Tag: tax return

10 Money Saving Tax Tips



Last Updated: Jan 23, 2014

Are you paying more taxes than you have to? Author and CPA John Vento provides some advice to help you maximize your post-tax return savings.

April fifteenth is fast approaching. Have you filed your taxes yet? If you’re like most Americans, you’re probably still scurrying around trying to get all the necessary papers together so that you can get started, all the while wondering if this might finally be the year that you receive a nice refund. Unfortunately, when all is said and done, you’ll probably have shelled out too much in taxes. There is no better time of year to draw attention to how much money we’re paying Uncle Sam, and he encourages all Americans to explore smarter tax tactics. 

Most people don’t realize that taxes are their biggest expense. Plus, they dread the whole tax issue so they avoid thinking about it and procrastinate making changes that could save them a significant amount of money.

It’s important to take the time to understand what has changed in our national tax law and how it affects you specifically. There are things that you can do when filing this year’s return and throughout next year to reduce your tax burden. And, of course, there’s never a bad time to plan how you can make the most of what you have left over after taxes.

Anyone who followed the recent fiscal cliff showdown knows it ended in what’s been dubbed the American Taxpayer Relief Act of 2012. Here’s a quick look at its basics:

While the changes in tax law may complicate things for some, there are still many ways to keep more of your money. When you take the right steps, you can use your taxes to help accumulate wealth. In order to reach financial independence, it is imperative that you understand the basics of our tax system, and that you practice careful and strategic tax preparation and planning so your personal tax burden does not deplete your income unnecessarily.

Read on to learn how you can make the most of this year’s return.

1. Make sure you aren’t missing out on any deductions. This new tax law signed in January extended a number of tax breaks that had expired at the end of 2011 or 2012. Some of these tax breaks could affect your 2012 tax return, which you will be filing in the coming months. Be sure not to overlook these tax deductions when preparing your income tax return this year:

The good news is there are tons of possible deductions out there just like these, including deductions based on mortgage and loan interest, investment interest, and more.

2. File an amended return for missed tax deductions and credits. If you missed any tax deductions or credits you were entitled to over the past few years, it’s not too late to correct that mistake by filing an amended return. Say you discover after filing that you have not taken advantage of several deductions or tax credits that you were entitled to. Don’t beat yourself up: You can file an amended return to claim an additional refund. Generally, the statute of limitations is three years from the date you filed your tax return. Therefore, you can file a claim or refund for the last three years of tax returns if you uncover a recurring error.

This is a great way to improve your cash flow, and it’s a great example of why you should meet with your tax advisor throughout the year. I can’t stress that enough. Again, there’s no better way to ensure you’re taking advantage of the deductions that apply to you than to get the help of a tax planner!

3. Be smart about when you make certain payments. Many people aren’t aware that you may be able to shift income and deductions to the tax year that will result in lower taxes. For instance (depending on your circumstances), if your estimated city and/or state income tax payments are due in January, you can pay them before December 31 and reduce your federal income tax liability by as much as 39.6 percent of the early payment. This is assuming you are not subject to alternative minimum tax.

Likewise (again, depending on circumstances), prepaying your January mortgage payment in December and paying your first quarter real estate taxes before December 31 can help you to obtain tax breaks. Or you may also be able to shift income among family members to take full advantage of their lower tax brackets.

4. Make full use of tax-deferred accounts. These include IRAs, 401(k)s, annuities, and some life insurance contracts. The government allows you to postpone taxes on this income because they want to encourage you to be responsible and prepared for retirement. The Internal Revenue Code is a mechanism by which the government can influence taxpayers’ behavior by giving them incentives to do or not do certain things. It views tax-deferred accounts as a way of helping taxpayers save money for the long-term and build a secure, comfortable, and sustainable retirement for themselves.

Of course, you will eventually have to pay taxes on that deferred income when you withdraw it from those accounts. But that’s okay—this is still one of the methods to achieve financial independence in a tax-advantaged way. I recommend deferring taxes as long as possible, because every year your income is in an IRA, for example, the entire principal, including the money you would have had to pay in taxes plus earnings, will continue to compound. In essence, the government is giving you a tax-free loan that you can utilize to help maximize your savings. You’re earning money on your funds and the tax dollars you didn’t give up to the government.

Another benefit of deferring income is that, most likely, you’ll be paying into these accounts during your higher-earning years when your tax bracket is higher. If you draw the money out during retirement, you may be subject to a lower tax rate.

5. Take full advantage of work expenses to maximize your tax-free income. One way to increase your tax-free income is to make sure your employer reimburses you for all expenses you paid that are within the guidelines set by your employer and the IRS.

For instance, you can be reimbursed for business travel, meals and entertainment, expenses for a work vehicle, or continuing education. If you have any job-related expenses that aren’t reimbursed by your employer, for example, union dues, job search expenses, and some classroom supplies for teachers, you may be able to get a tax deduction for the amount that exceeds 2 percent of your adjusted gross income (AGI). Ultimately, though, getting reimbursed will always result in your paying less in taxes.

6. Understand gift and estate tax changes. In technical terms, an estate tax is an excise tax levied on the right to pass property at death. It covers everything from real estate to cars to jewelry to investments and more, and is imposed by most state governments, as well as the federal government.

