Be Strategic With Your Estate Plan

When individuals change jobs, they generally move their 401(k) plan to their new employer’s plan or transfer them into an IRA account. The law allows you take a distribution and then redeposit the funds into the new account or to make a trustee-to-trustee transfer from the prior account to the new one.

It is generally better, for tax reporting issues, to make a trustee-to-trustee transfer between plans rather than to take a distribution. This avoids the reporting issues on your tax returns and any possibility of the transfer ending up being taxable. If you take a distribution, keep in mind that the rollover must be completed within 60 days or it becomes taxable. If you are considering your new employer’s plan, investigate your investment options and plan fees before making the transfer.

The failure to file a federal tax return can be costly — whether you end up owing more or missing out on a refund.

There are several reasons taxpayers don’t file their taxes. Perhaps you didn’t know you were required to file. Maybe, you just kept putting it off and simply forgot. Whatever the reason, it’s best to file your return as soon as possible. If you need help, even with a late return, the IRS is ready to assist you.
Here are some things to consider:

• Failure to File Penalty. If you owe taxes, a delay in filing may result in a "failure to file" penalty, also known as the “late filing” penalty and interest charges. The longer you delay, the larger these charges grow.

• Losing your Refund. There is no penalty for failure to file if you are due a refund. However, you cannot obtain a refund without filing a tax return. If you wait too long to file, you may risk losing the refund altogether. The federal deadline for claiming refunds is three years after the return due date. For example, the last day for claiming a federal refund for your 2006 tax return will be April 15, 2010.

• EITC. Individuals who are entitled to the Earned Income Tax Credit must file their return to claim the credit even if they are not otherwise required to file.

Whether or not you must file a tax return will depend upon a number of factors, including your filing status, age and gross income. Please call for assistance.

Newlyweds and the recently divorced taxpayers should ensure the name on their tax return matches the name registered with the Social Security Administration (SSA). A mismatch could unexpectedly delay a tax refund.

• For recently married taxpayers, the tax scenario begins when the bride says "I do." If she takes her husband's last name, but doesn't tell the SSA about the name change, a complication may result. If the couple files a joint tax return with her new name, the IRS computers will not be able to match the new name with the Social Security Number (SSN). If a new spouse has not made the change with the SSA administration, she should use her old name on the tax return.

• After a divorce, a woman who had taken her husband’s name and made that change known to the SSA should contact the SSA if she reassumes a previous name.

The key to avoiding filing problems is to match the tax return name with what the SSA has on record for that SSN.

It's easy to inform the SSA of a name change by filing Form SS-5 at a local SSA office. It usually takes two weeks to have the change verified. The form is available on the agency's web site at www.socialsecurity.gov or by calling 800-772-1213 and at local offices. The SSA web site provides the addresses of local offices.

As the April 15 deadline approaches, we begin to receive calls from taxpayers who do not have the ready cash needed to pay their tax liability. There are significant penalties for failing to pay your tax liability by the April 15 due date.

Whether paying with a timely filed tax return, or filing and paying late after receiving a bill from the IRS (and we have determined the bill is correct), taxpayers are encouraged to pay the taxes they owe in full. If taxes are not paid, and no effort is made to pay them, the IRS can ask a taxpayer to take action to pay the taxes, such as selling or mortgaging any assets owned or getting a loan. If the taxpayer continues to make no effort to pay the bill, or other payment arrangements have not been made, the IRS could take more drastic measures, such as levying bank accounts, wages, or other income, or taking other assets. A Notice of Federal Tax Lien could be filed that may have a detrimental effect on a taxpayer’s credit standing.

The penalties and interest charged by the IRS are substantially higher than most commercial lending rates, so it is generally better to borrow the funds elsewhere and pay the IRS in full. Where taxpayers cannot raise part or all of the funds to pay their taxes by conventional means, the IRS offers credit card payment and installment agreements.

Credit Card Payment – Payments can be made by credit card. However, the IRS does not pay the discount fees of credit card companies, so that is an additional fee that will be added to your credit card charge. Even though these fees are deductible as a miscellaneous itemized deduction, if you are considering paying by credit card to increase your airline miles, you should probably forget it. The cost is more than the miles are worth! Payments by credit card can be made through one of two official vendors:

• Official Payments Corporation at 1-800-2PAYTAX (1-800-272-9829) - www.officialpayments.com, or

• Link2Gov at 1-888-PAY1040 (1-888-729-1040) - www.pay1040.com.

Installment Agreement – Taxpayers wishing to pay off a tax debt through an installment agreement, and owe:

• $25,000 or less in combined tax, penalties, and interest can apply for an installment agreement using a simplified procedure.

