jump to navigation

Tax Tip of the Week | The Tax Landmines of Lending to Family Members November 6, 2019

Posted by bradstreetblogger in : Business consulting, General, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

People often lend money to family members, but few think about the IRS when making the “loan”.  In the article that follows, Bob Carlson, Senior Contributor to Forbes, discusses the procedures and consequences one should consider before getting out the checkbook. If you are in this situation as a lender, or as a borrower, the following article does a great job of explaining the “rules” that you need to consider.

                                     –    Norman S. Hicks

Many people are happy to lend money to their loved ones, especially to children and grandchildren. But before stroking the check, review the tax rules. The tax consequences vary greatly depending on the terms of the loan. A small change in the terms can mean a big difference in taxes and penalty. 

Too often, family loans are informal arrangements. They don’t carry an interest rate or have a payment schedule. They essentially are demand notes. Payment isn’t due until the lending parent or grandparent demands it, and that’s not likely to happen unless the lender’s financial situation changes adversely. 

That runs afoul of the tax rules. In a family loan, when there is no interest rate or a rate below the IRS-determined minimum rate, the interest that isn’t charged is assumed to be income to the parent from the child. In other words, there is imputed interest income or phantom income. The parent is to report interest income at the IRS-determined minimum rate as gross income, though no cash is received. The borrower might be able to deduct the same amount if they qualify for the mortgage interest deduction. 

In addition, the lending parent or grandparent is assumed to make a gift of the imputed interest to the borrowing child or grandchild. In most cases, the annual gift tax exclusion is more than sufficient to prevent the gift from having any tax consequences. In 2019, a person can make gifts up to $15,000 per person with no gift tax consequences under the annual gift tax exclusion. A married couple can give up to $30,000 jointly.

To avoid these tax consequences, there should be a written loan agreement that states interest will be charged that is at least the minimum interest rate determined by the IRS for the month the agreement was signed. You can find the minimum rate for the month by searching the Internet for “applicable federal rate” for the month the loan agreement was made. The rate you use will depend on whether the loan is short-term, mid-term, or long-term and on whether interest compounds monthly, quarterly, semiannually, or annually.

The applicable federal rate is based on the U.S. Treasury’s borrowing rate for the month. That means it’s a low rate and is likely to be a lower rate than the child or grandchild could obtain from an independent lender. 

It’s a good idea for the borrower to make at least interest payments on a regular basis. Otherwise, the IRS could argue that there wasn’t a real loan and the entire transaction was a gift.

There are two important exceptions to the imputed interest rules.

A loan of $10,000 or less is exempt. Make a relatively small loan and the IRS doesn’t want to bother with it.

The second exception applies to loans of $100,000 or less. The imputed income rules apply, but the lending parent or grandparent can report imputed interest at the lower of the applicable federal rate or the borrower’s net investment income for the year. If the borrower doesn’t have much investment income, the exception can significantly reduce the amount of imputed income that’s reported.

Suppose Hi Profits, son of Max and Rosie Profits, wants to purchase a home and needs help with the down payment. Max and Rosie lend $100,000 to Hi. They charge 3.22% interest on the loan, which was the applicable federal rate in July 2019 for a long-term loan on which the interest is compounded semiannually. 

If Hi Profits doesn’t make interest payments, Max and Rosie will have imputed income of $3,220 each year that must be included in their gross income. In addition, they will be treated as making a gift to Hi of $3,220 each year. As long as they don’t make other gifts to Hi that put them over the annual gift tax exclusion amount ($30,000 on joint gifts by a married couple), there won’t be any gift tax consequences.

Hi can have the loan recorded as a second mortgage against the property. That might enable him to deduct the imputed interest on his income tax return, though he made no cash payments.

Max and Rosie have two costs to the loan. The first cost is the investment income they could have earned on the $100,000. 

The other cost is the income taxes they’ll owe on the imputed interest income. 

To avoid tax problems with a loan to a family member, be sure there’s a written loan agreement stating the amount of the loan, the interest rate, and the repayment terms. The interest rate should be at least the applicable federal rate for the month the loan is made. Simple loan agreement forms can be found on the Internet.

If the loan calls for regular payment of interest, or interest and principal, those payments should be made and should be documented. The more you make the transaction look like a real loan, the less likely it is the IRS will try to tax it as something else, such as a gift. 

A written loan agreement also can prevent any misunderstandings between the borrower and your estate or other family members after you’re gone. Your will should state whether you want the loan repaid to your estate, forgiven and deducted from the borrower’s inheritance or treated some other way.

Family loans are in wide use. Be sure you take the extra steps needed to avoid problems with the IRS.

Credit given to Bob Carlson, Senior Contributor to Forbes Media.  Bob is the editor of Retirement Watch, a monthly newsletter and web site he founded in 1990.  The above article can be found at: https://www.forbes.com/sites/bobcarlson/2019/10/16/the-tax-landmines-of-lending-to-family-members/#30802295468f.

Thank you for all of your questions, comments and suggestions for future topics. We may be reached in Dayton at 937-436-3133 and in Xenia at 937-372-3504.  Or visit our website.  

This Week’s Author – Norman S. Hicks, CPA

–until next week.

Tax Tip of the Week | What Type of Entity Should I Be? October 30, 2019

Posted by bradstreetblogger in : Business consulting, Depreciation options, General, Tax Planning Tips, Tax Tip, Taxes , add a comment

Clients who are starting a business often ask us “What type of entity should I be?” While there is no definitive answer, this tax tip will cover some of the more common choices that can be made, and some of the concerns and tax treatment of those choices.

When an individual starts a business and is the only owner, if that person does nothing else tax-wise, the business is treated as a sole-proprietorship, meaning the taxpayer files a Schedule C as part of his or her annual Form 1040. If two or more people start a business, and do nothing else, the business is treated as a partnership, and files a partnership return, Form 1065.

Many clients are concerned about legal protection and will ask “Should we incorporate?” The answer, as it is with most tax questions, is “it depends”. While corporations arguably provide the most legal protection of any entity, they are also a bit more costly to form than other entities, and can be a bit more cumbersome to operate. According to Nellie Akalp, in an article published in the CPA Practice Advisor on October 10, 2019, she states “the law requires a corporation to:

•    Select a Board of Directors, meet with the board regularly and keep detailed meeting minutes.
•    Formally register the business by filing Articles of Incorporation with the state.
•    Obtain a Tax ID Number or Employer Identification Number (EIN) from the IRS.
•    Draft corporate bylaws.  Corporate bylaws are the official rules for operating and managing the company, proposed and voted on by the Board.”

Prior to 2018, corporate tax rates were graduated, the highest rate being 35%. The Tax Cuts and Jobs Act (TCJA) enacted in late 2017, changed the corporate tax rate to a flat 21% which was good for some, but not all. Corporations making less than $50,000 per year actually got a tax increase. Previously, the tax rate for this bracket was 15% so these corporations now have to pay 6% more in federal tax. Another consideration is the “double-taxation” of money taken out by the owners. Dividends paid to shareholders are not deductible by the corporation, and are taxed to the recipient.

For those who don’t want the formalities and expense of forming and operating a C corporation, forming a Limited Liability Company (LLC) can be an attractive alternative.  We have had new clients tell us they are incorporated, which we usually verify on the Ohio Secretary of State’s website, only to find out they are really an LLC. An LLC is not an incorporated entity, but does provide a layer of protection. If a business is sued, and has not incorporated or become an LLC, the owner’s personal assets can be at risk. A single-member LLC, absent any other elections, files a Schedule C, just as a sole-proprietor does. A multi-member LLC, absent any elections, files a partnership return, Form 1065. If desired, a single-member or multi-member LLC can elect to be taxed as a corporation by filing IRS Form 8832, Entity Classification Election.

