Archive for the ‘IRS’ Tag
New Tax Impacts for Trusts with Capital Gains – Part II
Filed under: Trusts and Estates | Tags: $11950, 1040, 3.8%, B trust, beneficiary, bypass trust, California, Capital Gains, dividends, gifting trust, income, income beneficiary, interest, irrevocable trust, IRS, lawsuit, net investment income, principal, private, remainder beneficiary, revocable living trust, revocable trust, Social Security Number, tax, Uniform Principal and Income Act, UPIA
Comments (1) Originally published in the Cedar Street Times
November 15, 2013
Two weeks ago I laid the groundwork of some of the basics on revocable and irrevocable trusts in order to start discussing new implications due to law changes in 2013. Revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return. Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.
In early 2013 new laws were passed that increased the personal income tax rates from 35 percent to 39.6 percent on people in the highest tax bracket ($400,000 filing single or $450,000 married filing joint). It also raised the capital gains rate to 20 percent for these same people (up from 15 percent). In addition, a new 3.8 percent Medicare surtax is assessed on net investment income (think interest, dividends, capital gains, among others) for people making over $200,000 single or $250,000 filing joint. Most people do not make $450,000 or even $250,000 a year, so this seems innocuous to many.
However, many people making less than these thresholds do have irrevocable trusts – most commonly after a spouse has passed away. The problem with irrevocable trusts is that the thresholds to be impacted are so much lower. Once your trust has just $11,950 (2013) of income, you have hit the top bracket and will be subject to the 39.6 percent income tax rate, 20 percent capital gains rate, and the 3.8 percent Medicare surcharge! One stock sale could easily put you in the top bracket! This effectively means an 8.8 percent tax increase on capital gains and 4.6 percent to 8.4 percent increase on other types of income. That is a big hit every year, and will be something new to battle.
If you can avoid having the income taxed to the trust, and instead have it distributed out and taxed to the beneficiaries, you can probably save a chunk of taxes since it will be taxed at the lower rates on the beneficiary tax returns – assuming your individual beneficiaries are not in the top tax bracket!
Whether or not you have discretion or are required to distribute income to beneficiaries is defined in your trust document. Even the very definition of “income” itself, for trust accounting purposes, is governed by your trust document primarily and the state’s principal and income act, secondarily. The proper allocation of income and expenses to trust accounting income or principal is very important to beneficiaries (whether they realize it or not), since trust accounting income generally goes to one beneficiary, and the principal often goes to a different beneficiary down the road…so it determines the amount the beneficiaries receive. Many common irrevocable trusts are written to require the distribution of trust accounting income each year to the current beneficiaries with rights to dip into principal as needed to maintain an ascertainable standard of living. Upon death, the remaining principal goes to the remainder beneficiaries.
The California Uniform Principal and Income Act does not define capital gains as income, but as a principal transaction – basically an asset changing form – for instance from real estate to cash. I hardly ever see trusts that even mention capital gains, much less defining it as a part of income. In the absence of trust language, the principal and income act governs, therefore many trusts in California are not permitted to distribute capital gains to the beneficiaries.
It is amazing to me how many trust tax returns I have seen over the years that violate this – often because the preparer does not really understand trust taxation rules. I have even run into cases where the prior preparer has never even asked for the trust document, and thus relies on the default settings in their tax software in conjunction with “the way we’ve always done it” to govern! This would be analogous to creating a detailed shopping list and asking your neighbors to go shopping for you; in lieu of taking your list, they go on the internet and print out a list of common things people buy, and then supplement it with things they have bought for other neighbors in the past! Chances are pretty good; you will not get what you need! Enforcement of correct trust income tax preparation comes much more often by threats of lawsuit against the trustee than by IRS audit. Keep in mind the remainder beneficiary’s attorney would be happy to sue the trustee for shorting his client’s share by not following the terms of the trust.
In two weeks we will conclude our discussion.
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.
IRS Affected by Government Shutdown
Filed under: General, National Debt | Tags: $800, 000, appeals, audit, Congress, essential employees, Exxon, funding, furlough, GM, Google, government shutdown, income tax, interest, IRS, payroll tax, Penalties, refunds, Target, taxpayer advocate
Leave a comment Originally published in the Cedar Street Times
October 4, 2013
Due to the inability of Congress to come to terms regarding the government shutdown (or just about anything for that matter), I have a pretty good chance that this article will still be worth reading by the time it is published in the newspaper on Friday!