• More than $25,000 in combined tax, penalties, and interest may still qualify for an installment agreement, but must complete a more complex application including the submission of financial statements.

The IRS user fee for setting up an installment agreement is $52 for direct debit agreements and $105 for non-direct debit agreements. Certain low-income taxpayers will qualify for a reduced fee of $43. These fees must be paid with the first installment. You will also be charged interest and may be charged a late payment penalty on any tax not paid by its due date, even if your request to pay in installments is granted. Interest and any applicable penalties will be charged until the balance is paid in full.

If you are unable to pay your liability in full, please call this office as soon as possible. Procrastination can lead to further problems, penalties and interest.

Now that you have your taxes completed for 2009, you are probably wondering what old records can be discarded. If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why the records needed to be kept in the first place.

Generally, we keep “tax” records for two basic reasons: (1) we need to keep the records in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) we need to keep track of the tax basis of our capital assets so when we actually dispose of them we can minimize the tax liability.

With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return. And of course, the statutes don’t begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return in order to evade tax.

If an exception does not apply to you, for federal purposes, you can probably discard most of your tax records that are more than three years old; add a year or so to that if you live in a state with a longer statute.

Examples - Sue filed her 2006 tax return before the due date of April 15, 2007. She will be able to dispose of most of her records safely after April 15, 2010. On the other hand, Don filed his 2006 return on June 2, 2007. He needs to keep his records at least until June 2, 2010. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with the carte blanche discarding of records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. They need to be separated and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

• Stock acquisition data - If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.

• Stock and mutual fund statements – Where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after final sale.

• Tangible property purchase and improvement records - Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

Have questions about whether or not to retain certain records? Give us a call first; it is better to make sure before discarding something that might be needed down the road.

For example, when the large $250,000 and $500,000 home exclusion was passed into law several years back, homeowners became lax in maintaining home improvement records thinking that the large exclusions would cover any potential appreciation in the home’s value. Guess what happened during the real estate boom? The exclusion was not always enough! Records can be important, so please use caution when discarding them.

As reported in a statement issued by IRS, it has continued to make strong progress in a number of key enforcement areas. IRS enforcement efforts increased in fiscal year 2007; overall, enforcement revenue reached $59.2 billion, up from $48.7 billion in 2006.  (Note: Because the enforcement activities take place in years after the filing years, the results are always 2 or 3 years behind.)

Individual enforcement - Overall, the total individual return audits were up 7% in 2007. The table below is a summary of IRS audit activity for fiscal year 2007:

(1)One out of 11 individuals with incomes of $1 million or more faced an audit in 2007.

Business enforcement – Overall, the total business return audits were up 14% in 2007. The table below is a summary of IRS audit activity for fiscal year 2007:

(2)Assets between $10 million and $50 million dollars

A question that often arises is whether prepaid business expenses can be deducted in the year it is paid. Unfortunately, they cannot. Generally, where an expense relates to a period covering more than 12 months, the IRS and most courts agree that the deduction must be spread over the period to which the expense applies.

For example, you purchase a three-year maintenance plan for your office photocopy machines. The service company offers you a discount to prepay the contract, which you end up doing. In this case, the expense must be amortized (ratably deducted) over the three-year period and not all at once in the year paid. If you had only prepaid three months of the contract, that amount would have been deductible in the year paid. This rule precludes business owners from prepaying expenses as a means to reducing their profits for a particular year.

If you have questions regarding prepaid expenses, please give us a call.

If you gave any one person gifts in 2009 that are valued at more than $13,000, you must report the total gifts to the Internal Revenue Service even if you have not exceeded the $1 million gift tax exemption. The gift tax return is used to track the nontaxable gifts and determine when gifts from all years exceed the gift exemption and become taxable. The person who receives your gift does not have to report the gift to the IRS or pay gift or income tax on its value.

Gifts include money and property, including the use of property without expecting to receive something of equal value in return. If you sell something at less than its value or make an interest-free or reduced-interest loan, you may be making a gift.

There are some exceptions to the tax rules on gifts. The following gifts generally are not taxable and do not count against the annual limit:

• Tuition or Medical Expenses that you pay directly to an educational or medical institution for someone's benefit
• Gifts to your Spouse
• Gifts to a Political Organization for its use
• Gifts to Charities

If you are married, both you and your spouse can give separate gifts of up to the annual limit of $13,000 to the same person without making a taxable gift.

Alternatively, with consent from your spouse, you can make a gift of up to $26,000 ($13,000 x 2) to the same person without making a taxable gift. This is commonly known as splitting gifts between spouses. Essentially, it means a gift by you or your spouse to a third person can be considered as made one-half by each of you provided there is consent by both spouses.