Another election that can be made by either an LLC, or a corporation, is the election to be taxed as an S Corporation. This is just a taxation election and doesn’t change the type of entity making the election. The election is made by filing Form 2553, Election by a Small Business Corporation. The title of this form is somewhat of a misnomer because it indicates that only a corporation can make the election. Not only can small corporations make the election, but so can LLC’s.

Dividends paid by an S corporation (normally called distributions when made by an S corporation) generally are not taxable to the recipients (unless there are basis issues), which avoids the double-taxation issue of C corporations. The net profits of an S corporation are not taxed at the corporate level, but instead are passed through to the owners, and are taxed on their individual returns, regardless of whether any distributions were made. And this net profit is not subject to self-employment tax (FICA taxes) as is Schedule C income and partnership income reported by an active individual. Not all of the S corporation’s profits can be taken as distributions however. The IRS requires owners who are active in the business to take a reasonable salary. The salary, of course, has FICA taxes withheld, and the company has to pay matching FICA taxes as with any employee.

According to Nellie Akalp, “To qualify for S-Corp status:

•    The business must be a U.S. corporation or LLC
•    It can maintain only one class of stock
•    It’s limited to 100 shareholders or less
•    Shareholders must be individuals, estates or certain qualified trusts
•    Each shareholder must consent in writing to the S Corporation election
•    Each shareholder must be a U.S. Citizen or permanent resident alien with a valid United States Social Security number
•    The business must have a tax year ending on December 31”

The TCJA provided for a new deduction beginning in 2018 called the Qualified Business Income Deduction. This deduction is available for most types of “pass-through” business income and is limited to 20% of qualified business income provided certain qualifications are met. Because it is for “pass-through” income, C corporations do not get any benefit. Most other types of business income do qualify, such as sole-proprietors, partnerships, LLC’s and S corporations. So this is yet another consideration when deciding on the type of entity a business should be.

As you can see, there are several types of entities and quite a bit to consider when making the entity choice. Hopefully this article helps to give you some perspective.

Credit given to Nellie Akalp for the excerpts taken from her article “Why Small Businesses May Want to Consider Electing S Corp Status” published in the CPA Practice Advisor on October 10, 2019.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Norman S Hicks, CPA

–until next week.

Tax Tip of The Week | Did You Know All Ohio Businesses Must File An Annual Report of Unclaimed Funds? October 23, 2019

Posted by bradstreetblogger in : Business consulting, General, Tax Planning Tips, Tax Tip, Taxes, Uncategorized , add a comment

It’s that time of year again…

Time to report unclaimed funds! This one really gets business owners excited (sarcasm intended).

As stated by the Ohio Department of Commerce, “All businesses that are located and/or operate in the State of Ohio, or hold funds due to Ohio residents, are required to file an Annual Report of Unclaimed Funds.”

Unclaimed Funds Reports are due by November 1st.

The Ohio Treasury wants Ohioans to recover money that is rightfully theirs. Every year 200,000 Ohioans lose track of their funds. They either put money in financial institutions and forget about it, or simply cannot track it in their records.

What is the Division of Unclaimed Funds?

The Ohio Department of Commerce, Division of Unclaimed Funds exists to protect money lost by Ohioans in various financial institutions, find the people the money belongs to, and then returns it as quickly as possible. More than $1 billion currently is in the custody of the Division of Unclaimed Funds. The Ohio Treasury makes Ohioans aware of the Division of Unclaimed Funds, so that they get back money rightfully theirs. You can perform a search using the following link:

SEARCH UNCLAIMED FUNDS

What types of accounts qualify as unclaimed funds?

We have a document from the Ohio Department of Commerce that helps explain what qualifies as “unclaimed funds,” as well as how to report them, here:

 HOW TO FILE AN UNCLAIMED FUNDS REPORT

Even if you have no unclaimed funds to report, a negative report must be filed.

What happens if your Ohio-based company does not report?

According to the Ohio Department of Commerce:

“For failing to report unclaimed funds or underreporting unclaimed funds, the company may incur civil penalties of $100.00 per day. The company may also have to pay interest at a rate up to 1% per month on the balance of unclaimed funds due per Ohio Revised Code section 169.12.”

What is NAUPA?

The National Association of Unclaimed Property Administrators (NAUPA) is a non-profit organization that maintains a national database, called Missing Money, to help people find unclaimed property.

MISSING MONEY

For additional assistance, contact the Ohio Department of Commerce’s Division of Unclaimed Funds at 1-877-644-6823.

Still struggling in determining how to file an Unclaimed Funds Report?

At Bradstreet & Associates and Bradstreet & Company CPAs, we’re here to help. If you need assistance filing your report, please call our Xenia office at 937-372-3504 or our Centerville office at 937-436-3133.

A complete information booklet on Reporting Unclaimed Funds is available here:
http://www.com.ohio.gov/documents/unfd_AnnualReportOfUnclaimedFunds.pdf

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Co-Authors – Bobbie Haines & Linda Johannes, CPA

–until next week.

Tax Tip of the Week | A Retirement Plan Too Often Ignored September 11, 2019

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Taxes , add a comment

If your business fits the definition of an owner-only employee business then a Solo 401(k) retirement plan may be a great idea for you.  And, oh yeah, another caveat – you are not allowed to have any employees other than you and your spouse. If your sole proprietorship, partnership, S corporation or C corporation fits the necessary parameters then you may make contributions to a Solo 401(k) plan.

This type of retirement plan allows higher contribution amounts and more investment options than many other retirement plans. The Solo 401(k) even has ROTH options and its account holder may borrow against the plan assets. They are also inexpensive to setup and maintain. Even though created by Congress in 2001 – we still don’t see as many of these plans as I think we should.

If you think you may qualify for the Solo 401(k), please remember that this plan must be formed by year-end for the contributions to be deducted for that same year.

The below WSJ article by Jeff Brown was published on July 9, 2019 and contains additional details.

                                                                                                            -Mark Bradstreet

Millions of U.S. workers rely on employer-sponsored 401(k)s to save for retirement. But what about freelancers, sole proprietors and workers in the mushrooming gig economy, or people who want to leave the corporate cocoon and strike out on their own?

Financial advisers say that far from being left out in the cold, these workers have access to an often-overlooked retirement-savings vehicle that offers some distinct advantages: an “individual” or “solo” 401(k).

Available to self-employed people, as well as business owners and their spouses, solo 401(k)s allow participants to make contributions as both an employer and employee. That means individuals can sock away large sums that dramatically reduce income taxes, among other perks.

Although enrollment data is hard to come by, financial advisers say solo 401(k)s have been slow to get the respect they deserve since they were created by Congress in 2001. Many financial-services firms waited years to start offering the plans, and many business owners who could have them don’t know they exist.

“You’d be surprised how many people don’t know about solo 401(k)s, especially accountants,” says Sean Williams, wealth adviser with Sojourn Wealth Advisory in Timonium, Md.

Perks advisers like

Solo K’s, as some call them, allow participants to avoid the complex rules covering corporate 401(k)s. Not only do solo K’s permit virtually unlimited investing options, they allow participants to choose between making traditional tax-deductible contributions or after-tax Roth contributions. Some advisers prefer them over better-known options for people who work on their own, such as SEP-IRAs (simplified employee pension individual retirement arrangements) and Simples (savings incentive match plan for employees).

