MORE ON THE NATP YEAR-END TAX UPDATE

As promised, here are some items of interest that was discussed at last week’s NATP year-end tax-update class -

• Student loan interest reported on a Form 1098-E under the dependent student’s Social Security number can be claimed as an adjustment to income, subject to the statutory limitations, on the parents Form 1040 if the parents actually paid the interest and they are legally responsible for the loan – i.e. they co-signed the loan. Be ready to send the IRS proof of legal responsibility if questioned down the road.

• For 2010 the Adoption Credit is refundable. If the credit is from an adoption initiated in 2010, and not the result of a prior year’s carryover, copies of documenting paperwork must be sent in with the return, much the same as the documentation required for those claiming the Homebuyer’s Credit.

• Non-prescribed “over the counter” medicines can no longer be paid through an employer-sponsored medical expense Flexible Spending Account beginning in 2011. So if there is money left in your FSA stock up before year-end. Such items were never deductible as a medical expense on Schedule A.

• Cell phones are no longer considered “listed property” for purposes of the special record-keeping.

• And here is a bit of info that has apparently been passed along to NATP from a reliable insider source - the IRS is looking more closely at self-prepared tax returns generated by Turbo Tax software. It seems the Service is aware of the many failings of the Turbo Tax 1040 preparation software. Just another reason to forget about preparing your return yourself using a software package and seek the services of a competent tax professional.
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We talked about the new requirements for small businesses and landlords to send a Form 1099-MISC to everyone to whom they pay more than $600 during the year. One excellent comment - if these requirements remain it will mean that hundreds of thousands, if not millions, of individual taxpayers will be applying for Employer Identification Numbers.

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Currently sole proprietors, one-person LLC owners, and landlords who do not have employees don't need to get a separate EIN for their business or rental. These taxpayers could use their Social Security Numbers for bank accounts. However I, and my fellow tax pro participants, doubt if these taxpayers, faced withing having to send out a multitude of 1099-MISC forms, will want to make their Social Security Number public knowledge by including it on these 1099s. So they will need to get an Employer Identification Number to use instead.

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I am sure the idiots in Congress did not take this into consideration when passing the ridiculous new requirements.

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During a discussion of “who is a tax preparer” in regard to the new tax pro regulation regime the instructor gave the following scenario –

She has a client whose only income is from self-employment. He has no investment income or activity and does not itemize. Each month the client brings in his business checkbook, account statement and other related information to the instructor’s office and an employee of the instructor’s firm inputs the necessary information into Quickbooks. This employee also reconciles the client’s business checking account. In January the employee prints out a profit and loss report for the business from Quickbooks. The instructor “imports” this P+L to her tax preparation software and the software spits out the 1040 and Schedules C and SE.

In this scenario who is a tax preparer – the instructor, the employee, or both.

If you ask me the answer is neither - the return was prepared by the software!

The text explained that included in the definition of a tax preparer is –

“A non-signing tax return preparer who renders advice (written or oral) to a taxpayer (or to another tax return preparer) on a position that is directly relevant to the determination of the existence, characterization, or amount of an entry on a return that constitutes a substantial portion of the return." And -

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"A person who furnishes to a taxpayer, or another preparer, sufficient information and advice so that completion of the return is largely a mechanical or clerical matter.”

Let us also look as some “scenarios” from the IRS FAQ page on the subject -

“* I am a tax return preparer, and I have a PTIN. My firm employs a bookkeeper. She gathers client receipts and invoices, and organizes and records all information for me. Although I use the information that our bookkeeper has compiled, I prepare my clients’ tax returns and make all substantive determinations that go into computing the tax liability. Does my bookkeeper need to have a PTIN? (posted 9/28/10)

No, she is not a tax return preparer, and is not required to have a PTIN.

* I am a tax return preparer, and I have a PTIN. Every tax filing season I hire two paid interns from the accounting program at a local college to help me during the busy season. The interns perform data entry from the tax organizer that my clients fill out, and assemble the documentation that the clients have submitted. Where clients have submitted incomplete information, or more information is needed, the interns may call clients to gather information missing from the tax organizer, but they are not allowed to provide advice or answer tax law questions. I prepare and sign all my clients’ returns. Do my interns need to have a PTIN? (posted 9/28/10)

No, the interns are not tax return preparers, and are not required to have a PTIN.