If you need assistance determining if you are liable for a gift tax return, please give us a call.

With lenders becoming more conservative, money tightening up, and the real estate market in decline, many homeowners and speculators find themselves faced with some unpleasant choices. One strategy is to wait until home prices rebound, but that could be some time and probably too far off for the owner with a variable rate or short-term introductory rate loan and increasing mortgage payments.

There are other reasons—such as job relocation, divorce, declining income or poor health—that can force a property owner to sell in a down market and possibly take a financial loss. This article explores the tax ramifications of selling a home or rental property at a loss. But first, here are some terminology and tax rules associated with selling property:

• Personal-Use Property - The general rule that applies to personal-use property is that gains are taxable as capital gains but losses are not deductible. Examples of personal-use property are the family car (no business use) and the family home or second home. So, if you sell your personal residence or second residence at a loss, that loss is not deductible.

• Investment Property – For investment property, generally, gains are taxable and losses are deductible as capital gains/losses. However, the amount of capital loss that can be deducted annually is limited. If, after combining all investment capital gains and losses, the result is a loss, the loss is generally limited to $3,000 per year. Examples of investment property include vacant land or improved real estate that is not a business property, home or second home.

• Business Property – The general rule for business property is that gains are taxable as capital gains and losses are deductible as ordinary income. Examples of business property include residential rentals, commercial rentals and an office-in-the-home.

• Primary Home Sale Gain Exclusion – Generally, an individual who owns and lives in a home for two of the prior five years can exclude $250,000 of home sale gain. This applies to each individual so a couple could exclude $500,000. In addition, an individual who does not meet the two-out-of-five requirements may still be able to exclude a lesser amount if the home was sold due to certain unforeseen circumstances.

Now let’s apply these general rules to some representative situations that are likely to occur in a down real estate market.

Example #1 – You sell your primary (or second) home for a loss when taking into consideration what you originally paid for the home, improvements and the sales costs. Bad news - your home is personal use property and losses from “personal-use property” are not deductible. Thus, there is no tax relief from having a loss on the sale of your primary or secondary home.

Example #2 – You purchased a residential or commercial property as a rental. Now the value has declined below your basis and a sale will result in a loss. Since it is business property, the entire loss will be deductible as ordinary income in the year of sale. Thus, you will achieve tax relief based on your tax bracket(s) in the year of sale. Caution: The depreciation of the real property that you claimed as a rental expense decreases your cost basis. This means that you could actually end up with a tax gain on the sale when you thought you would have a loss.

Example #3 – You purchased vacant land for an investment and need to sell it. Unfortunately, the sale will result in a loss. The good news is the loss is tax-deductible, but lacking any capital gains to offset the loss, you will only be able to deduct $3,000 ($1,500 if filing as married separate) of the loss in the sale year; the excess loss carries over to future years.

Example #4 – Your home that you are selling for a loss includes an office from which you conduct your business. The home office is deductible under the income tax rules, and represents 10% of the home. In this case, 10% of the loss would be deductible as an ordinary loss in the sale year. None of the remaining 90% of the loss is deductible due to the personal- use property rules.

Example #5 – Yes, we read your mind. You are planning to move out of your home that will sell for a loss and convert it to a rental thinking you could then deduct the loss. Problem with this strategy is that tax law requires you to use the fair market value (FMV) of the home at the time of conversion as the business basis if the FMV is less than your adjusted cost basis. Thus, the loss in value that occurred prior to the conversion will not be included in your loss when you sell the rental. However, if the market continues to decline, you will be able to take advantage of any future losses.

Example #6 – The property will sell for a loss, so you decide to just let it go into foreclosure. By doing this, you avoid the sales costs but destroy your credit rating for years to come. In addition, if the property sells at auction for less than the mortgage balance, you may, depending on some complicated rules, have to include in your income the difference between the loan amount and the sales price (referred to as debt relief income).

Example #7 – Let’s say you originally purchased your home for $200,000; it increased in value to $300,000, so you refinanced it for $240,000 and used the money to buy a car, go on vacation, pay off credit card balances, etc. Now your mortgage is higher than both your basis (cost) in the home and its current value. Your home sells for $225,000, and assuming you have $10,000 in sales costs, you end up with a tax gain of $15,000 rather than a loss, which may come as a surprise. The gain may or may not be taxable depending upon whether you qualify for the home sale gain exclusion. Bad news is you need to make up the $15,000 mortgage shortage and the $10,000 sales costs.

We strongly suggest you carefully weigh your options before selecting a course of action. A consultation appointment may be appropriate to see what option is the best for your particular tax situation. Please give us a call.

