Don’t Overlook the Child and Dependent Care Tax Credit

Day camps are common during the summer months.  Many parents pay for them for their children while they work or look for work.  If this applies to you, your costs may qualify for a federal tax credit than can lower your taxes.  Here are ten tips to know about the Child and Dependent Care Credit:

  1.  Care for Qualifying Persons. Your expenses must be for the care of one or more qualifying persons.  Your dependent child or children under age 13 usually qualify.  For more about this rule see Publication 503, Child and Dependent Care Expenses.
  2. Work-related Expenses.  Your expenses for care must be work-related.  This means that you must pay for the care so you can work or look for work.  This rule also applies to your spouse if you file a joint return.  Your spouse meets this rule during any month they are a full-time student.  They also meet it if they’re physically or mentally incapable of self-care.
  3. Earned Income Required. You must have earned income, such as from wages, salaries and tips. It also includes net earnings from self-employment (Schedule C). Your spouse must also have earned income if you file jointly.  Your spouse is treated as having earned income for any month they are a full-time student or incapable of self-care. This rule also applies to you if you file a joint return.  Refer to Publication 503 for more details.
  4. Joint Return if  Married.  Generally, married couples must file a joint return.  You can still take the credit, however, if you are legally separated or living apart from your spouse.
  5. Type of Care. You may qualify for it whether you pay for care at home, at a daycare facility or at a day camp.
  6. Credit Amount.  The credit is worth between 20 and 35 percent of your allowable expenses. The percentage depends on the amount of your income.
  7. Expense Limits. The total expense that you can use in a year is limited.  The limit is $3,000 for one qualifying person or $6,000 for two or more.
  8. Certain Care Does Not Qualify. You may not include the cost of certain types of care for the tax credit, including: (a) Overnight camps or summer school tutoring costs; (b) care provided by your spouse or your child who is under age 19 at the end of the year; and (c) care given by a person you can claim as your dependent.
  9. Keep Records and Receipts. Keep all receipts and records for when you file your tax return next year.  You will need the name, address and taxpayer identification number of the care provider.  You must report this information when you claim the credit on Form 2441, Child and Dependent Care Expenses.
  10. Dependent Care Benefits. Special rules apply if you get dependent care benefits from your employer.  See Publication 503 for more on this topic.

Remember that this credit is not just a summer tax benefit. You may be able to claim it for qualifying care that you pay for at any time during the year.

It’s Time to End (or at Least Reduce) the Taxation of Social Security Benefits

Opinion

Tax Reform Recommendation

By Gary A. Hensley, MBA, EA

As we begin another season of watching political candidates aspire to the presidency, we will be smothered with ideas about how to “save” federal trust funds such as Social Security. Due to the ever-increasing senior citizen demographic (those 62 and older for our purpose here), most candidates will be loath to suggest anything that would impinge on their future benefits (at least until another election has passed). From a strictly political perspective, it’s irresponsible to discuss any type of funding source reduction. Which is another way of saying you will likely only see this point-of-view here.

It’s a two-edged sword—to give seniors more disposable income by not taxing their Social Security benefits is helpful to them, but at the same time it reduces those dedicated tax dollars from going into the fund to preserve its future financial integrity. Ending the taxation of Social Security benefits, however, will have a negligible effect on the final solution needed to shore up the major funding issues associated with Social Security (for example, there are now only two workers for each Social Security retiree) but will have an immediate positive impact on seniors struggling with rising health care costs, food, gasoline, rent or mortgage payments, etc.

For 2011, the most recent year of income by source data available from the IRS, total Social Security benefits reported were $490.7 million (25.8 million returns) and $201.6 million of this was taxable (16.8 million returns). More specifically, for the adjusted gross income range of $25,000 to $75,000, the taxable Social Security benefits totaled $84.3 million (9 million returns). In 2015, single filers could pay as high as 25% on their taxable benefits in this range and married couples 15%.

