Mid-Year Tax Planning – 2014

Tax Season 2014 has come and gone and now it’s time to think about tax planning for tax year 2014. Items which could impact your 2014 taxes include certain life events and expired tax provisions.

Certain Life Events

Have you recently had a birth, adoption or death in your family? Have you gotten married, divorced, retired, or changed jobs this year? If so, you and your tax professional need to discuss the potential impact on your 2014 taxes. For example:

1) For Qualifying Children under the age of 17, a tax credit up to $1,000 per qualifying child may be allowed (which may be refundable.)
2) If you have retired (or are planning on retiring), you need to analyze how your change in income resulting from receiving IRA or pension distributions, and/or Social Security benefits will impact your tax liability.
3) A divorce or marriage could impact your tax situation in multiple ways (for example, alimony paid or received, deductions for mortgage interest and real estate taxes on your home, QDROs (qualified domestic relations orders) and potential changes in the standard deduction and personal exemptions allowed.)

Expiring Tax Provisions
Given the current political climate, it is not known if or when an agreement on extending the Expiring Tax Provisions (“extenders”) may be reached. These extenders have made tax planning a challenge for both taxpayers and tax professionals. Therefore, if any of these provisions impact you, it is important that you contact your tax professional or personally monitor legislative activity so that you are aware of the possible tax consequences:

1) Sales Tax Deduction: Prior to 01/01/2014, taxpayers may have been eligible to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Schedule A. This included the sales tax paid on the purchase of a vehicle. This deduction is no longer available to individuals.
2)Mortgage Insurance Premiums: Prior to 01/01/2014, taxpayers may have been eligible to deduct the amounts paid for qualified mortgage insurance premiums along with their mortgage interest (subject to adjusted gross income limitations). Effective 01/01/2014, no deduction is allowed for these premiums paid or accrued after this date.
3)Tax-free Distributions from Individual Retirement Plans for Charitable Purposes: Prior to 01/01/2014, taxpayers over 70 ½ may have been eligible to exclude from their gross income distributions up to $100,000 from their IRA to a qualified charitable organization. This permitted taxpayers to satisfy their Required Minimum Distribution (RMD) and not include the amount in their income. As this reduced their Adjusted Gross Income (AGI), which favorably impacted the taxable amount of Social Security benefits received, this was a large tax advantage for taxpayers. This special distribution provision is not available for distributions after 2013.
4) Qualified Principal Residence Debt Exclusion: Prior to 01/01/2014, the discharge of principal residence debt (qualified mortgage on a taxpayer’s main home incurred to buy, build or substantially improve his or her main home) was generally excluded from gross income. As many taxpayers are still experiencing financial difficulties resulting in foreclosures, short sales or debt forgiveness on their primary residence, the tax ramifications for 2014 will have major tax consequences.

Other Steps to Consider Before the End of the Year

You should thoroughly review your situation before year-end to determine the best tax strategies for 2014 and the impact on 2015 as well. Accelerating income/deferring deductions into 2014 or deferring income/accelerating deductions to 2015 are just a couple of approaches that could benefit you.

If you have any foreign assets, be aware that there are reporting and filing requirements for those assets. Noncompliance carries stiff penalties.

Be a “Professional” Writer — All Year Long

By Gary A. Hensley, MBA, EA

If you are new to the writing life, or even a veteran, you are in the business of writing if your intent is to write long-term and make a living (or at least a profit) from your work. You are self-employed (you work for yourself) and that means you are a sole proprietor for tax purposes. You will need to file a Schedule C with your federal Form 1040 to report your writing income and expenses.picture004

If you visit www.irs.gov and type Schedule C in the search box, you will see some of the expenses allowed. Part of your business responsibility includes keeping accurate business records, during the calendar year (not after), to track your income and expenses. You will be on the “cash basis” of accounting, i.e. you report your writing income when it has actually been received and your expenses when they have been paid.

Most of you hire someone to “prepare” your annual tax return. Many of you keep your participation to an absolute minimum. This is akin to turning in a partially-completed manuscript, replete with grammatical errors, to an editor, and then expecting him or her to return a bestseller to you.

