Monday, November 30, 2009

GUIDANCE FOR TAXPAYERS WITH RENTAL PROPERTY

I expect that by now there is a website, and probably a blog, about every aspect of every subject imaginable.

This includes TAXES. There are all kinds of websites on income tax topics – from the dreaded Alternative Minimum Tax (AMT) to Volunteer Income Tax Assistance (VITA). And there are all kinds of general and specialized tax-related blogs, like THE WANDERING TAX PRO.

While there are a multitude of web pages and web articles devoted to the subject of reporting rental income and expenses on IRS Schedule E, and a Google search results in tons of links on the subject, I could not find a website or blog specifically devoted to this subject.

So here I have decided to fill the void with a new blog titled THE INTERNET GUIDE TO IRS SCHEDULE E – which is now “up and running”.

This new blog will deal with all aspects of reporting income and expenses from rental real estate on Schedule E of the federal Form 1040.

It will discuss in detail how and when to report rental income and what expenses are deductible and how to deduct them.

It will cover all kinds of rental real estate – from two-family owner-occupied properties to vacation rentals to apartment buildings to commercial property.

It will also include a regular BUZZ-like feature to provide links to and comments on other online resources - websites, web pages, online articles, and blog posts – on the subject.

Your comments on and suggestions for this new blog are certainly welcome. You can comment on a particular post or email me at rdftaxpro@mail.com. When emailing be sure to put INTERNET GUIDE TO IRS SCHEDULE E in the “Subject Line”. The rules for submitting comments and questions to TWTP will also apply to my new blog.

So before you do anything else please check out THE INTERNET GUIDE TO IRS SCHEDULE E!

TTFN

Saturday, November 28, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’

Did you survise "Black Friday"? I didn't leave the apartment - except to get breakfast from a local deli and to get my mail.
* In case you missed my Thanksgiving Day entry – check out this Thanksgiving-themed post from Professor James Maule of MAULED AGAIN titled “Gratias Vectigalibus”. His comments echo some of my own sentiments.

* And in case you were too busy shopping on “Black Friday” to visit TWTP – check out my post on “The ‘Education Menu’ of Tax Benefits

* USA TODAY reports that “Americans' Tax Burden is Lightest in Developed World”.

Total U.S. tax revenues in 2008 equaled 26.9% of gross domestic product, according to provisional figures released Tuesday by the Organisation for Economic Co-operation and Development. That figure – which includes local, state and federal taxes, including Social Security – was lower than the 1990 ratio and far below levels across Europe. In Denmark, the total tax take exceeds 48% of the economy. In France, it tops 43%; Germany, 36%.”

Try telling someone who lives in New Jersey that their tax burden is “light”.

* Joe Kristan joined Kay Bell and Kelly Phillips Erb (and, of course, king of the tax bloggers Paul Caron) in reporting and commenting on the proposed “war tax” included in the "Share the Sacrifice Act" in his post "War Tax. Why Stop There?" over at the ROTH AND COMPANY TAX UPDATE BLOG.

Joe, his tongue firmly in check (where it is often found), suggests –

It might be a good idea to have a dedicated "Share the Sacrifice" tax for every new program. The possibilities are endless:

- A 'Give it up For Goldman' tax to finance TARP and the bailouts.
- 'Reach Deep for Realtors' to finance the extended homebuyer credit.
- A 'Pimp your Neighbor's Truck' tax to finance "Cash for Clunkers."
- 'Pay up for Pork' for any transportation bill.
- A 'Share the Stupid' tax for the stimulus spending
.”

Joe also offers “Bend Over For Benzes” to finance Iowa’s film tax credit. I would revise this a bit to “Bend Over For Bozos” for just about any quick fix reaction tax bill from Congress.

* Kelly Phllips Erb tells us “7 Audit Lessons (or How I Learned to Stop Worrying and Love the IRS)” at TAX GIRL.

Love the IRS” may be going a bit far. I doubt if anyone loves the IRS. But there is no reason to hate, or fear, the Service.

As I mentioned in Wednesday’s BUZZ Kelly’s law firm was audited by “Sam”. This post continues the tale of her audit – and provides 7 great tips for anyone facing an audit.

I have blogged in the past about the fact that I have, thank the Lord, had very little audit experience over the past 38 years. I can count the number of audits I have been involved with on the fingers of both hands. I do not represent taxpayers before the IRS (one reason I never saw the need to become an EA), nor do I want to if I can help it. I only get involved in the audit of a tax return I have personally prepared. But from what little audit experience I have had I can tell you that Kelly’s tips are right on the money. While the audit in question was of a corporation, these tips apply to audits of 1040s as well.

Every taxpayer faced with an IRS, or state, audit should read this post before going to the appointment.

* Stacie Clifford Kitts asks, “Have You Heard About Form 1099K?” over at STACIE’S MORE TAX TIPS.

Stacie tells us –

If you use Paypal or another service to process credit card payments, under these proposed regulations you may be receiving a new form 1099K which will report the amount of payments processed by the service for you.”

She then goes on to quote the official IRS notice on the new requirements. According to the notice, these new requirements will take effect “starting with transactions in calendar year 2011”. So don’t go looking for an 1099K form this coming January or February.

* The NATP’s weekly email newsletter reminds us of something I believe I mentioned earlier in the year here in a BUZZ installment -

NRP Employment Tax Audits to Begin in February 2010

In February 2010, the IRS will begin its first Employment Tax National Research Project (ET NRP). Business practices regarding employment tax issues may have changed significantly over the last 25 years since the last IRS employment tax study in the 1980s.

Examinations comprising the study will be conducted to collect data that will allow the IRS to understand the compliance characteristics of employment tax filers. The results will allow the IRS to gauge more accurately the extent to which businesses properly comply with employment tax law and related reporting requirements. When completed, this information will help the IRS select and audit future employment tax returns with the greatest compliance risk.

There are two main goals for the ET NRP:

• To secure statistically valid information for computing the Employment Tax Gap, and
• To determine compliance characteristics so IRS can focus on the most noncompliant employment tax areas.

The IRS will randomly select 2,000 taxpayers each year for the next three years. The examinations will be comprehensive in scope. Taxpayers will receive notices describing the NRP process similar to those used in recent NRP studies for individuals and Form 1120S corporations.

Records pertaining to employment tax returns and issues will be subject to review during these examinations. Employers should have all of their records available to expedite these examinations
.”

* Back at the ROTH AND COMPANY TAX UPDATE BLOG, Joe Kristan’s post “New Business? How Do You Go About It?” led me to “Get It Right the First Time” by Chris Branstad at IOWABIZ.COM.

It is great to have one’s professional advice supported by peers. Both Chris and Joe echo my advice on incorporating.

Chris says –

Running to the secretary of state to get corporate filings is not the first step in developing your business.

Incorporating before your business has an identity is like getting a marriage license before you decide on a groom. You will likely have to start over.

First, determine: Who are you? What do you want? What is your growth strategy? What is your exit plan?


Chris’s marriage analogy is similar to what I have used in the past. I have told readers and clients that incorporating is like marriage – getting the marriage license may be cheap, but the divorce can cost a fortune.

Joe advises (highlight is mine) –

Don't go with a corporation -- S corporation or C corporation -- unless you really are sure of what you are doing. Once you incorporate, you may find yourself with taxable income for the privilege of undoing it.”

Joe gives the best advice of all, which applies to a multitude of tax issues – “You should get your tax pro involved”!

* And speaking of great advice, the Small Business Taxes and Management site’s News and Tip of the Day for Friday, November 27th gives an excellent piece and advice and provides a court case reference to tell you why.

