Document Those Receipts

If your only income is through salary, dividends, interest, etc. you probably will have few worries about the IRS asserting you have unreported income. But if you or your spouse have a business, you've got to be able to document amounts received that are not business income.

For example, your spouse has a consulting business. You're taking a trip to a Germany and agree to purchase six cuckoo clocks for a friend for a total of $4,000. You use your credit card and upon returning your friend reimburses you the $4,000. You're later audited and the IRS claims the $4,000 you deposited in your personal bank account was unreported income from your business.

The first question is will you even remember what the $4,000 was for? If you pass that test, can you prove it? There are many income sources that may be difficult to prove; some are easy. A loan from relatives for your business. The repayment of a loan you made to your neighbor to start a business. The proceeds of a yard sale. The sale of an inherited art work.

At a bare minimum make some sort of diary entry to describe the source of the income. Copy the check before depositing the money. Retain any documentation such as a note that substantiates a loan, a bill of sale for an item, etc.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Is That 1099-C Correct?

In McCormack v. IRS, T.C.  Memo 2009-239, the Tax Court ruled that the IRS cannot rely on merely the fact that a Form  1099-C has been issued by a creditor, when the taxpayer has  made a good faith dispute of the amount due and owing, and there is then  a settlement reached between the parties to that dispute. 

The IRS must  do more than rely on the amounts set forth in the Form 1099-C.  Under  IRC Section 6201(d), in any court proceeding, if a taxpayer asserts a  reasonable dispute with respect to any item of income reported on an  information return and has fully cooperated with the IRS, the burden is  then on the IRS to produce reasonable and probative information  concerning a deficiency, in addition to the amount identified on the  information return. 

In the case, the taxpayers asserted reasonable  disputes as to the amounts reflected on Forms 1099-C, and the IRS failed  to produce reasonable and probative information independent of the  third party information returns.

While not at issue in the McCormack case, taxpayers need to know that there is a provision in the tax law  providing taxpayers with the right to be protected against the  fraudulent issuance of information returns.  Under Internal Revenue Code Section 7434 of the  Internal Revenue Code, civil damages can be assessed if any person  "willfully files a fraudulent information return with respect to  payments purported to be made to any other person."  Damages recoverable  are equal to the greater of $5,000 or the sum of any actual damages  sustained by the taxpayer as the proximate result of the fraudulent  information return, including any costs attributable to resolving the  deficiencies asserted as a result of such filing, plus the costs of the  action, and in the court's discretion, reasonable attorney's fees

Kenneth Hoffman of K.R. Hoffman & Co., LLC is a highly sought after tax and business counselor. Counseling Entrepreneurs, Professionals and Select Individuals who are struggling with ever changing tax laws and who are paying too much in taxes. All the while he is protecting his clients from the IRS and other taxing authorities using proactive tax planning strategies, ensuring compliance with minimal tax liability.

Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday between 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you. 

Green Apple

For 20 years now, Apple has blazed a reputation for stylish design and innovative products, creating a near-cult following among fans. Apple's computers appeal to the artists and designers who set so many of today's trends. Their iPod has helped change how the world listens to music. Their iPad has made online content available nearly anywhere. And their iPhone is helping change the way we communicate with friends, family, and colleagues. (Just a few years ago, your mother-in-law didn't have a cell phone. Now she sends text messages and "checks in" on Facebook.)

Apple may be the most successful company on earth. At one point last year, they had more cash on hand ($76.2 billion) than the United States government ($73.8 billion). And Apple is currently the most valuable company on the planet, with a "market cap" (total value of tradeable shares) that topped $590 billion dollars on April 10. (That's right . . . those iTunes you casually download for a buck each have created a company worth over half a trillion dollars.) In fact, Apple's current market cap is more than the gross domestic products of Iraq, North Korea, Vietnam, Puerto Rico, and New Zealand -- combined.

But Apple's most recent annual report reveals the company's genius for creating successful marketing strategies also extends to successful tax strategies. How else would you describe a strategy that lets Apple earn billions and pays less than 10% of their taxable income in tax?

How do they do it? Largely by keeping the money they earn outside the United States, outside the United States. Apple owns subsidiaries in tax havens like Ireland, the Netherlands, Luxembourg, and the British Virgin islands. They helped pioneer the "Double Irish with a Dutch Sandwich" strategy that hundreds of other multinational companies have imitated. Apple even maintains a subsidiary in tax-free Nevada -- the blandly-named "Braeburn Capital" -- to manage that enormous cash haul without paying tax in its home state of California. For 2011, the company paid a worldwide tax of $3.3 billion on $34.2 billion of profit. But one study concludes that Apple would have paid $2.4 billion more without these rules.

