Congress passed two new tax laws, one in 2010 and one at the beginning of this year, that both contain provisions to increase income taxes on higher income taxpayers starting in 2013. The 2012 American Taxpayer Relief Act (relief? really?) increases tax rates on earned income and capital gains, reduces personal exemptions, and reduces itemized deductions. The 2010 Health Care Reform Act (sometimes referred to as Obamacare) adds a surtax on investment income and increases the Medicare earned income tax. Here is how they work:
1. Long-term capital gains. For single taxpayers with taxable income of more than $400,000 ($450,000 if filing married filing jointly (MFJ), the tax rate on long-term capital gains increases from 15 percent to 20 percent.
2. Qualified dividends. Same tax treatment as long-term capital gains.
3. Income tax bracket. Taxpayers with taxable income above $400,000 if filing as single (or $450,000 if filing as MFJ) will see their top tax bracket increase from 35 percent to 39.6 percent.
4. Itemized deduction phase-out. Taxpayers with adjusted gross income (AGI) above $250,000 if filing single (or $300,000 if filing MFJ) will have to reduce their otherwise allowable itemized deductions by 3 percent of the amount by which the AGI exceeds the $250,000 or $300,000 threshold.
5. Personal exemption phase-out. Taxpayers with AGI above $250,000 if filing single (or $300,000 if filing MFJ) will lose 2 percent of their personal exemption for every $2,500 of income in excess of the threshold amounts. The personal exemption amount in 2013 is $3,900.
6. Medicare earned income tax. Wage earners pay a 1.45 percent Medicare tax on all their earned income and self-employed individuals pay 2.9 percent. Unlike the Social Security tax, which is capped at $113,700 of earnings in 2013, the Medicare tax applies to all earned income. Starting this year, workers with AGIs above $200,000 if filing single (or $250,000 if filing MFJ) will pay an additional 0.9 percent Medicare tax on earned income above $200,000 if filing single (or $250,000 if filing MFJ).
7. Medicare investment income tax. This new tax adds a 3.8 percent additional tax to all investment income for taxpayers with modified adjusted gross incomes (MAGI) above $200,000 if filing single (or $250,000 if filing MFJ). Investment income includes taxable interest, dividends, capital gains, most rent and royalty income, and income from nonqualified annuities.
If any of these new taxes apply to you, you should do some tax planning now to avoid a big surprise next spring when tax time rolls around. I suspect that the majority of higher income individuals are simply not aware of just how much bigger Uncle Sam's bite will be.
Thursday, November 7, 2013
Wednesday, November 6, 2013
IRS Volunteer Tax Prep Sites Have Accuracy Problems with 49% of tax returns prepared incorrectly
Anonymous visits by government auditors have uncovered accuracy problems with some of the tax returns prepared by volunteers who staff the Internal Revenue Service’s Volunteer Program, according to a new report.
The report, from the Treasury Inspector General for Tax Administration, examined the no-cost federal tax return preparation and electronic filing services provided by volunteer tax preparers working with low- and moderate-income, elderly, disabled and limited-English-proficient taxpayers under the auspices of the IRS’s Volunteer Income Tax Assistance, or VITA, program and its Tax Counseling for the Elderly, or TCE, program.
For the report, TIGTA auditors conducted a review to determine whether taxpayers visiting IRS Volunteer Program sites receive quality service, including accurately prepared tax returns. This was a follow-up audit to TIGTA’s prior reviews of the program.
TIGTA found that the IRS continues to emphasize to volunteers the necessity of reviewing the intake/interview sheets with taxpayers during tax return preparation. In addition, training and resource materials were adjusted to clarify and underscore the due-diligence obligations of volunteers. However, there were still accuracy problems with some of the tax returns prepared for TIGTA auditors making anonymous visits to Volunteer Program sites.
Of the 39 tax returns prepared for auditors during the 2013 filing season, 20 of them (or 51 percent) were prepared correctly, while 19 (or 49 percent) were prepared incorrectly. That represents a two-percentage-point increase over the 49 percent accuracy rate for the same number of returns in the 2012 filing season. The 19 incorrect tax returns resulted from incorrect application of the tax law, insufficient requests for information during the intake and interview process, or lack of adherence to quality review requirements.
“Ensuring that tax returns are accurately prepared by volunteers remains a challenge for the IRS,” said TIGTA Inspector General J. Russell George in a statement. “When volunteers use established interview and quality review processes, the accuracy of the tax returns they prepare improves.”
The IRS continues to refine its anonymous shopping process to evaluate the accuracy of tax returns prepared at Volunteer Program sites, TIGTA noted. This process reported a 49 percent accuracy rate for the 43 tax returns prepared, which compares with the 51 percent accuracy rate TIGTA found. The IRS’s anonymous shopping also found the same causes that TIGTA reported for the inaccurately prepared tax returns.
In the report, TIGTA recommended that the IRS ensure that volunteer return preparers, quality reviewers, and site coordinators annually complete intake/interview and quality review training. In response to the report, the IRS agreed with TIGTA’s recommendations and plans to require that all volunteer instructors, return preparers, quality reviewers and site coordinators complete intake/interview and quality review training annually.
“Recognizing the importance of achieving and maintaining high standards of accuracy within the program, we have continued to take actions and devote resources improve the accuracy of prepared tax returns,” wrote Peggy Bogadi, commissioner of the IRS’s Wage and Investment Division, in response to the report.
She noted that a training document had been created for the use of volunteers providing guidance on the IRS’s intake, interview and quality review processes. She also pointed out that during the 2013 filing season, over 91,000 volunteers had helped more than 3.3 million individuals prepare and file their federal and state income tax returns.
“The IRS greatly appreciates the community service that volunteers provide to underserved segments of the taxpaying public and appreciates TIGTA’s acknowledgement of these contributions,” said the IRS statement. “Results from TIGTA’s audit visits were based on three pre-determined scenarios and only 39 returns prepared during these reviews, which is not statistically valid. While we are concerned with any level of error and will address the issues raised in the report, any attempt to extrapolate the findings from 39 visits of this type to the typical tax return prepared by VITA / TCE volunteers would unfairly characterize the tax assistance provided by our volunteers. By comparison, our quality review showed a 91 percent accuracy rate on the more than 3.3 million federal and state returns prepared by our nearly 91,000 volunteers. The IRS remains committed to continually improving the volunteer program, and have agreed with TIGTA’s suggestions.”
The report, from the Treasury Inspector General for Tax Administration, examined the no-cost federal tax return preparation and electronic filing services provided by volunteer tax preparers working with low- and moderate-income, elderly, disabled and limited-English-proficient taxpayers under the auspices of the IRS’s Volunteer Income Tax Assistance, or VITA, program and its Tax Counseling for the Elderly, or TCE, program.
For the report, TIGTA auditors conducted a review to determine whether taxpayers visiting IRS Volunteer Program sites receive quality service, including accurately prepared tax returns. This was a follow-up audit to TIGTA’s prior reviews of the program.
TIGTA found that the IRS continues to emphasize to volunteers the necessity of reviewing the intake/interview sheets with taxpayers during tax return preparation. In addition, training and resource materials were adjusted to clarify and underscore the due-diligence obligations of volunteers. However, there were still accuracy problems with some of the tax returns prepared for TIGTA auditors making anonymous visits to Volunteer Program sites.
Of the 39 tax returns prepared for auditors during the 2013 filing season, 20 of them (or 51 percent) were prepared correctly, while 19 (or 49 percent) were prepared incorrectly. That represents a two-percentage-point increase over the 49 percent accuracy rate for the same number of returns in the 2012 filing season. The 19 incorrect tax returns resulted from incorrect application of the tax law, insufficient requests for information during the intake and interview process, or lack of adherence to quality review requirements.
