Welcome to the Tax Blog

News, information, and opinions about:

  • Federal, State, and Virginia Beach Taxes
  • The Tax Preparation Business
  • Tax Planning

If you have a question or comment, please drop me a line. Paul @ PIM Tax.

15 July 2017

Virginia beach tax preparation accidental Virginia resident militaryThere is a provision in the Servicemembers Civil Relief Act (SCRA) that creates a nice loophole allowing many military personnel to avoid paying state income taxes. The provision wasn’t placed in the SCRA for the purpose of creating a tax loophole. It was put there to prohibit the states from taxing the incomes (and personal property) of military personnel who are living in the state only to comply with military orders. However, many military servicemembers are using this provision to avoid paying any state income taxes. Congress added a paragraph to the SCRA in 2009 that extended this same benefit to qualifying military spouses.

I don’t refer to it as a “loophole” to imply that people who use this provision are being sneaky or dishonest. This is a completely legal and legitimate tax maneuver. I used this tactic when I was in the Navy, and I encourage military personnel (and their spouses) to use it whenever possible. In fact, the point of this article is make sure no one inadvertently disqualifies themselves from being able to use it!

How It Works:

Here is what the first 2 paragraphs of SCRA (Section 571) say:

(1) In general. A servicemember shall neither lose nor acquire a residence or domicile for purposes of taxation with respect to the person, personal property, or income of the servicemember by reason of being absent or present in any tax jurisdiction of the United States solely in compliance with military orders.
(2) Spouses. A spouse of a servicemember shall neither lose nor acquire a residence or domicile for purposes of taxation with respect to the person, personal property, or income of the spouse by reason of being absent or present in any tax jurisdiction of the United States solely to be with the servicemember in compliance with the servicemember’s military orders if the residence or domicile, as the case may be, is the same for the servicemember and the spouse.

In short, if you are in the military and under orders to work in another state (not your home state), that state can’t make you pay taxes there just because you are present in their state. The same goes for the spouse, if the spouse is a resident of the same state as the servicemember.

I think these are fair and reasonable protections to afford military families. They work hard, move often, and sacrifice much. It is not unreasonable to allow them to maintain their tax home in the location of their choice.

Here’s the Loophole: It doesn’t prevent the servicemember from establishing residency in a state where the tax laws are advantageous – such as in a state without a state income tax. So, that is exactly what I did...

I enlisted in the Navy in 1987 from my home state of Ohio. Under the SCRA I retained my status as an Ohio resident even though the Navy had relocated me to Florida. At that time Ohio was taxing the incomes of military personnel who claimed status as Ohio residents. It didn’t take me long to figure out that Florida had no income tax and it would benefit my wallet to become a Florida resident. I marched my Buckeye behind down to the Duval County Courthouse and declared Florida as my legal domicile. Then I took the certificates they gave me to my personnel office and they changed me over to Florida for pay purposes. Despite multiple moves, I retained my status as a Florida resident throughout my Navy career.

SCRA Protections are Limited.

Many servicemembers falsely believe the SCRA gives them total immunity from the taxing authority of the states in which they live and serve. This is simply not true. What the SCRA says is that the state can’t consider them a resident for tax purposes solely because they are stationed/posted there under military orders. This presumes the servicemember intends to return to their state of legal residence after their military career. If the servicemember (or spouse) takes other actions indicating they intend to stay in the new state, then that state can legally consider them a resident even if they are still serving in the military.

Let’s look specifically at Virginia.

Virginia uses the term domicile. Under Virginia tax law your domicile is the place where you permanently live, even if you are currently not residing at your domicile. It is the place you intend to return to at some point in the future. If you are a member of the armed forces and move to Virginia to comply with military orders you are presumed to maintain your legal domicile as indicated in your military records. In this situation, Virginia cannot tax your military income or your personal property.

There are things you could do, however, to change this situation. If you take actions consistent with establishing your domicile in Virginia, then Virginia has the legal right to declare you a resident of Virginia and make your military income subject to Virginia taxes.

