What Are Your Chances of Being Audited? Part III – Red Flags
Filed under: Audit | Tags: 1099 matching, American Opportunity Credit, art, audit, audit selection, automobile mileage, child tax credit, earned income tax credit, foreign income, Health Care Tax Credit, hobby, home office deduction, horse racing, IRS, meals and entertainment, music, painting, performing, photography, red flags, refundable tax credits, rental losses, travel expenses, Treasury Department, video
Leave a Comment Originally published in the Cedar Street Times
June 13, 2014
Four weeks ago I discussed some of the statistics regarding your chances of being audited by the IRS, and two weeks ago I discussed audit selection methodology. A few of the high points from the articles were: 1) on the average, audit rates for individuals are generally less than one percent each year, and increase as you make more money, 2) about 75 percent of audits are actually mail correspondence audits focused on a narrow request of information for specific items on your return rather than a full-blown in-person, field audit, 3) the IRS does not release its exact methods of selecting audits, and many people have incorrect notions about this process, 4) the IRS does tell us audit selection is aided by a computer scoring system to help find returns that will likely yield a change; it uses computer matching to ensure information reported on 1099s by third parties matches what you report; it uses publicly available information; and it uses statistical random sampling. The rest of this article will be devoted to “red flags.”
So what are these “red flags” everyone talks about? One fairly obvious assumption we can make from the audit statistics released by the IRS is that they follow the money! You are three times more likely to be audited if you make over $200,000 a year and over eleven times more likely to be audited if you make over $1,000,000 a year. C-corporations face a similar dynamic of increasing audit rates on larger corporations – for instance, one out of every three corporations with assets over $250 million are audited.
Not reporting all your income even when it is reported to the IRS should not be a surprising red flag, but it happens frequently. I see this most commonly with stock sales reported on a 1099-B when people prepare their own returns – they either forget, or do not understand the form. I also see this with contract work where a 1099-Misc is issued and the individual forgets to report it.
There are a number of issues related to small businesses that raise eyebrows. Keep this in mind – anytime there is an easy path for someone to pass-off personal expenses as business expenses, you are going to have a higher level of scrutiny. For instance – relatively high amounts of: business automobile mileage (or claiming 100% business use on your vehicle – very rare in reality), home office deductions, meals and entertainment, or travel expenses. All of these can be easily abused, so they are highly scrutinized. If you are beyond the norms, you are a clearer target.
Here is another golden nugget – if your job is one that millions of people do for fun as a hobby (although perhaps not nearly as well!), then you have a higher level of audit risk, particularly if you are losing money. Think of the arts – photography, video, music, drawing, painting, performing, etc. Also, think of horse racing and breeding for the wealthier set.
That brings us to another “red flag,” businesses that lose money every year. The IRS is trying to determine which of these three describes your nonprofitable business situation: 1) Are you really trying to make this successful and genuinely feel it will be profitable overall? 2) Are you trying to deduct your personal expenses, your hobby, or keep up appearances? or 3) Are you just plain nuts? By allowing people to continue businesses circumscribed in two and three, the rest of the country is having to foot the bill for the lost tax revenues. This is because the “losses” generated are offsetting the person’s other income that would otherwise be taxable. With no realistic future expectation to recuperate the losses, the IRS is ready to pounce.
Claiming rental losses in California is fairly common due to the high cost of our real estate, but claiming a real estate professional designation in combination with these losses is an area of greater concern. If your main occupation is in the real estate related field, and you work at least 750 hours in this trade, you are allowed to deduct all of your rental losses in the year they are incurred. Everyone else get to deduct $25,000 at most, and are rapidly phased out to no deductions for the losses based on income levels. The losses get suspended until the property is disposed of or until there is passive gain to offset. There are a lot of challenges when it appears the person has substantial earned income from a trade or business unrelated to real estate or if there is very little income from real estate related trades.
Refundable tax credits such as the Earned Income Tax Credit, Child Tax Credit, American Opportunity Credit (for education), and Health Care Tax Credit can also be a point of concern, particularly when the total refund on your return is higher than the tax paid in to the system! The IRS receives thousand of fraudulent returns each year that use refundable credits to steal money from the government.
Although harder to catch, unreported foreign income is an area worth mentioning due to the extremely high penalties by the Treasury Department for failure to report foreign accounts, and it has been a hot-button issue that has raised billions in revenues.
The above is not an exhaustive list, but it does describe many commonly seen areas of concern.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
What are Your Chances of Being Audited? Part II – Audit Selection
Filed under: Audit | Tags: 1098, 1099, audit, audit selection, audit selection methodology, computer matching, contact third parties, DIF, Discriminant Inventory Function System, internet, IRS, National Research Program, newspapers, NRP, public information, random, Taxpayer Compliance Measurement Program, TCMP, W-2
Comments (1) Originally published in the Cedar Street Times
May 30, 2014
Two weeks ago I discussed some of the statistics regarding your chances of being audited by the IRS. A few of the high points from that article were: 1) on the average, audit rates for individuals are generally less than one percent each year, although audit rates jump to over three percent on people making over $200,000 a year, 2) about 75 percent of audits are actually mail correspondence audits focused on a narrow request of information for specific items on your return rather than a full-blown in-person, field audit, 3) partnership, LLC, and s-corporations have a less than half of one percent chance of being audited, while small c-corporations with less than $10 million in assets have an audit rate just under one percent, 4) larger c-corporations have increasingly higher chances of being audited with a roughly one in three chance for corporations with over $250 million in assets. If you would like to read the full article, you can read it on my website at http://www.tlongcpa.com/blog. The rest of this article will be devoted to audit selection and in two weeks we will discuss “red flags.”
