Professional Tax Services, Inc.

Tax services, consulting & IRS representation

Tax Advice for Year-End 2012

Posted on | December 27, 2011 | No Comments

Each and every one of you has a different financial situation, so giving generic tax advice is difficult.  But here are some basic things to consider if you are in a position to invest, have a business or simply want to try to reduce your overall tax burden. 

There are essentially three things you can do to help reduce your tax burden.

  1. First, have tax free income.  This would entail putting as much money into tax free CD’s or bonds as you can.  The mere investment in such instruments would not, in itself, provide any tax savings, but income from them would be tax free.  This is a strategy used by the very wealthy but could be effective if you have the money to invest in such instruments and are willing, at least for now, to accept a relatively low rate of return.
  2. Second, take advantage of existing tax deductions and credits allowed in the tax code.  You should be familiar with the deductions and credits you qualify for and take full advantage of them when you file.  Credits can be very advantageous as they are a one-for-one reduction of the income tax you owe, but deductions are valuable as well. 
    1. Taking allowable deductions on your Schedule A is important.  You use Schedule A when your allowable expenses exceed the standard deduction.  This generally means you must own a home.  If you don’t already own a home, you should consider doing so, especially in this extremely good buying environment.  Owning a home allows you to deduct mortgage interest and real estate taxes on Schedule A which in turn allows you to deduct contributions, state sales tax, and medical expenses, if they exceed the threshold.  You can also deduct investment expenses and certain non-reimbursed employee expenses. 
    2. There are a number of other deductions and credits available to you that you should be aware of.  Some are familiar, like the Child tax credit, but there are many more credits and deductions such as education credit, student loan interest, credit for child and dependent care; the list goes on.  Your tax professional can help you understand the credits and deductions available to you.
  3. Finally, the third way to reduce taxes is to defer income to future years.  This is done by contributing to retirement plans and other tax deferring vehicles.  Take advantage of any retirement plan available to you where you work by contributing as much as you can.  If you cannot contribute the maximum, contribute enough to qualify for the employer matching.  If you are self-employed, set up a retirement plan in your business.  Except for ROTH IRA’s, money you contribute to a retirement plan is not taxable in the current year and therefore reduces your taxable income.  The same holds true for contributions to and HSA and an IRA and other vehicles. Contributing before tax money to these plans means you don’t pay taxes on that money in the current year, however, as a general rule you do pay tax when you withdraw the money in a later year. 

For those of you who are business owners, there are a number of strategies that you should consider to keep your taxes as low as possible.  I have several articles on my Biznik profile page that address various business strategies to protect your business and reduce taxes.  http://biznik.com/members/bill-bradfield-ea

Keeping excellent business records and selecting the right business entity can make a tremendous difference in your business taxes.  Good record keeping means you won’t miss those expenses you took during the year.  Having the right business entity can make a difference in the taxes you pay and provide other non-tax advantages.  If you have a business, I strongly advise consulting with a tax professional. 

One of my jobs as a tax professional is to keep up with changes in the tax code that affect my clients.  Since 2012 is a presidential election year, I know it will be a very interesting to watch.  Who knows what the future will bring.  Regardless of politics, however, here are some things you should know.

  1. The tax cuts, enacted when George Bush was President and extended last year by President Obama are slated to expire at the end of 2012.  If that is allowed to happen, taxes for most of us will go up.
  2. As I write this, Congress is arguing (something they seem to do very well) about the extension of the payroll tax cut.  I believe it will be extended, but if not, your payroll taxes will go up about $1,000 in 2012. 
  3. There are a number of new taxes in the Patient Protection and Affordable Care Act (ObamaCare).  As you know this is slated to be reviewed by the Supreme Court next year.  If the Supreme Court upholds the law, here are a few of the things to look forward to in the next few years:
    1. Increased Medicare tax for those families with income greater than $250K
    2. Increased Medicare tax (3.8%) imposed on other income sources, not just your wages
    3. For those who can take medical deductions on Schedule A, the threshold will increase to 10%, rather than the current 7 ½%.  All the more reason to have a HSA. 
    4. You will no longer be able to pay for over-the-counter medications through your HSA, MSA or flexible spending account

 Finally, here are a few strategies to consider as 2012 approaches:

  1. If you are an employee who routinely gets a sizable refund each year, consider increasing the number of dependents you claim on your W-4.  This will increase the amount of money you receive in your paycheck and reduce the interest free loan you are giving the government each year.
  2. Don’t get blindsided with taxes in April or later.  Know what you will owe and make sure you set enough aside to cover those taxes.  Unusual circumstances can lead to big surprises come tax time.  Examples include:
    1. An early distribution from an IRA
    2. Receipt of unemployment compensation with no tax withholding
    3. Sale of appreciated property or investments
    4. Foreclosure of a home or forgiveness of debt
    5. Review your portfolio.  If you have substantial gains, consider selling some of your losers to offset the gains.
    6. If you own a business and need capital equipment, consider buying and using Code Section 179 depreciation to take the full cost in the year of purchase.
    7. Start a Medical Savings or Health Savings Account if you don’t already have one and fully fund it.  This allows you to pay for out-of-pocket health expense with pre-tax dollars.
    8. If you don’t have a retirement plan at work, set up and contribute to an IRA.
    9. Consider restructuring your business.  The type of business entity you have can have both tax and non-tax consequences.  The best time to do this is on Jan 1. 
    10. Finally, don’t forget those charitable donations.  Remember, any donation over $250 requires acknowledgement from the non-profit organization. 

