Archive for the ‘Back to Basics’ Category
Back to Basics Part XVI – Form 3903 – Moving Expenses
Filed under: Back to Basics | Tags: 39 weeks, 50 miles, 78 weeks, distance, Form 3903, Gas, hotel, house hunting, laid off, leases, lodging, meals, military, move, moving expenses, packing, parking, reimbursement, retiring, security deposits, time, tools, transferred, transportation, utilities
Leave a comment Originally published in the Cedar Street Times
June 12, 2015
The U.S. Census Bureau estimates that average Americans will move 11.7 times in their lifetimes, with 6.4 of those moves between the ages of 18 and 45. Most of those moves between 18 and 45 will likely be work related moves that will qualify people for tax breaks on the expenses incurred during the moves. Today we will be talking about Form 3903 – Moving Expenses. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
A lot of people may not realize they can deduct expenses related to a move. It is true, that in order to receive preferable tax treatment, a move must have a change of work location component, but it does not actually mean you have to find a job before you move, or even be the reason you move in the first place. You could move to the Monterey Peninsula, or anywhere for that matter, simply because it is beautiful, and you could still deduct moving expenses as long as you meet two primary tests – time and distance.
The time related test says that you must have a full-time job for 39 weeks out of the first 52 weeks in your new location. You do not have to know in advance. The weeks do not have to be contiguous, nor do they even have to be with the same company, or even start when you arrive, but they do need to be full-time. There are some exceptions to this 39 week requirement, such as getting laid off, getting transferred by your employer, or retiring to the U.S. from another country. Another out for you is to keel over and die, at which point your executor can still claim the moving expenses on your final return…people rarely go for this tax planning strategy.
If you are self-employed, you have to work full-time for 78 weeks out of the first 104 weeks after moving. You might wonder how you are supposed to take a deduction for something that takes longer than a year to really know if you qualify. The answer is that you claim the deduction in the tax year or tax years the moving expenses are incurred if you have reason to believe you will meet the requirements. If you are wrong, and you claimed expenses you should not have, you are supposed to either amend the prior return(s) or add it as additional income to your next tax return. If you did not claim expenses and later realized you qualified, then you have to amend.
The other test is the minimum 50-mile distance test. People often think the distance test is based on the distance from their old home to their new home, but it is actually based on the difference between the distance from your old work place to your old home and your old work place to your new home. So if your old commute was 10 miles one-way to work, then the distance from your new home to your old work place needs to be at least 60 miles. This could create some interesting situations. Let’s assume you work a block from your house. Then you receive a high-paying job offer in another town 51 miles away. Your family is rooted in your existing community so you really do not want to leave the area. With the increased pay you decide to buy the house for sale which is next door to your old house. In this case you would meet the distance test, even though you will have only moved next door, and you can deduct any qualified expenses.
So what expenses qualify? In a thimble, the answer would be packing costs, transit of household goods and family members, as well as lodging costs. In other words, all the packing boxes, tape, markers, bubble wrap, movers, truck rentals and related fuel, airline costs, parking and tolls, pet transportation costs, hotel bills, etc. If you drive your cars to transport them, or if you use them for trips back and forth to haul goods, you can deduct 23.5 cents per mile or deduct gas and oil receipts. You can also deduct the cost of storing your goods between houses for up to 30 days. In addition, you can deduct the cost of disconnecting or reconnecting your utilities. If you are moving overseas, you can deduct the costs of storage of your household items in the U.S. each year until you return. After the year of move, these expenses would not go on a 3903, but directly on your 1040 or 1040NR.
There are number of costs you are specifically NOT allowed to deduct as well. Some of these include meals during the move, extra driving or lodging due to sightseeing during the move, pre-move house hunting expenses, fees paid for breaking leases, or security deposits given up on your old home, among others.
If you are in the military, and you receive PCS (Permanent Change of Station) orders, you are automatically qualified, and neither the time nor distance tests apply. You can also deduct the costs of your move within one year of ending your active duty. There are other special rules for military moves as well.
Regardless of who you are, if you get reimbursed by your employer and the reimbursements are not treated as taxable income to you (included in box 1 of your W-2 as income), then you can only deduct the expenses in excess of the reimbursement. Normally, employers report moving expense reimbursements in box 12 with a code ‘P,’ and they are not treated as income in box 1.
Once you figure out your deductible expenses and reimbursements, the Form 3903 is a short five-line form. It feeds into the adjustments to income section on the face of your 1040. This is positive since it is available to all taxpayers, and not just those who itemize deductions.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics – Part XV – Form 2848 Power of Attorney
Filed under: Back to Basics | Tags: competent, conservatorship, CPA, disease or injury, executor, Form 2848, Form 56, FTB, incompetent, IRS, Notice of Fiduciary Relationship, out of the country, Power of Attorney, practice rights, representative, sign your return, trustee
Leave a comment Originally published in the Cedar Street Times
May 29, 2015
Question: My mother is older and it is sometimes difficult for her to sign her tax returns. I have a general power of attorney over her affairs that her estate planning attorney put together for us, so am I authorized to sign her tax returns? Also, we need to file a tax return for my son, who is away at college. Can I sign for him now that he is over 18? Can I call the IRS and talk to them about my mother’s taxes or my son’s taxes if needed?
Answer: In all of these cases, the IRS would first want you to file a Form 2848 – Power of Attorney. This is a limited power of attorney that just governs tax issues. (California also has an equivalent Form 3520, although they will generally accept a copy of the IRS Form 2848 as well.)
The Form 2848 is the standard document the IRS uses to process any individual that is acting as a representative for another person. As a CPA, I use this document as well when a client needs me to get access to their past tax information, balances owed, current status of notices, etc. It is also used if they need me to represent them during a tax audit. As with a general power of attorney, it is only good as long as the person is living. Once someone dies, a Form 56 – Notice Concerning Fiduciary Relationship is filed instead. An authorized executor or trustee, for instance, would file a Form 56, as a fiduciary, and they literally step into the shoes of the deceased individual with all the rights and authority that person had. After filing the Form 56, the fiduciary could then file a 2848 to authorize someone else, such as a CPA to represent them.
