Welcome to the Tax Blog

17 June 2017

Using 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.

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. 

• Retirement Planning
• Common Tax Mistakes

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.

• Business Deductions
• Residential Real Estate Deductions
• Common Tax Mistakes

28 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!

• Tax Preparation Business
• Schedule A Deductions
• Virginia State Taxes

16 May 2017

I 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.

• Tax Preparation Business
• Common Tax Mistakes

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.

• Tax Preparation Business
• Residential Real Estate Deductions
• Tax Penalties
• Common Tax Mistakes