If you're agreeing to something with the IRS, get it in writing. In Harry E. Crisci (2009-2 USTC 50,647; U.S. District Court, West. Dist. Pa.) the IRS levied on the auction proceeds from the sale of the company's assets. The amounts recovered by the Service were applied to both trust fund and nontrust fund liabilities of the company, rather than first applying all the proceeds to the trust fund liabilities. That left the company officers with a personal liability. The Court found no evidence the IRS said the proceeds would first be applied to the trust fund liability and found reliance by the company on the Service's vague statements unreasonable.”
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* A guest post by Kimmer at THE MISSOURI TAX GUY just made it into the BUZZ. The title - "Personal Finance 101: Budgeting - It Doesn't Have to Hurt". It is a good primer on the subject.
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* Don’t limit your Christmas gift-giving to presents for individuals. Make gifts to charity as well. Here is a good one to consider:

The Second Chance Fund of the American Humane Association- The medical costs of treating and rehabilitating an abused animal can easily become overwhelming for any animal welfare organization -- particularly when long-term care is necessary. The Second Chance Fund is one way American Humane works to support member organizations in their vital work. By providing financial assistance, in select cases, to animal welfare organizations responsible for the temporary care of animals as they are prepared for adoption into permanent, loving homes, the program provides animal victims of abuse or neglect with a second chance at life.

TTFN

Friday, November 27, 2009

THE "EDUCATION MENU" OF TAX BENEFITS

Earlier this week I discussed the new American Opportunity Credit for qualified post secondary tuition, fees and course material expenses.

The AOC is only one of many items on the “menu” of education tax benefits.

THE AOC replaces the HOPE education credit. The other credit available for educational expenses is the Lifetime Learning Credit, which it non-refundable. While the AOC is limited to the first 4 years of post-secondary education, and cannot be claimed more than 4 tax years, the Lifetime Learning Credit is available for all years of postsecondary education and for courses to acquire or improve job skills and for an unlimited number of years.

The Lifetime Learning Credit is also available for all years of postsecondary education, including graduate school, as well as for education to acquire or improve job skills. The student does not have to be pursuing an undergraduate degree or other recognized education credential and it is available for a single class. The cost of course materials cannot be used in calculating the Lifetime Learning Credit.

The amount of the credit is 10% of up to $20,000 in qualified expenses for a maximum of $2,000. While the AOC is $2,500 maximum is per student, the Lifetime Learning credit $2,000 maximum is per tax return. You can have two dependents in college during the year, and each can claim up to $2,500 of the American Opportunity Credit. But if you have two dependents in graduate school in the same year the maximum Lifetime Learning Credit you can claim for both combined is $2,000.

The phase out range is for “modified” AGIs of between $50,000 and $60,000 for singles and $100,000 and $120,000 for married couples. It is not available to married taxpayers who file separately.

Special rules apply for both credits for a student attending college in a Midwestern disaster area.

Click here for a good IRS-published comparison of the two credits.

You can claim an “above-the-line” deduction (“adjustment to income”) for qualified tuition and fees. This deduction is limited to $2,000 for modified Adjusted Gross Income of up to $65,000 for singles and $130,000 for married couples filing joint and $4,000 for MAGI of up to $80,000 for singles and $160,000 for joint filers. The deduction is not available for married taxpayers who file separately.

The deduction is available for tuition and fees and student-activity fees and course-related books, supplies and equipment if they must be paid as a condition of enrollment or attendance.

Taxpayers can also claim an itemized deduction as an “employee business expense”, or a deduction on Schedule C if self-employed, the cost of education that is (1) expressly required by an employer, by law, or by government regulation, or (2) maintains or improves skills required in your current trade or business. Education is not deductible if it (1) is the minimum requirement for a trade or business, or (2) prepares one for a new trade or business, even if the taxpayer does not intend to enter the new trade or business.

Deductible expenses include –

• tuition, textbooks, registration fees, and supplies,
• round-trip transportation to the education (the only time travel is deductible),
• meals (at 50%) and lodging while away from home,
• lab fees, student cards, insurance and degree costs, and
• writing expenses for term papers and dissertations (i.e. research and typing)

Generally expenses for education that lead to a degree are not deductible, as it is assumed that an undergraduate degree is the “minimum requirement” for a trade or business and a graduate degree prepares one for a new trade or business. See my post on “Is An MBA Deductible”. A graduate degree may also be deductible for teachers.

There are no income or AGI limitations involved with such a deduction, other than the 2% of AGI exclusion for “miscellaneous” itemized deductions.

With a deduction the tax benefit received is determined by your marginal tax rate (i.e. are you in the 10%, 15%, 25%, 28% or 35% tax bracket).

When determining whether to claim a credit, above-the-line deduction, or Schedule A or C deduction for education, as in any situation when you are given options, you should calculate the tax benefit under each each option to determine the one that provides the most overall federal, state and local tax savings. While a credit is generally better than a deduction, this is not always the case. Because of AGI and other considerations I have often come across returns where it was “more better” to claim a deduction than a credit.

For parents of newborns or young children perhaps the best way to save for their college education is with a Qualified Tuition Program (QTP), also known as a “Section 529 Plan”. Contributions to a 529 Plan are not deductible, but the earnings that accrue over the years are tax-free if used for qualified education expenses. For purposes of Section 529 qualified expenses include tuition, required fees, books, supplies, equipment, computer equipment and services (for 2009 and 2010), special needs services, and, for someone who is at least a half-time student, room and board.

There are no statutory limitations to the amount that can be contributed to a Section 529 Plan, other then they cannot be more than the amount necessary to provide for the qualified education expenses of the beneficiary, but there are Gift Tax considerations, and there are no AGI or MAGI income phase-outs. Anyone can contribute to a Section 529 Plan regardless of income.

Here is a great idea – use the cash gifts your newborn receives to open a Section 529 Plan.

For more information on Section 529 Plans click here.

You can also save college using the Coverdell Education Savings Account. Parents and family members can contribute up to a maximum of $2,000 per student beneficiary per year to a Coverdell ESA.

As with a Section 529 Plan, contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed and distributions are tax-free if they are used for a beneficiary’s qualified education expenses at an eligible institution.

What is good about a Coverdell ESA is that distributions can be used for qualified education expenses for Kindergarten through 12th Grade as well as college and graduate school. Qualified expenses include tuition, fees, books, supplies and equipment (not computers), and room and board for students who are enrolled at least half-time.

Of course there is a “modified” AGI phase-out range - $95,000 to $110,000 for singles (including Married Filing Separate) and $190,000 to 220,000 for Married Filing Joint.

The above are only a few of the items on the “education menu”. Click here for an IRS-published overview of the education menu. More detailed information is available in IRS Publication 970 (Tax Benefits for Education).

There are special rules for coordinating the interaction of the various items on the education menu. For more information you should consult your tax professional.

TTFN

Thursday, November 26, 2009

HAPPY THANKSGIVING!

I hope you have a "successful" Thanksgiving!
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My father was taken from rehab to the hospital yesterday, so we will be celebrating the holiday at the Jersey Shore Medical Center this year.
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My Thanksgiving dinner will consist of a ham and cheese sub from my friend Carmen's deli.
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At least Nosey (my cat) will be having turkey!
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Before you go please check out this Thanksgiving-themed post from fellow tax blogger Professor James Edward Maule of MAULED AGAIN (click here), which echoes some of my own sentiments.
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TTFN

Wednesday, November 25, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’ – WEDNESDAY EDITION


AND I THOUGHT I WAS ADDICTED TO BLOGGING!

* JOE TAXPAYER’s “This Week’s Roundup” led me to an answer to the question “What is a Charitable Gift Annuity?”, a guest post written by Benjamin Clark at CHRISTIAN PF.

As Benjamin explains –

The basic premise of the charitable gift annuity is the donor gives a gift to the charity and the charity agrees to pay an annual annuity to the beneficiary for the remainder of the beneficiary’s life. Upon the beneficiary’s death, the agreement terminates and the charity is under no further obligation.”

* Shannon Buggs of the HOUSTON CHRONICLE is correct when she says “It's Better to Break Even”.

She is, of course, talking about breaking even when you file your Form 1040 (or 1040A).

If you get the withholding amount just right, you can wind up on Tax Day not having to write a check for additional taxes owed. In the end, the goal of tax planning is to pay as little in taxes as legally possible.

Please notice I did not write that the goal is to collect the biggest refund check you can.

But people with middle and high incomes who get refunds are making no-interest loans to the government and just getting back the money they could have been using sooner.

Yet about three of every four American households — more than 100 million taxpayers — get refunds averaging about $2,700.

That's a big chunk of money they could have been saving, investing, spending or giving to charities over the course of the year.

And if they had been using that money in any of those ways, those households would have been boosting the economy
.”