 Have a prosperous New Year.

Bill Bradfield, EA

206-295-2291

http://www.professionaltaxservicesinc.net/

How To Get A Free Harvard MBA For Solopreneurs

Posted on | March 2, 2011 | No Comments

Rarely do we find a gem that provides a magic elixir that can help a business grow and provide solopreneurs with uncanny business acumen; almost like having a Harvard MBA at your beck and call.  Do you know of such a gem?

Well, my friends, it’s right under your noses.  More to the point, you are using it right now.  I’m talking about Biznik.  Yes, Biznik, and you need to be taking advantage of it to grow your business.

I joined Biznik 1 ½ years ago on the recommendation of a business colleague.  I must admit I was a bit skeptical, thinking I might get a few contacts, but probably not much more.  Man, was I wrong.  I quickly learned it is a potpourri of business expertise, potential contacts, and very educational.  If you have not learned that by now you have really missed the boat.  Biznik provides solopreneurs with so much that it’s hard to know where to begin.  Let me give you my take on some of the most important ingredients of this magic elixir called Biznik. 

In my humble opinion the most important ingredient is you, and me and all of us at Biznik.  Biznikers are a font of information and most are willing to help you in any way they can.  I really mean that; I see it every day.  All you need to do is reach out.  Get to know others through networking functions and by connecting electronically on the Biznik.  I’ve done this and as my network grows, so does my business.  You will soon discover key people in the Biznik community that you need to connect with.  You will develop referral partners, mentors and other beneficial relationships.  A very special solopreneur culture has developed within Biznik, one that you will not see anywhere else.  Who could ask for anything more?

Another important ingredient is your profile page.  This is where you get to shamelessly promote your business, which for the most part, is you.   Through the other resources on Biznik, which I will mention shortly, you will draw people to your profile page.  Make sure it really does promote your business, as succinctly as possible, and I guarantee you will bring in more business.  Treat your profile as you do your website.  Make sure it presents a professional and inviting image and actually explains what sets you apart from others. 

Another important ingredient is archived articles.   I would wager to say that for any business related topic you might be interested in, there are Biznikers out there who have already written about it or are willing to, if asked.   I know firsthand that many of you have been reading articles.  This is my first article in over a year.  In 2009 I wrote six articles which were reasonably well read when they were published.  Those six articles continue to be read on a daily basis.  Just last week I had almost 100 hits on those six articles.  I’m not saying that to pat myself on the back.  What I want you to take from this is that you can benefit greatly from writing articles and from reading them as well.  Writing articles is an excellent way to give back to Biznik.  It is my belief that you get out of Biznik what you put into it, actually, a lot more.   You have certain talents and information that other Biznikers would love to have and learn.  Share that expertise by writing articles.  Polish the articles and make them interesting.  There are consequences of doing so.  You will have readers from within and outside the Biznik community.  In time, your Biznik profile will move up in Google rankings. And you know that means more business.  I live on the U.S. side of the Canadian border.  An unintended consequence of my articles and improved Google ranking is that I am now contacted frequently by Americans living in British Columbia needing to have their U.S. taxes done.  I never thought of that when I started writing articles.  Go ahead and Google <tax professional, Blaine, WA> and see who pops up as the first two listings on page one, after the paid listing.  That’s what I’m talking about. 

Yet another ingredient of Biznik is Biz Talk.  Here’s where you can ask a question, provide an answer to other Biznikers or just take part in a conversation to make a connection.  Lately I’ve been very active on Biznik.  It’s easy to do.  As a result, I get many hits on my profile page, including people who have found me on Google or other sources; potentially leading to more new business. 

I highly recommend you upgrade to Pro or Pro VIP status if you can at all afford it.  It will be money well spent.  Biznik Co-founder Lara Feltin has written several articles on how to take advantage of Biznik.  Here’s one of them.  http://biznik.com/articles/what-does-your-google-pagerank-mean-and-how-does-it-matter  Read it and the others she has written; there is a wealth of information in them, all of which will help you and your business.   

Review the advantages of becoming a paid member of Biznik.  http://biznik.com/about/benefits.  I joined as a Pro VIP and have never regretted it.  I have been repaid many times over and so will you.

I credit Biznik for much of the success of my business.  I’ve worked hard, of course.  Who hasn’t as they are struggling to start up a business?   I’ve used other resources to grow my business as well, but I can unequivocally state that Biznik has been a major source of information, a source for my referral partners, a catalyst for the growth of my business and the reason behind my excellent rating in Google. 

Thank you Biznik for being here and doing what you do.  You provide an unmatched service to all of us.  And thank you fellow Biznikers for being members of the Biznik community and for being there for the rest of us. For those of you who have not discovered the magic of Biznik, all I can say is you have no idea what you are missing.  Try it, you’ll like it!