While there is no precise formula for establishing a domicile in Virginia, the Tax Commissioner of Virginia has consistently used the following factors to determine whether or not a servicemember has crossed the line and established a Virginia domicile:

1. Obtaining a Virginia Driver’s License. This tends to be a showstopper. The Virginia Code section 46.2-323.1 requires all applicants for a Virginia driver’s license furnish a statement certifying they are a resident of Virginia. Furthermore, members of the armed forces stationed in Virginia are not required to obtain a Virginia driver’s license. Doing so is completely voluntary and shows strong intent to remain in Virginia.
2. Voter Registration. Another showstopper. Federal law requires all states to provide absentee ballots to military members who cannot be present in their home state to vote. To be qualified to vote in Virginia you must be a resident of the precinct in which you vote. Thus, a servicemember registering to vote in Virginia is committing a voluntary act that indicates intent to establish domicile in Virginia.
3. Maintaining Contacts in Your Home State. Do you still own property, have family, a business, registered cars, driver license, and maintain your voting registration in your home state? These indicate continued connections to your home state and intent to return there someday.
4. Other Indicators. Have you purchased property in Virginia, registered your cars in Virginia, or exercised other benefits of being a Virginia resident? These are not showstoppers, but may indicate a pattern of intent to remain in Virginia.

If your intent is to retain your residence in your home state outside Virginia, then you need to make an effort to maintain ties to that state. On the flip side, if you voluntarily make ties to Virginia, then Virginia has the right to claim you have abandoned your previous domicile and established a new domicile in Virginia – making you a Virginia resident subject to Virginia income taxes.

As always, if you have questions, please contact me.

03 July 2017

Tax Court(This could so easily have happened to one of my clients...)

Decisions of the US Tax Court are made available to the public online, and I read them whenever I get a chance. They are a great source of information on how the courts are interpreting the Internal Revenue Code, and I often learn things I can apply to the benefit of my clients.

All Tax Court opinions, memos, and summaries are formatted similarly. They start with a narrative on the pertinent facts of the case, discuss any evidence presented to the court, discuss the pertinent articles of the Internal Revenue Code and any precedents in case law, and then the Judge renders his or her judgment.

This format allows me to make a bit of a learning game out of reading the court documents. I can read the narrative of the case and try to predict how the judge will rule. After dozens of cases I am getting rather good at guessing the outcome, but I read one last week that I missed by a mile.

Taxpayers wind up in Tax Court because they dispute a determination of the IRS. In Tax Court the taxpayer is always The Petitioner – that is, the taxpayer initiates the case against the IRS by petitioning the court to hear their case. The Commissioner of the IRS is The Respondent. This arrangement exists because the IRS has told a taxpayer they owe taxes (and possibly penalties) and the taxpayer disagrees. After exhausting other options to get the IRS to stop trying to impose the taxes, the taxpayer has the right to petition the Tax Court to resolve the dispute.

However, with rare exceptions, the IRS is presumed to have determined the correct amount of tax on the taxpayer. Therefore, the burden is on the taxpayer to prove to the Tax Court the IRS has made a mistake.

In this case, the taxpayer, Mr. Z., was employed as an event organizer for a software company. He made a good wage travelling around setting up conferences and training seminars for his employer. In 2013, he got the idea to start a side business that would hold small film festivals in different college towns. There were a lot of startup costs and the idea was slow to catch on. For tax year 2013 Mr. Z claimed his new business on Schedule C of his individual income tax return, showing gross receipts of $690 and expenses of $32,747.

The IRS audited Mr. Z’s 2013 tax return and disallowed the $32,747 in business expenses because they determined Mr. Z’s activities were better classified as a hobby, not a business. Hobby losses cannot be written off against any income other than hobby income, so Mr. Z’s expenses in excess of $690 were disallowed. Mr. Z petitioned the Tax Court for relief.

After reading the narrative I was convinced Mr. Z had started a business (not a hobby) and would be granted relief from the IRS determination by the Tax Court. So convinced, in fact, that I skipped over the judicial arguments section and went straight to the end of the document to read the ruling. When I discovered Mr. Z had lost his case I scrolled back up to read more and find out how the Judge could come to such a different conclusion.

In the Opinion, Judge Guy lays out 9 points to ponder when determining whether an activity is a business or a hobby. They are:

1) Manner in which the taxpayer carries on the activity
2) Expertise of the taxpayer
3) Time and effort expended by the taxpayer on the activity
4) Expectation assets used in activity will appreciate in value
5) Taxpayer’s success in carrying on similar activities
6) History of income or losses with respect to the activity
7) Amount of occasional profits earned
8) Financial status of the taxpayer
9) Elements of personal pleasure

Judge Guy then goes point-by-point (for a dozen or so paragraphs) in creating a scorecard for Mr. Z with respect to each of these determining factors. (As there were no assets in the business to appreciate, point 4 was not considered.)

