TAX FACTS & NOTES : 2008
An Update on Tax Issues and the IRS...
While several tax law adjustments were passed in 2007, none provided sweeping change to the tax codes. There were a number of niche and arcane revisions, but for the masses no great relief developed. We’re left with an increasingly complex set of tax codes, complicated even more by the insidious alternative minimum tax which Congress appears to refuse to eliminate. Presented herein are a few items that I hope you’ll find informative.
FILING DELAYS EARLY DURING TAX SEASON
Congress waited until late in December to extend certain beneficial tax provisions, most notably a small fix to reduce the impact of alternative minimum tax. The late action has caused IRS to be delayed in finalizing forms, which will cause some early filers to wait until early February to efile returns. This won’t affect many people as forms should be finalized by early February.
MORTGAGE INSURANCE DEDUCTION
Surprise! Congress passed a benefit to certain homeowners by now allowing an itemized deduction for mortgage insurance premiums paid. This will benefit married filing jointly taxpayers whose gross income is $100,000 or less ($50,000 for married filing separately) and it applies only to acquisition indebtedness. On your mortgage interest statement (Form 1098), you’ll now find a box that reports the mortgage insurance premiums you paid in 2007.
ALTERNATIVE MINIMUM TAX
At the last minute, Congress passed a law that increased (slightly) the income threshold that determines who is subject to this archaic tax. It won’t help many people and many more taxpayers will be subject to AMT. For more details about AMT, view our website, www.batsontax.net.
CHARITABLE CONTRIBUTIONS
All charitable contributions made now require a receipt as well as proof of payment. Previously, a cancelled check was sufficient to prove charitable contributions, but under new regulations no deduction is allowed without a receipt from the charity.
DEPRECIATION FOR LEASEHOLD IMPROVEMENTS
Congress now allows certain leasehold improvements made to properties to be depreciated over 15 years as opposed to longer periods under prior law.
KIDDIE TAX EXPANSION
Prior law made investment income earned by minors under age 18 taxable at the higher tax rate of the parents (over $1,700 of unearned income). New law expands this tax treatment to full-time students under age 24 effective with the 2007 filing year.
IRS ATTACKS MISCLASSIFIED WORKERS
To avoid payroll taxes and withholding requirements, some firms treat workers as “contractors” rather than employees. IRS has introduced a new Form 8919 that will allow taxpayers who believe they were actually employees, rather than contract workers, to avoid the full impact of self-employment taxes. If you receive a 1099 Misc, Nonemployee Compensation for work that you performed, let’s see if the new form can help you. IRS is making a concerted effort to enforce rules applying to employee vs. contractor relationships.
HEALTH SAVINGS ACCOUNTS
One of the best new tax devices to assist with the rising costs of health care, the HSA is getting better. It allows health care funding to be fully deductible without being subject to the medical expense 7.5% threshold. Under prior law, your HSA deduction was limited to the deductible of your health care plan. Under new law, you may take a deduction for HSA funding to the max of the allowable deduction regardless of your health care deductible. (Of course, a number of rules and limitations apply.) Even better, HSA contributions can be made up to April 15, 2008 and still be deductible on your 2007 return. Current limits are $2,850 for self-only coverage and $5,650 for family coverage with an over-55 “catch up” addition of $800.
IRA CONTRIBUTIONS
If you’re eligible, IRA and Roth IRA contributions are still very advantageous. For 2007, the deduction allowed is $4,000 for those under age 50 and $5,000 for age 50 and over. However, the rules for participation are tricky and we advise you to let us guide you before you make these contributions. You’ll have until April 15th to fund your account effectively for the 2007 year.
SECTION 179 EXPENSING
Small businesses and proprietors continue to receive the benefit of “writing off” the first $125,000 of fixed asset purchases during 2007. Under regular rules, assets having a life in excess of one year must be depreciated over a varying period of years, but code section 179 allows total expensing of asset purchases up to the $125,000 limit for certain small businesses. This applies even if a business or proprietorship has borrowed funds to purchase the assets. New for 2007 is the ability to use Sec 179 for Off-the-Shelf computer software. Section 179 has been a real boon to businesses and has undeniably boosted capital spending since its inception several years ago.
DEMINIMIS RENTAL INCOME 14 DAYS
IRS nails us on most items of income, but did you know you can rent out your personal residence up to 14 days and the income is tax free? It is a quirk, but a valuable one in areas such as Augusta where the Masters Tournament creates a huge demand for short-term housing. This doesn’t apply to rental property – only to personal residences.
INHERITED IRAS
When the spousal beneficiary of a deceased person inherits an IRA, it can be rolled into an IRA rollover account with no immediate tax impact. However, when a beneficiary such as a child or relative inherits an IRA, different rules apply. Under new law, a non-spousal beneficiary now has the option to accept the IRA under the required minimum distribution rules that applied to the owner. This allows a longer time period for the taxes to be paid and relaxes prior rules which would have required a much quicker payout and taxation of the IRA. This will be an increasingly important and useful rule as baby boomers and their parents pass on their retirement plans to children and other relatives.