It is important to note that you cannot give just anyone full representation rights by filing a Power of Attorney. CPAs, attorneys, EAs, and immediate family members, are the only ones you can appoint for individual representation and provide them with full authority and practice rights before the IRS. (There are certain other classes that have limited practice rights, however.)
The Form 2848 also allows you to designate what authorities and for what tax periods you want to designate to your representative (such as “Income taxes and Gift taxes, Forms 1040 and 709, 2011-2015”). You can also indicate if you want your representative to receive copies of all IRS communication with you, if you want them to be able to add additional representatives without your consent, sign your returns, etc. If you want them to be able to sign your returns, there is additional language required as specified in the instructions to the 2848.
Generally, anytime you file a new Form 2848 it will replace any prior power of attorneys on file with the IRS unless you indicate otherwise and provide copies of the prior power of attorneys you wish to remain in effect. Both, the taxpayer and the representative must sign the power of attorney. Also note that this IRS Form 2848 – Power of Attorney does not replace or affect a general power of attorney in any way for other purposes. It is only used with the taxing authorities.
If the taxpayer is competent, but unable to sign the Form 2848, the IRS will allow an “X” to be made with the signature of two witnesses as well, and an explanation. In the case of someone who is incompetent, hopefully they had a general power of attorney. In these cases, as with the situation of the mother in the question at the beginning of the article, the power of attorney can be filled out with the exception of the taxpayer signing, and then the general power of attorney can be attached to the Form 2848. In the case of incompetent individuals without a general power of attorney in place it can become a sticky situation. A conservatorship is the proper legal vehicle to give one adult authority over another adult’s affairs when that person is incompetent and no other planning is in place, but this can be quite costly and impractical at times. I’ll let you wrestle with the IRS on that one!
If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
As an addendum to the print version of this article, I am adding this additional information regarding authorizing someone else to sign your tax returns for you. Generally, you can only authorize someone to sign your returns if: 1) disease or injury prevents you from signing, 2) you are out of the country for at least 60 days prior to the tax return due date, or 3) you request and the IRS grants you permission. In the question of the college student who needs a parent to sign his returns or the mother who has difficulty signing, both would have to meet one of these three requirements as well.
Back to Basics Part XIV – Form 2441 – Child and Dependent Care Expenses
Filed under: Back to Basics | Tags: $3000, $5000, $6000, 13 years, Child and Dependent Care Expenses, childcare, cleaning, clothing, cooking, day camps, daycare, dependent care benefits, Education, Flexible Spending Account, food, Form 2441, Form W-10, FSA, kindergarten, lodging, overnight campts, summer school, tutoring
Leave a comment Originally published in the Cedar Street Times
May 15, 2015
Question: I am the bread winner in our household. My wife is a homemaker and is the primary caregiver for our children, but we still send them to daycare once a week so she can have some uninterrupted time to go shopping, have a quiet lunch, and do some other chores. Can we claim the childcare expenses and get the childcare credit?
Answer: No. One of the requirements for claiming childcare expenses is that it is enabling you to go to work, or actively job search (or you are disabled or a full-time student). If your wife had a part-time job, or a self-employment activity and worked one day a week, then you could claim the childcare for the day you work each week, but you would still not be able to claim the childcare for the non-working day, even though you paid for childcare. This would also be why you cannot claim your Friday night babysitter when you go to dinner and a movie – nobody is working!
This week we are talking about Form 2441 – Child and Dependent Care Expenses. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
As our Q&A clearly pointed out, the intent of the credit is to allow people to earn more money…which the IRS can then tax. But there are a host of other rules. First of all, who qualifies? If it is for childcare, the child has to be under 13 years old. If the child turns 13 during the year, you can claim expenses up until the day the child turns 13. You can also claim dependent care expenses for a physically or mentally disabled spouse or any other disabled person you can claim as a dependent. You can even claim it for disabled individuals that would be a dependent except their income was too high (there are a few other exceptions as well).
Divorced or legally separated parents can generally only claim the credit if the child lives with them the majority of the nights of the year. Even if you are allowed to claim the child as your dependent per your divorce agreement (such as in alternating year agreements), you still cannot claim the childcare expenses you pay unless the child spends the majority of the nights of the year with you. If your status is Married Filing Separate, you can only claim the credit if you meet the requirements already discussed, plus, you must not have lived with your spouse at any time during the last six months of the year, and you must have paid more than 50 percent of the costs of maintaining your household.
Second, what expenses qualify? Clearly the normal child or dependent care expenses paid to the provider while you work are deductible. You can also deduct the cost of day camps for children during the summer, for instance, but not overnight camps, tutoring, or summer school. You can claim the cost of household expenses such as cleaning and cooking if the individual is also caring for your child and the benefit is partly for your child (such as a nanny that cleans, cooks, and cares for your child). You cannot deduct the cost of education, food, entertainment, lodging, or clothing unless the expenses are incidental to the care provided and not separated out on the care provider’s bill. However, for children younger than kindergarten, you can deduct education expenses as childcare.
Third, how is the credit calculated? The most in childcare expenses that you can claim is $3,000 for one qualifying individual. If you have more than one qualifying individual you can claim up to $6,000. The expenses do not cap out at $3,000 per person either, meaning that if you had only $1,000 of expenses for one child but had $8,000 for the other child, you could still claim $6,000. The credit is then multiplied by a factor of 20 to 35 percent based on your adjusted gross income. If you had over $43,000 in adjusted gross income, which most people do in California, you will be limited to 20 percent. So the 20 percent times $6,000 would be a $1,200 maximum tax credit. Remember that tax credits are much better than tax deductions as they are a dollar for dollar reduction of tax. There are some other limitations as well. For instance, the amount of the credit is limited to the amount of tax you owe (meaning that it is not a refundable credit). Also, the aggregate amount of expenses you can claim are limited to the lower of your earned income or your spouse’s earned income.