Remember, in Tax Court the burden is on the taxpayer to prove the IRS determination is not correct. In this case the IRS determined Mr. Z’s business was a hobby. Therefore, Mr. Z had to provide evidence to support his claim that his activities were a business and not a hobby.

Mr. Z was unable to provide such evidence. Like many of the small business owners I know, he did not keep good records. Judge Guy determined that only the amount of time and effort expended by Mr. Z (point 3) favored classifying the activity as a business. For everything else, there was insufficient evidence available to change the IRS determination the activity was a hobby.

Throughout the Opinion Judge Guy discusses the lack of records, business plans, profit projections, budgets, and the other documents business people are expected to produce when they start a business. Without those documents Mr. Z was unable to demonstrate his activities were those of a business. Without those documents Judge Guy was unable to change the determination of the IRS.

Most of the new business startups I see follow a similar pattern to Mr. Z. They have a good idea and they just want to run with it. The need to properly document their activities is barely considered. They do not generate budgets or business plans, and many are just horrible at keeping records. If the IRS determined their activities were a hobby instead of a business, they would not be able to provide sufficient evidence to get a Tax Court judge to overturn the IRS ruling. They could very easily find themselves in Mr. Z’s shoes, owing additional taxes and penalties years after they thought the matter was settled.

Mr. Z paid $13,028 in additional taxes and penalties for the luxury of not keeping good business records. How much are you willing to pay for that luxury? If your answer is $0, then you need to seriously consider getting professional assistance in establishing your record keeping standards and processes. You may need it to one day prove you are actually running a business.



Virginia Beach Tax Preparation adjusted basis in asset24 June 2017

My cultural reference du jour is a nod to Ms. Meghan Trainor’s very catchy 2014 tune about her backside. Whilst I have always been appreciative of such assets, this article is about appreciating assets of an entirely different nature. We are talking about assets that increase in value (specifically houses), making them taxable, and how you might mitigate or avoid paying the taxes on them altogether.

The first thing we need to do (after we stop with the 'basis' and 'assets' puns) is make sure we are all speaking the same language. I’m going to throw some words around and I want to make sure you know what I mean when I use them. I looked at the dictionary definitions, but I decided to explain these terms in my own words.

Appreciate – In this context appreciate means increase in value. If I say I have an appreciated asset that means I have an asset that is worth more now than when I acquired it.

Asset – that’s a thing I own that has monetary value. My house is an asset. My truck is an asset. My stock and bond funds are assets.

Basis – This is the dollar amount of your investment in the asset. This is often the purchase price of the asset – but not always. Sometimes things happen that adjust (change) your basis in the asset. (This can be confusing and it’s the reason I am writing this article.)

Capital Gain – When you sell an asset for more than you paid for it you have a capital gain.

Capital Gain Taxes - When I sell an asset that has appreciated I have a capital gain. Generally speaking, capital gains are considered income and are subject to income taxes. The tax rate on capital gains depends on the type of asset you own and the length of time you have owned it.

Depreciate – In this context depreciate means to decrease in value. It is the opposite of appreciate.

Fair Market Value (FMV) – The current value of the asset on the open market.

Tax Basis (or Taxable Basis) – This is your investment in the asset for tax purposes. This can be confusing because at times it appears to have nothing to do with the actual amount of your investment or the value of the asset.

Taxable Gain – Generally speaking, taxable gain is (Sale Price – Tax Basis)

Step-up in Basis – When someone dies all their assets are transferred to (inherited by) beneficiaries. The beneficiary’s basis in the inherited asset is the fair market value of the asset on the date the previous owner died. If the asset appreciated since it was acquired by the previous owner, then the beneficiary receives a “step-up in basis”.

Let’s Focus on Residential Real Property (like houses and condos).

As an asset class houses are large and complex. People tend to own them for long periods compared to other asset classes. They also do things with them that can change the tax basis of the asset. If a house owner improves the house (by, say, adding an additional room) s/he can increase their tax basis in the property. If the house owner uses the house in a business s/he can take a business expense for depreciating the property and lower their tax basis in the property.

While far from universal, houses tend to appreciate over time. Selling them generates a capital gain for the homeowner. Fortunately, Congress decided to give us a tax break on our homes. Capital gains up to $250,000 for single filers and $500,000 for couples filing jointly are excludable under section 121 of the tax code if the house is used as a primary residence.

