grandchild, at age 1, inherits the Roth, whose assets have grown to $5 million. Because of the new $5 million GST, the Roth assets would not be subject to estate tax or generation-skipping transfer tax.
Under Roth rules, an heir must take required minimum distributions, but the distributions can be stretched over a lifetime, and assets left in the Roth can continue to grow tax free. Based on a 1-year-old’s life expectancy of 81.6-years, assuming an average annual return of 8 percent, Slott calculates that the grandchild’s lifetime income from the Roth would be $408 million — “completely free of estate, gift, income and capital gains taxes,” he says.
If both grandparents left a big Roth account to the same grandchild, the tax-free inheritance would be almost twice that amount, depending on the age of the grandchild when the second Roth is inherited.
You don’t have to have stratospheric wealth to get in on these great estate planning benefits. Consider: A $100,000 Roth inheritance would let a grandchild pocket more than $8 million, tax-free. This would have been possible even under the old GST tax exclusion, but the old Roth rules, which prohibited conversions from IRAs and 401(k)s for those with incomes above $100,000, would have prevented many from taking advantage of the opportunity.
With the new $5 million estate tax exemption, passed along with the GST exemption last year, the Roth has become a turbocharged, tax-favored inheritance tool for any generation. But the benefits are even more pronounced when the Roth income is spread over the long expected lifetime of a grandchild.
Grace Allison, senior vice president and tax strategist at Northern Trust, cautions that the upfront tax bill on Roth conversions can take the shine off of this strategy, so it’s critical to crunch the numbers. If you convert $5 million, at the highest tax rate of 35 percent, you’ll have to hand over about $1.7 million.
That kind of tax bill is mind-numbing for most people, but in the universe where ultra-wealthy people are trying to preserve their multimillions, $1.7 million may seem like a small amount, considering how much will be saved in taxes in the long run.
In the extreme example above, the total tax savings would be in the neighborhood of $100 million over the grandchild’s lifetime, probably much more
Did Congress intend for this big generational benefit? Although the government could surely use wealthy taxpayers to pay big upfront tax bills on Roth conversions right now, the amount it would forgo in taxes on inherited money over decades would be staggering.
Whether intentional or not, opportunities to combine the Roth with the GST exemption are limited: The exemption is scheduled to drop to $1 million in 2013.
And it’s always possible that tax reforms will rescind these tax breaks before that. Roberton Williams, senior fellow at the Urban Institute, says that if any drastic changes are made, it will be Congress’s mess to figure out how to honor previous tax breaks in Roth accounts. In the meantime, get ’em while you can.

Identity Theft Involving IRS Is Mushrooming.

FROM THE WALL STREET JOURNAL:

Dealing with the IRS is stressful enough. So is dealing with identity theft.
For a large and growing number of Americans, there’s a fresh hell: dealing with both at once.
Since 2008, the IRS has identified about 470,000 incidents of identity theft affecting more than 390,000 taxpayers, Sen. Bill Nelson (D., Fla.) said at a Senate Finance Committee hearing on Wednesday.
The problem appears to be expanding rapidly. In 2008, there were about 52,000 incidents involving the IRS, according to the Government Accountability Office. In 2010, there were 245,000.
Many of the cases involve scammers using stolen Social Security numbers to file fraudulent returns in hopes of getting a quick refund check. But some cases also involve people using fake Social Security numbers for work, resulting in unexpected reported income for the real Social Security number holder.
Either way, the phenomenon can be a nightmare for victims.  For everyone, it’s another sign of how complicated and vulnerable the income-tax system can be.
At a separate House hearing on Wednesday, lawmakers considered the growing problem of improper and fraudulent payments under several popular tax credit programs that are aimed at helping lower-income people. Some of those claims also seem to be coming from people who are disguising their identity.
False refund claims by prison inmates are a particular source of aggravation for officials, in part because of the difficulty of solving the problem. Mr. Nelson said he’s working on ways to strengthen information-sharing in order to crack down on scams.

TAX TIPS FOR S CORP STRUCTURE

FROM FOXBUSINESS.COM

When you become self employed, you must decide what form of business entity to establish. The basic categories include: sole proprietorship, partnership, C corporation, LLC (Limited Liability Company), and S corporation. 