Everyone is aware by now that over 800,000 federal employees are on furlough. I read that this is more than all the employees of Target, General Motors, Exxon, and Google combined. That is a lot of people! Included in these 800,000 are most of the Internal Revenue Service employees.
Many of you may be cheering right now, but certainly not anyone that is waiting on a refund or currently trying to work out any problems with the IRS. Prior to the furlough, telephone wait times to speak with an IRS agent have been 15 – 45 minutes, or sometimes you would get the message that they were too busy to even put you on hold, and then hang up on you. Right now you will have an indefinite wait since the call centers are completely closed. All local IRS offices are also closed to the public as well. The shutdown will of course put even more pressure on wait times when funding is restored, and there is a backlog of problems to resolve.
This is an interesting time to be shutdown considering that extended personal tax returns are due on October 15. The IRS still expects individuals and businesses to file all tax returns on time, keep making income and payroll tax payments, etc. Presumably, they have some essential employees still on-the-clock to let the mailman in and to make deposits! They are encouraging electronic filing since those returns are processed automatically by computers. Paper returns will not be processed, however any payments enclosed will still be processed! All tax refunds are suspended until normal operations resume.
Computer generated IRS notices will continue to be mailed out, but all audits, appeals, and taxpayer advocate cases are suspended. If you had meetings scheduled they will be rescheduled.
The IRS website will still be up and running, but certain services may be unavailable. The IRS automated telephone system will also still be working (800) 829-1040.
I can only assume that penalties and interest will still accrue even if you are waiting on the IRS to resolve an issue.
I called the IRS employee emergency hotline for kicks. They are informing employees that they cannot perform any work, even if they want to volunteer their time to keep certain cases moving, and they cannot use any government computers, equipment, or other resources. If they were en route traveling when the furlough began, they were to immediately return home.
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.
When Can I Throw Out My Tax Returns?
Filed under: General | Tags: 1099-B, basis, document retention, FTB, how long should I keep my tax returns, installment sale, IRA, IRS, rental property, save tax returns, statute of limitations, throw away tax returns
Leave a comment Originally published in the Cedar Street Times
May 3, 2013
It is time to do some spring cleaning! Do not miss your opportunity as summer is coming quickly, at which point you will be required to keep everything for another year. Perhaps you will find that old pair of muddy tennis shoes in the garage – now the home to three indignant spiders as you turn their palace upside down. Or maybe you will find that half-used bottle of hotel shampoo under the sink – a small, but satisfying entitlement for a $300 room charge. Ah, and then there are those tax returns you filed way back in April – is it time to get rid of those too?!
You can do whatever you want, but my advice is to keep them. In fact, I would say you may want to keep every tax return (and the supporting documents) you have ever filed – I know I have. Record retention is always an interesting debate and you hear a lot of people say three, five, or seven years as a rule of thumb for many types of documents. Regarding tax returns, the real answer is unique to each person depending on his or her tax circumstances and risk tolerance.
Someone that works a W-2 job, has no other sources of income, no investments, contributes to no retirement plans, and files the returns correctly would have little risk if discarding the returns after four years. If you do make retirement plan contributions, depreciate any assets, have an installment sale agreement, or a host of other things, it would not really be wise to discard the returns in accordance with a rule of thumb.
The IRS generally has three years from the later of the due date (or extended due date) or the date you file to audit your returns. The California FTB has four years from the later of the non-extended original due date or the date you file in order to audit. You should never throw out returns or source documents until you are outside of these statutes of limitation. If you have understated your gross income by more than 25 percent (even if by accident), then the IRS has six years to audit you. People can get tripped up on this pretty easily if they fail to report stock sales. I have seen this before with people preparing their own tax returns that ignore the 1099-B issued year-after-year because they did not really understand it. If you filed a false tax return or there was any kind of fraud, there is no statute of limitations.