Now Apple has become part of the political debate. At the risk of grossly oversimplifying a pretty complicated discussion, Democrats in Washington scoff that taking an extra $2.4 billion in tax last year would have squelched Apple's creativity. Republicans reply that using the cash to grow the business or distribute more dividends to shareholders will grow the economy faster than if it goes to the IRS. Both President Obama and presumed Republican nominee Mitt Romney have called for eliminating corporate tax loopholes in order to pay for lower rates (28% in President Obama's plan, 25% in Governor Romney's). Either way, Apple is likely to become one of the stories -- like Warren Buffett paying a higher tax rate than his secretary -- that come to define this year's campaign.

Taxes always play a part in Presidential races. But this time, with the economy still struggling and the Bush tax cuts scheduled to expire in a few short months, taxes will be even more important than usual. Our job, as November approaches, includes helping you understand just what the candidates' proposals mean for your bottom line. So keep up with these emails -- and if you're curious how any of the proposals you hear about would affect your plan, call us!

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Business Recordkeeping

In David A. Olagunju et ux. (T.C. Memo. 2012-119) the taxpayer was denied deductions for a number of items because he could not substantiate the deductions.

The Court disallowed travel expenses for one of the taxpayer's businesses between New Jersey and Washington because the taxpayer owned houses in both locations and he did not show the business reason for the travel to Washington. The Court disallowed a deduction for checks written to organizations where there was no clear business purpose. The Court disallowed rent expense where the taxpayer could not produce a lease on the premises.

The Court also questioned the credibility and authenticity of the taxpayers' cash receipts where the handwriting on them matches the handwriting on some other receipts issued by different vendors. The Court also disallowed certain other handwritten invoices.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Removal of Tax Lien From Credit Report

New IRS procedures allow for the taxpayer to file an Application for a Withdrawal of a Federal Tax Lien (Form 12277) after the debt has been paid in full. 

The advantage of a Withdrawal, rather than merely a Release, which is always filed when the tax is paid, is that from a credit standpoint, the Withdrawal acts as if the Federal Tax Lien was never filed in the first place.  The removal of the Federal Tax Lien from your credit report should increase your overall credit score.

There is a specific way the form should be completed.  If you have a Federal Tax Lien on your credit report, please contact us.

K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes and understand their financial affairs. Discover how we can help you with your business and tax challenges; call me at (954) 591-8290 or drop me a note.

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Expense Documentation

We've often mentioned the importance of adequate documentation to substantiate a business deduction. Ideally you should have a canceled check and an invoice marked paid with the serial number of the item purchased. While that may be viable for certain big-ticket assets, realistically, that's not often the case for most expenses. And the IRS knows that. There are many other ways to document expenses that are acceptable. However, you should be able to show that payment was made (e.g., a canceled check) and the nature of the item purchased (e.g., an invoice with a description of the item).

 Travel and entertainment, auto expenses and charitable contributions. There are separate rules for these items, and they're very strict. I won't deal with them here. They'll be detailed in an upcoming blog post.

Canceled check. The check should have the payee and should show the cancellation on the back. Why the cancellation? In the case of large or unusual purchases, the IRS may check that the payee actually cashed the check.

Checks not returned. Many businesses (and individuals) no longer have their checks returned. The IRS will accept images of the check. In order to be accepted as proof of payment, the statement must exhibit a high degree of legibility and readability. If your bank doesn't send you hard copies of the images, you should be able to download PDF copies of the checks. Don't rely on the bank to save statements and check images. After a certain period of time you may not be able to retrieve them without cost. Download statements and images each month. (That's good advice for other statements where you may no longer receive hard copies such as telephone bills, etc.) You may also be able to show proof of payment by providing:

• an invoice marked "paid",
• a check register or carbon copy of the check, and
• an account statement that shows the check number, date, and amount.

An account statement prepared by a financial institution showing check clearance will be accepted as proof of payment if the statement shows:

• the check number,
• the amount of the check,
• the date the check amount was posted to the account by the financial institution, and
• the name of the payee.

Credit/debit cards. If payment is made using a credit card, the IRS requires that you have an account statement that shows the amount of the charge, the date of the charge (i.e., transaction date), and the name of the payee. If payment is made using a credit card, the IRS requires that you have an account statement that shows the amount of the charge, the date of the charge (i.e., transaction date), and the name of the payee. Most likely your credit card company is already mailing you these statements monthly. Cards specifically designed for business like American Express business credit cards will also provide year-end summaries. Note, this will only provide proof of payment.