Business Expenses

Posted on | December 18, 2009 | 8 Comments

TIS THE SEASON

TO DO TAX PLANNING

 

TAKE ALL THE LEGITIMATE

BUSINESS EXPENSES YOU CAN

 

Some might say that the list of potential business expenses is limited only to what the mind can perceive. That would be a big stretch.   Believe it or not, the IRS knows your business better than you do.  That is to say, they know what expenses are ordinary and acceptable for your type of business.  After all, they have audited millions of businesses over the years.  So, when it comes to deciding what business expenses you can legitimately take, why not start with IRS publications and other documents to find out what the IRS will allow.  You may even find some expenses you never thought of taking. 

To be deductable, expenses must be “ordinary” and “necessary.”  That is, to be deductable, the expense must be normal, usual and customary for the type of business you are in (that’s the ordinary part) and it must be necessary for your specific business. 

I have created a generic list for you to use as you prepare to do your taxes.  Use this as a checklist to make sure you have not forgotten anything.  I will be updating the list from time to time to insure it is as complete as possible although I’m not trying to cover every niche business.  I’m sure there are some unique expense items that I haven’t even thought of, but this list will be a good starting point for all of you to review to ensure you don’t miss any of the big ticket items.  If any of you want to add to the list, send me an e-mail and I’ll be glad to do so. 

Sometimes, depending on your business entity, expenses are handled differently, that is to say, they might do on a different part of your return.  Feel free to contact me if you have any questions. 

Let me start by giving you links to some IRS publications that you might find useful:

  1. Pub 538 – Accounting Periods and Methodshttp://www.irs.gov/pub/irs-pdf/p538.pdf
  2. Pub 535 – Business Expenseshttp://www.irs.gov/pub/irs-pdf/p535.pdf
  3. Pub 587 – Business Use of Your Home – http://www.irs.gov/pub/irs-pdf/p587.pdf
  4. Pub 463 – Travel, Entertainment, Gift and Car Expenseshttp://www.irs.gov/pub/irs-pdf/p463.pdf
  5. Pub 334 – Tax Guide for Small Businesseshttp://www.irs.gov/pub/irs-pdf/p334.pdf
  6. Pub 583 – Starting a Business & Keeping Recordshttp://www.irs.gov/pub/irs-pdf/p583.pdf

So here’s the list: 

 Cost of Goods Sold (generally for those who make or build something)

            Cost of products or raw materials

            Storage

            Direct labor – labor involved in manufacturing the product

            Factory overhead – the costs of running the factory

            Capitalization of direct costs for certain production activities

            Inventory

            Freight in

Dump fees

Employees pay including certain fringe benefits

Owner’s salary – only if the business entity is a corporation or subchapter S corporation.

Owner’s draws, per se, are not a deductible expense

Independent Contractor fees

Consultant fees

Advertising

Commissions and fees

Generally, penalties are not deductible

Professional services

            Bookkeeping

            Accounting

            Tax preparation

            Legal

            Professional photographer

            Web designer

Partnership guaranteed payments (only in partnership returns)

Rent

Taxes on leased property

Cost of getting a lease

Improvements by lessee (generally amortized)

Equipment rental

Interest

            Mortgage interest (for business real estate)

            Vehicle loan interest (business vehicles; to extent used in the business)

            Capitalization of interest

            Prepaid interest

            Credit line and business loan interest

Taxes & licenses

            Real estate taxes (business assets)

            Employment taxes

            Other business related taxes

            Business licenses

            Building permits and fees

Insurance

            Business insurance (for example, E&O insurance)

            Auto insurance (prorated for business use)

            Self employed health insurance                                 

Capitalized expenses (amortizing or depreciating them over a proscribed period of time)

            Business start-up costs

            Business organizational costs

            Business assets

            Improvements

                        Capital vs. Deductible expenses

Amortization

            Intangibles such as Goodwill

Business bad debts are handled differently depending on the accounting method you use

             Cash basis – not deductible – income is not recognized until money received

            Accrual basis – deductible because income recognized when earned

Repairs (vs. capital improvements) and maintenance

Repairs keep the property in good working condition without materially adding to the properties’ value.  Examples include painting, fixing a leak, replacing broken items, etc. 

Personal vs. business expenses – be very careful not to intermingle the two.

Personal expenses are never deductable as business expenses, although many people try

Charitable expenses

With the exception of a C Corporation, charitable expenses will carry to your Schedule A.

Depreciation

            MACRS

            ADS

            Assets to be depreciated

                        Software

                        Office equipment

                        Furniture

                        Automobile

                        Manufacturing equipment

                        Buildings

                        Capital improvements

Bonus depreciation – only used when allowed by IRS

Section 179 depreciation

            Allows full amount to be taken in current year – subject to limits

Depletion

Pension & profit sharing plans – treatment depends on business entity

            SEP

            IRA

            401K

            SIMPLE

Employee benefit programs – treatment depends on business entity

            Insurance

            Health and welfare programs

Reimbursable business expenses through a formal reimbursement plan

Domestic production activities credit

Business credits – there are many types of business credits

Travel (must be for a business purpose)

            Airline tickets

            Rental car       

            Hotel/motel

            Taxi

Meals and Entertainment (generally limited to 50% of actual expenses)

            Travel

            Entertaining customers or meeting with colleagues

Office in home (OIH) expense

Business must be profitable before you can take OIH expenses in current year

Special rules apply See my blog http://www.professionaltaxservicesinc.net/2009/08/office-home-expense/