Even if you are outside the statute of limitations, however, you may still need prior tax returns to support positions you are taking on current tax returns that are inside the statute of limitations. Think about someone that has been contributing to an IRA for many years and was unable to take deductions due to income limitations. Each of these nondeductible contributions would have created basis in the IRA which would lower the taxable amount of distributions while in retirement. If the IRS audited your returns in retirement and questioned your basis, having all the past tax returns showing the nondeductible contributions would be a saving grace.
People that have rental properties or home offices may find tax returns from twenty-five years ago helpful in proving the basis in the property when it is eventually sells due to depreciation deductions taken on each past return. I have also had situations where clients had no idea what their cost basis was for a stock sale, and we were able to help recreate and substantiate the cost basis by reinvested dividends reported on tax returns stretching back several decades.
The safest thing to do is just keep them, or at least scan them and maintain the electronic files through the years.
One other pointer – be sure you do not throw out purchase records, refinance documents, or receipts of improvements to any type of property you own as you will likely need this information if you ever sell it.
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.
Independent Contractor Vs. Employee: 1099s Due Jan. 31
Filed under: Employers | Tags: 1099s, 20 points, California Labor Commission, control, disability, employee, Form 8919, Form SS-8, FTB, independent contractor, IRS, labor laws, payroll taxes, Penalties, Revenue Ruling 87-41, W-2, workers' compensation
Leave a comment Originally published in the Cedar Street Times
January 25, 2013
By the end of this month, business owners will have sent 1099s to their independent contractors and W-2s to their employees. Many business owners think it is their choice, or perhaps a choice they can make together with the person performing the services on how they are to be treated. It is not.
Business owners certainly see the savings to treat workers as independent contractors – no payroll taxes, no overtime, no break periods, no meal periods, no workers’ compensation insurance, no benefits, or a myriad of other California laws to follow. Even if the worker gets higher pay to cover the extra taxes incurred as an independent contractor, he does not have to carry unemployment insurance or disability insurance on himself and sometimes thinks that is a personal benefit. Of course, not having insurance is problematic for the worker and for the system as a whole, which depends on people paying premiums.
At the end of the day, people who are employees wearing the cloak of an independent contractor, are usually getting the short-end of the stick, because they really are dependent on the employer, and no longer have the ordinary benefits afforded by labor laws. California knows this, and they come down hard on the employers when it is discovered that employees are misclassified as independent contractors. Unfortunately, even for business owners that treat a misclassified independent contractor well, it can come back to haunt them if the individual becomes disgruntled.
Misclassification can get extremely expensive, or even sink a small business. Besides legal fees, you could be hit with the tax liability, penalties, and interest from the IRS and FTB for all the back payroll taxes for the employee during the period misclassified. You may also have to pay back wages and benefits the employee would have been entitled to. The California Labor Commission can also fine you $5,000 to $25,000 per violation.
So, how do you know if someone is an employee or an independent contractor? According to law it comes down to the right to direct and control the details and means of the work. The IRS published Revenue Ruling 87-41 listing twenty points to consider as a guide. They have also published their own internal auditor’s training guide, which provides more insight. You can even file a Form SS-8 Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding to get an IRS determination in writing. This form is most often used by disgruntled workers along with Form 8919 when they feel the employer misclassified them and they now owe tax or cannot get unemployment or disability benefits. However, employers may also file the Form SS-8, or simply use it internally as a kind of double check to see if they feel they are classifying workers correctly. All of these documents mentioned are available free online with a simple Google search.
Here is a simplified rundown of the twenty points from Revenue Ruling 87-41 which would help in the determination process. You do not have to have all of them and no single one is decisive, but the first three are given a lot of weight. You may have an employee if: 1) you require the worker to follow specific instructions on when, where and how work is to do be done; 2) you provide formal or informal training for the worker; 3) the worker has predetermined earnings and always get paid for the work and does not have the ability to make a profit or incur a loss; 4) the services performed by the worker are highly integrated into your own and affect business success; 5) the worker is personally required to perform the services instead of having the option to have their own worker perform the services; 6) you hire, supervise, and pay for your worker’s assistants; 7) you have a continuous relationship with the worker – such as working with you every day; 8) you dictate the hours or days the worker performs services; 9) the worker works full-time for you; 10) you require the worker to perform services at your work site even though it could be done elsewhere;
11) you require the worker to perform services in a specific order or sequence; 12) you require written or oral reports regularly; 13) you pay hourly, weekly, or monthly versus by invoice or project completion; 14) you reimburse the worker’s travel and business expenses; 15) you provide the worker’s supplies, tools, computers, etc.; 16) you provide an office for the worker; 17) the worker does not provide the same services to anyone else; 18) the worker does not advertise his own services to the general public, have business cards, etc.; 19) you can discharge the worker at any time instead of having to honor contract terms; 20) the worker can terminate his services without having to honor any contract terms.