While I do agree with what Shannon is saying, considering the pitiful state of interest on liquid savings I also do understand why some of my clients use excess withholding as a form of “forced savings”, and I also understand the, while illogical, psychological pleasure of a big refund.

* Kay Bell keeps us up-to-date on the status of health care “reform” in her post “Health Care Debate is On!” at DON’T MESS WITH TAXES.

She tells us that the already-passed House version of the Health Care bill is 2000+ pages, and the not-yet passed Senate version is “right now is more than 2,000 pages. What finally is approved, if anything, could be even bigger.”

* And over at her other blog – EYE ON THE IRS at Bankrate.com – Kay reports on some “Black Friday Tax Holidays”.

* Trish McIntire warns newly marrieds about an unexpected surprise that they may get at tax time in “Wedding Bell Blues” at OUR TAXING TIMES. The marriage penalty for a two-income couple is alive and well!

I have always advised dual income couples to marry early in the year. You are considered married for tax purposes for the entire year if you are legally married on December 31st. So, if you are going to pay the tax penalty for being married you might as well “get your money’s worth” and enjoy the “benefits” (such as they are) for as long in the year as possible.

* Tax lawyers usually are called upon to help taxpayers, especially corporations, with problem audits. But the corporations of tax lawyers can also be audited. So Kelly Phillips Erb tells us in her post “On the Other Side of the Table”. It seems that Kelly’s law firm is being audited!

Kelly has a healthy attitude about the whole thing. She says, “There’s no use being freaked out about it – advice that I give my clients (and my readers) and advice that I’ll stand by”.

And, “I’m trying to take something positive from the whole mess. Besides blog fodder (how convenient is that?), it is giving me some additional perspective from the client side – and that can only be good, right?

Good luck, Kelly!

* Joe Kristan, author of the ROTH AND COMPANY TAX UPDATE BLOG, reminds business owners that, while a wink is the same as a nod to a blind horse, “'Bought' Isn't the Same as 'Placed in Service'”.

Deductions for fixed assets -- depreciation and Section 179 deductions -- don't necessarily start when you buy an asset. They are only available when the asset is ‘placed in service’.’”

Joe goes on to tell about a court case where a taxpayer used this rule to his advantage.

The bottom line of the post is one that is especially applicable at this time of the year –

That's a taxpayer victory here, but it also implies a warning to taxpayers: if your machinery is still in shipping crates needing to be put together at year-end, it's probably not yet eligible for depreciation or Sec. 179 deductions. If you want the deduction this year, get it out of the box and hook it up!

* Don’t be surprised if the Social Security number that appears on a 1099 you receive next January looks like this – “XXX-XX-1234”.

Bill Perez tells us about an IRS pilot program in which “Your Social Security Number May Be Truncated” over at WILLIAM’S TAX PLANNING BLOG.

* I no longer exchange gifts – but when I did I stayed home on Black Friday and did my shopping online. If I were still buying gifts I would be checking out the items in this message I recently received.

TTFN

Tuesday, November 24, 2009

OI VEY! AN UPDATE ON MY LAST POST

Mary O’Keefe, a tax professor and author of the BED BUFFALOES IN MY TAX CODE blog, is keeping me honest.

Mary has brought to my attention an excellent IRS 2-page comparison of the American Opportunity and Lifetime Learning education tax credits. Click here to download.

Under the heading “Who Can Claim a Dependent’s Expenses?” this IRS tool confirms what I said in my post –

If the taxpayer does not claim the exemption on the tax return the dependent can claim the credit.”

However it points out a what Mary calls “bed buffalo” in a footnote –

None of the credit is refundable if the taxpayer claiming the credit is a child (a) who is under age 18 (or a student who is at least age 18 and under 24 and whose earned income does not exceed one-half of his or her own support); (b) who has at least one living parent, and; (c) who does not file a return.”

So while James in my post’s example can claim the credit on his tax return, none of the credit is refundable. This means that James’ tax liability must be at least $2,500 (and, of course, the tuition and other costs used to determine the credit must be at least $4,000) to take full advantage of the credit.

I stand corrected.

A special “thank you” to Mary for keeping me honest!

TAX PLANNING AND THE AMERICAN OPPORTUNITY CREDIT

In this past Saturday’s edition of the BUZZ I told you about the finding of a Treasury Inspector General for Tax Administration (TIGTA) review of the education tax credits.

TIGTA's review looked at taxpayers who claimed the credit in 2006 and 2007 and found that, in 2006, approximately 203,000 taxpayers erroneously claimed a total of over $300 million in Hope Credits. In 2007, over 169,000 taxpayers erroneously claimed a total of over $232 million in Hope Credits.”

Well that is nothing compared to what will happen with 2009 and 2010 returns, when the HOPE credit becomes the American Opportunity Credit and, as such, becomes partially refundable.

Hey, we all know by now that refundable credits are basically an open invitation to commit tax fraud.

Some background on the AOC-

The new American Opportunity Credit modifies the existing HOPE Credit for tax years 2009 and 2010. The “new and improved” HOPE Credit is now available to many more taxpayers, including those with higher incomes, as the AGI phase-out range is $80,000 - $90,000 for singles and $160,000 - $180,000 for married couples, and those who owe no tax, as it is partially refundable. It also adds required course materials (“books, supplies and equipment needed for a course of study whether or not the materials are purchased from the educational institution as a condition of enrollment or attendance”) to the list of qualifying expenses, and allows the credit to be claimed for four post-secondary education years instead of two. The maximum credit has also been increased to $2,500 per student.

Click here to go to the IRS page of American Opportunity Credit: Questions and Answers.

Despite the increased AGI phase-out range, many parents with dependents attending college will still be unable to receive any tax benefit, especially in my neck of the woods. However, there is HOPE (no pun intended).

IRS Field Service Advice FSA 200236001 tells us that there is a way for a dependent child to claim the HOPE Scholarship credit.

James Q Taxpayer, the son of John Q and Jane Q, was an unmarried full-time college student who had net taxable income for the year. John and Jane were entitled to claim James as a dependent.

During the year, James incurred expenses that qualified for the HOPE education credit. However, John and Jane's Adjusted Gross Income (AGI) was in excess of the maximum AGI threshold, and could not claim the credit.

James' tax liability, before any credits, was more than the amount of combined federal and state tax savings John and Jane would have realized by claiming James as a dependent.

John and Jane, although entitled to, did not claim James as a dependent on their 1040. James filed a tax return, but did not claim an exemption for himself. James did, however, claim the HOPE Scholarship credit on his return.

The National Office of the IRS has concluded that because the parents (John and Jane) could claim a dependency exemption for the "child" (James), he (James) could not claim an exemption for himself. But, as the parents did not claim the child as a dependent, the child (James) was entitled to claim the HOPE Scholarship credit on his return if he met the eligibility requirements.

I know of no reason why this will not also apply to the American Opportunity Credit.

This “loophole” suggests a tax planning opportunity. If the taxable income of James above, the dependent student, can be controlled it would be good to make sure James earns at least enough to generate a tax liability that assures he will be able to take full advantage of the American Opportunity Credit, including its refundable portion. {OOPS! CLICK HERE TO READ A CORRECTION - rdf}

It may be too late to generate sufficient income for a qualifying dependent student for 2009 – but there is still 2010.

TTFN

Monday, November 23, 2009

AS THE CONGRESS TURNS

As I mentioned in Saturday’s BUZZ, "tax-challenged" Chuck Rangel promised an “extenders” bill will be acted on in December.

I just got the word that the House Ways and Means Committee has issued a 7-page summary of the proposed “Tax Extenders Act of 2009”. According to the summary, the Act will extend for one year only (through December 31, 2010) 40 tax provisions that are currently scheduled to expire on December 31, 2009. The Committee hopes to pass this Act by the end of the year.

The estimated $30 Billion cost would be offset by tax-raising provisions, but these provisions are not identified in the summary.

While most of the provisions are business-related, the Act will extend the “usual suspects” of 1040 tax benefits –

• The option to deduct state and local sales tax instead of state and local income tax.

• The above-the-line deduction for educator expenses.

• The above-the-line deduction for qualified tuition and fees.

• Tax-free transfers from IRAs to charities.

Added to the list of regulars is the additional standard deduction for real estate taxes.