Regarding audit selection, let me start by saying that no matter what you read or hear, nobody knows the exact methodology the IRS uses to select returns for audit as it is not public information. All we really know is the broad overview the IRS tells us about its methodology and the limited statistical information the IRS releases about audits; the rest is conjecture based on the type of returns that we as tax practitioners see being audited. Of course that can be warped by our own experiences. That said, when you have been in the field long enough and have read about or talked to others about their experiences, you do get a good idea of the common issues for the types of clients with which you work. When a client comes in and says, “I heard that if you report over ‘x amount’ of this, it is a red flag,” or “I am not going to file until ‘this date’ because you are less likely to be audited,” I know they have latched onto some misguided information.
So what does the IRS say about their audit selection tools and methods? First, they tell us there is a computer scoring system called “Discriminant Inventory Function System” (DIF). This system looks at your return and compares your return to similar returns to come up with a score for your return; the higher your score, the more likely an audit will yield a tax change.
Secondly, they use computers to match information reported on your return with information reported by third parties such as on Forms W-2, 1099, 1098, and the like. Automatic notices can be generated as a result of mismatched items.
Third, they admit to using a variety of other tactics and resources such as the internet, newspapers, and other public information, or even people who may file a complaint or “squeal” on you. They say they will investigate these sources for reliability before using it for an examination.
They also have the right to contact third parties about you, such as neighbors, co-workers, bankers, etc. Generally they have to inform you if they contact someone else unless they feel it would jeopardize their ability to collect the tax or that you might retaliate against the individual.
Although I have not seen this written as a tactic employed, I am aware of a situation where the IRS was selecting returns because they were prepared by a particular tax professional in a particular industry (and no, it wasn’t me!).
In addition there have been various programs over the years such as the Taxpayer Compliance Measurement Program and the more current National Research Program which introduces a random statistical selection methodology. One of the uses for the information gathered in this program is to fine-tune the DIF computer scoring system. It also means that ANYONE can be audited.
In two weeks we will discuss “red flags.”
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
What are Your Chances of Being Audited? Part I – Audit Statistics
Filed under: Audit | Tags: audit, audit likelihood, audit percentages, business, C-corporations, correspondence audit, field audit, individuals, less than one percent, Partnerships, returns, risk, S-corporations, Special Agent, tax, tax audit, Treasury Agent
Leave a Comment Originally published in the Cedar Street Times
May 16, 2014
I have a diverse base of clients, but there is one thing that many of them have in common: they all know the phrase, “…but I don’t want to raise any red flags.” The part prior to the “but” generally explains how he or she wants to push the limits and minimize the tax liability. Then I let them in on a little secret, “Did you know the IRS is partially color blind?”
I say this because a component of audit selection is a random statistical process whereupon everyone gets a chance to spin the audit wheel. But the majority of returns are selected for audit because of, well, “red flags.” In this issue I will speak about some of the juicy numbers of audit likelihood, and in two weeks, we will discuss some of the methods of selection and possible red flags.
Looking back over the past 16 years of data released by the IRS, you will probably find comfort in knowing that the overall audit selection rate for individuals has generally been close to or under one percent. In 2013 there were 1,404,931 audits on the 145,819,388 tax returns filed, or a 0.96 percent audit rate! When most people think of an audit, however, they think of having to meet with a beady-eyed pencil pusher whose sole mission in life is to cause them stress and shake down every last dime out of their pocket. In reality, only about 25 percent of those audited actually meet with an auditor in a “field audit.” So now your odds are only 1 out of every 424 people!
The majority of the audits are handled by correspondence mail, and are generally very narrowly focused just asking you to send in supporting documentation on a limited scope of items. It is less intrusive, but sometimes can actually be more challenging to handle since the auditors do not have to look you in the eye, and are generally hiding behind a cloak of anonymity. It is also evident from my experience that a lack of training in tax law is prevalent by those reviewing the correspondence audits.
When people are selected for audit, they generally say, “why are they wasting their time on me, shouldn’t they be going after the bigger fish.” What they are really saying is, “I really don’t care who they audit as long as it isn’t me!” But to honor their words, you will find that the IRS does in fact follow the money for the most part. The more money you make, the more likely you are to be audited according to the statistics the IRS releases.
The overall audit rate for individuals making less than $200,000 in 2013 was 0.88 percent. For those making over $200,000 per year, the rate jumped to 3.26 percent. And for those making over $1,000,000, the rate jumped to 10.85 percent. The other big difference is that you are two-and-a-half more times likely to have a field audit than a correspondence audit when making over $200,000 or over $1,000,000.
