The NY Daily News is reporting that actor Stephen Baldwin has been arrested and charged with state income tax evasion.
Read about it in the Daily News.
Failing
to file your tax return and pay your taxes can and does lead to a
criminal conviction. Contact me immediately if you have not filed your
federal or state taxes. Don't end up with your mug shot in the local
newspaper.
Kenneth Hoffman counsels Entrepreneurs, Professionals
and Select Individuals in taking control of their taxes, and businesses.
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.
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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
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Proof a Minister Opted Out of Self-Employment Tax
Ministers are allowed to opt out of Self Employment tax by filing Form 4361 with the IRS. Some refer to this as Social Security. There are a number hoops and hurdles a minister must jump through in order to opt out. Once the Form 4361 is approved, it is irrevocable unless Congress allows it.
An approved Form 4361 is very difficult to replace. Without the approved form, it is hard to convince the IRS and the Social Security Administration that the minister is exempt from Self Employment tax. The courts have allowed the exemption without an approved form where the minister has retained proof that he filed the form.
When I prepare a ministers tax return, I ask if they have opted-out and for a copy of the approved Form 4361. Occasionally a minister will not have a copy of their approved Forms 4361. To make matters worse, they also do not have any evidence of filing the form with the IRS. In the past, I have had little guidance to give to them regarding how to obtain a duplicate of the approved form. However, the IRS recently published a Minister Audit Techniques Guide reviewing all the rules regarding ministers for its agents.
An IRS agent can confirm the exemption by:
- For ministers who filed the Form 4361 after 1988, the agent can order a transcript for the year under audit. Included on this transcript should be an indicator that tells the agent the minister is exempt from Self Employment tax.
- If the transcript is not an option, the agent can contact the Taxpayer Relations Branch at the IRS Service Center where the Form 4361 was filed and request a copy of the form.
- The last option is to contact the Social Security Administration in Baltimore and ask them to provide confirmation of a minister's exempt status.
If you are a minister and cannot locate your approved Form 4361, please call Kenneth Hoffman at 954-591-8290 or email him for assistance in obtaining a copy of your approved Form 4361. It is better to know for sure you are exempt, then to discover you are not exempt when a large tax bill is sent your way.
Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. 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.
Income from Foreign Sources
Many U.S. citizens earn money from foreign sources. But unless it is
exempt under federal law, taxpayers sometimes forget that they have to
report all such income on their tax return.
As such, some U.S. taxpayers living abroad have failed to timely file U.S. federal income tax returns or Reports of Foreign Bank and Financial Accounts (FBARs). Some of these taxpayers have recently become aware of their filing requirements and want to comply with the law.
Effective September 1, 2012, taxpayers who are low compliance risks are able to get current with their tax requirements without facing penalties or additional enforcement action. These taxpayers generally have simple tax returns and owe $1,500 or less in tax for any of the covered years.
U.S. citizens are taxed on their income regardless of whether they live inside or outside the United States. The foreign income rule also applies regardless of whether the person receives a Form W-2, Wage and Tax Statement, or Form 1099.
Foreign source income includes earned and unearned income, such as:
- Wages and tips
- Interest
- Dividends
- Capital gains
- Pensions
- Rents
- Royalties
But there is some good news. Citizens living outside the United States may be able to exclude up to $95,100 of their 2012 foreign source income if they meet certain requirements. This will increase to $97,600 in 2013.
If you're married and you and your spouse both work abroad and meet either the bona fide residence test or the physical presence test, each of you can choose the foreign earned income exclusion. Together, you can exclude as much as $190,200 for the 2012 tax year.
If you earn income from outside the country, please be sure to meet with me about it. I can advise you on how to address all of the tax implications of this situation.
Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. 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.
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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
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Home Ownership by Unmarried Individuals
If you co-own a home with someone who is not your spouse, such as a significant other or sibling, special tax rules apply to you during the period of ownership as well as at the time of sale. Watch for dollar limitations and allocations of tax benefits.
Mortgage interest
Interest on acquisition debt to buy, build, or substantially improve a principal residence plus one other designated home cannot exceed $1 million. Interest on home equity debt is limited to borrowing up to $100,000. To qualify for either acquisition debt or home equity debt, the debt must be secured by the first or second home.
The same $1.1 million combined debt limit applies to joint filers and single individuals. However, unmarried co-owners with total mortgages exceeding $1.1 million on their first and/or second homes must allocate the limit between them and deduct only a proportionate share of the interest paid. The allocation can be based on any reasonable method, such as by:
- The amount of mortgage payments during the year. For example, if one owner made all of the mortgage payments, that owner would be entitled to deduct 100% of the mortgage interest, up to the dollar limits.
