Monday, August 31, 2009

ABSOLUTES

There are very few “absolutes” when it comes to income taxes.

The answer to just about every individual or business tax question is “it depends”.

This is true for the basic questions “is it taxable?” and “is it deductible” (see my 2007 post “It Depends”) to more involved questions like “can I claim him/her as a dependent?”, “should I file joint or separately”, “should I expense or depreciate”, “should I incorporate”, “should I buy or lease”, and so on.

There are really no definitive answers that apply to all taxpayers in all cases. The correct answer depends on the individual “facts and circumstances” of the specific situation. This is why, as Albert Einstein said, “The hardest thing in the world to understand is the income tax”. It is also what makes taxes interesting and intriguing to those of us who choose to prepare them for a living.

There are, however, some “musts” when it comes to taxes – things that you simply MUST do when it comes to your income tax return.

The obvious first MUST - you MUST not “cheat”. You MUST report all taxable income from all sources and you MUST claim only legitimate deductions that are allowed in the Tax Code and that you have actually incurred and paid. This does not mean that you cannot interpret the Tax Code in your favor, or plan activities or transactions in a way that makes them deductible (see my guest post “How to Enjoy a Tax Free Vacation” at BARGAINEERING).

Here are some more MUSTS -

• You MUST keep good, contemporaneous records of all your income and deductions in the manner prescribed by the IRS and the Tax Code. This is especially important if you are self-employed, as the IRS will be paying special attention to Schedule Cs in the future as part of its “war” on the Tax Gap. Special recordkeeping requirements exist for such deductions as charitable contributions, charitable, medical, and business mileage, business meals and entertainment, business use of “listed property” (see my 2008 post “Listed Property”).

• If you have a one-person business, whether a corporation, an LLC, or a just plain Schedule C sole proprietorship you MUST keep your business life and personal life separate, and you MUST run your entrepreneurial activity in a “business-like” manner. This means having a separate checking account for your business (see my post "You Do Need a Business Checking Account").

• If you are required so to do based on your level of income, you MUST file an income tax return, or an automatic extension form, by the statutory due date (usually April 15th), even if you cannot pay all or any of the tax due. And if you have requested an extension you MUST be sure to get your tax return in the mail by the final deadline (usually October 15th), again even if you cannot pay all or any of the tax due. As I have pointed out many times in the past, the penalty for paying late is .5% (1/2 of 1%) of the tax due per month while the penalty for filing late is a full 5% of the tax due per month – 10 times more! And not filing a tax return at all can have serious consequences down the road (see my post “What Happens If You Do Not File Your Federal Income Tax Return”).

• You MUST not ignore correspondence or balance due notices from the IRS or a state tax authority. Even though more often than not a balance due notice from “Sam” or any of your other “uncles” or “aunts” is wrong you MUST respond (See my post “Oh No – A Letter From The IRS”). When you get a letter or notice from “Sam” or a state agency send it to your tax professional immediately!

Another must – your MUST become a regular visitor to my blog THE WANDERING TAX PRO to keep up-to-date on federal income taxes!

TTFN

Saturday, August 29, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’

* Stacie Clifford Kitts, CPA of STACIE’S MORE TAX TIPS girds for battle with June Walker. In her post “A Tax Blog Throw Down - I Dished it Out - Now it Looks Like I Will Have to Take It” she says, “it appears that I am soon to be the target of Ms. Walker’s rants as I might have been a bit harsh in my comments to her retaliation post.”
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Why did she “retaliate”? “I believe some of her {June Walker’s} comments were snide, belittling, unprofessional, and unnecessary.”
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We are all awaiting JW’s next entry in the saga to see for which of the multitude of tax pros who commented on her “offending” post she rips new ones.
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* Kay Bell tells us that Chuck Rangel, Chairman of the tax-writing House Ways and Means Committee, is in trouble again in her post “Ways & Means Chair In Trouble ... Again” at DON’T MESS WITH TAXES.
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Bill also discusses Chuck in “Some People Never Change” at the APRIL 15.COM blog.
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* Kay Bell, a member of the Taxpayer Advocacy Panel (TAP), also reports on what was discussed at the recent TAP meeting she attended on the topic of registering tax preparers in the post “More Tax Preparer Oversight Questions”.
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According to Kay, “My general assessment of the TAP conversation with the IRS rep regarding the tax preparer regs is that the agency truly is open, at least right now, to all ideas on this topic”.
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* Joe Kristan tells us about “Another Fail for the TurboTax Defense” at the ROTH AND COMPANY TAX UPDATE BLOG. I do believe that this is the third time the Tax Court has said that blaming tax preparation software for tax return FUs is not a valid defense. You sign the return - you are responsible!
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The Moral, as Joe points out, is - “The ‘Garbage-in, Garbage-Out’ Doctrine trumps the TurboTax Defense”.
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Joe also points out that the Turbo Tax Defense is only successful with Presidential appointees.
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* Joe also provides a quote that describes New Jersey politicians to a tee in “This Explains a Lot of the Tax Law”.
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Some key phrases from the quote –
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extraordinarily fixated on power and status and extraordinarily motivated to keep it” and
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exceptionally prone politicians are to narcissism, motivated cognition, self-deception, and brazen lying.”
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* Monica Lawver wants to know “Where Do I Sign Up?” to get involved in pushing Congress for tax simplification.
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As I point out in my comment, “There is really no effective lobby for the individual taxpayer. Until there is, all the other lobbies for special interest groups, with their huge budgets, will continue to entice Congress to complicate the Tax Code in their favor.”
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Monica, I will be glad to work with you on a “Tax Professionals for Simplification” organization.
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* TAX GIRL Kelly Phillips Erb tells us - “Laura Schultz was expecting to hear from the IRS. After all, the Denver-area house cleaner owed the IRS about $80. But when she opened up a letter from the IRS, it wasn’t quite was she was expecting: a refund check for $122,783.51.” As her post title puts it, “Now THAT’S A Refund!”.
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Kay Bell also discusses the story in “IRS Issues $122,783.51 Erroneous Refund”.
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* NJ is number 1 - again! Paul Caron, the TAX PROF, gives us a list of “the proportion of taxpayers paying AMT in each state in 2007” in “AMT By State, 2007”.

Paul points out that (highlight is mine), “In two-thirds of the states, less than 3.5% of taxpayers were subject to the AMT, but in New Jersey 8.7% of taxpayers paid AMT, and 7.7% owed AMT in neighboring New York. More than 6.5% of taxpayers in California, Connecticut, and the District of Columbia were subject to the AMT.”
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* Here’s another reason not to use Facebook or MySpace. While it seems that just about every tax blog had a post on this topic in the last few days, the post “Are Tax Collectors Your Friends?” at the TAX CONTROVERSY UPDATE blog by Townsend and Jones LLP first led me to the Wall Street Journal article “Is 'Friending' in Your Future? Better Pay Your Taxes First”.
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According to the article –
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Tax deadbeats are finding someone actually reads their MySpace and Facebook postings: the taxman.
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State revenue agents have begun nabbing scofflaws by mining information posted on social-networking Web sites, from relocation announcements to professional profiles to financial boasts.
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In Minnesota, authorities were able to levy back taxes on the wages of a long-sought tax evader after he announced on MySpace that he would be returning to his home town to work as a real-estate broker and gave his employer's name. The state collected several thousand dollars, the full amount due.
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Meanwhile, agents in Nebraska collected $2,000 from a deejay after he advertised on his MySpace page that he would be working at a big public party
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* The IRS has issued a draft copy of the 2009 Form 8863 (Education Credits). The form has been revised to include the new American Opportunity Credit. There is also now a Page 2 to calculate the refundable AOC and the amount of nonrefundable education credits.
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*Trish McIntire takes on “some marketing lines many preparers (including myself) use” in her post “Buyer Education 1”, the first entry “in a small taxpayer education series” at OUR TAXING TIMES.
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In this entry - “The issue isn't the actual talking point but either making it a stand alone criteria or not understanding the spin involved”.
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* And last, but certainly not least, Russ Fox discusses language in the new ObamaCare legislation “that may make you just a bit uneasy” in his post “Don't Worry, We're From the Government” at TAXABLE TALK.
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I do admit to a feeling of uneasiness.
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TTFN