* I am a tax return preparer, and I have a PTIN. I have an administrative assistant in the office who also performs data entry during tax filing season. At times, clients call and provide him with information, which he records in the system. Using the data he has entered, I meet with my clients and provide advice as needed. I then prepare and sign their returns. Is my administrative assistant required to have a PTIN? (posted 9/28/10)

No, the administrative assistant is not a tax return preparer, and is not required to have a PTIN.”

I am sure that there is more to the scenario in question than the instructor presented. I expect that the instructor reviews the P+L statement before importing it, and makes any adjustments for items such as Section 179 expensing, discussing the report with the client if she has any questions. I also expect that she determines the amount of contribution that the client could make to a SEP self-employed retirement plan and discusses this with him. And she would also ask him for the amount of health insurance premiums he paid for himself and his family, and other questions to see if there are any additional items to report or deduct. And I am sure she at least double-checks the return that is “spit out”.

In any case it is my belief that simply preparing an internal financial statement does not constitute preparing a “substantial” portion of the tax return – and therefore the employee of the instructor’s firm that does the Quickbooks input is not a tax preparer.

An internal financial statement, such as the P+L discussed above, whether prepared by the client or by an employee of the preparer, is merely a piece of documentation that is used by a tax pro to prepare the return. It is the same as a Form W-2, 1099, or K-1. It is the same as if the client simply provided a handwritten sheet of paper with his business income and expenses for the year – only a more formal presentation.

The P+L is not the Schedule C – several adjustments may need to be made in transferring the information from the P+L to the Schedule C – and being able to generate a P+L from a GL software package does not mean one knows how to prepare a Schedule C. So in this case the instructor, who actually “prepares” and signs the return, is the only tax preparer.

What do you think?

TTFN

THE TAX COURT AND CELL PHONES

When it comes to tax deductions - some deductions require special recordkeeping. This is true with what is called “listed property”.

In 1984 Big Brother, via the Tax Reform Act of 1984, decided to restrict the depreciation deduction for the business use of items “lending themselves easily to personal use”, which were labeled “listed property”. Included on the “list” were –

* Passenger automobiles.

* Property of a type generally used for entertainment, recreation, or amusement (including photographic, phonographic, communication, and video recording equipment.

* Computers and related peripheral equipment

In 1989 cellular telephones and “similar telecommunication equipment” were added to this “list”.

Internal Revenue Code Section 274(d) (4) requires that you keep detailed records to document the business use of “listed property”.

With a cell-phone your log would indicate the date, number called, person called, business purpose (or “personal”), and length of call. If the bill listed each call separately you would indicate the cost for each call on the log. If you pay a flat fee for unlimited minutes you would need to do a calculation for each monthly bill.

David Mellem, EA, of Ashwaubenon Tax Professionals, and former Director of Research and popular seminar instructor for the National Association of Tax Professionals, provides special email alerts on tax issues to tax pros. A recent email dealt with court cases concerning the deductibility of cell phone usage.

Here are the court cases discussed by David in his email alert -

* TC Summary Opinion 2009-97 - The deduction for cell phone usage was denied because the taxpayer couldn’t substantiate his business use of the phone. The Court felt the taxpayer did use his cell phone for business purposes, and the taxpayer conceded that he used his cell phone to make personal calls (i.e. call his wife while he was away from home). The taxpayer produced copies of cell phones bills but was not able to show which calls were business and which were personal. As the taxpayer did not provide the substantiation necessary for listed property the Tax Court was required to deny the deduction.

* Philip Jay Berg, 103 AFTR 2d 2009-249 – The taxpayer attempted to claim a deduction without documentation under the famous “Cohan Rule”. But the Tax Court’s decision stated “The Cohan rule does not apply to certain expenses, such as cell phones, automobiles and trucks, which are governed by the strict substantiation requirement of §274(d).”

* T.C. Summary Opinion 2009-81 – The Tax Court denied the deduction for cell phone usage. The taxpayer indicated that his employers suggested that drivers might find cellular telephones useful but did not reimburse its drivers to have a cellular telephone. He used the cell phone to contact other truckers, shippers, and receivers to discuss such things as the best routes for his particular destination and load type, load weight, and vehicle size. This information is not readily available from typical road maps. These were clearly genuine business calls. The taxpayer also used the phone for personal calls. He did not keep a log of his calls, and estimated that 80 percent of the calls had a business purpose. The Tax Court pointed out that for listed property the taxpayer is required to have adequate records or corroborative documentation. Since the taxpayer relied only on estimated use and did not have the required records or evidence, Tax Court was required to deny the entire deduction.