The taxation of Social Security benefits debuted, in 1984 (Code Sec. 86), during Ronald Reagan’s presidency and was capped at 50% of benefits received. In 1993, the tax cap was raised to 85% of benefits received under President Bill Clinton. Thus, it has been a bipartisan effort to get where we are today.

In 1981 the National Commission on Social Security Reform (sometimes referred to as the Greenspan Commission after its chairman) was appointed by Congress and President Reagan to work on the financing crisis in Social Security. The result of their study included several amendments that were passed by Congress, signed by President Reagan and made into law in 1983.

As originally passed, if the taxpayer’s combined income (total of adjusted gross income, interest on tax-exempt bonds, and 50% of Social Security benefits and Tier I Railroad Retirement Benefits) exceeds a threshold (base) amount ($25,000 for an individual with a filing status of single or head-of-household, $32,000 for a married couple filing a joint return, $0 if married filing separately and the taxpayer lived with his or her spouse at any time during the tax year), the amount of benefits subject to income tax is the lesser of 50% of benefits or 50% of the excess of the taxpayer’s combined income over the threshold (base) amount. The additional income tax revenues resulting from this provision are transferred to the trust funds from which the corresponding benefits were paid.

The 1993 formula amendment increased the maximum due to no more than 85% of benefits (and added a second tier adjusted base amount of $44,000 for married taxpayers filing jointly, $0 for married taxpayers filing separately and not living apart during the entire tax year and $34,000 for all other taxpayers). From 1983 until the present, the cumulative rate of inflation has been 137.5% and, yet, the threshold (base) amounts have never been increased.  

As an example, in 2014, a married couple (both 63 years old), filing jointly, one retired and drawing benefits and the other still working full-time (and not drawing benefits) have the following sources of income: wages at $40,000; interest income of $1,500; taxable pension retiree income of $14,000; and Social Security benefits of $18,000. In this scenario, the couple would be required to report 85% of the Social Security benefits (or $15,300) as taxable benefits on their return! The couple’s taxable income, after the standard deduction ($12,400) and two personal exemptions ($7,900) would be $50,500. Their marginal (highest) tax rate would be 15%. Fifteen percent times the taxable Social Security benefits will add an additional $2,295 to their tax bill.

Although you can ask for federal income tax withholding on your Social Security benefits, most first-timers who owe tax are caught with their pants down and end up with a tax bill (or significantly reduced refund). Also, if you do owe a balance on your federal tax return greater than $1,000, you could be subject to an underpayment penalty!

Thirteen states also tax Social Security income. Some states mirror the way Social Security is taxed on the federal level, while others have their own set of rules that they go by. For those that mirror the federal formula, repealing the tax at the federal level would also eliminate the state tax burden on this income.

One final kick in the pants: In 2015, if you continue to work for wages or have self-employment income and you are drawing Social Security retirement benefits before full retirement age (66), you will be required to pay back to Social Security one dollar for every two dollars you earn in excess of $15,720. Different rules apply for the year you reach full retirement age. Early retirees who continue working may have taxable Social Security benefits (more likely if they are filing a joint return and the other spouse is also working) and yet still be required to pay back some of those benefits for the same year if earnings exceed the Social Security exempt amount.

It’s past time for Congress to repeal the taxation of Social Security benefits. Unlike an IRA or 401k retirement plan, which allows a participant to reduce the current year’s taxable income by the amount of his or her annual contributions, employees received no income tax deduction for mandatory Federal Insurance Contributions Act (FICA) deductions withheld from their paychecks during their working lifetime. Surely this tax provision can be repealed and offset by reducing the billions of dollars of fraud and waste in the federal budget. The federal earned income credit (EIC) program alone has fostered billions of dollars in fraudulent claims that have been paid out and never recovered. In 2013, the IRS estimates it paid out $5.8 billion in fraudulent refunds to identity thieves.

RECOMMENDATIONS (in order of preference):
1. Repeal the taxation of Social Security benefits.
2. Index the income threshold (base) amount to the rate of inflation before Social Security benefits can be taxed. The cumulative rate of inflation since 1983 (when the law was originally passed) to 2015 is 137.5%. That would move the threshold (base) amount immediately for married couples to $76,000 (from the original $32,000) and for singles to $59,000 (from the original $25,000). This would help a substantial segment of our middle-class income seniors have a better quality of life, which they have earned.