Estate tax changes are often in flux. For instance, before the end of 2012, a wealthy individual could give gifts to his or her family members throughout his or her lifetime and receive an exemption for the first $5.12 million and avoid the gift tax and possibly the estate tax after death. However, the American Taxpayer Relief Act permanently changed the exemption to $5.25 million for 2013 and will also be indexed for inflation annually going forward. As you can see, it’s important to stay abreast of estate tax changes so that you can take advantage of them when the opportunity arises and prevent costly mistakes! As always, be sure that you’re working closely with a trusted tax advisor.

7. Know what the Affordable Care Act means for your taxes. Under the Affordable Care Act, you have limited opportunities to deduct medical costs (including self-paid medical insurance premiums) for you and your family. Starting in 2013, your deduction may be limited to only the amount that exceeds 10 percent (7.5 percent through 2012) of your AGI. With this new threshold for deducting health-related costs, fewer people will be getting this tax break going forward. With that said, establishing a Health Savings Account (HSA) has just become so much more important. With an HSA, if your health insurance plan is considered a high-deductible plan, you can contribute $3,250 as a single individual or $6,450 under a family plan, and an additional $1,000 if you are 55 or older.

Contributing money to an HSA will give you a tax deduction above-the-line in arriving at your adjusted gross income. This means these contributions will reduce your adjusted gross income and taxable income dollar for dollar. If you then withdraw money from these accounts to pay for qualified medical expenses, these withdrawals will not be taxable to you. This is a terrific strategy for paying your medical bills with pre-tax dollars. They are a great way for people who have high-deductible health insurance plans to save money because of the pre-tax benefits, lower premiums, and ability to roll savings over year after year.

8. Know the tax advantages of property ownership. If you sold your home this year, a tax advantage may be in store. Specifically, if you owned and used the home as your principal residence for at least two years out of the five preceding the sale, you might be able to avoid the tax on any profits you made from the sale.

This tax-free income is by far one of the most favorable reasons for home ownership.

Also, be aware of the potential benefits that come with owning property used in your business or other income-producing activities, like rental real estate. You will be able to take a depreciation deduction. And even if the property is increasing in value each year, the government allows you to take a write-off for depreciation, which is actually a phantom deduction. You may be able to generate a positive cash flow and pay no tax on this income after deducting depreciation expense. 

9. Get smart about education credits. Parents of college students, rejoice: If you paid qualified tuition and fees for an eligible student in the first four years of college or post-secondary institution, you may qualify for the American Opportunity Tax Credit (AOTC) of up to $2,500 for each eligible student (in 2012).

Likewise, if you paid qualified expenses for yourself, your spouse, or your dependents who enrolled in eligible educational institutions during the year, you may be able to claim the Lifetime Learning Credit of up to $2,000. Unlike the AOTC above, this credit does not have a degree or workload requirement. It is not limited to the first four years of post-secondary education, and there is no limit on the number of years it can be claimed.

If your income exceeds the eligibility requirements to take advantage of the two preceding education tax credits, you may elect to forego claiming your child’s exemption on your tax return and instead let your child claim these education credits if he has a tax liability. Calculate your tax bill as well as your children’s and take advantage of the method that provides your family with the greatest tax savings.

10. Don’t give the government an interest-free loan. Your employer provides you with a withholding certificate, Form W-4, in which you indicate your filing status and allowances. The more exemptions you claim, the less tax your employer withholds from your paycheck. Before you start to claim every exemption in sight, though, keep in mind that this is just an estimate of the tax to be paid. Your true tax is calculated when you file your actual income tax return.

You should adjust your exemptions so that you are not overpaying or underpaying the taxes withheld from your paycheck. Although most people like a big tax refund at the end of the year, this simply means you are giving the government an interest-free loan. When you put it in those terms, that check from the IRS doesn’t seem so attractive anymore. Trust me; there is no easier way to improve your cash flow than by adjusting your exemptions so that you are not overpaying your tax with each paycheck.

Make tax planning part of your life. Always ask yourself, Is this the most tax-effective way to handle this financial situation? Viewing your financial decisions through a “tax lens” is, by far, the most efficient way to save money and accumulate wealth, without dramatically altering your lifestyle. Get informed and partner with a tax advisor who can guide you along the way.

About the Author:
John J. Vento is author of Financial Independence (Getting to Point X): An Advisor’s Guide to Comprehensive Wealth Management (Wiley, 2013, ISBN: 978-1-1184-6021-4, $40.00, www.ventocpa.com). He has been the president of the New York City-based Certified Public Accounting firm John J. Vento, CPA, P.C., and Comprehensive Wealth Management, Ltd., since 1987. John has been ranked among the most successful advisors of a nationwide investment service firm and has held this distinction since 2008.

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Taxes and Homeowners Associations: A Confusing Combination

If you own a home in a planned community or development there is a good chance you are a member of a homeowners’ association (HOA).  One perplexing aspect of HOA management is following the tax reporting requirements of the IRS.  Some common questions our office receives are “Must our HOA file a tax return?”  “What return must it file?” and “What happens if we haven’t filed for a number of years?”  In today’s article, I will address some of these basic questions.  My goal is to clarify some of the confusion associated with HOA tax reporting and help your HOA avoid the frustration and additional expense that often accompany noncompliance.