“Solo 401(k)s are better than the other options,” says Vincenzo Villamena, a certified public accountant with Online Taxman in New York, “because of the ability to contribute to a Roth and the higher contribution limits.”

Like corporate 401(k)s, the maximum contribution this year for solo K’s is $56,000, including up to $19,000 in pretax individual income, plus an employer contribution. (For people age 50 or older, the maximum is $62,000, due to a catch-up provision.) By comparison, Simples limit employee contributions to $13,000 this year ($16,000 for investors age 50 or over), and employer matches to 3% of compensation up to a maximum of $5,600. SEPs, meanwhile, limit annual employer contributions to $56,000 or 25% of income, whichever is less, and there is no employee contribution.

Contributions to solo K’s cannot exceed self-employment income, which is counted separately from any income earned by working for others.

According to Donald B. Cummings Jr., managing partner of Blue Haven Capital in Geneva, Ill., contributions can come from other sources if regular income from the business is needed to pay ordinary expenses. “Say a 50-plus-year-old business owner inherits $500,000 from a deceased relative. She now has access to better cash flow and can theoretically contribute 100% of her compensation” up to the limit, he says.

An investor also can move cash into a solo K from a taxable investment account, reducing taxable income and getting tax deferral on any future gains.

Opening one up typically takes only a few minutes of paperwork with a financial firm such as Vanguard Group, Fidelity Investments or Charles Schwab Corp. SCHW 1.03% Providers typically don’t require a minimum contribution to open an account, or minimum annual contributions.

Business owners who set up the solo plan as a traditional 401(k) get a tax deduction on contributions, tax deferral on gains and pay income tax on withdrawals after age 59½. (If they withdraw before 59½, they generally will pay both income tax and a penalty.) If they choose to go the Roth route, contributions are after taxes but qualified withdrawals are tax-free, which can be a plus for those who expect to be in a higher tax bracket later in life. And unlike ordinary Roth IRAs, which are available only to people with incomes below certain thresholds, anyone who opens a solo K can pick the Roth option. “The single largest benefit of a solo 401(k) is the ability to contribute Roth dollars,” says Brandon Renfro, a financial adviser and assistant finance professor at East Texas Baptist University in Marshall, Texas. “Since you are the employer in your solo 401(k), you can simply elect that option,” he says. “This is a huge benefit over the other types of self-employed plans.”

Another plus is that account holders can borrow against the assets in a solo 401(k), says Pedro M. Silva, wealth manger with Provo Financial Services in Shrewsbury, Mass. That isn’t allowed with alternatives such as SEPs.

“Business owners often write large checks, and having access to an extra $50,000 for emergencies or opportunities is a valuable feature of the plan,” Mr. Silva says.

Words of caution

A solo 401(k) must be set up by the end of the calendar year for contributions to be subtracted from that year’s taxable income. But, as with an IRA, money can be put in as late as the tax deadline the following April, or by an extension deadline.

Investors who want to change providers can transfer assets from one solo 401(k) to another with no tax bill, as long as the investments go directly from the first investment firm to the second. But if the assets go to the investor first there may be tax consequences, even if they are then sent to the new provider.

Business owners should be aware that the hiring of just a single employee aside from a spouse would require the plan to meet the tricky nondiscrimination test that applies to regular 401(k)s, says Stephanie Hammell, an investment adviser with LPL Financial in Irvine, Calif. That test is designed to make sure executives don’t get a better deal than employees.

Business owners in that situation might do better with a SEP or Simple plan, which don’t have the nondiscrimination hurdle, according to Dr. Renfro.

And as with all financial products, it pays to shop around for the best combination of investment offerings, fees and customer service, experts say.

“Set up your account with an investment provider that either doesn’t charge fees for the administration of the account, or charges very minimal fees,” says Natalie Taylor, an adviser in Santa Barbara, Calif. “Choose an investment provider that offers high-quality, low-cost investment options inside of the individual 401(k) account.”

Credit Given to:  Jeff Brown. This appeared in the July 9, 2019, print edition of the Wall Street Journal as ‘The ‘Solo’ 401(k) Is Often Overlooked.’ Mr. Brown is a writer in Livingston, Mont. He can be reached at reports@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | A Need to Know on Capital Gains Taxes September 4, 2019

Posted by bradstreetblogger in : Business consulting, Depreciation options, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

Generally, capital assets that are held in excess of one year and sold at a profit may be taxed at three (3) possible tax rates: (1) 0%, (2) 15% or (3) 20%. For most people, the rate used depends upon their filing status and the amount of their taxable income. Gains from the sale of capital assets not held for a year are taxed as ordinary income. If capital assets are sold at a loss – generally, only $3,000 ($1,500 married filing separate) may be deducted annually unless other capital gains are available as an offset.

Everyone thinks that Congress designed the zero-percent capital gain rate just for them. That thinking is only natural since so many reporters and so many politicians have over-hyped the catchy expression of “zero-percent rate.” The truth is VERY few taxpayers will ever be in position to take advantage of the zero-percent long-term capital gain rate. To do so, for most single and married couples filing jointly, their taxable income not including the capital gains must be less than $39,375 or $78,750, respectively. Remember your taxable income might include any Form W-2s, interest and dividend income, business and rental income etc. But, it also includes the capital gain itself. So, not a very big window exists for the possibility of qualifying for using the zero-percent rate. If your income other than capital gains, less your deductions exceeds these taxable income ceilings then the window not only shuts but disappears as though it never existed. This capital gain tax calculation is not made the same as the calculation of income taxes which are calculated using the incremental tax brackets. And, depending upon the amount of your regular taxable income not including the capital gains above and beyond the amounts of $39,375/$78,750 – you will then use either the 15% OR the 20% tax bracket for the capital gains rate. Don’t forget the “net investment income tax” of 3.8% which could be an additional tax along with your particular state income tax. Ohio taxes capital gains as ordinary income. Also, technically outside the tax world – various income levels may also affect the amount of your Alternative Minimum Tax (AMT), Medicare insurance premiums and the amount of student loan repayments (if applicable).

More information and explanations follow in the article below by Tom Herman as published by the Wall Street Journal on Monday, June 17, 2019.

                            -Norm Hicks and Mark Bradstreet

By tax-law standards, the rules on capital-gains taxes may appear fairly straightforward, especially for taxpayers who qualify for a zero-percent rate.

But many other taxpayers, especially upper-income investors, “often find the tax law around capital gains is far more complicated than they had expected,” says Jordan Barry, a law professor and co-director of graduate tax programs at the University of San Diego Law School.

Here is an update on the brackets for this year and answers to questions readers may have on how to avoid turning capital gains into capital pains.

Who qualifies for the zero-percent rate?

For 2019, the zero rate applies to most singles with taxable income of up to $39,375, or married couples filing jointly with taxable income of up to $78,750, says Eric Smith, an IRS spokesman. Then comes a 15% rate, which applies to most singles up to $434,550 and joint filers up to $488,850. Then comes a top rate of 20%.

But don’t overlook a 3.8% surtax on “net investment income” for joint filers with modified adjusted gross income of more than $250,000 and most singles above $200,000. That can affect people in both the 15% and 20% brackets. For those in the 20% bracket, that effectively raises their top rate to 23.8%. “That 23.8% rate is the rate we use to plan around for high net-worth individuals,” says Steve Wittenberg, director of legacy planning at SEI Private Wealth Management.