Automobile and truck expenses

            Mileage vs. actual (allowable expenses to maintain and operate vehicle)

                        Actual almost always exceed mileage but you must keep good records

                        You must keep written records either way

            Auto loan interest

            Leasing expenses

Parking fees and tolls 

Miscellaneous Expenses         

Bank charges

Business start-up expenses (if under $5000 and not amortized)

Business Bond

Consulting fees

Credit and collection costs

Credit card processing fees

Damages

Delivery (Freight out)

Discounts

Documents

Dues and subscriptions

Dump fees

Exposition (show) fees and expenses

Equipment rental

Federal (FUTA) and State (SUTA) unemployment taxes

Ferry fees

Gifts

Limited to $25 per client or customer

Internet fees

Janitorial

Labor & Industry taxes

Laundry & dry cleaning

            Only for specialized clothing

Maintenance

Marketing

Meeting expenses

Miscellaneous

Office expenses

Organizational expenses (if not amortized)

Pay pal fees

PO Box

Postage and delivery

Printing

Professional memberships (special rules apply)

Professional education (Continuing professional education)

Professional supplies and publications

Real estate agent fees

Sales & promotion expenses

Security

Small tools & equipment

Staging costs

Storage

Supplies

Surety bond

Telephone

            Cell phone

            Second phone in home for business

            Fax line

Training & professional education

Utilities

Waste disposal

Web hosting

Website costs

Work clothing (special rules apply)

IRS AUDITS

Posted on | December 11, 2009 | No Comments

IRS AUDITS 

The IRS is stepping up audits of taxpayers at a rapid pace.  Each of the past several years there has been a significant addition of Revenue Agents (RA) and Revenue Officers (RO); those responsible for auditing returns and collecting taxes.  In addition, the IRS has been improving its already sophisticated computer programs, resulting in much more thorough and accurate reviews of tax returns, including comparisons to documents forwarded to the IRS by third parties; W-2s, 1099MISC, 1099INT and many, many others. 

The number of audits has increased steadily each year for the past eight years in all categories, both personal and business tax returns.  Of significant concern is that the IRS recognizes that small business owners, especially those who file Schedule C are prone to making mistakes and keeping poor records.   Guess what?  This is one of the areas where they are focusing their attention.  Over recent years the IRS has received a lot of money in additional taxes, penalties and interest by auditing small Schedule C businesses. 

So, why does the IRS audit tax returns?  The IRS wants you to comply with the tax code by filing and paying on time.  The IRS wants you to be intimidated.  Our U.S. tax system is a voluntary one.  The vast majority of us play by the rules; we file and pay on time.  But, in order to get us to do that, the IRS puts the “fear of God” in us by auditing tax returns and getting maximum publicity on those high profile cases where they throw a celebrity or ordinary citizen in jail.  The result is that most of us fear the IRS more than just about anything else.  We get an IRS letter in the mail and many of us are paralyzed.  We don’t want to open it! 

The IRS has a sophisticated system of computer programs that it uses to determine who gets audited.  Obviously, they don’t have the staff to audit everyone, so they have to select the ones that they think will be the most fruitful, i.e., result in the largest amount of  taxes, penalties and interest.  All individual tax returns are computer scored by the IRS DIF system.  Discriminate Function (DIF) is a highly secretive mathematical technique used to score income tax returns as to their examination potential.  Generally, the higher the DIF score, the higher the potential for audit.  Once the IRS selects returns to be audited, it then determines what kind of audit it will do.  One thing I want you to always remember. 

The first type of audit is a CORRESPONDENCE AUDIT.  This is the simplest form of audit, but has proven to be very lucrative to the IRS in terms of return on investment.  The taxpayer receives a computer generated letter from the IRS saying the IRS is proposing to make an adjustment(s) to their tax return unless the taxpayer can substantiate (prove) the expenses he/she claimed on their tax return.  The letter gives you 30 days to do so.  As I’m sure you all know by now, when you are dealing with the IRS, in the vast majority of issues, the burden of proof is on you.  You must respond to the IRS with documents that show you actually incurred the expense.  Common issues handled by correspondence audits include mortgage interest, taxes, contributions and many more.  Correspondence audits are usually focused on a few specific items in your tax return and are limited to that. 

The next type of audit is the OFFICE AUDIT.  An office audit means that you are summoned to the office of a local IRS Revenue Agent who will look at your return in more depth.  These audits are generally focused on specific areas of your tax return but a RA can look are the entire return and even open up other tax years if he/she feels warranted.  Many times small businesses are selected for office audits.  As with the correspondence audit, the burden of proof is on the taxpayer.  These audits are generally completed in one visit, just a few hours, assuming the taxpayer is prepared when he/she comes to the office. 

The final type of audit and by far the most comprehensive is the FIELD AUDIT.  As suggested by the name, in this case the RA comes to your home or place of business.  In a field audit, expect to have a very experienced Revenue Agent and expect he/she to look at all aspects of your return, your personal financial life and, if warranted, other tax years as well. 

So, what should you do if you are notified your tax return is being audited?  First of all, if your return is selected for an audit, that in no way implies that you made a mistake on your return.  Selection simply means that the IRS has one or more questions about your return.  If it is a correspondence audit and if the audit is focused on a specific issue and you have substantiation for your deduction, go ahead and handle the audit yourself by following the instructions in the letter.  If, after you have done so, the IRS still says you owe money, I highly recommend you hire an Enrolled Agent, CPA or attorney to represent you; someone with experience in dealing with the IRS. 