For federal tax purposes, homeowners associations are treated as corporations.  Even if an HOA was created as an association or a nonprofit corporation with its respective state, it is still considered a regular corporation for federal tax purposes.  The only exception is the rare instance in which the HOA has filed for recognition and been accepted as a nonprofit by the IRS.  Such recognition is expensive, relatively difficult to obtain, and most often requested by filing form 1024 with the IRS and utilizing tax code section 501(c)(4).

Corporations are generally required to file Form 1120, U.S. Corporation Income Tax Return, annually.  Filing form 1120 has several distinct disadvantages for an HOA.  First, Form 1120 is fairly complex and requires a level of bookkeeping sophistication many HOAs lack.  A second disadvantage of filing Form 1120 is that all of the HOA’s “income” is taxable.  Basically, this means that any funds collected and not spent (for example, funds set aside for road maintenance or replacement) during the year may be subject to corporate income tax.  A third disadvantage of Form 1120 for an HOA is that it may subject the HOA to making estimated tax payments, another burden for the often overburdened volunteer treasurer.

The tax code gives many HOAs the ability to avoid Form 1120 by making a special election.  Section 528 allows Homeowner Associations that meet certain requirements to bypass Form 1120 by filing Form 1120-H, an income tax form specifically designed for Homeowner Associations.  Form 1120-H is a one page form that is much easier to complete than the many page, multiple schedule Form 1120.  Although most HOA’s qualify, each must meet certain requirements to utilize this election.  To file Form 1120-H, at least 60% of the HOA annual revenue must be “exempt-function income.”  Exempt-function income includes membership dues, assessments, fees and interest on those fees.  Also, 90% of the HOA’s expenditures must be for management, maintenance, acquisition and construction of association property.

If the HOA qualifies to file Form 1120-H, only its “non-exempt” income is taxable.  Non-exempt income includes interest and dividends, rental income from property owned by the association, and laundry/vending machine income.  The HOA is allowed to deduct expenses directly related to the generation of non-exempt income but must have written records to prove the deductions.  Form 1120-H allows for a $100 deduction from non-exempt income to arrive at taxable income.  The HOA’s taxable income is then subject to a flat tax rate of 30% (32% for time share associations).

Check out our 1120-H Basics Course to learn how you can complete this form yourself

Filing Form 1120-H is an election that must be made each year.  The election is made by filing Form 1120-H by its due date (the 15th day of the third month after the end of the HOA’s tax year – a six month extension to file can be obtained by filing Form 7004).  Once made, the election cannot be revoked without IRS consent. 

If Form 1120-H is not filed within twelve months of its due date (including extensions), the HOA may lose the opportunity to file the form 1120-H for that tax year.  The HOA must then file the longer and more complex Form 1120.  The HOA may also be required to pay penalties for late filing and late payment of any tax due.

In today’s article we have, hopefully, clarified some if the confusion surrounding a Homeowners Association’s income tax filing requirements.  We have not, however, had time to discuss more complex HOA tax issues that may impact your association’s particular circumstances.  Please contact our office or contact another tax professional before making any tax-moves on your own.

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Last Minute Changes That Can Affect Your 2010 Tax Return

The close of 2010 ended an era of major changes in federal tax legislation. Last year witnessed at least four pieces of legislation that made significant changes to the tax rules for individuals and businesses.  And just when we thought taxes couldn’t get more complicated, Congress slipped the Tax Hike Prevention Act of 2010 into the IRS’s mail slot as it left Washington for Christmas vacation.  The law, previously named The Relief Unemployment Insurance Reauthorization Act of 2010, extends the basic framework of the “Bush era” tax structure through 2012.

The Tax Hike Prevention Act also includes a number of retroactive changes for the 2010 tax year – changes that have forced the IRS to reprogram their computers and delayed filing for many individual and business filers.  Today I’ll review a few of the changes that may impact your 2010 personal return:

State and Local Sales Tax Deduction:  Taxpayers who itemize deductions will be able to deduct the greater of state income tax or state and local sales tax paid during the year.  This deduction corrects an inequity affecting taxpayers living in states that do not have an income tax.  Although most West Virginian’s and citizens of neighboring states obtain the greatest tax benefit by deducting their state’s income tax, special circumstances such as paying sales tax on big ticket items such as a car, a boat, building materials, or even a home (including mobile and prefabricated homes) can make claiming sales tax more advantageous.

Mortgage Insurance Deduction: Homeowners who pay qualified mortgage insurance premiums will be able to deduct these premiums on schedule A of their tax return.  Qualified mortgage insurance is insurance that secures a mortgage used to acquire a new home.  The policy must be issued by the Department of Veteran Affairs, the Federal Housing Administration, Rural Housing Service or a private mortgage insurer.  Note that the amount of this deduction may be limited or eliminated if your adjusted gross income exceeds $100,000.