There are several other twists, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Among them: a maximum of 28% on gains on art and collectibles. There are also special rates for certain depreciable real estate and investors with certain types of small-business stock. See IRS Publication 550 for details. There also are special rules when you sell your primary residence.

State and local taxes can be important, too, especially in high-tax areas such as New York City and California. This has become a much bigger issue in many places, thanks to the 2017 tax overhaul that included a limit on state and local tax deductions. As a result, many more filers are claiming the standard deduction and thus can’t deduct state and local taxes. But some states, including Florida, Texas, Nevada, Alaska and Washington, don’t have a state income tax. Check with your state revenue department to avoid nasty surprises.

How long do I typically have to hold stocks or bonds to qualify for favorable long-term capital-gains tax treatment?

More than one year, says Alison Flores, principal tax research analyst at The Tax Institute at H&R Block. Gains on securities held one year or less typically are considered short-term and taxed at the same rates as ordinary income, she says. The rules are “much more complex” for investors using options, futures and other sophisticated strategies, says Bob Gordon, president of Twenty-First Securities in New York City. IRS Publication 550 has details, but investors may need to consult a tax pro.

The holding-period rules can be important for philanthropists who itemize their deductions. Donating highly appreciated shares of stock and certain other investments held more than a year can be smart. Donors typically can deduct the market value and can avoid capital-gains taxes on the gain. But don’t donate stock that has declined in value since you purchased it. “Instead, sell it, create a capital loss you can use, and donate the proceeds” to charity, Mr. Gordon says. You can use capital losses to soak up capital gains. Investors whose losses exceed gains may deduct up to $3,000 of net losses ($1,500 for married taxpayers filing separately) from their wages and other ordinary income. Carry over additional losses into future years.

If you sell losers, pay attention to the “wash sale” rules, says Roger Young, senior financial planner at T. Rowe Price . A wash sale typically occurs when you sell stock or securities at a loss and buy the same investment, or something substantially identical, within 30 days before or after the sale. If so, you typically can’t deduct your loss for that year. (However, add the disallowed loss to the cost basis of the new stock.) Mr. Young also says some investors may benefit from “tax gain harvesting,” or selling securities for a long-term gain in a year when they don’t face capital-gains taxes.

While taxes are important, make sure investment decisions are based on solid investment factors, not just on taxes, says Yolanda Plaza-Charres, investment-solutions director at SEI Private Wealth Management. And don’t wait until December to start focusing on taxes.

“We believe in year-round tax management,” she says.

What if I sell my home for more than I paid for it?

Typically, joint filers can exclude from taxation as much as $500,000 of the gain ($250,000 for most singles). To qualify for the full exclusion, you typically must have owned your home—and lived in it as your primary residence—for at least two of the five years before the sale. But if you don’t pass those tests, you may qualify for a partial exclusion under certain circumstances, such as if you sold for health reasons, a job change or certain “unforeseen circumstances,” such as the death of your spouse. See IRS Publication 523 for details. When calculating your cost, don’t forget to include improvements, such as a new room or kitchen modernization.

Credit given to Tom Herman. This article appeared in the June 17, 2019, print edition as ‘A Need to Know on Capital-Gains Taxes.’ Mr. Herman is a writer in New York City. He was formerly The Wall Street Journal’s Tax Report columnist. Send comments and tax questions to taxquestions@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA & Norman S. Hicks, CPA

–until next week.

Tax Tip of the Week | Can S Corporations Save Taxes? Apparently, Some Politicians Think So. August 21, 2019

Posted by bradstreetblogger in : Business consulting, Deductions, Depreciation options, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes , add a comment

In an effort to save federal income taxes, many people and not just some politicians route their business income through S corporations.  Their profits which may be retained by the S corporation and/or distributed to the shareholder(s) are typically the result of keeping the shareholder’s reasonable wages at a level that assures a corporate profit.  Keeping these reasonable wages below the FICA ceiling ($132,900 for 2019) may save taxes of 15.3% from FICA and Medicare, combined.  If, these wages exceed the FICA ceiling then the potential tax savings drop to only the Medicare tax of 2.9% plus another .9% if individual’s wages are over $200,000 ($250,000 married filing jointly).

The point to be made here is that at the right income levels, significant tax savings may exist with the proper use of an S corporation.  However, these savings come along with the possibility of additional IRS scrutiny.  And, since you may be paying less social security taxes, your future social security benefits may be dinged ever so slightly; but these tax savings are now in your own pocket.

The below WSJ article authored by Richard Rubin covers a portion of this age-old tax saving strategy along with some interesting commentary.

               -Mark Bradstreet

Democratic presidential candidate Joe Biden used a tax loophole that the Obama administration tried and failed to close, substantially lowering his tax bill.

Mr. Biden and his wife, Dr. Jill Biden, routed their book and speech income through S corporations, according to tax returns the couple released this week. They paid income taxes on those profits, but the strategy let the couple avoid the 3.8% net investment income tax they would have paid had they been compensated directly instead of through the S corporations.

The tax savings were as much as $500,000, compared to what the Biden’s would have owed if paid directly or if the Obama proposal had become law.

“As demonstrated by their effective federal tax rate in 2017 and 2018—which exceeded 33%—the Biden’s are committed to ensuring that all Americans pay their fair share,” the Biden campaign said in a statement Wednesday.

The technique is known in tax circles as the Gingrich-Edwards loophole—for former presidential candidates Newt Gingrich, a Republican, and John Edwards, a Democrat—whose tax strategies were scrutinized and drew calls for policy changes years ago. Other prominent politicians, including former President Barack Obama and fellow Democrat Hillary Clinton, as well as current contenders for the 2020 Democratic nomination Sens. Elizabeth Warren and Bernie Sanders, received their book or speech income differently and paid self-employment taxes.

Some tax experts have pointed to pieces of President Trump’s financial disclosures and leaked tax returns to suggest that he has used a similar tax-avoidance strategy.

Unlike his Democratic rivals and predecessors in both parties, Mr. Trump has refused to release his tax returns, and his administration is fighting House Democrats’ attempt to use their statutory authority to obtain them. Democratic presidential candidates have released their tax returns and welcomed criticism to draw a contrast with Mr. Trump.

“There’s no reason for these to be in an S corp—none, other than to save on self-employment tax,” said Tony Nitti, an accountant at RubinBrown LLP who reviewed the returns.

Mr. Biden, who was vice president from 2009 to 2017, has led the Democratic field in polls since entering the race. He is campaigning on making high-income Americans pay more in taxes and on closing tax loopholes that benefit the wealthy.

Mr. Biden has decried the proliferation of such loopholes since Ronald Reagan’s presidency and said the tax revenue could be used, in part, to help pay for initiatives to provide free community-college tuition or to fight climate change.

“We don’t have to punish anybody, including the rich. But everybody should start paying their fair share a little bit. When I’m president, we’re going to have a fairer tax code,” Mr. Biden said last month during a speech in Davenport, Iowa.

The U.S. imposes a 3.8% tax on high-income households—defined as individuals making above $200,000 and married couples making above $250,000. Wage earners have part of the tax taken out of their paychecks and pay part of it on their returns. Self-employed business owners have to pay it, too. People with investment earnings pay a 3.8% tax as well.

But people with profits from their active involvement in businesses can declare those earnings to be neither compensation nor investment income. The Obama administration proposed closing that gap by requiring all such income to be subject to a 3.8% tax, and it was the largest item on a list of “loophole closers” in a plan Mr. Obama released during his last year in office. The administration estimated that proposal, which didn’t advance in Congress, would have raised $272 billion from 2017 through 2026.

