TECHNICAL CORRECTIONS

Everyone admits that there needs to be “technical corrections” made to the hastily written GOP Tax Act.  In addition to those being discussed, here are some changes I believe should be enacted -

+ If Congress believes the deduction for state and local taxes should be limited to $10,000, the maximum amount allowed for a married couple filing a joint return, currently also $10,000, should be increased to $20,000.  Two single individuals living together can claim $10,000 each for a total of $20,000.  Why should a married couple be penalized by limiting the deduction to $10,000 on a joint return?

+ The Child Tax Credit of $2,000 per child, increased from the previous $1,000 to make up for the loss of the personal exemption, is only allowed for dependent children under age 17.  A dependent child who turns age 17 during the year gets the lower $500 “Other Dependent Credit”.  It is my assumption that the Child Tax Credit was intended to cover dependent children through high school.  The age threshold for the higher Child Tax Credit should be changed from under age 17 to under age 18 or even under age 19. 

+ The American Opportunity Credit was intended to provide tax relief for the 4 years of college leading to an undergraduate degree.  Currently the credit is only available for 4 tax years.  But since a college year begins in the fall of one year and ends in the spring of another year a 4-year degree program actually takes place within 5 calendar years.  Qualified calendar-year taxpayers, which almost everyone is, should be allowed to claim the American Opportunity Credit for 5 tax years.

As an aside - I do not believe the American Opportunity Credit, or any credit or deduction that is in reality a distribution of social welfare or other government benefits, belongs in the US Tax Code.  But as long as it is there it should be done properly to accomplish its intended purpose.  And I oppose the $10,000 SALT limitation, but if it is there it should be applied fairly.

So, what do you think?

TTFN

ANOTHER VERY VERY VERY VERY VERY VERY VERY IMPORTANT TOPIC

As a result of the GOP Tax Act, for tax years 2018 through 2025, or until new tax legislation is enacted, only mortgage interest on “acquisition debt” – money borrowed to buy, build or substantially improve the residence – is deductible on Schedule A.  Interest on home equity debt interest – money borrowed to buy a car, pay for college, pay down credit card interest, etc. – is not deductible, regardless of the amount.  Period.  And there is no grandfathering of existing home equity debt.

It has always been important for homeowners to keep separate track of acquisition debt and home equity debt, because of the previous $100,000 principal limitation on the deduction for home equity interest and the fact that home equity debt interest was not deductible in calculating the dreaded Alternative Minimum Tax.  However, I do not know of a single homeowner who actually did this.  Even before the hastily written GOP Tax Act was scribblings on a cocktail napkin I had commented that the deduction for mortgage interest, both on Schedule A and Form 6251, was perhaps the area of the Tax Code where proper documentation and strict adherence to the law was the most overlooked (or actually ignored).    

But if the dreaded AMT was not a consideration this wasn’t an issue in most cases because of the $100,000 home equity principal threshold.  Now it is truly vital that his be done, going back to the original purchase mortgage for the property.

I explained this in detail to applicable 1040 clients last tax season when giving them their finished 2017 tax returns.  And I gave these clients worksheets with instructions and a detailed example to use to track the two different types of debt and offered to track the debt for them during the year at a slightly reduced hourly rate.

Nobody contacted me during the year to ask me to do it for them.  And this past tax filing season every single client either (1) assumed that they could not itemize, because I told them so last year and it didn’t matter, or (2) totally ignored the need to differentiate between acquisition debt and home equity debt and, like every other year, merely gave me their 1098s and expected me to either intuitively know the correct amount to claim or pull a number out of the air.

The one good thing about dealing with this issue during the tax filing season is that most clients who consistently itemized in the past can no longer itemize, regardless of the amount of mortgage interest paid, so it did not matter that they did not properly identify the correct amount of deductible interest.