How Does the IRS Taxpayer Advocate Service Work for You?

The Taxpayer Advocate Service (TAS) is an independent organization within the Internal Revenue Service.  It protects taxpayers’ rights by ensuring that all taxpayers receive fair treatment. It can also help you to know and understand your rights under the Taxpayer Bill of Rights.

The Taxpayer Bill of Rights describes ten basic rights that all taxpayers have when dealing with the IRS.  These are your rights.  Know them.  Use them.

The TAS site at taxpayeradvocate.irs.gov also can help you with common tax issues and situations:  what to do if you made a mistake on your tax return; if you got a notice from the IRS or you’re thinking about hiring a tax preparer.

What can a Taxpayer Advocate do for you?

TAS can help you resolve problems that you can’t resolve with the IRS.  And the service is free.  Always try to resolve your problem with the IRS first, but if you can’t, then contact the Taxpayer Advocate Service.  Timely contact with TAS is paramount to resolution.

  • TAS helps individuals, businesses, and tax-exempt organizations.  If you qualify for TAS help, your advocate will be with you at every turn and do everything possible.
  • You may be eligible for TAS help if your IRS problem is causing financial difficulty or you believe the IRS procedure just isn’t working as it should.
  • TAS has offices in every state,  the District of Columbia, and Puerto Rico.  Your local advocate’s number is in your local directory and at taxpayeradvocate.irs.gov.  You can also call TAS at 1-877-777-4778.

The Taxpayer Advocate Service is your voice at the IRS.  Don’t hesitate to use it!

Filing Extensions Without Penalties and Interest

Can’t file your tax return by the April 15th deadline?

Taxpayers can request an automatic six-month extension of time to file the tax return.  But, taxpayers beware, there is a catch!  An extension is just an extension on the time to file the return; it is NOT an extension on the time to pay!

Taxpayers are required to estimate the amount of tax that may be due with the tax return and remit payment with the extension to avoid Failure to Pay penalties.  These penalties, plus interest, could accrue from April 15 until the tax is paid, regardless of the extension.  If a balance is still owed when the actual tax return is filed, at least the penalties and interest will have been minimized.

If taxpayers are unable to file their tax return by April 15, there are several ways to request an automatic extension of time to file an individual return.  Enrolled agents and other tax professionals can e-file the Application for Automatic Extension of Time to File US Individual Tax Return (Form 4868) for taxpayers.  Or, the application can be found on the IRS website (www.irs.gov), printed and mailed to the IRS, or e-filed.  Whether taxpayers use a tax professional or submit the application themselves, all or part of the estimate of the income tax due can be paid with a check, credit/debit card, or by using the Electronic Federal Tax Payment System.

Information regarding remitting payment may be found on Form 4868. Be sure to record the confirmation number provided upon payment.

If a taxpayer estimates that they will owe taxes and is unable to pay, it is important that they file their returns timely.  Put another way, either file an extension or your completed return by April 15, even if you cannot pay the full balance due.  If you do not, Failure to File penalties will be assessed (at 5% per month times the balance not paid by April 15 up to a maximum of 25%) in addition to Failure to Pay.  You may establish a payment plan to pay the balance due.

If you receive a notice from the IRS at any time during the year, contact your tax preparer immediately.  If you did not hire one to prepare your tax return, you should then contact a licensed tax professional.  Only enrolled agents (EAs), CPAs and attorneys have unlimited rights to represent you before the IRS.  The term enrolled agent reflects that an EA can act as your “agent” before administrative levels of the IRS–meaning he or she can talk to or meet with IRS in your stead.  To find an enrolled agent in your area, visit the searchable “Find an EA” directory at http://www.naea.org.