Under current law, S-corporation owners can legally avoid paying the 3.8% tax on their profits as long as they pay themselves “reasonable compensation” that is subject to regular payroll taxes. S corporations are a commonly used form for closely held businesses in which the profits flow through to the owners’ individual tax returns and are taxed there instead of at the business level.

The difficulty is in defining reasonable compensation, and the IRS has had mixed success in challenging business owners on the issue. The Bidens’ S corporations—CelticCapri Corp. and Giacoppa Corp.—reported more than $13 million in combined profits in 2017 and 2018 that weren’t subject to the self-employment tax, while those companies paid them less than $800,000 in salary.

If the entire amount were considered compensation, the Bidens could owe about $500,000. An IRS inquiry might reach a conclusion somewhat short of that.

“The salaries earned by the Bidens are reasonable and were determined in good faith, considering the nature of the entities and the services they performed,” the Biden campaign statement said.

For businesses that generate money from capital investments or from a large workforce, less of the profits stem from the owner’s work, and thus reasonable compensation can be lower. For businesses whose profits are largely attributable to the owner’s work, the case for reasonable compensation that is far below profits is harder to make.

To the extent that the Bidens’ profits came directly from the couple’s consulting and public speaking, “to treat those as other than compensation is pretty aggressive,” said Steve Rosenthal, a senior fellow at the Tax Policy Center, a research group run by a former Obama administration official.

Mr. Nitti said he uses a “call in sick” rule for his clients trying to navigate the reasonable-compensation question: If the owner called in sick, how much money could the company still make?

“The reasonable comp standard is a nebulous one,” Mr. Nitti said. “This is pretty cut and dried. If you’re speaking or writing a book, it’s all attributable to your efforts.”

The IRS puts more energy into cases where the business owners pay so little reasonable compensation that they owe the full Social Security and Medicare payroll taxes of 15.3%, Mr. Nitti said.

In a statement released Tuesday along with the candidate’s tax returns, the Biden campaign noted that the couple employs others through its S corporation and calls the companies a “common method for taxpayers who have outside sources of income to consolidate their earnings and expenses.”

Credit given to: Richard Rubin. This article was written July 10, 2019. You can write to Richard Rubin at richard.rubin@wsj.com—Ken Thomas contributed to this article.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This week’s author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | IRS Audit Rate Falls – Should You Relax? July 24, 2019

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Planning Tips, Tax Tip, Taxes, Uncategorized , add a comment

I cringe every time the newspaper headlines read that the IRS audit rate is falling. My worries are that our clients may become lazy on their record keeping along with the retention of appropriate supporting business documentation (e.g. receipts, cancelled checks, deposits slips, paid bills, invoices, etc.). Thankfully, my fears have remained unfounded as the stakes are too high with the IRS to become complacent.

As a side note, many taxpayers fail to realize that if your record keeping is poor – the IRS simply won’t use your records. Instead, the IRS may consider all of your deposits as taxable income whether they were otherwise taxable or not. And, if no supporting documentation was retained then all of your expenses may be disallowed. Ouch!

On May 21, 2019, the WSJ ran an article authored by Richard Rubin, IRS’s Audit Rate Continues to Fall. This article below shares further insights on who is being audited and to what extent the IRS budget is being increased.  

                                                                    -Mark Bradstreet

WASHINGTON—The Internal Revenue Service audited just 0.59% of individual tax returns last year, marking the seventh consecutive annual decline as the tax agency copes with smaller budgets and fewer workers.

That total was down from 0.62% the year before and hit the lowest mark since 2002, according to data released Monday.

Audits of the highest-income households dropped sharply, to their lowest levels since the IRS began reporting that data in 2008. In fiscal 2018, the IRS audited 6.66% of returns of filers with more than $10 million in adjusted gross income, down from 14.52% in 2017. Among households with income between $1 million and $5 million, the audit rate dropped from 3.52% to 2.21%.

The IRS released the data as it is trying to persuade Congress to make long-run investments in the agency’s technology and enforcement staff. So far, however, key Republicans in Congress remain skeptical, and there are mixed signals about whether the government will reverse the steady decline in tax enforcement.

“I’m not averse to beefing up their budget a little bit but I want to see results,” said Sen. John Kennedy (R., La.), who heads the subcommittee that oversees the IRS budget. “I’ve got a lot of confidence in the new commissioner and in the new secretary, but I’m not into just throwing money at the wall because the bureaucracy says we need more.”

President Trump has proposed boosting the IRS’s budget by 1.5% for the fiscal year that starts Oct. 1, to $11.5 billion from $11.3 billion, including a down payment on improving the agency’s technology.

The administration also is proposing a $15 billion, decadelong increase in IRS enforcement funding, which the agency says would generate $47 billion in additional federal revenue. That net gain of more than $30 billion would come from enforcing existing laws.

The IRS has been shrinking steadily, partly because electronic filing has increased its efficiency. But many of the recent changes have stemmed from Republican spending cuts after they took control of the House in 2011 and after the IRS said in 2013 that it had improperly scrutinized some conservative nonprofit groups.

Adjusted for inflation, the 2019 IRS budget is smaller than in 2000 and is 19% below peak funding in 2010, according to the Government Accountability Office. The agency’s workforce declined 4% in 2018 and is now 21% below where it was eight years ago, and the number of examiners that performs audits shrunk 38% from 2010 to 2017, according to the agency’s inspector general. Those cuts came as Congress handed the IRS more responsibility to administer the Affordable Care Act and police offshore bank accounts.

Declining IRS resources contributed to the decline in audits but weren’t the only cause, said David Kautter, assistant Treasury secretary for tax policy, who was acting IRS commissioner for much of fiscal 2018.

“In this age of technology, it’s easier to identify areas of noncompliance,” he said Monday.

Democrats say the IRS budget cuts are disproportionately benefiting high-income households.

“Republicans in the Senate and the House have been very much geared towards a policy that has produced lots of poor people being audited and lots of well-off people basically getting off the hook,” said Sen. Ron Wyden (D., Ore.), the top Democrat on the Senate Finance Committee. “It takes more resources. There’s no way around it.”

Mr. Kennedy said he wants more details on the IRS modernization plans, pointing to the agency’s difficulties overhauling its technology.

Sen. James Lankford (R., Okla.) said he wants more updated information on the tax gap—the difference between taxes owed and taxes paid—which should be released in the coming months.

“We need to be able to see it and know what we actually could get a return on, from enforcement,” he said.

The Congressional Budget Office estimates that an extra $20 billion spent on IRS enforcement could yield $55 billion over the next decade and more beyond that as audits generate revenue. Once the IRS completed staff training and computer upgrades, the government could get as much as $5.20 in additional revenue for every $1 spent, according to CBO.

The agency started 2,886 criminal investigations in 2018, down from 5,234 just five years earlier, according to the agency’s inspector general. The IRS criminal investigations unit had 26% fewer special agents than it did in 2012.

The IRS also has fewer employees working to collect taxes from people who already owe. Each collections officer generates about $2 million a year, which means the smaller IRS is leaving $3.3 billion a year on the table, just from collections, according to the agency’s inspector general.

Tax experts say the agency’s performance could be improved through better taxpayer service and a simpler tax system. So would rules that gave the IRS more information about sources of income—such as profits from cash businesses—that they lack now.

Taxpayers are extremely likely to comply with tax rules when the IRS independently has access to information about their finances. Wages reported on Form W-2 almost always show up on tax returns. When the IRS doesn’t have withholding payments or information, people are more likely to underreport their income.