FYI, the American Recovery and Reinvestment Act of 2009 had previously extended the residential energy tax credit for 2009 and 2010.

There is no mention of extending, even for one-year, the annual dreaded Alternative Minimum Tax (AMT) “fix” (the AMT is dreaded, not the fix). House lawmakers indicated that passing of the annual “fix” will be done next year.

Click here to download the Committee’s 7-Page Summary.

TTFN

Saturday, November 21, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’

* OOPS! Sorry I missed Kay Bell’s T3 (Tax Twitter Tuesday) in Wednesday’s BUZZ. Anyway, here it is now – “Tax Twitter Tuesday 11.17.2009”.

* This page on “How to Pay Less Taxes” at EFILE.COM is chock-a-block with good tax planning and preparation tips and advice, many of which I have talked about here and elsewhere for years. It is nice to have all this information in one place.

* An email from the Treasury Inspector General for Tax Administration (TIGTA) announced the release of a new report titled “Improvements Are Needed in the Administration of Education Credits and Reporting Requirements for Educational Institutions”.

It seems that –

TIGTA's review looked at taxpayers who claimed the credit in 2006 and 2007 and found that, in 2006, approximately 203,000 taxpayers erroneously claimed a total of over $300 million in Hope Credits. In 2007, over 169,000 taxpayers erroneously claimed a total of over $232 million in Hope Credits.”

Another reason why such benefits should not be administered via the Tax Code (as I have been saying now for some time)!

I was especially interested to read the following item from the email (highlight is mine) –

TIGTA also performed a computer analysis of all Forms 1098-T, a tuition statement provided by educational institutions to students, from 2005 through 2007. The form includes a box in which the educational institution may show the amount of tuition paid by the student, which is the figure that taxpayers and the IRS use in order to determine the amount of the credit. However, educational institutions are given the option of showing the amount billed for qualified tuition and related expenses rather than the amount paid. TIGTA found that the box in which the amount of tuition paid may be shown was blank on 80 percent of the Forms 1098-T it reviewed. Educational institutions expend approximately 5.1 million hours each year to complete Forms 1098-T and an estimated $3.8 million to mail the forms to students. Although a few government agencies use some of the information on the form, the IRS does not use the form to match or confirm the amount of the claim.”

This just goes to emphasize my comment that the Form 1098-T as currently issued by most colleges is like “tits on a bull”. For the most part the Form 1098-Ts that I get from clients are totally useless. Who cares how much was “billed” - I need to know how much was paid! And if the IRS is not going to match 1098-T information to the tax return what is the purpose of having it at all?

TIGTA made legislative recommendations to “enact legislation to either revise the reporting requirements for Form 1098-T so that the IRS and taxpayers are able to use it to calculate the amount of the claim or else relieve educational institutions of the burden of producing the form”. I hope there is some follow through on this.

* MISSOURI TAX GUY Bruce continues on the subject of the dreaded Alternative Minimum Tax (AMT) with the follow up post “How Do I Know if I Have to Worry About the AMT?

* Chad Bordeaux has a good post on “What is a Qualified Charitable Organization?” over at BEANCOUNTER RAMBLINGS.

Chad tells us that, “Many times, people will think that donations can be deducted when they can not”. He provides a good example –

An example that I usually bring up to explain this is related to a local homeowner’s association in the area. At least once a year, they send out a flyer that promotes a neighborhood get together (aka “party”). In the flyer they specifically state that they need donations for the keg fund and to remember that “these are tax deductible.” I hate to burst their bubble, but they are not tax deductible for a host of reasons. Primarily because the donations are not made to a qualified charity. The homeowner’s association is a tax-exempt organization (aka “non-profit”), but it does not have a charitable purpose.”

Just because an organization is “tax exempt” does not automatically mean that payments made to it are deductible as a charitable contribution.

If I may add a caveat to the subject – if you are putting your donations of old clothes in a “drop-off box” be sure that the box actually belongs to a charity. Here is some advice I gave in a July 2007 edition of the BUZZ (highlight has been added) -

While I have, in the past, found errors in and disagreed with items discussed in Sandra Block’s weekly YOUR MONEY column in USA TODAY, I do recommend last Tuesday’s installment ‘Your Money: Donated Clothes May Not Help Charities’. When donating used clothes and household items to charity you should go with the ‘old reliables’ like Goodwill Industries, the Salvation Army, Vietnam Veterans of America or your local church – this way you are sure to be giving your items to a legitimate charity. In many cases the charity will come to you to pick up your donations. And if you are putting your donations in a “drop-off box” make sure the name of the charity is clearly indicated on the box. While these boxes may be convenient it is “more better” to drop off your donation at a local Goodwill or Salvation Army store or donation center, where you can get a signed receipt.”

* Kay Bell goes into detail on the tax provisions of the Senate health care “reform” bill in her post “2,074 pages + $849 billion = Senate Health Care Bill” at DON’T MESS WITH TAXES.

Joe Kristan also deals with one of the tax provisions in “Harry Reid's Funky New Medicare Surtax” at the ROTH AND COMPANY TAX UPDATE BLOG.

I found this nice listing of “the 17 tax increases in the Senate health care bill, which are estimated to raise $370.2 billion in revenues over ten years” as published by the Joint Committee on Taxation in the post “The Number 17 May Mean Something This Year” at the SACRAMENTO TAX BLOG, which is written by Owen S. Arnoff, EA.

I don’t quite know what “Conform definition of medical expenses” means in this context. And I, at this point, would certainly oppose “Raise 7.5% AGI floor on medical expenses deduction to 10%”.

* An article by Ryan J. Donmoyer at BLOOMBERG.COM reports that “Rangel Says House Democrats Will Seek to Renew US Tax Breaks”.

According to the article –

New York Representative Charles Rangel said House Democrats will move next month to renew dozens of tax breaks before they expire at year’s end” and “the panel will send a measure containing most of the extensions directly to the House floor for consideration, bypassing a committee debate.”

Apparently there are 73 tax laws that are schedule to expire on December 31, 2009, as per a report by the Joint Committee on Taxation.

The expiring items include the normal tax deductions and the AMT “fix” that have come to be identified as the “extenders” because the idiots in Congress can’t make up their mind whether or not the deductions should be part of the permanent Tax Code or that the dreaded AMT should be fixed or, more better, destroyed and end up passing a 1 or 2 year extension. In the past the fools in Washington have often sat on their hands for most of the year and waited till the last minute to pass the extenders. At least now, when the bill passes, we will begin 2010 knowing that these deductions and the AMT fix is in place for the year.

* Along the lines of extending tax breaks, Joe Kristan has a post on this topic – “Theory, Meet Practice” – at the ROTH AND COMPANY TAX UPDATE BLOG.

Joe tells us that -

George Yin, former Chief of Staff of the Congressional Joint Committee on Taxation, thinks temporary legislation -- such as the perpetually-expiring AMT patch and research credit -- is a good thing.”

Ridiculous - the constant extending of expiring tax breaks is a bad thing!

* Back to Kay Bell at DON’T MESS WITH TAXES. She gives us “A Look at Who's Paying How Much Taxes” with references to several recent studies on the topic by differing organizations.

Kay ends the post with some questions for her readers –

What do you think? Are you being overtaxed? Are the rich disproportionately bearing the U.S. tax burden? Or are middle-class and poorer taxpayers really paying more relatively speaking than the wealthy? Should Congress let the income tax rates go back up in 2011?

Regardless of which position you take, how would change the tax system?


I look forward to reading the comments.

* TAX GIRL Kelly Phillips Erb apparently also writes for “The Legal Intelligencer”. Over there she gives some advice on “Holiday Parties: Keeping Expenses Low and Deductibility High”.

* It will soon be time for sending out Christmas cards. I usually get my first one just after Thanksgiving, although I do not mail my own out till mid-December.

FYI, I order my cards from American Humane.

Here is a suggestion for inclusion on your Christmas Card list – passed along to me via a tweet from, once again, taxtweet Kay Bell – Holiday Mail for Heroes.

And finally another option passed along by a tweet – click here.

TTFN

Friday, November 20, 2009

DO IT YOURSELF!

Earlier this week I pointed out that telling all Schedule C filers to incorporate, and telling a one-person business to incorporate solely for the purpose of reducing his/her audit profile, is truly bad advice (click here for post).

