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28 April 2017
Tax Season 2017 (during which we mostly prepare tax returns for 2016) is finished. I have a few clients on extension (or as Wandering Tax Pro Robert D. Flach calls them "GDEs". - the "E" stands for extension, you can figure out the "GD" for yourself.) I also have a few clients who need to amend previous tax years, but the pace has definitely slowed.
And what a pace it was for me! Virginia Beach continues to turn out and turn up at PIM Tax Services. My client base grew dramatically from the prior year. I was grinding pretty hard for 2 months straight, and I love it! I hit quite a few of my business development milestones this year and it was very gratifying. Thank You Virginia Beach!
Last year I made a post about the most common tax errors I saw during tax prep season. I think I'll make that an annual tradition. Not because I want to make any of my clients feel ashamed for making mistakes, but I know a lot of DIYers search for help/knowledge on the internet and I don't mind letting them know what to watch out for. Just because you don't have me prepare your taxes doesn't mean I want you to overpay the government!
So without further ado - here are the top mistakes I saw during Tax Season 2017:
1. Not Treating a Rental Property as a Business. Virginia Beach is densely populated with military personnel. It’s fairly common for military members and couples to purchase a home and then receive PCS orders out of the area. For a variety of reasons many military members (and even some non-military members) decide to turn their home into a rental property. I call these “accidental” or “unintentional” landlords. They didn’t buy the house with the intention of making it a rental property, but it ended up being a rental property anyway.
The tax code is blind to your intention in this regard. The IRS does not care WHY you bought your house. The minute it becomes a rental property it is a business property, and it gets the same treatment as every other residential rental property. If the IRS is treating your property like a business, you should, too. There are significant tax advantages to doing so, and significant disadvantages for not doing so. If you don’t know what they are, then you ought to get a tax professional involved from the onset. So many people wait a few years, realize they’ve made a mess, and then come looking for help to sort it out. It’s so much easier (and cost effective) to get it right the first time.
I have written this many times, and it is still true - I have found costly mistakes on 100% of the self-prepared Schedule Es I have reviewed.
2. Not Responding Immediately to an IRS (or State) Tax Notice. The IRS scares people. There are good reasons to have a healthy respect for their authority, but some people get really rattled when they see a letter from the IRS. Sometimes they set it aside for a while, afraid to open it. Sometimes they open it, read it, and set it aside to respond to later. DON’T DO THAT! IRS notices age like bread, not wine. The longer they sit the worse they get. Not to mention independent research has shown that two-thirds of IRS notices are INCORRECT.
The IRS has a system called the Automated Under Reporting (AUR) program. The AUR system spits out IRS notices to taxpayers based on an algorithmic review of a tax return, and they are not reviewed by any person at the IRS before they are sent. Most of them are wrong, but they all have a deadline by which you must respond or further IRS action will be taken. Don’t sit on them, take action immediately.
3. Sloppy Record Keeping. I’ve written about this a few times, but it bears repeating: Tax records are for YOUR benefit. Here’s why – the courts interpret the internal revenue code to mean that ALL your income is taxable. Any adjustments, deductions, or tax credits you might receive are bestowed upon you through legislative grace. It is the taxpayer’s responsibility to prove they are entitled to any adjustment, deduction, or credit.
May people seem to believe it is the other way around – that they are entitled to claim adjustments, deductions, and credits and the IRS must prove they are not entitled to claim them. It absolutely does not work that way. If you are audited and you cannot document your qualification for a deduction or credit the IRS will disallow it and charge you additional taxes, interest, and possibly penalties. Keep good records!
4. Planning Too Late. Every year I am contacted in April and asked what can be done about reducing someone’s tax burden for the prior year. While there may be a couple of options available, the best opportunities have come and gone. You plan by looking out the windshield at where you are going, not looking in the rear view mirror at where you’ve been. If you want to do some tax planning – and I think everyone should – then call me in April about THIS year, not last year!
5. Those Damn Charity Receipts. Pardon my French, but you’ve seen them. They are everywhere. Goodwill, CHKD, DAV, Eggleston, Vietnam Veterans, etc. they all offer the same deal. You drop off items you no longer want, they hand you a blank receipt for it. Then 8 months later you hand that blank receipt to me to prove you made a charitable donation because you (rightfully) want the deduction from your taxes. The problem is I wasn’t there when you made the donation. I don’t know if you gave them one old sock or an oak bedroom suite.
YOU have to fill out the rest of that receipt. The charity you gave the items to isn’t allowed to fill it out – YOU have to do it. You have to write down what you gave them, what its value was, and how you determined that value. (hint: it’s usually “Thrift Store Value”.)
Like I wrote above – it’s up to you to prove your right to every adjustment, deduction, and credit. That extends to the charitable deduction as well. A blank receipt is not proof that you donated anything. Fill them out!
Overall I had a great tax season. PIM Tax Services continues to grow and I find it very exciting. I made a lot of new friends/clients this season and – even more fantastic – nearly all of my 2016 clients returned in 2017. I’m always looking for ways to improve and become more efficient. Helping people head off their tax issues before they come to see me is one way I hope to accomplish the delivery of affordable tax planning and preparation services to as many people as possible.