Let’s look at a scenario in which these tax concepts come into play:

John and Mary purchased their house in 1971 for $80,000, and have lived in it ever since (original basis $80,000). They raised their 3 children in that house. In 1992 they spent $20,000 to add a mother-in-law suite so Mary’s elderly mother could move in with them. (Their adjusted basis is now $100,000 because they spent $20,000 to improve the property.)

Mary’s mother passed in 1998. John and Mary paid off the mortgage to the house in 2001 and now own it free and clear. By 2017 John and Mary are elderly and could use some assistance. Their house is now their most valuable asset, valued at $380,000. John and Mary want to stay in their house and would like their daughter Debbie to come over every day to help care for them. To entice Debbie they offer to transfer the house to her name.


There is a significant tax difference between transferring assets while you are alive and transferring them when you are dead. John and Mary’s tax basis in the house is $100,000. If they transfer the house to Debbie while they are still living, John and Mary’s tax basis transfers to Debbie. This house IS NOT Debbie’s primary residence. When she sells it she will have to pay taxes on any capital gain from the sale. If she were to sell the house for $380,000, her taxable gain would be $280,000. Even at the best capital gains tax rate, Debbie may owe somewhere in the neighborhood of $42,000 in taxes from the sale of the house.

If John and Mary want Debbie to receive the greatest possible financial benefit from the house they should keep it in their names and make sure it transfers to Debbie when they both pass. If they do that, when Debbie inherits the property she receives a step-up in basis to the FMV of the property as of the date of the last remaining parent’s death. Let’s assume this was still $380,000. If Mary has a tax basis of $380,000 and sells the property for $380,000, then she has no capital gain (and therefore owes no tax on the sale).

Let's continue with this scenario...

It’s 2020 and the house has appreciated to be worth $400,000. John and Mary have both passed and Debbie inherits the house with a step-up in basis to $400,000. Debbie sells the house to Paul for $400,000. Paul immediately places the house into service as a rental property. The county tax assessor has indicated that the value of the property is based on the land being worth $125,000 and the house being worth $275,000. Because the property is now being used in a business it can be depreciated for tax purposes. Per the Internal Revenue Code land does not depreciate, therefore the depreciable basis for the property is Paul’s basis in the building - $275,000.

For tax purposes residential real estate depreciates linearly over 27.5 years. Therefore, Paul is entitled to claim a $10,000 depreciation expense deduction for this rental property each year. Paul owns the rental property for 10 years and then decides to sell it. He never made any other capital improvements to the property.

Over the 10 years he has owned it Paul has taken a total of $100,000 of depreciation expense on this property. When he sells it he must adjust his basis in the property to reflect this depreciation deduction. His original basis was $400,000. With $100,000 of depreciation adjustments his adjusted basis is now $300,000.

Paul sells the property for $500,000. Paul has $200,000 of gains, but he actually has 2 different types of gains. The first $100,000 is essentially recapturing the depreciation expense. This is (confusingly) known as “unrecaptured section 1250 gain”. The second $100,000 of gain is a capital gain, and is taxed at the capital gains rate. (Paul never lived in this house, so he does not qualify for the section 121 exclusion.)

If you’ve read this far and your head hurts, you’re probably going to hate what I am about to say next. I have kept these examples very simplistic to highlight some of the concepts used in adjusting basis. I wanted to keep the math easy. In reality, there are several additional factors (such as selling/buying costs) that would need to be considered when figuring the adjusted basis on a house.

These can be difficult concepts, but they are also very important. The value of a house is typically significant relative to the total of a person’s assets. House sales can also have significant tax implications, so you want to make sure the basis is correctly calculated and you are paying the correct tax bill each year. As always, if you have questions, call me.



17 June 2017

Virginia beach tax preparation avoiding penaltiesUsing tax-advantaged accounts (IRA, 401k, 403b, TSP, etc.) is a great way for most Americans to prepare for their retirement. You can either take a tax break now (traditional) or enjoy your tax break later (Roth). If you have a plan sponsored by an employer you may be able to receive some matching money from the company or agency you work for to increase your retirement savings. That can help you achieve the goals of your retirement plan even faster.

Unfortunately, life does not always cooperate with our plans. Some people find it necessary to tap into their retirement accounts to pay for things prior to retirement. Medical expenses, divorce, accidentally over-contributing to an account, college tuition – if you can think of an expense, someone has probably had to tap into their retirement account to pay for it.