Over the years most homeowners have refinanced their mortgage, often several times, for a variety of reasons, taken out home equity loans or lines of credits, also for a variety of reasons, and consolidated mortgage and equity loans.  In NJ, where most of my clients live, the market value of homes was excessively inflated at various times, creating the potential for additional borrowing.  There were many instances when a homeowner’s mortgage principal exceeded the original purchase price of the property and the cost of subsequent capital improvements.  Unless the homeowner purchased a new home recently, most, if not all, current mortgages include some combination of acquisition debt and home equity debt.

It is the responsibility of the taxpayer, and NOT the tax preparer, to separately track acquisition and home equity debt and properly identify the correct amount of deductible acquisition debt interest.  You can ask your tax pro to do this, or he or she may actually have been doing this on his or her own, but never assume or expect that he or she has been doing it. 

And it is the responsibility of the taxpayer to provide documentation for the amount of mortgage interest deducted if questions by the IRS.

Two important points to know when tracking the debt -

(1) Thankfully, to simply the tracking process, when applying principal payments to the different type of debt in mixed-use mortgages you first reduce home equity debt and any debt you have identified as investment debt.  Acquisition debt is paid down last.

(2) When a homeowner refinances, only that portion of the principal of the new loan that represents the pay-off of the principal on the original mortgage, if it is all acquisition debt, continues to be acquisition debt.  Any closing costs for a refinance that are included in the principal of the new loan is home equity debt.

The first step to determine the amount of current acquisition debt is to go back to the Closing or Settlement Statement for the very first refinance.  Look at the amount of principal of the original mortgage that was paid off in the refinance.  Compare this number to the 1/1/2018 principal balance reported on the Form 1098 for the current mortgage. 

If the pay-off of the initial mortgage is $100,000 and the 1/1/18 principal balance is 150,000 you then need to determine if any of the additional $50,000 was used to pay for capital improvements to the property.  If not, multiply the $100,000 by the rate of interest you are paying on the current mortgage.  If the rate is 3.5% than the Schedule A deduction is $3,500.

If the 1/1/2018 principal balance is $98,500 than all of the interest paid in 2018, and reported on the Form 1098, is fully deductible acquisition debt interest.

Of course, this example assumes you still have the Closing or Settlement Statement for that first refinance.  In discussing how long a taxpayer should keep records I recommend “if you own real estate keep all Closing or Settlement Statements for the purchase and refinancing of the property, and documentation of any capital improvements, for as long as you own the property plus four additional years”. 

For new homeowners going forward, if the limitation of the mortgage interest deduction to acquisition debt interest continues, and I personally believe it should despite the added complication -

(1) If you need to borrow money for home improvements open a separate home equity loan or line of credit and use this ONLY for home improvements that qualify as acquisition debt.  And keep documentation of the improvements. 

(2) If you need to borrow money for anything else - to pay down personal debt, pay for college, buy a car, etc - open a separate home equity loan or line of credit and use this ONLY for non-acquisition purposes.

(3) Never consolidate or combine the three mortgage accounts.  And if you refinance, always pay the closing costs in full with cash, or money from the non-acquisition home equity line of credit, and ONLY refinance the existing principal balance of the original mortgage.

So, homeowners who may still be able to itemize – read and understand this post carefully and either pay your tax professional to separately track your debt before the end of 2019 (and NOT during the 2020 filing season) or do it yourself. 

If you are going to do it yourself and want my worksheets and detailed instructions for doing this order my MORTGAGE INTEREST GUIDE.

Any questions?

TTFN

HERE'S A THOUGHT

While we are all thinking about tax reform - I have published my thoughts on what a new Tax Code should look like in THE TAX CODE MUST BE DESTROYED, but here is an alternative thought.

We have always had the option to deduct either a Standard Deduction or Itemized Deductions.  But what about both?

* We would begin with a base Standard Deduction amount, maybe $5,000 or $6,000 per taxpayer/spouse. 