Five Key Tax Tips about Tax Withholding and Estimated Tax

If you are an employee, you usually will have taxes withheld from your pay. If you don’t have taxes withheld, or you don’t have enough tax withheld, then you may need to make estimated tax payments. If you are self-employed you normally have to pay your taxes this way. Here are five tips about making estimated taxes:
1. When the tax applies. You should pay estimated taxes in 2015 if you expect to owe $1,000 or more when you file your federal tax return next year. Special rules apply to farmers and fishermen.
2. How to figure the tax. Estimate the amount of income you expect to receive for the year. Also make sure that you take into account any tax deductions and credits that you will be eligible to claim. Use Form 1040-ES, Estimated Tax for Individuals, to figure and pay your estimated tax.
3. When to make payments. You normally make estimated tax payments four times a year. The dates that apply to most people are April 15, June 15 and Sept. 15 in 2015, and Jan. 15, 2016.
4. When to change tax payments or withholding. Life changes, such as a change in marital status or the birth of a child can affect your taxes. When these changes happen, you may need to revise your estimated tax payments during the year. If you are an employee, you may need to change the amount of tax withheld from your pay. If so, give your employer a new Form W–4, Employee’s Withholding Allowance Certificate. You can use the IRS Withholding Calculator tool help you fill out the form.
5. How to pay estimated tax. Pay online using IRS Direct Pay. Direct Pay is a secure service to pay your individual tax bill or to pay your estimated tax directly from your checking or savings account at no cost to you. You have other ways that you can pay online, by phone or by mail. Visit IRS.gov/payments for easy and secure ways to pay your tax. If you pay by mail, use the payment vouchers that come with Form 1040-ES.

Additional IRS Resources:
Publication 505, Tax Withholding and Estimated Tax
Estimated Tax – frequently asked Q & As
Tax Topic 306 – Penalty for Underpayment of Estimated Tax

Substantiating Your Business Expenses Is Critical to Keeping Them

By Gary A. Hensley, MBA, EA

By and large, the rules are straightforward:  the burden of substantiating the “income” of a taxpayer falls on the Internal Revenue Service (IRS) and the burden of substantiating expenses (or deductions) falls totally on the taxpayer.

The position of the IRS and their field revenue agents has been and will be inadequate or no expense documentation/substantiation equals no deduction.  The next recourse for the taxpayer is to go to IRS Appeals and argue that the revenue generated couldn’t have taken place without incurring “some” associated expenses (the Cohan Rule).  The results at the Appeals level varies widely in each case and, generally, the best case scenario is an allowance of “some” of the deductions claimed.  The expense of going to Appeals can more than offset whatever expenses are allowed by the appeals officer (especially if you retain professional representation).

Recent Court Decisions

Under Internal Revenue Code (IRC) section 274(d), for certain expenses, taxpayers are required to be able to provide specific detailed information to substantiate the expenses.

As demonstrated In the recent case of Garza, T.C. Memo. 2014-121, the result boiled down to an all-or-nothing proposition.  Without proper substantiation, no deduction is allowed for a Sec. 274(d) expense, even if the court believes that a legitimate expenditure was made.

Sec. 274(d) identifies four classes of expenses for which specific substantiation is required:

  • Sec. 274(d)(1) for travel expenses (including meals and lodging while away from home);
  • Sec. 274(d)(2) for any item with respect to an activity that is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity;
  • Sec. 274(d)(3) for business gifts (which are limited to $25); and
  • Sec. 274(d)(4) for expenses with respect to any listed property (as defined in Sec. 280F(d)(4)).

In Garza, the court said that “while we believe that petitioner had business travel expenses in relation to his employment, the Court must heed the strict substantiation requirements of section 274(d).”  To support its ruling, the court cited DeLima, T.C. Memo. 2012-291, in which the Tax Court indicated that it had no doubt that the taxpayer used a vehicle for business purposes, but it was bound to deny the vehicle expense deduction because she failed to follow the requirements of Sec. 274(d) and the regulations.