If you are facing an office or field audit, I recommend you immediately hire an Enrolled Agent, CPA or attorney to help represent you.  They will generally attend the audit in your behalf, but will require you to supply the substantiation required to prove your deductions/income in question.  Someone experienced in dealing with the IRS can save you a lot of money and give you peace of mind especially in office and field audits. 

IRS Stepping up Audits

Posted on | November 20, 2009 | No Comments

I expect to see a significant  increase in the number of audits by the IRS.  The trend has been upward for several years now and I expect that to continue.  As I have previously stated, one of the primary areas of interest by the IRS is Schedule C businesses.  The IRS is in the process of hiring another 2200 auditors and collectors and it is looking to find every tax dollar it can.

With the economy still in bad shape that means tax revenues are way down.  You would think the government would slow it’s spending.  No, just the oposite, spending is increasing at an alarming rate.  So, with spending up and tax revenues down, the Congress and the Administration have asked the IRS to work harder to find as many tax dollars as possible.

I expect the IRS to continue to look hard at mortgage interest deductions.  There are specific limits on what can and what cannot be taken as a mortgage interest deduction.  The IRS has already begun to focus on this and I expect them to do even more.  I will write a blog on mortgage interest deductions sometime in the next few weeks. 

Another area of emphasis by the IRS is to coordinate with states to look hard a small businesses to find those businesses that have misclassified workers as Independent Contractors (IC) to avoid paying employment taxes.  When they find those companies I expect the IRS to go back several years and to apply hefty penalties to those they determine are misclassifying employees as IC’s.

There will be other things the IRS will focus on as well, so taxpayer beware!  Know the rules and follow them.  This is not the time to be bending or breaking the rules.  If your not sure what the rules are, talk to a professional.  If you are operating in a gray area, clean up your act before it is too late.

FIRST TIME HOMEBUYER’S CREDIT EXTENDED

Posted on | November 6, 2009 | No Comments

The much used first time homebuyer’s tax credit has received congressional approval and has just been signed by the President . The measure was included in H.R. 3548, extension of unemployment benefits. According to the National Association of Realtors, as many as 1.2 million new and resale home transactions were completed as a result of the first time homebuyer’s credit. The extension of this credit, which has proven very popular amongst first time homebuyers, will continue to help the struggling home market. The $8,000 credit was due to expire on November 30th but will instead be extended for all first time homebuyers who enter into contracts prior to April 30th, 2010 and closed by June 30th, 2010. Also included in the bill is a new credit of up to $6,500 for some existing homeowners. To qualify for this new credit, homeowners must have been in their current residence for a consecutive five year period. The new bill also raises the qualifying income limits to $125,000 for single taxpayers and $115,000 for married filing joint taxpayers. The current limits are $75,000 and $150,000.

LUCKY DUCK!

Posted on | October 30, 2009 | 1 Comment

How many times in your life have you said something like “wow, why does she get all the luck?”  Or, I sure wish I had her luck.  No matter what she does, she makes money.  No matter what he does, he comes out smelling like a rose. 

Well, I’m not going to tell you that there is no such thing as luck.  There certainly is.  But what if I told you there are things you can do to help make your own luck?  Let me tell you about luck.  On one particular night mission in Vietnam, my airplane was suddenly surrounded by tracers; bullets being fired in front of me and on both sides.  And to make matters even scarier, only one bullet in five is a tracer.  I quickly maneuvered the airplane in a Split S (rolled inverted pulled hard until I was headed in the opposite direction) and to my surprise, when I landed, and thoroughly checked out the airplane, I had not been hit by a single bullet.  Now that’s luck!  Or maybe I made the right move just in the nick of time.  Regardless of what it was, I know God was my copilot that night. 

Some years ago, I was very envious of a peer of mine who always seemed to get the breaks.  No matter what that guy did, he always seemed to come out on top.  It wasn’t just once, or twice, but this went on for quite some time.  I was having a discussion with a mentor of mine, someone who had been around the block a few times and was a lot wiser than I.  I happened to let it slip that I was jealous of so-and-so because he always got the breaks.  My mentor’s response surprised me.  He said “Bill, luck is when preparedness meets opportunity.  Bob is just better prepared than you and the others are.”  Wow, that was really an eye opener.  I had never thought of it that way.

After hearing what my mentor had to say, I realized that to a certain degree, I could control my own luck.  I could at least be better prepared to handle situations before they happened.   Here is a good analogy.  When US Air flight 1549 lost both engines and “Sully” Sullivan ditched his Airbus 320 into the Hudson River, was that luck?  Maybe a little, but Sully was prepared for such an emergency.  Through hours and hours of emergency procedures practice in the simulator, Sully had the experience to deal with a very serious situation.  Had he practiced that particular emergency before?  No.  But because he practiced many different kinds of emergencies, he was able to maintain calmness and a level head as he dealt with this new situation.  Not only that, but Sully thought through those kinds of scenarios in his own mind to mentally prepare himself.  Was there any luck involved?  Of course there was some, everything had to be just right for this to happen, but if it weren’t for Sully’s preparedness, no one would have survived that ditching in the Hudson.  You can bet that pilots are now practicing something similar in their simulator training now. 