The EITC is for people who work, but have lower incomes. If you qualify, it could be worth up to $5,657 for 2009 ($5,666 for 2010. So, you could pay less federal tax or even get a refund. The credit is a refundable credit, so you can receive the benefits of the credit even if you may not owe any taxes. That’s money you can use to make a difference in your life.

Over 23 million taxpayers receive in excess $45 billion dollars in EITC – making the credit a great investment in the lives of those who claim it. However, the IRS estimates 20 to 25 percent of people who qualify for the credit do not claim it. At the same time, there are millions of Americans who have claimed the credit in error, many of whom simply don’t understand the criteria.

The EITC is based on the amount of your earned income and whether or not there are qualifying children in your household. If you have children, they must meet the relationship, age and residency requirements. Additionally, you must file a tax return to claim the credit.

If you were employed for at least part of 2009 or 2010, you may be eligible for the EITC based on these general requirements (the rates shown are for 2009, but the 2010 will be very similar):  

• You earned less than $13,440 ($18,440 if married filing jointly) and did not have any qualifying children.

• You earned less than $35,463 ($40,463 if married filing jointly) and have one qualifying child.

• You earned less than $40,295 ($45,295 if married filing jointly) and have two qualifying children.

• You earned less than $43,297 ($48,297 if married filing jointly) and have more than two qualifying children.

In addition, you must meet a few basic rules:

• You must have a valid Social Security Number.

• You must have earned income from employment or from self-employment.

• Your filing status cannot be married, filing separately.

• You must be a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident alien, and filing a joint return.

• You cannot be a qualifying child of another person.

• If you do not have a qualifying child, you must:
o be age 25 but under 65 at the end of the year,
o live in the United States for more than half the year, and
o not be a qualifying child of another person.

• You cannot file Form 2555 or 2555-EZ (related to foreign earned income).

Members of the military can elect to include their nontaxable combat pay in earned income for the earned income credit. If you make the election, you must include in earned income all nontaxable combat pay received. If you are filing a joint return and both you and your spouse received nontaxable combat pay, then each of you can make your own election. The amount of your nontaxable combat pay should be shown on your Form W-2 in box 12 with code Q.

If you have any questions, please give this office a call.

We can generally provide you with copies of tax returns prepared by the office for current and three prior calendar years. There may be a nominal reproduction charge. Please keep in mind, that due to privacy laws, we can only provide the copy to you and not to a third party. If you would like copies of returns that were not prepared by this firm, you can easily obtain tax return or tax account transcripts by phone or mail directly from the IRS.

A tax return transcript shows most line items from the tax return (Form 1040, 1040A or 1040EZ) as it was originally filed, including any accompanying forms and schedules. It does not reflect any changes you, your representative, or the IRS made after the return was filed. In many cases, a return transcript will meet the requirements of lending institutions such as those offering mortgages and student loans. You should receive your tax return transcript within 10 working days from the time the IRS receives your request.

A tax account transcript shows any later adjustments either you or the IRS made after the tax return was filed. This transcript shows basic data, including marital status, type of return filed, adjusted gross income and taxable income. The IRS does not charge a fee for transcripts, which are available for the current and three prior calendar years. Allow 30 calendar days for delivery of a tax account transcript.

To request either transcript:

• By phone: Call 800-829-1040 and follow the prompts in the recorded message.

• By mail: Complete IRS Form 4506-T, Request for Transcript of Tax Return. If you need a photocopy of a previously processed tax return and attachments, complete Form 4506, Request for Copy of Tax Form, and mail it to the IRS address listed on the form for your area. There is a fee of $39.00 for each tax period requested. Copies are generally available for the current and past six years.

Forms 4506-T and 4506 can be found on the IRS Web site at IRS.gov or by calling the IRS forms and publications order line at 800-829-3676.

If you need assistance in obtaining past returns, please give our office a call.

The IRS has been stepping up their tax return audits after several years of heavy reliance on correspondence audits. Their mission is to help fill the tax gap. The areas of increased audits include Schedule Cs (sole proprietor businesses) where the Treasury Department estimates income is underreported by an estimated $68 billion.

An IRS tax audit can come in a number of forms. The most demanding are the face-to-face audits, which require sitting down with an auditor and reconciling income and deductions.

Others are the less demanding correspondence audits where the IRS has reason to believe that the taxpayer failed to include reported income or has overstated deductions.

Face-to-Face Audits – Self-employed, high-income taxpayers, those who have omitted substantial income, or those who repeatedly fail to show income to support their lifestyle are more likely to be subject to these types of audits. Some are simply random to provide the IRS with statistics for targeting the most fruitful audit results.