- The percentage of home ownership. For example, if the home is owned 50/50, then each owner could deduct half of the total mortgage payments, regardless of which one actually made the payments.
Real estate taxes
There is no limit on the amount of real estate taxes that can be deducted. Again, co-owners can allocate the deduction for property taxes in any reasonable manner. Again, this can be done according to the percentage of ownership or the actual real estate taxes paid in the year.
Recapture of the homebuyer credit
If co-owners claimed a first-time homebuyer credit for the purchase of principal residence several years ago, recapture of the credit to the extent required is allocated in the same way in which the credit was originally claims. For example, if two people bought a home in 2008 and claimed the $7,500 credit, $500 of that credit must be recaptured in 2012. The amount that each owner recaptures depends on how much of the credit each owner claimed. If they split the credit, then each recaptures $250 on his or her personal income return.
Home sale exclusion
Gain on the sale of a principal residence (other than gain allocated to nonqualified use of the home) can be excluded up to a set dollar limit as long as you used the home as your principal residence for at least 2 of the 5 years preceding the date of sale. The dollar limit for a single individual is $250,000 of gain.
When co-owners are unmarried, each can exclude his or her share of gain up to this dollar limit. The dollar limit does not have to be apportioned between the owners. For example, if a home that is co-owned equally by 2 unmarried individuals is sold for a gain of $550,000, one-half of the gain, or $275,000 is allocated to each owner. Each owner can exclude up to $250,000 of gain on their personal income tax returns.
Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. 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 from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.
Timing of Deduction for Start-Up Expenses
Section 195 of the tax code generally requires taxpayers to capitalize start-up expenditures. Fortunately, the first $5,000 of such expenditures can be expensed in the year in which an active trade or business begins, if the total such expenditures don't exceed $50,000. Expenditures in excess of $5,000 (or where the $5,000 allowance is phased out because of the $50,000 cap) can be amortized over not less than 180 months (15 years). The rule shouldn't be ignored. If a proper election to expense the expenditures isn't made, all the expenditures must be capitalized.
What are start-up costs? Start-up costs can include investigatory expenses such as conducting market surveys, analysis of locations, product sources, etc., amounts paid to evaluate several businesses and to determine whether to enter the business and which business to acquire, and preliminary due diligence to assist in a potential acquisition. However, once the business has been identified, additional due diligence such as a review of the acquisition's books and records by an accounting firm and or law firm don't qualify. Other items that qualify include expenses such as pre-opening advertising, hiring initial employees, training, salaries, travel expenses, etc.
Example--Sue Flood incorporates Madison Dresses, Inc. in April 2009. On May 1 she signs a lease for the store and hires Ann to help her stock the racks, decorate, etc. In addition, Madison is paying $1,000 for rent. Madison opens its doors for business on July 1, 2009. From May 1 through July 1 Madison paid $8,000 in salaries, rent, etc. as pre-opening expenses. On Madison's return for 2009, Sue can deduct $5,000 of the total pre-opening costs. The remaining $3,000 must be amortized over 180 months, beginning in the month business began.
Tax Tip--Clearly, it makes sense to keep the pre-opening expenses as low as possible. One way is to make sure you have all your resources ready before beginning. In the example above it would have made no sense for Sue to hire Ann on May 1 if the racks, dresses, etc. weren't going to be delivered for two months. A second way may be to begin business before the everything is in place. For example, you're opening a bar and grill in a resort area. The bar portion will be ready quickly, but the inspections and permits for food service will take three months. Open the bar now and the additional costs associated with the food service may be expensed as expansion costs. Caution. Check with your tax adviser on this approach.
Organization expenses fall under a different Code Sections, but the rules are similar. They include the costs of incorporating a corporation (Sec. 248) or of setting up a partnership (Sec. 709). Such expenses include setting up the books of the entity, legal fees in incorporating or organizing the partnerships, etc. (Caution. Not all organization expenses qualify.) Expenditures up to $5,000 can be expensed, if the total such expenses don't exceed $50,000. Expenses in excess of $5,000 must be capitalized and amortized over no less than 180 months.
The next issue to deal with is, when does the business begin? This is a factual issue and it's not often clear. Before looking at the nuances, the first question is, do you need a license or permit? If you haven't got the permit from the town, county, etc., you're most likely not in business. If you need a liquor license to sell wines and spirits, you're not in business until you get that license. Same for a restaurant; you'll need a license. On the other hand, if you had the restaurant but not a liquor license you could open for business and serve food only. There can be exceptions, but make sure you're on firm ground. But just because you have a license doesn't mean you're in business. If you don't need a license, business usually begins when your doors are open to customers. Generally that's also the same time you make your first sale, but not always. If there's any question (e.g., you don't have a fixed establishment, but sell over the phone) try to document the time.