If you have any questions, please contact me.
24 January 2017
I bought a new gizmo the other day and I was hoping to find a manual in the box. I'm old school. I like a book when I can get it. The kind with pages and such. Unfortunately, those are quite rare these days and my new gizmo was no exception. There was a Quickstart Guide - that 1 or 2 page graphically intensive sheet with basic instructions on how to not break your new gizmo before you get online to find the actual documentation you need to learn how to work it.
It occurred to me taxes have become the same thing. We used to go down to the library or post office to pick up tax forms and instructions. No longer. Now all of the instruction manuals are online. The only thing missing is the Quickstart Guide. There isn't a Quickstart Guide for taxes. I started to contemplate what one might look like. Then I decide, what the heck - I'll make one. And just for fun I'll throw in my analogy about taxes being membership dues owed to Club America.
Behold, my friends - the completely unofficial federal tax Quickstart Guide. I hope you find it useful.
07 January 2017
Money is tied to most of the decisions we make in life. Where we work, if we work, which schools our children attend, the car we buy, the house we live in, how and when to retire, where we eat, what clothes we wear - money is a factor in all these decisions and many many others. Anything so intricately entwined in our lives will influence our emotions. It cannot be escaped. I don't look at this as a good or bad situation. It simply is.
On paper taxes are all about numbers. There are columns of numbers to be added and subtracted until you get to the final answer. There shouldn't be anything emotional about it. In the real world, however, there can be a tremendous amount of emotion surrounding the preparation of a tax return. These emotions are natural, but I have witnessed them influence people's behavior in a variety of ways that cost them money. I believe that's OK as long as they understand that is what they are doing. I could save money by changing the oil in my car myself, but I don't want to. That's my choice, and I know why I am making it.
Below are some of the emotions I frequently see and the results they can have that cost people money.
1. Reluctance to See a Professional Tax Preparer. Hiring a professional to prepare your taxes is going to save you time and if your tax situation is even a little complex it will likely save you money. Yet, many people are reluctant to hire a professional to prepare their taxes. I see several emotions behind this:
A. Fear of Looking Ignorant and/or Disorganized. In our society money is one way we keep score. If you have more money, you are winning the rat race. Even more valued than having lots of money is the perception of being shrewd and efficient with your money. Mr. Money Mustache has made a career out of demonstrating his ability to live well on very little money. Many people don't want to use a professional tax preparer because they fear looking ignorant and inefficient with their money. They avoid that feeling by avoiding professional tax preparers. It is probably costing them money.
B. Overconfidence. Some people find this difficult to believe, but we humans are naturally more confident than we should be. Evolution bred lack of confidence out of us long ago. Picture a nomadic tribe during a drought thousands of years ago. They have been walking for weeks looking for water. They get to the top of a hill and they see nothing but another hill on the horizon. The confident ones set out for that next hill, certain they will find water if they keep looking. The ones lacking confidence sit down and perish. We have evolved to be confident. That's why I yell instructions at the Browns' quarterback on my TV on Sundays in the fall. In my fervor I somehow believe I know more about football than someone who made it to the NFL. At tax time a lot of people think they know a lot about taxes. They are determined to prepare their own tax returns, and it is probably costing them money.
C. We're All a Bunch of Crooks. Some people had a bad experience with a tax professional in the past. Or someone they know did. Or they read about it in the paper or saw it on the news. It's a legitimate fear. There are scoundrels in every profession and tax preparation is no different. There aren't as many as you think, though, and there are easy ways to tell the good ones from the bad ones. Don't let your bias against tax professionals cost you money.
2. Immediate Gratification. Some people are just not very patient when it comes to pleasure. Getting money can be a pleasurable experience, and some people can't seem to wait a week or two to experience it. They want their refund and they want it right now! That's why refund anticipation loans (RALs) and refund anticipation checks (RACs) are so popular. They provide instant gratification to the taxpayer - you can walk out of your tax preparer's office with a check or a direct deposit to your bank account already on the way. But make no mistake, those RALs and RACs are expensive. There might be a good reason why you can't wait a week or two for your tax refund, but most of the time people are just feeling an urgency to have the pleasure of getting their refund, and it is costing them money.
3. Fear of Owing the Government at Tax Time. Behavioral economists call it loss aversion. It is the concept that losses feel about twice as bad as gains feel good. In other words, losing $100 has about the same amount of psychological impact as finding $200 - just in the opposite direction. With respect to taxes people react to loss aversion by allowing the government to withhold excessive taxes from their paychecks throughout the year so they can get a refund when they file their tax returns. There is no logical reason to do this. It is your money. A tax refund check is not a bonus from the government. They are simply returning the money they took out of your paychecks all year to cover your tax bill. If you get a refund it is because they took more than was necessary to pay your taxes and they are returning it to you. I don't think anyone would voluntarily overpay their Cox Cable or Dominion Power bills every month just so they could get some of it returned at the end of the year. Yet millions of Americans overpay their tax bill every paycheck so they can get a refund when they file their taxes, and it's because writing a check to the government feels twice as bad as getting a refund feels good. That is an emotional decision, not a logical one. If you are providing the government with an interest free loan it is costing you money.