* A taxpayer could also deduct a “homestead” amount - either the total amount of real estate taxes and mortgage interest (on limited principle) paid on one primary principal residence if a homeowner, or the actual amount of rent paid up to a maximum of $12,000, or a standard amount of $10,000, per household and not per taxpayer, if this is more than the actual homeowner or renter expenses.

* And a taxpayer could deduct actual contributions to charity (but not to churches or religious organizations for religious activity – see my above referenced publication), up to the current 50% of income limitation (with the excess carried forward).

In addition, there would be the normal “adjustments to income” for self-employed health insurance, half the self-employment tax, and contributions to retirement accounts, and early withdrawal penalties on CDs.

There would no longer be a Schedule A for Itemized Deductions.  However, there probably would be a need for a Schedule CC to itemize charitable contributions.

Just a thought. 

So, what do you think?

TTFN

WHAT YOU SHOULD LEARN FROM A RECENT TAX COURT CASE

A recent court case - Lewis, TC Memo 2017-117 – brings attention to the importance of keeping good records of your tax deductions.

Willie Lewis was a minister and an author who occasionally performed weddings, attended meetings, and conducted seminars.  He timely filed a federal return that claimed a deduction for unreimbursed employee business expenses.  The IRS audited the return and disallowed the deductions for the business expenses.

The Tax Court found that Lewis was not engaged in a trade or business for profit under Internal Revenue Code Sec. 162.  So the deductions related to his ministry and book writing activities were limited to the gross income he derived from these activities. However, because Mr. Lewis derived no gross income from the activities, he wasn't entitled to any deductions.

But the more important take away from this decision is the fact that the Court concluded that even if Mr. Lewis were found to have engaged in a trade or business for profit, the claimed deductions, which consisted mostly of automobile and travel-related expenses, would not be allowed because the taxpayer failed to properly substantiate them.  Lewis produced no accounting records, bank statements, invoices, or any other records traditionally associated with a business operating for a profit. He only submitted credit card statements and a summary showing certain expenses.  

As per IRC Sec. 6001 taxpayers are required to substantiate their claimed deductions. In addition, per IRC Sec. 274, additional substantiation is required for -

1. Any traveling expense, including meals and lodging away from home.

2. Any item with respect to an activity in the nature of entertainment, amusement, or recreation.

3. Any expense for gifts.

4. The use of "listed property", such as a passenger automobiles.

The taxpayer must substantiate expenses by adequate records or by sufficient evidence corroborating -

1. the amount of the expense,

2. the time and place of the travel, use of the property, etc.,

3. the business purpose of the expense, and

4. the business relationship to the taxpayer.  

The bottom line – it is vitally important to keep proper contemporaneous documentation of all business-related expenses, whether claimed as employee business expenses on Schedule A or trade or business expenses on Schedule C.

Actually it is vitally important to keep proper contemporaneous documentation for ALL items deducted on your tax return.

TTFN

 

 

 

 

 

 

 

 

 

 

 

TAX REFORM – DOING AWAY WITH DEDUCTIONS AND LOOPHOLES

One of the skimpy details of idiot Trump’s tax “plan” is to offset lower rates with the removal of tax deductions and “loopholes”.

 

This is a very sound concept that should be embraced in whatever the eventual tax reform package will actually look like.

 

I have always strongly felt, and continue to do so, that the tax return should not be used to distribute government social welfare and other program benefits.  So I believe that items like the Earned Income Credit, the Additional Child Tax Credit, the Advance Premium Credit, the various education tax benefits, and other similar “tax expenditures”, while the idea behind them may be appropriate and acceptable, should be removed from the Tax Code.  These benefits should be distributed in other ways.

 

Here are some of the deductions whose removal from the tax return I would support.

 

ü  Real estate tax deduction for all personal real estate other than the primary principal residence.

 

ü  Personal property tax deduction.

 

ü  State and local sales tax deduction.

 

ü  Acquisition debt mortgage interest deduction for a second personal residence.