Some people get dependent care benefits through their work. For instance an employer may pay the childcare provider directly or actually provide childcare onsite. Or, the employee may make pre-tax contributions from his or her paycheck and put the money into a Flexible Spending Account (FSA) through work to be used for childcare expenses. The amount or value of these items cannot exceed $5,000 each year. Several limitations to this amount are applied on Form 2441. If some of it is disallowed it is added back as an adjustment to wages. There is also the possibility of getting the credit pertaining to the extra $1,000, since $6,000 of expenses are allowable with multiple children, and the dependent care benefits are capped at $5,000.
The Form 2441 itself is a two page document. The first part requires information about the care provider such as name, address, taxpayer identification number and amount paid. Your safest course of action is to provide a Form W-10 to the daycare provider, for the daycare provider to fill out and give back to you. This is a special form just for daycare providers to fill out to provide their correct taxpayer identification information and certification to you. You can then safely rely on that document and not be concerned about the denial of your deduction if you have incorrect information in this regard. Part II of the Form 2441 requires information on the individuals receiving the care and then calculates the tax credit. Part III deals with dependent care benefits and plays into Part II as well.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part XIII – Form 4868 Application for Automatic Extension
Filed under: Back to Basics | Tags: April 15, automatic extension, certified mail, estimated tax payments, Extension, Form 3519, Form 4868, Franchise Tax Board, interest, IRS, late payment penalty, late return penalty, October 15, Social Security Number, underpayment penalty, United States Treasury
Leave a comment Originally published in the Cedar Street Times
April 3, 2015
Two weeks ago we discussed underpayment of estimated tax – a penalty that is assessed prior to the April 15 due date if you did not pay enough tax in ratably throughout the prior year. Essentially these penalties are the equivalent of the taxing authorities wanting to be paid in installments rather than a lump sum check at the end of the year. (You would be equally upset if your employer only paid you once a year as well!) So they effectively charge you interest (currently a three percent rate) if you do not have enough tax paid in quarterly throughout the year. This week we are going to talk about filing an extension and the penalties and interest that you will incur beginning after April 15 if you do not file and/or pay on time. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
The most important piece of advice is to file your return on time! When I say on time, I mean by April 15, or if you file a valid extension, then by October 15. In years where those dates fall on a weekend or holiday, the return due date is pushed to the next business day. There can be hefty penalties for filing a late return, which we will discuss later. Form 4868 is the federal form used to apply for an extension, and you have to postmark it by April 15 for it to be valid. If you are concerned of a postal mishap, U.S. certified mail is the correct way to document it was mailed on time. California gives you an automatic six month extension if you need it, and nothing is required to be filed to receive the extension. (Note there are exceptions regarding extensions for individuals out of the country on April 15, as well as for military people overseas, which we are not discussing in this article.)
Regardless of whether or not you file an extension, the tax is still due on April 15. So you want to be sure you have enough tax paid in to cover the liability when you finally do file the return. This means, you have to do a rough calculation at least, and then send in a check for the estimated tax with the 4868. It would be prudent to estimate on the high side if there is any doubt. If you end up not owing as much as you paid in, you can get a refund when you file the returns, or you can have it applied to the next year’s tax returns, and it will be credited to you as of the original April 15 due date when the first estimated tax payment was also due for the current year taxes (for those that pay quarterly estimates, this is very helpful).
When putting people on extension that pay quarterly estimated taxes, I will typically have them pay the remaining projected balance due from the prior year, plus the first quarter estimate for the current year and have all of this applied as a payment towards the prior year return. This gives them a cushion in case the estimates are wrong. Then, after the returns are filed, any leftover amount is then applied to the current year return and gets credit as of April 15 and everything is fine. If you project you will owe to California, then you will have to fill out a California Form 3519 Payment for Automatic Extension for Individuals and remit a check with that form.
The mechanics of filing the federal Form 4868 are quite simple. On the left side of the form you fill out your name, address, and social security number. On the right side you list your estimate of your total tax liability, the amount you have paid in so far, and then subtract the two to get the estimated amount you are short or over. If you are short, then you write in how much you are planning to pay with the extension. Hopefully you have enough to pay the balance, but if you do not, just pay what you can, and keep making payments when possible. Write your name, social security number, the year for which the tax is due and “Form 4868” on the check as well.
The California Form 3519 Payment for Automatic Extension is quite simple also. You do not even have to list estimates, but just the amount you are paying in addition to your name, address, etc. You would provide similar information on your check to California as well. Federal checks are made out to the “United States Treasury.” California checks are made out to the “Franchise Tax Board.” The mailing addresses are on the forms and related instructions, which can be downloaded online for free. If you are sending in a check for a married filing joint tax return, it is best to put both taxpayer names and social security numbers on the forms AND on the checks.
Now let’s talk about what penalties and interest you will incur if you do not file on time and/or pay on time.
Late Return Penalty
As I mentioned earlier, the most important piece of advice is to file your return on time! A late tax return with the IRS carries a hefty penalty of five percent of the unpaid tax PER MONTH or portion of a month until you file your tax returns. For those of you who aren’t doing the math in your head, that is the equivalent of an annualized interest rate of 60 percent per year (and you thought credit cards were bad!). Fortunately they cap that penalty after five months of delinquency thus maxing it out at 25 percent. Not to be left out, California conforms to this and charges the same for late returns based on the amount of California tax owed.
Late Payment Penalty
Regardless of whether or not you file an extension, if you do not pay the tax by April 15, the IRS will assess you 0.5 percent PER MONTH on the unpaid tax, capping out after 50 months at 25 percent. If the return is also delinquent (no extension filed), the five percent per month late return penalty includes the 0.5 percent per month late payment penalty for the first five months. After the first five months, then you only pay the additional 0.5 percent late payment penalty. So the maximum federal late return and late payment penalty could be 25 percent late return penalty (4.5 percent plus 0.5 percent for five months) plus another 22.5 percent (0.5 percent per month for the next 45 months for the continuing late payment penalty) equals a total of 47.5 percent. California has a slightly different approach on this and immediately charges five percent of the balance if you are even one day late. In addition they assess 0.5 percent PER MONTH or part of a month for the first 40 months, also capping you at 25 percent. So one day late in California will actually cost you 5.5 percent in late payment penalties.