Qualified Conversation Contribution (QCC) Deduction:  The maximum charitable deduction a real property owner can take for making a QCC was increased from 30% to 50% of their adjusted gross income (farmers and ranchers can deduct up to 100%). The carry-forward period for the unused deduction was extended from 5 to 15 years (plus the year the donation was made).  A (QCC) is a contribution of a qualified real property interest to a qualified organization for conservation purposes.  A qualified real property interest includes a donor’s entire interest in real property, a remainder interest, and certain easements in that property.

Higher Education Tuition Deduction:  Students or those who claim them as dependants will continue to be able to deduct qualified education expenses as an above the line deduction on the front of form 1040.  This deduction will be available for 2010 and 2011.

Classroom Teacher Expenses: Teachers will be able to deduct up to $250 “above the line” on the front of form 1040 in 2010 and 2011.  The deduction applies to out-of-pocket expenses incurred by teachers for certain books, equipment, and supplies used in the classroom.

Alternative Minimum Tax (AMT):  The AMT exemption “patch” was increased for 2010 and 2011.  The AMT is a parallel tax structure in which many exemptions and deductions are replaced with a single exemption amount.  The AMT is calculated during the tax return preparation process.  The taxpayer must pay the higher of the normal income tax or the AMT.  The AMT was originally created to keep high income taxpayers from taking “unfair” advantage of the tax code.  Unfortunately, the AMT exemption amount does not automatically adjust for inflation. Although many members of the middle class must now pay the AMT, the increased exemption will keep an estimated 20 million more taxpayers from being subject to it.

These last minute changes affect 2010 personal income tax rules and should be kept in mind as you organize your 2010 taxes information for your preparer.  Since the Tax Hike Prevention Act also created many last minute changes that will affect 2010’s businesses and corporate filings, the next “Let Talk Tax” column will discuss these changes.  If you have any questions regarding your personal or business taxes or need assistance preparing your 2010 income tax return, please contact our office to speak with a tax professional.

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Business Owners:  Lower Your Red (Audit) Flags

If you are the sole owner of an unincorporated business and have not elected to be treated as a corporation for tax purposes, you are considered a “sole proprietor.”  Sole proprietors report their business income and expenses on Schedule C, Profit or Loss from Business.  Schedule C then becomes part of your individual tax return, Form 1040.  Sole Proprietorships are the most common form of business in the United States, making Schedule Cs the most common business form filed with the IRS.

Top IRS Target: Unfortunately, the IRS attributes much of the United States’ “Tax Gap” – the difference between taxes that should be paid and tax actually reported – to errors made by sole proprietors’ on their Schedule Cs.  The underreporting of tax by sole proprietors has made business owners and their Schedule Cs, among the most targeted for IRS audit. 

Today, I will discuss several “red-flag” errors that invite IRS scrutiny of sole proprietors and their Schedule Cs.

Incorrect Business Classification Code: One of the most common mistakes made on Schedule C is entering the wrong business classification code.  The business classification code is reported in Box B of the 2011 Schedule C.  It tells the IRS what type of business/industry the proprietor is in and is used to compare the business’s reported income and expenses to those of similar businesses in the same industry.  If items reported on a particular return have a high deviation from the averages reported by others, it is more likely to be selected for review. 

Using an incorrect business code, or the entering the audit-inviting 99999 (for an unclassifiable business) can drastically increase the chances of “further review”.  Lower this red flag by taking the time to select the classification code that is most appropriate for your business.

Auto Expenses: More errors are made reporting vehicle business expenses than virtually any other Schedule C item.  These errors are caused by three factors: 1) Most sole proprietors use their personal vehicles for business purposes, 2) The rules regarding the business use of personal vehicles are complex and often confusing, and, 3) Many owners do not retain the records necessary to substantiate the vehicle deduction claimed. 

This article is not long enough to address the complexities of claiming the auto but it will allow me to share the following cautions:
1. Only legitimate business vehicle use is deductible (and there many rules defining business use). 
2. Most owners can deduct auto expenses in one of two ways: actual expenses, based on the percentage of annual business use, or by using an allowable mileage allowance for each vehicle. Be very, very careful if you decide to switch between the two methods in different years. 
3. Owners must have some form of a business mileage log to substantiate the business use claimed. 

The IRS is well aware of these rules. Owners can lower this red-audit-flag by understanding and following these rules or by seeking professional assistance. 

Claiming Business Losses Year After Year:  The reasoning behind this red flag actually makes sense.  Being in business, by its very definition, means a profit motive exists.  The IRS generally gives new businesses two years of losses (more for some industries) before the owner must be able to show a profit motive (also called “material participation”). 

If the owner cannot show a profit motive, the IRS could reclassify the activity as a hobby, making revenues taxable, expenses only deductible as an itemized deduction, and no loss allowed.  For more information, please see my article, The Hobby Tax-Trap, at the Journal-news.net or in the articles section of hbsbusiness.com. 

This article has discussed three red-flag areas sole proprietors should be aware of when completing Schedule C.  There remain, however, many rules, limits and requirements not included in this article.  In my next column, we will discuss another error-prone deduction, the home office deduction.  Until then and, as always, please remember that this or any article does not constitute or replace the advice of a qualified professional.  If you have any questions regarding your taxes, please feel free to call our office at (304) 267-2594 to speak with a tax professional.