You need to accurately summarize your income and expense records before you meet with your preparer (or do the return yourself). One example: make sure you have added up all your business miles for 2014 and multiplied them by 56 cents per mile. The law requires that you maintain a “contemporaneous” record of your business mileage during the year. Get a $5 day-planner at Walmart and put it in your glove compartment. Use it each time you head out on business. Jotting down the beginning and ending odometer readings, and the business purpose, makes you bullet-proof if you are audited. You will be amazed at the total amount of business miles (and very happy with the large expense deduction). Proper recordkeeping in other areas will yield the same results.

In addition to proper recordkeeping, you need to take additional steps to document (or support) your professional (business) status as a writer. A diary of your various business activities will be very helpful. A manuscript submission/rejection/resubmission record will show continuous activity. Attendance at a writer’s club and writing seminars will indicate you are trying to improve your skills. A separate bank account/debit card for the business is critical.

It’s not unusual for any new business to sustain losses during the early years; however, to have those losses allowed, you must be able to demonstrate that you are “active” in the business.

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This article originally appeared in the January 2014 newsletter The Write Life.

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Can a shareholder of an S corporation deduct the home office expense?

A shareholder of an S corporation cannot deduct expenses paid on behalf of the corporation without a corporate resolution [Craft, T.C. Memo 2005-197].

If the corporation has adopted a resolution requiring the employee/shareholder to incur expenses as may be necessary or required, and it states that such expenses will not be reimbursed by the corporation, the court ruled these expenses were deductible as employee business expenses which are miscellaneous itemized deductions, subject to the 2% adjusted gross income (AGI) limitation.  Otherwise, the court noted that the voluntary payment of corporate expenses by officers, employees, or shareholders are not deductible and must be considered capital contributions or loans to the corporation. A corporate resolution or policy in place requiring a corporate officer to assume certain expenses indicate that those expenses are his or her expenses as opposed to those of the corporation.

If the above requirements are met, a shareholder is allowed to deduct expenses for business use of the home, assuming the shareholder receives reasonable wages for services renderedSuch expenses are deducted  as employee business expenses on Schedule A, Form 1040, subject to the 2% of AGI limitation.

Exception for rentalA taxpayer is not allowed to deduct expenses for business use of the home attributable to rent paid by the employer if the employee is providing services.  The employer (the S corp) is allowed a deduction for rent paid, but the employee is not allowed a deduction for business use of the home [IRC 280A(c)(6)].

The IRS Doesn’t Really “Audit” Tax Returns

By Gary A. Hensley, MBA, EApicture004

It is a misnomer to label IRS “examinations” as “audits.”

I am not sure how the terminology evolved over the years as it relates to Internal Revenue Service (IRS) examinations—perhaps it helped build the fear factor regarding the dreaded IRS examination. The process of completing a certified financial audit (performed in the United States by Certified Public Accountants) involve standards and principles of financial reporting and accounting promulgated by the Financial Accounting Standards Board (FASB), generally accepted auditing standards (GAAS), and generally accepted accounting principles (GAAP). IRS examinations are guided by the Internal Revenue Code [IRC] as passed by Congress (which it has constantly amended [tweaked] for economic and social policy reasons).

For example, the majority of deductions allowed on Schedule A of the personal income tax return (Form 1040) are based on social policy considerations. Property taxes on your home and home mortgage interest are allowed deductions because Congress has historically used the IRC to “promote” home ownership as good social policy. Once a deduction is allowed by the IRC, powerful lobbyists do all they can to make sure they never get removed; only enhanced. Several taxpayer-friendly sections of the IRC expired at the end of 2013; however, a bill to extend these provisions is already in the making so that they will once again be available for 2014 and beyond. They will be superficially knocked around and debated on both sides of the political aisle but, in the end, they will be renewed with slight modifications at best. In contrast, certified financial audit standards use guidelines that evolve slowly over time and the baseline attest functions and standards are not modified without great debate and review by nongovernmental bodies.