Electronic funds transfer. If you transfer funds electronically, the IRS will accept an account statement prepared by a financial institution showing an electronic funds transfer as proof of payment if the statement shows:

• the amount of the transfer,
• the date the transfer was posted to the account by the financial institution, and
• the name of the payee.

Invoice. You must have an invoice or other documentation showing what you purchased. A canceled check without an invoice or some other document showing the item purchase could be a problem. Statements from a supplier may be substituted, but only if they show the item. Fortunately, since most businesses are computerized, a supplier could generate a duplicate invoice if an agent insisted on seeing one. But it's best not to rely on that. When paying invoices, write the check number and amount paid on the invoice and the invoice number on the check so that you can cross reference them later if necessary.

Save all invoices. Don't assume the IRS will accept a check written to the telephone company without an invoice. The check could have been for payment of your personal line.

What about independent contractors? Even for small jobs, ask for an invoice. In addition, make sure you give the party a Form 1099, if applicable. No 1099? You could lose the deduction or be subject to penalties. What about those cash payments to some contractors? No invoice and no record of payment probably could mean no deduction.

Cash register tapes. You go to the local hardware store to purchase some fasteners for the business and get only a cash register tape with no details of the items purchased. Will it fly? If the total is relatively small and it's not a common occurrence, and agent should accept it. Write a description of the items on the slip--1 gallon paint for repainting wall; bolts for shelving. Fortunately, most stores now print the detail on the tape.

Caution on tapes. Many businesses, including major big box retailers, use heat sensitive tape to print receipts. The life can vary widely from less than 1 month under poor conditions (the glove box of your truck) to several years under good conditions. Don't take a chance. Make photocopies of the tapes.

Reasons for purchase. The business purpose of most of your purchases may be obvious. An agent is unlikely to question a laser printer cartridge, a computer, a book on how to use a computer program, etc. But be prepared for questions if the invoice or tape shows the purchase of items that normally wouldn't be business related or could be personal as well as business. For example, the purchase of a book with no clear business relationship, power tools by a computer consulting business, etc. Don't take a chance on remembering the reason several years later when you're audited. Write the business reason on the receipt or attach a description to the receipt.

Avoid personal purchases through the business. It's convenient to use a company check or credit card to purchase personal items. Resist the urge. Your accountant may spend time making the entries to adjust your expenses. If he doesn't or misses some that an agent catches, the agent might increase his scrutiny of all your expenses. You could be liable not only for additional taxes and interest but also an accuracy-related penalty. In flagrant cases the IRS may claim fraud, particularly if other indications are present.

Checks made to cash. While you should try to avoid them at all cost, that's nearly impossible. The larger the amount, the more careful you should be. Be sure to indicate on the check what the purchase was for. This is one time when an invoice can be critical. An invoice marked paid in full would certainly help your position.

Cash expenses. Some expenses will be so small that an invoice or even a cash register tape is impractical. You may also be paying in cash rather than by using a check or credit card. Keep a diary showing the date, place, amount, and description of the item purchased or service obtained. For example, "11/20/12, Madison Hardware, $6.25, nuts and bolts for shelving".

Business standards for documentation. Any invoice, contract, etc. should be up to industry standards. For example, a receipt from a local deli for sandwich platters for the office party may be scribbled on an invoice without a number (it should, of course, be dated). But an invoice for a collision repair on the company truck should contain detailed parts and labor, since the shop normally does that for insurance purposes.

Other documentation. You should also retain other documentation that might be used in addition to or in place of an invoice. For example, a contract for services, lease on equipment or office space, warranties on equipment, service contracts, etc.

Petty cash. If you keep a petty cash fund, slips showing expense reimbursements should be sufficient to document the expenses. That's assuming the expenses are small, as one would expect. Make sure that the nature of the expense is clear from the slip. Employees should check that and, if not, write on the slip the type of expenses and the vendor.

Expense reports. We're not talking travel and entertainment here. It's not unusual for an employee to purchase office supplies, small equipment, shop supplies, maybe even items to be used on the manufacturing floor that may be critical. Officers and especially officer/shareholders often pay company expenses out of their own pocket. While it's best to avoid such situations, that's not always possible. The correct procedure is to have the employee file an expense report and attach the documentation. The company should then cut the employee a check for the amount documented. For example, you need a color printer for a rush job. An employee buys an inkjet printer with his own credit card. He should file an expense report and attach the credit card slip and any other documentation from the store.