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Home Office Deduction Danger

If you are the sole owner of an unincorporated business and have not elected to be treated as a corporation for tax purposes, you are considered a “sole proprietor” for tax purposes.  Sole proprietors report their business income and expenses on Schedule C, Profit or Loss from Business.  Schedule C then becomes part of the owner’s individual tax return, Form 1040.  Sole Proprietorships are the most common form of business in the United States, making Schedule Cs the most common business form filed with the IRS.

Top IRS Target: Unfortunately, the IRS attributes much of the United States’ “Tax Gap” – the difference between taxes that should be paid and tax actually reported – to errors sole proprietors make on their Schedule Cs.  The frequency of errors made on Schedule C has made them among the most targeted for IRS “review.” 

In my last column, I discussed three of the red flags most often waved at the IRS by sole proprietors: 1) Using the incorrect business classification code, 2) Errors made in reporting their business auto use, and 3) Claiming losses year after year.  If you missed this article, you can read it here – Business Owners:  Lower Your Red (Audit) Flags or it is available at the Journal-news.net.  Today, I will round out our “red-flag” discussion by reviewing the 4th major Schedule C red flag: the home office deduction.

Home Office Deduction:  Business owners who do not have separate places of business often have no choice but to perform business activities from their home.  Those who have a home area that is used regularly and exclusively for business may be entitled to take the Home Office Deduction.  Claiming the Home Office Deduction allows the business owner to deduct a portion of many household expenses such as mortgage interest, property taxes, and utilities from business income.  Those who start their day working in the home office may also be entitled to start counting business mileage from the home instead of from their first business appointment. 

Unfortunately, many who claim the Home Office Deduction do so in error.  The frequency with which this this deduction is erroneously claimed makes it one of the first deductions the IRS questions.  This article will help owners ensure their home office passes muster if and when it is questioned.

There are two tests a workspace must pass to be considered a home office for tax purposes:

Exclusive Use Test: To qualify as exclusive use, the workspace must only be used for conducting business.  The area does not have to be an entire room.  Part of a room – a desk, chair and filing cabinet, for example, that is used strictly and only for business will qualify.  Caution: The dinner table or a desk shared with children to do their homework does not pass the exclusive use test.  Please note that different rules apply to space used to store supplies or inventory as well as areas used for daycare.

Regular Use Test: In addition to being used exclusively for business, the workspace must also be used on a consistent basis, not incidentally or occasionally as the owner’s principal place of business.  This rule becomes complicated when the business has more than one business location.  Under these circumstances, the home workspace must be of “significantly greater” importance in providing the product or service than any other location.

If, however, a business has no other business location, the office will qualify as the principal place of business when: 1) It is used regularly and exclusively for management and administrative activities (such as invoicing and preparing estimates) and, 2) The owner has no other location from which to conduct these activities.

This article has discussed the basic requirements one must meet to claim the Home Office Deduction.  There remain, however, many rules, limits and requirements not included in this article.  Please remember: this or any article does not constitute or replace the advice of a qualified professional.  If you have any questions regarding your taxes or would like assistance in preparing your tax returns, please feel free to call our office at (304) 267-2594 to speak with a tax professional.

 

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Giving to Caesar: Taxing Ministers

Preparing a minister’s tax return can prove challenging for everyone involved: The minister who must keep records, the church secretary who prepares the W2 forms, the church leadership who determines minister compensation, and the tax professional who prepares the return and advises for the future.  My goal in this article is to help ministers prepare for next tax season and to enlighten church leaders about how the IRS taxes their minister’s compensation.

According to the IRS, a minister is an individual who is “duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination.” To be considered a minister for tax purposes, these individuals must be hired by a church or religious organization to perform religious duties. 

Practicing ministers are considered “dual-status” taxpayers.  They are employees of the church for federal income tax purposes but treated as being self-employed when determining Social Security and Medicare taxes, unless they are exempt from these taxes.  To be exempt a minister must have taken a vow of poverty as a member of their religious order, or filed for an exemption.  Ministers can file for this exemption (using Form 4361) if they, conscientiously or as a matter of religious principle, are opposed to receiving public insurance payments.  Generally, a minister has until the due date of their tax return for the second year they are compensated for ministerial duties to file Form 4361 and claim this exemption.

Salaries a church pays to its ministers are considered wages and must be reported each year on form W2 (social security and Medicare boxes will be blank).  Payments a minister receives directly from individuals (for weddings, for example) are considered self-employment income.  Payments called “gifts” or offerings are also self-employment income if the minister performs a service for it. 

In fact, difference between a “gift” and earnings is often misunderstood.  Money is only considered a gift when the giver has not received and does not expect to receive anything from the minister in return, such as a sermon, a wedding, or a song.  In other words, if any service was performed in exchange for the “gift” it is taxable income to the minister.

Ministers can receive a parsonage (housing) allowance that is not subject to income tax.  Like wages and “gifts,” however, the allowance is subject to self-employment tax if the minister is not exempt.  A parsonage allowance is the rental value (including utilities) of a home provided by the church or cash paid directly to a properly ordained or licensed minister to rent or purchase a home (including utilities, taxes and insurance).  If a home is provided by the church, the amount excluded from income cannot exceed its fair rental value. 