Interest
In addition to the above penalties, interest is also charged starting on April 16 until the taxing authorities get paid in full. Since you had the use of the money and they did not, they want to be paid for their lost use of the funds. The interest rate varies and is adjusted each quarter for the IRS and twice a year for California. The current interest rate is three percent for both the IRS and California. If you had the money sitting in a bank account, you clearly lost out, however, if you had it invested in the markets, you would have probably come out ahead in the past few years. Whereas, you can sometimes get the taxing authorities to waive penalties if you had reasonable cause, interest is virtually impossible to waive. Without the before mentioned penalties, there are many people that would love a three percent loan!
If you have noticed a common thread for the above interest and penalties, it is that they are all based on the amount of tax you were short starting on April 15. If you had paid in more than enough on April 15, there would be no penalties and interest, even if you did not file an extension. Theoretically, you could file several years late and incur no penalties as long as you eventually give them a return showing all the tax had been paid in on time. I do not recommend this practice, however! Eventually you would receive notices and they would even estimate a tax return for you and assess tax, penalties, and interest. Those are usually not in your favor! Also, you never start the statute of limitations running, so you keep yourself open for audit longer.
Most importantly, like me, have fun when you are preparing these forms. If you find all of this interesting, perhaps you should have become an accountant!
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part XII – Form 2210 – Underpayment of Estimated Tax
Filed under: Back to Basics | Tags: Form 2210, interest, Les Miserables, penalty, Thenardier, Underpayment of Estimated Tax
Leave a comment Originally published in the Cedar Street Times
March 20, 2015
Believe it or not, time is actually starting to run out if you plan on filing your taxes by April 15. Many firms require complete information to be in the office by late March or the beginning of April in order to assure the returns are completed by the April 15 rush. Most people understand that personal tax returns and any tax owed are due on that day. Even if you file a 6-month extension for the return, the tax is still due on April 15. This requires you to consider the possibility of a short-fall and then send in an estimate by April 15 if deemed necessary, otherwise you will incur interest and penalties if you underestimate.
There are a number of charges the taxing authorities stack up to collect a little extra flow for the general treasury if you are delinquent, and they are all based on unpaid tax. There is a late return penalty, a late payment penalty, an underpayment of estimated tax penalty, plus interest! If you have ever seen the play Les Miserables, it can seem a bit like the opportunist innkeeper, Thenardier who sings, “Charge ’em for the lice, extra for the mice, two percent for looking in the mirror twice! Here a little slice, there a little cut, three percent for sleeping with the window shut.”
In two weeks we will discuss filing extensions and cover the penalties that can start accruing after April 15 – those include late return penalties, late payment penalties, and interest. This week we will focus on the penalty that can accrue throughout the past year up until April 15 – underpayment of estimated tax. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
Underpayment Penalties and Form 2210
While underpayment of estimated tax sounds like a concept that would just apply to people that make quarterly estimated taxes, the reality is that it applies to all of us. It even applies to those that file their returns on time and pay all of their taxes by April 15th. So why would you owe penalties for being such a model citizen?!
Think of it like this: if your employer decided that paying you every two weeks for the wages you had earned was too much of a hassle, and decided instead they were just going to cut you a check once a year in December (or heck, how about April 15 of the following year – why rush it!), you may have a difficult time paying your bills throughout the year, and would then have to borrow money and pay interest on it to carry you until you got your next annual paycheck.
Even if you were a superb money manager and budgeted your annual paycheck carefully so you wouldn’t have to borrow money, you would still conclude that this is an unfair deal and demand that they pay you some interest since you do not particularly fancy giving your employer a free loan for a year! The taxing authorities are the same way. Their “paycheck” is the taxes you owe them and they want to get paid throughout the year, or at least get compensated for your continued use of their paycheck. California and the federal government do not exactly have stellar records of managing money (what government does?). As such, they have to issue bonds to borrow money to cover their expenses and then are stuck paying interest on the bonds! So they want their paycheck!
Employees have taxes taken out of each paycheck and remitted regularly by their employers. Self employed people do not, and generally must pay quarterly estimates. But in either case, if you come up short at the end of the year, the taxing authorities will assess “underpayment penalties” if you do not meet certain thresholds.
So when are underpayment penalties assessed? In the simplest calculation, the federal taxing authorities take your total tax liability at the end of the year, divide it by four and assume they should have received 25 percent by April 15, 25 percent by June 15, 25 percent by September 15, and 25 percent by January 15 of the following year. They look at the dates and amounts sent in by you and then figure out how much your were short and for how many days. They then assess the three percent rate on those figures and amounts of time. California has a special schedule which requires 3o percent paid in April, 40 percent paid in June, 0 percent in October, and 30 percent in January. This unequal schedule requiring 70 percent of your tax to be paid in during the first five months of the year was California’s little trick to help balance the budget a few years back.
You also may be wondering why it is June 15 and September 15 instead of July 15 and October 15, as June is only two months after the first quarterly payment was due (but you owe it on income for three months!). The answer is that I have no idea. I heard once that it had to do with a projected budget short fall by Congress many decades ago, and they were trying to balance their budget. That would make sense, but I can’t say for sure.
If you have taxes withheld by your employer or another source, for calculation purposes, they are evenly spread out to the four quarters, no matter when the taxes were actually paid. For instance – if you got a large bonus at year-end, the taxes would be allocated evenly to all quarters. This makes sense since in the default calculation, the income is also spread out evenly to all quarters.
Self employed people can have problems with this, however, since the actual dates of the estimated tax payments are used in their cases, but the income is still spread out evenly by the default calculation. This could create unjust penalties if they earned a big chunk of their revenue near year end, and then sent in a check at year-end. The revenue would be spread out to all quarters, but the taxes would look delinquent since they were paid at year-end. The Form 2210 allows you to correct this by using an annualized income installment method whereby you enter in your year-to-date cumulative net income (as well as other income and deductions) at the end of each quarter to change the calculation method, and avoid these penalties.