“Ensuring that tax returns are accurately prepared by volunteers remains a challenge for the IRS,” said TIGTA Inspector General J. Russell George in a statement. “When volunteers use established interview and quality review processes, the accuracy of the tax returns they prepare improves.”
The IRS continues to refine its anonymous shopping process to evaluate the accuracy of tax returns prepared at Volunteer Program sites, TIGTA noted. This process reported a 49 percent accuracy rate for the 43 tax returns prepared, which compares with the 51 percent accuracy rate TIGTA found. The IRS’s anonymous shopping also found the same causes that TIGTA reported for the inaccurately prepared tax returns.
In the report, TIGTA recommended that the IRS ensure that volunteer return preparers, quality reviewers, and site coordinators annually complete intake/interview and quality review training. In response to the report, the IRS agreed with TIGTA’s recommendations and plans to require that all volunteer instructors, return preparers, quality reviewers and site coordinators complete intake/interview and quality review training annually.
“Recognizing the importance of achieving and maintaining high standards of accuracy within the program, we have continued to take actions and devote resources improve the accuracy of prepared tax returns,” wrote Peggy Bogadi, commissioner of the IRS’s Wage and Investment Division, in response to the report.
She noted that a training document had been created for the use of volunteers providing guidance on the IRS’s intake, interview and quality review processes. She also pointed out that during the 2013 filing season, over 91,000 volunteers had helped more than 3.3 million individuals prepare and file their federal and state income tax returns.
“The IRS greatly appreciates the community service that volunteers provide to underserved segments of the taxpaying public and appreciates TIGTA’s acknowledgement of these contributions,” said the IRS statement. “Results from TIGTA’s audit visits were based on three pre-determined scenarios and only 39 returns prepared during these reviews, which is not statistically valid. While we are concerned with any level of error and will address the issues raised in the report, any attempt to extrapolate the findings from 39 visits of this type to the typical tax return prepared by VITA / TCE volunteers would unfairly characterize the tax assistance provided by our volunteers. By comparison, our quality review showed a 91 percent accuracy rate on the more than 3.3 million federal and state returns prepared by our nearly 91,000 volunteers. The IRS remains committed to continually improving the volunteer program, and have agreed with TIGTA’s suggestions.”
Tuesday, November 5, 2013
Record Retention Guide- How Long To Keep Tax Records
You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep records that support items shown on your return until the period of limitations for that return runs out.
Property: Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these records to figure your basis for computing gain or loss when you sell or otherwise dispose of the property.
Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up. You must keep the records on the old property, as well as the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.
Keeping records for nontax purposes: When your records are no longer needed for tax purposes, do not discard them until you check to see if they should be kept longer for other purposes. Your insurance company or creditors may require you to keep certain records longer than the IRS does.
Why Keep Records?
There are many reasons to keep records. In addition to tax purposes, you may need to keep records for insurance purposes or for getting a loan. Good records will help you:
Identify sources of income. You may receive money or property from a variety of sources. Your records can identify the sources of your income. You need this information to separate business from nonbusiness income and taxable from nontaxable income.
Keep track of expenses. You may forget an expense unless you record it when it occurs. You can use your records to identify expenses for which you can claim a deduction. This will help you determine if you can itemize deductions on your tax return.
Keep track of the basis of property. You need to keep records that show the basis of your property. This includes the original cost or other basis of the property and any improvements you made.
Prepare tax returns. You need records to prepare your tax return. Good records help you to file quickly and accurately.
Support items reported on tax returns. You must keep records in case the IRS has a question about an item on your return. If the IRS examines your tax return, you may be asked to explain the items reported. Good records will help you explain any item and arrive at the correct tax with a minimum of effort. If you do not have records, you may have to spend time getting statements and receipts from various sources. If you cannot produce the correct documents, you may have to pay additional tax and be subject to penalties.
Kinds of Records To Keep
Basic records
Basic records are documents that everybody should keep. These are the records that prove your income and expenses. If you own a home or investments, your basic records should contain documents related to those items.
Your basic records prove the amounts you report as income on your tax return. Your income may include wages, dividends, interest, and partnership or S corporation distributions. Your records also can prove that certain amounts are not taxable, such as tax-exempt interest.
Note: If you receive a Form W-2, keep Copy C until you begin receiving social security benefits. This will help protect your benefits in case there is a question about your work record or earnings in a particular year. Review the information shown on your annual (for workers over age 25) Social Security Statement.
Expenses
Your basic records prove the expenses for which you claim a deduction (or credit) on your tax return. Your deductions may include alimony, charitable contributions, mortgage interest, and real estate taxes. You also may have child care expenses for which you can claim a credit.
Home
Your basic records should enable you to determine the basis or adjusted basis of your home. You need this information to determine if you have a gain or loss when you sell your home or to figure depreciation if you use part of your home for business purposes or for rent. Your records should show the purchase price, settlement or closing costs, and the cost of any improvements. They also may show any casualty losses deducted and insurance reimbursements for casualty losses. Your records also should include a copy of Form 2119, Sale of Your Home, if you sold your previous home before May 7, 1997, and postponed tax on the gain from that sale.
When you sell your home, your records should show the sales price and any selling expenses, such as commissions.
Investments
Your basic records should enable you to determine your basis in an investment and whether you have a gain or loss when you sell it. Investments include stocks, bonds, and mutual funds. Your records should show the purchase price, sales price, and commissions. They may also show any reinvested dividends, stock splits and dividends, load charges, and original issue discount (OID).
Proof of Payment
One of your basic records is proof of payment. You should keep these records to support certain amounts shown on your tax return. Proof of payment alone is not proof that the item claimed on your return is allowable. You also should keep other documents that will help prove that the item is allowable.
Generally, you prove payment with a cash receipt, financial account statement, credit card statement, canceled check, or substitute check. If you make payments in cash, you should get a dated and signed receipt showing the amount and the reason for the payment.
If you make payments by electronic funds transfer, you may be able to prove payment with an account statement.
Account statements: You may be able to prove payment with a legible financial account statement prepared by your bank or other financial institution. These statements are accepted as proof of payment if they show the items reflected in Table 2.
Pay statements: You may have deductible expenses withheld from your paycheck, such as union dues or medical insurance premiums. You should keep your year-end or final pay statements as proof of payment of these expenses.
Specific Records
This section is an alphabetical list of some items that require specific records in addition to your basic records.
Alimony
If you receive or pay alimony, you should keep a copy of your written separation agreement or the divorce, separate maintenance, or support decree. If you pay alimony, you also will need to know your former spouse's social security number.
Business Use of Your Home
You may be able to deduct certain expenses connected with the business use of your home. You should keep records that show the part of your home that you use for business and the expenses related to that use.
Casualty and Theft Losses
To deduct a casualty or theft loss, you must be able to prove that you had a casualty or theft. Your records also must be able to support the amount you claim.
For a casualty loss, your records should show:
The type of casualty (car accident, fire, storm, etc.) and when it occurred,
That the loss was a direct result of the casualty, and
That you were the owner of the property.
For a theft loss, your records should show:
When you discovered your property was missing,
That your property was stolen, and
That you were the owner of the property.
Child Care Credit
You must give the name, address, and taxpayer identification number for all persons or organizations that provide care for your child or dependent. You can use Form W-10, Dependent Care Provider's Identification and Certification, or various other sources to get the information from the care provider. Keep this information with your tax records.
Contributions
You must keep records to prove the contributions you make during the year. The kinds of records depend on whether the contribution is cash, noncash, or out-of-pocket expenses. For information on contributions and the records you must keep, see Publication 526, Charitable Contributions.
Credit for the Elderly or the Disabled
If you are under age 65, you must have your physician complete a statement certifying that you were permanently and totally disabled on the date you retired.
You do not have to file this statement with your Form 1040 or Form 1040A, but you must keep it for your records.
If the Department of Veterans Affairs (VA) certifies that you are permanently and totally disabled, you can substitute VA Form 21-0172, Certification of Permanent and Total Disability, for the physician's statement you are required to keep.