“I don’t believe the solution is more agents, more audits and more intrusive government into taxpayers,” said Rep. Kevin Brady (R., Texas), the top Republican on the House Ways and Means Committee. “I think it’s smarter audits.”

But the drops in enforcement and the IRS budget have run in tandem, and the nonpartisan estimates from CBO, GAO and the IRS inspector general say reversing the spending cuts would generate money.

“We’re just in never-never land here. The IRS has had its capacity to do its job attacked. There’s no other way to say it,” Rep. Earl Blumenauer (D., Ore.) said at a recent hearing. “They can’t keep pace with what they’re up against.”

Credit given to:  Richard Rubin. This article was written May 20, 2019. You can write to Richard Rubin at richard.rubin@wsj.com

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | When The Questions Are The Answers June 26, 2019

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Tip, Taxes, Uncategorized , add a comment

Let’s take a break from tax topics this week. Yes, even I sometimes get tired of talking about income taxes. So, the topic this week is about leadership. All of us lead someone. Of course, the most important person to lead is yourself. And, as the old saying goes, if you can’t lead yourself then how can you lead someone else?

True leaders don’t give out answers. Often, they don’t know the answers. But the good leader knows their staff has inside them the answers that they seek. Good questions from a good leader help reveal these answers.  

This is further explained along with some examples in the following WSJ article, To Be a Better Leader, Ask Better Questions written by Hal Gregersen. It was published on Tuesday, May 14, 2019.  

                               -Mark Bradstreet

It is often said that the definition of insanity is doing the same thing over and over, and expecting a different outcome.

Well, the same can be said of questions: Keep asking the same kind of question, and it is insane to think you are going to get a different kind of answer.

If you want a dramatically better answer, the key is to ask a better question.

In that one simple statement I have found a career’s worth of research, teaching and advisory work. No one raises an objection when they hear it—who could argue with the value of brilliant reframing? But at the same time, that statement alone is rarely enough. Most people want to be handed the five paradigm-smashing questions to ask.

Unfortunately, that isn’t possible. But what is possible is creating the conditions where the right questions are more likely to bubble up. To that end, here are some clear, concrete, measurable steps that any boss—or anyone, for that matter—can take to come up with those paradigm-smashing questions we all seek.

1. Understand what kinds of questions spark creative thinking.

There are lots of questions you can ask. But only the best really knocks down barriers to creative thinking and channel energy down new, more productive pathways. A question that does has five traits. It reframes the problem. It intrigues the imagination. It invites others’ thinking. It opens up space for different answers. And it’s nonaggressive—not posed to embarrass, humiliate or assert power over the other party.

One CEO I know is aware that his position can get in the way of getting honest information that will challenge his view of things. Instead of coming at his managers with something like, “Competitor X beat us to the punch with that move—how did we let that happen?” he gets more useful input with questions like, “What are you wrestling with and how can I help?” He asks customers and supply-chain partners: “If you were in my shoes, what would you be doing differently than what you see us doing today?”

Think about how these questions change the whole equation. People don’t start off defensive. The problem isn’t already tightly framed. The questions are open-ended, and the answers can be imaginative—rather than telling the boss what he wants to hear.

If you want to turn this first point into a trackable activity, how about this: Start noting in a daily diary how many questions you’ve asked that meet the five criteria.

2. Create the habit of asking questions.

Many bosses simply aren’t used to asking questions; they’re used to giving answers. So, in the early stages of building your questioning capacity, it’s helpful to start by copying other people’s questions. It’s the equivalent of practicing your scales. Once you’ve got the scales down, you can start to improvise.

You could do worse than to follow the questions asked by management thinker Peter Drucker, who liked to jump-start strategic thinking by asking: “What changes have recently happened that don’t fit ‘what everyone knows’”?

Another example: A leader in a consumer packaged-goods company constantly asks: “What more can we do to delight the customer at the point of purchase? And what more to delight them at the point of consumption?”

Again, think about what that does. Sure, the CEO could constantly repeat that the company wants to satisfy consumers. But by asking this question, it builds the habit of thinking in questions. And that, in turn, leads to daily inquiry about matters large and small, and an organization that keeps pushing its competitive advantages forward.

3. Fuel that habit by making yourself generate new questions.

Don’t stop with that generic question set, no matter how well you think it covers the bases. It will become just another activity rut reinforcing today’s assumptions if you and others become too familiar with it. Your goal is to generate new and better questions, not to cap your questioning career at the level of playing flawless scales.

New Perspectives, New Solutions

If you or your team are stuck on a problem, stop and spend four minutes generating nothing but questions about it. As in brainstorming, go for high volume and do no editing in progress. This will often yield a new way to look at the challenge and at least one new idea to solve it. Here’s an example of a question burst:

Instead, every day, note something in your environment that is intriguing and possibly a signal of change in the air. Then, restrain yourself from issuing a comment on it—or if it’s your habit, a tweet—and instead take a moment to articulate the questions it raises.

Then share the most compelling of those questions with someone else. Engage with it for a minute. To some extent, this is doing “reps,” exercising your questioning muscles so they’ll be strong enough when the occasion demands. But it’s also more than that, because chances are it will actually be one of these many, seemingly small, questions that yields your next big breakthrough.

Let me offer a well-known example. Blake Mycoskie was in Argentina when by his account he noticed a lot of children running around barefoot. He didn’t need to ask why they didn’t have shoes—obviously they were poor—but here’s the question it brought him to: Is there a sustainable way to provide children with shoes without having to rely on donations? And thus, he launched the social enterprise Toms, with its famous “one-for-one” business model.

4. Respond with the power of the pause.

When someone comes to you with a problem, don’t immediately respond with an answer. This is harder than it sounds, because you have probably internalized a sense long ago that you’re the boss because you’re decisive and have good judgment—in other words, you have the best answers.

Instead, make it your habit to respond with a question—ideally one that reframes the problem, but at least one that draws out more of your colleague’s thoughts on the matter. I’m not talking about the cop-out rejoinder of, “Well, what do YOU think we should do?” Help the person think through how the decision should be made, with questions like: “What are we optimizing for?” “What’s the most important thing we have to achieve with whatever direction we take?” Or: “What makes this decision so hard? What problem felt like this in the past?”

The payoff here comes in two forms. You’re teaching the colleague the value of pausing to get the question right before rushing to the answer. And nine times out of 10, you’re going to wind up with a better answer than the one you would have blurted out with less deliberation.

5. Brainstorm for questions.

This is an idea that is so simple, and involves an exercise so fast, that it constantly surprises me how effective it is. Whenever you or your team is at an impasse, or there is a sense that some insight is eluding you regarding a problem or opportunity, just stop and spend four minutes generating nothing but questions about it. Don’t spend a second answering the questions, or explaining why you posed a certain one. As in brainstorming, go for high volume and do no editing in progress. See if you can generate at least 15-20.

Eighty percent of the time, I find, the exercise yields some new angle of attack on the problem, and it virtually always re-energizes people to go at it with renewed gusto.

Here’s an example from an innovation team in a consumer-goods company. Struggling to come up with a new concept to test, we tried one of those question bursts. It started with, “What if we launched a response to [a competitor’s product] and did it better?” But soon enough it arrived at, “Are we stuck on assuming a certain price range? What if a customer was willing to give us 10 times that—what could we deliver that would be that valuable to them?” Bingo—the team zeroed in on that question as having real juice in it, and started generating more exciting ideas.