The overall audit rate for business returns such as C-corporations, S-corporations and Partnerships in 2013 was 0.61 percent of the 9,938,483 returns filed. Partnerships and S-corporations had the lowest percentage at 0.42 percent, generally since the income passes through and is taxed to the individual owners instead. C-corporation audit rates, however, vary even more drastically than individual rates – small corporations with less than $10 million in assets had a 0.95 percent audit rate. Corporations with $10 million to $50 million in assets had a 6.98 percent audit rate, $50 million to $100 million – 15.51 percent, $100 – $250 million – 19.43 percent, and one out of every three corporations with assets over $250 million were audited! So yes, the IRS does go after the big fish!
Clients will sometimes receive threatening letters indicating that if they do not respond by a certain date, that liens could be placed or their assets could be seized. I have always found “seizure” to be an overly aggressive choice of words at the early juncture these letters will often arrive, and it is telling that only 547 IRS seizures occurred in the entire country in 2013.
Finally, another interesting statistic for those that find it thrilling to not report income (a.k.a. tax evasion); if you ever have a Special Agent from the Treasury Department show up at your door, I suggest you take that seriously. They are basically your beady-eyed pencil pushers…but with guns! There were 4,364 criminal investigation prosecutions recommended in 2013…and the conviction rate was 93.1 percent. The average sentence for tax and tax related cases was 31 months in prison. Remember, avoiding taxes through planning, is fine, but evading taxes is a place you never want to be!
Given all these statistics, you may also find it interesting to know that the IRS budget has been cut by close to five percent for 2014, and they have the fewest number of employees in the past 16 years. I am not sure this is really a good thing, as it will surely reduce the number of qualified individuals trying to wield an already overburdened system, but it will likely mean your risk of audit will be even lower.
In two weeks we will talk more about red flags and audit selection.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
Filing an Amended Tax Return
Filed under: General, Refunds | Tags: 1040X, 540X, amended, amendment, April 15, math error, October 15, refund, tax return, underreported, www.irs.gov
Leave a Comment Originally published in the Cedar Street Times
May 2, 2014
It’s May! The sun is shining and the grass is green. There is plenty of daylight in the evenings and summer is just around the corner. You even have your tax returns complete. Things are looking good! As you mosey out to the mailbox and pull out today’s haul, you see a letter with an unusually interesting stamp, one kind of like your dad used to collect…then it hits you, “Wait a minute, did I claim the deduction for donating Dad’s stamp collection to the museum! I even spent $300 on the appraisal, and I completely forgot about it! And my taxes are already done!”
Fortunately for the hypothetical you as well as everyone else, there is a cure-all remedy elixir called an amendment.
The Internal Revenue Service (IRS) provides form 1040X and the California Franchise Tax Board (FTB) provides form 540X to facilitate this process for individuals. The ‘X’ comes from the fact that you must be eXtra crazy to want to do your taxes again. Actually, I have no idea where the ‘X’ comes from, but it is probably rooted in something – just like 401(k) plans. Many people don’t realize 401(k) is simply the Internal Revenue Code Section that lays down the rules for that particular type of retirement plan. Somebody was not having a creative day when they came up with that one. But I digress…
The IRS version and the FTB version of amendments follow a similar format with a column of the original amounts reported, a column for the net change, and a revised column. They do not cover all lines in the tax returns, however, but selected key lines as well as subtotals for other things. Any affected schedules and statements are re-prepared in full in the corrected manner and attached to the returns. The returns must be paper filed, and if there are changes to amounts reported for tax withholdings, the physical copies of the forms showing the withholdings must be attached.
Simple math errors are generally corrected by the taxing authority computer systems, and a change letter is sent automatically, so you generally don’t have to file an amendment if for some reason you noticed an arithmetic error on the return. With computer tax preparation so prevalent, it is rare to see this unless the return is hand-prepared. As a side note of interest, every client hand-prepared return I have re-prepared in the past ten years, aside from something basic like a single person with a W-2 or a pension, has had preparation errors – a tribute to the complexity of our tax code today.
If you missed something large and underreported your taxable income significantly, it is to your benefit to amend as soon as possible as interest and penalties will continue to grow. You could also be assessed a 20 percent accuracy related penalty.
The IRS generally gives you three years to file an amendment and the FTB gives you four years. More specifically and to illustrate, if you filed your 2013 1040 return on or before April 15, 2014, you have until April 15, 2017 to file your 1040X amended tax return. If you filed for an automatic extension until October 15, then you have until the earlier of 1) three years from the date you actually file the return or 2) three years from October 15. If however, you are delinquent on paying the tax you owe, and you have an outstanding balance that carries on for a period of time, that time frame could be extended as you have at least two years (one for California) after the date you actually pay the tax to file an amendment.
After filing an amendment, don’t hold your breath waiting for a response, as it typically takes two or three months to process the returns. If you are curious, however, you can check the status of your return at http://www.irs.gov.
I have worked with quite a number of people over the years where we have gone back to file amended tax returns to claim missed deductions from the past and obtain a refund. If the amendment can yield a greater refund than the cost of preparing the amendment, it is certainly worth considering!