Most IRS revenue agents are not trained “financial” auditors; they are IRS-trained tax compliance agents. Many come straight out of college with an accounting major (which may or may not have included one class on traditional financial auditing). There is no requirement for prerequisite auditing experience with a CPA firm prior to coming on board with the IRS as a revenue agent. Revenue agents are the front-line employees that do the face-to-face field examinations in the taxpayer’s home or business for the IRS. Unfortunately, many of the group managers that supervise the revenue agents also lack this traditional financial audit experience. There are IRS revenue agents that have the CPA credential (a plus for any taxpayer who has them as an examiner) and others, like myself, who had Enrolled Agent (EA) status and extensive national and local CPA firm audit experience before entering employment with the IRS as a revenue agent. Senior agents will quickly identify the significant issues (or determine there really aren’t any) and move the examination toward closure. And, believe it or not, some examinations do end up with the taxpayer receiving a refund for overpayment of taxes.

The IRS has compliance “procedures” that are used on examinations. It’s no secret that from year-to-year more examinations are conducted on higher income taxpayers, specific professions, and industries. The Audit Guides used by revenue agents are available for review by the public (which is sort of like sending your playbook to the opposing team). Many of the procedures are the “check the box” type. The IRS examination goal is to determine that the taxpayer is in “substantial” compliance with the IRC—not absolute compliance. IRS examinations are targeted to one or more areas to test for tax compliance depending on the nature of the return being examined (more on this later). A standard field examination starts with the selected examination year but may be expanded to prior and subsequent years if significant tax errors appear to follow a pattern.

In my opinion, IRS revenue agents with prior traditional financial auditing experience have a significant advantage in developing civil and criminal fraud examination cases because they: (1) are more likely to pick up anomalies during the initial and subsequent taxpayer interviews (the Lt. Columbo technique is a favorite); and (2) generally have more experience with forensic accounting techniques (connecting the financial dots to flush out missing information). The taxpayer (or his or her representative) should engage the examiner about his or her prior experience and training and ask for a business card.

During examinations, it is important to remember this; the burden of proof for unreported income is on the IRS: the burden of proof for deductions is on the taxpayer. No proof (substantiation); no deduction (although the Cohan rule can be helpful).

What is your examination risk?

Your individual IRS examination risk is determined by a number of factors including the areas the IRS may have under increased review. Last year’s examination rate of 0.96% for individuals was the lowest since 2005. This means the IRS examined just one out of every 104 filed returns. However, this figure includes correspondence examinations…exams by mail that typically question a limited number of items on the tax return, such as missing income from interest, dividends, royalties and earnings from self-employment. Last year, they represented over 1.06 million of the 1.4 million examinations that the IRS did. The number of face-to-face examinations by revenue agents was much lower…0.24% or 1 out of every 417 returns. Examination rates for partnerships, S corporations and regular corporations of all sizes fell in 2013 and are projected to decline in 2014 as well.

Tax returns are typically “scored” against a computer database to determine examination potential. Those passing a certain threshold are then reviewed by senior IRS agents who determine whether or not the return should be sent to field offices for examination. A final review is made by the group manager in the field office before an examination is actually scheduled by a revenue agent.

The Initial Contact

The initial contact for a field audit (in your home or business) will contain a letter asking you to confirm an appointment date, a publication that reviews your rights during the examination, and an Information Document Request (IDR) form that will give you the initial examination blueprint (or “heads up”) on the income and/or expenses the examiner intends to review. Business and/or personal bank statements will always be reviewed for the initial examination period. The IDR is a significant piece of information for the taxpayer as, again, it outlines the areas the IRS feels the need to review. The taxpayer does have the “right” to be represented during the examination. If you feel you want or need professional assistance during the examination, it would be best to obtain that representation before the first face-to-face visit (or any telephone calls from the agent). Attorneys, CPA’s, and Enrolled Agents (EA’s) are allowed to represent you during an IRS examination.