 

ü  Home-equity debt mortgage interest deduction – the deduction for interest on home equity borrowing not used to buy, build, or substantially improve a taxpayer’s principal primary residence.

 

ü  Deduction of mortgage insurance premiums as mortgage interest (already gone).

 

ü  Depreciation deduction for real estate and capital improvements thereto.

 

ü  Depreciation deduction for business use of a personal automobile.

 

ü  Auto loan interest deduction for business use of a personal automobile.

 

ü  Auto lease payment deduction for business use of a personal automobile.

 

ü  The adjustment to income for Educator Expenses (why should teachers only be given this benefit and not other public service employees like police, fire, EMTs, stc?).

 

I discuss the reasoning for my choices in detail in A TAX PROFESSIONAL FOR TAX REFORM.

 

What deductions would you keep and what deductions would you remove?

 

TTFN

 

 

 

 

 

 

 

 

 

 

 

 

 

 

JUST BECAUSE IT IS “DEDUCTIBLE” DOESN’T MEAN YOU CAN DEDUCT IT

This past tax season I got the following email from a client –

“I was just informed that I am able to write off my union dues which were $370 for the year.” 

The client was correct.  Union dues are deductible on Schedule A as a “Miscellaneous Expense”.  But the client did not actually get a tax deduction for union dues on her 2016 tax return.

Just because a legitimate expense you incurred during the year is “deductible” does not mean that you can actually deduct the item and receive a tax benefit.

Let’s look at this particular “deductible” item – my client’s union dues. 

First you must itemize – have more “itemizeable” deductions than the Standard Deduction you are allowed based on your filing status. 

There are situations where you either must itemize or it is beneficial to itemize, even if your total allowable deductions are not more than the Standard Deduction – but these are truly rare.  And there are certain items that can be deducted either directly against a category of income reported on Page 1 of the 1040 – expenses related to self-employment income on Schedule C or EZ, expenses related to rental income on Schedule E, and direct expenses related to the sale of investments on Schedule D – or “above the line” as an “Adjustment to Income”.  But in this case union dues are an itemized deduction claimed on Schedule A.

A classic example of the need to itemize to claim a deduction comes from another of my clients many years ago.  When sending me her tax “stuff” a client expressed great joy in her note because she donated her used car to charity so she would get a big tax deduction – as the charity to whom she gave the car had advertised.  She was truly disappointed when I told her she got no tax benefit for her gift because she could not itemize (she rented an apartment, so had no deductions for property tax and mortgage interest, and had truly minimal other deductions – and the market value of the used car donated did not push her “over the top”).

Second, in the case of most Miscellaneous Expenses – job-related expenses such as union dues, investment expenses, and tax preparation fees - you must first reduce the total by 2% of your Adjusted Gross Income before you get any tax benefit.  If your AGI is $100,000 and your total expenses are $1,500 you get no tax deduction – 2% of $100,000 is $2,000, which is more than $1,500.  If your allowable expenses total $2,125 your tax deduction, for which you will receive an actual tax benefit, is only $125.

And third, if you are a victim of the dreaded Alternative Minimum Tax you get no, or a limited, tax benefit from Miscellaneous Expenses.  Miscellaneous itemized deductions subject to the 2% of AGI limitation are not deductible in calculating AMT.

In the example at hand, the taxpayer could itemize but did not have total allowable Miscellaneous Expenses, including the union dues, in excess of 2% of AGI.  So, while “deductible”, she could not actually deduct, and receive any tax benefit, from her union dues.

In many cases the “deductibility” of an item depends on the specific facts and circumstances of the individual taxpayer.  As I have said many times before, the answer to the question “Can I deduct X, Y, or Z” is almost always “it depends”.