6. Reward your questioners.

Finally, keep track of how you respond when someone in the room asks a question that challenges how you’ve been approaching a problem or feels like it threatens to derail a solution train already leaving the station.

I remember hearing from executives at one company that the boss always surprised his top team by being willing to hear out even the craziest ideas. When others in the room were shaking their heads and hastening to move along, he would be the one to say, “Wait, say more…” to find the part of that flight of fantasy that could work.

If there’s one constant theme here, it’s the idea that bosses should reconceive what their primary job is. They aren’t there to come up with today’s best answers, or even just to get their teams to come up with them. Their job is to build their organization’s capacity for constant innovation.

Their enterprise’s future—and their own career trajectory—depends on their resolve to ask better questions.

Credit given to By Hal Gregersen. Dr. Gregersen is executive director of the MIT Leadership Center, a senior lecturer at the MIT Sloan School of Management and author of “Questions Are the Answer.” He can be reached at reports@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | IRS Audits June 19, 2019

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Tip, Taxes , add a comment

No one in their right mind would welcome an IRS audit. However, sometime during your life, you may expect to have an IRS audit of some sort, even if only a correspondence audit. Other types of IRS audits include what they call a field audit which occurs at your place of business and an office audit which occurs at the IRS office. From time to time, clients will mention to me that they don’t fear an audit because they have done nothing wrong and have all of the necessary substantiation. Even, in the best of cases, audits are no fun – they are ALWAYS a huge time suck for you and for your professional and, thusly, can be quite expensive.

A further note about correspondence audits – at least half of the tax notices you receive from the IRS are incorrect. Yet, too many taxpayers upon receiving a notice with a balance due simply send the IRS a check. Yes, the IRS loves people like that! Upon receipt of any IRS correspondence, please immediately relay it to your CPA for an appropriate review and response.

It is rare, but not entirely unheard of, for an IRS agent to appear at your home or place of business. If that were to happen and regardless of how friendly they appear your best response is typically very simple. Be polite and inform the agent your CPA will be handling the questions on your behalf. Then, give the agent the name and contact information of your CPA. Ask the agent nicely to call your CPA with any questions that they may have. The same is also true for the receipt of an IRS letter notifying you that your income tax returns are under audit. Get that letter to your accounting firm so they can handle the audit on your behalf. It is not in your best interest to speak to the IRS agent before, during or after the audit. That is the job of your professional.  

The below article written by Jane Hodges – HOW MUCH DO YOU KNOW ABOUT IRS AUDITS? was published in the WSJ on March 25, 2019. It provides further information on the IRS process.

                                          –    Mark Bradstreet

The Internal Revenue Service audits tax returns every year—striking fear in the hearts of many whose accidental or deliberate errors may have led them to underpay the U.S. Treasury.

While the prospect can be terrifying, very few returns are actually audited and many audits are resolved through correspondence. The volume of IRS audits has declined in recent years to 933,785 in 2017 from 1.56 million in 2011, according to IRS data. Some audits even result in a refund. Many, of course, result in tax liabilities.

Still, it never hurts to prepare taxes with care, save records and understand changing tax laws (or work with professionals who do) so your returns will be less likely to raise flags.

What follows is a quiz to help readers hone their smarts about IRS audits.

1. What does the IRS call an audit?

A) Audit
B) Examination
C) Tax year review
D) Tax interview

Answer: B. Audits are referred to as examinations, and a taxpayer being audited corresponds with or meets an “examiner” assigned to his or her case.

2. What percentage of returns were audited during 2017?

A) 0.5%
B) 1.5%
C) 3.8%
D) 6.2%

Answer: A. During fiscal 2017, the IRS audited 0.5% of the 196 million returns it received during the calendar year 2016. That was down from 0.7% the previous year.

3. How does the IRS choose which tax returns to audit?

A) It hires private investigators
B) It looks at tax returns associated with filers undergoing existing audits
C) Computer screening
D) It reviews those whose income has more than doubled in a 10-year period

Answer: B and C. The IRS looks at the company that audit subjects keep. “We may select your returns when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit,” it says in an FAQ about audits on an IRS website. It also uses random computer screening in which algorithms track “norms” for deductions and expenses relative to the filer’s income and other factors.

4. How does the IRS notify a person or business of an audit?

A) By letter
B) By phone
C) Through email
D) Via process server

Answer: A. The IRS typically notifies taxpayers of audits in letters citing what years are under examination and which deductions or aspects of the returns need verification, substantiation or discussion. Once the audit is under way, a representative may call, but the IRS doesn’t initiate audits over the telephone. If you get a call from someone claiming to represent the IRS and notifying you of an audit, it is likely a scam.

5. Where are audits conducted?

A) In an IRS office
B) At the taxpayer’s home or place of business
C) Via correspondence
D) At the office of an authorized representative (tax attorney, CPA, enrolled agent)

Answer: Any of the above, depending on the degree of the inquiry or where the taxpayer stores records or conducts business and other factors. The IRS generally makes the final determination.

6. What percentage of tax audits are conducted by correspondence?

A) 12.6%
B) 32.5%
C) 50.9%
D) 70.8%

Answer: D. During fiscal 2017, when the IRS examined tax returns for the prior year and before, some 70.8% of audits were conducted by correspondence.

7. How long does the IRS expect taxpayers to keep tax records?

A) Forever
B) Five years following the date a return is filed
C) Three years following the date a return is filed or two years from the date a tax is paid
D) Six years, or seven years if the taxpayer is writing off bad debt or worthless securities

Answer: C, and sometimes D. Generally, the IRS suggests taxpayers keep tax records for three years after filing a return or two years from the date they paid tax. In some circumstances, say, if you failed to report income, didn’t file a return, or were flagged for filing a fraudulent return, it’s advisable to keep records longer.

8. Which household income level experiences a 12.5% incidence of audits?

A) $125,000 or more
B) $200,000 or more
C) $250,000 or more
D) $1 million or more

Answer: D. According to Intuit, 1% of taxpayers earning $200,000 or less are audited. Beyond that, the more a taxpayer earns, the more likely an audit is. Some 4% of those earning more than $200,000 are audited, and 12.5% of those earning $1 million or more are audited.

9. When filing taxes, what form of filing is most error-prone, according to the IRS?

A) Electronic filing
B) Returns filed by mail
C) Returns filed from abroad
D) Returns that are filed after an extension request

Answer: B. According to IRS information provided to TurboTax, those who file a return by mail show a 21% incidence of errors, while those who file electronically show only a 0.5% incidence of errors. TurboTax does not cite a reason why online filers have less errors, but presumably online filing software runs math or does automatic calculations which could reduce math-related errors.

10. How far back does the IRS go when choosing returns to audit?

A) 2 years
B) 3 years
C) 6 years
D) 10 years

Answer: B and C. The IRS generally goes back no more than three years in choosing returns to audit, but if it finds a “substantial error,” the agency says it may go back as far as six years.

Credit Given to: By Jane Hodges. Ms. Hodges is a freelance writer in Seattle and has been audited. She can be reached at reports@wsj.com. This appeared in the March 25, 2019, print edition as ‘How Much Do You Know About IRS Audits?’

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Law: An Art or a Science? May 29, 2019

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Planning Tips, Tax Tip, Taxes , add a comment

Is preparing tax returns an art or a science? My answer may depend upon the day you ask me. But, more often than not, I would say that tax preparation is a blend of an art AND a science.