If the minister receives a housing allowance in the form of cash, only the actual cost of housing can be excluded from income.  The non-taxable housing allowance must be the lowest of the following: 1) Fair rental value plus other costs such as utilities, 2) The amount of the allowance, or 3) Actual amounts paid for housing (mortgage payments (or rent), utilities, taxes, insurance, repairs, maintenance and furnishings). 

A minister can deduct personal expenses they incur in the performance of their duties.  Ministers who are not paid for their services can deduct these expenses as a charitable contribution.  A salaried minister, however, must deduct his employment-related expenses as a miscellaneous itemized deduction which will not be beneficial until the deduction exceeds 2% of Adjusted Gross Income (AGI).  Expenses incurred in the creation of business income (such as weddings) would be deducted on schedule C.  Furthermore, a paid minister who also receives tax-free income (such as a parsonage allowance) must reduce these expenses by the percentage of total income that was tax free. 

The ministry certainly has its rewards. It also has its challenges.  One of these challenges arrives each year around tax time.  In this article I was only able to highlight a few of the complexities impacting a minister’s tax return.  If you find yourself confused by these complexities, please feel free to contact our office to consult with a tax professional.

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Caution: Home Office Deduction

If you are the sole owner of an unincorporated business and have not elected to be treated as a corporation for tax purposes, you are considered a “sole proprietor” for tax purposes.  Sole proprietors report their business income and expenses on Schedule C, Profit or Loss from Business.  Schedule C then becomes part of the owner’s individual tax return, Form 1040.  Sole Proprietorships are the most common form of business in the United States, making Schedule C the most common business form filed with the IRS.

Top IRS Target: Unfortunately, the IRS attributes much of the United States’ “Tax Gap” – the difference between taxes that should be paid and tax actually reported – to errors sole proprietors make on their Schedule Cs.  The frequency of errors made on Schedule C has made them among the most targeted for IRS “review.” 

In an earlier column, I discussed three of the red flags most often waved at the IRS by sole proprietors: 1) Using the incorrect business classification code, 2) Errors made in reporting their business auto use, and 3) Claiming losses year after year.  If you missed this article it is available at the Journal-news.net or in the articles section of hbsbusiness.com.  Today, I will revisit our “red-flag” discussion by reviewing the 4th major Schedule C red flag: the home office deduction.

Benefits and Requirements:  Business owners who do not have separate places of business often have no choice but to perform business activities from their home.  Those who have a home area that is used regularly and exclusively for business may be entitled to take the Home Office Deduction.  Claiming the Home Office Deduction allows the business owner to deduct a portion of many household expenses such as mortgage interest, property taxes, and utilities from business income.  Those who start their day working in the home office may also be entitled to start counting business mileage from the home instead of from their first business appointment. 

Unfortunately, many who claim the Home Office Deduction do so in error.  The frequency with which this deduction is erroneously claimed makes it one of the first deductions the IRS questions.  This article will help owners ensure their home office passes muster if and when it is questioned.

There are two tests a workspace must pass to be considered a home office for tax purposes:

Exclusive Use Test: To qualify as exclusive use, the workspace must only be used for conducting business.  The area does not have to be an entire room.  Part of a room – a desk, chair and filing cabinet, for example, that is used strictly and only for business will qualify.  Caution: The dinner table or a desk shared with children to do their homework does not pass the exclusive use test.  Please note that different rules apply to space used to store supplies or inventory as well as areas used for daycare.

Regular Use Test: In addition to being used exclusively for business, the workspace must also be used on a consistent basis, not incidentally or occasionally as the owner’s principal place of business.  This rule becomes complicated when the business has more than one business location.  Under these circumstances, the home workspace must be of “significantly greater” importance in providing the product or service than any other location.

If, however, a business has no other business location, the office will qualify as the principal place of business when: 1) It is used regularly and exclusively for management and administrative activities (such as invoicing and preparing estimates) and, 2) The owner has no other location from which to conduct these activities.

This article has discussed the basic requirements one must meet to claim the Home Office Deduction.  There remain, however, many rules, limits and requirements not included in this article.  Please remember: this or any article does not constitute or replace the advice of a qualified professional.  If you have any questions regarding your taxes or would like assistance in preparing your tax returns, please feel free to call our office at (304) 267-2594.

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Use Tax: The WV Stealth Tax

If your business has ever been audited by the WV State Tax Department the result may have included a very expensive vocabulary lesson.  It is a lesson that forever stamps the phrase “Use Tax” into your, the owner’s, lexicon.

Most business owners are very familiar with the proper collection and remittance of sales tax.  One section, the Use Tax section, of your sales tax return, however, remains unnoticed by many until an auditor tallies up a jaw-dropping deficiency bill.  In today’s article, I will discuss the basics of Use Tax.  My goal is to help trigger a spark of “Use Tax” recognition long before an auditor asks to see years of receipts for major purchases.