Fortunately, there are some general rules that may allow us to be “penalty proof” so we do not have to worry about this every year, 1) If you have paid in at least 90 percent of the current year tax liability you are penalty proof, or 2) If you paid in at least as much tax as your tax liability in the prior year, then you are penalty proof unless your income is over $150,000 (75,000 if Married Filing Separate), then simply paying in at least as much tax in the prior year will not qualify you – you will have to pay in 110 percent of the prior year amounts, or 3) If the net tax you owe is less than $1,000 after subtracting out payments you made by April 15, then you are penalty proof. California conforms to all of these federal rules. It also has an additional rule for taxpayer’s that make over $1,000,000 ($500,000 Married Filing Separate) – those taxpayers are required to pay in 90 percent of the current year tax or they will face penalties.
Contrary to its unfortunate label as a “penalty,” it is essentially just interest. And it is currently at that same rate of three percent per annum. I often have clients that say they hate paying penalties and want to do whatever they can to avoid underpayment penalties. When I ask them if they would like a loan at a three percent rate of interest instead, they want to know where they can get more of it! If you are going to owe a substantial sum and would need to take the money out of investments that are almost certainly earning more than three percent in todays markets, it would be a wise decision to pay the penalties and pocket the spread. If your money is just sitting in a bank account, however, it would be a different story.
In addition to the calculation sections, the Form 2210 also has boxes to request relief from late payment penalties.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back To Basics Part XI – Form 2106 Employee Business Expenses
Filed under: Back to Basics | Tags: 2%, 2106, 2106-EZ, actual expenses, cell phone, clothing, DMV fees, Gas, insurance, Lease payments, Logo, logoed, miscellaneous itemized deductions, not subject to two percent, overnight travel, repairs, standard mileage deduction, two percent limit, uniform, union dues
Leave a comment Originally published in the Cedar Street Times
March 6, 2015
Looking back over the past four months in our Back To Basics series, we have covered the 1040, Schedule A – Itemized Deductions, Schedule B – Interest and Ordinary Dividends, Schedule C – Profit or Loss from Business, Schedule D – Capital Gains and Losses, Schedule E – Supplemental Income and Loss (i.e. – rental properties), and Schedule F – Profit or Loss from Farming. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog . We are now going to shift our attention to a few common supporting forms in your tax returns.
Form 2106 – Employee Business Expenses is our topic today. Unreimbursed employee business expenses documented on this form feed into the section near the bottom of Schedule A called Job Expenses and Certain Miscellaneous Deductions. Any expenses you incur that are necessary and ordinary to your profession for which you are not reimbursed by your employer are potentially tax deductible. Note that these expenses do not have to be required by your employer. They can be common and expected expenses in your profession, or they could simply be items that are helpful and appropriate. Clearly there is a lot of judgement in this standard, but it is not a blank check.
Common expenses include the use of your vehicle for work purposes (other than to and from your home), 50 percent of meals and entertainment expenses (often in sales related positions), union dues, educational conferences, trade magazines, books, classes, etc. in your job field. Overnight travel expenditures such as lodging, meals (50 percent), airfare, and car rentals could be deductible. A portion of your cell phone or internet service fees could be deductible. If you have a home office in lieu of a regular office and it is for the convenience of the employer (not for your convenience), then a percentage of the expenses of maintaining your household could be deductible. (This is actually documented on a separate Form 8829.)
There are also areas of abuse that have led to rules that prohibit specific things that might otherwise be deductible. One of these areas is clothing. You might think that your business attire should be deductible, unfortunately it is not if it can be worn in public and not be clearly identifiable as a uniform. Your employer must also require you to wear it. For instance, a nurse or police officer clearly has a deductible uniform, but business people, even if they have to “look nice” for clients and wear suits, for instance, cannot deduct the cost of their clothing. I unfortunately, cannot deduct my bowties, even though it is a bit of a trademark look for me!
If you have logoed clothing with your business name, however, you would likely not have a problem if your employer requires you to wear it. A number of years ago I gave this speech to a client that was a business owner; the next year he came into my office, turned around, and sure enough, he had his business name logoed on the seat of his pants! If you do have a uniform or logoed clothing, you can also deduct the cost of laundering these items.
Logically, to the extent you are reimbursed for your expenses, you cannot deduct them. If, however, your employer includes your reimbursements in your W-2 box 1 taxable wages, you would need to claim the expenses. Also, if your employer has an accountable plan where they will reimburse you for expenses and you simply fail to submit for reimbursement, you are out of luck, and cannot deduct the expense. If the employer will not reimburse you, but you still deem the expense as helpful and appropriate, you can claim the expense.
Calculating deductible vehicle expenses can get quite complicated. The 2106 is a two page form and the entire second page is devoted to figuring out the vehicle expenses. In addition, there are other forms for the depreciation. The simplest method is to use the standard mileage rate (currently 56 cents a mile) and tracking your business miles. You can only use the standard mileage rate if you started using that method in the first year you placed the vehicle into business use. For expensive vehicles or low mileage use, this generally does not pay off. The actual expense method involves tracking all the receipts for gas, repairs, insurance, DMV fees, lease or finance payments, etc. as well as calculating and tracking depreciation expense on the vehicle. But if you have an inexpensive vehicles that you will drive a lot for a long time, you would likely be better off with the standard mileage method.
Form 2106 is the full version of the form, which allows you to not only document hard costs, but also handle vehicle expenses either through standard mileage or actual expense and depreciation. It is also used when you receive partial reimbursements from an employer. The 2106-EZ is a one page form that can be used if you do not have employer reimbursements to report and you do not use the actual expense method for calculating vehicle expenses. If you do not have vehicle expenses at all or reimbursements, you can report the hard costs directly on the schedule A, and you do not need a 2106 or 2106-EZ.