But I did add that there are times when it may indeed be cost effective for a closely-held business to incorporate.

If, after careful consideration of all the facts and circumstances and a detailed cost benefit analysis, and after consulting with a competent tax professional, you decide that it would be appropriate to incorporate your one-person business you certainly do not need a lawyer to do so.

While I am not familiar with all the states procedures, I expect that you can incorporate easily online via the website of your State. Last year I formed a NJ corporation online in about half an hour.

FYI, registering your business as an LLC is equally as easy and can generally be done online.

You can also very easily get an Employer Identification Number from the IRS at the Service’s website.

You also do not need a “Black Beauty” or other such corporate package with by-laws, corporate seal and personalized stock certificates, which lawyers are fond of selling at a nice mark-up, or pay an inflated fee for a lawyer to prepare corporate bylaws.

You can download free blank stock certificates and corporate by-laws and purchase an inexpensive corporate seal from a variety of online sources. I expect you can also find free pro-forma corporate resolutions online. Just do a “Google” or other search.

What do you think a lawyer will do when preparing your by-laws? He/she will have a secretary or paralegal clerk go to the firm’s work processing inventory, pull down pro-forma by-laws, and type in your name and information. And when a lawyer forms a basic corporation the same secretary or paralegal goes online and files the appropriate forms. Even when there was paper filing the secretary or clerk would do all the work. You can do this just as easily yourself for free.

Here are a few online resources (FYI I have no personal experience with or connection to these resources):

PRINTABLE STOCK CERTIFICATES

CORPORATE BY-LAWS

CORPORATE BY-LAWS

CORPORATE SEAL

Where you may need the assistance of a lawyer, experienced in tax matters, is if you are forming a partnership, to help with the writing of the Partnership Agreement. And, of course, you also may need to consult a lawyer when forming a more complex corporation, with multiple shareholders of differing inter-relationships.

You certainly should sit down with a competent tax professional, experienced in business taxes, and go over all of your options in detail, and perform the requisite cost benefit analyses, before making any moves.

TTFN

Thursday, November 19, 2009

DOGGIE DEDUCTIONS

An email from a former co-worker (who I recently ran into coincidentally after not seeing each other for about 20 years) brought up an interesting tax issue.

Here is the pertinent portion of the email -

My wife is raising a puppy for The Seeing Eye in Morristown, NJ. The puppy is delivered at about 6 weeks and stays with the host family until the puppy reaches 12-15 months of age, at which time it is returned to The Seeing Eye for the appropriate training to become a Guide Dog. The host family is responsible for introducing the dog to the public - independently along with group excursions. Fees paid to a veterinarian are reimbursed by the Seeing Eye. However, dog food, toys and travel are not reimbursed in full. Someone in the club was wondering if these unreimbursed expenditures could be claimed as a charitable deduction. My gut feeling was that since these expenditures are made through a grocery or pet store it would be difficult to substantiate these expenditures for inclusion on the Form 1040 Schedule A. The travel, however, to attend meetings and outings may be something that could be utilized on the Form 1040 Schedule A.”

According to IRS Pub 526 (Charitable Contributions) –

Although you cannot deduct the value of your services given to a qualified organization, you may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be:

• Unreimbursed,
• Directly connected with the services,
• Expenses you had only because of the services you gave, and
• Not personal, living, or family expenses
.”

I found this advice being given at the “Frequently Asked Questions About Puppy Raising” Page of the Guide Dogs for the Blind website –

Q: Are the costs of raising a Guide Dog puppy tax deductible?

A: Yes. Guide Dogs for the Blind is a nonprofit charitable organization, and all expenses incurred by the raiser as they relate to raising the puppy (dog food, veterinary bills, gas mileage, etc.) are considered a donation to Guide Dogs. Guide Dogs suggests all puppy raisers consult with a tax advisor to receive the proper IRS requirements for documentation
.”

I tend to agree with the advice provided by Guide Dogs for the Blind.

The Seeing Eye in Morristown, NJ is a qualified charity. The purpose of the organization is to raise and train Seeing Eye dogs for use by a blind person. The dog is placed in the volunteer taxpayer’s home by The Seeing Eye as a puppy to be raised. The volunteer taxpayer begins the dog’s training by “introducing the dog to the public - independently along with group excursions”. When the dog is old enough to begin actual guide dog training it is returned to the organization.

The email indicates that the expenses incurred by the family, other than veterinarian bills, are “not reimbursed in full”. According to the organization’s website, it “provides a stipend to help defray the cost of food”, but this does not cover the total cost of the food. And no reimbursement is given for travel costs.

The website says – “Your Area Coordinator will give you an initial eight-pound bag of puppy food. We suggest you purchase the same brand in 40-pound bags at local feed stores.” So The Seeing Eye tells the volunteer taxpayer what type of food it should buy.

There is an actual “out of pocket” for food as well as for dog toys and travel to the vet and “to attend meetings and outings”.

Let’s apply the guidelines in the IRS pub.

1. A portion of the expenses are unreimbursed. There is a true “out of pocket”. Only the "out of pocket" portion is deductible.

2. The expenses are directly connected with the service of raising the puppy provided by the volunteer taxpayer.

3. The expenses are incurred only because of the service of raising the puppy provided by the volunteer taxpayer. And

4. These are not “personal, living, or family expenses”. The volunteer taxpayer is not taking in the dog to be the family pet – but as a true volunteer service to the organization. The taxpayer is required to begin the puppy’s socialization training and to return the dog when it is old enough for more specialized training.

As for substantiation – a travel diary (notes made in a regular pocket date book) would document the miles driven to meetings and organization sponsored outings. The deduction in this case would be 14 cents per mile (the standard mileage allowance for charity). The fact that the cost of the dog food and toys are on bills from pet stores and groceries should not matter. One would just circle the applicable items and make a note on the individual receipts and save them in a separate envelope. At the end of the year the amounts would be added up and the stipend received would be deducted to determine the amount of the tax deduction.

If the puppy placed by The Seeing Eye is the only dog in the household substantiating the cost of food, etc. is easy. If there is one or more other family dogs in the picture one would have to allocate the food purchases among the dogs, unless a special brand or type of food is purchased for the future guide dog that is different from the food purchased for the family dog(s). In the case of multiple dogs the cost of “toys” may be questionable, unless the volunteer taxpayer is told by The Seeing Eye what specific toys or other aides are to be purchased to assist in the puppy’s specialized socialization training.

Of course, as the email suggest, these volunteer expenses are only deductible if you can itemize on Schedule A.
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FYI, according to the IRS publication on Medical and Dental Expenses (Pub 502) -

You can include in medical expenses the costs of buying, training, and maintaining a guide dog or other service animal to assist a visually-impaired or hearing-impaired person, or a person with other physical disabilities.”

So when the guide dog is placed with a blind person, that person can deduct in full, as a medical expense (subject to the 7 1/2% of AGI exclusion) all the costs associated with the dog (i.e food, vet bills, etc).

The guidelines used to determine if the dog-raising expenses of my friend and his wife are deductible can be applied to other types of volunteer work.

For example, if you are a regular “docent” at a museum, or if you are a Board or commitee member of a charity, or if you drive members of your church’s youth organization to group events you can deduct your round trip mileage to the museum, to attend meetings, and to the events. And if you are a scoutmaster you can deduct the cost to purchase and clean your uniform. IRS Pub 526 discusses such deductible expenses in more detail.

So, Jack, I hope that I have answered your question.

Do any of my fellow tax professionals have anything to add?

TTFN

Wednesday, November 18, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’ – WEDNESDAY EDITION

The BUZZ is “chock-a-block” today! Perhaps the biggest BUZZ yet.

* Let’s start with a great story that has nothing to do with taxes from Stacie Clifford Kitts of STACIE’S MORE TAX TIPS, “A Small Town and A Diabolical Marketing Strategy that Sucked Me In”, which provides a great warning for travelers driving through small towns.

* TAX CPA Marilyn Lawver’s post “Maybe Next Year” - which observes, “It looks like we won't see any significant reform in the near future. No end in sight to massive AMT, endless credits, and a brand new Schedule L, too! Oh goody” – brought me back to her earlier post “How Does That Work”, which included some excellent comments on our current tax system -

As often happens, I find myself comparing this situation to medicine (which just might have something to do with being married to a doctor). If we only change a code section here, or a regulation there, we're just treating symptoms and not the disease.