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
Tax Return $3 Presidential Election Campaign Fund
Filed under: General | Tags: $3, 1974, campaign financing, John F. Kennedy, Obama, Presidential Election Campaign Act, Presidential Election Campaign Fund, Romney, Senator Al Gore, Senator Robert Kennedy, Senator Russell Long, Sr., tax returns
Comments (1) Originally published in the Cedar Street Times
April 18, 2014
Have you ever wondered exactly what that little section is at the top right of your personal tax returns with checkoff boxes for the taxpayer and spouse to send $3 to the Presidential Election Campaign Fund? And why is it on your tax returns?
The majority of people do not check the boxes. There are of course a variety of reasons for this. Perhaps they are just apathetic towards politics, and the boxes appear like additional meaningless gibberish to wade through at tax time. Or perhaps they loathe politics and politicians in general and would dry-heave at the idea of giving three of their hard-earned dollars to a few baby-kissers! Or just maybe they understand campaign finance laws, agree with Congress’ original intent, and have made an educated decision about whether or not to check the box.
Despite the explicit language in that section on the return: “Checking a box below will not change your tax or refund,” many people still think they are contributing extra money out of their pocket to give to the election process if they check the box. In reality, what Congress has done is given you the ONLY direct choice you have about how the tax dollars they just collected from you are going to be spent. This is your one opportunity to pull the purse strings!
The concept of public dollars being used for presidential election campaign financing had its genesis in the early and mid-1960s amidst a series of campaign financing scandals and a growing disparity between the parties’ abilities to raise funds. The idea was to level the playing field for candidates running for president to make it more difficult to buy America’s vote.
The Presidential Election Campaign Act, sponsored by Senator Russell Long was passed in 1966, but was repealed the next year in a challenge led by Senator Al Gore, Sr. Gore and Senator Robert Kennedy felt that the current law did not do enough since it was not the sole mechanism of financing and still allowed the “corrupting influence” of large private contributions. Ironically, the Kennedy family had used vast amounts of its family’s personal wealth to finance and ultimately win the election of 1960 for Robert’s brother, John F. Kennedy, as well as financing Robert Kennedy’s bid for election in 1968 against Johnson.
The issue was then revived and was passed again in 1971 as a tax return checkoff to allocate $1 beginning on the 1972 tax returns. Congress decided that Americans would get to decide how much money would be utilized to fund the elections. President Nixon and most Republicans were opposed to the idea in general, so the IRS was not being pressured to make it easy. It was a separate form that had to be requested and it was not advertised very well – only bringing $4 million into the fund the first year. In 1973, Senator Long did some negotiating with the IRS and the checkoff box was moved to the front of the Form 1040 the next year. By the 1976 election $90 million had been collected.
The intent of the Presidential Election Campaign fund is to provide full funding for the major party presidential nominees in the general elections, provide funds for the party nominating conventions, and provide partial funds for the primary elections.
In order to receive the funds, the candidates must show broad national public support in the primaries; they must not spend more than $50,000 of their own money; in the general elections they cannot accept any private individual or Political Action Committee (PAC) funds; and there is a cap on the maximum that can be spent on the election campaign.
The various caps and funding amounts were indexed for inflation, however the checkoff amount was not. The only change since 1972 came in 1994 when the checkoff amount was raised from one dollar to three dollars by Congress. Making matters worse, its peak participation in 1980 of 28.7 percent of taxpayers utilizing the checkoff has consistently fallen to the 2012 level of only 6.4 percent. If there is a shortfall, then candidates will just get less money prorata.
President Barack Obama and Mitt Romney became the first general election candidates since the program’s inception to turn down public financing and to raise the funds privately instead. And two weeks ago, President Obama signed into law legislation that ends the portion of the law that finances the presidential nomination conventions.
All of these factors combined indicate the pendulum is rapidly swinging the other direction and unraveling the system that has operated over the past 40 years. I suppose after a few more scandals or when one party starts out-fundraising the other substantially there will be outcry again, and the campaign finance laws will be reinvigorated once again.
At least for now, you still have the option to tell Congress how to spend a few of your tax dollars. If you have already filed your returns for 2013 and have an incredibly intense desire to contribute to this degenerating fund, you can file an amendment to do so. Interestingly, if you now have an incredibly intense desire to uncontribute to this fund, you cannot amend your return to do that! This will lead us to our next topic in two weeks – amending your tax returns!
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
Tax Deadline Looms
Filed under: General | Tags: April 15, deadline, Form 3519, Form 4868, late filing penalty, late payment penalty, tax extension
Leave a Comment Originally published in the Cedar Street Times
April 4, 2014
If you have been hibernating through the winter months, it is time to awaken from your slumber and complete your tax returns for 2013. As a tax professional it is interesting to see how each tax season seems to take on a flavor of its own. This year I found that many clients did not come in early, but delayed gathering their tax information, and came in much later. Another professional in the area called me last week and said he was experiencing the same issue. Compressing an already compressed time frame certainly makes for long hours, and will probably lead to more extensions as well.