Friday, August 28, 2009

AFTERTHOUGHTS - Part II

Today’s afterthought concerns my post “Manual Labor”.
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As you know, in my 38 seasons of preparing 1040s I have never used tax preparation software to prepare a Form 1040, or any other tax return. I prepare close to 400 individual federal income tax returns each year manually.
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As Joe Kristan suggests in a post to the ROTH AND COMPANY TAX UPDATE BLOG, I do wear this fact as a “badge of honor”.
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At a National Society of Tax Professionals seminar in San Antonio several years ago when my hand was the only one raised in response to the question “Who still prepares returns by hand?”, seminar leader Beanna Whitlock, former IRS Director of the Office of National Public Liaison and then Executive Director of NSTP and a longtime professional tax preparer, shook my hand and said in effect that I was the only one in the room who really knew how to prepare tax returns.
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As I state in my comment to Joe’s above-referenced post –
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I am certainly not advocating that all tax practitioners should prepare all of their returns manually. I am just saying that it has worked for me for 38 tax seasons and I see no need, in my particular situation, to change now. Why should I spend thousands of dollars upfront and hundreds more each year – and have to increase my fees accordingly without seeing any in pocket benefit from the increase – when the expense would not provide any benefit to me. If it ain’t broke why fix it.”
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I also tell Joe -
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I am not against the use of tax preparation software, and do agree that its major benefit is that when an error is discovered it is easier to fix by simply entering the correct number. On a manual return if I find an error I often have to rewrite as much as the entire return.”
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My “afterthought” concerns something of great value that is lost by using software instead of paper and pencil.
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While I do all my federal 1040s manually, I do use general ledger software (One Write Plus, which is no longer available) for both myself and my clients, and have been doing so for over 20 years. I do not think that I would ever go back to keeping books by hand.
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In the days when I manually kept the books of a suburban Art Center, which included paying bills, if I wrote a check to a vendor it would remain in my memory. Back then if you had asked me six months after the fact if a certain bill was paid I could say with certainty yes or no without having to look it up – because I would remember writing the check.
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When we changed over to general ledger software, which would generate checks as part of the Accounts Payable process, I had no idea what was and was not paid because I did not personally write a check. All I did was push “enter” to have checks written for all outstanding bills. If someone wanted to know if a bill was paid I would have to look it up in the system.
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Similarly when I hand write a 1040, and all the various schedules thereto, much of what I have written remains in my memory for years. I will, for example, remember that you sold shares of AT+T three years ago, or that you claimed larger than usual charitable contributions in 2005, simply because I had handwritten the return.
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General ledger software and tax preparation software are indeed signs of progress. But when thinking on this I am often reminded of the comments made by the character Henry Drummond in the classic play about the Scopes Monkey Trial INHERIT THE WIND –
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It’s as if there’s a little man who sits behind a table and hands out the price of progress….who says, ‘Yes, ma’am, you can have the vote and you can participate as an equal in politics . . .but you won’t be able to hide behind your apron strings any more’. And, ‘Yes, sir, you can have an airplane and travel great distances quickly . . . but the clouds will smell of gasoline and the birds will lose their wonder.’ And, ‘Yes, ma’am, you can have a telephone and you can share information instantly with others . . . but you’ll give up some of your privacy and distance will lose its charm.’”
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For everything benefit we gain from progress we do, indeed, give something up.
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TTFN

Thursday, August 27, 2009

AFTERTHOUGHTS - PART I

I will be using the next few TWTP posts to provide some “afterthoughts” on previously posted topics.

I recently traded “dueling blog posts” with Mary O’Keeffe of the relatively new and quite interesting tax blog BED BUFFALOES IN YOUR TAX CODE (click here to find out what “bed buffaloes” are) on the subject of testing requirements for licensing tax preparers – which was a continuation of what began as an email discussion with Enrolled Agent and ethics CPE instructor Kevin Huston.

You can view the “dueling posts” here (be sure to read all the comments) –

WE AGREE TO DISAGREE (TWTP)

TAX PREPARER OBJECTIONS TO TESTING—AND MY RESPONSES (BBIYTC)

You may also want to view my post DEAR IRS.

Mary teaches Income Tax Policy & Practice at Union College in upstate New York and runs the Union College Volunteer Income Tax Assistance (VITA) program, where Union College economics students with IRS training and certification prepare and e-file free income tax returns for low and moderate income Schenectady NY taxpayers. Her VITA site prepares 600+ returns per season.
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VITA is an IRS-sponsored program that “offers free tax help to low- to moderate-income (generally, $49,000 and below) people who cannot prepare their own tax returns”.
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In my 38 tax seasons I have had no hands-on experience or contact with the VITA program. I do not believe I have ever seen a tax return prepared by a VITA volunteer. So I have no personal experience from which to speak. Most of my knowledge of the workings of the program come from Mary’s posts and comments on the "tax blogosphere” and links from Mary's blog.
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I do applaud the ideals of the program. I also applaud the good work of the many VITA volunteers throughout the US, and the fact that the VITA volunteers restrict their work to simpler returns, knowing their strengths and limitations and not to “bite off more than they can chew”. However, as they deal with low income taxpayers they also deal apparently quite competently with such relatively complicated issues as Dependency, Filing Status, and the Earned Income Tax Credit, Child Tax Credit, and Credit for the Elderly.
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Most of the VITA volunteers are students and teachers. Unfortunately the demands of the tax filing season do not permit most practicing tax professionals, like myself, from volunteering for VITA and similar programs. We have a brief period of time (Feb 1 – April 15) to timely file 1040s and earn probably 70% or more of our annual income.
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Mary is a college professor and a VITA manager and volunteer, and not a practicing tax professional, and comes to the discussion from that unique point of view. Her comments on registration, licensure and testing are based on her experience with VITA. She calls for an annual competency test for tax preparers as a requirement of licensure, similar to the requirements for VITA volunteers.
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VITA volunteers are generally part-time, non-professional, seasonal tax preparers. As I said above mostly students and teachers. When I say “non-professional” I do not mean that the returns they prepare are not done “professionally” - but simply that they are not experienced year-round tax professionals. They do not prepare tax returns for a living.
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Given this fact it is very appropriate that these volunteers must pass a basic competency examination in order to participate in VITA, and that they must pass such a test each year if they are continuing volunteers.
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Plus, as these volunteers are in effect working for the IRS it is appropriate that they be tested annually as an arse-covering measure for the IRS.
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As I have posted and wrote time and again, I feel very strongly that there must be some kind of “grandfathering” exemption from an initial proficiency test for long-time experienced tax professionals in the licensing process. And I agree with most others that a one-time test is sufficient – there is no need for annual, or bi-annual (if one’s license must be renewed every other year), testing.
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In my proposal for registration and licensure VITA and other volunteer preparers would not need to be licensed as they do not prepare returns for a fee. I feel their current testing requirements to be more than adequate.
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There is a big difference between part-time seasonal volunteer preparers and experienced full-time professional preparers. What is appropriate and practical for one group is not necessarily appropriate or practical for the other.
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I await Mary’s comments on these afterthoughts, and I look forward to future blog discussions with Mary. Unlike with some other tax bloggers, who shall remain nameless, we can have a good spirited debate while maintaining mutual respect and courtesy. And by staying on topic and not veering off in personal attacks.
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TTFN

Wednesday, August 26, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’ – WEDNESDAY EDITION