Expansion versus new business. If you're just expanding an existing business, pre-opening expenses shouldn't have to be capitalized. For example, you already operate four restaurants in the local area. You decide to open a fifth. The expenses should be deductible as ordinary business expenses. On the other hand, it you set up a new corporation, LLC, etc. to own and operate the additional restaurant, you'll probably have to treat the costs as start-up expenditures. As always, there are exceptions. Check with your tax advisor.
In a recent case (Thomas J. Woody (T.C. Memo. 2009-93)) in February 2004 the taxpayer started investigating the real estate market so he could acquire real estate for investment or rental. Throughout 2004 the taxpayer looked at many properties he was interested in buying for this real estate investment and rental business. He made multiple offers to purchase properties but was out-bid on most of his offers. In May 2004 he entered into a contract to purchase a property on Bradley Avenue in Camden, New Jersey. However, after a home inspection revealed many defects in the property, he canceled the contract because the seller was not willing to make the needed repairs.
The taxpayer did not purchase any investment or rental property until he purchased the property on Randolph Street in Camden, New Jersey, on December 30, 2004, i.e., the next to last day of the year at issue. At that time, there was no tenant in the property, and he did not secure a tenant until sometime after 2004. Furthermore, there was nothing in the record to indicate that he held the property out for rent in 2004.
Throughout 2004 the taxpayer performed many other tasks in conjunction with his alleged business. He created a name for his endeavor -- Value Property Investments -- and began marketing his services via business cards, flyers, and word of mouth. In May 2004 he completed a business outline with "buying, remodeling, and renting property" being the stated purpose of Value Property Investments. On October 17, 2004, he paid $21,490 to the Wealth Intelligence Academy for certain training classes, which he subsequently attended to acquire real estate investment skills. After he took the Wealth Intelligence Academy courses, his business plan shifted from merely buying, remodeling, and renting to also include what the taxpayer referred to as "flipping" or "wholesaling" However, he never consummated this type of transaction during 2004.
In November 2004 the taxpayer applied, and was approved, for a loan from the U.S. Small Business Administration, and he obtained an employer identification number from the IRS. In December 2004 he obtained a credit card in the name of "Thomas J. Woody Value Property Invest" and opened a checking account in the name of "Mr. Thomas J. Woody D/B/A Value Property Investments".
Despite all of the foregoing activity, he did not purchase any investment property until December 30, 2004, and he did not buy or sell any other property, rent out any property, or hold any property out for rent, nor did he engage in "flipping" or "wholesaling" during tax year 2004.
The IRS disallowed the taxpayer's Schedule C expenses for 2004 because it determined that the taxpayer was not engaged in the active conduct of a real estate investment business as alleged. The taxpayer contended he commenced his real estate investment and rental business on May 1, 2004 when he entered into a contract of sale on the Bradley Avenue property. Thus, he contended that all his expenses associated with his business incurred after that date should be deductible business expenses. The IRS asserted that the taxpayer was not actively engaged in the real estate investment and rental business at any time during 2004, because he did not become actively engaged in business, i.e., by buying, selling, renting, or offering to rent property, until he held the Randolph Street property out for rent some time after 2004.
The Court noted that whether a taxpayer is engaged in a trade or business is determined using a facts and circumstances test under which courts have focused on the following three factors that indicate the existence of a trade or business: (1) whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer is regularly and actively involved in the activity; and (3) whether the taxpayer's activity has actually commenced.
The Court held the taxpayer's activities did not rise to the level of a trade or business until, at the earliest, the time he purchased the Randolph Street property on December 30 of the year in suit. More likely, his activities did not rise to the level of a trade or business until he held the Randolph Street property out for rent sometime after the close of the year in suit, but the Court did not have to decide that issue.
Opening a new business is a major undertaking and the pre-opening costs can be substantial. To maximize your tax deductions and your cash flow, plan carefully and get good advice both tax and business.
Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. 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 from 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.
Capital Gains and Losses It's All In The Timing
The year’s end has historically been a good time to
plan tax savings by carefully structuring capital gains and losses.
If there are losses to date − As an example, suppose the stocks and other capital assets that were sold during the year result in a net loss and that there are other investment assets still owned by the taxpayer that have appreciated in value. Consideration should be given to whether any of the appreciated assets should be sold (if their value has peaked), thereby offsetting those gains with pre-existing losses.
Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income (AGI). Individuals are subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.
All of this means that having long-term capital losses offsetting long-term capital gains should be avoided, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.
To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.
If there are no net capital losses so far for the year – If a taxpayer expects to realize such losses in the subsequent year well in excess of the $3,000 ceiling, consider shifting some of the sales and resulting excess losses into the current year. That way, the losses can offset current year gains, and up to $3,000 of any excess loss will become deductible against ordinary income in the subsequent year.
Paper losses or gains on stocks may be worth recognizing (i.e., selling the stock) this year in some situations. But if the stock is sold at a loss with the idea to repurchase it, the repurchase cannot be within a 61-day period (30 days before or 30 days after the date of sale) under the “wash sale” rules. If it is, the loss will not be recognized and will simply adjust the tax basis of the reacquired stock. Careful handling of capital gains and losses can save substantial amounts of tax.
Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. 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 from 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.
Business Expense Documentation and Tax Deductions
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. We won't deal with them here. They'll be detailed in an upcoming report.
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 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. Talk to your tax advisor.
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.
Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. 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 from 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.
File Joint Tax Return Each of You Are Responsible
If you file a joint tax return, you're generally liable for taxes on the return if your spouse doesn't pay. Sec. 6015 provides relief from that rule for an innocent spouse. But you must meet certain requirements.
In Sharon K. Hudgins (T.C. Memo. 2012-260) the taxpayer sought relief from the liabilities she incurred with her deceased husband. In considering the taxpayer's request for relief the IRS determined that (1) of the outstanding 2007 tax liability, $3,639 was attributable to the taxpayer and $17,058 was attributable to her spouse; (2) the taxpayer did not have a reasonable belief that her spouse would pay the tax because she did not review the return in the first instance and because the tax liabilities shown on the spouse's individual returns from 2001 and 2002 were also not timely paid and (3) the taxpayer was not making a good-faith effort to comply with the tax laws because she did not file her 2008 return, which had an extended due date of October 15, 2009, until October 20, 2009.
The Court reviewed the factors and concluded that the taxpayer failed to satisfy the safe harbor requirements and the equitable factors in Rev. Proc. 2003-61 and that she was not entitled to relief.
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Can You Prove Basis When Selling Property
In Jovita Diaz (T.C. Memo. 2012-241) the taxpayer sold two pieces of real property. The purchase prices were not in dispute. But in the first property she argued she made $60,000 in improvements after purchase. The costs included $40,000 for renovating the garage to be used as a daycare center and $20,000 for improving the driveway and walkway.
She testified that she hired a contractor to perform the improvements, but she did not introduce any records which supported the costs. She did not introduce an invoice from the contractor, a canceled check, a construction permit for the improvements, or before and after pictures.
Also, she did not introduce any records that showed the property was used as a daycare center. The taxpayer contended that she did not have documentation because she kept moving from one place to another. The Court found her testimony was unpersuasive in support of her claim of $60,000 of improvements. The taxpayer claimed $10,000 in improvements (installation of a lawn) with respect to the second property, but again, could show no support. The Court disallowed any increase in basis for the improvements. In addition, the Court allowed the imposition of the accuracy-related penalty for failure to keep records.
K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.
Tax Court Says To Seek Help
In Robert L. Bernard et ux. (T.C. Memo. 2012-221) instead of correctly reporting the IRA distributions on their tax return, the taxpayers mischaracterized $99,334.82 of the distributions as proceeds of sale, claimed a combined basis of $49,054, and reported $50,280.82 as long-term capital gains and agreed they failed to report certain additional distributions.
When the 2007 return was prepared, the taxpayer had misfiled or misplaced the information returns reporting their income. The taxpayers had received notice that the IRS was challenging their treatment of IRA distributions on tax returns for earlier years. The taxpayers obtained an extension of time to file the 2007 return because he was suffering from depression, confusion, and memory loss. He was hospitalized in May 2008 during the period of extension for filing the 2007 return.
The taxpayers prepared the return themselves using commercial software. They advanced several arguments as to why they shouldn't be taxed on the full amount of the distributions, but Court rejected the arguments. The IRS also claimed the taxpayers were liable for the accuracy-related penalty. The taxpayers relied on his health problems as an excuse for the numerous errors on the return.
The Court noted that the taxpayers confused authorities describing a serious medical condition as an excuse for late filing of a return with those describing reasonable cause sufficient to avoid a penalty under Section 6662(a). The Court viewed the taxpayers' failure to seek competent help in preparing the return as negligence and allowed the penalty.(emphasis mine)
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K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.
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