Even deductions that you assume based on “common knowledge” are fully deductible may be limited due to “facts and circumstances”.  Just because you receive a Form 1098 reporting $12,459 in mortgage interest for the year does not mean you can deduct $12,459 on Schedule A.  I believe many taxpayers do not deduct the correct amount of allowable mortgage interest.  Your actual mortgage interest deduction is limited based on the amount of the loan and how the money borrowed was used.  For complete details check out my MORTGAGE INTEREST GUIDE. 

So just because someone tells you, or you hear or read somewhere, that an item is “deductible” does not mean you can actually deduct it on your tax return.  As usual check with your tax professional before doing anything.

 

TTFN

 

 

 

 

 

 

 

 

 

 

 

 

2016 GUIDE TO SCHEDULE A

I have compiled a comprehensive explanation of just about everything you every wanted to know about claiming itemized deductions on your 2016 Schedule A.   

 

This valuable guide discusses in detail the deductions for –

 

·         MEDICAL AND EXPENSES

·         TAXES YOU PAID

·         INTEREST YOU PAID

·         GIFTS TO CHARITY

·         CASUALTY AND THEFT LOSSES

·         JOB EXPENSES AND CERTAIN MISCELLANEOUS DEDUCTIONS

·         OTHER MISCELLANEOUS DEDUCTIONS

 

I also explain –

 

·       ITEMIZING WHEN DEDUCTIONS ARE LESS THAN THE STANDARD    DEDUCTION

·        SEPARATE RETURNS

·        RECORDKEEPING

·       THE ALTERNATIVE MINIMUM TAX

·       YEAR-END TAX PLANNING FOR ITEMIZED DEDUCTIONS

 

This guide is a must for all taxpayers who itemize, or who should be itemizing.  Even if you use a tax professional to prepare your returns, the more you know about what you can deduct and what records to keep the more organized you will be at tax time, and the less likely you are to miss any deductions to which you are legally entitled.

 

And now – year-end tax planning time – is a good time to get this.

 

The cost of this comprehensive guide is only $8.95 delivered as a pdf email attachment.

 

Send your check or money order for $8.95 payable to TAXES AND ACCOUNTING, INC, and your email or postal address to –

 

GUIDE TO ITEMIZED DEDUCTIONS

TAXES AND ACCOUNTING, INC

POST OFFICE BOX A

HAWLEY PA 18428

 

TTFN

 

 

 

 

 

THE NEW TAX CODE - WHAT WILL NOT BE IN INCLUDED

Last week my posts in the re-writing the Tax Code series talked about what I would put in the new simple, fair, and consistent federal Tax Code. Today I would like to list some of the current and recent Tax Code provisions that will not be included.

First and foremost – the new Tax Code would not have any kind of “Alternative Minimum Tax”. There would be only one method of determining income tax liability. The dreaded AMT would be dead and buried – for good.

There would be no Adjustments to Income for –

Educator Expenses
Business Expenses of Reservists, Performing Artists, etc
Moving Expenses
Self-Employed Health Insurance
Student Loan Interest
Tuition and Fees
Domestic Production Activities

That is not to say that all of these items would no longer be deductible. Educator expenses, Business Expenses of Reservists, and Moving Expenses would be deductible under the category of Employee Business Expenses. The deduction for health and long-term care insurance premiums for self-employed taxpayers would be claimed directly on Schedule C or F.

Also gone for good are the following credits -

Education Credit
Retirement Savings Credit
Residential Energy Credit
Alternative Motor Vehicle Credit
Making Work Pay Credit (already gone)
Earned Income Credit
Additional Child Tax Credit
First-Time Homebuyer Credit (already gone)
And all other weird and sundry special interest business and personal credits

Now taking these benefits out of the Tax Code does not necessarily mean that the government will no longer provide benefits to encourage higher education, energy-efficient purchases, and to encourage individuals “on the tit” to work. As I have been saying for years, such government benefits should be administered as direct “point of purchase” payments or discounts paid out by the appropriate cabinet agency.

· When you buy a qualifying energy-efficient water heater or hybrid car you would get a “cash-for-clunkers-like” discount directly from the seller, who would be reimbursed directly by the government.