Surprise! There is a Wednesday BUZZ after all!
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* A post at Stacie Clifford Kitts’ blog STACIE’S MORE TAX TIPS (A Blog About - Duh - Income Tax) led me to this excellent “Understanding IRS Guidance - A Brief Primer” at the IRS website.
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* Jean Murray of JEAN’S BUSINESS LAW/TAXES: US BLOG, a colleague of William Perez at about.com, joins the debate on the appropriateness of a separate business checking account in two posts – “Do You Need a Separate Business Checking Account?” and “How to Simplify Your Business Checking and Accounting”.
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The bottom line of her first post (the highlights are mine) – “My suggestion (and remember I'm not a CPA or an attorney): If you are a sole proprietor, having only one checking account is not a problem as long as you can keep your business and personal records separate and be sure you are not recording personal expenses as business expenses. If you are any other kind of entity (LLC, partnership, or corporation), get a separate checking account.”
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This post points out two good reasons why a separate business checking account is important in any situation -
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• “To let the IRS know you are a separate business entity, so they don't look on your business as a hobby”. And
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• “To maintain the integrity and separateness of your business from your personal life”.
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Her second post also has an excellent message – “I'll make this as simple as possible: You MUST keep track of all business expenses, in order to claim them as deductions. And all expenses you record as business, must be for a legitimate business purpose.”
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She includes two more MUSTS –
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• “Record business income and purchases as they happen.” And
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Include the important information about each business transaction.”
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Jean, FYI I am not a lawyer! I am just a simple “unenrolled” tax professional with 38 filing seasons of experience.
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* It is a good idea to go back to blog posts that you have found interesting or useful time and again to check out any comments that have been published since your last visit.
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Stacie Clifford Kitts, whose blog I referenced above, has submitted a comment to my post “WHY CAN’T WE ALL JUST LEARN TO GET ALONG?”. It is the same comment that she submitted to June Walker’s offending blog post. Check it out.
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Stacie has also joined the fray with her own post on the subject titled “Wowser - A Tax Blog Throw Down - Why Keeping a Separate Business Checking Account Can Save Your Clients Money
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Right on, sister! BTW – I like the new look of your blog.
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* June Walker, who started this whole debate, provided two rebuttal posts – “Bravo Indies” and “Indies Are Not Corporations”. In neither of these posts did she address the actual issue or the comments from other tax professionals – although she promises to respond “accordingly” at some point. Her second post was basically an attack on Peter Pappas. These two deserve each other, as they both apparently get “postal” when someone dares to disagree with them. When promising to address comments from tax pros Ms Walker specifically referenced a phrase, “chick think”, from the comment by Stacie Clifford Kitts I mentioned above. Poor Stacie – I expect she will be the next to feel the Wrath of Walker!
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Before I leave this mess – a new comment, supporting a separate business checking account, by JustJan, a CPA from Michigan, has been published at the “offending” post “There’s No Shortage of Bad Advice Out There”. Check it out.
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* That is enough about “the debate”. But I am not finished with Stacie Clifford Kitts yet. She has an informative post on “Retirement Plans - 7 Steps to Making a Hardship Distribution”.

* The IRS is now on YouTube! Click here.
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* Click here to download a 126-page transcript of the consumer and tax professional panel discussions on registering tax preparers from the July 30 public forum.
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* Joe Kristan adds his always valuable 2 cents to my two-part discussion on the advantages and disadvantages of incorporating in “Corporations: Yea or Nay?” at the ROTH AND COMPANY TAX UPDATES BLOG.
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Joe’s good advice – “If you don't know what to do, start with the partnership or proprietor formats; if nothing else, they are the easiest formats to change
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The post includes perhaps the best quote about corporations that I have seen to date, what Joe calls “the famous Bittker and Eustice admonition”. It basically sums up my opinion on the use of the corporate entity for small business (great minds do think alike) -
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Decisions to embrace the corporate form of organization should be carefully considered, since a corporation is like a lobster pot: easy to enter, difficult to live in, and painful to get out of.”
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I wonder how many lawyers tell their clients that?
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TTFN

Tuesday, August 25, 2009

TO INCORPORATE OR NOT TO INCORPORATE - THAT IS THE QUESTION! PART II

In Part I we discussed the tax and non-tax advantages of a corporation. Now for the disadvantages of incorporating.

Fellow tax blogger, and tax attorney, Kelly TAX GIRL Erb provided an excellent review of business entity choices a while back in a guest post at the PROBLOGGER.NET blog titled “6 Types of Business Entities to Consider for Your Blogging Business”. In it she says –

The disadvantages of a corporation are increased administrative expenses, compliance formalities and the potential for ‘double taxation’.”

These disadvantages all add up to one big one – substantial additional cost! There is no doubt in anyone’s mind that it costs a lot more to form, maintain and eventually dissolve a corporation (whether “C” or “S”) than any other form of business entity.

Kelly tells us that, “Increased administrative expenses are due to more complicated accounting and tax compliance (i.e. filing corporate returns).” And, of course, the substantially increased compliance formalities, substantially more than other forms of business organization, result in substantially increased costs for accounting and tax preparation and federal, state and local taxes and fees.

’Double taxation’”, Kelly tells us, “is the result of a C corporation being a separate taxable entity and not a pass through. This means that the C corporation pays a tax on its income for the corporate year and the shareholders pay tax on dividends received from the corporation.”

One must consider state as well as federal tax costs. While on the federal level if you have no net taxable income you pay no federal income tax, many states charge a “minimum tax” or “franchise fee” for the privilege of operating as a corporation in the state. My state of New Jersey is especially abusive in this area. A corporation could have “0” taxable income yet still pay from $500.00 to as much as $2,000.00 in “minimum” Corporation Business Tax!

And let’s face it - choosing to incorporate also substantially increases not only your paperwork and expenses but also your potential for agita and aggravation. Because there are a lot more complicated rules a corporation must follow there are a lot more things that can go wrong – and very expensively wrong.

A final disadvantage of a corporation is the potential cost in time, agita (again) and dollars to “dissolve” the corporation. With marriage you can pay a couple of bucks for a licence and be wed by a municipal judge – but you could pay a fortune to get a divorce. It is similar with a corporation. You can easily, and relatively cheaply, incorporate online (I just did it the other day in NJ for $125.00 in about 15 minutes) – but there can be a lot of paperwork and potential expense involved to end the corporation, as well as, once again, the potential for “double taxation”.

When dissolving an incorporated business the best course of action for the seller is to sell the shares of the corporation – which will result in a capital gain transaction on Schedule D of the sellers Form 1040, probably taxed at the lower capital gains rate (which this year could be “0”). However most buyers do not want to do this. They would prefer to purchase the individual assets of the business activity from the corporation. There is no special capital gains tax rate for corporations. A corporation is taxed at regular corporate rates on any gain from the sale of its individual assets. The double taxation comes into play when the corporation, in dissolution, passes on the cash from the sale and any remaining assets to the shareholder(s).

Lawyers love corporations and generally recommend it automatically, regardless of whether or not it is truly the best business entity form for the particular situation. Why? Duh - It generates lots of fees!

One does not need to pay a lawyer an excessive fee (for about a half hour or less of his/her secretary’s time to type a pro-forma certificate) to form a basic one-person corporation. It is a very simple process. And now that many states (like New Jersey) allow one to incorporate easily online with almost immediate conformation it is even simpler.

Obviously with more complicated specific circumstances involved in the individual corporation, multiple private stockholders and/or unique/diverse issues and intricacies, one should indeed consult a qualified attorney experienced in corporate law (including federal and state corporate tax law).

Of course not all lawyers are money-grubbing shysters. There are indeed exceptions who will offer true and honest advice to small business clients based on the individual facts and circumstances. For example in the guest post by tax attorney Kelly Phillips Erb mentioned earlier it is correctly and wisely pointed out that, “In most cases, a C corporation is ‘overkill’ for a freelancer with no immediate plans for expansion, hiring of employees, etc.”

Because of the possible tax savings but guaranteed additional costs involved any individual who is considering incorporating his/her one or more person business should do some very serious number crunching first to determine if there is a true potential cost benefit to making such a choice. It is very important that the first person you consult about such a decision is a tax professional, and not an attorney. It is possible that you may eventually need to consult with an attorney, but certainly not before carefully reviewing all the facts with a tax pro.

My bottom line - unless employee benefits such as health insurance premiums, medical reimbursements and pension contributions are a material issue, my recommendation for one starting out in business is to do so as a one-person LLC electing to be taxed as the “default entity” – with one person that is a sole proprietor filing Schedule C. If you find down the road that you would be better off as a corporation you can always change your form, either by remaining an LLC and electing to revise your tax treatment or by actually incorporating the existing business.

The costs of forming and maintaining and dissolving an LLC are still minimal, especially when compared to the costs of forming and maintaining and dissolving a corporation. As has become true with corporations, it is very easy to form an LLC online at your state’s website. You do not need a lawyer to form a basic one-person LLC.

The final word - Perhaps the most important statement made in Kelly Erb’s above-referenced post is – “Laws vary from state to state as to how various entities are structured {and taxed – rdf}, so check with your tax or legal professional for specifics: I can’t stress this enough.” .

TTFN

Monday, August 24, 2009

TO INCORPORATE OR NOT TO INCORPORATE - THAT IS THE QUESTION! - PART I

As a general rule posts to THE WANDERING TAX PRO are limited to 1040 issues, including those that pertain to Schedule C. While I have prepared many “entity” returns (corporation, partnership, trust, non-profit organization – Forms 1120, 1065, 1041, 990) over the years I no longer accept “entity” clients (unless absolutely necessary).

However, as the decision whether or not to incorporate a business activity is in some degree a Schedule C issue I have decided to address it.