I am not trying to convince you that we should all make the same decisions about money. Money impacts emotions and different people react differently to money situations. We all have our own comfort level. Some of us lay awake at night because we didn't do the most logical thing with our money, and some of us lay awake at night because we did. Each of us has to make decisions that leave us relaxed enough to sleep. The point of this article was to raise awareness that many people (maybe you) are making decisions regarding their taxes based on emotion, and that they might not be aware that they are. Most people would prefer to pay the absolute minimum amount of tax they are required to pay, but many people are not paying the lowest possible tax because they are unknowingly making emotional rather than logical decisions.
Like everyone, I get emotional about my money. I try to limit it, but it is unavoidable. However, if we are talking about your money I will be the calm, rational person in the discussion. If you would like a calm, rational perspective on your tax situation you should give me a call.
02 January 2017
I am not an accountant, but I will tell you without hesitation that accounting is important. If you are self-employed or starting a small business it is more than important – it is essential. You might get away with having your personal financial records in disarray, but if you are self-employed or starting a small business and you aren’t keeping your books properly you are begging for trouble.
Accounting is the language of business. It allows anyone to look at your books and understand where your business stands financially. Who might want to do this?
The bank if you need a loan.
The tax man (federal or state)
Someone thinking about buying (or buying into) your business
Anyone – like you – who is making decisions for the business
Roughly 40% of small business owners say that accounting is the worst part about running a business. You can put me in that category. I just wanted to help people with their taxes and financial planning. Keeping track of receipts for office supplies and internet service wasn’t supposed to be so darn time consuming! But I do it because it is important for PIM to succeed. More than half of small business startups in the United States fail. How many wouldn’t have if they had kept better track of their accounting?
Now that I have stressed the importance of accounting, let me take a step back and suggest something my accountant friends might find radical. (Possibly even alarming.)
Not everyone needs full strength accounting.
If you’re just starting up and/or self-employed you might not be considering a bank loan for your business. You might not be thinking about selling your business or bringing in a partner. You might just be doing your thing on the side and enjoying the extra cash flow when it happens. If this is the case, you might not need monthly/quarterly cash flow and income statements. You might not need to be able to produce a balance sheet on short notice. You might not need full strength accounting.
But you do need some accounting. You can’t escape the tax man. He will have his due. However, you may be able to satisfy him with some simple tax basis record keeping – and keep the tax man (and your tax preparer) satisfied when it is time to file (and pay) your taxes.
Tax basis record keeping is performed with the end result in mind. The end result is your tax return. You must have sufficient records to file a correct tax return. So, what does the tax man want to know?
The tax man wants to know how much you made, because that’s what you pay taxes on. Therefore, you have to have some records showing how much money you earned – how much revenue you generated. You need to keep track of the cash that is coming into your business.
Does the tax man also want to know your business expenses? Not really. Your business expenses are deducted from your revenue, and that reduces the amount the tax man can tax. The tax man is perfectly content for you to pay taxes on all of your revenue. He doesn’t care whether you have any business expenses or not – but YOU do. You need those business expenses to reduce the amount of taxes you pay.
What the tax man cares about is whether or not you can properly document your business expenses. You are allowed to take the legitimate business expenses that you can prove. Therefore, proper record keeping of expenses is in your best interests.
For many self-employed people or small startup businesses, tracking your income and expenses is all the accounting you need. You can get a fancy program or hire an accountant for that, but I’m not sure why you would. A simple spreadsheet will do, and you can get simple spreadsheets for free with a Gmail account. (Google Sheets)
It will be helpful if you group your expenses in roughly the same manner the IRS does on schedule C (lines 8-27). You’ll be glad you did when it comes time file your tax return. Don’t lose a lot of sleep trying to figure out the difference between “supplies” (line 22) and “office expenses” (line 18) (or any of the several other poorly-defined categories on schedule C). Just pick one and do your best to be consistent. You’re not going to lose an audit for calling a commission (line 10) a professional service (line 17). They all get totaled on line 28, so no matter which category you chose it’s going to end up on line 28 sooner or later. Do your best and if you have questions, call me.
Slimmed down tax basis accounting can be a time (and money) saver if you don’t need full strength accounting. Just make sure you don’t need full strength accounting before you decide to cut some corners you actually shouldn’t be cutting. If you have a capital intensive business, need to borrow to expand, have employees and payroll, or thinking about selling your business one day you are going to need a balance sheet and cash flow statements. You will need full strength accounting.
But...if you’re driving for Uber, being a weekend photographer, walking dogs in the afternoon, or baking cupcakes in your home – you can probably just use a spreadsheet to keep track of your income and business expenses with a little tax basis accounting and be fine.