Education Expenses
If you have the records to prove your expenses, you may be entitled to claim certain tax benefits for your education expenses. You may qualify to exclude from income items such as a qualified scholarship, interest on U.S. savings bonds, or reimbursement from your employer. You also may qualify for certain credits or deductions. You should keep documents, such as transcripts or course descriptions, that show periods of enrollment and canceled checks and receipts that verify amounts you spent on tuition, books, and other educational expenses.
Exemptions
If you are claiming an exemption for your spouse or a dependent (a qualifying child or a qualifying relative), you must keep records that support the deduction.
Employee Business Expenses
If you have employee business expenses, see Publication 463, Travel, Entertainment, Gift, and Car Expenses, for a discussion of what records to keep.
Energy Incentives
If you want to claim one of the tax incentives for the purchase of energy-efficient products, you must keep records to prove:
When and how you acquired the property,
The purchase price of the property, and
That the property qualified for the credit.
The following documents may show this information.
Purchase and sales invoices.
Manufacturer's certification statement.
Canceled checks.
Gambling Winnings and Losses
You must keep an accurate diary of your winnings and losses that includes the:
Date and type of gambling activity,
Name and address or location of the gambling establishment,
Names of other persons present with you at the gambling establishment, and
Amount you won or lost.
Health Savings Account (HSA) and Medical Savings Account (MSA)
For each qualified medical expense you pay with a distribution from your HSA or MSA, you must keep a record of the name and address of each person you paid and the amount and date of the payment.
Individual Retirement Arrangements (IRAs)
Keep copies of the following forms and records until all distributions are made from your IRA(s).
Form 5498, IRA Contribution Information, or similar statement received for each year showing contributions you made, distributions you received, and the value of your IRA(s).
Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., received for each year you received a distribution.
Form 8606, Nondeductible IRAs, for each year you made a nondeductible contribution to your IRA or received distributions from an IRA if you ever made nondeductible contributions.
For a worksheet you can use to keep a record of yearly contributions and distributions, see Publication 590, Individual Retirement Arrangements (IRAs).
Medical and Dental Expenses
In addition to records you keep of regular medical expenses, you should keep records of transportation expenses that are primarily for and essential to medical care. You can record these expenses in a diary. You should record gas and oil expenses directly related to that transportation. If you do not want to keep records of your actual expenses, you can keep a log of the miles you drive your car for medical purposes and use the standard mileage rate. You should also keep records of any parking fees, tolls, taxi fares, and bus fares.
For information on medical expenses and the standard mileage rate, see Publication 502, Medical and Dental Expenses (Including the Health Coverage Tax Credit).
Mortgage Interest
If you paid mortgage interest of $600 or more, you should receive Form 1098, Mortgage Interest Statement. Keep this form and your mortgage statement and loan information in your records. For information on mortgage interest, see Publication 936, Home Mortgage Interest Deduction.
Moving Expenses
You may be able to deduct qualified moving expenses that are not reimbursed. For more information on what expenses qualify and what records you need, see Publication 521, Moving Expenses.
Pensions and Annuities
Use the worksheet in your tax return instructions to figure the taxable part of your pension or annuity. Keep a copy of the completed worksheet until you fully recover your contributions. For information on pensions and annuities, see Publication 575, Pension and Annuity Income, or Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits.
Taxes
Form(s) W-2 and Form(s) 1099-R show state income tax withheld from your wages and pensions. You should keep a copy of these forms to prove the amount of state withholding. If you made estimated state income tax payments, you need to keep a copy of the form or your check(s).
You also need to keep copies of your state income tax returns. If you received a refund of state income taxes, the state may send you Form 1099-G, Certain Government Payments.
Keep mortgage statements, tax assessments, or other documents as records of the real estate and personal property taxes you paid.
If you deducted actual state and local general sales taxes instead of using the optional state sales tax tables, you must keep your actual receipts showing general sales taxes paid.
Sales Tax on Vehicles
You may be able to deduct state and local sales and excise taxes (or certain other taxes or fees in a state without a sales tax) paid in 2010 for the purchase of a new motor vehicle after February 16, 2009, and before January 1, 2010. Keep your purchase contract to show much sales tax you paid.
Tips
You must keep a daily record to accurately report your tips on your return. You can use Form 4070A, Employee's Daily Record of Tips, which is found in Publication 1244, Employee's Daily Record of Tips and Report to Employer, to record your tips.
Property: Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these records to figure your basis for computing gain or loss when you sell or otherwise dispose of the property.
Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up. You must keep the records on the old property, as well as the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.
Keeping records for nontax purposes: When your records are no longer needed for tax purposes, do not discard them until you check to see if they should be kept longer for other purposes. Your insurance company or creditors may require you to keep certain records longer than the IRS does.
Why Keep Records?
There are many reasons to keep records. In addition to tax purposes, you may need to keep records for insurance purposes or for getting a loan. Good records will help you:
Identify sources of income. You may receive money or property from a variety of sources. Your records can identify the sources of your income. You need this information to separate business from nonbusiness income and taxable from nontaxable income.
Keep track of expenses. You may forget an expense unless you record it when it occurs. You can use your records to identify expenses for which you can claim a deduction. This will help you determine if you can itemize deductions on your tax return.
Keep track of the basis of property. You need to keep records that show the basis of your property. This includes the original cost or other basis of the property and any improvements you made.
Prepare tax returns. You need records to prepare your tax return. Good records help you to file quickly and accurately.
Support items reported on tax returns. You must keep records in case the IRS has a question about an item on your return. If the IRS examines your tax return, you may be asked to explain the items reported. Good records will help you explain any item and arrive at the correct tax with a minimum of effort. If you do not have records, you may have to spend time getting statements and receipts from various sources. If you cannot produce the correct documents, you may have to pay additional tax and be subject to penalties.
Kinds of Records To Keep
Basic records
Basic records are documents that everybody should keep. These are the records that prove your income and expenses. If you own a home or investments, your basic records should contain documents related to those items.
Your basic records prove the amounts you report as income on your tax return. Your income may include wages, dividends, interest, and partnership or S corporation distributions. Your records also can prove that certain amounts are not taxable, such as tax-exempt interest.
Note: If you receive a Form W-2, keep Copy C until you begin receiving social security benefits. This will help protect your benefits in case there is a question about your work record or earnings in a particular year. Review the information shown on your annual (for workers over age 25) Social Security Statement.
Expenses
Your basic records prove the expenses for which you claim a deduction (or credit) on your tax return. Your deductions may include alimony, charitable contributions, mortgage interest, and real estate taxes. You also may have child care expenses for which you can claim a credit.
Home
Your basic records should enable you to determine the basis or adjusted basis of your home. You need this information to determine if you have a gain or loss when you sell your home or to figure depreciation if you use part of your home for business purposes or for rent. Your records should show the purchase price, settlement or closing costs, and the cost of any improvements. They also may show any casualty losses deducted and insurance reimbursements for casualty losses. Your records also should include a copy of Form 2119, Sale of Your Home, if you sold your previous home before May 7, 1997, and postponed tax on the gain from that sale.
When you sell your home, your records should show the sales price and any selling expenses, such as commissions.
Investments
Your basic records should enable you to determine your basis in an investment and whether you have a gain or loss when you sell it. Investments include stocks, bonds, and mutual funds. Your records should show the purchase price, sales price, and commissions. They may also show any reinvested dividends, stock splits and dividends, load charges, and original issue discount (OID).
Proof of Payment
One of your basic records is proof of payment. You should keep these records to support certain amounts shown on your tax return. Proof of payment alone is not proof that the item claimed on your return is allowable. You also should keep other documents that will help prove that the item is allowable.
Generally, you prove payment with a cash receipt, financial account statement, credit card statement, canceled check, or substitute check. If you make payments in cash, you should get a dated and signed receipt showing the amount and the reason for the payment.
