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.

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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

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.

Article in the 2014 edition of Christian Writer’s Market Guide

The just-released 2014 edition of Christian Writer’s Market Guide contains my article “Nailing Down Your Professional Status” starting on page 186.

The guide is an excellent resource and I am very pleased that one of my articles was selected for inclusion.  Great way to start the new year!

 

Take the Free Out of Freelance Writing

My brother, Dr. Dennis E. Hensley, put forward this advice recently in the May/June 2013 issue of Advanced Christian Writer (pages 3-4). He states:  “Outsiders to our profession think writing is fast and easy, that we have all the time in the world, and that seeing our names in print is enough payment to woo us in.  Lawyers, accountants, life coaches, psychiatrists, and fitness trainers charge for their advice and services.  The most frequent question I hear in response to this situation is, ‘But how much should I charge?’” This is where I would like to insert my own answer to this question.  Back in October 2012, I wrote a blog on this site titled “Writers: Stop Losing Money—Use This Fee Formula.”  Check it out.  In the blog, I outline a four-step process on how you should set your fees.  The formula can also be used to determine the absolute minimum fee (breakeven) if you are aggressively trying to break into a new market.  The formula covers the direct expenses of the specific assignment, the indirect costs of operating your business, your target profit percentage and the associated taxes that will be due on the assignment profit. Dr. Hensley further advises that you “match the market.  If you price your writing services too low, potential clients will wonder why your bid doesn’t match the bids of the other two writers he contacted.  Thus, you should check websites and ad brochures to find out what your competition is charging.  Naturally, there are such considerations as your level of education, experience, and previous client references.  But assuming most things are comparable, you should ask for what the market will sustain. “Don’t sell yourself short.  Writing is hard work, so you deserve proper compensation.  Move from freelance to moderately-priced-lance to outright-expensive-lance.”

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Dr. Dennis E. Hensley is the author of more than 50 published books.  His newest book, Jesus in the 9 to 5, will be released on October 18th

Properly Reporting Royalties Received from your Publisher or Agent

What is the correct information reporting for royalty payments made by a publisher for the rights to an author’s book or other literary composition if such royalties are: (1) paid directly to the author or (2) paid to the author’s literary agent who then forwards all or part of such payments to the author?

First, the required reporting form to be sent to the author is Form 1099-MISC in any calendar year that the royalties aggregate $10 or more [Internal Revenue Code § 6050N(a) (relating to royalties)].  The royalties are reported on Schedule C in the income section by the self-employed author.

#1  Royalties Paid Directly from Publisher to Author

This is a straightforward process.  The publisher will send the author Form 1099-MISC when the royalties paid to the author aggregate $10 or more during a calendar year no later than January 31st of the following year (example:  2013 royalty payments are required to be reported to the author (and the IRS) no later than January 31, 2014).  The amount reported to you should be the gross royalties for the year.  If the publisher took out any fees or expense amounts before paying you during the year, I will explain how to handle that below.

#2  Royalties Paid Directly from Publisher to Literary Agent and then from Literary Agent to Author

In this scenario, both the publisher and the literary agent are considered “payors” of royalties for purposes of Internal Revenue Code § 6050N.  As such, the publisher must file Form 1099-MISC, reporting payments of royalties to the literary agent (named as the “recipient” on the form).  One special exception:  if the literary agent is a corporation, the publisher is not required to complete and file Form 1099-MISC on the payments made to the literary agent.

Most mistakes are made here…

The literary agent (whether a corporation or not) must file a Form 1099-MISC for the royalties paid to the author regardless of whether the literary agent receives a Form 1099-MISC from the publisher.  The instructions to Form 1099-MISC provide that gross royalties (before reductions for fees, commissions, or expenses) paid by a publisher directly to an author or literary agent or paid  by a literary agent to an author must be reported on Form 1099-MISC.  Thus, although the literary agent may have subtracted commissions and expenses before making the payment(s) to the author,  the Form 1099-MISC  required to be filed by the literary agent must report the gross amount of royalties received from the publisher pursuant to Internal Revenue Code § 6050N for each specific client-author.

Personal experience notes…

Based on my experience, I am aware that some agents are either not filing Form 1099-MISC at all or they are reporting royalties to their authors on an after-commission/expense basis.   This puts their client, the author, in jeopardy.

What can you do as an author?

If you don’t receive a Form 1099-MISC from your agent by January 31st, request one before you file your tax return.  If you receive a Form 1099-MISC with any amount other than the gross royalties paid to you during the calendar year, request a “corrected” Form 1099-MISC be issued to you (with a corrected copy also sent to the IRS).

Properly Reporting Royalties on your Tax Return

Once you receive your Form 1099-MISC with the gross royalties paid from the publisher on it (either from your publisher or your agent), you will report that amount on Schedule C as part of your gross receipts or sales in the income section of that form.

At this point, you are thinking, why do I have to report my gross royalties even though I  received a different amount of money after agent commissions or other expenses were deducted?   That is a very appropriate question.

In order for you to pay tax only on the amount you actually received, you will enter the related expenses such as the agent’s commissions in the expense section of your Schedule C (for example:  Agent’s commissions and fees would be a deduction in Part 2-Expenses of Schedule C on line 10).  Any other deductions taken from your royalties before you received the net payment would also be deductible on the appropriate Schedule C expense line.   This will ensure that you have reported your gross royalties, as required, but you have also deducted the expenses related to that income.   When you do this correctly, your business net income will include only the amount you actually received during the year.