Too often when people are presented with a tax problem of sorts – what do they do? Well, of course, they pull out their smartphone and GOOGLE their question. In all honesty I am guilty of this quick fix as well. Naturally, we are all looking for the answer that we wish to hear. That being anything that will save us taxes. Most GOOGLE responses, especially the ones near the top of the search page are click bait. They have the answers you want to see. You are doing yourself a disservice if you stop with that “fast and loose” answer. You have to look for the “odd” stuff, the twists and turns that accompany the exceptions to every tax rule. Some of these may help you while others will cost you money. Even once you have found the exceptions then one must continue to look for how your question fits in with or conflicts with other sections of the Internal Revenue Code. And, what about that tax law change or court case that was handed down yesterday. What about that new tax law on the horizon? Did you notice that the website where you fell in love with the answer is six (6) years old?

The “art” part comes from trying to hit a moving target. A target that is not always visible but at the end of the day you have to take the shot. Or, at least spin it in a fashion so that you have not crossed the often-fuzzy line and stayed in the gray.

                                        –    Mark Bradstreet

An Internal Revenue Service official once introduced me to the rule of PUNG. When writing about taxes, he said, make frequent use of the words “probably, usually, normally and generally.”

That’s generally good advice—not only for tax columnists struggling to explain tricky tax laws but also for tens of millions of taxpayers racing to file their returns on time. “The law is chock-full of exceptions and counterintuitive twists that are easy to overlook and can often have an important impact on your tax bill”, says Claudia Hill, owner of TaxMam Inc., a tax services firm in Cupertino, Calif.

With the tax-filing deadline fast approaching for most of us, here are a few reminders from tax pros on how the fine print can sometimes be your friend.

Filing deadline: For most taxpayers, the filing deadline is April 15. But it’s April 17 for taxpayers who live in Maine or Massachusetts because of the Patriots’ Day holiday there on April 15 and the Emancipation Day holiday in the District of Columbia on April 16. It can be even later for other taxpayers, such as those in places designated as federal disaster areas.

If you need more time to file, as millions of people do each year, don’t panic: The IRS gives automatic six-month extensions until Oct. 15. But its website notes that an “extension of time to file your return doesn’t grant you any extension of time to pay your taxes.” The IRS estimates it will receive more than 14.6 million extension requests; a spokesman says.

Casualty losses: Fires, floods, mudslides, tornadoes, hurricanes and many other natural disasters made 2018 a year many of us are eager to forget, and this year already is shaping up as another grim reminder of Mother Nature’s awesome power.

At first glance, the wide-ranging tax law enacted in late 2017 might seem like yet another disaster for the many people who suffered major casualty losses. That law generally eliminated personal casualty and theft-loss deductions for most taxpayers, starting last year. But there is an important exception, says Jackie Perlman, principal tax research analyst at The Tax Institute at H&R Block Inc. in Kansas City, Mo. Victims still are eligible to deduct net personal casualty losses “to the extent they’re attributable to a federally declared disaster,” the IRS says.

Warning: There are important loss limitations and other tricky calculations to consider. For details, see IRS Publication 547.

Here is a holdover from the old law that may surprise some people because it sounds counterintuitive: Victims in federal disaster areas can choose to claim their losses for the year in which the disaster actually struck or for the prior year. For example, taxpayers with net personal casualty losses this year could claim their losses on their return for 2018—or they could wait until next year and claim it on their return for 2019, says Ms. Jackie Perlman of H&R Block. Taxpayers who suffered losses in 2018 could claim those losses on their return for that year—or on their return for 2017 (typically by filing an amended return).

14-day rule: As a general rule, the net rental income you get from renting out your home is subject to tax. But “there’s a special rule if you use a dwelling unit as a residence and rent it for fewer than 15 days,” the IRS says on its website. “In this case, don’t report any of the rental income and don’t deduct any expenses as rental expenses.”

Those 14 days don’t have to be consecutive, says Ms. Claudia Hill, who is also an enrolled agent (enrolled agents are tax specialists authorized to represent taxpayers at all levels of the IRS). But if you rent your home for 15 days or more, include all of that rental income in your income, says Ms. Jackie Perlman.

Refund claims: Don’t assume that you have forever to file your federal income-tax return as long as you are entitled to a refund. About 1.2 million taxpayers could lose almost $1.4 billion in unclaimed refunds because they still haven’t filed a 2015 Form 1040 return, the IRS warned in a recent press release.

“In cases where a federal income tax return was not filed, the law provides most taxpayers with a three-year window of opportunity to claim a tax refund,” the IRS says. If they miss that deadline, “the money becomes the property of the U.S. Treasury. For 2015 tax returns, the window closes April 15, 2019, for most taxpayers.”

Here are other reasons to pay attention: The IRS reminded taxpayers seeking a 2015 tax refund “that their checks may be held if they have not filed tax returns for 2016 and 2017. In addition, the refund will be applied to any amounts still owed to the IRS or a state tax agency and may be used to offset unpaid child support or past due federal debts, such as student loans.”

Credit for excess Social Security tax: Most people probably assume it’s a waste of time to check and see how much their employers withheld from their paychecks for Social Security. But consider doing it anyway, especially if you’re a high-income taxpayer who worked for two or more employers last year. The maximum amount that should have been withheld for 2018 was $7,960.80 (6.2% of $128,400, which was the maximum amount of wages subject to the tax.) If more than that was withheld, claim a credit for the excess amount. However, if any single employer withheld too much, ask the employer to adjust the tax for you, the IRS says. “If the employer doesn’t adjust the overcollection you can file a claim for refund using Form 843.”

Interesting exception: Interest income you receive on U.S. Treasury bills, notes and bonds is taxable at the federal level. But don’t forget that such interest is tax-free at the state and local level. That can be especially important for taxpayers in New York City, California or other high-tax areas.

Additional standard deduction: Thanks to the 2017 law, tax professionals predict many more people will claim the standard deduction for 2018, rather than itemizing. That law included a sharp increase in the basic standard deduction and generally limited state and local tax deductions to $10,000 per household. The basic standard deduction for 2018 is $24,000 for married couples filing jointly, or $12,000 for most singles and those who are married but filing separately.

But there is an extra amount for older taxpayers, those who qualify as blind, or both. For example, if you’re married filing jointly and you and your spouse each are 65 or older, the total standard deduction for 2018 would be $26,600. See IRS Publication 17 for more details.

IRA deadline: It might seem logical to assume there is nothing you can do now to affect your return for 2018. But for some people, it isn’t too late: The IRS says contributions to a traditional IRA can be made for a year “at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 2018 must be made by April 15, 2019 (April 17, 2019, if you live in Maine or Massachusetts).”

Educator Expenses: Teachers and other educators who pay for educational supplies and other expenses out of their own pockets should be aware that those costs may be deductible up to $250 a year. This special deduction applies to teachers from kindergarten through grade 12, instructors, counselors, principals or aides in school for at least 900 hours during a school year. Qualified expenses include “ordinary and necessary expenses paid in connection with books, supplies, equipment (including computer equipment, software, and services), and other materials used in the classroom,” the IRS says. But you can’t deduct expenses for home schooling or for “nonathletic supplies for courses in health or physical education.”

If you and your spouse file jointly and both are eligible, “the maximum deduction is $500,” the IRS says. “However, neither spouse can deduct more than $250 of his or her qualified expenses.” This deduction goes on Schedule 1 of Form 1040, line 23.

Credit given to: Tom Herman. This article was written for the WSJ on Monday, March 25, 2019. Mr. Herman is a writer in New York City. He was formerly The Wall Street Journal’s Tax Report columnist. Send comments and tax questions to taxquestions@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Mark Bradstreet, CPA

–until next week.