Over the past few years, new rules have been phasing-in which force financial companies to report cost basis in the stock they sell on your behalf. (Generally I like this new requirement as I have to repaint my ceiling much less frequently as clients are no longer staring at it so intently to come up with the basis in the stock they inherited thirty years ago.) I recall last year, we had many clients with revised 1099 financial packages being issued well into late March. Although I did not see a lot of late issued/revised financial packages this year, I have a feeling that has something to do with why many people opted to bring in their information later.
Technically, you are supposed to file an amendment if additional information surfaces that was not reported on your original returns. This can be cost prohibitive, however, especially if it consists of minor changes. If these items are missed, sometimes the IRS will just send a proposed adjustment and basically rework the tax return for you and propose a balance to pay. California’s Franchise Tax Board will typically follow-up as well once they get wind of the issue from the IRS..
If you cannot get your returns completed on time, then you may wish to file an extension.
If you are filing your own extension for your personal tax returns with the IRS use Form 4868. Be sure to get some kind of proof of delivery and make a copy of the extension. Even with delivery confirmation it is difficult to prove what you sent. The best way is to e-file the extension through home-use tax software or by using a tax professional that e-files and obtains an electronic submission ID (the new modernized e-file system replaces the old declaration control number system with submission IDs). What about California? In the midst of a tiresome sea of nonconformity with the IRS, I continue to applaud California for this one act – you need not file a form to be granted an automatic extension! After you have filed your federal extension you have until October 15, 2014 (six months) to file your California personal return as well.
BEWARE!! Just because you file an extension does not grant you additional time to pay! The tax you calculate on the return you are going to prepare and file by October is still due by April 15. So if you think you might not have enough tax withheld, you need to make some good estimates and send in some checks. You may want to hire a tax professional to help with this calculation. You can send the federal check with Form 4868. For California, you can use FTB Form 3519 to send with your check. There are also electronic options for paying both of these.
If you do not pay your tax or file your return on time, interest and penalties are calculated based on any amount of tax you come up short. Interest varies with market changes (currently three percent a year for the IRS and California).
If you file an extension, but do not pay in enough tax by April 15, you will pay late payment penalties and interest. The IRS late payment penalties are a half-percent of the balance each month (up to 25 percent). California will charge you five percent up front plus another half percent of the balance each month (up to 25 percent).
If you fail to file an extension or file after the extended due date, the IRS and California penalties are each five percent of the balance each month (up to 25 percent). California has an additional trick. If you extend your return and then file late, they go all the way back to the original due date to calculate penalties and interest owed as if you never had an extension.
You may also incur underpayment of estimated tax penalties depending on your circumstances.
One other nice thing to know: if you owe no tax, you will owe no penalties, even if you file late.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
New Retirement Account Option – myRA
Filed under: Retirement Assets | Tags: Employee Benefit Research Institute, G-Fund, Government Securities Investment Fund, income limit, My Retirement Account, myRA, Obama, retirement plan trinkets, Roth-IRA, Thrift Savings Plan, TSP
Comments (3) Originally published in the Cedar Street Times
March 21, 2014
President Barack Obama announced in his State of the Union Address at the end of January, the formation of a new retirement plan option which will likely get started towards the end of 2014. The account type, dubbed “myRA” (pronounced “My R.A.”) is short for “My Retirement Account.” Despite a plethora of retirement plan options already available, one might ask, do we need yet another option to complicate planning? Despite all of the options available, roughly one third of employees in the United States still do not contribute to any type of retirement plan. Another third participates in an employer sponsored plan, and roughly the other third has an employer sponsored plan and some type of IRA as well. In a survey conducted by the Employee Benefit Research Institute, 57 percent of Americans say they have less than $25,000 in total savings (excluding the value of their house or defined benefit plans).
The point of the myRA is to help make it more accessible for the bottom third of savers to work on saving for retirement. My analysis is that in its current form, it may mildly assist in this manner, but could be used by more savvy investors as a way to access, to a limited extent, the G-Fund, a solid short-term investment option only available to people with government sponsored TSP programs.
The problem with myRAs is that they do not automatically enroll employees upon initial employment. This has been a desire of the President, but would require Congressional action. The goal of automatic enrollment would be to make it the default option, unless the employee deliberately opts out of the program. Without automatic enrollment there is very little reason to believe employees would be more likely to join these plans than ones already offered by employers. That said, many small employers currently do not offer plans to employees due to the added expense of operating and/or contributing to the plan, and most of them exclude a lot of short-term or part-time employees.
The myRA would have a very low entry point – with only a $25 opening contribution by an employee, no fees or requirements for the employer to contribute, and a $5 per paycheck minimum contribution, it is theoretically much more accessible, especially for short-term and part-time employees. The plan would also be portable from one employer to the next, helping to reduce “retirement plan trinkets” – my term when people carry around a half dozen retirement plans from all their former employers. The program would be administered by the federal government, and since it would have only one investment option, there should be a lot less questions and hassles to set up. The employer would simply direct a portion of the employee’s direct deposit to the government, instead of the employee’s bank account.