While there are two types of corporations (for income tax purposes) – the regular “C” corporation and the “Sub-chapter S” corporation – I will be addressing only the regular “C” corporation in this post. I feel that the advent of the LLC (Limited Liability Corporation) has reduced the benefit of becoming an “S” corporation.

Every person who is starting a business should not automatically incorporate. In most cases the one-person freelancer, “indie” or small business does not need to incorporate. It only unnecessarily and substantially increases costs, paperwork and agita.

There are several benefits, both tax and non-tax, to incorporating a business.

Historically the most popular non-tax reason for forming your business as a corporation is “limited liability protection”. The corporation has been around for a long time and has been proven in the courts over the years as a way of protecting the personal assets of the business owner(s), or shareholder(s). In most cases the creditors of the corporation cannot take the personal assets of the shareholders to satisfy debts or obligations of the corporation. .

For example, if a customer falls in your store (or spills hot coffee purchased from your fast food restaurant’s drive-up window on his/her lap while driving away) and sues you for $2 Million and wins the court cannot force you to sell your personal residence to satisfy the obligation if the corporation only has $10,000 in assets. Or if your corporation has a loan on which it defaults the bank or other creditor cannot go after your personal assets to cover the outstanding balance if the corporation has no cash.

Of course as with any law there are exceptions that allow lawyers to keep their fees flowing in. If it can be proven that you, as owner of the business, were personally responsible for the fall, or personally “contributed” to the fall, you could also be sued as an individual. And if you, as corporate officer, co-signed or guaranteed the loan the bank can come after you personally to make good. There is no way to get full guaranteed “limited liability” protection in all situations – but the corporation has generally been the best way to get the most protection.

But the corporation is not the only business entity that provides limited liability protection. We now have the “Limited Liability Company” or “LLC”. As one would expect from the title, an LLC provides the limited liability protection of a corporation without all the other “excess baggage” that comes with a corporation. I do believe that all states now allow for a one-person LLC. As long as you follow all the legal formalities, as well as keep your personal assets separate from your business assets (such as by maintaining a separate business checking account – are you listening, June Walker), your liability will largely be limited to your business assets

My only caveat is that, although it has been around since March of 1977 (with the passage of the Wisconsin Limited Liability Company Act), and is now an available option in all states, the LLC is still to some degree the “new kid on the block” and its liability protection has yet to be truly tested in the courts.

One tax-related benefit of incorporating is the fact that a business organized as a corporation will have a lesser chance of being audited than a sole proprietorship filing a Schedule C. If you look at two identical businesses – one filing a Form 1120 (the income tax return for a corporation) and one filing a Schedule C – each with identical gross income and business expenses – there is a much greater chance that the Form 1040 with the Schedule C will be chosen for an audit.

The reason for this is a corporation, with gross receipts that if reported on a Schedule C may be considered to be “large” in relation to other Schedule C businesses, will be relatively “small” when compared to the total population of corporations. And it appears that the IRS will be specifically targeting certain Schedule C businesses for audit in the near future as part of its war on the Tax Gap.

This benefit is most attractive to those who do not want to report all of their income to the IRS and/or who want to overstate deductions or claim personal deductions as business expenses. Tax fraud of this type will be less likely to be caught if one files as a corporation.

As for the honest taxpayer/businessperson who will be properly reporting all income and claiming only legitimate deductions – you should not incorporate if this is your only reason for doing so. It is not worth the additional cost and agita. While nobody wants to be audited, if you are one of the unlucky few who are selected, as long as you have been honest and have kept good receipts and records you should be able to successfully “pass” any audit.

Perhaps the biggest tax advantage of a corporation – especially a one-man corporation – comes in terms of tax-free employee benefits and reducing the overall Social Security and Medicare (FICA) Tax liability.

If you are the 100% owner of a corporation and hire yourself as an employee of the corporation you can give yourself many employee benefits, included but not limited to health insurance, life insurance, reimbursement of medical expenses, and pensions, the costs of which are deductible by the corporation but tax-free to you as an employee.

A major financial benefit comes in the way a corporation pays FICA tax on an employee as opposed to the way a self-employed sole proprietor filing a Schedule C pays “self-employment” tax. An employee pays Social Security and Medicare (FICA) tax on “gross wages”. The employer (corporation) pays half as a deductible expense and the employee pays half via withholding. A sole proprietor pays Social Security and Medicare (Self-Employment) tax on “net earnings from self-employment”, which is basically 92.35% of the Schedule C bottom line. The sole proprietor pays 100% of the tax on his/her 1040.

If a one-man corporation wants to “0” out net income by paying himself/herself a salary he/she can use employee benefits to reduce the “pot” that the wages come from. If he/she starts out with $60,000 and can use $20,000 to pay for legitimate deductible employee benefits, including the employer share of FICA tax, than his salary is $40,000 and FICA tax is paid on $40,000.

A sole proprietor’s allowable “employee benefits” (for himself) are deductible from gross income as an “adjustment to income” and not from net earnings from self-employment. If he/she has net earnings from self-employment of $60,000 he can reduce his income tax by deducting health insurance premiums and pension contributions, but he still pays self-employment tax on $55,410 ($60,000 x .9235) – which is $15,410 more than the corporate employee. The result is $2,358 more in Social Security and Medicare taxes paid.

While a corporation can pay and deduct the medical expenses of an employee under a “medical reimbursement plan” and pay and deduct, within limits, certain life insurance premiums, a Schedule C filer cannot claim medical expenses or life insurance as a business expense on Schedule C to reduce net earnings from self-employment. He/she must claim the medical expenses as a personal itemized deduction on Schedule A, subject to the 7½% of AGI exclusion, and cannot deduct life insurance premiums anywhere on his 1040.

Let us look at the real-life example of a client who has a small retail store. He is currently a one-man “C” corporation. His gross receipts for the year were slightly over $200,000.00. He took a salary of $45,000.00, bringing his federal net taxable income to $2.00. As part of the price for the privilege of living in New Jersey he paid $12,857.00 in health insurance premiums for himself and his family through the corporation. The corporation paid $3,734.00 in federal and state payroll taxes in addition to the $3,681.00 in FICA and unemployment and disability contributions (SUI and SDI) withheld from the $45,000.00 in wages. The Corporate Business Tax paid during the year was $500.00.

If the client had operated as a sole proprietor filing a Schedule C the net earnings on his federal Schedule C would have been $62,093.00 ($2.00 corporate income + $45,000.00 salary + $3,734.00 payroll taxes + $12,857.00 health insurance premiums + $500.00 NJ-CBT). His self-employment tax would be $8,773.00 ($62,093.00 x .9235 = $57,343.00 x 15.3%).

The additional tax paid as a sole proprietor would be $1,358.00 ($8,773.00 - $3,734.00 corporate payroll tax expense - $3,681.00 payroll tax withholdings). There would be a very small federal income tax savings - as the net taxable earnings from self-employment, after deducting the health insurance premiums and one-half of the self-employment tax would be $44,849.00 instead of $45,000.00 – but the state income tax liability would be more due to the increased earnings reported from self-employment and possible decreased medical deduction.

This particular entrepreneur did not make a contribution to a pension plan from the corporation. But if he did that would have further reduced the FICA tax liability. If the corporation had made a tax deductible contribution of $5,000.00 to a SEP on behalf of the owner/employee the W-2 wages would now be $40,000.00. The FICA savings on $5,000.00 would be an additional $765.00.

Of course you must also factor into your calculations the state Corporation Business Tax (which was $500.00 in the above example) and the additional accounting and tax preparation fees that a corporation would pay – and, of course, the agita factor.

And there is another tax-related benefit. A corporation provides you the option to select your “fiscal year”. You do not have to report income and expenses on a calendar year basis. You can, for example, choose a fiscal year of July 1 to June 30, or April 1 to March 30. Having a non-calendar fiscal year can provide some tax planning opportunities for the closely-held corporation.

. . . to be continued

Tomorrow - the disadvantage of incorporating.