08 December 2016
With the election of Donald Trump as President and the return of a Republican Congress to Washington the press is jumping with speculation about changes to U.S. tax laws. I suspect some tax law changes are coming in 2017, but I won’t try to speculate about what the final outcome is going to be. I don’t have a working crystal ball, and if I did I wouldn’t be giving away its secrets for free on the internet. As I’ve said elsewhere, if I could predict the future you probably couldn't afford me.
Instead, let’s focus on what we actually know for sure. There are some known tax changes on the way. Some are already here and some are coming. Knowing them can help you prepare your taxes this year and plan for the future. That is valuable information. Far more valuable than me guessing about what President-elect Trump is going to do.
Issues Impacting 2016 Taxes.
1. The standard deduction increased for Head of Household filers in 2016. (Everyone else stayed the same.) The 2016 standard deduction amounts are in the table below.
|Filing Status||2016 Standard Deduction (2015 value)|
|Married Filing Jointly||$12,600|
|Head of Household||$9,300 ($9,250)|
|Married Filing Separately||$6,300|
2. The personal exemption for each person claimed on your 2016 tax return increases to $4,050 (from $4,000 in 2015). This amount gets adjusted for inflation every year, and is always rounded to the nearest $50.
3. Due Diligence forms for the AOC and CTC tax credits. This is new and annoying. The American Opportunity Tax Credit (AOC) and the Child Tax Credit (CTC) are partially refundable. That means you can have a zero ($0) tax liability to the IRS and still collect a ‘refund’. Free money from the government attracts fraud, and the IRS solution is to turn tax preparers into Tax Cops. They do this by forcing tax preparers to interview tax clients and record their responses on a special form that gets submitted with your tax return. If you are eligible to receive either of these credits I will be asking you several seemingly silly questions designed to prove that your children are your children and they are really going to college as you claim. I apologize in advance – it wasn’t my idea.
4. ACA Penalty Increases. The shared responsibility payment (a.k.a Obamacare Penalty) for not having health insurance is now $695 per uninsured adult and $347.50 per uninsured child OR 2.5% of your AGI – whichever is GREATER. (I have seen predictions the ACA will be repealed, but as of this writing it remains the law of the land.)
5. HSA contribution limit increased if you have family coverage. In 2016 you can contribute up to $6,750 if you have family health insurance coverage on a high deductible health care plan (up from $6,650 in 2015). If you have individual coverage you can contribute up to $3,350 (same as 2015). HSA contribution limits include money your employer contributes as well as your own contributed money. You can contribute to your HSA up until the tax filing deadline (April 18, 2017) and still take the deduction on your 2016 tax return.
6. IRS Launches More Online Tools. The IRS is attempting to move more customer service features online to allow taxpayers to resolve tax issues without involving an actual agent. These new tools allow a taxpayer to see if they owe a balance to the IRS and integrate with existing payment options to allow taxpayers to “take care of their tax obligations in a fast and secure manner”. Given the significant difficulties the IRS has had with existing online tools, I suspect there may be some growing pains. I’ll be standing by to see if/how this works.
For Planning Purposes Going Forward.
47 provisions of the tax code will automatically expire at the end of 2016. Most of them you’ve never heard of, and will have no impact on you (unless you were looking for accelerated depreciation of your race horse, or a tax credit for mine rescue training…). There are a few, however, worth discussing.
Taxes are complicated, that’s why some tax firms charge ridiculous fees for their service. While we can’t do too much with speculation on where the tax code is going to be next year, there is a lot we can do with the hard information we have about changes that have already happened or are about to happen. As always, if you have any questions, please contact me.
22 November 2016
You borrowed $25,000, quit paying on the loan, and then the lender decides to cancel your debt. Sounds good, right? You don’t have to pay it back. Your credit score probably took a beating, but at least that creditor will quit blowing up your phone and making you dread the trip to the mailbox. This seems like a very good thing. You might even do a little happy dance.
Then in February you receive a form 1099-C in the mail. It says “Cancellation of Debt” in big letters on it. This looks suspiciously like a tax form. What does this mean? Tax forms are almost never welcome news. Did you do your happy dance too soon?
You may have. You received that form because the tax code considers cancelled debt to be income, and income is taxable. It may need to be included as income on your tax return. You might have succeeded in getting one creditor off your back, but if you can’t pay your taxes on the cancelled debt you may have only traded one creditor for another one. The most relentless and capable creditor on the planet – the IRS.
Debts for which you are personally liable (responsible) are known as recourse debts. If a recourse debt is forgiven or discharged for less than the full amount owed, the unpaid amount is considered to be income to you. That amount will be on the form 1099-C issued to you by the lender. A copy of that 1099-C also goes to the IRS, and they will be looking for you to include that amount as income when you file your next tax return.
That is...unless you qualify for one of the exceptions or exclusions.
There are certain situations in which that cancelled debt does NOT have to be included as income. If you have cancelled debt you will want to investigate these to see if you qualify for one of the exceptions or exclusions. If you do, maybe you can get your happy dance back.