One tip: if, during the review of your tax return, prior to your first appointment, you discover any honest mistakes, errors or omissions, bring it up early in the examination process. Part of every agent’s job is to assess your credibility as a taxpayer. Bringing up honest mistakes will score points for you with the agent and he or she will be more likely to accept your verbal explanations regarding other matters that arise.

© 2014 by Gary A. Hensley

Surprise IRS Victory in IRA Rollover Case

Recent Tax Court Decision

In fact, the surprise victory is in direct conflict with IRS Publication 590, the bible for Individual Retirement Accounts (IRAs). Here it is, in a nutshell: starting in 2015, no matter how many IRA accounts you have, you will only be allowed one rollover per year (no longer one rollover per year per account) [Bobrow v. Commissioner, T.C. Memo. 2014-21, filed January 28, 2014].

“Industry leaders, financial advisers, and everyone else who handles IRAs are stunned,” said Denise Appleby, the editor and publisher of The IRA Authority.
According to Appleby, there are two ways to move money between IRAs:

1. Transfers, which are not reported to the IRS and not reported on a tax return. The IRA owner never touches the money. You can do this as often as you like, whenever you like, Appleby said.
2. And rollovers. With this method, the IRA owner takes the money as a distribution and they have 60-days to rollover (put back) the amount in an IRA. And this, you can do only once per 12-month period, said Appleby.

According to Appleby, the IRS, through their publications and regulations, has said for at least 20 years that the rollover method applies on a “per-IRA” basis. In other words, if you have 12 IRAs, you can do 12 rollovers for the year (12-month period) as long as each IRA does it only once.

In 2008, Alvan Bobrow, who had a few IRAs, rolled over two distributions from his IRAs and took the position that the rollovers were valid because they were done in a timely manner, and involved different IRAs, Appleby wrote in her analysis of the court case. His position was that he had not broken any rules, as explained by the IRS in their publication for the past 20 years.

The IRS disagreed and determined that only one of the two rollovers was valid. So, the IRS and the Bobrows went to court. And the Tax Court—much to the amazement of all IRA experts—agreed with the IRS.

The mistake cost the Bobrows an additional $51,298 in income tax and a penalty of $10,260.

Per the Tax Court, only one of the Bobrow’s distributions was eligible for rollover during the 12-month period. The Tax Court concluded that the Internal Revenue Code Section 408(d)(3)(B) limitation—the relevant section of the federal tax code—applies to all of a taxpayer’s retirement accounts and that regardless of how many IRAs he or she maintains, a taxpayer may make only one nontaxable rollover contribution within each one-year period.

The Bobrow case highlights, according to Appleby, an important rule that we sometimes overlook: “If conflicting information is provided in multiple sources, one must consider the hierarchy and reliability of such sources. In this case, Publication 590 is not authoritative and is not considered official guidance. The Tax Code is the more authoritative, and supersedes any other guidance in the event of conflict.”

What Now?
Well, according to Appleby, the IRS will be changing its publications, changing what they have been saying for 20-plus years. The IRS will implement this change for everyone, everyone except the Bobrows who still have to pay the tax and penalty, starting January 1, 2015.

Appleby said individuals should start moving money via transfers and not rollovers. “There are too many pitfalls with rollovers and none with transfers,” she said.

Starting in 2015, make sure you only do one rollover per year.

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Click here for Reference:  IRS Announcement 2014-15

 

My Second Video Credit! Mike Martin’s “More of Your Taxes Explained”

Just released today!

Mike Martin’s “More of Your Taxes EXPLAINED!” debuted today on YouTube.

Mike is also a Young Adult novelist. His book, THE END GAMES, is available at all online booksellers, including Amazon: http://dft.ba/-theendgamesmartin

This video covers “self-employment” tax issues and general information applicable to all taxpayers.

I was fortunate to be a co-writer and tax adviser for this video. Look for my name “in lights” at the end of the video (it’s even in large type).  To view it, click here.

I hope your tax preparation and filing is going well this year and that some of my blogs have been helpful.