As previously mentioned, these expenses flow into the Schedule A as Miscellaneous Itemized Deductions Subject to 2% along with a few other things such as tax preparation fees and investment expenses. This means they are subject to a two percent of adjusted gross income (AGI) threshold. For example, if your AGI is $100,000, the first $2,000 of these expenses do not even count as an itemized deduction. In addition, you have to have enough itemized deductions to get over the standard deduction (2014 – $6,200 for Single and $12,400 for Married Filing Joint) before they will reduce your taxable income.
Generally, a better strategy is to get your employer to pay for these expenses, even if it means you take a lower salary as a trade-off. You are better off since you will not be subject to a two percent floor!
As with everything there are exceptions. People in the military reserves, for instance, are not subject to the two percent floor. Detailed IRS publications exist on all the rules if you are looking for some more bedtime reading!
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part X – Schedule F
Filed under: Back to Basics | Tags: accrual basis, agriculture risk coerage, agriculture risk coverage, cash basis, Commodity Credit Corporation, cost-share payments, counter-cyclical, crop insurance proceeds, direct payments, diversion payments, Farm, federal disaster payments, headright, Long, patronage dividends, price loss coverage, price support coverage, Schedule F, South Carolina, Switzerland
Leave a comment Originally published in the Cedar Street Times
February 20, 2015
When the Long family emigrated from Switzerland in 1737, they settled in the colony of South Carolina. At the time, the headright system was in place, and every person received 50 acres of land for making the journey across the Atlantic. The Longs stayed in South Carolina, and the land remained in our family until my dad and his sister-in-law sold the last remaining four hundred acres about ten years ago. (Somewhere in our files we still have that original grant paperwork.) Four hundred acres may sound like a lot to native Californians, but the phrase “dirt cheap” actually means something in other parts of the country!
Anyway, my dad grew up on that farm raising animals, picking cotton, and then in high school, packing peaches for another farmer in the area. As time rolled on, farming became tougher for small farms, and the government eventually started paying my grandfather to NOT farm, and plant trees instead! What a deal! That was fine for my grandfather as he also had an architectural practice already dividing his time. I am sure the subsidies he received were part of some government plan aimed at decreasing supply and driving up prices for other farmers, and I am sure he had to report those on a Schedule F – Profit or Loss from Farming.
Schedule F is our topic today. Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.
The header section of Schedule F is an information gathering area about the type of farming you do, your participation level in the business, and various other questions. Similar questions can be found on Schedule C for businesses or Schedule E for rental or other supplemental income activities.
Schedule F is a two page form, and nearly half of that real estate is devoted to gathering income. By comparison most other schedules in the tax return have a tiny section devoted to income gathering. This is due to the wide variety of sources of farming income.
Section I covers income for cash basis farmers. Cash basis simply means you declare income when you receive the money, and you deduct expenses when you pay out the money. Section III on page two covers income gathering for accrual basis taxpayers. This means income is declared when it is earned (not necessarily received), and expenses are deducted when incurred (not necessarily paid).
Farming has been at the root of American lives since the country was founded, and it is not always an easy or a consistent business to run. As a result there are many special programs available to farmers (or non-farmers as in the case of my grandfather) as well as certain tax advantages. Farmers may see income from all kinds of sources, many tied to government programs or insurance, such as direct payments, patronage dividends, counter-cyclical payments, price loss coverage payments, agriculture risk coverage payments, price support payments, market gain from the repayment of a secured Commodity Credit Corporation (CCC) loan gains, diversion payments, cost-share payments (sight drafts), crop insurance proceeds, federal disaster payments, etc.
Due to the unpredictability of nature, there are even special provisions available to farmers that allow them to average their income over a three-year period. This is done by completing Schedule J.
You can imagine being a little upset if instead of having your income spread evenly over two years and being in a top bracket of 15 percent in both years, that you make zero in one year due to a drought and double in year two due to wonderful rain and sunshine, and then wind up in a 25 percent top bracket! Not only did you suffer the hardship of having no income one year, but then you ended up with a bigger overall tax bill on the same amount of income.
Another example of a favorable provision says that if you have to sell livestock due to weather-related conditions, such as a drought, you have the option of reporting the income in the year following the sale. So you get to defer the income. Your farm must be located in an area qualified for federal aid due to the weather-related condition.
Part II of Schedule F deals with gathering expenses. Due to the length of time it takes to get many crops or animals into a productive state, there are a lot of very specific rules regarding deducting versus capitalizing farm expenditures.
For example, if a crop takes more than two years growing time before it comes to fruition, you generally must capitalize the costs during the period. In most cases you can make an election to expense the costs, however. The instructions to Schedule F tell us, “you cannot make this election for the costs of planting or growing citrus or almond groves incurred before the end of the fourth tax year beginning with the tax year you planted them in their permanent grove.” As you can tell, the rules can get very specific depending on what you are growing, and where!
Similar to a Schedule C business, if an unincorporated farm is owned and operated by a husband and wife in a community property state, such as California, they should split the income and expenses according to the work performed and file two Schedule Fs. This assists with filing two Schedule SEs for self-employment income for each.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part IX – Schedule E
Filed under: Back to Basics | Tags: Arnold Palmer, AT&T Pebble Beach National Pro-Am, at-risk, estates, fair market value, Form 4835, Form 6198, Form 8582, K-1, mortgage-backed security, Partnerships, passive activity losses, personal residence, personal use, Real Estate Mortgage Investment Conduits, REMIC, rental real estate, royalties, S-corporations, schedule E, sub-prime, Supplemental Income and Loss, trusts, vacation home
Comments (2) Originally published in the Cedar Street Times
February 6, 2015
So you decided to put your home up for rent for two weeks surrounding the AT&T Pebble Beach National Pro-Am. Fortunately for you, it was rumored that Arnold Palmer once spent the afternoon on your front lawn. As a result, there are so many prospective renters that you are having to beat them away with golf clubs.