· Additional government grants would be given through the existing Student Financial Aid system, directly reducing tuition payments, again with the institution being reimbursed by the government.

· Incentives to work could be built in to the Aid to Families With Dependent Children program – such as a government reimbursement for certain payroll tax withholdings.

· If the government wants to give those with student loans a break it should just reduce the amount of interest on the loans, providing subsidy payments directly to banks.

In an earlier post in the series I mentioned that, as of this writing I have not decided if the new Code will have a special increased dependent exemption amount or a Dependent Credit. Whichever option I chose will replace the current Child Tax Credit.

There will be itemized deductions that also will not “make the cut”, but I will discuss these items in future posts.

TTFN

READ MY LIPS!

Read my lips -

Do not fail to claim a legitimate, documented tax deduction on your 2010 Form 1040 just because you read somewhere that it is an IRS “red flag” and that claiming it will automatically result in an IRS audit.

(1) If your deduction is legitimate and you have sufficient documentation to prove its authenticity in an audit then what is the problem? An audit is not something that must be avoided at all costs – it is merely an inconvenience.

(2) Just because the IRS pays closer attention to tax returns that contain certain deductions or credits does not mean if you return contains this deduction of credit you will “automatically” be audited. The IRS only audits a small percentage of 1040s – and several factors are involved in determining which returns are selected for audit.

(3) If you fail to claim a legitimate deduction or credit you have, in effect, audited your own return and disallowed the deduction – neither of which the IRS may actually do.

(4) Just because you read somewhere that an item is an IRS “red flag” does not mean that the item is really an IRS “red flag”.

I must add that if the alleged “red flag” deduction or credit is legitimate and documented, but another item on your return is not, an IRS audit might turn up the “questionable” item. The answer is obviously to claim only items that are legitimate on your tax return, and be sure to have sufficient documentation for all deductions and credits you claim.

In addition to being an inconvenience an audit will also cost you some money – especially if you bring your tax pro with you or send him/her to the audit as your legal representative under a Power of Attorney. You will need to pay for the tax pro’s time. If you are selected for an audit you should determine if the amount of additional tax, interest, and penalty charges you may be assessed for the item(s) in question is more than your potential costs at the various levels of the audit process.

If you are selected for an audit by the IRS or state tax authority, or receive any correspondence from these guys, the first thing you should do is immediately send the notice or correspondence to your tax preparer.

TTFN

DON'T ELIMINATE THESE DEDUCTIONS

Many of the tax reform proposals that are surfacing recommend eliminating the itemized deduction for local real estate and state and local income or sales taxes. Some also call for doing away with the deduction for mortgage interest; one wants to replace the deduction with a 15% credit.

I want to keep the deductions for state and local taxes and mortgage interest on acquisition debt.

We are well aware that a family living in New York, New Jersey or California with a combined annual income of $150,000 may just be getting by, or is barely comfortable, while a similar family residing elsewhere in the US can live like royalty on $150,000 per year. However the federal income tax system is geographically neutral - the tax rate schedules are the same no matter where in the US you live.

So it is possible that a family in middle America, with less actual dollars of earnings but a much higher disposable income and standard of living, is paying a smaller federal income tax than one with less disposable income, due to a much higher cost of living, in the Northeast.

The income is higher in certain regions of the country because the cost of living, including housing costs and state and local real estate, income and sales taxes, is much higher. The cost of a home is much higher in New Jersey than Kansas, and so are the state income taxes and local property taxes and corresponding mortgage interest.

The deductions for local real estate tax, state and local income or sales tax, and mortgage interest on acquisition debt are greater in New York, New Jersey, California, and other higher income states than in states with lower costs of living. The ability to claim these deductions helps to provide some degree of regional “equalization” and alleviate geographic tax “penalties”.

TTFN

LET THE READER BEWARE!