Congress generally imposes a penalty for using retirement funds to pay for non-retirement expenses. Not only do you have to pay income taxes on your tax-deferred withdrawals as though they are regular income, but there is also a 10% penalty tax on top of that. I’ve seen firsthand how shockingly fast those taxes can add up. (There’s a reason I keep a box of tissues on my desk.)

Our government of the people, by the people, and for the people is not completely heartless, however. Congress has made exceptions to the 10% penalty for some pre-retirement withdrawals. But...in typical Congressional fashion, those rules are not uniform. They vary depending on the type of expenditure and the type of account the money comes from. I study taxes for a living and I have a difficult time keeping them straight. That’s why I made the chart below – so I can keep track of when a retirement account distribution is going to trigger a penalty tax.

The chart covers traditional retirement plans only. Roths are different, and more straightforward. The only difference is whether your Roth account is sponsored by your employer (Roth 401(k), Roth 403(b), Roth TSP) or if it is a Roth IRA. In both employer-sponsored Roths and Roth IRAs you receive no tax benefit for the money you contribute to the account. Therefore you can also take it out without paying taxes on it. It’s like putting money into your bank and then taking it out – you don’t pay tax on the deposit or the withdrawal. The catch is that you must have owned the account for at least 5 years before you make the withdrawal. While it works like a bank, the government does not want you using it like a bank. And remember – you can only take out your contributions tax free. Any earnings or profits withdrawn for non-retirement expenses are going to get you the 10% penalty tax.

This brings us to a difference between employer-sponsored Roths and Roth IRAs. With a Roth IRA you can stipulate that you are withdrawing only contributed money. With an employer-sponsored Roth you cannot. Your withdrawal will be part contribution and part earnings, and the earnings part will be subject to taxation if they are deemed not qualified.

For traditional retirement accounts refer to the chart below. I tried to keep it simple, but it is a complex problem that does not readily lend itself to simplification.


Your Situation

Employer Plans (401(k), 403(b), etc.)



You are at least 59 1/2 years old when you withdraw.

No Penalty

No Penalty


You were automatically enrolled in a plan and you didn't want to participate, so you withdrew your money

No Penalty

No Penalty for SIMPLE IRAs and SARSEPs


You contributed more than you were allowed to your account and you withdrew some before the deadline

No Penalty

No Penalty


Original account owner dies and you inherit it.

No Penalty

No Penalty


You have become totally and permanently disabled.

No Penalty

No Penalty


Money is withdrawn due to the property settlement of a divorce (Qualified Domestic Relations Order)

No Penalty

Not Applicable


You use the money to pay for college (or other qualified higher education)

10% Penalty

No Penalty


You establish and receive a "series of substantially equal periodic payments" from your account

No Penalty

No Penalty


Dividend pass through from an ESOP

No Penalty

Not Applicable


Up to $10,000 for Qualified First-time Homebuyers

10% Penalty

No Penalty


The IRS forces you to take a distribution to pay a tax bill (IRS Levy)

No Penalty

No Penalty


You used the money to pay unreimbursed (no insurance coverage) medical expenses that exceeded 10% of your AGI

No Penalty

No Penalty


You used the money to buy health insurance while you were unemployed.

10% Penalty

No Penalty


You were a military reservist called to active duty for more than 179 days and you made the withdrawal during the time you were called for active duty

No Penalty

No Penalty


You decide to withdraw your IRA contribution before the due date of the tax return

Not Applicable

No Penalty


You withdraw the EARNINGS on an IRA contribution

Not Applicable

10% Penalty

You withdrew the money and then contributed it to another qualified account as a qualified rollover within 60 days of the withdrawal.*

No Penalty

No Penalty


Employee takes withdrawals after he or she separates from service (quits/retires) during or after the year the employee reaches age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan)

No Penalty

10% Penalty


Probably the most important thing I can tell you is that if you have questions – ask! And ask BEFORE you take money out of your retirement account. Once you make the withdrawal you nearly always have to live with the consequences. Give me a call if you have questions. 

 * This is also known as an indirect rollover. You can only do 1 indirect rollover per 12-month period. If you do more than 1, then you are going to pay taxes and penalties on the subsequent withdrawals. 


virginia beach tax prep rental placed in service

03 June 2017

I see a lot of landlords during tax season. One of the things they frequently have trouble understanding is when their rental property is “placed in service” and/or “taken out of service”. I thought I would write a quick article to address this issue because using the wrong date is costing taxpayers money.