David tells us that the deduction was also denied in T.C. Summary Opinion 2008-101 and T.C. Memo 2008-280.

The bottom line – if you use a cell phone for business you must keep a log identifying business usage.

FYI - a Cell Phone Log is one of the forms, schedules and worksheets included in “THE WANDERING TAX PRO’S DOCUMENTING 2010 DEDUCTIONS”.

TTFN

LISTED PROPERTY

Here is a “winter rerun” from the pages of my former blog THE FLACH REPORT.

When it comes to tax deductions - some deductions require special recordkeeping. This is true with what is called “listed property”.

In 1984 Big Brother, via the Tax Reform Act of 1984, decided to restrict the depreciation deduction for the business use of items “lending themselves easily to personal use”, which were labeled “listed property”. Included on the “list” were –

* Passenger automobiles.

* Property of a type generally used for entertainment, recreation, or amusement (including photographic, phonographic, communication, and video recording equipment.

* Computers and related peripheral equipment

Computers and peripherals used 100% for business at a “regular business establishment” are not considered to be “listed property”. This includes a computer used 100% for business in a qualified home office.

In 1989 cellular telephones and “similar telecommunication equipment” were added to this “list” under Internal Revenue Code Section 280F (d)(4)(A)(v).

As a general rule, only “listed property” that is used more than 50% for business will be eligible for Section 179 expensing and “accelerated” depreciation under MACRS (Modified Accelerated Cost Recovery System). Assets with 50% or less business use must be depreciated using “Straight Line” under the ADS (Alternative Depreciation System) “class life”. The “class life” of automobiles, computers and cell phones is five (5) years under both MACRS and ADS.

In a situation where the “business use percentage” of a “listed” asset is more than 50% in the first years, but drops below 51%, or the property is either sold or removed from business use (i.e. converted to 100% personal use), in a subsequent year (before the property’s depreciation “class life” has expired), you must “recapture” the “accelerated” depreciation claimed in the early years.

In the first year that business use of the property falls below 51% you must add to the “ordinary income” of the business (as “Other Income” on Line 6 of the Schedule C) the difference between the actual depreciation, including any Section 179 expensing, claimed in the earlier years and the depreciation that would have been allowed in those years using the “Straight Line” depreciation method. No Section 179 deduction would be allowed for less than 51% business use.

Let’s say you purchased a computer for your business in 2005 for $1,000.00. You determined that you used it 95% for business in 2005 and 2006. You elected to depreciate, rather than expense under Section 179, the computer. Your depreciation deductions for 2005 and 2006 under MACRS would be $190.00 and $304.00, for a total of $494.00. In 2007 you give the computer to your son and purchase a new one for the business. You must claim $209.00 as “other income” on Line 6 of your 2007 Schedule C. Under the “Straight Line” method your depreciation deduction would only be $95.00 and $190.00, for a total of $285.00.

If you had decided to expense the computer under Section 179 in 2005, your 2007 “recapture” income would be $665.00 ($950.00 - $285.00).

Internal Revenue Code Section 274(d) (4) requires that you keep detailed records to document the business use of “listed property”. For automobiles you would keep a mileage log (to be discussed in a future posting).

For computers, cameras, audio/video equipment, etc you should keep a log noting the date, length of time, and purpose for each use of the item. Personal or family use can simply be designated "personal" but business use should show enough detail to enable you to prove the relationship to your work. For example a daily computer log entry could indicate –

1 hour reading and answering business emails.

1 hour word processing for business correspondence to Client A and Client C.

2 hour word processing business proposal for Client E.

1 hour internet research on topic C for business project A.

½ hour reading and answering personal emails.

Total Daily Useage = 5½ hours.

With a cell-phone your log would indicate the date, number called, person called, business purpose (or “personal”), and length of call. If the bill listed each call separately you would indicate the cost for each call on the log. If you pay a flat fee for unlimited minutes you would need to do a calculation for each monthly bill.

My package of SCHEDULE C FORMS AND WORKSHEETS, (available as a “word document” email attachment for only $2.00) includes Auto, Cell Phone and Computer Log forms. Click here to order.

I realize that it is a pain in the arse to have to log your computer and cell-phone use, but this is what you will need to have to substantiate your deduction if audited by “Sam”.

Any questions?

TTFN