FORGIVEN MORTGAGE DEBT RELIEF
Addressing the subprime lending crisis, Congress has provided relief for some homeowners whose mortgage debt is forgiven by lenders. Previously, a homeowner could be taxed on the amount of forgiven debt. For example, before the new law, an individual with a $200,000 mortgage whose lender foreclosed on the home and sold it for $170,000 would have to pay taxes on the $30,000 difference representing the net debt forgiven. Now, the forgiven debt is not taxable. Under the new law, up to $2 million of such debt may be forgiven effective January 1, 2007 and extending to December 31, 2009.
AUDIT ACTIVITY
During the 2007 year, two IRS audits were conducted in our offices. One was targeted at a Schedule C (proprietorship) taxpayer whose 2003 return was prepared by another firm. IRS was interested in the relatively high gross revenue and the relatively low profit reported. Unfortunately, there were numerous errors on the return, the prior preparer had few workpapers to support his work, and the Agent succeeded in forcing a sizable adjustment to the return.
The other audit was of an S corporation 2005 return that was prepared by us. In this audit, IRS was examining whether sufficient basis existed to allow the taxpayer to deduct losses generated by the corporation. This audit has not been completed, but the agent indicated that IRS will be increasing its activity on the issue of basis in S corporation stock.
IRS ACTIVITY
In 2008, IRS is expected to perform 13,000 audits, many of which will focus on cash-oriented taxpayers who file Schedule C or Schedule F. They’re looking for omissions of cash receipts, inflation of expenses and deductions and thankfully, they’re also looking for those who cheat and lie to receive the earned income credit.
The EIC program is essentially a federal handout to low-income taxpayers who have children, but it is being rampantly abused by some taxpayers who have become aware of the ease of receiving these handouts and are quite willing to lie and cheat in order to get a government check. The Service is increasing its efforts to crack down on fraud in this area, some of which has even been created by unscrupulous tax preparers.
IRS is also getting much more sophisticated with matching reporting documents such as 1099s, 1098s and W2s to tax returns. Where differences occur, IRS sends CP 2000 letter notices to the taxpayer proposing increased taxes unless the taxpayer can provide documentation to support the difference.
As noted previously, IRS is also becoming more active in exploring contractor vs. employee classifications. Some businesses attempt to avoid payroll taxes by treating workers as contractors when those people should have been paid as employees, and the Service is keen on making its point with regard to the requirements of employment. This is good for all of us who attempt to abide by the laws.
IRS has identified a “tax gap” of $300 billion per year, representing the difference between actual taxes owed and actual taxes collected. This gap is largely comprised of cash transactions that are unreported, and these activities are prime targets for IRS investigation. One of the first things an IRS auditor will ask for is bank statements, and they’ll be closely scrutinized against tax filings. Additionally, IRS has a data base and computer programs that will allow them to collect information from various sources to tackle suspected unreported income.
“SUPPOSE I JUST GET CASH FOR MY WORK AND DON’T REPORT IT ON MY RETURNS?”
Several years ago, a friend called me in panic because IRS had filed federal charges against him for tax fraud. He had been collecting cash payments for services that he didn’t report on his tax returns. He felt he was safe because he never deposited these funds to his bank accounts, but IRS outwitted him. They asked how he paid for gasoline, power bills, phone bills, and household expenses since few of these were paid via his bank account, but he had a nice home with all the amenities. Eventually, he conceded underreporting of over $100,000 of income over a 3 year period and he settled with IRS for over $50,000 in back taxes, penalties and interest. He was lucky to escape a much more serious outcome. It’s just this kind of thing that IRS is keenly targeting.
WE HIGHLY RECOMMEND:
1. Electronic Filing - Whether you are due a refund or owe the government, e-filing is the best way to ensure your returns are received by the agencies. Further, e-filing avoids delays and many errors that can hold up processing, and significantly speeds your refunds! Our fee is $50.
2. Tax Authorization - When we check the box as “third party designee”, tax agencies are authorized to discuss any questions on your returns with us directly. This can save a great deal of time and paperwork, as well as fees, should questions arise about your filings. Our fee is $25.
3. Indefinite Storage of Your Tax Files - By law, we are required to hold your files and data for 3 years, which we always do. But there are often reason to hold your data indefinitely which we are glad to do at your direction. To offset our costs of storage, our fee is $25 per year.
A PERSPECTIVE
While tax collection, tax laws and IRS are feared and reviled, taxes are a necessary evil in support of the political and societal choices we make as citizens. To support our national lifestyle, we must collect the funds to pay for the choices we make. Congress is the culprit; IRS is the enforcer.
IRS in the past 10 years has evolved into a fairer, more sophisticated and more educated entity than it was before. This is partially due to a series of Congressional rebukes, deserved and earned, but IRS still has a job to do and it protects those of us who attempt to comply with the law. Tax cheaters, non-filers, illegal activities, and tax protestors cost the remainder of us millions of dollars every year, and these are the folks we hope IRS will expend its efforts to harvest.
Tax avoidance, using all legal means, is your right and our job as your tax preparer. Be assured as always we will do everything in our power to use the laws correctly and to arrive at the lowest legal liability for your returns. And if you are audited, we’ll be there to defend you vigorously.
Thank you for your confidence and for allowing us to serve you!
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