As a depreciable business asset a rental property is placed in service whenever it is placed in a state of readiness and availability for use in the taxpayer’s trade or business (Brown vs Commissioner, TC Memo 2009-171

Notice that the definition of placed in service does not include used in the trade or business in the definition. The property does not have to be rented to be in service, is just has to be ready and available. For residential rental properties this typically means the date the property was made available to be rented. You can use the date the property was first advertised for rent as the placed in service date. If you use a property manager you can use the date the property management company was contracted for service.

For example, Jimmy placed a ‘for rent’ sign on his property on May 1. On August 7 he signed a lease with, and received his first rent check from, his first tenant. Jimmy’s property was placed in service May 1.

I often see do-it-yourself tax preparers use the date the property was rented as the date it was placed in service. This is costing them money. If Jimmy was preparing his own taxes and he used August 7 as the date the property was placed in service he would have needlessly deprived himself of 3 months of rental property expense deductions for the tax year the house was placed in service.

The placed in service date is also important in determining the tax treatment of certain items of repair and upkeep. Repairs made before a property is placed in service are classified as ‘capital expenditures’. These must be added to the depreciable basis of the property and deducted as depreciation expenses over the lifetime of the property – 27.5 years. Repairs made after a property is placed in service are considered business expenses and can be deducted in the year they are accomplished.

Let’s look at two similar scenarios.

Mary bought a house and placed it in service on April 1. On April 15 she replaced one of the windows in the house. The window replacement cost $400. Because the window was replaced after the property was placed in service Mary can deduct the entire cost of the window on the tax return for the year the window was replaced.

Ed buys a house on April 1. He replaces one of the windows on April 5. The cost of the window replacement was $400. On April 15 Ed places his property in service as a rental property – meaning he made the unit available to be rented. Because the window was replaced before the house was placed in service the cost of the window must be capitalized and added to the depreciable basis of the property. Residential rental properties depreciate over a 27.5 year period. Ed can only deduct $10.30 for the window in the year he had it replaced (($400/27.5)(8.5/12)). The rest of the cost of replacing the window can be deducted over his next 27 tax returns.

Judging from the reactions of some of my clients, Ed is likely to find the tax treatment of his window replacement highly irritating. He is going to wish he had known to place his rental property in service prior to the replacing the window.

Don’t try to get fancy, though. You can’t buy a property, place it in service, and then gut the kitchen for a two-month remodeling project. Remember – part of the definition of placed in service means placed in a state of readiness. A house with no kitchen cannot reasonably be considered to be in a state of readiness.

Taking a property out of service follows a similar logic, but in reverse. When the property is no longer available or ready to be a rental property it is no longer in service. Often people will use the last date the property was actually rented as the last day the property was in service, which can cause them to short themselves on their tax return. Another example:

Terry and Tina have a residential rental property. The tenants move out on April 30. They advertise the property for rent, but they do not acquire new tenants. Frustrated with their experience as landlords, they sell the property on October 15.

The property was taken out of service the day it was sold, October 15. Even though Terry and Tina had the property for sale before that date they also had it available to rent. If they had acquired tenants before buyers they could have easily delisted the property for sale. If Terry and Tina had said the last day the property was in service was April 30 they would have missed the opportunity to claim the rental property deductions for 5.5 months of the year the property was sold. This could result in them paying more taxes than necessary.

There are significant tax benefits to owning residential rental property. There are also some ‘tips and tricks of the trade’ you should know to maximize the tax benefits available to you as a landlord. If you are unaware of those tips and tricks, please give me a call. I am always happy to discuss your situation.

Virginia beach tax prep military turbo tax28 May 2017

Flip Wilson was one of my favorite comedians of the 1970s. From 1970 - 1974 he hosted his own prime time comedy TV show. I used to beg my mother to let me stay up late enough to watch it. Each episode of the show consisted of several sketches featuring characters Wilson created and portrayed. One of his most popular characters was a sassy woman named Geraldine Jones, whose never seen boyfriend "Killer" was invariably in jail or at the pool hall.  It was always the Devil's fault for whatever predicament Geraldine found herself in - and she was always in some predicament. Geraldine saying "The Devil made me do it" became such a popular character and catch phrase that Flip Wilson released a comedy album as Geraldine Jones titled "The Devil Made Me Buy That Dress".