Just like when we keep adding new credits and deductions, we keep trying to cure our economic ailments with more and more medication. And from the stories I hear, more medication is not always the best answer! It often makes things worse
.”

* TAX PROF Paul Caron tells us about a court case in which “Tax Court Applies Cohan Rule to Allow Deduction for Portion of Unsubstantiated Charitable Contributions”.

The Cohan rule (for, yes, George M Cohan, the “Yankee Doodle Dandy”) is generally applied to employee business expenses, specifically travel expenses. It is interesting to see it applied to charitable contributions, although there apparently is precedent. However, this ruling applies to a 2005 tax return, before Congress enacted strict documentation rules for charitable contributions.

What is the Cohan rule? Check out my post “In the Courts” for a basic description. Perhaps I will write a post on it next week.

{OOPS! It seems I got ahead of myself and published the post on GMC yesterday (Tuesday)! I hope you didn’t pull your hair out trying to find the reference to the Cohan Rule in last Saturday’s BUZZ.}

* Paul also brings out attention to the report “Judging Tax Expenditures: Spending Programs Buried within the Nation’s Tax Code Need to be Reviewed” by Citizens for Tax Justice in his post “CTJ: Judging Tax Expenditures”.

The report’s summary tells us (highlights are mine) –

Special tax breaks, known as tax expenditures, are generally enacted with goals unrelated to ensuring that the tax system collects revenue efficiently and fairly. Instead, these programs are designed to encourage particular activities or reward specific groups of taxpayers. Because they lack tax policy justification, tax expenditures are often described as spending programs “hidden” within the tax code.

Tax expenditures are exceedingly popular among lawmakers, but not for reasons of good policy. Rather, political attitudes and loose procedural rules are responsible for the excitement surrounding these provisions. This undeserved popularity can and should be reined in, at least in part, by implementing a tax expenditure performance review system. Such a system would impartially judge whether these provisions are fulfilling their stated objectives
.”

I have been saying basically the same thing for some time now.

* The NY TIMES has a good article by Ron Leber on “Financial Decisions to Make as You Divorce”.

Ron correctly points out that it is important to consider tax consequences when dividing assets -

In general, it’s crucial to consider the after-tax value of everything, from retirement accounts to deferred compensation when splitting up assets. Annette Brown, a divorce specialist in San Francisco, also noted that judges sometimes failed to consider which spouse could best benefit when awarding the right to future tax deductions and credits relating to the couple’s children.”

It is important to get a tax professional involved in drafting the divorce document, or at least let one review the document before you sign. A lawyer may be extremely competent and experienced in divorce law but may not know his arse from a hole in the ground when it comes to taxes.

I recently went through a long and tedious situation with the IRS, which I eventually “won”, because a divorce agreement was not properly worded.

Check out my 4-part series on “Till Divorce Does Us Part” – Part I, Part II, Part III, Part IV.

* I like Ron Teuber’s “Friday's Tax Quote - November 13, 2009” at the TAX LAW FORUM blog –

"A fine is a tax for doing something wrong. A tax is a fine for doing something right."
- Anonymous.

That Anonymous guy really said a lot of good stuff!

* Kay Bell discusses a truly unique tax subject that has been getting some press lately in “Dissecting Taxation of Human Body Parts” at DON’T MESS WITH TAXES.

Kay quotes from an item by Lisa Milot of the University of Georgia Law School –

"Transfers of human body materials are ubiquitous. From surrogacy arrangements, to sales of eggs, sperm and plasma to clinics, to black markets for kidneys, to pleas for donations of body materials, these transfers are covered and debated daily in popular and academic discourse.

There are no statutory provisions directly on point, Internal Revenue Service guidance is outdated and conflicting, and the small number of judicial decisions in this area are narrowly written to resolve only the tax liability of the particular taxpayer before the court
"

Kay’s bottom line – “Well, it turns out that a pound of flesh (although usually much less) might one day literally be considered when it comes to taxation.”

My special report on DEDUCTING MEDICAL EXPENSES ON YOUR 2009 FORM 1040 (available for $2.00 sent as a pdf email attachment) tells us that, while the value of the donated egg or embryo are not taken into consideration, you can deduct -

The cost of fertilizing and transferring a donated egg or embryo, as well as expenses to obtain an egg donor that are directly related to and in preparation for receiving the donated eggs or embryo. This includes agency fees, donor fees, the donor’s medical and psychological testing fees, insurance premiums paid for post-procedure assistance, and legal fees for preparing the donor contract.”

* Another Kay Bell item - this time it is not from DON’T MESS WITH TAXES but Kay’s other blog EYE ON THE IRS at Bankrate.com. I offer the post “'Accidental' Mortgage Interest Deduction”. This post discusses the history of the mortgage interest deduction – which Kay has gone from "accident to birthright."

Kay tells us that -

Many economists believe, however, that the effort to increase homeownership, typically through tax breaks, has played a major role in our current economic crisis.”

And, Kay, thanks for the post on my George M Cohan item!

* Bruce, the MISSOURI TAX GUY, has lots of interesting “stuff” in his weekly “Reads from Last Week” entry. I thank Bruce for the reference to, and thoughts on, my post on a National Sales Tax.

Bruce is always finding new interesting blogs. I especially liked the post he referred to from the OUTBREAK blog, a blog which is also new to me. And, as usual, Bruce links to some good advice from personal finance blogs.

As for “Snoopy music”, I like “Supper Time” from the musical YOU’RE A GOOD MAN, CHARLIE BROWN. And, of course, the tales of Snoopy’s battles with the Red Baron from the 60s.

*Bruce also begins what looks like a series of posts on the dreaded Alternative Minimum Tax with “A Brief Overview of the Alternative Minimum Tax (AMT)”, which details the background and history of the damned thing.

* FYI, JOE TAXPAYER also has a weekly BUZZ-like review of personal finance blog posts which he titles “This Week’s PF Blogger Roundup”. I especially liked the post “5 Dumb Mistakes That Smart People Make” that JT references.

* The OUTBREAK blog that I discovered on Bruce’s post led me to a good “State By State Sales Tax Summary” from Wray Rives, CPA’s self-titled blog. The 9/1/09 post provides details and links for each state that has a sales tax. It is a good post to “favorite” for future reference.

* TIGTA (the Treasury Inspector General for Tax Administration) has issued a report titled “Millions of Taxpayers May Be Negatively Affected by the Reduced Withholding Associated With the Making Work Pay Credit” (now there is a mouthful – say that 5 times fast!). The report discusses a disturbing, but not unexpected, result of the new tax withholding tables instituted to allow taxpayers to take advantage of the MWP credit.

According to the press release (highlights are mine) -

TIGTA found that the implementation of the MWPC creates the possibility that more than 15.4 million taxpayers may be advanced more of the credit (through reduced withholding) than they are entitled to receive. When filing their tax returns for 2009 and 2010, such taxpayers may ultimately owe additional taxes. Some also may be subject to estimated tax penalties.”

Back when the new withholding tables were instituted I, and just about every other tax blogger, warned about the unintended consequences. As TIGTA explains -

The MWPC was implemented using new income tax withholding tables. However, the changes to the withholding tables did not take into consideration: dependents who receive wages; single taxpayers with more than one job; and joint filers where one or both spouses have more than one job or both spouses work. Other groups potentially affected include: individuals who file a return with an Individual Taxpayer Identification Number; those who receive pension payments; and Social Security recipients who receive wages.”

* Russ Fox makes a very astute observation in his post “Senator Reid Looking at Increasing Social Security, Medicare Taxes for the Wealthy” at TAXABLE TALK –

Frankly, the current Administration and the current Congressional leadership has little clue about economic development.”

If any!

* Annette Nellen, CPA/Esq discusses the “Need for Penalty Reform at Federal Level” at 21st CENTURY TAXATION. She tells us that “There are about 130 civil penalties in the Internal Revenue Code”.

The post takes you to a very extensive article on the subject by Annette at another “location”.

* Trish McIntire gave us two good posts at OUR TAXING TIMES on Sunday.