Exceptions exempt you from paying taxes on the cancelled debt due to the nature of the cancelled debt. There are several exceptions, but I am only going to cover the two most common ones.
Gifts and Inheritances. You borrowed money from your parents to purchase your first home and you’ve been paying them back on terms you have agreed to. Then, at Christmas they decide to forgive the remainder of the debt as a gift to you. You do not have to include this cancelled debt as income. (It would be pretty weird if your parents issued you a 1099-C in this situation, but hopefully you get the point of the example.)
Likewise, if someone forgives your debt in their will, you don’t have to include that debt forgiveness as income.
Student Loans. Student loans issued by government and/or non-profit organizations can be forgiven if the person receiving the loan works in a specified – usually some type of public service - profession. (There are too many professions and nuances for me to list here, but Student Loan Hero does a good job of tracking them.)
If your loan and your work qualify for student loan forgiveness, you do not have to count that cancelled debt as income.
Exclusions exempt you from paying taxes on the debt because of your particular circumstances when the debt was cancelled. There are several exclusions, but I am only going to cover the top three.
Bankruptcy. If your debts were cancelled as part of a chapter 11 bankruptcy judgement, you do not have to include them as income. Your bankruptcy judgement must be final before you can claim this exclusion. The IRS does not consider matters pending before a court to be evidence of qualifying for the exclusion.
Insolvency (this is The Big One). Most people don’t just get up one morning and decide to stop paying on their debts. In most cases, they stop paying on their debts because they don’t have enough money to make the payments. In this situation, you may be what is known as insolvent. If you can prove you were insolvent immediately before the debt was cancelled, you do not have to include that debt (to the extent of your insolvency) as income on your taxes.
Of course, the IRS makes you prove you were insolvent (and the extent to which you were insolvent). You do this by filing form 982 with your tax return. On form 982 you list the assets and liabilities you had right before the debt was cancelled. You do not have to list any assets that are beyond the reach of your creditors (such as a retirement savings account) on form 982. If your liabilities exceed your assets, you are insolvent. The amount your liabilities are greater than your assets is the extent of your insolvency. Let’s look at some examples.
1. You had $10,000 of debt cancelled by the lender. Immediately prior to the cancellation of debt you had $80,000 of assets and $100,000 of liabilities. The extent of your insolvency is $20,000. The extent of your insolvency is greater than the amount of your cancelled debt, so you do not have to include any of the cancelled debt as income.
2. You had $10,000 of debt cancelled by the lender. Immediately prior to the cancellation of debt you had $80,000 of assets and $84,000 of liabilities. The extent of your insolvency is $4,000. In this case, only $4,000 of the cancelled debt can be excluded. $6,000 of the cancelled debt must be included as income.
Qualified Principle Residence. If the cancelled debt was used to purchase your main home, then it is excluded from income. The IRS defines your main home as the one in which you live the most. You can only have one main home. If you refinanced your home only the amount of the loan that covered the principal of the original loan is qualified principle residence debt. Let’s look at an example.
Your original mortgage in 2005 was $200,000. In 2008 the principal on that loan was $180,000 and you refinanced for $280,000. You used the extra $100,000 to fund your son’s college education. Only the amount of the original mortgage principal ($180,000) secured by the refinancing loan is excludable as qualified principle residence debt.
There are some additional rules on qualified principle residence debt regarding money spent to make improvements and additions to the home that I don’t want to try to explain here. I just mention them so you are aware they exist if you have mortgage debt cancelled. If that is your situation, contact me and we can dig into the details.
Having a debt cancelled can be a good first step in getting your finances reorganized. Just be aware that the lender will issue you (and the IRS) a 1099-C reporting this as income to you. If that happens, contact me and we will see if there is a way for you to legally exempt your cancelled debt from your income.
10 November 2016
I stumbled across this interesting quote while reading a recent blog post about taxes. It comes from the Tax Court Judge's opinion on a case he had decided:
Deductions and credits are a matter of legislative grace, and taxpayers must prove entitlement to the deductions and credits claimed.
I'm not altogether happy with the term legislative grace to describe tax deductions and credits. Congress writes deductions and credits into the code to encourage behaviors they have deemed beneficial. Congress wants us to buy houses, so they create a deduction for mortgage interest. Congress wants us to be educated, so they create tax credits for higher education. I'm not sure grace accurately describes that situation. But I digress...
The real point the judge is making is that taxpayers aren't entitled to claim a deduction or credit just because they exist. You have to qualify for them; and, if asked, you have to provide evidence that you qualified for the ones you have claimed. If you can't provide such eveidence, then your right to the deduction or credit does not exist.
A paper trail is almost always the best. Receipts, invoices, financial statements, proper bookkeeping, and journal (or log) entries make very compelling arguments in favor of your right to claim the deduction or credit. It may seem bothersome to keep track of and keep up with these things, but not nearly so bothersome as getting your tax deduction revoked by the IRS and getting a bigger tax bill (with penalties and interest).