So what can you do to prepare yourself for the unknowns in your life and business? 

  1.  There is an old adage, “plan for the worst and hope for the best.”  In the flying business this is exactly what we do.  Most emergencies cannot be practiced in the airplane, for obvious reasons.  They are, instead, practiced in the simulator.  Modern day simulators are so realistic that pilots quickly forget they are in the simulator and think they are in the airplane.  By practicing the worst possible emergency situation in the simulator, when a pilot is faced with a real life emergency in the airplane, he/she is able to deal with it in a calm, level headed manner.  Most of the time, the emergency is far less severe that what has been practiced in the simulator and can be handled with apparent ease.   Yes, I know, I got off track a bit there.  I realize you don’t have a simulator for your business. So what do you do?  Know your business well.  Know what is important and what will keep your business on track and growing.  Concentrate on those things.  Don’t let life’s little emergencies sidetrack you in your efforts.  Think about what you are going to do and say when you finally meet that one big client have been hoping to land. Think through how you are going to respond to that client in various scenarios.  In other words, be prepared.  Don’t leave anything to chance. 
  2. Have a business plan. Understand your business and know what is important to move your business forward.  Think about what can go wrong.  Have a contingency plan for all those things that could go wrong.  Every now and then, climb up to 30,000 feet and take a total view of your business.  Remember, it’s hard to see the forest through the trees.  While at altitude, so to speak, make a calm assessment of your business.  In your day to day operations, whatever you do, don’t let the mundane, unimportant things bog you down.  When you see you are getting off track, make adjustments to your plan.
  3. Stay focused.  One of the airplanes I flew in my Air Force career was AWACS.  It is a four engine 707 with a large rotodome on top and is the USAF equivalent to a Navy aircraft carrier; always being sent to the hot spots.  I was the chief pilot for the AWACS program in both the USAF and NATO.  That meant that I had the responsibility to evaluate other pilots and flight crews.  During the evaluation flight we always threw in a simulated emergency or two.  On occasion, we experienced an actual emergency.  Sometimes I could see the entire four man flight crew focus totally on the emergency, leaving only the autopilot to fly the airplane.  This is how a simple emergency can be turned into a disaster.  It is so easy to get caught up in the moment and forget about the big picture.  You must remain focused on the important things in your business.    

So next time you start to get envious of someone else who always seems to have good luck, know that good luck can be yours as well by preparing yourself properly.

FIRST TIME HOMEBUYER’S CREDIT EXPIRING

Posted on | October 23, 2009 | No Comments

The American Recovery and Reinvestment Act included up to an $8,000 credit for first time homebuyers (the credit is actually 10% of the value of the home purchased, up to $8,000).  A first time homebuyer is someone who has not owned a house in the three years prior to the purchase.  Unlike the 2008 homebuyer’s credit which has to be paid back, this credit does not have to be paid back if the homebuyer remains in the home for at least three years. 

The credit can be claimed on either the 2008 or 2009 tax return, however, the home must be purchased prior to December 1, 2009 to qualify for the credit.  That means that closing must occur prior to that date.  So, those of you considering buying a house and taking advantage of the credit, you need to move very quickly if you are still early in the buying process.

There is some talk in Congress about extending the credit, but my advice is to close on a house prior to Dec 1, 2009 if you want to take advantage of the credit.

Who’s Afraid of the Big Bad Wolf?

Posted on | October 6, 2009 | No Comments

I just attended an intensive training program on dealing with the IRS.  One of the instructors, at prominent tax lawyer, said that, based on his experience, about 15% of the U.S. population becomes functionally illiterate when they receive an IRS letter.  Another 5 – 10% breaks out in a cold sweat and many are afraid to open the letter.  What causes all this fear?  Should you be afraid?

Since our income tax system in the U.S. is a voluntary one, the IRS wants us to believe they are watching our every move and will come knocking on your door if you make even the smallest error on your tax return.  They want the image as the Big Bad Wolf.  Does it work?  For the most part, you betcha! 

Let’s look more closely at how the IRS operates and some of the statistics to see if you have good reason to be afraid.  The IRS sends millions of letters to taxpayers every year.  Many of the letters they send out are straight forward and are administrative in nature.  They may be correcting a math error, advising that you left something off the return and giving you a chance to fix it.  Or they may be more serious, assessing a penalty if you filed late or notifying you that your tax return is being audited.  Unfortunately, they never send you a letter saying you are doing great, keep up the good work.

So, what are your chances of being audited?  Actually they are very small.  On average, a little over1% of filed tax returns get audited each year, however that number has been going up in the past decade and as you will see a little later, the odds increase depending on the type of return you file.  Several years ago an IRS research study showed that there is an underpayment of taxes of about $300B (B as in Billion) per year, known as the “Tax Gap.”  About $250B of that comes from underreporting income and/or overstating expenses. 