If you make payments by electronic funds transfer, you may be able to prove payment with an account statement.
Account statements: You may be able to prove payment with a legible financial account statement prepared by your bank or other financial institution. These statements are accepted as proof of payment if they show the items reflected in Table 2.
Pay statements: You may have deductible expenses withheld from your paycheck, such as union dues or medical insurance premiums. You should keep your year-end or final pay statements as proof of payment of these expenses.
Specific Records
This section is an alphabetical list of some items that require specific records in addition to your basic records.
Alimony
If you receive or pay alimony, you should keep a copy of your written separation agreement or the divorce, separate maintenance, or support decree. If you pay alimony, you also will need to know your former spouse's social security number.
Business Use of Your Home
You may be able to deduct certain expenses connected with the business use of your home. You should keep records that show the part of your home that you use for business and the expenses related to that use.
Casualty and Theft Losses
To deduct a casualty or theft loss, you must be able to prove that you had a casualty or theft. Your records also must be able to support the amount you claim.
For a casualty loss, your records should show:
The type of casualty (car accident, fire, storm, etc.) and when it occurred,
That the loss was a direct result of the casualty, and
That you were the owner of the property.
For a theft loss, your records should show:
When you discovered your property was missing,
That your property was stolen, and
That you were the owner of the property.
Child Care Credit
You must give the name, address, and taxpayer identification number for all persons or organizations that provide care for your child or dependent. You can use Form W-10, Dependent Care Provider's Identification and Certification, or various other sources to get the information from the care provider. Keep this information with your tax records.
Contributions
You must keep records to prove the contributions you make during the year. The kinds of records depend on whether the contribution is cash, noncash, or out-of-pocket expenses. For information on contributions and the records you must keep, see Publication 526, Charitable Contributions.
Credit for the Elderly or the Disabled
If you are under age 65, you must have your physician complete a statement certifying that you were permanently and totally disabled on the date you retired.
You do not have to file this statement with your Form 1040 or Form 1040A, but you must keep it for your records.
If the Department of Veterans Affairs (VA) certifies that you are permanently and totally disabled, you can substitute VA Form 21-0172, Certification of Permanent and Total Disability, for the physician's statement you are required to keep.
Education Expenses
If you have the records to prove your expenses, you may be entitled to claim certain tax benefits for your education expenses. You may qualify to exclude from income items such as a qualified scholarship, interest on U.S. savings bonds, or reimbursement from your employer. You also may qualify for certain credits or deductions. You should keep documents, such as transcripts or course descriptions, that show periods of enrollment and canceled checks and receipts that verify amounts you spent on tuition, books, and other educational expenses.
Exemptions
If you are claiming an exemption for your spouse or a dependent (a qualifying child or a qualifying relative), you must keep records that support the deduction.
Employee Business Expenses
If you have employee business expenses, see Publication 463, Travel, Entertainment, Gift, and Car Expenses, for a discussion of what records to keep.
Energy Incentives
If you want to claim one of the tax incentives for the purchase of energy-efficient products, you must keep records to prove:
When and how you acquired the property,
The purchase price of the property, and
That the property qualified for the credit.
The following documents may show this information.
Purchase and sales invoices.
Manufacturer's certification statement.
Canceled checks.
Gambling Winnings and Losses
You must keep an accurate diary of your winnings and losses that includes the:
Date and type of gambling activity,
Name and address or location of the gambling establishment,
Names of other persons present with you at the gambling establishment, and
Amount you won or lost.
Health Savings Account (HSA) and Medical Savings Account (MSA)
For each qualified medical expense you pay with a distribution from your HSA or MSA, you must keep a record of the name and address of each person you paid and the amount and date of the payment.
Individual Retirement Arrangements (IRAs)
Keep copies of the following forms and records until all distributions are made from your IRA(s).
Form 5498, IRA Contribution Information, or similar statement received for each year showing contributions you made, distributions you received, and the value of your IRA(s).
Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., received for each year you received a distribution.
Form 8606, Nondeductible IRAs, for each year you made a nondeductible contribution to your IRA or received distributions from an IRA if you ever made nondeductible contributions.
For a worksheet you can use to keep a record of yearly contributions and distributions, see Publication 590, Individual Retirement Arrangements (IRAs).
Medical and Dental Expenses
In addition to records you keep of regular medical expenses, you should keep records of transportation expenses that are primarily for and essential to medical care. You can record these expenses in a diary. You should record gas and oil expenses directly related to that transportation. If you do not want to keep records of your actual expenses, you can keep a log of the miles you drive your car for medical purposes and use the standard mileage rate. You should also keep records of any parking fees, tolls, taxi fares, and bus fares.
For information on medical expenses and the standard mileage rate, see Publication 502, Medical and Dental Expenses (Including the Health Coverage Tax Credit).
Mortgage Interest
If you paid mortgage interest of $600 or more, you should receive Form 1098, Mortgage Interest Statement. Keep this form and your mortgage statement and loan information in your records. For information on mortgage interest, see Publication 936, Home Mortgage Interest Deduction.
Moving Expenses
You may be able to deduct qualified moving expenses that are not reimbursed. For more information on what expenses qualify and what records you need, see Publication 521, Moving Expenses.
Pensions and Annuities
Use the worksheet in your tax return instructions to figure the taxable part of your pension or annuity. Keep a copy of the completed worksheet until you fully recover your contributions. For information on pensions and annuities, see Publication 575, Pension and Annuity Income, or Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits.
Taxes
Form(s) W-2 and Form(s) 1099-R show state income tax withheld from your wages and pensions. You should keep a copy of these forms to prove the amount of state withholding. If you made estimated state income tax payments, you need to keep a copy of the form or your check(s).
You also need to keep copies of your state income tax returns. If you received a refund of state income taxes, the state may send you Form 1099-G, Certain Government Payments.
Keep mortgage statements, tax assessments, or other documents as records of the real estate and personal property taxes you paid.
If you deducted actual state and local general sales taxes instead of using the optional state sales tax tables, you must keep your actual receipts showing general sales taxes paid.
Sales Tax on Vehicles
You may be able to deduct state and local sales and excise taxes (or certain other taxes or fees in a state without a sales tax) paid in 2010 for the purchase of a new motor vehicle after February 16, 2009, and before January 1, 2010. Keep your purchase contract to show much sales tax you paid.
Tips
You must keep a daily record to accurately report your tips on your return. You can use Form 4070A, Employee's Daily Record of Tips, which is found in Publication 1244, Employee's Daily Record of Tips and Report to Employer, to record your tips.
Monday, November 4, 2013
10 Things You Need To Know About Getting Married & Taxes
FROM FORBES.COM
I thought it would be appropriate to post ten things you need to know about getting married and taxes:
- Your marital status is determined as of the last day of the tax year (for individual taxpayers, this is inevitably the last day of the calendar year). It doesn’t matter if you get married on December 31 – you’re married for the whole tax year so far as the IRS is concerned. Similarly, if you get divorced in July, you’re no longer married for the tax year. The one exception is for widows and widowers: the IRS still allows you to file as married (this is typically favorable for most taxpayers).
- Same sex couples who are married under state law are considered married for federal purposes. This includes not only income taxes but also gift and estate taxes. Registered domestic partnerships, civil unions, or similar formal relationships recognized under state law are not recognized for federal purposes.
- The so-called marriage penalty used to be attributable to the fact that the standard deduction for married couples was less than the deduction of two single taxpayers. That changed under the Economic Growth and Tax Relief Reconciliation Act of 2001. For 2013, the standard deduction for individual taxpayers is $6,100 and the standard deduction for married taxpayers is exactly twice that amount: $12,200.