How you retain and organize your document trail is up to you. The IRS does not dictate any specific record keeping system. (They have been known to accept notes written on a paper plate!) However, good record keeping can save you (and me) a lot of headaches at tax time. Accordion files are inexpensive and you can even get them with tabs to help you sort your documents. Get one and start saving your tax documents in it. If you're not sure whether or not to save a document, save it. It is much easier to throw away documents that aren't needed than it is to locate a copy of something you've thrown away.
If you're handy with technology you might consider going paperless. You can scan in your receipts and other documents and save them digitally. Just be sure to use a logical file naming method. DSC2016-0798.jpg isn't a very helpful file name to describe a hotel receipt. It would take quite a while to find that hotel receipt mixed in with a bunch of other files named DSC2016-XXXX.jpg. You should also maintain different file folders to sort your receipts by the tax category they fall under, and then keep those tax category folders within another folder for each tax year.
There are also computer programs and apps for smart phones that can help you store, organize and keep track of your tax documents. It doesn't really matter how you do it - it just matters that you do it.
So, keep good records. If you still don't know what that means, or how to do it, come see me. I will get you squared away.
Nerdy Tax History Stuff
It is sometimes possible to claim deductions without a paper trail. It's known as the Cohan Rule, named after the composer, playwright, and Broadway producer George M. Cohan. (That's a picture of his statue in Times Square.) Mr. Cohan had a lot of business-related expenses. As a Broadway big shot he traveled frequently and had to wine and dine lots of folks for business purposes. He claimed these as legitimate business expenses on his income tax return. He wasn't very good at keeping records, though. When the IRS asked to see proof of his business expenses he could not produce any. The IRS agreed that such expenses were legitimate in Mr. Cohan's business, but since he couldn't prove when or how much he had spent on travel and entertainment for clients the IRS revoked ALL of his unsubstantiated business deductions.
Mr. Cohan disagreed with the disallowance of all his business expenses for which he could not prove an exact amount, and took the IRS to court. The U.S. Circuit Court of Appeals agreed with Mr. Cohan. Judge Learned Hand (possibly the best-named judge in US History) wrote in his opinion:
...there was basis for some allowance, and it was wrong to refuse any, even though it were the travelling expenses of a single trip. It is not fatal that the result will inevitably be speculative; many important decisions must be such...
Today the Cohan Rule can be applied as justification for deducting some business expenses for which there is no paper trail so long as the expenses are reasonable and credible. But if you find yourself trying to use the Cohan Rule to defend some of your deductions, you probably need a lawyer, not an Enrolled Agent. Keeping good records is so much cheaper!
25 October 2016
I was contacted by a couple of clients yesterday who had suffered losses at the hands of Hurricane Matthew. One was particularly impacted. Her home was flooded and she and her children are currently displaced. Her insurance is not covering all her expenses. She is thankful no one was hurt when they evacuated their flooded home, but she is dealing with the added expense of a hotel room (that accepts pets), the expense and stress of arranging repairs to her home, replacing her damaged furniture and appliances, and working full time through all this to stay financially afloat. She was exhausted and I could hear her frayed nerves in her voice. She wanted to know if there is something that might help her financially. Something, perhaps, in the tax code.
Casualty losses due to flooding (and other natural disasters) can be deducted from your taxable income, lowering your tax bill, and/or increasing your refund. This is accomplished when you file your return, which I explain in greater detail later.
I wrote two versions of this article. One for the folks like my client who are dealing with a lot of [poop] right now, and don’t have time to digest a long tax article. For them I present the “Bottom Line Up Front”. Two paragraphs on what to do right now so that you have the documentation available at tax time to claim your casualty loss deduction.
For those with more time and interest I wrote “The Long Version”. I hope you find one or the other (or both) helpful.
If Matthew tore up your home and you’re displaced to a hotel or a friend’s house, here’s what you should do:
1. Keep all your paperwork. Every estimate, every insurance notice, every invoice, every receipt. Keep it all. Put it in a folder and bring it with you when we prepare your taxes in the spring. Don’t worry about whether you should save something or how to sort it. You have too many other urgent things going on right now, so just put it in a folder and bring it to me. I’ll go through it. I know what I’m looking for.
2. Take pictures. Most of us have a camera on our phone. Use it. Take pictures of all the damage and keep them. Download them to a folder on your computer. I’ll explain how to get them to me later when we prepare your taxes. They will become part of your tax record for 2016. We want to do this for two reasons: 1) my objective eyes might see something in them that you don’t, and 2) if the IRS wants proof you suffered casualty losses, pictures are a great tool to satisfy them.
Just do those two things for now, then focus on the other more urgent things. We’ll sort you out at tax time.
Hurricane Matthew came and went a few weekends ago, but many of us are still cleaning up and restoring our lives. Tade and I suffered little. Our daughter spent Saturday night in her old room because she lost power at her apartment. We woke up Sunday to find the electricity had been off briefly during the night (the flashing digital clocks always let us know) and the cable was out. There were a few branches down and the neighbor’s shutter was on our lawn, but that was about it. We missed a little football, but were otherwise no worse for the wear.