Congress has asked the IRS to aggressively try to close the “Tax Gap.”  One way they are doing it is by hiring more employees and conducting more audits.  Let me analyze this a little bit further.  Financially, most taxpayers lead rather uncomplicated lives.  They work for someone else, get paid by W-2, earn interest from their bank or brokerage, buy and sell a few stocks, put some money in a 401K or similar plan, pay their mortgage or are retired drawing a pension and social security.  Virtually everything financially in their lives is reported to the individual and to the IRS on one form or another.  For this large segment of taxpayers, it is a simple matter for the IRS to know who has filed and accurately reported their income and deductions.  In many cases, if a taxpayer does not file a return, the IRS will file a substitute tax return for the taxpayer.  This will only occur only if they taxpayer owes money.  If the taxpayer is due a refund, the taxpayer will probably never hear from the IRS.  Why?  By law, after three years the IRS no longer has to refund the money. 

So, how does the IRS know who to audit?  The IRS scores every tax return filed; known as the DIF score.  Through research, the IRS knows what types and how much a taxpayer should be taking in deductions based on his/her Adjusted Gross Income.  If the computer review of the tax return finds some of the numbers outside the norm, it assigns a higher DIF score to the return.  The higher the DIF score the more likely the return will be audited. 

I’ll give you one guess where the majority of the $250B shortfall comes from.  It comes from small businesses and self employed folks; that’s you and me.  Research and IRS experience from past audits have shown that there is a significant underreporting of income as well as overstating of expenses on many business returns.  This is especially the case with sole proprietorships and single member LLC’s that report their business income on Schedule C on their 1040 return.

As a self employed taxpayer, you are about 10 times more likely to have your Schedule C audited than you would be if you filed a Form 1065 (partnership or LLC return) or 1120/1120S (corporation or subchapter S return).    Based on years of audits the IRS knows that those small businesses who file on Schedule C probably don’t keep sufficient records and frequently can’t prove the income and expenses claimed.  On the other hand, small businesses who file Form 1065, 1120 or 1120S generally keep better records and frequently use a bookkeeper or accountant and a tax professional.   As a result, the IRS knows that the “low hanging fruit”, so to speak, is in Schedule C businesses.  So take the hint.  For those of you who are filing on Schedule C, you might want to consider another type of business entity. 

The IRS uses education of the public and audits to keep people in compliance.  Lately the IRS has been putting most of its emphasis on audits and is expanding its audit force.  Audits are the subject of another article, but, briefly, there are three types of audits,   Correspondence, Office and Field, with a Field audit being the most comprehensive one.  The IRS makes sure it gets a lot of publicity on its high profile audits and criminal actions. 

So, how do you protect yourself from the Big Bad Wolf? 

  • First of all, keep excellent records.  If you are not good at recordkeeping, hire a bookkeeper or accountant to help you or at least be on your team of advisors.  See:  (http://biznik.com/articles/ive-got-your-six).  Use a software program like QuickBooks to track income and expenses so you can create financial statements.  This will not only help you at tax time, it will help you immensely if you are audited.  These reports are also essential to understanding and managing your business.
  • Keep your personal and business finances separate.  Always!  Have separate bank accounts and credit cards for the business and for you personally.  By the way, if you are one of those people who does not believe cash is money (in other words, not reportable to the IRS as income), the IRS has ways to determine when you are not reporting income.  In a Field audit, they always do this analysis and sometimes in an Office audit as well. 
  • Have documentation to back up expenses you claim.  Cancelled checks are not considered adequate proof, although they are better than nothing; it’s always best to have a receipt for each item you claim.
  • Keep good automobile records if you use your car for your business.  I know it’s a pain, but keep a log in your car and annotate every business trip you take with the miles you drive and the reason for the trip.  This only takes a minute or two and it is well worth the effort.  If you are seeing a client, note who that client is.  If you are constantly going to the same place, for example you are in construction, you can use Map Quest to determine the mileage, but you still need to keep a log of the number of trips to that location.
  • File your tax return(s) on time.  On time includes an extension if you file for it.  Remember, the extension is to file your return, not to pay what you owe.  If you owe money, the IRS expects it all to be paid no later than April 15th. 
  • Lastly, if you get that dreaded letter from the IRS, open it immediately!  Not dealing with it quickly will only lead to more trouble later.  IRS letters can be long and difficult to understand.  If you used a tax professional to do your tax return, contact him/her immediately for their help.   If you did not use a tax professional and the issue seems serious, contact an Enrolled Agent (http://www.professionaltaxservicesinc.net/enrolled-agent/) or CPA who has experience dealing with the IRS.  I would not recommend contacting a tax lawyer unless you suspect the IRS is after you for fraud or you are under criminal investigation.  If agents show up at your door with a badge, it’s usually very serious.  That is when a tax lawyer should be consulted. 

Should you be afraid of the Big Bad Wolf?  Absolutely not!  If you follow the simple guidelines I laid out above, you really should have nothing to worry about.  That doesn’t mean you won’t get an IRS letter or be audited, but if you are you will be prepared.  Adding a tax professional to your team of advisors will give you extra peace of mind as well.

IRA CONVERSION STRATEGIES

Posted on | September 25, 2009 | No Comments

TRADITIONAL IRA TO A ROTH IRA CONVERSION STRATEGIES  

As the end of 2009 approaches, a significant opportunity awaits many individuals.  Beginning in 2010, taxpayers will be able to convert their traditional IRA (and funds that have been rolled over from a qualified plan) to a Roth IRA, regardless of their income level or filing status.  What’s more, the tax on the taxable income generated from a 2010 conversion may be deferred until 2011 and 2012.  This new conversion option presents both tax planning opportunities and challenges for 2009, 2010 and 2011. 