Use Tax Defined:  According the tax department, Use Tax is “imposed upon the use within West Virginia of tangible personal property and services bought or leased outside West Virginia for use or consumption within this State.”  What this basically means is if you (Yes you. Use tax can also apply to individuals.) or your business purchase an item (or contract for a service) from a location outside West Virginia and bring it into West Virginia (where it is used, consumed, or the service is performed), that purchase is subject to the same sales tax rules as any other West Virginia purchase.  The difference is that under these circumstances the tax is called Use Tax, not sales tax, and it is the buyer’s responsibility to pay, not the seller’s.  The buyer must report and pay Use Tax but will get a credit for any sale tax paid to the state where the items were originally purchased.

Here are some common situations that get taxpayers into trouble:

Situation: You buy $10,000 worth of computer equipment for your West Virginia office from an online computer vendor.  The vendor does not charge sales tax.  Your business must remit the $600 (10,000 * 6%) in Use Tax to the West Virginia Department of Tax and Revenue.

Situation: You purchase a $30,000 piece of heavy equipment in another state and bring it into West Virginia for use in your construction business.  You do not pay sales tax on the purchase.  You must remit $1,800 (30,000 * 6%) in Use Tax to WV.

Situation: You hire a doctor from another state who comes into West Virginia to conduct physicals on your employees.  Although the services are performed in West Virginia they are exempt from sales tax as a professional service and, therefore, are not taxable.  You do not owe Use Tax on this purchase.

Situation: As a final example, consider this common scenario: Your office manager lives in Virginia.  She routinely purchases office supplies for your West Virginia office in Virginia.  Over the course of the year, she purchases $10,000 of supplies using your business credit card.  These purchases are subject to Use Tax but you get a credit for taxes paid to Virginia.  Since Virginia has a tax rate of 5% (4% state and 1% local) you will get a Use Tax credit for the $500 sales tax ($10,000 * 5%) paid to Virginia.  But, because West Virginia has a tax rate of 6% you will still owe $100 ($10,000 * 6% = $600, minus $500 = $100) to West Virginia on these purchases. 

An Undue Burden: Many would argue that the complexity and reporting requirements of Use Tax place an undue burden on taxpayers.  Most business owners simply don’t have time to review every purchase for potential Use Tax liability and they don’t have the money to pay their accountant to analyze every receipt.  On the other hand, the state might argue that noncompliance results in millions of lost tax dollars, a situation that has gotten worse with the growth of internet purchases.  They might also argue that out-of-state sellers who do not follow the same rules have an unfair advantage over in-state sellers of the same products.  This unfair advantage drains money from both the local economy as well as its tax base.  Use Tax simply levels the playing field.

Use Tax is here to stay: Regardless of your opinion, Use Tax is here to stay.  Long-forgotten, receipt-filled shoe boxes will continue to provide a treasure-trove of unpaid Use Tax (plus penalty and interest, of course) for the unwary.  To reduce your chances of falling into the Use-Tax-Trap take the following steps:

The Bottom Line: Simply recognizing the potential liability and paying Use Tax when due can save thousands in penalties and interest down the road.

 

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HOA’s Must File Taxes

If you own a home in a planned community or development there is a good chance you are a member of a homeowners’ association (HOA). One perplexing aspect of HOA management is the tax reporting requirements of the IRS.  I have discussed this topic several times in the past. Still, it continues to generate more calls and web visits than any other topic.  Some common questions our office receives are “Must our HOA file a tax return?” “What return must it file?” and “What happens if we haven’t filed for a number of years?”  Today, I’ll revisit some of these basic questions in order to clarify some of the confusion associated with taxes and your HOA’s reporting requirements. 

Home Owner Associations are Corporations: For federal tax purposes, homeowners associations are treated as corporations. This is true even if an HOA was created as an association or a nonprofit corporation with its respective state.  The only exception is the rare instance in which the HOA has filed for recognition and been accepted as a nonprofit by the IRS. Such recognition is expensive and difficult to obtain.  Nonprofit recognition is requested by filing form 1024 with the IRS and utilizing tax code section 501(c)(4).

IRS Form 1120:  Corporations are generally required to file Form 1120, U.S. Corporation Income Tax Return, annually. Filing form 1120 has several distinct disadvantages for an HOA. First, Form 1120 is fairly complex and requires a level of bookkeeping sophistication many HOAs lack. A second disadvantage of filing Form 1120 is that all of the HOA’s “income” is taxable. Basically, this means that any funds collected and not spent (for example, funds set aside for road maintenance or replacement) during the year may be subject to corporate income tax. A third disadvantage of Form 1120 for an HOA is that it may subject the HOA to making estimated tax payments, another burden for the often overburdened volunteer treasurer.

IRS Form 1120-H for HOAs:The tax code gives many HOAs the ability to avoid Form 1120 by making a special election. Section 528 allows Homeowner Associations that meet certain requirements to bypass Form 1120 by filing Form 1120-H, an income tax form specifically designed for Homeowner Associations. Form 1120-H is a one page form that is much easier to complete than the many page, multiple schedule Form 1120.

Qualifying for 1120-H: Although most HOA’s qualify, each must meet certain requirements to utilize this election. To file Form 1120-H, at least 60% of the HOA annual revenue must be “exempt-function income.” Exempt-function income includes membership dues, assessments, fees and interest on those fees. Also, 90% of the HOA’s expenditures must be for management, maintenance, acquisition and construction of association property.