This can be especially critical when it comes to an employee/owner/shareholder. Without the expense report the company can't take the deduction because it didn't pay for the item; the employee/owner can't take the deduction because it's not a valid deduction. Special rules apply to partnerships and there's an exception if the business has a policy of not reimbursing. Talk to your tax advisor.

Cohan rule. The last resort. It's called the Cohan (Cohen vs. Commissioner, 39 F. 2d 540 (2d Cir. 1930)) rule because it evolved from a court case where the taxpayer was George M. Cohan. Cohan claimed travel and entertainment expenses for which he had no receipts. The court allowed him a deduction based upon the fact he was able to convince the court he incurred expenses but did not have proof of payment or the actual amount. Ironically, this rule cannot be applied to travel and entertainment expenses any longer. Now if required, no receipt, no deduction, no exception for those expenses.

How does the Cohan rule work today? If you can show you definitely incurred the expenses and are entitled to a deduction but don't have the receipts or proof of payment, the court may allow a deduction based on an estimate. But there has to be some basis on which the court can make the estimate. For example, you have no receipts to prove your fuel oil expense for 2012 because you inadvertently destroyed the bills. In addition, the company went out of business. Clearly you incurred some charges to heat your building. The court may estimate the expense based on an average of fuel bills for several years.

This is a last resort for a number of reasons. First, you may have to go to court to get the deduction. Second, the court is almost assuredly going to try and underestimate the amount of your deduction. Third, the rule will probably not be applied if you have access to the documentation but don't produce it (e.g., you could ask a vendor to produce the necessary statements, even if it cost you). Fourth, you'll still have to convince the court you incurred the expenses. It may believe your testimony; it may not. You'll be on safer ground if you have some corroborating evidence.

Finally, the court is under no obligation to assist you. Even if your records are destroyed through no fault of your own (e.g., a fire), the court can require you to reconstruct. You'll fare better if you can show the lack of records either isn't your fault or, if it is, there are extenuating circumstances. For example, you normally have excellent documentation but telephone and utility bills for one year were inadvertently discarded.

Corroborating witnesses. Sometimes you can convince the IRS or the court you incurred the expenses by producing witnesses. That may work, but if the witnesses aren't convincing or the court believes the testimony may be biased (they're employees or relatives), it doesn't have to accept their testimony. And that happens in a high percentage of cases. Again, not an approach to rely on.

Too much paper? In many cases you don't have to save paper copies. Electronic versions of statements received from vendors or others will normally suffice, but they must be readable. You can also scan documents and save them as electronic copies. If the documents are signed (e.g. a lease), you might want to retain an original copy. And consider retaining hard copies of important asset purchases. Contact us if you have questions or if you want to implement a paperless office.

Retention time. You may have heard hold canceled checks and other documents for 3 years, but it's more complicated than that. Technically it's three years from the date you filed the return. But if the IRS suspects you underreported your income, it can go back 6 years. If it believes fraud is present, there is no limit. For assets such as autos, equipment, etc. you should retain all documentation for at least 3 years after the asset is disposed of. And longer retention periods can apply to employment records. If you need a single rule of thumb, use a 7-year holding period for most records. But the best approach is to check with your tax adviser.

Documentation vital. Based on an informal analysis, it appears that more taxpayers lose in Tax Court because they can't substantiate their expenditures than for any other reason. While the IRS sometimes does show some flexibility, it's generally a stickler for records and can disallow the smallest expenditure for lack of them.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

2012 Tax Campaign Preview

Here's some more news from the campaign trail that may affect your taxes. On April 9, former Pennsylvania senator Rick Santorum suspended his campaign for the 2012 presidential race. This move effectively clears the way for former Massachusetts governor Mitt Romney to assume the Republican nomination.

Romney has made taxes a centerpiece of his campaign, and we expect to see even more attention focused on the issue as November draws near:

• Romney would make the Bush tax cuts permanent.

• He would cut top rates to 25% for both individuals and corporations.

• He would eliminate tax on interest, dividends, and capital gains for taxpayers making under $200,000.

• He would eliminate the estate tax entirely.

• He would eliminate the Alternative Minimum Tax (AMT) as well as new taxes imposed by the 2010 healthcare reform legislation.

Most tax professionals see their clients just once a year. But we realize that this year's Presidential race will have a major effect on your taxes. So we're committed to tracking both candidates' tax proposals, letting you know how they affect your wallet, and offering proactive suggestions to plan for tax law changes. We're not here to take sides. We just want you to know we've got your back.

We'll be following the race carefully through November and beyond. So, if you have questions, don't hesitate to call us at 954-591-8290.