The lone investment option is the Thrift Savings Plan offered G-Fund – Government Securities Investment Fund. This fund invests in United States government securities and its goal is to outstrip inflation but is also guaranteed by the full faith and credit of the United States government. Its guaranteed return is the weighted average of all outstanding Treasury notes and bonds with a four year or longer maturity. So effectively you get a long-term rate, even though your investment could be short-term. Since 1987 its average return has been 5.4 percent per year. In 2013 it returned 1.89 percent – not fantastic, but much better than most short-term investments available today, and with no risk.
One of the key characteristics of a myRA is that it is effectively a Roth IRA. This means you get no tax benefit for putting money into the account, but it grows tax-free forever, has no required minimum distribution when you turn 70 1/2, and there is no tax on the principal or earnings when you withdraw it in retirement. Like a Roth IRA, f you need to take money out sooner, you can take out your original contributions with no penalties (but not earnings). The same income phaseouts for Roths apply to myRAs as well – you must have adjusted gross income less than $129,000 filing Single, and $191,000 Married Filing Joint ton contribute. In addition, the same aggregate IRA contribution limits ($5,500 for people under 50 and $6,500 for people over 50) will apply for all IRAs, including your myRA.
A key provision with a myRA is that once the account balance hits $15,000 (or 30 years) it is automatically converted to a regular Roth IRA. However, people can rollover funds from a myRA to a regular Roth IRA at any time to keep their balance below $15,000. I could see this used by people who like access to the G-Fund as a safe, possibly, short-term investment that provides a decent rate of return.
Personally, I think we need to consolidate and simply our retirement plan options, and not create more animals to supervise. But for now, the tax code continues to grow more complex – benefitting some, and making things more confusing for most.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
Property Taxes on Equipment, Furniture, Tools, Etc. Due April 1
Filed under: General | Tags: assessed, assessor, audit, Board of Equalization, BOE-571-A, BOE-571-L, Business property tax, California Constitution, computers, construction in progress, depreciation, due date, equipment, furniture, improvements, intangible, land improvements, leased equipment, leasehold improvements, machinery, Monterey County Assessor's office, property, Revenue and Taxation Code, structural improvements, supplies, tangible, tax, tools, vehicles
Leave a Comment Originally published in the Cedar Street Times
March 7, 2014
Many people starting up a small business for the first time are surprised to learn that there are business personal property taxes due each year on the value of everything from the chair they sit in, to their computer, to the pads of paper in the supply closet. Most people are familiar with property taxes assessed on their home each year, but a business is also taxed on all of its personal property. When I say personal property, I mean anything that is tangible, but is not real property (real estate). Intangible assets like copyrights, patents, goodwill, or even software are generally not subject to tax.
This business property tax is established in the California Constitution and the Revenue and Taxation Code. It falls under the jurisdiction of the California Board of Equalization (the same group that handles sales tax), but it is administered by and filed with the assessor’s office of each county. For most businesses, the form to file is BOE-571-L (BOE-571-A for agricultural businesses), and it is due on April 1st of each year. Even though the form is due on April 1st, there is a grace period, and you technically have until May 7th to postmark the form so it will not be delinquent. (This is much appreciated by CPAs that are working to get income tax returns completed by April 15!) It is also important to note that the reporting covers your property that existed as of January 1st, and not as of the date you fill out the form.
Maybe you have been in a business for a few years, or maybe 20 years in unusual cases and have never seen a request for this form. Are you in trouble? There is an interesting rule that states if the total cost of your business personal property is under $100,000, you do not have to voluntarily start filing the form. That would cover a lot of small businesses. However, if you receive a request from the assessor’s office to file the form, you must file every year going forward. As information sharing has become more mainstream among various government agencies, it is fairly common to get a request in the first year or two you operate, even as a tiny sole proprietor.
The BOE-571-L asks you to break down your property into various categories and by year of purchase. As the property gets older, it is assessed less each year. (Tip: retain a copy of your submitted form for reference when filing for the next year.) Each form is processed by hand. The assessors appreciate having attached lists that identify more specifically the property you list in the various categories and years. As you will see on the form, it is not always clear which category to put things in. For instance, the word equipment is used in four different categories, and you might not be sure where it should be included. Categories are assessed and depreciated at different rates, so the assessor has a better chance of assessing you the correct tax if you provide more information. If you have questions, you can call the Monterey County Assessor’s office at 831-755-5035 and ask for the business property tax department. They are generally available to answer any questions you may have.
It is probably fairly obvious that computers, printers, copiers, furniture, equipment, machinery, and tools are assessed. In addition, the supplies you have on hand for your business are assessed. If you do not have a good idea of this value, one approach, or instance, may be to take your office supplies account in your accounting records and divide by 12 if you think you keep about a month of supplies on hand.
Leased property such as a copy machine, is an area that people sometimes overlook. Your lease agreement will indicate whether you, or the company you lease from is responsible for the property taxes. If you are responsible, you need to report it on your BOE-571-L. Licensed vehicles through the Department of Motor Vehicles (DMV) do not need to be reported here whether owned or leased, as they are being taxed through the DMV.