I have several friends and clients who suffered property damage. Something few of them knew before talking to me is that you can deduct casualty losses (for which you are not compensated by insurance) on your tax return. It doesn’t make up for all your losses, but it can help take some of the sting out of your tax bill, or increase your refund.
The biggest bummer about this tax deduction is that it must exceed 10% of your adjusted gross income before it starts to count. That’s a big hurdle to get over, but don’t let it dissuade you from claiming it. I have clients who suffered significant property damage in 2015. Deducting it from their taxes increased their 2015 tax refund by about $14,000. Not everyone can expect such dramatic results, but I mention it to highlight this is not a tax benefit you should ignore.
How it works
Casualty (and theft) losses are itemized deductions on Schedule A of the Form 1040 – meaning you have to itemize your tax deductions in order to claim it. If you take the standard deduction you can’t claim the casualty losses. It is legal to claim your deductions any way you want to, so (as always) we want to file your tax return in the manner that is LAMA (legal and most advantageous) to you.
You also need to claim this in the year that it happened. Matthew came through in 2016, so you need to claim any casualty losses from Matthew on your 2016 tax return. There are some provisions in the law to enable taxpayers to claim the damages on a prior year return, but Matthew happened late in 2016, so claiming casualty losses associated with Matthew are best handled on the 2016 tax return. There is no provision in the law to delay claiming the losses until you file your 2017 taxes.
There is a heavy paperwork lift to claiming this deduction correctly. The IRS wants to know:
a. How much you paid for your damaged property
b. Insurance reimbursements received for the damages
c. The Fair Market Value of the property before it was damaged
d. The Fair Market Value of the property after it was damaged (Salvage value)
I bet if you’re reading this because you had casualty losses that list just pushed your frustration level up a couple of notches. Again, don’t let it dissuade you. It’s not as hard as it looks. Take a couple of deep breaths and keep reading.
Of course you don’t remember how much you paid for each item in your home. Nobody does. That line is really there for any personal property you have that might have appreciated (increased) in value since it was purchased. For most people this would only be their house – and you probably remember what you paid for your house. (If you don’t you can easily find out). Nearly all other personal property (furniture, cars, clothes, etc.) depreciates (decreases) in value from the time it is purchased. For those items, a reasonable estimate of the purchase price will suffice.
If you were reimbursed by insurance there should be a statement from the insurance breaking down the reimbursable items. Typically, however, there are only two categories: the house and the contents. Nearly all of us have the contents of our houses listed as “unscheduled property” with our insurance companies. That means we haven’t listed each individual item with the insurance company, but instead we accept a flat rate (usually 10% of the house’s replacement value) as the insured value of all the contents of the house. It’s easier than updating your insurance policy every time you buy a chair, but the downside is that you can easily have losses exceeding the insured value of your home’s contents.
Knowing the Fair Market Value of your property is also something that few people can easily do. Unfortunately, this is where we are going to need to spend some time to get it right because this is the amount you can deduct from your taxes (after adjusting for salvage value, see below). Fair Market Value is NOT replacement cost. The Fair Market Value is the price you could have sold the property for the day before it was damaged.
The IRS uses the following example in their guide:
You bought a new chair 4 years ago for $300. In April, a fire destroyed the chair. You estimate that it would cost $500 to replace it. If you had sold the chair before the fire, you estimate that you could have received only $100 for it because it was 4 years old. The chair wasn't insured. Your loss is $100, the FMV of the chair before the fire.
Fair Market Value after the property was damaged is also known as “salvage value”. If your property was ruined after Matthew and you have it hauled off to the landfill, then its salvage value is $0. However, if it was damaged, but still usable, then it has some salvage value. You have to estimate this if you keep the item, or keep track of what you sold the item for if you sell it. If you donate the item to a charity, the salvage value is the same as the amount you claim as a deduction for the charitable donation.
We use all of the above numbers to figure out your actual losses. Then, strangely, we subtract $100 from it. It’s like the IRS has a $100 deductible. Then we subtract 10% of your adjusted gross income, and you can deduct the remainder from your taxes. If you had large casualty losses relative to your income for the year it can make a big difference to your tax bill.
Losses from a casualty can be devastating both emotionally and financially. Some things have more sentimental value than cash value, and might be irreplaceable. I hope this didn’t happen to you, but if it did, I hope you at least found a few answers in this article that help put your mind at ease.
I covered a lot of information in this post. There is a lot more to claiming casualty losses that I left uncovered. If you have questions, please contact me.
21 October 2016
Criticizing the IRS is an American pastime. Most of us do it at least a little. Some of us do it a lot. How awesome would it be to get paid to criticize the IRS? To actually look at how the IRS does business and tell them how they are getting it wrong. There is someone who has this great gig, and her name is Nina Olson. She is the National Taxpayer Advocate. Not only does she get paid to provide feedback to the IRS on how they can improve service to taxpayers, but she has an army of 2,000 tax professionals to help her do it!