A Dubious Privilege

The "Occupy Wall Street" movement argues that we live in a divided nation. First there's a gilded "1%" enjoying lives of ease and privilege. Then there's a downtrodden "99%" struggling just to stay in place. But here's a take on "the 1%" that you won't hear at your local tent city . . .

The IRS is struggling just like the rest of us to carry out its mission with limited resources. Back in 2003, they audited just one out of every 203 returns. By 2010, that number was up to one out of 90. To stretch that audit budget even further, they're auditing more and more taxpayers by mail. But one study shows that 10% of IRS mail never gets where it's supposed to go, and 27% of those who do get their mail don't even realize they're actually being audited! Naturally, that leads to more and more of the paperwork screwups that every taxpayer fears.

Enter Nina Olson. She's the IRS's first and only Taxpayer Advocate, a position created by the 1998 "Taxpayer Bill of Rights" act. She supervises the Taxpayer Advocate Service, a nationwide group of 2,000 caseworkers who specialize in cutting through red tape and greasing the wheels of the great gummy IRS machine. If the IRS sends your mail to the wrong address, slaps you with a lien after you've already paid your bill, or just makes a mistake they can't seem to fix, Olson's office is the one we'll call.

Last month, Olson delivered a presentation to the Federal Bar Association on how "the 99%" experience the tax system. And the picture she painted makes a tent in lower Manhattan Park look like a room at the Ritz. One in three taxpayers who call the Service don't get an answer. Only half of those who write hear back within six weeks. The IRS is relying on computers instead of people to audit all but the highest-income taxpayers. And perhaps most curious of all, she says, "we're getting to a situation where the only people who get face-to-face audits are the 1%"!

Now, correct us if we're wrong, but do you really consider face time with an IRS auditor a "privilege"? We all know that at least some level of government is necessary. But there are just some parts you don't want to see up close and in person. Like the "Level 4" Biolab at the Atlanta Centers for Disease Control, for example, where we store the Ebola virus, Crimean-Congo hemorrhagic fever, and other superbugs we can't risk having out on the loose. Or the "Supermax" penitentiary in Florence, Colorado, where we "store" the most dangerous felons we can't risk having out on the loose. Or the inside of any IRS Service Center!

Does Olson's "1%" comment conjure up images of plush IRS offices, with thick oriental carpets and rich leather upholstery, staffed by discreet, white-gloved concierges sitting at granite-topped desks? We can assure you that when it comes to getting audited, even the 1% have to settle for the same government-issue linoleum floors, metal chairs, and battleship gray desks as everyone else. (And really, in the unlikely event you are audited, we probably won't let you go with us anyway! Trust us -- it's for your own protection.)

We talk in these emails about how proactive planning cuts your tax bill. But paying less tax isn't the only perk of a good tax plan. Did you know that smart tax planning can also cut your audit risk? In fact, some strategies -- like choosing certain business entities -- can cut that risk by as much as 90%. So call us if you think face time with an auditor is a "privilege" you can do without!

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Using Business Checkbook for Personal Purposes Raises Suspicions

Using your business checkbook for personal purposes can always raise suspicions. In Dwight D. Vanover (T.C. Memo. 2012-79) the taxpayer had already undergone a criminal investigation by the IRS in connection with the underreporting of income from his business.

During the years at issue the taxpayer used the business account to buy a $159,000 boat and two collectible cars, one for $60,000 in cash; the other for $32,500 in cash and some 11 additional vehicles from various sellers for a total of $277,000.

The taxpayer's tax preparer testified that he relied on the taxpayer's summary statements of income and expenses and the taxpayer did not provide any supporting documents. He also testified that he was unaware the business bank account was used to pay the taxpayer's personal expenses.

The Court looked at the other "badges of fraud" and concluded that the IRS had proven by clear and convincing evidence that the taxpayer underpaid his tax liabilities for the years at issue and that some part of the underpayment was due to fraud.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Bonus Depreciation

Don't automatically take the 100% bonus depreciation, the Section 179 writeoff or even the 50% bonus depreciation. Work through the numbers.

Taking a big deduction this year could leave you with no future deductions and that will cost you if you're in a higher bracket in the future. The self-employment tax (for sole proprietorships and partners) can also be a factor. Deductions will save the self-employment tax, but the deduction is wasted once your self-employment income drops below zero.

Additionally, those depreciation deductions will have to be recaptured if you sell the asset or your business in an asset sale. While the only way to get a good answer is to work through the numbers, a red flag should go up if the depreciation or Sec. 179 deduction forces your business income to go negative.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.