Ultimately, the determination is a legal issue. If you do not feel comfortable making the decision on your own, an attorney that focuses on employment practice matters should be consulted.
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.
Donating Your Bald Eagles and Blue Jeans
Filed under: Charitable Donations, Trusts and Estates | Tags: appraisal, Art Advisory Panel, Bald and Golden Eagle Protection Act, charitable contributions, charitable deduction, Estate Tax, IRS, noncash donation
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
August 1, 2012
If you missed the July 22 issue of the New York Times, you missed a great article about estate tax the IRS is trying to levy on a piece of art that includes a genuine stuffed bald eagle. The IRS has valued the piece of art at $65 million and wants the heirs of New York art dealer Ileana Sonnabend to pay approximately $29.2 in estate tax.
The rub, however, is that it is illegal to sell the piece of art due to the 1940 Bald and Golden Eagle Protection Act. The heirs and their appraiser are of course contending the value is $0 since they cannot legally sell it – how can it have value? The IRS Art Advisory Panel reportedly called it a “stunning work of art” and is contending that it could be sold illegally on the black market and therefore has value. It sounds to me like our government wants to have it both ways – you cannot sell it but, we are still going to tax you as if you could. I think our tax policy should promote legal activities!
The end of the article mentions a possible charitable donation instead. I suppose this could be an option for the heirs. Unfortunately, the estate tax would not be eliminated, since the heirs would be the donors and not the decedent. They would also have to be able to absorb a $65 million donation in a six year period against their income. IRS law allows you to make a charitable contribution up to 50% of your income each year which can be carried over for up to five more years. After that, you lose the rest permanently. One strategy for large noncash gifts is to give a partial interest in the item each year and loan the rest to the charitable organization. This way, you do not lose any of the valuable deductions.
It is important to remember that current IRS law requires an appraisal for donations over $5,000. This would also include multiple gifts during the year of similar items that add up to over $5,000. So if you are taking lots of trips with household items and blue jeans, just make sure it does not go over $5,000 during the year. It is hard to get an appraisal on a pair of jeans you donated eight months ago. Oh, and be sure to get your charitable gift receipt!
Regarding the bald eagle art – I sure am glad Mrs. Sonnabend did not leave it in her will to me – sounds more like a white elephant from my perspective!
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.
Losing Your Home? Favorable Tax Provisions Expire 12/31/12.
Filed under: Foreclosures and Short-Sales | Tags: 1099-C, cancelled debt, Foreclosure, FTB, insolvency, IRS, qualified principal residence indebtedness, recourse, section 108, Short-Sale
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
May 16, 2012
If you think you may not be able or willing to hold on to your home for the long-term, you should seriously consider your options for short sale or foreclosure as soon as possible. At the end of this year, Internal Revenue Code Section 108(a)(1)(E) is set to expire (California tax law conforms to the expiration also). This is the provision that allows people to possibly exclude from income, cancelled debt when recourse loans on their primary residence are higher than the value of the home. These transactions take three to 12 months to complete, so time is of the essence.
Between foreclosures and short sales, short sales are your best option in this regard. This is where you find a buyer and the lender accepts the buyer’s offer, even though it is less than what you owe the lender. Current law in California forces lenders to cancel the remaining debt as of the date of the short sale and prohibits them from pursuing your personal assets if they agree to the short sale. A foreclosure does not guarantee the lender will not pursue you for the remaining debt. Even if they do decide to cancel the debt, it may not be until after the end of this year.