Before 2010, only individuals with modified adjusted gross incomes (AGI) of $100,000 or less can convert amounts in the traditional IRA to a Roth IRA.  Moreover, married taxpayers filing separate returns have also been prohibited from converting their traditional IRA to a Roth IRA as well.  However, beginning in 2010, the $100,000 AGI limit on conversions of traditional IRAs to Roth IRAs is eliminated completely.  This special treatment gives everyone, regardless of his or her income level the opportunity to convert a traditional IRA to a Roth IRA.  Additionally, filing status restrictions are also lifted, allowing married taxpayers filing a separate return to convert a traditional IRA to a Roth IRA.

It is important to understand that an IRA conversion is treated as a taxable distribution, taxed as ordinary income at your marginal tax rate.  This, in effect, accelerates that taxable income that you would eventually pay on distributions from a traditional IRA once you retire, but does so in exchange for never taxing any future appreciation in the value of your account from what it is today.  That is often a significant tax advantage.  You should also note that unlike a withdrawal from an IRA, a conversion does not trigger any 10 percent early withdrawal penalties. 

Although conversion to a Roth IRA does trigger immediate taxable income, Congress provided a special incentive in 2010 to jump-start Roth conversions.  In 2010 (and 2010 only), individuals will have the choice of recognizing their conversion income in 2010 or averaging it over 2011 and 2012.  The latter option, which the taxpayer must elect to put into effect, allows you to pay taxes on the converted amounts ratably over two years, instead of recognizing it all as income in one ear.  You will be taxed at the rates in effect for 2011 and 2012. 

For some taxpayers, their tax rate may rise after 2010 even if their income does not.  President Obama has proposed, and Congress is expected to enact, legislation to restore the top two pre-2001 marginal income tax rates after 2010.  This means that the top two brackets will be 39.6 percent and 36 percent after 2010.  Consequently, if you do not want to take the chance that your income tax rate will be higher in 2011 and 2012 than in 2010, you may want to elect to pay the full tax on the Roth conversion on your 2010 income tax return, at 2010 income tax rates.

Higher-income individuals, who plan to pay the entire conversion tax in 2010 instead of ratably in 2011 and 2012 because of the anticipated increase in the top marginal tax rates, may want to avoid, for year-end 2009, the traditional year-end-planning techniques of accelerating deductions and deferring income.  Alternatively, consider doing the opposite this year to avoid being pushed into the highest brackets by a large IRA to Roth IRA conversion. 

Taxpayers are expected to convert their traditional IRAs to Roth IRAs for a variety of reasons.  Roth IRAs have two major advantages over traditional IRA’s:

  • Roth IRA distributions are tax-free if they are qualified distributions.  To be qualified, they must be made after a five-year holding period has passed and after the accountholder reaches ate 59 ½ or on account of death, disability, or the qualified purchase of a first home. 
  • Roth IRAs are not subject to the required minimum distribution (RMD) rules that apply to tradition IRAs (as well as individual qualified plans).  Therefore, a Roth IRA accountholder who reaches age 70 ½ does not need to begin taking distributions; instead, the funds can continue to grow tax free until they are needed or are passed on to heirs. 

The tax-free nature of qualified Roth IRA distributions may prevent individuals from being taxed in a higher tax bracket that would otherwise apply if he or she were withdrawing taxable distributions from a traditional IRA.  Moreover, these distributions—unlike those from traditional IRAs—do not affect the calculation of tax owed on Social Security payments and do not affect AGI-based deductions. 

An IRA to Roth IRA conversion should be considered by individuals who:

  • Can afford the tax on the converted amounts;
  • Anticipate being in a higher tax bracket in the future than they are currently in; and
  • Have a significant amount of time before reaching retirement to allow assets to grow tax-free and recoup dollars that may have been lost due to the conversion tax. 

If you are planning on taking advantage of the Roth IRA conversion opportunity next year, consider some of the following strategies this year: 

  • Because of the economic slowdown, many individuals are postponing retirement.  Roth IRAs, unlike traditional IRAs, generally have no age limitation on contributions from earned income or on mandatory payouts.  This is an advantage for individuals who are extending their careers beyond traditional retirement age. 
  • If you are able to make deductible traditional IRA contributions this year, do so. This can help you reduce you 2009 tax bill and, if you convert to a Roth IRA in 2010, you will not have to pay back the tax savings until 2011 and 2012, if you elect to ratably pay the tax over the two-year period.
  • If you anticipate being below the $100,000 AGI level this year, consider converting to a Roth IRA right away while your traditional IRA account balance is still low because of stock market declines.  If your situation is different from what you anticipated before you filed your 2009 return, you might consider “recharacterizing” your 2009 Roth conversion back to a traditional IRA and then converting to a Roth IRA in 2010 instead.

There are a significant number of tax and financial considerations that come into play when determining whether to convert your traditional IRA to a Roth IRA.  If you have any questions about traditional IRA to Roth IRA conversions and the new 2010 planning opportunity, please contact me.

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About

As an Enrolled Agent and consummate tax professional, Bill provides year-round, affordable tax services for his clients. Bill is experienced in small business start-up and tax planning in addition to a full range of tax return preparation.

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