Structural improvements, fixtures, land improvements, construction in progress, and land development are required on the form as well. Generally, however, structural improvements, land improvements, and land development information is not assessed by the business property tax division and is passed along to the real property division for them to decide whether or not to assess it, or wait for the next time the property as a whole is assessed. Construction in progress would be assessed by the business property tax department: i.e. – you have spent $200,000 in construction on a building that is not complete at the end of the year. Once the building was completed, the business property tax department would stop assessing it, and the real property department would start assessing it.
Fixtures such as counters, sinks, lights, bolted down equipment, etc. would generally be assessed by the business property tax department. If you are a tenant and pay for any leasehold improvements, you should report and will be assessed on those as well. Most leases are written that the property becomes the landlord’s after the tenant moves out of the space.
One final issue that often comes up in an audit is whether or not the business has property that was purchased and immediately expensed on its books and tax returns, and therefore do not show up on depreciation schedules, which is often the main source for reportable property. In the code, there is no immateriality exclusion for something as small as a stapler, but in practice the auditor is not going to assess you on those items. You should look for more significant items, however, such as the $400 in books you bought for your business library.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
Relief if You Paid Tax on a Short-Sale 2011-2013
Filed under: Foreclosures and Short-Sales, Residence Sale | Tags: 580(b), 580e, anti-deficiency, Barbara Boxer, California, cancellation of debt, Chief Counsel, debt, exclusion, Foreclosure, Franchise Tax Board, FTB, Internal Revenue Service, IRS, nonrecourse, principal residence, qualified debt, qualified principal residence indebtedness, recourse, refund, section 121, Senate bill 458, Senate bill 931, Short-Sale
Leave a Comment Originally published in the Cedar Street Times
February 21, 2014
Hopefully we are nearing the end of the short-sale and foreclosure saga that has continued since 2008. My litmus test based on tax return filings is indicating that things are much closer to being back on track. Prior to 2008, it was all about 1031 exchanges. Those turned off like a faucet when the markets crashed, and then short-sales and foreclosures took center stage. I have seen those tapering off over the last couple years, and I am starting to see 1031 exchanges again. The cycles continue!
But before we leave short-sales and foreclosures in the dust, there is a possible silver-lining handed down by the IRS and FTB in the last few months. Taxpayers that generated income tax as a result of a short-sale in California on their principal residence, retroactive to January 1, 2011, may be entitled to a refund.
California Code of Civil Procedure Section 580b has been dubbed California’s “anti-deficiency laws” for years. It had a positive effect on homeowners because it basically said if you had never refinanced your home and you lost it in a short-sale or foreclosure that you could not be pursued for the balance you still owed (the deficiency), and the remaining debt would not be taxable income to you because the debt was considered nonrecourse debt.
This, however, left many people out in the cold that had refinanced. Suddenly, it was a different ball game if you had done a refinance (and who didn’t during the run of good years up through 2007!?), and the debts were then allowed by lenders to be treated as recourse debts and they could pursue your personal assets. Alternatively they could cancel the debt if it was not worth pursuing, leaving you with taxable income for the amount cancelled.
Congress stepped in (and California generally conformed) during the housing crisis and enacted favorable legislation which said you could exclude cancellation of debt income generated by your personal residence. The catch, however, was that the debt had to be “qualified debt.” In short, if you lived off the equity in your house by refinancing to pull cash out and did anything with it other than improve the property, then you were not eligible for the exclusion on that portion and would still have to pay tax.
Then, a few years ago, California passed Senate bills 931 and 458 which were codified into law as California Code of Civil Procedure Section 580e as of January 1, 2011. This resulted because some unscrupulous lenders were entering into short-sale agreements to allow sellers to go through with the sale of their property for less than the amount owed to the bank, but then still pursuing the seller for the remaining debt after the fact (often a big surprise to the seller). California’s enactment of this law was good news for homeowners because it basically said, even if you had refinanced, but had entered into a short-sale agreement with a lender, then you could not be pursued for the remaining balance owed and that lenders would basically have to cancel the debt. Of course, cancelling the debt could mean tax was owed, but that was still better than being pursued for the remaining balance!
Finally, in November 2013 a letter from the Office of the Chief Counsel at the IRS written to Senator Barbara Boxer, due to an inquiry from her, stated that the IRS would treat any debt pursuant to California’s 580e as nonrecourse debt! The Chief Counsel’s office at California’s Franchise Tax Board followed up with their own letter a month later saying they will conform to the IRS interpretation.
This means that anyone who filed a tax return in 2011 or 2012, or even this year, and reported cancellation of debt income related to the short sale of a principal residence, should consider filing an amendment for a possible refund. It is still possible to have income tax, primarily if you did not live in the house for two of the last five years prior to your short-sale. The reason is that when a home is disposed of with nonrecourse debt, the total amount of debt outstanding at the time of the short-sale becomes the sales price of the home. You then subtract your cost basis, and the difference is your gain on sale. However, if you lived in the home for two of the last five years, then you get a $250,000 gain exclusion for filing as a single status, and $500,000 gain exclusion if married filing jointly, pursuant to IRC Section 121.
You need to act on this during the next year if your short sale was in 2011 as the statute of limitations expires three years after filing.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
Aren’t All Tax Returns Created Equal?