TTFN

Saturday, August 22, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’

* Monica Lawver adds he voice to those tax professionals who correctly believe that an “indie” does need to have a separate business checking account in the post “Banking Blunders” at THE TAX CPA.
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Thanks, Monica, for the support!
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* On the same subject, the website LLC Made Easy, which appears to be a great resource for forming and maintaining an LLC (I will have to check it out more carefully) has an article on “Why You Shouldn't Commingle Business and Personal Funds”. The author says, “But, for several reasons, you want to get your ducks in a line first and keep your business and personal accounts separate to avoid commingling of funds.”
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The article goes on to make the following points –
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Mixing business and personal funds is sloppy.
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It's bad legally, for the reasons above, and it's simply bad business.
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It also makes accounting difficult and inaccurate. Accounting is more than just doing your taxes
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* Before leaving the subject - while June Walker has finally published the comments on her offending post she has not provided any response or rebuttal. It appears she is ignoring the issue and the multitude of tax professionals who disagree with her.
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If she is so wrong on this basic issue it makes you wonder about the value of advice she offers in other areas. Plus her attitude stinks. She certainly has a lot to learn on how to deal with “peers” (and I use that term generously) who disagree with her.
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She has actually provided some good advice – “Be careful. Know your source.”
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* Kay Bell tells us that some rich Americans want to pay more federal income tax in “'Tax Us More,' Say Some Rich Americans” at DON’T MESS WITH TAXES. They are passing around a petition to be signed by individuals with taxable incomes over $235,000.
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If these individuals feel strongly that they should pay more of their income to the government they are welcome to make voluntary contributions to the US Treasury. Hey, such voluntary contributions are deductible on Schedule A! According to IRS Publication 526 (Charitable Contributions), included among the five types of organizations to which you can make tax deductible contributions is (as usual, the highlight is mine) –
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The United States or any state, the District of Columbia, a U.S. possession (including Puerto Rico), a political subdivision of a state or U.S. possession, or an Indian tribal government or any of its subdivisions that perform substantial government functions.
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Note. To be deductible, your contribution to this type of organization must be made solely for public purposes
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Unfortunately I am not in the income bracket of those this petition will affect, so I will not be asked to sign it.
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* Richard Hatch (the fool from SURVIVOR and not the actor from STREETS OF SAN FRANCISCO) says he was imprisoned for being gay. Joe Kristen of the ROTH AND COMPANY TAX UPDATE BLOG thinks “There Could Be Another Explanation”.
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There is, Joe. Richard Hatch was imprisoned for being an idiot!
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* Mary O’Keefe, who seeks out BED BUFFALOS IN YOUR TAX CODE, has two posts that address the issues I discussed in my post “There Has Got To Be A Better Way” – “Why The IRS Is Doing Everyone's Work” and “More On Why Is The IRS Doing Everyone's Work?”.
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Mary’s initial post on this topic was inspired by Prof Jim Maule’s “Tax Talk At The Gym” over at MAULED AGAIN>
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* And Mary ends the week at BED BEFFALOS by quoting from an article from a recent U of Chicago Journal that tells us “City Dwellers Bear Disproportionate Federal Tax Burden”.
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This concept is nothing new to a resident of New Jersey.
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* Roni Deutch, THE TAX LADY, gives an updated list of “Tax Professionals Active on Twitter”. You will find me there – rdftaxpro.
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* Another famous female tax blogger, just as much a lady, TAX GIRL Kelly Phillips Erb provides some information on next year’s Census and warns us to “Avoid Census/Tax Scams”.
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Kelly reminds us –
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The IRS and the US Census Bureau are separate entities. An official US Census worker will not ask you about your tax returns or other confidential tax information. Additionally, the US Census does not have access to your confidential tax information – any claims made regarding taxes owed or other inconsistencies will not be raised by a US Census worker.”
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If my clients are listening – I do not fill out Census Forms for individuals. I have no more knowledge about them then you do, and, as they usually arrive during tax season, I do not have the time to waste on them.
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* Richard Close, known as the IRS HITMAN, discusses his “IRS Tax Issues: The Top 3 Tax Sins”. While I would not necessarily pick the same three in the same order as my top 3 “sins”, Richard does give some good advice.
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* NATP’s TAXPRO WEEKLY email newsletter brings us two BUZZbits -
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Processing Delays for Forms 1040X - The IRS is experiencing higher than expected inventory levels of Forms 1040X, Amended U.S. Individual Income Tax Returns. Due to these inventory levels, the processing time frame is temporarily extended to 12 - 16 weeks (normal processing time is 8 - 12 weeks). Contacting the IRS regarding the status of the return is not necessary and the returns will be processed as soon as possible.”
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And –
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Kentucky Disaster Relief - Following severe storms, flooding and straight-line winds in Kentucky on August 4, 2009, the President declared Jefferson County a federal disaster area qualifying for individual assistance.
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As a result, the IRS is postponing until October 5, 2009, certain deadlines for taxpayers who reside or have a business in the disaster area. The postponement applies to return filing, tax payments, and certain other time-sensitive acts otherwise due between August 4, 2009, and October 5, 2009. In addition, the IRS will waive the failure to deposit penalties for employment and excise deposits due on or after August 4, 2009, and on or before August 19, 2009, as long as the deposits were made by August 19, 2009.
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Additional information for this and other disasters is available on the IRS website
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* An article from Forbes.com reports that “Watchdog Growls At IRS' Audits By Mail”.
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The “watchdog” in the title is the Treasury Inspector General for Tax Administration (TIGTA). A new TIGTA report “lends support to growing complaints about the Internal Revenue Service's big audit-by-mail program”.
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While I would very much prefer getting a letter from “Sam” asking for specific documentation on a 1040 via return mail to a face-to-face, sit-down office audit, and I would expect so would any taxpayer, I do not want the extra agita and aggravation that IRS and/or postal delays could cause.
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As I have said in the past, just about every letter I send to the IRS nowadays results in a response a month or two later that the IRS has not had enough time to properly review my correspondence and needs an additional 45 days, followed 45 or so days later by basically the same letter.
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* Two new tax blogs have started up – TAX TIPS: KEEP MORE OF WHAT YOU EARN and TAX GEEK BLOG.
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*Some good information and advice from Friday’s TIP OF THE DAY from the Small Business Taxes and Management site –
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Bank gifts taxable . . . Some banks are offering gifts or cash awards for opening new accounts. You should be aware that any such payments are taxable income and you'll receive a Form 1099-INT next January. And before running to open that account, check to see if that's the cheapest option. Getting $100 cash doesn't make much sense if you're paying an extra $8 a month or you'll get hit with high fees. That's particularly true for a personal account. The gift will be taxable, but the fees won't be deductible. Do the math. You could get lucky and find yourself in a win-win situation.”
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* And, finally, CCH reports that “Cash for Clunkers Program to End August 24, DOT Announces”.
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TTFN
PS - No BUZZ next Wednesday. You will have to wait until Saturday!

Friday, August 21, 2009

FIREFIGHTER MEALS

Over the years I have done 1040s for many, many police officers, fire fighters, and other municipal service employees. I am often asked about the meal deduction for fire fighters.
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Here is the word (with documentation) –
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It is common in fire stations throughout the US for firefighters to operate a “common mess” because of the long shifts routinely worked by firefighters and the requirement that the firefighters remain in the station house unless called away on official business. Under a common mess arrangement, the firefighters contribute to a fund from which the food for their meals is purchased.
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Payments to an organized mess that are required of a fireman by his immediate superiors at the fire station, regardless of whether he leaves his assigned duty station during the normal 24-hour shift and actually participates in the mess, are expenses that are directly and proximately related to the active conduct of the fireman’s trade or business and are deductible under IRC Section 162(a). [Robert E. Cooper, 67 T.C. 870, Nonacq.,1978–1 C.B. 2; Richard R. Sibla, 68 T.C. 422, Nonacq., 1978-1 C.B. 3.]
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The key point here is that the payments must be required as a condition of employment. In T.C. Summary Opinion 2004-63 the court upheld that if the firefighters’ payments into a common meal fund are voluntary (not a condition of employment), the expenses constitute personal expenses and are not deductible.
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As with any other employee business expense the deduction is first reported on Form 2106 (or Form 2106-EZ) and carried over to Schedule A as a miscellaneous deduction subject to the 2% of AGI exclusion.
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And as is the case with any meals claimed as an employee business expense you only get a tax benefit (tax deduction) for 50% of the total meals.
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We are talking about a potentially sizeable deduction here. Let us say that there are ninety (90) 24-hour shifts in a year and each fire fighter is required to contribute $20.00 per shift to the common mess fund. That is a total of $1,800 – or a tax deduction of $900. Added to other required employee business expenses of fire fighters, such as uniform cost and maintenance, equipment purchases, union dues, education for advancement, etc, it is not difficult exceed 2% of AGI.
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If you are a firefighter and you participate in a common mess check to see if your payments are “voluntary” or “required”. If they are indeed “voluntary” check with your union and see what can be done to make the payments “required” so they will be legitimately deductible.
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TTFN

Thursday, August 20, 2009

I FOUND IT!