The Office of the Taxpayer Advocate, more commonly known as the Taxpayer Advocate Service (TAS), was created in 1996. It is an independent office within the Internal Revenue Service with two Congressionally mandated functions. 1) Provide help to individual taxpayers in dealing with the IRS, and 2) Provide systemic help to the IRS to improve service to taxpayers.
If you are having significant issues in dealing with the IRS to resolve a tax problem, you may be able to get help from the Taxpayer Advocate Service. They have offices in all 50 states, DC, and Puerto Rico. If the TAS takes your case, you are assigned a specific representative who will personally work with you until a solution to your issue is found.
Just keep in mind the Taxpayer Advocate Service isn’t there to answer every tax question you might have. They are there to assist taxpayers who are experiencing abnormal difficulties. Cases the TAS will accept fall into four general categories:
1. Where a taxpayer is experiencing some financial difficulty, emergency, or hardship, and the IRS needs to move much faster than it usually does (or even can) under its normal procedures. In those cases, time is of the essence. If the IRS doesn't act quickly (for example, to remove a levy or release a lien), the taxpayer will experience even more financial harm.
2. Where many different IRS units and steps are involved, and the case needs a "coordinator" or "traffic cop" to make sure everyone does their part. TAS plays that role.
3. Where the taxpayer has tried to resolve a problem through normal IRS channels but those channels have broken down.
4. Where the taxpayer is presenting unique facts or issues (including legal issues), and the IRS is applying a "one size fits all" approach, isn’t listening to the taxpayer, or doesn’t recognize that it needs new guidance for those circumstances.
In their role of providing direct support to taxpayers the TAS is in a unique position to gather data on the most common issues causing taxpayer distress. These are the issues that may indicate a systemic problem in the IRS and the National Taxpayer Advocate is required to address these issues in an annual report to Congress.
In the 2015 Annual Report to Congress the National Taxpayer Advocate highlighted 24 serious problems at the IRS. Below are some of the comments Ms. Olson made about the IRS to Congress:
• TAXPAYER SERVICE: the IRS has developed a comprehensive “Future State” plan that aims to transform the way it interacts with taxpayers, but its plan may leave critical taxpayer needs and preferences unmet.
• IRS USER FEES: the IRS may adopt user fees to fill funding gaps without fully considering taxpayer burden and the impact on voluntary compliance.
• REVENUE PROTECTION: hundreds of thousands of taxpayers file legitimate tax returns that are incorrectly flagged and experience substantial delays in receiving their refunds because of an increasing rate of “false positives” within the IRS’s pre-refund wage verification program.
• PREPARER ACCESS TO ONLINE ACCOUNTS: granting un-credentialed preparers access to an online taxpayer account system could create security risks and harm taxpayers [Paul’s Note: Seems like a great reason to make sure you’re hiring an Enrolled Agent to prepare your taxes!]
• AFFORDABLE CARE ACT (ACA): the IRS is compromising taxpayer rights as it continues to administer the premium tax credit and individual shared responsibility payment provisions.
• IDENTITY THEFT (IDT): the IRS’s procedures for assisting victims of IDT, while improved, still impose excessive burden and delay refunds for too long.
Of course, not all systemic failures are the IRS’s fault. They don’t write the tax laws; they just implement them. Assisting thousands of taxpayers each year will sometimes uncover problems, discrepancies, or inconsistencies in the underlying tax law. So, in addition to telling the IRS how to get better, the National Taxpayer Advocate gets to tell Congress how they screwed up the tax law. The 2015 Annual Report to Congress contains 15 recommendations to Congress on how to fix the tax laws to protect taxpayer rights, reduce taxpayer burdens, minimize IRS waste, and improve the Whistleblower program to enhance compliance.
I think I would thoroughly enjoy a job where I got paid to tell Congress and the IRS how they are messing up. Especially when I am learning how they are messing up by helping individual taxpayers get their tax issues resolved - which is something I already enjoy doing.
If you think you might qualify for assistance from the Taxpayer Advocate Service, get in touch with them. It is your right as a taxpayer. Just remember that you need to exhaust all ordinary means of resolving your situation first (unless you are about to suffer grievous financial damage at the hands of the IRS – then you get head-of-the-line privileges).
If you are having an issue with the IRS (or a state taxing authority) you can give me a call and I will help you get it resolved. Don’t delay. The IRS starts a timer as soon as they send you that letter, so the sooner we get to work your problem, the better. In fact, being ahead of the IRS timelines can help to put us in an advantageous position with respect to getting a favorable outcome to your issue.
Paul D. Allen is a proud member of the National Association of Enrolled Agents, the National Association of Tax Professionals the Financial Planning Association of Hampton Roads, the National Association of Personal Financial Advisors (NAPFA), and The Tidewater Real Estate Investors Group. You can read more about Paul's background here.
Bought some software and then started having second thoughts? Stuck on a particular issue? Give me a call and ask about a consultation. I might be able to get you back on the path to finishing your own return.