- Also double? The capital gains tax exclusion that applies to selling your home. If you owned your home for at least two out of the past five years and it served as your primary residence for two of the past five years, you can exclude up to $500,000 from income subject to capital gains when you sell your home. Single taxpayers may only exclude up to $250,000. Here’s a quick example: let’s assume you bought your home for $100,000 (assuming no capital improvements or other adjustments to basis) and you are selling it for $600,000. If you are single, you can exclude $250,000 of the $500,000, so that you pay capital gains tax on the remaining $250,000. In the same example, a married couple would exclude $500,000 – and pay no tax. For purposes of the exclusion, only one spouse has to own the house for two of the past five years but both have to live in the house for at least two years (though you may count time that you were living together in sin, as Mom would say).
- You don’t inherit your spouse’s tax liability when you get married. If your spouse has outstanding tax liabilities before you tie the knot, those don’t become yours. Ditto for child support and student loan defaults. That doesn’t mean that it won’t be a headache: filing jointly may still subject you to having your refund seized. You’ll have to notify the IRS that you want your refund split; this is referred to as an “Injured Spouse” allocation.
- You don’t have to file jointly when you’re married but you may not file as Single. If you want to file a separate return, the correct marital status is Married Filing Separate. If you elect to file as Married Filing Separate, both spouses must make the same election. Similarly, if you choose to itemize your deductions, both spouses must itemize; if you opt for the standard deduction, both spouses must claim thestandard deduction.
- Your spouse is never your dependent. The correct term is “personal exemption” – and if you are filing a joint tax return, you may claim one exemption for yourself and one for your spouse.
- Once you get married, your parents cannot claim you as a dependent if you file a joint return with your spouse (unless that joint return is filed only to claim a refund of withheld income tax or estimated tax paid). It doesn’t matter if mom and dad are still paying the bills for you and/or your spouse or if they otherwise support you. Additionally, if you are filing a joint return and your spouse can be claimed as a dependent by someone else, you and your spouse cannot claim any dependents on your joint return.
- If you aren’t working, you can still benefit from an individual retirement account (IRA). One of the often overlooked perks of filing jointly is that you and your spouse can each make tax deductible IRA contributions even if only one of you is earning money. For 2013, the maximum you can contribute to all of your traditional and Roth IRAs – including for a spousal IRA – to qualify for the deduction is the smaller of $5,500 ($6,500 if you’re age 50 or older), or your combined taxable compensation for the year.
- Your signature on that return means something. You might cheat on your husband or your wife and get away with lying about it but you don’t want to cheat on the IRS. When you sign that return, you are acknowledging to the IRS that you know what’s in the return and that you agree with it. Specifically, you swear under penalty of perjury “that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete.” Unlike an argument at your house, the IRS doesn’t care who said what and when. Unless you meet very narrow criteria (usually related to fraud or abuse) to qualify for Innocent Spouse relief, your signature on a joint return binds you to the consequences of that return – that includes civil and criminal penalties.
It’s a lot to contemplate. But getting right is important… Worrying about money and taxes can take a toll on a relationship. Throw in job stress, in-laws, owning a home, and a few kids – it’s quite a lot to sort out. Don’t put off talking about money and finances. Hire a good accountant. And be prepared. Years from now, you’ll be glad you did.
Wednesday, October 9, 2013
7 tips for getting the most out of QuickBooks
QuickBooks is a powerful tool that many small business owners rely on to keep their financial records up to date. But are you getting the most out of your software investment? Here are a few tips to help you increase efficiency and maximize your use of QuickBooks.
Tip #1 - Use QuickBooks on the go with remote access
Intuit (the company behind QuickBooks) understands busy professionals sometimes need to work on the go. Remote access options for QuickBooks have expanded, and you can now log into your file from anywhere – even while meeting with your accountant! Remote access methods include QuickBooks Online, desktop sharing and QuickBooks hosting on the cloud.Tip #2 - Download data whenever possible
Downloading banking and credit card activity directly into QuickBooks is a huge timesaver, even when factoring in initial set-up time. Downloading data minimizes the chance of human error and records activity quicker than inputting it manually.Tip #3 - Set a closing date password to protect data
On a regular basis and before you send your QuickBooks file to your accountant for year-end closing,make sure to set a closing date password. This safeguard will prevent users from accidently changing closed data periods by requiring anyone trying to make a change to enter the password in order to save the transaction in QuickBooks.Tip #4 - Memorize transactions
Are you tired of entering the same transaction every month in QuickBooks? QuickBooks has the capability to memorize recurring transactions (invoices, bills, checks, etc.) and set them for automatic posting daily, weekly, monthly, quarterly and annually.Tip #5 - Use the find feature to locate transactions faster
If you’re looking for a particular invoice, do you open the form and click “Previous” until the form appears on the screen? This can be a long and tedious process. Using the "find" feature is the most efficient way to find transactions in QuickBooks. This tool will search for almost any transaction-level data, depending on your filters.Tip #6 – Add depth to financial reporting with class tracking
Using class tracking in QuickBooks gives a business one more dimension – a way to categorize and track business activity that is meaningful in your particular company. Assigning a class to transactions allows you to report on each class separately. You should use classes to group transactions into categories that are different from your chart of accounts. As with most features in QuickBooks, planning up front to determine which classes your business needs will make them the most effective.Tip #7 – Expand functionality with QuickBooks add-ons
Many add-on products are available to expand the functionality of QuickBooks. For example, Bill.com for QuickBooks Online enables you to receive electronic bills (or scanned paper bills) and pay vendors electronically from your desktop or mobile device, with transactions automatically entered into QuickBooks Online, so you can have a paper-free bill-pay process. Another helpful add-on is Transaction Pro Importer, a web service that makes it easier to import an Excel or CSV data file into QuickBooks Online.Tuesday, August 27, 2013
Nonprofit Check Up – Is Your Bookkeeper Embezzling?
Not Susie (your bookkeeper’s first name), you say with the certainty you would give your own sister. Only Susie isn’t your sister. She is (fill in the blank i.e. John’s) sister. John and his wife have lost their jobs – both of them have been out of work for six months with no prospects of employment and unemployment insurance about to run out. John desperately comes to his sister and asks for a loan. She doesn’t have it but she knows where she can get it – your organization’s checking account is about to make an unauthorized “loan” but only until John gets back on his feet, so Susie swears to herself. Is there a scintilla of a doubt that she means it – not one! She sincerely means to return the unapproved “loan” ASAP.
This scenario should sound familiar. We can tell you about numerous executive directors that have called Auditors Inc. with the oft used phrase, “if only I had known about you before this happened”. What they don’t want to admit is that they would have behaved exactly the same way because bottom line, NO ONE wants to seriously entertain the thought that their bookkeeper – their right hand person (especially in the case of a small nonprofit) would steal. How can she come into the office every day, look you straight in the face with that smile and ask how your kids are and then stick the financial knife into your innards.
This is how. Her loyalty is to her family – not the nonprofit. She psychologically separates her daily work from her deception. She convinces herself that it is only temporary. What you need to know is that she is not a demonic thief. She is a human being that has made a stupid long term decision to a short term need. Only the definition of short term keeps changing and as time goes by, she looses track of how much she has stolen. Most embezzlers, when caught, are truly shocked when they hear the final tally.
How to increase your revenue is someone else’s expertise.
Our expertise – making sure that you hold on to the revenue that has been raised/earned by the “sweat of your brow” – making sure that Susie doesn’t steal you into bankruptcy (30% of all bankruptcy is due to embezzlement). And if you catch the embezzlement, you’re lucky – most embezzlement -an act of concealment goes undiscovered – after all, the embezzler isn’t out to kill the cow – just milk it.
So how do you deal with this reality. The answer is obvious – defined as something that goes unseen until someone expresses it simply. The next 10 procedures illustrate this axiom. They involve little more than common sense. They are the opposite of those procedures recommended by most CPAs – the ones that can not be implemented by the small nonprofit for the lack of the resources required for implementation.