Filed under: General, Switching Preparers | Tags: Attorney, bond, California, California Tax Education Council, Certified Public Accountant, commodity, continuing education, CPA, CRTP, CTEC, CTEC Registered Tax Preparer, EA, Education, Enrolled Agent, exam, H&R Block, Jackson Hewitt, Liberty Tax Service, license, Registered Tax Return Preparer, requirements, RTRP, tax returns, TurboTax
Leave a Comment Originally published in the Cedar Street Times
February 7, 2014
There is a belief by many people that a tax return is a bit of a commodity – basically you are going to get the same results no matter if you or anybody else prepares the return. If that were true, your only goal would be to find the absolute cheapest tax preparer in town (or do it yourself).
A number of years ago Money magazine used to annually send out the same hypothetical family’s tax return to be prepared by 45-50 tax preparers across the country. The surprising result was that it was rare in any year to have even two tax returns prepared the same way. The most recent one that I could find resulted in only 25 percent of the preparers coming within $1,000 of the theoretical correct answer. That means 75 percent missed the mark by more than $1,000. This certainly speaks to the complexity of the tax code, and why you really need to have someone with as much relevant experience, education, and training as possible to navigate the tax terrain. You may think you are being savvy by saving $200-$300 by getting a deal on your tax preparation, but what did you get? Maybe you overpaid your tax by a $1,000 in the process of saving $300. And how would YOU ever know.
When it comes to hiring someone to prepare your returns, credentials are not everything, but they certainly are a measuring stick of the education, training, testing, and commitment required. Here are your options:
Do-It-Yourself Software (i.e. TurboTax) – Tax software, whether for professionals or amateurs is certainly a requisite tool to bring any measure of accuracy or efficiency to preparing a tax return. Computers are quick at math and very accurate at crunching numbers (that is the part that is “guaranteed” to be accurate by do-it-yourself software providers), but if you provide the wrong input, or your software is not even programmed to ask you or accept all the variables you might need, then you will get a wrong answer every time (that part they don’t guarantee).
In addition, without an understanding of the forms and tax law, you will have no idea if there is a glaring error staring you in the face when you are ready to submit the forms. I have seen countless returns butchered through the use of tax preparation software over the years. I am currently amending three years of tax returns for a family that overpaid their taxes by $1,000 a year for the past twelve years due to a simple mistake that the software was not able to point out to them. Unfortunately the statute of limitations has run out on the first nine years and they cannot get a refund at this point.
RTRP -“Registered Tax Return Preparer” – This is the current basic credential required by the IRS to prepare tax returns for pay. There is no formal high school or college education required, no professional class and exam process to become licensed, and no continuing education requirement. You just pay $65 to the IRS and you can prepare tax returns professionally! This designation was created in the last few years with the intent of having a basic exam and some continuing education, but the testing and education requirements have been put on hold pending legal challenges to the requirements. RTRPs have limited practice rights before the IRS.
CRTP – “CTEC Registered Tax Preparer”– (CTEC stands for CA Tax Education Council) – This is the current basic credential required by California to prepare tax returns for pay. Again, there is no formal high school or college education required. There is a 60 hour professional class (equivalent to three or four semester units in college – one class) that is offered by many providers in person, on the internet or by self-study with an exam on the material covered. There is 20 hours of continuing education each year, and a $5,000 bond. This is the license that the vast majority of preparers hold in California at chains such as H&R Block, Liberty Tax Service, and Jackson Hewitt. CRTPs also have limited practice rights before the IRS.
EA – “Enrolled Agent” – This is the highest of the two designations offered by the IRS, and EAs can practice in any state. Again there is no formal high school or college education required, and there is no required professional class (although an intensive prep course is generally taken). There is a 10.5 hour proctored three-part exam with 100 question each – one on individual, one on business returns, and one on practice procedures and ethics with essentially 24 hours of continuing education each year. EAs have unlimited practice rights before the IRS.
CPA – “Certified Public Accountant” – Licensed by each state (although there is reciprocity to practice with nearly every state now). California requires a college degree with 150 semester units (five years) including 24 semester units of accounting and 24 semester units of business related courses in taxation, economics, finance, management, etc., 10 semester units of ethics, and another 20 semester units of accounting studies which a masters of taxation or masters of accountancy would satisfy. You must then work for a year under the direct supervision of a CPA. If you want to be able to sign audit reports, you have to have 500 supervised audit hours. You must also pass a 14 hour proctored four-part national exam and then a CA ethics exam. California also requires a LiveScan background check and fingerprinting of all applicants. There is essentially 40 hours of continuing education required each year for California CPAs. CPAs have unlimited practice rights before the IRS. Although CPAs are trained in, and can do a lot more than just your tax returns, most small CPA firms focus on tax preparation.
Attorney – Licensed by each state. We won’t discuss the requirements to become an attorney, as attorneys rarely prepare tax returns. Some attorneys that specialize in tax will prepare tax returns, although most of those are focused on estate tax returns. Attorneys that do prepare tax returns will often have obtained a CPA license also. Attorneys have unlimited practice rights before the IRS.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
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.
Travis H. Long, CPA, Inc. Blog 