Finally you settle on a renter and a nice fat $40,000 check for two weeks! Score! But then you remember this pesky thing you do each year called taxes, and you start wondering how you are going to report this on your tax returns. The surprising answer is that it won’t get reported at all. There is a rule which states if you rent your home for 14 days or less during the year, you do not have to report the income. All $40,000 is tax free! But what if your renters need an extension of one day? Don’t do it! If you do, the entire amount is now taxable on Schedule E.
In this issue, we are discussing Schedule E – Supplemental Income and Loss. Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.
Schedule E is a two-page form used to report income from rental real estate, royalties, and income from partnerships, s-corporations, trusts, and estates. Part I handles the reporting of income and expenses of rental real estate and royalties. There is a section regarding rental real estate that asks for the number of days rented at fair market value and the number of days of personal use. This information is necessary in order to apply limitations regarding the rental of personal residences and vacation homes. Any personal use will affect the allowable deductions to some extent. (See my articles “Renting Your Vacation Home” on my website originally published August 10 and 24 of 2012 for more details.)
All expenses related to caring for your rental real estate can be deducted. Besides costs such as property taxes, interest, repairs, etc., you can also use the standard mileage rate (56 cents per mile for 2014) to deduct any rental related mileage you drive. If your property requires you to travel away from home overnight, you can deduct lodging and 50 percent of your meals as well.
If rental property generates a loss, there are several tests that must be applied near the bottom of Schedule E page one to determine if the losses will be allowed, or suspended for use in future years. You can only take losses to the extent that you have an investment at-risk. Form 61K-198 is used to determine this. There are also rules limiting the amount of losses you can use against other income if the losses come from passive activities. Rental real estate is generally considered a passive activity, and Form 8582 is used to determine if your losses will be limited.
Part II of Schedule E begins on page two and summarizes income and losses from flow through activities of partnerships and s-corporations. Your share of these activities is reported to you on a Form K-1. Again, at-risk and passive activity loss limits are applied. Your basis in the underlying partnership or s-corporation activity as well as your level of participation and type of ownership interest are considered in these calculations.
Part III covers your share of estate and trust activities reported to you on a K-1 in a similar fashion as in part II. The main difference being that there are generally no at-risk limitations to worry about.
Part IV covers income or losses from Real Estate Mortgage Investment Conduits. These are essentially mortgage-backed securities: a solid product which earned a bad reputation during the financial crisis from 2007-2010 when sub-prime mortgages were bundled and sold together.
Part V summarizes the income and losses from the first four parts of Schedule E and pulls in farm land rentals as well which are calculated on a separate Form 4835.
Getting back to your $40,000 two-week rental. It turns out that the Arnold Palmer that spent an afternoon on your front lawn was simply a glass of watered-down iced tea and lemonade, and your renters backed out. Better luck next time…
In two weeks we will discuss Schedule F – Profit or Loss from Farming.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics – Part VIII – Schedule D
Filed under: Back to Basics | Tags: $3000, 1099-DIV, adjusted cost basis, bonds, business, capital assets, Capital Gains, capital losses, carryover, cost basis, distributions, Form 4797, Form 8949, gift, holding period, inherited, investments, long-term, mutual funds, personal, Schedule D, short-term, stocks
Comments (1) Originally published in the Cedar Street Times
January 23, 2015
Imagine yourself on Antiques Roadshow and they tell you that an old porcelain mug you found in your attic last summer is worth $8,000-$10,000 dollars! You are of course elated, and decide to sell the mug. Fast forward to February, and your accountant starts asking you questions about this sale, such as your adjusted cost basis and your holding period. You really have no idea how you even got it. You know it was in the family for a long time, and you think that maybe it was in a box of things your mom left for you when she moved to Palm Springs where she now resides. What do you do? I don’t know exactly, but I know this much – it will go on your Schedule D in some form.
In this issue, we are discussing Schedule D – Capital Gains and Losses. Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.
Schedule D is used to report gains or losses from the sale or exchange of capital assets. Capital assets consist of a variety of things. The personal use items you own – such as your home, your vehicles, household items etc. are capital assets. Gains from the sale of personal items are taxed. Losses, however, are generally disallowed. Your personal investments such as stocks, bonds, or real property held as an investment are also capital assets. Gains and losses are allowed on personal investments.
The same types of items used in your trade or business, however, would be reported on a Form 4797 and would be taxed differently as well.
Assets that have a mix of personal use and business use can have elements reported on both forms.
To determine your gain or loss on a capital asset, you must know your cost basis in it. If it is something you bought, your cost basis is generally the amount you paid for it; if it is something you inherited, your cost basis is often the fair market value at the date of death; or if it was something given to you, your cost basis is generally the same as that of the prior owner.
There can also be adjustments to this basis, such as when you make improvements to your home – the money you spend would be an adjustment upwards. Once you know your adjusted cost basis, you simply subtract it from the sales price to determine your gain or loss. If you scrapped it, your sales price is zero. Sometimes it can be quite challenging to determine the cost basis, especially if records no longer exist. Technically, if you cannot prove your basis, the IRS can take the position that your basis is zero. This could be very unfavorable, especially if you just sold a $10,000 mug with unknown origins!
It is also important to know the length of your “holding period.” The date you purchase the property is generally the beginning of your holding period and the date you dispose of the property is the end of your holding period. For property received as a gift, you include the holding period of the person who gave it to you.
If your holding period is over a year, it is subject to favorable long-term capital gains rates – basically a 15 percent federal rate for most people. (Although it could be as low as zero percent or as high as 20 percent depending on your tax bracket and the amount of capital gains you have. Also, collectible items you sell such as old coins or antique vehicles are taxed at a 28 percent rate.) If your holding period for the asset is a year or less, it is considered a short-term holding and is taxed like ordinary income (a higher rate for most people). Inherited property is always considered to have a long-term holding period. California does not have a special rate for long-term holdings and treats all capital gains as ordinary income on its tax return.
As mentioned before, there is no deduction for losses on your personal use items. You can, however, take a loss on your personal investments. They would reduce any other capital gains, first, and then if there are still losses remaining, you can use $3,000 to offset any other type of income you have on your tax returns. The rest would get carried over to future years.