It’s important to discuss entity selection with both your attorney and your tax pro, before deciding what structure is best for your business. Each option offers advantages and disadvantages, so don’t take the decision lightly. Every business situation is unique and requires a full study to make the most beneficial determination.

Below are some of the advantages and disadvantages of the Sub S corporate structure, but do not just run with my ideas thinking you’ve found the best solution-- unless you are running straight to both your tax pro and your attorney to discuss further.

Also remember, most attorneys do not know tax law backward and forward and a tax pro should not be sought out for legal advice. These are separate fields and both professionals have enough knowledge of the other’s just enough to be dangerous.

With that in mind, let’s explore.

But first, one more aside: If you select an LLC business structure, you can elect to be treated for tax purposes as any of the above entities. At the federal level there is no tax return for an LLC--it’s what you call a check-the-box entity. If, as an LLC, you elect to be treated as a sole proprietorship, you will file a Schedule C with your individual income tax return, if a partnership you will file a Form 1065 –partnership income tax return, if a C corporation you will file a Form 1120 corporate income tax return, and if you elect sub S corporation, you will file a form 1120S, sub S corporate income tax return. The tax rules regarding whichever entity you select for tax purposes will apply to your LLC.

When you file your incorporation papers, you must remember to complete Form 2553 to elect treatment as a sub S corporation. I have seen a failure to file mistake made many times. A business owner sets up the corporate paperwork with his attorney. The tax pro isn’t in the loop and the form isn’t filed timely with the IRS. The IRS then classifies the corporation as a C corp, applying the rules for that entity, which may unnecessarily cost the taxpayer thousands of dollars in taxes. Fortunately, the IRS has taken a more lenient attitude in the past several years, allowing taxpayers to late file the form and make it retroactive to the origin of the corporation.

As a sub S corporation, you as the owner/operator will have to go on payroll and set a reasonable pay rate for yourself and report and pay payroll taxes. Your pay will be deducted as a business expense on the corporate income tax return. Any profit from the sub S corporation above and beyond all ordinary and necessary business expenses, (including your W2 wages), will not be taxed at the corporate level. Instead, the profit (or loss) will flow out to you and any other shareholders on a Schedule K-1 where it will be included as passive income on your form 1040.

The advantage here is that passive income is not subject to the 15.3% self-employment tax which funds your Social Security and Medicare accounts. Sole proprietors and partners in a partnership are required to pay this tax on profits. Also, as passive income, sub S income can offset passive losses. This means that if you are in a high-income bracket, and have losses on rental real estate for example, you can apply those losses to your sub S income.

If you were a sole proprietor or a partner, those rental real estate losses may very well be suspended and carried forward to future years because your income levels are too high and your business profits aren’t classified as passive income. For example: You own three rental properties that report a loss on Schedule E of $50,000 and your sub S income on your K-1 is $200,000. You can apply the rental losses to the sub S income and pay taxes on only $150,000. If you instead were a sole proprietor, you would be required to pay taxes on $200,000 and carry forward $50,000 of passive rental real estate losses to future years. Ouch!

Your wheels are turning. You are considering becoming a sub S corporation, giving yourself a salary of $30,000 on which you will essentially pay the 15.3% self-employment tax although it will be called payroll taxes at that level. Then you’ll take the remainder of your profit; let’s say $200,000 as passive income, free of that big tax hit. Beware! Several years ago the IRS landed on all fours on attorneys doing just that. The project consisted of reclassifying the passive income as wages and hitting them with expensive payroll tax bills along with penalties and interest. Its point being that the wages taken were not reasonable in light of the profit. After all, how many attorneys would go to work for a profitable corporation at a salary of $30,000 per year?

Another caveat: It may not be prudent to go to the expense as well as the increased paperwork requirements of incorporating if your profit is less than $100,000 per year or if you are the type that refuses to keep up with paperwork. Failure to comply with the complex rules and paperwork requirements of corporate life may well blow your corporate structure and the legal shelters it provides right out of the water. That’s why I admonish you to visit both an attorney and a tax pro before diving in.