Substantiation Required

Sec. 274(d)(4) requires the taxpayer to substantiate “by adequate records or by sufficient evidence corroborating the taxpayer’s own statement”:

  • The amount of the expense or other item;
  • The time and place of the travel, entertainment, amusement, recreation, or use of the facility or property, or the date and description of the gift;
  • The business purpose of the expense or other item; and
  • The business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift.

In light of the above requirements, the message from the above paragraph is that “a taxpayer’s own statement” by itself is not sufficient in the IRS’s consideration of whether to allow a deduction.  As Garza and other cases show, the IRS and the courts look for contemporaneous records with the details listed above and, without it, they may disallow the deduction.

Taxpayers and their tax advisers need to understand what type of substantiation is required to take a deduction (with a solid foundation) on a tax return.

 

 

 

Warning! Form 1099-MISC and Payments to LLCs

By Gary A. Hensley, MBA, EA

Most of you are aware that you need to issue a Form 1099-MISC to independent contractors you paid $600 or more for services (not goods) during 2014 no later than February 2, 2015 (also you send a copy to the IRS by March 2, 2015).  The payments reported cover only those payments made in the course of your trade or business.

Many entrepreneurs believe (incorrectly) that if a vendor has LLC or L.L.C. after their company name (meaning limited liability company) that no Form 1099-MISC is required to be sent.  Compounding this belief?  The member(s) of many LLCs will tell those that they have rendered services to that it isn’t necessary or required to send them a Form 1099-MISC.  The requirement to file Form 1099-MISC is the government’s attempt to reduce the multi-billion underground (untaxed) economy.  Thus, if you are required to file a Form 1099-MISC and do not, a penalty will be assessed for each form not filed.  The penalty for not filing or filing late depends on the extent of tardiness.

A LLC can fall into three different categories:  (1) a single-member LLC which is a sole proprietorship (filing Schedule C as part of the individual’s personal Form 1040); (2) two or more members organized as a partnership LLC (filing Form 1065); and (3) one or more members filing as a corporate LLC (either a “C” corporation or a “S” corporation, filing Form 1120 or Form 1120-S, respectively).  Categories (1) and (2) should always be sent a Form 1099-MISC if they provided $600 or more in services to you in 2014.  With very few exceptions, you are not required to send Form 1099-MISC to category (3) organizations.  Most LLCs choose to be taxed as sole proprietors (commonly referred to as a “disregarded entity” in tax-speak) and partnerships.  When in doubt, send a Form 1099-MISC to all vendors you paid $600 or more for services in 2014.  There is no down side in doing so.

One exception that will be relevant to writers, literary agents and publishers:  Any amount you pay in royalties of $10 or more, in the course of your trade or business, requires you to send a Form 1099-MISC.  [Please refer to my article on properly reporting royalties.]

The following steps will help you nail down your compliance in this area:

  1.  Review all your payments for services to each vendor during 2014 and determine who received $600 or more in payments from you.
  2. Review your vendor records to determine if you have the complete name and address for those identified in step 1 above and also that you either have the vendor’s Social Security Number (SSN) or Employer Identification Number (EIN).  If you are lacking any of these critical items, you will need to mail a Form W-9 to the vendor requesting this information.  Keep a copy of the W-9 in your vendor file documenting your attempt to get the needed information along with the date you mailed it.  A USPS Certificate of Mailing is an inexpensive way to show proof of mailing.  In the future, obtain the W-9 information at the time you retain the vendor.  If the vendor refuses to furnish the information or sign the form—buyer beware!
  3. Next, you will use the official IRS Form 1099-MISC for each vendor.  The form is in triplicate with the top copy (shaded in red) going to the IRS and the other two copies going to the vendor and your vendor file.
  4. Finally, you will summarize your Form 1099-MISC information on IRS Form 1096 which you can mail to the IRS or file electronically along with the red copy(ies) of Form 1099-MISC.

You may wish to engage a local accountant or payroll processing specialist to help you with steps 3 and 4.

For additional IRS information on this topic, you may refer to IRS Form 1099 at the IRS website—www.irs.gov.

I hope this article will clarify your reporting requirements and further audit-proof your returns.