The Schedule D itself is essentially a summary of capital gain and loss activity that are mostly determined by other forms that feed into the Schedule D. Part I summarizes short-term gains and losses, and Part II summarizes long-term gains and losses. Form 8949 is the main supporting form used in both of these sections. It was added a few years ago after changes to broker cost basis reporting requirements occurred. The Form 8949 sorts out long-term and short-term transactions for which cost basis is reported to the IRS and not reported to the IRS, and handles the actual transactional reporting.
Parts I and II also have areas were short-term and long-term gains can be reported from other forms such as installment agreements, business casualty and theft losses, like-kind exchanges, as well as pass through entities such as partnerships, S-corporations, estates, and trusts. Long-term capital gains distributions from mutual funds on a 1099-DIV are reported in Part II. (Short-term capital gains distributions from mutual funds are actually included as ordinary dividends on the 1099-DIV, and are reported on Schedule B instead.) In addition, short-term and long-term loss carryovers from prior years are added into their respective parts on Schedule D.
Part III nets the short-term gains or losses against the long-term gains or losses. It then helps you determine the gain or loss to enter on the 1040. It also walks you through several worksheets to determine the amount of tax and tax rates you will pay on any gains.
So what would you do about the mug? Hopefully mom would have some recollection of the history. Maybe there was a somewhat recent time when it was passed by inheritance and would have received a step-up in basis. Of course, you should have figured that out before you sold it, and then had an appraisal done to support it! Otherwise, if it had just been gifted from one person to the next, the mug probably had very little if any cost basis, and you might be stuck with a big taxable gain.
In two weeks we will discuss Schedule E – Supplemental Income and Loss.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back To Basics Part VII – Schedule C
Filed under: Back to Basics | Tags: 1099-Misc, cash basis, community property, cost of goods sold, depreciation, disregarded, EIN, Form 4562, Form 8829, interest income, LLC, material participation, meals and entertainment, per diem, Schedule C, sole proprietorship
Leave a comment Originally published in the Cedar Street Times
January 9, 2015
In this issue, we are discussing Schedule C -Profit or Loss from Business. Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.
Schedule C is generally used to report income and expenses for your self-employment activities for which no partnership exists or no entity has been established (such as a C or S-Corporation or LLC) – in other words, it is used for a sole proprietorship. Of course there are exceptions and wrinkles to the rules. Here are a few common ones. In most states, a husband and wife which own and operate a business together would file a partnership return instead of a Schedule C. However, since California is a community property state, a husband and wife should generally file two Schedule Cs and split the income and deductions based on their distributive shares, even if filing a joint return.
One important reason for doing this is that two Schedule SEs would also be filed reporting the Social Security and Medicare taxes separately for each spouse. They would each be subject to the full taxable wage base for Social Security, but they would also each receive credit for their earnings which would figure into their Social Security checks in retirement.
An LLC with only one member that is operating a business would also report the business activity on a Schedule C instead of a 1065 Partnership return. Since you can’t have a partnership between you and yourself, the formal entity structure is disregarded for federal tax purposes and reported like a sole proprietorship. In community property states such as California, a husband and wife that both own and operate the business are actually considered one member for LLC purposes. If they were the only two owners, the entity would be disregarded, but they would then report on two Schedule Cs as discussed above.
Now that we have discussed who uses the form, let’s move to the form itself. The initial section of Schedule C asks for identifying information – the name of the business, the type of business, address, etc. If you have an employer identification number you can enter that as well. This would be required if you have employees on payroll. You can also obtain one if you simply do not want to hand out your Social Security number whenever a formal taxpayer identification number is needed – such as for filing 1099-Misc forms for independent contractors.
There are also some other direct questions regarding your basis of accounting, level of participation, and filing compliance. Most small businesses under $10 million in annual revenues operate by the cash method of accounting as it has many advantages. Material participation is a tightly defined standard by the IRS which can affect your ability to take losses in a down year. The questions on 1099 filings are loaded questions designed to help the IRS easily identify businesses that are not filing required 1099s for payments to independent contractors, for interest received, etc.
In Part I Income, you list your gross receipts, subtract sales returns and allowances, subtract cost of goods sold (which are detailed in Part III) and then add other income such as interest income or certain credits. Part III Cost of Goods Sold is mainly geared towards retailers, wholesalers, and manufacturers. It provides a place to detail beginning and ending inventory and any associated labor and material costs associated with production of the goods. Even taxpayers on a cash basis are generally required to track inventory. Cash basis typically means you get the deduction when you spend the cash, and you record the income when you get the cash. But with inventory, you do not get the deduction until the inventory is sold or disposed.
In Part II you detail all your expenses. The instructions to Schedule C do a pretty good job of explaining what types of expenses they want on each line. Some of the lines are supported by additional forms such Form 4562 Depreciation and Amortization feeding into Schedule C line 13 for Depreciation. Line 24b for Meals and Entertainment is unique as most qualified meals and entertainment are allowed only a 50 percent deduction. Another unique aspect is that preset per diem rate deductions are allowed for self-employed individuals (and employees) for meals, entertainment, and incidental expenses in lieu of tracking actual receipts. Some of these per diems are quite generous depending on the location of travel, and taxpayers can sometimes get a much larger deduction than the amount they actually spend.
Line 30 for expenses for business use of your home is another example where an entirely separate form (Form 8829) is used to calculate the deduction. There is also an alternative simplified method introduced with the 2013 returns that gives you $5 square foot for business space (up to $1,500) without having to track actual expenses on Form 8829.
Line 32 contains a few questions about whether your investment in the business is “at-risk” or not. Basically they are asking if you are financially liable if things go south, and could you lose the money you have injected into the business in the past. This affects your ability to take losses in down years.
Part IV details your vehicle deduction for standard mileage rate users. For 2014, this amount is 56 cents a mile. If you track actual expenses instead, you would not fill out this part.
Part V is for any additional expenses not discussed in Part II.
In two weeks we will continue our Back to Basics series with Schedule D – Capital Gains and Losses
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
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