Taxes and 1120-H: If the HOA qualifies to file Form 1120-H, only its “non-exempt” income is taxable. Non-exempt income includes interest and dividends, rental income from property owned by the association, and laundry/vending machine income. The HOA is allowed to deduct expenses directly related to the generation of non-exempt income but must have written records to prove the deductions. Form 1120-H allows for a $100 deduction from non-exempt income to arrive at taxable income. The HOA’s taxable income is then subject to a flat tax rate of 30% (32% for time share associations).

The 1120-H Election: Filing Form 1120-H is an election that must be made each year. The election is made by filing Form 1120-H by its due date (the 15th day of the third month after the end of the HOA’s tax year – a six month extension to file can be obtained by filing Form 7004). Once made, the election cannot be revoked without IRS consent.

If Form 1120-H is not filed within twelve months of its due date (including extensions), the HOA may lose the opportunity to file the form 1120-H for that tax year. The HOA must then file the longer and more complex Form 1120. The HOA may also be required to pay penalties for late filing and late payment of any tax due.

Check out our 1120-H Basics Course to learn how you can complete this form yourself

This article has, hopefully, clarified some of the confusion surrounding a Homeowners Association’s income tax filing requirements. Please remember: This or any article does not constitute or replace the advice of a qualified professional.  If you have any questions regarding your taxes or would like assistance in preparing your tax returns, please feel free to call our office at (304) 267-2594 to speak with a tax professional.

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IRS Collections: Liens and Levies

As the saying goes “The Taxman Cometh.”  Step by step he approaches: Hard-soled shoes slapping pavement, a trench-coat spotlighting shadows.  Penalties and interest mount as he searches for those who have not filed returns and those who have underpaid their taxes.  There are many ways he can find you.  Maybe an amount reported on a W2 or 1099 was missing from a tax return.  Maybe a cash-paying contractor got audited and had to substantiate his expenses.  Maybe a taxpayer consistently pays his mortgage but reports very little income on his tax return.  It really doesn’t matter how he finds you.  Once he does, you’re pulled into the IRS collection process. 

Today, I will discuss the basics of a tax assessment and two of the tools used by the IRS to collect back taxes:  tax liens and levies.  My goal is to provide those facing “The Taxman” with an idea of what to expect when they enter the IRS collection process.   

Assessment: The term “assessment” simply means the IRS has determined that a tax is due.  Once an assessment has been made, the IRS generally has ten years to collect the taxes due.  An assessment occurs most commonly on the date a tax return is filed.  If a return is not filed the IRS may use its financial reporting system to file a return for the taxpayers based on information received from employers (W2s), vendors (1099-misc), banks (1099-Int), and brokers (1099-div and 1099-B).  This return is called a Substitute for Return (SFR).  An assessment made with an SFR is nearly always to the taxpayer’s disadvantage as it is based primarily on income information that is reported by employers, banks, brokers, etc. and not by the taxpayers.  As such, the return will lack most deductions, exemptions, and credits. 

Once assessed, the IRS has two basic tools to collect past due taxes: the federal tax lien and the federal tax levy. 

Lien: A federal tax lien is a claim to all property a taxpayer owns at the time or after a lien arises.  Liens arise automatically when taxes remain unpaid ten days after the IRS sends its first notice of taxes due and demands payment.  If the tax due exceeds $10,000 the IRS may file a formal tax lien, notifying the public of its claim to a taxpayer’s property (in February 2011 the IRS announced it was increasing the formal lien threshold from $5,000 to $10,000).  A lien that is formally filed will negatively affect the taxpayer’s credit, harming their ability to buy, sell and refinance properties.  A tax lien remains in effect until the tax is paid, the collection statute expires, or the IRS removes the lien.

Levy: The second tool the IRS uses to collect past due tax is the federal tax levy.  A levy occurs when the IRS physically takes a taxpayer’s property to pay past due taxes.  The IRS can levy both income and property including wages, payments from customers, retirement income, social security payments, state and federal tax refunds, savings and checking accounts, vehicles, real estate, or other valuables. 

Although the filing of a tax lien may be more-or-less automatic, the IRS must follow certain procedures before it can levy a taxpayer’s property.  The IRS will send a 30-day notice that it intends to levy a taxpayer’s assets.  When this notice is received, the taxpayer still has the opportunity to make payment, enter into an installment agreement, or appeal the levy if they believe the amount due is incorrect or improperly issued.  This appeal must be made within 30 days of receiving the notice of intent to levy.  An appeal can still be made after the 30 day deadline has passed, but the taxpayer will be bound by the decision and lose their right to further appeals.

Worried that you may not be in compliance with form 1099-MISC? Check out our 1099-MISC Basics course to get all of your compliance questions answered.

This article has provided a very basic outline of IRS collection process.  It has not discussed more specific details including IRS timelines, specific IRS notices regarding past due taxes, the appeal process, or circumstances under which the IRS may remove a lien or forego a levy.  As always, if you find yourself caught up in the IRS’s collection process or would like assistance with any tax situation, please feel free to contact our office at (304) 267-2594.

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