The first, “Buyer Education VII”, continues her excellent series with a discussion of “Advice From Non-Preparers”.

Trish correctly says –

I would suggest calling your tax professional if you are tempted to follow tax advice given by your:

• Barber/Hairdresser
• Real Estate Agent
• Car Sales Person
• Home Improvement Guy or Gal
• The Loudmouth at Work
• The Know-it-All Relative
• The Golf Cart Sales Person
• The Fund-raiser
• Anyone who will make money or benefit from you making the tax decision they are suggesting.

I am sure most of these people are good people. Some of them have heard the info they are sharing and are passing it on. The problem is that they may not understand it well enough to share, or didn't get all the restrictions, or they're wrong. Or, they are trying to sell you something and using tax savings/credit to get you interested or push the sale
.”

Hey, I have said for years now that the best tax advice I can give someone is to not accept tax advice from anyone other than a competent tax professional.

Trish then goes on to talk about “Locking the Barn Door”. She tells us –

My concern is with the tax planning that isn't getting done, now or at any time of the year. These are the major, life changing events and it is surprising how many taxpayers don't think of them until it is too late. A few examples:

• Retirement
• Child leaving home (not just to school) or turning 17
• Starting Social Security (with or without retirement)
• Unemployment
• Starting a business
• Divorce
• Marriage

All these life events can cause a change in your taxes and generally not for the good. But, they can be planned for and adjustments made to withholding and estimates
.”

Hey, I have been saying, “Once the ball drops on One Time Square and the New Year is rung in there is little you can do to reduce your tax liability” for decades.

* Over at the INTUIT (Hey, man, I’m not into it) website Terry Myers and Dee DeScherer tell us that “2009 has also seen a number of important new rulings from the IRS and the courts” and that “These new rulings may have a significant impact on the returns of certain clients” in a “Tax Article” titled “New Rulings Impact 2009 Form 1040”, and provides a detailed discussion of some of these rulings.

A tip of the hat to Kerry M. Kerstetter, the TAX GURU.

* Andy talks about “Taxes and Gains I Can Exclude When Selling My Home” in a comprehensive post on the subject at SAVING TO INVE$T.

* The BRAIN DEAD SIMPLE! FINANCIAL ORGANIZING blog has a good post titled “A Tool for Comparing Roth vs Traditional IRAs”.

This subject has been covered extensively by other personal finance bloggers and authors; the purpose of this post is to provide links to articles covering the basic concepts, and a simple tool for comparing taxable, tax-free Roth and tax-deferred traditional IRA and 401 (k) accounts.”

* The TAXES OBSERVED blog, a new one to me, has been running a series on FAQs regarding the new First Time Home Buyer’s Tax Credit.

* Let me end by wishing myself a happy 56th birthday.

TTFN

Tuesday, November 17, 2009

BEWARE OF BAD BLANKET ADVICE

There is very little, if anything, about tax law that is a “no-brainer” – especially when it comes to business taxes. That is why tax professionals exist.

I do agree that all small businesses, regardless of the number of owners, that would not benefit financially by incorporating should register their activity as an LLC to get the liability protection. It is relatively inexpensive to do so, and it can probably be done online by the business owner himself/herself without having to pay a lawyer. But I also believe that a one-person LLC should elect the “default” entity and file a Schedule C. It is my opinion that if you want to file as a corporation you should incorporate.

I believe it is bad advice to tell ALL taxpayers who have a Schedule C business to incorporate. There is no tax advice that applies to all businesses in all situations (except don’t cheat). The decision to incorporate a business requires careful review of all the specific facts and circumstances of the individual situation. And taxes are not the only consideration. In a majority of cases it is not financially beneficial, either in the short or long term, to incorporate.

The advice that one should incorporate solely for the purpose of avoiding an audit seems to me to be saying, “If you want to cheat on your taxes you can incorporate and the IRS will not audit you”. It is not good tax or financial advice.

I have said time and again that an IRS audit is not something that should be avoided at all costs. Tax returns should be prepared, and decisions about choosing a business entity should be made, in such a manner as to generate the absolute least amount of federal, state and local taxes (income and payroll) within the parameters of federal and state laws. If you will pay less taxes (income and payroll), fees and other costs by filing a Schedule C you should do so, honestly and ethically, and not worry about being audited.

If your return is prepared correctly, and you document all items of income and deduction properly upfront, then an audit is nothing more than an inconvenience.

It is very true that one consideration out of many in determining whether or not to incorporate is the fact that the audit profile of the business will be reduced, and more so in coming years. But it is only one – and a minor one at that. At most it is merely “icing on the cake”. Unless, of course, you are a crook.

If you are told that there is a substantially greater chance of being audited if you deduct your $10,000 gift to a qualified charity, which you did properly and have all requisite documentation, it would be bad advice to tell you not to deduct the $10,000. The deduction is genuine and you can prove it. Who cares if the IRS asks you to prove it?

I do agree that there are indeed times when it is “more better” financially to incorporate a one-person business, especially when excessive health insurance costs are involved. But certainly not in all cases.

The decision to incorporate is by no means a “no-brainer”. It involves a lot of brain work!
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Fellow tax professionals - what do you think?

I'M A YANKEE DOODLE TAX PRO!

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As promised in last Saturday’s BUZZ here is the story on the famous “Cohan Rule”.

George M Cohan was a playwright, composer, lyricist, actor, singer, dancer and producer who started out Vaudeville with the family act known as “The Four Cohans”. According to Wikepedia he was "Known as 'the man who owned Broadway' in the decade before World War I, he is considered the father of American musical comedy”.

Appropriately his life was made into the Broadway musical GEORGE M!, which was Joel Grey’s follow-up to CABARET. GEORGE M! also starred a young Bernadette Peters as Cohan’s sister.

His life story had previously been brought to the big screen in the classic YANKEE DOODLE DANDY with James Cagney. This movie is usually shown each year on July 4th on TCM or elsewhere. BTW, Cagney reprised the role of GMC for a guest appearance in THE 7 LITTLE FOYS, with Bob Hope as Eddie Foy. And, correct me if I am wrong, but I do believe that Eddie Foy himself appeared briefly as himself in YANKEE DOODLE DANDY.

GMC was famous for the line “My mother thanks you. My father thanks you. My sister thanks you. And I thank you”, which was addressed to the audience at the end of the family’s Vaudeville act.

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Among the many songs written by GMC are "Give My Regards to Broadway", “The Yankee Doodle Boy” (“I’m A Yankee Doodle Dandy”), “You're a Grand Old Flag", "Forty-five Minutes from Broadway", "Mary Is a Grand Old Name" and “Over There". He also taught us how to spell H-A-RR-I-G-A-N.

George M is still represented on Broadway in the form of a statue in the middle of Times Square.

FYI, while he always said he was “born on the 4th of July”, according to his Wikepedia profile a baptismal certificate indicates that he was actually born on July 3, 1878.

The “Cohan Rule” refers to the decision in the federal court case Cohan vs. Commissioner, 39 F. 2d 540 (2d Cir. 1930). This case resulted from one of the first IRS audits. The IRS disallowed Cohan’s deductions for business travel citing Internal Revenue Code Section 162. Under IRC 162 a taxpayer must establish that an expense was (1) paid or incurred for (2) business or profit-oriented purposes and (3) the amount spent.

Fred W. Daily explains the situation in his copyrighted article “Getting Audited? Can't Find All Of Your Records? No Problem”.

The IRS took the position with Mr. Cohan that even if he could convince an auditor that the business expense qualified for a deduction (satisfy number 1 and 2), that he also must be able to fully document the amount spent (number 3). George replied that he was always on the run, and had little time to document many of his expenses. George challenged the IRS stringent record keeping requirements in court. His lawyers argued that the IRS was wrong because even though records were missing, George had presented other credible evidence of the amount of the expenses on which approximations of the true amounts could be made.

George had explained the necessity of the (undocumented) expenses and offered his recollections and approximations of the amounts incurred. The items ran from cab rides and tips to large hotel and restaurant expenses for George and his entourage. The Federal Appeals Court, in an opinion by the aptly named Judge Learned Hand, held that the sums were allowable business expenses. It was unreasonable of the IRS not to allow, at least some of his earnings, not to be based on Cohan's approximations
.”