I sometimes think about Geraldine Jones when I am reviewing the self-prepared tax returns of a new client. I will see something unusual - something I think may be wrong, so I will ask the new client why they claimed a deduction or credit for which they don't seem to qualify. Most common answer: Turbo Tax let me claim it.

I envision this person sitting in front of their computer screen, reading a question from the Turbo Tax interview, not really sure of the meaning. They read the question 3 or 4 times hoping the lightning bolt of clarity will magically strike. Getting bored and frustrated with both the question and the tax preparation process in general they decide on a meaning and plug in an answer. If Turbo Tax takes it they must be OK - right?

Many taxpayers mistakenly believe if the tax software (Turbo Tax being the most commonly used) allows you to claim a deduction, then it is OK to claim it. This belief is categorically NOT TRUE. Some even believe if the tax software allows it, then the tax software company is liable for any mistakes on the tax return. Again - NOT TRUE. The taxpayer is solely responsible for the contents of the tax return they file. (You may be able to purchase additional insurance from your tax software company, but that doesn't mean you aren't responsible for you tax return. It just means you can get compensated by the tax software company if you're being held responsible.)

The Tax Court has ruled on this issue many times, the most commonly cited case being Bunney vs Commissioner from April, 2000.  Mr. Bunney had taken early distributions from his IRAs, but had not reported them on his tax return. He also claimed deductions to which he was not entitled. He was assessed the tax, the 10% early withdrawal penalty tax, plus an additional 20% negligence accuracy-related error penalty. Mr. Bunney petitioned the court for relief from the 20% negligence accuracy-related penalty because he had a "complicated return" for which he used tax software. The court ruled against Mr. Bunney stating, "Tax preparation software is only as good as the information one inputs into it."

A more recent attempt (Bulatikes vs Commissioner, May 2017) ended with the same result. Mr. Bulatikes claimed deductions to which he was not entitled. To avoid the accuracy-related penalties he blamed Turbo Tax. He received the same result as Mr. Bunney - the court upheld the finding of the IRS that the use of tax software does not provide a reasonable basis for claiming deductions to which a taxpayer is not entitled.

I think the most common software-induced error I see locally is the deduction of vehicle registration fees on the federal tax return. The IRS allows you to deduct any taxes you paid on personal property that are based on the value of the property. In some states the cost of annual vehicle registration is based on the value of the vehicle being registered - making the cost of registration deductible on your federal tax return. Virginia IS NOT one of those states. In Virginia the cost of registration is determined by vehicle class, NOT vehicle value. Therefore, the vehicle registration fee paid to Virginia is not deductible on the federal return.

Several times this past season I was confronted by taxpayers who were certain their Virginia vehicle registration fees were deductible items on their federal tax return. In each of these cases I heard the argument "Turbo Tax has let me do it for years." The implication being if Turbo Tax allows it, then it has to be correct. Not true.

Turbo Tax allows it because in some states the vehicle registration can be deducted. Virginia just isn't one of those states.  It is the responsibility of the taxpayer to know whether or not the vehicle registration for their state meets the criteria for a federal deduction. A trained and experienced tax professional (such as an enrolled agent) can add significant value when you don't know all the answers yourself.

If you still want to tackle your taxes on your own, just remember - Turbo Tax made me do it will not get you off the hook with the IRS!



16 May 2017

virginia beach tax preparation errorI didn’t really “fire” the last CPA I used to prepare my taxes, but it was clear from our final conversation that he was not going to be rehired the next year. I had already determined I should be getting more for my $700 than access to someone I had to teach how to prepare my tax return.

He was a poor communicator, which made him a horrible fit for someone providing me a service. I tend to have a lot of questions about my money, and since my taxes are my money, I had a lot of questions. He didn’t want to talk to me at all. I don’t think it was just me. I don’t think he liked to see any of his clients. He had me upload my documents to a web portal early in the tax season. When I went to pick up my completed return (the first time) it was waiting for me with his receptionist. A big fat envelope with my tax return in it and the signature sheets (and my bill) stapled to the outside. The receptionist showed me where to sign and asked how I’d be paying. I wasn’t offered the opportunity to review the return. I wasn’t even offered a chair. Sign here. Pay up. Get out.

Not my style.

I opened the envelope and my eyes went straight for the bottom line. Right away I knew something was wrong. My income was similar to the previous year, but my tax bill was considerably higher. It took me about 2 minutes to find the error. I showed the receptionist, who was, of course, clueless. The CPA was too busy to see me then, so I left a note about the error and left everything with the receptionist.