I knew it had existed, although only briefly, but thought it was from the mid to late 1970s. It actually was in effect for tax years 1982 through 1986.
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What am I talking about? Why IRS Schedule W – “Deduction for a Married Couple When Both Work”. It was created to provide relief from the “marriage penalty”.
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I had first mentioned the Schedule W in last Saturday’s BUZZ post when commenting on the new IRS Schedule L.
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According to the instructions for the 1983 Schedule W “Complete this schedule and attach it to your 1040 if you take the deduction for a married couple when both work.” The deduction, an “Adjustment to Income” (above-the-line), was available if both husband and wife “work and have ‘qualified earned income’ {i.e. - W-2 or self-employment income less adjustments to income for employee business expenses and IRA and Keogh contributions - rdf}” and “file a joint return”.
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I rediscovered this deduction going through the Tax Analyst’s “1040 Achieve”, where you can download the federal Form 1040 from the original 1913 version through 2006. Upon finding it in 1982 I went to my client files and pulled out the folder for a client whose 1040 I have been preparing since 1981.
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While I am only required by law to keep copies of the current and three previous years’ returns, I actually have copies of all returns I have filed for as long as a person/couple/surviving spouse remains a client. There is one file, originally a client of my mentor, which has copies back to the late 1960s!
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To calculate the deduction you would first determine the individual net “Qualified Earned Income” for each spouse. The deduction was 10% (5% for 1982) of the lesser of the lower net qualified earned income or $30,000.
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The 1983 Schedule W for my client showed that the husband had W-2 earnings of $37,226 and the wife had a W-2 for $16,800. Neither had any applicable adjustments to income, so the deduction was $1,680 – 10% of the wife’s $16,800 Form W-2. If the wife’s W-2 had been for $33,600 the deduction would be limited to $3,000 – 10% of $30,000.
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The Schedule W discussed above should not be confused with George W's Schedule W - click here.
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BTW – in my search of 1040s of the 1970s I came across a credit available on the 1975 return only for “Purchase of New Personal Residence” claimed on Form 5405 (the same form number currently used for the First-Time Homebuyer Credit). So it is true that "everything old is new again"!
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TTFN

Wednesday, August 19, 2009

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’ – WEDNESDAY EDITION

* The TAX GIRL starts the BUZZ off with a good entry in her Ask the Tax Girl series – “Ask the taxgirl: Volunteering and Charitable Deductions”.
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I have just one question for Kelly – which one of the three Girl Scout leaders in the picture is you?
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* I came across this quote recently from United States Freight Co. v. U.S., 422 F.2d 887 (U.S. ct. of Cl. 1970) which says it all (the highlight is mine) -
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"[W]hat makes sense" does not necessarily dictate the definitive answer in the tax area; apparent conceptual niceties often must give way to the hard realities of statutory requirements.”
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* Mary O’Keefe reports on a sting operation on tax preparers in NYS in her post “30% of Preparers in NY ‘Secret Shopper’ Visits ‘Horribly Fraudulent’" over at her BED BUFFALOES IN YOUR TAX CODE blog
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The post was “inspired” by a newspaper profile on William Comiskey, the Deputy Commissioner for Enforcement in the New York State Tax Department. Unfortunately the profile does not give any details on the preparers in the sting or the specific results. Can anyone out there point me to a report or article that discusses the actual sting?
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* The discussion with Kevin that began in my post “We Agree to Disagree” continues with Mary O’Keefe in the comments section. Be sure to check out the comments to this post.
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Mary then carries on in the post “Tax Preparer Objections to Testing--and My Responses” at BED BUFFALOES, providing her response to my comments on her comments.
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My debate with Mary is another good example of how two competent and ethical tax professionals, coming at a subject from different perspectives, can carry on a civil debate on a tax issue with mutual respect and without resorting to personal attacks or put-downs – simply agreeing to disagree.
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* Now for how a discussion should not be conducted - I hope you have read my post "Why Can't We All Just Learn to Get Along?". In it I include a comment that I submitted to a tax blogger who I dared to disagree with (and I am not alone in my disagreement) and who responded not with discussion or debate but with belittling and personal attacks. As of this "writing" my comment was not published.
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Apparently other tax bloggers submitted comments which were also not published. Check out the comments to my post - especially Hal Leahy's extension Tax Court research.
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And a thank you to Trish McIntire who also responded via the post "You're Out" at OUR TAXING TIMES.
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*She likes me! She really likes me! Monica Lawver has included me in the top five of her top ten tax blogs in “Favorite Tax Blogs” over at THE TAX CPA blog.
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With perhaps one exception (for personal reasons) I am in truly great company on her list. And, Monica, you are on my list of Top 10. I only wish you would blog more often.
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* Kay Bell reminds us that “
First-Time Homebuyer Credit Clock Ticking” and discusses some related state tax breaks at DON’T MESS WITH TAXES.
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* IRS HITMAN Richard Close provides a good overview of the topic “
Hobby vs. Business: How to Classify your Summer Business”.
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* Roni Deutch gives us some “
Back to School Tax Tips for the Educator Expense Deduction” at her TAX HELP BLOG.
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TTFN

Tuesday, August 18, 2009

WHY CAN’T WE ALL JUST LEARN TO GET ALONG?

What is it with some people? Just because someone respectfully disagrees with you on a subject does not make them a fool, or stupid, or uninformed.

It seems I have, unintentionally, acquired a new enemy in the blogosphere because I have disagreed with the advice they have offered in a public blog post.

The new enemy is June Walker, whose advice I strongly disagreed with in my post “You Do Need A Business Checking Account”. First check out her response in the post “There’s No Shortage of Bad Advice Out There”.

Here is the comment I submitted to her blog this morning:

JW-

Ah, another debate among tax professionals!

Why can’t we learn to just get along?

I agree with your post’s title – “There’s no shortage of bad advice out there” – however we disagree on who is actually providing the bad advice.

First of all, sorry for not being perfectly “PC”. This is a legitimate complaint. I do try to use “he/she” etc instead of he in my posts.

Secondly I take exception to being compared to “the tax pro who totally misunderstands indie life” simply because I disagree with you on one issue. I have been preparing 1040s for “indies” since 1972, a bit longer than you, and have been an “indie” myself most of the past 38 years.

Now on to your comments on my comments (the highlights are hers) -

You say - “Well, he says, “loan” money to the business account from your personal account and then return it later. If you have attended my seminars or read my book you know: That leaves a very wiggly audit trail for the IRS to follow.”

It would seem to me that using one’s personal checking account for both business and personal expenses is more wiggly an audit trail for an IRS auditor to deal with.

You then quote your original post - “The very next example from the IRS in the publication is the mixed use – personal and business – of your automobile. So, let’s see how efficient two checking accounts would be in this situation – hmm … guess you are expected to pay for each gas purchase with two checks – one for the personal use amount of gas and a business check for the business use portion.”

What a silly example. What fool would give a gas station attendant his/her check to pay for a gas purchase? Do you know of any gas station that would accept a check? If the business person uses the Standard Mileage Allowance he/she would just reimburse himself/herself from the business checking account for the appropriate business mileage. If the actual expense method were chosen the business portion of total auto expenses would be reimbursed.

One would expect you to use the usual courtesy of “Mr” in front of Flach when discussing me. You mention that I “took respectful disagreement” to your post. One would expect you to provide the same respect.

Rather than merely “pooh-poohing” me as one who does not understand “indies” just because we disagree I would prefer a serious discussion on the issue. You could, perhaps, explain why if you do not agree with my statement that an indie should “do as much as possible to give your self-employment activity the appearance of a real business entity so that the IRS does not come back and say that it is really a ‘hobby.’”

Regarding your other opponent - I am not a fan of Mr Pappas, and have myself felt his wrath, similar to your wrath, when I dared to disagree with him. I would agree with your reference to him as “Attila the Tax Lawyer”. It appears that he does not know how to express “respectful disagreement”.

To be fair I do not believe you advised corporate officers to pay business expenses with a personal check. I took your post to be concerned with self-employed individuals, LLCs or not, who file a Schedule C.

I totally disagree with his statement – “If you have a serious business, it’s unwise to operate as a sole proprietorship and probably malpractice for a lawyer not to point that out to his clients.” Lawyers in general like to tout corporations because of the additional legal fees involved in forming and maintaining a corporation.