Kay Bells’s latest TAX CARNIVAL led me to an interesting post titled “The Truth Behind Tax Deduction Advice” at the Green Bridge Advisors’ LETS BLOG MONEY blog.

The author starts out with a good statement – “I personally believe that it is never a bad time to plan or even talk about taxes”.

“The Truth Behind Tax Deduction Advice” reacts to an article on Kiplinger’s website titled “10 Ways To Lower Your Taxes”, and states, “Articles like these, whether in financial magazines or on blogs geared toward personal financial topics seem to be guilty of stating a deduction, and then summarizing them without going into full detail including the drawbacks and limitations.”

I agree with what the author is saying. Truth be told, a separate article or post could be written about each of the “10 Ways” discussed by Kiplinger.

The message of the LET’S BLOG MONEY post is similar to that of my previous TWTP post “A Tax Deduction is Only Worth What It Is Worth”.

Oft times a client will read an item that says, as the Kiplinger article did, you can save taxes by increasing your deduction to charity. When sending me their tax “stuff” they include a highlighted or underlined note – “I gave an extra $500 to charity this year”. They read the article, took the advice literally, and anticipate a bigger refund because of their action. Unfortunately I have to tell them – “That is very nice, and I am sure the charity appreciated your gift, but you do not have enough total deductions to itemize, so the extra $500 doesn’t do a damned thing to reduce your tax liability”.

Clients are always including clippings of articles on taxes when sending me their “stuff”, as if they are telling me something I don’t already know.

Included in the post’s comments on Kiplinger’s advice to give to charity is –

“If you are looking to lower your tax bill, especially if it is due to the fact that you need the extra money in the refund, then why would you spend money to save even less on your return?”

An excellent point! What is being said here is, as I have said many times before, it makes no sense to spend $100 to save $30. You are not saving $30 – you are losing $70!

Never spend money solely for the purpose of getting a tax deduction. Spend the money because you need to or want to and, if deductible, get a secondary benefit of tax savings.

Yes, you can save taxes, if you itemize, by making a contribution to a qualified church or charity. But you will not put any additional money in your pocket by doing so. You will be “out of pocket” by the amount of the contribution less the probably 15% - 35% tax saving.

Another thing to consider is that many tax deductions and credits are phased out or completely disallowed based on your Adjusted Gross Income. An article or blog post may tell you that you can deduct, or get a credit for, tuition and fees paid for your dependent’s college education, but your level of income may be such that you do not get the full, or any, tax benefit.
.
A blog post or online or print article or column by a non-practicing tax professional that discusses what types of things are tax deductible may give you something to think about, and something to discuss with your own tax professional, but you should never act blindly on what you read. Check it out with your tax pro first before doing anything.

It is important to remember that many online, magazine and newspaper items on taxes are written by professional writers and not by professional tax preparers. Regarding the item from the Kiplinger website that the post discussed it is pointed out that – “the author, Kimberly Lankford does not have anything regarding an accounting or tax background on her mini-bio”.

And if you read any fine-print disclaimer for such items it will no doubt say that the item is for “information purposes only” and “does not constitute legal or tax advice”. Often such disclaimers advise readers to consult their own tax professional.

So both the Green Bridge Advisors and I both say – LET THE READER BEWARE!

.

TTFN

WHO'S AFRAID OF THE BIG BAD AUDIT?

A tax audit is indeed an inconvenience, and has a great potential for agita and aggravation, but it is not something “evil” that must be avoided at all costs. As I have blogged in the past, if your deductions are legitimate and properly documented you should have nothing to worry about.

While my office audit experience over the past 38 tax seasons has been minimal, considering the volume of returns I have prepared during the 38 seasons, I have found the IRS auditors with whom I have had dealings, while of varying degrees of competence and tax knowledge, to be, for the most part, pleasant and cooperative. I have, thank my lucky stars, never had to deal with a real male sex organ.