1) Perform a credit check. This type of check as opposed to a civil/criminal background check is much more reliable. Someone experiencing a cash crunch runs a higher embezzlement risk. Admittedly, bad credit does not guarantee that they will embezzle and some may say this is not a fair assessment, but for people charged with the responsibility of handling the company’s assets, we think it is fair and reasonable. On the other hand, we must also allow for the possibility that the individual has a “squeaky clean” credit record because of a previous embezzlement?
2) Only another designated person can add/delete/edit a new customer/vendor in the accounting program. A common embezzlement technique is to set up dummy vendors and customers. So, you may consider this a pain in the butt, but for the few moments it takes, it is time well spent.
3) The authorized check signers should make a list of every check that they sign and turn their monthly lists over to a designed person who will review the bank statement for checks that clear the account. You are not relying on your memory to catch checks that were not legitimately signed.
4) All client invoices must be sequentially numbered and you want to review every invoice that goes out preventing your bookkeeper from double billing or overbilling your clients. Again make a list of the invoice numbers and as they are paid, check them off.
5) Either you or your outside professional should review all adjusting journal entries. These entries are the customary place to hide a lot of unauthorized activity.
6) You can skip items 2 thru 4 with the following procedure. Once a year, you or someone else should print out the activity ledger sheet for every customer and vendor. Spend the required time (generally no more than 1 day) to call each customer and each vendor to “confirm” all payments either to or from your organization. This insures that your bookkeeper is not issuing unauthorized checks and invoices.
CPA firms used to “confirm” accounts receivable and payable balances (a 2nd cousin to this practice) before they went high tech. This is still an extremely effective procedure to confirm that your cash expended was in fact received properly and all receipts your customers paid were received by your organization.
7) If your organization handles a lot of cash – it is imperative that you have at least 2 people working together. You can not afford to have less than 2; otherwise, embezzlement is almost a forgone conclusion. The incidence of embezzlement collusion is rare.
8) Perform a physical asset check at least once a year. You want to make sure that your computers and other physical assets don’t sprout wings.
9) Should you suspect a problem, call the Secret Service – don’t call the local police (whose white collar crimes division is already inundated). Believe it or not, corporate theft falls under the jurisdiction of the Secret Service.
10) And lastly – forgive our shameless plug – if you simply don’t have the time or the inclination for the above procedures . We know what we are doing, we are affordable and your time is best spent in growing your organization.
You lock the doors to your car and house because you don’t want to fall victim to robbery. The difference between robbery and embezzlement is obvious. You generally don’t know the robber but you do know the embezzler. Don’t be surprised, when in court, face-to-face with your embezzler, if the embezzler’s attorney turns the tables on you, the executive direct and refers to your shared culpability due to your lack of oversight. Increasingly, Boards of Directors are beginning to hold management responsible for lack of oversight when embezzlement is discovered in the organization. The overwhelming majority of embezzlement can easily be deterred following the above procedures. Your bookkeeper will thank you. If s(he) is embezzling, most likely, s(he) is feeling caught between a rock and a hard place.
This is your responsibility – take care of it or accept the consequences just as the Madoff victims had to accept their responsibility in blindly turning over their money with virtually no oversight!
Additional Information
Two well known organizations in this country, the SBA charged with assisting small business growth and the ACFE, charged with detecting/preventing fraud – by their own admission ignore the most vulnerable sector to fraud. Neither of these organizations deal with fraud in the small organization sector (defined as any organization with less than 100 employees).
The ACFE was founded in 1988 because it was about that time that the AICPA began to water down audit standards (our explanation – not theirs).
As per the ACFE 2008 Report to the Nation:
“Small businesses are especially vulnerable and suffer the largest losses. Median loss suffered with less than 100 employees is $200,000. On page 36 of this report it states “70% of victims they examined had external audits that did NOT catch fraud”. Our question to the AICPA and other professional accounting organizations – how do you justify what you do in the cold light of these numbers??
The Association of Certified Fraud Examiners said it best:
“10% of all people will never steal. 10% of all people will always steal. 80% of all people will steal given the right motivation.”
The economy or addiction or fill in the blank provides the motivation.The organization’s lack of oversight provides the opportunity.
This scenario should sound familiar. We can tell you about numerous executive directors that have called Auditors Inc. with the oft used phrase, “if only I had known about you before this happened”. What they don’t want to admit is that they would have behaved exactly the same way because bottom line, NO ONE wants to seriously entertain the thought that their bookkeeper – their right hand person (especially in the case of a small nonprofit) would steal. How can she come into the office every day, look you straight in the face with that smile and ask how your kids are and then stick the financial knife into your innards.
This is how. Her loyalty is to her family – not the nonprofit. She psychologically separates her daily work from her deception. She convinces herself that it is only temporary. What you need to know is that she is not a demonic thief. She is a human being that has made a stupid long term decision to a short term need. Only the definition of short term keeps changing and as time goes by, she looses track of how much she has stolen. Most embezzlers, when caught, are truly shocked when they hear the final tally.
How to increase your revenue is someone else’s expertise.
Our expertise – making sure that you hold on to the revenue that has been raised/earned by the “sweat of your brow” – making sure that Susie doesn’t steal you into bankruptcy (30% of all bankruptcy is due to embezzlement). And if you catch the embezzlement, you’re lucky – most embezzlement -an act of concealment goes undiscovered – after all, the embezzler isn’t out to kill the cow – just milk it.
So how do you deal with this reality. The answer is obvious – defined as something that goes unseen until someone expresses it simply. The next 10 procedures illustrate this axiom. They involve little more than common sense. They are the opposite of those procedures recommended by most CPAs – the ones that can not be implemented by the small nonprofit for the lack of the resources required for implementation.
1) Perform a credit check. This type of check as opposed to a civil/criminal background check is much more reliable. Someone experiencing a cash crunch runs a higher embezzlement risk. Admittedly, bad credit does not guarantee that they will embezzle and some may say this is not a fair assessment, but for people charged with the responsibility of handling the company’s assets, we think it is fair and reasonable. On the other hand, we must also allow for the possibility that the individual has a “squeaky clean” credit record because of a previous embezzlement?
2) Only another designated person can add/delete/edit a new customer/vendor in the accounting program. A common embezzlement technique is to set up dummy vendors and customers. So, you may consider this a pain in the butt, but for the few moments it takes, it is time well spent.
3) The authorized check signers should make a list of every check that they sign and turn their monthly lists over to a designed person who will review the bank statement for checks that clear the account. You are not relying on your memory to catch checks that were not legitimately signed.
4) All client invoices must be sequentially numbered and you want to review every invoice that goes out preventing your bookkeeper from double billing or overbilling your clients. Again make a list of the invoice numbers and as they are paid, check them off.
5) Either you or your outside professional should review all adjusting journal entries. These entries are the customary place to hide a lot of unauthorized activity.
6) You can skip items 2 thru 4 with the following procedure. Once a year, you or someone else should print out the activity ledger sheet for every customer and vendor. Spend the required time (generally no more than 1 day) to call each customer and each vendor to “confirm” all payments either to or from your organization. This insures that your bookkeeper is not issuing unauthorized checks and invoices.
CPA firms used to “confirm” accounts receivable and payable balances (a 2nd cousin to this practice) before they went high tech. This is still an extremely effective procedure to confirm that your cash expended was in fact received properly and all receipts your customers paid were received by your organization.
7) If your organization handles a lot of cash – it is imperative that you have at least 2 people working together. You can not afford to have less than 2; otherwise, embezzlement is almost a forgone conclusion. The incidence of embezzlement collusion is rare.
8) Perform a physical asset check at least once a year. You want to make sure that your computers and other physical assets don’t sprout wings.
9) Should you suspect a problem, call the Secret Service – don’t call the local police (whose white collar crimes division is already inundated). Believe it or not, corporate theft falls under the jurisdiction of the Secret Service.