Let me know when you want to conduct a serious and respectful discussion on this topic.

TWTP

As of the time of this posting (4:00 PM EST) the above comment had not been published on Ms Walker’s blog, and therefore no response was provided. I will let you know if my comment ever does appear and what, if anything, Ms Walker has to say in rebuttal.

I would appreciate hearing from other tax professionals out there on the issue of using a business checking account. Who is right – Ms Walker or I?

FYI, Joe Kristan of the ROTH AND COMPANY TAX UPDATE BLOG has already weighed in on my side in his post “If You Have a Home Business, Should You Have a Business-Only Checking Account?” Joe says – “Mr. Flach gets it right. You will save yourself a lot of time at tax time, and a lot of grief in an IRS exam, if personal is personal, business is business, and that's that. Run your business like a business.”

TTFN

THERE HAS GOT TO BE A BETTER WAY!

Trish McIntire makes a good point in her post “Thank You Congress?” –

Could these programs have been done outside the tax system? I don't know. The Cash for Clunkers program isn't run through the IRS and it seems to be working quite well. Something to think about Congress.”

She is talking about the various credits and deductions currently in the Tax Code, and on the 1040, to “reward” certain beneficial behavior – like education, home ownership, saving for retirement, working, etc.

The $4,500 maximum “Cash for Clunkers” subsidy for trading in a used gas guzzler for a new, more fuel efficient auto is not paid out as a tax credit, refundable or otherwise, on the Form 1040. As Roni Deutch explains it in the post “A Deeper Look at the Cash for Clunkers Program” at her THE TAX LADY BLOG –

In fact, it is being managed the U.S. Department of Transportation, not the Internal Revenue Service. When a qualifying taxpayer goes to buy a car, the dealership will automatically credit the rebate towards the purchase price. You do not need to claim it on your income tax return, you do not need to request the rebate; the dealership should handle everything.”

As Trish pointed out, this process “seems to be working quite well”.

So why, then, could not the U.S. Department of Education automatically apply the American Opportunity Credit, or the HOPE or Lifetime Learning Credit, towards the price of tuition, with the possibility of any remaining available credit being applied at the college book store? Then the government would be assured that the money is actually spent on continuing education. If the student “drops out” the unused portion of the “government subsidy” would be returned to the Department of Education.

And why, then, could not the First Time Homebuyer Credit be applied to the purchase of a qualifying home at the actual closing? Then the government would be sure that a primary personal residence was actually being purchased by a “first-time” homebuyer. A “Statement of Qualification” could be added to the papers filed with the purchase on which the purchaser(s) would certify, under penalty of perjury, that he/she/they qualify for the $8,000 payment.

If there are credits to be provided to cover health insurance premium purchases in any upcoming Health Care Reform bill, why not have the U.S. Department of Health and Human Services credit the amount to the price of the actual premiums? Then the government would be sure that the money is actually spent on health care coverage.

Perhaps the amount of Retirement Savings Credit allowed could be actually deposited by the government into the individual’s IRA or other retirement savings account. Then the money would actually add to and help to grow retirement savings.

And in the case of the Earned Income Credit, why not just provide the qualifying individual or family with a supplemental welfare check, perhaps through the SSI system?

Doing things in this way would be beneficial in many ways.

(1) It would be easier for the government to verify that the recipient of the subsidy or hand-out actually qualified for the money, greatly reducing fraud. And tax preparers would no longer need to take on the added responsibility of having to verify if a person qualified for government funds.

(2) The qualifying individual(s) would get the money at the “point of purchase”, when it is really needed, and not have to go “out of pocket” up front and wait to be reimbursed when they file their tax return.

(3) We would be able to actually measure the true income tax burden of individuals. No longer would about half of the American population either pay absolutely no federal income tax or actually make a profit from filing a tax return. These people would still be receiving government hand-outs, but it would not be tied into the income tax system so they would actually be paying federal income tax.

(3) We could measure the true cost of education, housing, health, welfare, etc programs in the federal budget because the various subsidies would be properly allocated to the appropriate departments and not be reported as a part of net income collected via income tax.

(4) The Tax Code would be much less complicated, the cost to the public for preparing a tax return would be reduced, and the IRS would have much less to process and to audit.

Obviously, while this would reduce the burden of the IRS, it would increase the burden and paperwork of the individual departments and agencies that would take over the distribution of the subsidies and hand-outs. So the IRS budget would be reduced and the other individual budgets increased. The savings in tax fraud would probably cover any added expenses (I know there would still be fraud, but it would be more difficult than in the current situation). I sincerely believe that it is a trade-off that would ultimately be beneficial to all.

So – what to you think?

TTFN

Monday, August 17, 2009

FYI - THIS JUST IN

I never did receive a response to my original letter to IRS Commissioner Doug Shulman regarding the registration and licensure of tax preparers sent back in June - although I did receive a brief note acknowledging receipt of the letter and telling me that it was not being directed to the Commissioner but to some lacky in the Small Business section.
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However, today I did receive the following letter today in response to my more recent letter discussed in the post "Dear IRS" -
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"Dear Mr Flach:
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Thank you for your recent comments concerning Notice 2009-60. We appreciate the time and effort you spent preparing these comments.
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Sincerely,
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La Nita Van Dyke
Branch Chief
Publications and Regulations Branch
Legal Processing Division
Associate Chief Counsel
(Procedure and Administration)"
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At least it is something. Note that the description of the letter's author was longer than the actual content of the letter!

WE AGREE TO DISAGREE

Two competent and ethical tax professionals, one enrolled and one “unenrolled”, can disagree and still have a civil and creative discussion on a tax topic with mutual respect and consideration. Case in point –

I wrote a “think piece” on registration and licensure of tax preparers for the Viewpoint column of current issue of the National Association of Tax Professionals quarterly TAXPRO JOURNAL, adapted from posts on the subject at TWTP from earlier this summer.

Yesterday my editor forwarded an email she received from a tax pro and popular CPE instructor on the piece to me:

Dear Cindy -

I'd like to express my disagreement with the recent Viewpoint by Robert D. Flach, 'License and Registration, Please' (Summer 2009 TaxPro Quarterly).

Thirty-eight years of experience does NOT guarantee competence, therefore I disagree with grandfathering in non-Circular 230 professionals if we have some type of national tax professional registration. Competence can only be measured by a test, and CPAs and EAs have already passed such a test. Non-enrolled individuals should also have to pass a test based on the types of returns for which they would like to be licensed to prepare. A competent practitioner would have no problem passing such a test, even with only 3 or 4 years experience. What's the problem? An incompetent preparer should not be preparing taxes. Period.

As an Ethics CPE instructor myself, I also disagree with Mr. Flach's take on an annual ethics requirement. I don't kid myself into believing that my ethics classes are going to change a 38 year experienced but unethical preparer into an ethical preparer. That is not the purpose of the ethics class. The purpose is to keep the ethical preparer from sliding down the slippery slope. Sometimes going to church on Sunday actually keeps a husband from cheating on his wife the following week, or the wife from killing her husband. The temptations are always there, but how strong is the resolve if it hasn't been fed recently? Just because it was fed 38 years ago doesn't mean it couldn't use another meal now.

Sincerely,

Kevin C. Huston, EA


I replied:

Kevin -

Cindy Van Beckum of NATP has forwarded your email to me.

Thank you for sharing your opinion on this important issue.

(1) I sincerely do believe that 38 years of continued unblemished experience does indeed guarantee a degree of competence. In my case if I didn’t know what I was doing, and did not keep current, I could not stay in business at my current level this long. I firmly believe that proof of a commitment to annual continuing education is actually more of a test of competence and being current than a basic initial proficiency exam.

(2) If national registration and licensure of all tax preparers is to become a reality it will require the cooperation of all tax preparers. Forcing a person who has been in business for many years to take a test to be able to continue to make a living in his/her chosen profession does not encourage cooperation.

(3) As I point out in my editorial, it seems to me that it would be literally impossible for the IRS to properly administer a test to the close to 1 Million current tax professionals within a 6 month period.

You mention that EAs and CPAs have already passed a test. It is very true that EAs have passed an extensive and difficult test in tax preparation and representation knowledge. However CPAs have only passed a test, although also extensive and difficult, in accounting and auditing principles and practices. Passing the CPA Exam does not guarantee that a person is competent in 1040 preparation.

Regarding ethics classes, I repeat that if I ain’t honest to begin with listening to 2 hours at each and every CPE offering each and every year ain’t going to make me “see the light”. I am well aware of the punishments for unethical tax preparation. I doubt I would be around for 38 years if I encouraged and produced fraudulent 1040s.