Another FYI – Judge Learned Hand is the author of the famous quote –

Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands."

What the Cohan ruling says is that since GMC travelled the country to produce and appear in theatrical productions, which was public knowledge via programs and newspaper accounts, it is reasonable and appropriate to assume that he must have incurred certain deductible expenses.

Under the Cohan rule if there is no documentation, but other evidence clearly indicates that some deduction should be allowed, the court may come up with its own estimate. As the Fifth Circuit held, “if a qualified expense occurred, . . . the court should estimate the expenses associated with those activities”.

Over the years Congress has, by statute, required more detailed documentation for certain types of expenses in order for a deduction to be allowed – such as business travel and entertainment, business gifts, listed property (autos, computers, cell phones, and certain entertainment property), and, most recently, charitable contributions.

Is the Cohan Rule still a credible “defense” today? It appears so, as per the item from last Saturday’s BUZZ where it was applied not to business expenses but to charitable contributions.

In an August 2008 blog post from RUBIN ON TAX titled “Is There Life Left In the Cohan Rule” author Charles Rubin refers to the article “Cohen Rule Still Secures Some Deductions Despite Statutory Limits” by Paul G. Schloemer from Practical Tax Strategies. Schloemer conducted a survey of tax cases where the Cohan Rule was invoked to see if the rule still had viability. Rubin tells us, “Happily, he reports that the rule is alive and well”.

Rubin pointed out that –

Mr. Schloemer notes that there are two key variables that courts will look for in allowing a taxpayer to rely on the Cohan Rule. The first is that SOME documentation will be needed - oral testimony alone probably will not cut it. The second variable is the veracity of the taxpayer's testimony, since the court will need to have some level of trust in the taxpayer's assertions before it will allow deductions under the rule.”

Despite the fact that this “out” exists, you should not use it as an excuse not to keep good contemporaneous records and maintain detailed documentation of all your business expenses.

TTFN
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OOPS! THE REFERENCE TO THE COHAN RULE APPEARS IN TOMORROW'S (WEDNESDAY EDITION) BUZZ - IT WAS NOT IN SATURDAY'S BUZZ EDITION. MY BAD

Monday, November 16, 2009

THE WHABAA

President Obama signed the Worker, Homeownership, and Business Assistance Act of 2009 (H.R. 3548) into law on November 6, 2009. It had passed the Senate 98 to 0 and the House 403 to 12. So its passage was almost unanimous.

The Act extends unemployment benefits for 14 more weeks in all 50 states and up to 20 more weeks in states with a 3-month average unemployment rate of at least 8.5%. The temporary exclusion of the first $2,400 of unemployment benefits was not extended into 2010. The additional unemployment benefits is paid for by extending the 0.2 percent Federal Unemployment Tax Act (FUTA) surtax through June 30, 2011.

But since this is a blog about 1040 taxes I want to talk about the provisions that affect the 1040.

As we all know by now the centerpiece of this bill iss the extension and expansion of the First Time Homebuyer Credit, which was set to expire on November 30, 2009. The $8,000 refundable credit is extended for purchases made through April 30, 2010. It will also apply to purchases that close between May 1 and June 30, 2010, providing the taxpayer entered into a written binding contract to close before May 1, 2010.

The phase range out for purchases made after November 6, 2009 is now “modified” Adjusted Gross Income between $125,000 and $145,000 for single (and head of household and separate) filers and $225,000 and $245,000 for joint filers.

The Act also allows “existing homeowners” to claim a credit of up to $6,500 ($3,250 if married filing separate) on purchases made after November 6, 2009, if they owned and lived in, as a primary residence, the same home for any five (5) consecutive years during the eight (8) year period that ends on the date of purchase of the new home.

Qualified purchasers who close in 2009 can continue to elect to treat the purchase as being made in 2008 and file an amended 2008 return to claim the credit and a check. And qualified purchases made in calendar year 2010 can be treated as being made in 2009, with the credit claimed on the 2009 Form 1040.

So if you purchase a home, and qualify for the credit, in early 2010 be sure to give the Settlement/Closing Statement to your tax professional with your 2009 tax “stuff”. If you plan to purchase by the April 30 (or June 30) deadline but have not done so at the time you give your tax pro your “stuff” be sure to tell him/her of your intentions.

For purchases made after November 6, 2009, the purchase price cannot exceed $800,000. If you close on a home today, and you otherwise qualify for the credit, you will not be eligible for the credit if the purchase price of the home is more than $800,000. Previously there had been no limit.

I, and others, had criticized the previous credit for being too easy to get. All you had to do was ask for it. No documentation or declaration was required. As a result there were many fraudulent claims filed and tons of money was sent to individuals who did not qualify for the credit. To “fix” this Congress added additional requirements and conditions for the credit.

For purchases made after November 6, 2009, you must be at least age 18 in order to qualify for the credit, and you cannot be claimed as a dependent on another taxpayer’s return. And the definition of a “related party” now includes relatives of a taxpayer’s spouse. You cannot purchase the home from an “in-law” (parents, grandparents, children of a spouse) and qualify for the credit.

And, most important, you now must attach a “properly executed” copy of the Settlement or Closing Statement to your tax return. This applies to all qualified purchases made during calendar year 2009 through the 2010 expiration dates where the credit is requested on a 2009 (or 2010) tax return. The National Association of Tax Professionals’ analysis of the Act states that “it does not appear that closing statements need to be attached to amended 2008 returns”. Why Congress did not require this for all claims submitted after November 6, 2009, whether on a 2008 or 2009 return, is beyond me.

Unlike the initial $7,500 credit, none of the $8,000 or $6,500 credit needs to be repaid, unless the new home ceases to be the taxpayer’s principal residence within 36 months of the date of closing, except, or course, for death.

Special rules apply for members of the uniformed armed services, members of the Foreign Service, and employees of the “intelligence” community. The credit is available until April 30, 2011 (or June 30, 2011 if there is a written binding contract in place before 5/1/11) for those qualifying personnel stationed outside the United States for at least 90 days.

And the 36-month recapture provision is waived for qualified personnel who claimed the credit and either sold the home or stopped using it as a principal residence after December 31, 2008, due to government orders received for qualified official extended duty service.

FYI, while I will be thrilled if some of my clients can get a piece of this “pie”, I share the opinions of many of my fellow tax bloggers concerning this credit. If I were a Senator the vote would not have been unanimous.

The other provision of the Act that could affect 1040s is allowing taxpayers to elect to “carry back” a 2009 “net operating loss” (NOL) for five (5) instead of two (2) years. Certain small businesses were previously permitted to carry back a 2008 NOL for five (5) years. For 2009 NOLs the 5-year carryback period is eligible for almost all business operations, not just “small” businesses.

The amount that is carried back to the 5th preceding year may be limited to 50% of the taxpayer’s taxable income, without regard to the NOL, for that 5th year.

The NOL carryback issue is truly a complicated one, whether 2 or 5 years, as I recently discovered. Anyone who may be involved in a NOL situation should most definitely consult a tax professional who is experienced in NOL filings.

Of special interest to me, as a tax professional, is the provision of the Act that requires any tax return preparer who prepares more than 10 individual income tax returns during a calendar year (this includes returns for estates and trusts) to electronically file the returns.

This requirement is effective for tax returns filed after December 31, 2010. So it does not apply to the upcoming tax filing season, but will take effect in 2011 for the filing of 2010 returns.

While it was a common belief among tax professionals that such a requirement was coming, it was not expected to come so soon. We all thought that this mandate would be included in the eventual legislation that would require the IRS regulation of all paid tax preparers.

NATP recently told its members in its weekly email newsletter -

As it is stated, this is all the new law provides {i.e. e-filing required – rdf}. At this time, there is no guidance on how clients can "opt out" or otherwise file their returns on paper. It appears that a return that is "filed" by the taxpayer does not have to be electronically filed. The way in which the law is written is unclear on this point.”

Many states already have such e-file mandates. NJ requires paid tax preparers, who prepared 50 or more returns in the prior year, to file state income tax returns electronically – but this can be done free of charge, and without using tax preparation software, via the internet and clients can elect to “opt out” and elect to have their state return filed “the old fashioned way”.

TTFN