10) And lastly – forgive our shameless plug – if you simply don’t have the time or the inclination for the above procedures . We know what we are doing, we are affordable and your time is best spent in growing your organization.
You lock the doors to your car and house because you don’t want to fall victim to robbery. The difference between robbery and embezzlement is obvious. You generally don’t know the robber but you do know the embezzler. Don’t be surprised, when in court, face-to-face with your embezzler, if the embezzler’s attorney turns the tables on you, the executive direct and refers to your shared culpability due to your lack of oversight. Increasingly, Boards of Directors are beginning to hold management responsible for lack of oversight when embezzlement is discovered in the organization. The overwhelming majority of embezzlement can easily be deterred following the above procedures. Your bookkeeper will thank you. If s(he) is embezzling, most likely, s(he) is feeling caught between a rock and a hard place.
This is your responsibility – take care of it or accept the consequences just as the Madoff victims had to accept their responsibility in blindly turning over their money with virtually no oversight!
Additional Information
Two well known organizations in this country, the SBA charged with assisting small business growth and the ACFE, charged with detecting/preventing fraud – by their own admission ignore the most vulnerable sector to fraud. Neither of these organizations deal with fraud in the small organization sector (defined as any organization with less than 100 employees).
The ACFE was founded in 1988 because it was about that time that the AICPA began to water down audit standards (our explanation – not theirs).
As per the ACFE 2008 Report to the Nation:
“Small businesses are especially vulnerable and suffer the largest losses. Median loss suffered with less than 100 employees is $200,000. On page 36 of this report it states “70% of victims they examined had external audits that did NOT catch fraud”. Our question to the AICPA and other professional accounting organizations – how do you justify what you do in the cold light of these numbers??
The Association of Certified Fraud Examiners said it best:
“10% of all people will never steal. 10% of all people will always steal. 80% of all people will steal given the right motivation.”
The economy or addiction or fill in the blank provides the motivation.The organization’s lack of oversight provides the opportunity.
Monday, August 26, 2013
S Corporation Self-Employment tax Avoidance Still A Solid Strategy
FROM FORBES.COM -
Even though Sean P. McAlary lost in Tax Court, the decision in his case shows that S Corporations are still a valid self-employment tax avoidance strategy. If you operate as a sole-proprietorship, all of its income will be subject to self-employment tax. If you put the business into an S Corporation, none of the income will be subject to self-employment tax. Entrepreneurs will be inclined to heavily discount any decrease in future social security benefits as a trade-off, so organizing as an S Corporation and avoiding self-employment tax seems like a no-brainer for a sole proprietor.
The Exposure
There is a catch. In the C corporation arena, the IRS is wont to argue that very high salaries are disguised dividends. With S Corporations, the Service may take the position that corporate distributions are actually disguised salary. That can be pretty ugly, since the penalties for being late with payroll taxes are fairly stiff. When Sean McAlary Ltd got hit for just over $10,000 in FICA and Medicare tax, that did not really prove that the S Corporation low or no payroll strategy is a bad idea. I mean, nothing ventured, nothing gained. What is nasty is the $6,000 or so in penalties.
Win, Loss or Draw ?
So would Mr. McAlary have been better off for 2006 if he had run his business as a proprietorship and paid self-employment tax on the entire profit. Forgive me for not doing the precise computation, but it is actually close to a push. Mr. McAlary had his corporation pay him no salary at all. There was an agreement in place for his salary to be $24,000. The IRS expert argued that his salary should have been $100,755. The Tax Court determined that $83,200 was actually the right number. According to the discussion in the case the net income of the S Corporation was $231,454 and the total on page 2 of his Schedule E was $200,877. His distributions from the S corporation were $240,000. I can’t tell why there is a difference. Perhaps he or his wife has another S Corporation that lost money. Regardless, by running as an S Corporation, he avoided the effect of Self-employment tax on between roughly $120,000 and $150,000 of income, even after getting audited.
That nasty $6,000 in penalties probably puts him a bit behind particularly when you throw in the tsoris of going all the way to Tax Court. Mr. McAlary represented himself, though, and did win a small concession, so you can’t rule out that he may have enjoyed the fight. When you consider other years, where he did not get audited, he came out way ahead using the strategy.
How To Win Almost For Sure ?
Explaining things like this throws me back to the early days of my career. My elaborate analysis would need to be translated into terms that the client would understand. After absorbing as much of the analysis as he thought relevant, Herb Cohan would then say to the client – “Don’t be chazzer !” The more elaborate version of that caution on the limits of aggressiveness in tax planning was “Pigs get fed. Hogs get slaughtered.”.
What the McAlary case teaches us is not that you can’t use an S Corporation to avoid SE/payroll taxes. It teaches us that you really should not use the strategy to avoid SE/payroll taxes entirely.
The case also shows us where to go for guidance. The IRS expert cited Risk Management Association Annual Statement Studies. RMA, as we used to call it, is a great reference tool. I used to use it a lot, before I became overspecialized. It provides averages of financial statements submitted to banks by businesses applying for loans and the like. Apparently being an expert for the IRS on reasonable compensation is not exactly rocket science. You can do it for yourself and come up with a reasonable percentage of profit to take as salary. There is actually a wealth of other potentially useful data in RMA which might give you a sense of how well you are doing on things like inventory turnover and collections.
Don’t Be A Chazzer
The AICPA standards of tax practice prohibit me from giving clients audit lottery type advice, but you and I are just pals, so I think I am in ethical bounds when I tell you this.
If your business is reasonably profitable, don’t even think about taking less than whatever the unemployment wage base is in your state is. That varies substantially by state ranging from $7,000 in Arizona to $39,800 in Washington. By going below that limit you end up with another group of enforcers being interested in you. My limited experience with them is that they are very stubborn and since there are not many dollars at stake the temptation will be to just pay it. There is then the potential that they will rat you out to the IRS.
If your business is quite profitable, be a sport and take something over the FICA maximum. The savings can still be quire substantial. Newt Ginrgrich took about $250,000 in salary with profits over $2,500,000 in his S corporation. That got him some bad press, of course, but you are probably not going to be running for President. It is worth noting that the President, himself, did not play this particular game and paid SE tax on all the net income from his book royalties.
Policy Question
With the new Obamacare Net Investment Income Tax, almost all income that individuals get from businesses is potentially subject to a medicare levy of one sort or the other. An exception is business flow-through income from businesses in which the taxpayer materially participates. Were it not for that exception, the Obamacare tax would have taken the fun out of the S Corp SE game for fellows like Newt Gingrich. I worked briefly (17 months) for a national firm and got to rub elbows a bit with one of the national guys who would talk to congressional staffers. I asked him if there was any policy justification for this odd loophole and he knew of none.
Is The Game Worth The Candle ?
If you convert a proprietorship to an S Corporation, there are some costs to weigh. If you are going to take salary below the FICA max, there may be an effect on future social security benefits. Actually quantifying that is challenging, but you can give it a shot with some of the calculator programs. I have never gone through that exercise and my experience is that most business owners are dismissive of it. So you can take that factor as a “just saying” if you want.
Operating as an S Corporation will require another tax return to be filed, which might cost something. In principle, your individual return should be somewhat easier, since a Schedule C is no longer required. You may need to “remind” your tax preparer of that in order to realize that saving on the individual return that might offset some of the cost of the S Corporation return. If you are a brown paper bag type of client with a masochistic CPA, the realization on doing your return might be so lousy that even without your Schedule C, standard charges might come out higher than what you paid in the previous year. On the other hand if you are a mensch with a CPA who “knows how to bill” your fee will never go down from one year to the next if you don’t ask.
Although there is a good chance that the potential for your individual return being audited will go down, the S Corporation return will be another return that potentially could be audited. I don’t know how that balances out and I suspect that nobody knows, although you will find plenty of people who will tell you they know.