Whether debt is cancelled by short sale or possibly by foreclosure, the cancelled debt is potentially taxable income to you. If you did not take cash out during past refinances, or to the extent you put cash-out back into improving the property, you will likely be able to exclude the cancelled debt income from your taxable income due to code section 108(a)(1)(E)…until the end of this year. After that, you will likely only be able to exclude the debt if, and only to the extent you are insolvent (more liabilities than assets). Bankruptcy is another option, but it must be filed before you lose the property – in other words, plan early.
Imagine $200,000 of income on your tax returns from cancelled debt, generating an extra $75,000 or more of tax. Many people will find these transactions to be the largest potentially taxable transactions in their life, so it is important to seek competent professional advice, plan appropriately, and avoid the tax if at all possible.
Prior articles relating to foreclosures and short sales 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.
Paying the IRS: Installment Agreements
Filed under: Extensions, Tax Collections | Tags: 3567, 9465, collections, Extension, FTB, installment agreement, IRS, late filing penalty, late payment penalty, owe
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
May 2, 2012
Hopefully by now you have filed your tax returns. If you decided to file for an extension, that is fine, but keep in mind you have not extended your time to pay any tax owed. That was still due on April 17th. Filing the extension was key, however, because a late filing penalty is assessed at five percent of the balance owed for every month the return is late (capped at 25 percent). If you do not owe taxes, you are fine, even if you did not file an extension, since the penalty is based on the balance owed.
If you did file your return and you could not come up with enough cash to pay the IRS, you have payment options. If you feel you can pay the IRS within 120 days, call 1-800-829-1040 and advise them of this fact and they will not harass you for payment and you can avoid the cost of setting up an installment agreement.
If you need to make payments over time by setting up an installment agreement, the IRS will generally allow this quite easily if your balance is below $25,000, you can pay it off in seven years, and you are in good standing with the IRS. This is accomplished by filing Form 9465. There is a $105 fee to set up an installment agreement, unless you elect electronic payment withdrawals from your bank – this cuts the fee down to $52. Interest accrues at a variable rate which changes every quarter (currently three percent per annum) and late payment penalties may also still be assessed (1/2 percent per month, or portion thereof – approximately six percent per annum). Other minor penalties may apply also.
In practice, I have never had an installment agreement under $25,000 turned down or even questioned by offering a monthly payment amount equal to the starting principal balance divided by 60. If you owe over $25,000, you have to provide detailed information about your financial situation through additional forms before an installment agreement is granted. With an installment agreement in place, you avoid harassing letters and other possible collection actions such as levying bank accounts, garnishment of wages, forcing the sale of assets, etc. (Forcing the sale of assets is rare unless you owe at least $100,000…and are obstinate!)
If you have large tax debts that may be difficult or impossible to pay there are other less friendly avenues such as offers in compromise, or even bankruptcy filing if the tax debts are at least three years old.
California has a less generous installment agreement option, but can be requested by filing FTB Form 3567.
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 Extension
Filed under: Extensions | Tags: Extension, Form 3519, Form 4868, FTB, IRS, penalty
Comments (2) Originally Published in the Pacific Grove Hometown Bulletin
April 6, 2011
Imagine opening a letter from the IRS assessing you an $18,000 penalty because they claim you did not file your extension on time! I once worked with a client that was faced with this exact problem. The irritating part is that an extension request is an arguably meaningless filing since it is automatically granted if requested. Nonetheless, the IRS takes it seriously.
So with April 18th fast approaching (taxes are not due on the 15th due to the federal observation of the signing of the Compensated Emancipation Act by Abraham Lincoln in 1862), how can you protect yourself? 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 confirmation. What about California? In the midst of a tiresome sea of nonconformity with the IRS, I 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, 2011 (six months) to file your returns.
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 18. 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 4 percent a year for the IRS). IRS late payment penalties are ½ percent of the balance each month (up to 25 percent). If you fail to timely file, the IRS penalties are 5 percent of the balance each month (up to 25 percent). You may also incur underpayment of estimated tax penalties depending on your circumstances. California interest and penalties are similar or higher.
Oh, and remember my client with the $18,000 penalty – fortunately we were able to successfully petition to get the penalty waived!
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA. Travis can be reached at 831-333-1041.
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