You can appear for the audit yourself, but that is probably a bad idea since you are not trained in the rules and regulations regarding audit procedures and what limits the IRS’s incursion into your private life. You can authorize your tax professional to handle it without you. Often, this is the best way to prevent the audit from escalating beyond the original areas that attracted the IRS's interest in the first place. Practitioners experienced with IRS audits are less likely to become emotional or to make statements that would lead to additional IRS questioning.

Correspondence Audits – Employers, banks, lending institutions, schools, brokerage firms, escrow companies and others all feed data to the IRS, which the IRS, in turn, matches by computer to the information reported on your tax return. If there is a significant discrepancy, the IRS will correspond with the taxpayer. Sometimes these discrepancies will result in additional tax liability, while other times a simple explanation will satisfy the IRS and make the problem go away. Here are some examples of typically-encountered discrepancies:

• Unreported Retirement Income – Whenever a taxpayer takes money out of one IRA account and rolls it over within the 60-day statutory limit into another IRA or qualified plan, the income is not taxable. The IRS will know about the withdrawal but not the subsequent rollover, and unless the rollover is reported on the tax return, the IRS will believe it to be a taxable distribution. So what would have been a simple entry on the tax return results in a correspondence audit. When moving an IRA from one institution to another, making arrangements for a direct transfer will generally avoid these types of audits.

• Gross Proceeds of Sale – Generally, when real estate, stock or marketable securities are sold, the IRS knows what you sold and for what price. Thus, you must account for the sale on the tax return and compute the gain or loss. If you omit reporting the transaction, the IRS will treat the entire sales price as profit, adjust your tax, and notify you via a correspondence audit.

• Alimony Paid or Received – A taxpayer who pays alimony is able to deduct the amount he or she paid. On the other hand, the recipient of that alimony must report that amount as taxable income. The IRS checks to make sure the amounts match. If they don’t, expect a notice in the mail.

• Home Mortgage Interest – Each of your mortgage lenders will report to the IRS the interest paid on your mortgage for the year and issue you a Form 1098 for the same amount. If these amounts don’t reconcile, expect a notice or a request for an explanation. This is frequently an issue when the loan is from a private party not reporting the interest to the IRS, or when more than one individual is on the loan but the 1099 only has space for one Social Security Number (SSN). In both cases, the IRS provides a procedure for dealing with these issues on your tax return. However, if the procedure is not followed, the IRS will be unable to verify interest paid under your SSN and will issue a notice or request an explanation.

• Tuition Paid – Because of the education tax credits that can be claimed for paying tuition to a qualified higher education institution, the IRS requires those institutions to report the tuition received to the IRS and issue Form 1098-T to the student. Thus, the IRS has the ability to verify the tuition paid during the year, and any mismatch could result in a correspondence audit.

• Interest and Dividends – The IRS allows many financial institutions to issue substitute 1099s, i.e. forms that are not in the standard 1099 format. These substitute forms—with various types of interest and dividends reported separately and spread throughout lengthy annual account statements—can often be misinterpreted by an untrained eye. To make matters worse, many brokerage firms have issued amended 1099 statements late in the tax filing season because of errors in allocating the investment income by the proper type. Incorrectly reported, erroneously reported, or omitted investment earnings can trigger correspondence from the IRS.

• Non-Taxable Interest – Interest from municipal obligations are tax-free for purposes of computing federal tax. However, tax-free municipal interest income is added to income for purposes of computing taxable social security income and determining whether a taxpayer qualifies for earned income credit (EIC). Thus, all tax-free municipal interest must be reported on the tax return or risk a subsequent inquiry from the IRS.

• Cash Contributions – Regardless of the amount of cash contributed, the contribution must be backed up with either a bank record or written communication from the donee organization showing the: (1) name of the donee organization, (2) date of the contribution, and (3) amount of the contribution. The recordkeeping requirements may not be satisfied by maintaining other written records.

What this means is that unless the charitable organization provides written communication, cash donations put into a “Christmas kettle,” church collection plate, and pass-the-hat collections at youth sporting events will not be deductible. Donations by debit or credit card can be substantiated by bank records. These new rules will give the IRS the ability to audit taxpayer’s charitable contributions via correspondence audits since all contributions must be backed by a written receipt or bank record.

Don’t assume that just because you received a notice that the IRS is correct. They are frequently wrong. Please call this office before responding to any IRS notice. Tax laws are complicated, and the notices are not always easily understood.

Caution: It is strongly recommended that you contact this office immediately upon receipt of any inquiry from the IRS or state tax agency. Don’t procrastinate, because that only leads to further action on the part of the IRS or state agency.