If your business involves significant debt and has irregular income, there are a lot of tax traps in operating as an S Corporation. It gets really complicated if you have multiple businesses and real estate ownership is somehow involved. If you are the type of person inclined to pay the bills out of whatever account happens to have sufficient cash and let your accountant sort it out with journal entries, you may be setting yourself up for an income tax nightmare in your quest to save a few thousand dollars in SE tax. I have known partners in professional practices who contributed their partnership interests into S Corporations and encouraged me to do the same. I never regretted not doing it and they came to regret having done it, except the one who died. I’m pretty sure his executor really regretted it.
Finally, don’t ignore state and local income taxes in planning this move. There can be pluses and minuses depending on which state or states you are dealing with. New Hampshire is a particularly nasty place to fool with S Corporations and don’t get me started on New York City. Regardless, you need to consider state and local taxes carefully, particularly since you are not really saving a very high percentage federally from making this move.
Conclusion
Despite court losses and the lack of any discernible policy justification, it appears that the S Corporation SE tax avoidance strategy is still solid. Small business owners should examine the implication carefully, though, before jumping into it.
Even though Sean P. McAlary lost in Tax Court, the decision in his case shows that S Corporations are still a valid self-employment tax avoidance strategy. If you operate as a sole-proprietorship, all of its income will be subject to self-employment tax. If you put the business into an S Corporation, none of the income will be subject to self-employment tax. Entrepreneurs will be inclined to heavily discount any decrease in future social security benefits as a trade-off, so organizing as an S Corporation and avoiding self-employment tax seems like a no-brainer for a sole proprietor.
The Exposure
There is a catch. In the C corporation arena, the IRS is wont to argue that very high salaries are disguised dividends. With S Corporations, the Service may take the position that corporate distributions are actually disguised salary. That can be pretty ugly, since the penalties for being late with payroll taxes are fairly stiff. When Sean McAlary Ltd got hit for just over $10,000 in FICA and Medicare tax, that did not really prove that the S Corporation low or no payroll strategy is a bad idea. I mean, nothing ventured, nothing gained. What is nasty is the $6,000 or so in penalties.
Win, Loss or Draw ?
So would Mr. McAlary have been better off for 2006 if he had run his business as a proprietorship and paid self-employment tax on the entire profit. Forgive me for not doing the precise computation, but it is actually close to a push. Mr. McAlary had his corporation pay him no salary at all. There was an agreement in place for his salary to be $24,000. The IRS expert argued that his salary should have been $100,755. The Tax Court determined that $83,200 was actually the right number. According to the discussion in the case the net income of the S Corporation was $231,454 and the total on page 2 of his Schedule E was $200,877. His distributions from the S corporation were $240,000. I can’t tell why there is a difference. Perhaps he or his wife has another S Corporation that lost money. Regardless, by running as an S Corporation, he avoided the effect of Self-employment tax on between roughly $120,000 and $150,000 of income, even after getting audited.
That nasty $6,000 in penalties probably puts him a bit behind particularly when you throw in the tsoris of going all the way to Tax Court. Mr. McAlary represented himself, though, and did win a small concession, so you can’t rule out that he may have enjoyed the fight. When you consider other years, where he did not get audited, he came out way ahead using the strategy.
How To Win Almost For Sure ?
Explaining things like this throws me back to the early days of my career. My elaborate analysis would need to be translated into terms that the client would understand. After absorbing as much of the analysis as he thought relevant, Herb Cohan would then say to the client – “Don’t be chazzer !” The more elaborate version of that caution on the limits of aggressiveness in tax planning was “Pigs get fed. Hogs get slaughtered.”.
What the McAlary case teaches us is not that you can’t use an S Corporation to avoid SE/payroll taxes. It teaches us that you really should not use the strategy to avoid SE/payroll taxes entirely.
The case also shows us where to go for guidance. The IRS expert cited Risk Management Association Annual Statement Studies. RMA, as we used to call it, is a great reference tool. I used to use it a lot, before I became overspecialized. It provides averages of financial statements submitted to banks by businesses applying for loans and the like. Apparently being an expert for the IRS on reasonable compensation is not exactly rocket science. You can do it for yourself and come up with a reasonable percentage of profit to take as salary. There is actually a wealth of other potentially useful data in RMA which might give you a sense of how well you are doing on things like inventory turnover and collections.
Don’t Be A Chazzer
The AICPA standards of tax practice prohibit me from giving clients audit lottery type advice, but you and I are just pals, so I think I am in ethical bounds when I tell you this.
If your business is reasonably profitable, don’t even think about taking less than whatever the unemployment wage base is in your state is. That varies substantially by state ranging from $7,000 in Arizona to $39,800 in Washington. By going below that limit you end up with another group of enforcers being interested in you. My limited experience with them is that they are very stubborn and since there are not many dollars at stake the temptation will be to just pay it. There is then the potential that they will rat you out to the IRS.
If your business is quite profitable, be a sport and take something over the FICA maximum. The savings can still be quire substantial. Newt Ginrgrich took about $250,000 in salary with profits over $2,500,000 in his S corporation. That got him some bad press, of course, but you are probably not going to be running for President. It is worth noting that the President, himself, did not play this particular game and paid SE tax on all the net income from his book royalties.
Policy Question
With the new Obamacare Net Investment Income Tax, almost all income that individuals get from businesses is potentially subject to a medicare levy of one sort or the other. An exception is business flow-through income from businesses in which the taxpayer materially participates. Were it not for that exception, the Obamacare tax would have taken the fun out of the S Corp SE game for fellows like Newt Gingrich. I worked briefly (17 months) for a national firm and got to rub elbows a bit with one of the national guys who would talk to congressional staffers. I asked him if there was any policy justification for this odd loophole and he knew of none.
Is The Game Worth The Candle ?
If you convert a proprietorship to an S Corporation, there are some costs to weigh. If you are going to take salary below the FICA max, there may be an effect on future social security benefits. Actually quantifying that is challenging, but you can give it a shot with some of the calculator programs. I have never gone through that exercise and my experience is that most business owners are dismissive of it. So you can take that factor as a “just saying” if you want.
Operating as an S Corporation will require another tax return to be filed, which might cost something. In principle, your individual return should be somewhat easier, since a Schedule C is no longer required. You may need to “remind” your tax preparer of that in order to realize that saving on the individual return that might offset some of the cost of the S Corporation return. If you are a brown paper bag type of client with a masochistic CPA, the realization on doing your return might be so lousy that even without your Schedule C, standard charges might come out higher than what you paid in the previous year. On the other hand if you are a mensch with a CPA who “knows how to bill” your fee will never go down from one year to the next if you don’t ask.
Although there is a good chance that the potential for your individual return being audited will go down, the S Corporation return will be another return that potentially could be audited. I don’t know how that balances out and I suspect that nobody knows, although you will find plenty of people who will tell you they know.
If your business involves significant debt and has irregular income, there are a lot of tax traps in operating as an S Corporation. It gets really complicated if you have multiple businesses and real estate ownership is somehow involved. If you are the type of person inclined to pay the bills out of whatever account happens to have sufficient cash and let your accountant sort it out with journal entries, you may be setting yourself up for an income tax nightmare in your quest to save a few thousand dollars in SE tax. I have known partners in professional practices who contributed their partnership interests into S Corporations and encouraged me to do the same. I never regretted not doing it and they came to regret having done it, except the one who died. I’m pretty sure his executor really regretted it.
Finally, don’t ignore state and local income taxes in planning this move. There can be pluses and minuses depending on which state or states you are dealing with. New Hampshire is a particularly nasty place to fool with S Corporations and don’t get me started on New York City. Regardless, you need to consider state and local taxes carefully, particularly since you are not really saving a very high percentage federally from making this move.
Conclusion
Despite court losses and the lack of any discernible policy justification, it appears that the S Corporation SE tax avoidance strategy is still solid. Small business owners should examine the implication carefully, though, before jumping into it.
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