My audits have usually ended in “no change” or a minimal mutually agreed on small balance due. I do recall that on one occasion it was determined that the IRS owed my client about $20.00 – but we said we would rather have a “no change” determination than get a check for such a small amount.

In my “wanderings” on the internet I have come across a tax professional who, a while back, appeared, or so it seemed to me, to be advising clients and readers alike not to claim legitimate deductions on a 1040 simply because they fall into an assumed or proven IRS “red flag” category and might increase the chances of an audit.

According to this tax pro it is more important to avoid an audit than to file a correct and accurate return, and it is more important to avoid an audit than to pay the absolute least amount of income tax possible.

I firmly believe in this quote from former IRS Commissioner Donald Alexander (as usual, the highlight is mine)–

"As a citizen, you have an obligation to the country's tax system, but you also have an obligation to yourself to know your rights under the law and possible tax deductions -- and to claim every one of them."

If you actually spent the money for the item and the item is a legitimate tax deduction, and you can prove with physical documentation that you actually spent the money and that it is a legitimate tax deduction, claim it!

If you do not claim the deduction you are automatically auditing your own return and voluntarily overpaying the IRS, and probably also your state tax authority as well.

The same tax professional recently reported, and rightfully so, that IRS statistics indicate that Schedule C businesses are audited much more frequently than corporations. The professional went on to advise clients and readers, “This reason alone is sufficient to justify the additional costs and paperwork associated with forming a separate legal entity and filing its annual report and tax return”.

Again the tax pro says avoiding an audit is the most important factor to be considered.

I do agree that a business enterprise filing as a Schedule C “sole proprietor”, whether registered as an LLC or not, is more likely to be audited than one filing as a corporation. In my recent 2-part post on the advantages and disadvantages of incorporating I explained that –

“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.”

But the only taxpayer for whom this benefit should be the only reason for incorporating is the crook who wants to commit tax fraud, either on his/her own or with the assistance of an unethical tax preparer, by not reporting all income and/or overstating deductions and claiming personal items as business expenses.

The honest taxpayer/businessperson who will be properly reporting all income and claiming only legitimate deductions, and who keeps good receipts and records, should consider this tax advantage of incorporating as “icing on the cake” if, and only if, an extensive cost benefit analysis indicates that incorporating is justified. Or perhaps the deciding factor if it is a very close call.

Other tax bloggers have given more appropriate advice about incorporating in their postings -

• As I quoted in the above referenced 2-part post, TAX GIRL Kelly Phillips Erb, a tax attorney, has said, “In most cases, a C corporation is ‘overkill’ for a freelancer with no immediate plans for expansion, hiring of employees, etc.”

• Joe Kristan, in his post “Corporations: Yea or Nay?” at the ROTH AND COMPANY TAX UPDATE BLOG, says, “Which entity is best? That's a discussion to have with your tax advisor. 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. C corporations are the only ones that can cause your income to be taxed twice -- when earned and when distributed -- so make sure you really know what you're doing before you go that way.” Joe’s post also includes a quote from another party that best describes the situation – “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."

• John Sheeley, an Enrolled Agent and business advisor, writes a blog at www.johnsheeley.com that I recently discovered when he chose to “follow” me on Twitter. In his post “Choosing the Correct Business Entity Type” from earlier in the year he advises – “Always meet with your accountant or attorney BEFORE committing to the formation of a company. Make sure you form the right type of entity, in the correct jurisdiction. One size (or entity type) does not fit all.”

In my aforementioned 2-parter I revise John’s advice to say – “the first person you consult about such a decision is a tax professional, and not an attorney”.

The bottom line - You shouldn’t be so afraid of an audit of your return by the IRS that it causes you to pay extra income taxes by not claiming legitimate documented deductions, or causes you make a foolish move (incorporating) that will end up costing you a lot more money in the long run and result in unnecessary additional paperwork, filings, and agita, if you are an honest and ethical taxpayer.

Now if you are a crook that is another matter.

TTFN