He emailed me later that day to tell me the tax return was correct – that the error I found was not an error. I emailed him back a link to the IRS pub explaining the IRS rules on the matter. He waited a day and then agreed the return needed to be corrected.

A few weeks later I went back to sign the corrected return. Once again it was waiting for me with the receptionist. I checked to be sure the error was corrected. It was, and the bottom line on my tax return looked like a reasonable number. I signed the e-file authorization forms and then looked at the bill. He had added $125 for fixing the error on my tax return.

I told the receptionist there was no way in H377 I was going to pay an additional fee for finding a mistake and having it corrected. She was again clueless. The CPA was again too busy to see me. I again left a note. I took the e-file forms with me and left everything else. He e-mailed me later to say he had subtracted the extra $125 from my bill. A few days later I went back and finished the signing-and-paying procedure. The CPA’s door was open this time, so I stuck my head in to make sure he knew exactly where our client-practitioner relationship stood.

That was many years ago, but that story came back to mind recently as I was reviewing a tax return with a client. A very nice seasoned citizen, she had had her taxes prepared by a CPA firm for many years.  She was looking for a change, and her financial planner recommended me. I was showing her how her adjusted gross income was calculated when she interrupted me:

Client: What you’re doing is remarkable.

Me: What’s that?

Client: Explaining my taxes to me. No one has ever done that before.

It was her use of the word remarkable that stuck in my head later. Remarkable? That indicates I was doing something out of the ordinary. A tax preparer explaining someone’s tax return to them before asking them to sign it ought to be altogether ordinary. The tax payer is responsible for the contents of the return no matter who prepared it. They need to at least be a little familiar with its contents.

I also like to review a tax return with a client because we make a formidable team when we go over a tax return together. I am an expert on taxes. You are an expert on you. Those two things merge on your tax return. Going back to my CPA story, I was able to see something was amiss with my tax return almost immediately the first time I reviewed it because I knew it was very different from my prior year return. That was knowledge the CPA lacked (although he had a copy of my prior year return).

Reviewing the return with the client also gives us the opportunity to discuss tax planning strategies for the coming year. Sometimes it even segues into a general financial planning discussion, allowing me the opportunity to recommend some additional services to the client.

Also – and I hate to admit this – clients make good proofreaders. I type thousands of social security numbers and birth dates each tax season. I have a process to catch my typos, but even so a few sneak by. I much prefer having them caught by the client when we review than to have a return bounced by the IRS because the data was entered incorrectly.

It got me wondering why a tax preparer would prefer not to review a tax return with the client. My only explanation is it’s a money issue. I read tax professional practice management articles, blogs, and forums online. Some tax pros are reporting staggeringly high numbers of tax returns completed in a season. They must forgo reviewing the return with the client in order to attain such a high volume of tax returns. That’s not how I want to operate, but if their clients are satisfied I suppose there is no harm being done. 

On the other hand, the client might just find it remarkable to have their tax return explained to them.


28 April 2017

Virginia Beach Tax Preparation military mistakesTax 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.





Information in the Tax Blog is current as of the day it was posted. Tax laws change frequently, and it is likely that as time passes acts of Government will make some of the older blog content out of date.

The information provided is for education purposes only. It is general in nature and may not pertain to the Reader's situation. Every taxpayer's circumstances are unique. Reader's are urged to do some research or talk to a tax professional before acting on any of the information posted in this blog.

Paul D. Allen is a founding member of the Military Financial Advisors Association, as well as a 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 XY Planning Network. Paul is the Director of the CFP Board-Registered Program at The Regent University School of Law where he also teaches the Capstone Course in Financial Planning. You can read more about Paul's background here.


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Common Acronyms

ACTC - Additional Child Tax Credit

AGI - Adjusted Gross Income

AMT - Alternative Minimum Tax

APTC - Advanced Premium Tax Credit

AOC - American Opportunity Credit

CTC- Child Tax Credit

EIC - Earned Income Credit

HoH - Head of Household

LLC - Lifetime Learning Credit

MFJ - Married Filing Jointly

MFS - Married Filing Separately

MAGI - Modified Adjusted Gross Income

PIM - Plan of Intended Movement

PTC - Premium Tax Credit

QC - Qualifying Child

QHEE - Qualifying Higher Education Expenses

QR - Qualifying Relative

QW - Qualifying Widow(er)


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