I do believe that some periodical update on ethical issues, including preparer requirements and penalties, is a good idea. I have suggested 1 hour every other year. My main complaint is that for just about every 8 hours of CPE I pay for I get only 6 hours of actual tax knowledge.

I certainly do not wish that any new “Licensed Tax Practitioner” designation take anything away from the reputation or qualifications or credentials of the Enrolled Agent. I would not permit LTPs to “practice before the IRS”, other than currently unenrolled agents are already allowed so to do. I would continue to limit “practice” to EAs, CPAs and attorneys.

My final recommendations on licensure and registration, which have evolved a bit since writing my editorial for NATP, appear in my post “Dear IRS”.

RDF

Kevin responded:

Robert -

I am not directing the 38 years of experience comment at YOU personally, but twelve or thirteen years ago, I purchased a tax practice from a practitioner (dying of cancer) who had been doing taxes for well over 40 years on his kitchen table. He was still deducting sales tax in the 1990s, and the IRS apparently never audited any of his clients, so he (and more importantly his clients) assumed that the returns were correct. He also deducted a flat $5 a day on the tax returns of his many blind vendors 'who can't see whether someone handed them a $20 or a $1 bill) because he thought 'it was proper, they've already been dealt a blow, why not give them a few breaks'. There were also other glaring errors or misstatements that a competent tax pro would have noticed immediately. His 40 years experience did not translate into competence at all. His 40 years of experience without repercussion only steeled him in his abilities as a great tax professional. Some of his clients stayed on with me, and many did not because they felt that 'I didn't know taxes', because the IRS had 'allowed' those deductions for so many years, they must have been correct. God bless his soul, he passed away that year after handing over his clients, for whom he truly cared.

You are no doubt a conscientious professional. You may have even attended some of the tax update classes I've taught in your area. But there are many out there who don't share our passion to help our clients while at the same time upholding the tax law. Some of those people also belong to the same national organizations that we do. Perhaps they sleep through the ethics and other sections of the class and, to be fair, perhaps they do listen to one of the presentations every other year to see if there are any new wrinkles. But a CPE certificate still doesn't show you learned anything. If each class had a test at the end of every hour, then we'd know if the important messages were conveyed or not. Now you've earned your CPE. Testing.

I don't see it as a hindrance at all for someone like you to be able to pass a test which I believe will be equivalent to the test given at the completion of the H&R Block Basic Tax Course (or similar first year preparer course for 1040 returns). And you already get annual CPE. Come on, you're whining for nothing! Admit it, maybe you just don't want to pay the fee!

NATP and other organizations have a vested interest in seeing that their members pass (or are grandfathered in to) the licensing process. I disagree that 'it takes the cooperation of all preparers'. It becomes a responsibility of all preparers.

As for the impossibility of the IRS doing anything within a short period of time, you'll get no argument out of me. In my opinion, all of the major stakeholders would be granted authority to test (H&R Block and the other chains, and the national tax and accounting organizations). Prometric has already computerized the SEE exam for Enrolled Agents. Within two or three years they could computerize a basic tax prep test. In other words, the best way for the IRS to do it is to not have the IRS do it at all. Farm it out. It won't happen in 6 months, I agree.

As for the oversight, that WOULD take beefing up OPR.

You obviously missed my point about the ethics CPE. It isn't for the dishonest. It's to keep the honest honest. Just like the lock on your front door isn't going to keep out the thief. But it will keep your nosy neighbor from seeing what brand of deodorant you use while you are out in the back yard. Your neighbor of 38 years doesn't want to steal from you, he is just curious as to why your wife smells so nice. The lock keeps him from doing something he will regret later. It's a reminder not to go where he shouldn't.

You are obviously offended by having to take ethics. Well, let me let you in on a secret: right now you don't have to unless you're a Circular 230 professional. But for some reason even Circular 230 professionals need to be reminded about EITC due diligence, preparer fraud, and those things that can get them disbarred or censured. We don't want the 'good guys' to lose their ability to practice, do we?

Maybe the ethics classes you have attended are boring. I hear that often. You might want to attend one of mine. We play a Jeopardy style gameshow that's as educational as it is fun. I'm presenting it this Fall for the North Carolina Society of Enrolled Agents, the Ohio Society of Enrolled Agents and the Illinois Chapter of NATP. I've already presented it to the California Society of Enrolled Agents and the New York Society of Enrolled Agents within the last year. Next year, so far the California Society of Enrolled Agents (for a reprise) and the Michigan Chapter of NATP have booked me. The participants always say things like 'best ethics EVER' or 'wow, I thought I knew that, but I learned so much!' I'll send you links to the various state sites if you're interested. I'll even buy you a beer after class and we can share a laugh. Iced tea if you don't drink alcohol. Seriously.

Similarly, I teach a BASIS class to long-term practitioners who also say they thought they knew all that, but still learned something useful.

So the purpose of me responding is not to convince you out of your beliefs (I don't think I'm that persuasive), but to point out that there are many out there like me that have just as strongly held beliefs otherwise. That is what a good discussion needs, isn't it?

Kevin


And I returned the volley:

Kevin -

A good story about the 40-year veteran. I thought I had heard everything – but the $5.00 per day theft loss for the blind is a new one for me!

You mention you bought out the practice 12 or 13 years ago. Things were somewhat different during that preparer’s tenure – more FUs got past the IRS and preparer penalties were not an issue. I doubt if he would last as long today. If he was a kitchen table preparer I would not think he had lots of clients, and I expect that they were of lower income variety and not potential audit material.

Granted the best way to judge competence and being current would be an annual, or semi-annual, exam of all preparers. But this is obviously impractical and overly excessive.

And it is true that one could sleep through or find some other way of “cheating” CPE classes. I like how the IRS, and I believe also NATP, uses a badge scanner to record attendance at classes. However this process is flawed in that it only scans when one enters the class and not when one leaves. This procedure should be modified so that a person must scan when entering and leaving in order to get full credit.

But passing an exam is also not always a true measure of ability. Some individuals freeze up under the pressure of tests, while others can memorize facts for a short period and forget them the day after the test. And with so many people to test who is to say who is actually taking the test.

I still say that it would be literally impossible to properly administer a test for 1 Million + preparers (I include CPAs and attorneys who want to prepare 1040s in this number as explained in my proposal).

I do agree that it would perhaps be best if the IRS “outsourced” any initial proficiency test. While I expect that Henry and Richard and the various tax preparer membership organizations would jump on the bandwagon to offer exam review classes, I would not allow them to actually administer the test. This should be done either by the IRS itself or an “impartial” outside firm. I certainly would not trust anything administered by Henry and Richard.

A talented instructor, as I expect you are, can make even the driest subject interesting. To me it is still a waste of my time considering the current situation where almost every single CPE event has 2 hours of the topic included. (When I complained to the NJ-NATP about this waste of time I was told that attendance would drop off if ethics were not offered). I am not offended by an ethics requirement – what offends me is that even though I am not currently required to sit through 2 hours of ethics per year I am forced to pay for 4 to 6 hours of the topic each year.

I don’t believe that ethics classes are meant to keep an honest person honest. One’s degree of honesty is not determined or maintained by listening to even the best speaker. We are not talking about alcoholics or drug addicts who need constant reinforcement and support. If I really want to see what makes my neighbor’s wife smell so good your telling me that this is not “kosher” will not stop me. What stops me, other than personally integrity, is the prospect of going to jail for breaking and entering and stalking. I would compare the locked door more to practitioner penalties and existing legal sanctions rather than a lecture.

Now I would attend a class on BASIS.

RDF

Kevin’s final response:

Robert -

An idea I had last night was to quit calling the class 'ethics' all together. It really is about safeguarding your practice and income source. Staying away from the things that cause penalties and sanctions. Knowing where to find the rules when you're not sure. How to develop (and more importantly implement) a privacy policy and a disclosure/nondisclosure policy. Why an engagement letter can help both you and your client. So we could call the 2 hours 'Safeguarding Your Practice' or 'Best Practices For Your Practice' or anything like that. I believe that people do want to make sure they stay out of trouble, and the government is always changing the rules (last year's required disclosure verbiage, for example).

Thanks for the thoughts.

Kevin


Of course I had the last word:

Kevin -

Now that sounds like something I might sit through! Good idea. But only once during a year.

RDF

Hey, does anyone else want to join the discussion?

TTFN