2014 Tax Developments (sort of)

The US Senate is on track to hold a vote next week to restore nearly all of the key tax provisions that expired at the end of 2013 (details below).  Meanwhile, over at the US House of Representatives, the process is moving along but at a slower pace.

The House did approve legislation to permanently extend the Research & Development tax credits and will take up additional tax legislation on a bill-by-bill basis.  Accordingly, final reconciliation most likely won't occur until late in the year (read that as AFTER THE MID-TERM ELECTIONS).  You heard it here first, folks (OK, maybe not first but you did hear it here).

Here is a listing of the tax provisions that expired in 2013 and that we believe will be re-instated retroactively to January 1, 2014:

• The $500,000 cap on expensing business assets under Code Sec 179 (it was $500,000 for 2013 but dropped to $25,000 for 2014 with the 2013 expirations);
• The election for folks 70 1/2 and older to transfer up to $100,000 from their IRAs directly to Charity;
• The $2 million exclusion for debt forgiven on a primary residence; and
• The election to write off state sales taxes in lieu of state income taxes.

There are other provisions that are on the table and we'll keep you updated as news becomes available.  We do not believe that any of the generous "Bonus Depreciation" provisions for businesses will be re-instated.

Finally, for 2014 the estate and gift exemption amount is set at $5.34 million and it will rise annually with inflation.  The Obama Administration wants to raise the Estate & Gift tax rate by 5% (to about 45%) and cut the exemption amount to $3.5 million but the House Republicans have balked and we don't believe there is any reason to think that the Administration will get their way on this.

Enjoy your Spring! We'll be writing more in a few weeks.

How Long to Keep Records

Here is our third message in a series designed to help you handle the basics of sound business record keeping.  Our previous messages addressed checking accounts & logs and receipts.

You may hate the ‘records keeping’ part of the tax system, but it’s critical to your tax health. It’s also important the health of your business. Good records help you monitor and improve your business. Do not depend on the IRS for mercy when it comes to your tax records. You will never find the word “mercy” in the same sentence with the IRS. It does not exist in the code or the regulations.  I have yet to meet a “merciful” IRS agent. Where there is no mercy, you have no choice but to play defense and keep your records correctly.

Here we will address how long you should keep your records.

How Long to Keep Records

The statutes of limitations tell you the time period during which the IRS can audit your returns. If your returns are examined, you need tax records that prove your deductions. This means you need to keep your records for longer than you might think.  

Assets

Assets such as your car, desk, computer, and office building are relevant to your tax return during their depreciable class lives.  If you are depreciating the assets, the depreciation shows up in those returns. If you used Section 179 to expense the assets, then you have potential recapture during the depreciable class life. 

Example. You buy a $1,500 desk and depreciate it over the seven-year MACRS life (this takes eight years). In year eight, you still have to prove the depreciation. That means you need the original purchase record in year eight. You also need the purchase record in year eleven to meet the three-year statute of limitations on this year eight deduction.   If you used Section 179 expensing on this desk, your records requirement is identical to the example. You have recapture exposure during the eight years, and you need to hold onto your proof of purchase for three years beyond that, or 11 years in total.  

Make this easy. For any asset that has a life of more than one year, keep the purchase records in a permanent file. With a separate permanent file of asset purchases, you don’t have to think or worry about class lives or limitation periods. 

The five-drawer method

To use the five-drawer method, you need to keep your permanent files in another place (such as a different set of file drawers). Next, you must report your income and file and pay your taxes on time or with extensions, to limit your audit exposure to three years from the date you filed your return. If you fit this profile, the five-drawer system can simplify your records retention. It works like this:  

Drawer 1: Accumulation of current year tax return information

Drawer 2: Last year (tax return filed this year, say on April 15)
Drawer 3: Two years ago
Drawer 4: Three years ago
Drawer 5: Four years ago

At the beginning of each year, the contents of drawer 5 go to the dump and all drawers move down one notch.

Employment taxes

If you have employees, you must keep all employment tax records for at least four years after the date the tax becomes due or is paid, whichever is later. Again, simplify. If you have employees, use a six-drawer method. Toss the sixth drawer when your four-year statute expires.

Next time, we’ll talk about accounting software and payroll.

2nd Rule in a Series - Logs & Receipts - Audit-Proof Your Records

Here is our Second Message in a series designed to help you handle the basics of sound business record keeping.  Our prior message addressed Checking Accounts .

You may hate the ‘records keeping’ part of the tax system, but it’s critical to your tax health. It’s also important the health of your business. Good records help you monitor and improve your business.  Do not depend on the IRS for mercy when it comes to your tax records. You will never find the word “mercy” in the same sentence with the IRS. It does not exist in the code or the regulations.  I have yet to meet a “merciful” IRS agent. Where there is no mercy, you have no choice but to play defense and keep your records correctly.  

Here we will address logs and receipts.

Keep Logs

To deduct your vehicle expenses, you need proof of business use. This is true regardless of the form your business takes. 

Thus, if you operate as a corporation, you (the employee) must submit proof of your business use to the corporation.   We recommend that you keep your vehicle mileage in your appointment book so it reflects your business activities for each day. Further, the appointment-book recordings facilitate use of a sampling method, such as the three-month log of business miles to prove business use for the year.

If you own rental properties, you should track for at least three consecutive months the time spent on the rentals, to prove material participation and, if applicable, real estate professional status.   

If you claim a deduction for an office in the home, you should track time spent working in the home office. Your use of the home office must meet the “regular use” test. If you use your home office a little more than 10 hours a week on a consistent basis, you meet the requirements for regular use as set out in the Green Case.

Record Required Elements of Travel and Entertainment    

Regardless of business form, you need to prove, for each day of travel, where you were and why you were there.   For entertainment, you need to record: 

• who,
• what,  
• when,  
• where,  
• why, and  
• how much.  

You can meet all these requirements by adding a short note to the receipt with the name of the person you entertained, and why you entertained this person. 

The “why” should relate to the immediate or future business benefit you hope to achieve with the entertainment. Try to keep the “why” explanation to seven words or less.   We made up this seven-word guideline and have used it successfully for the past 15 years because it makes for a clear explanation of the entertainment activity. Further, you have additional corroborative evidence in your files and e-mails. 

The receipt contains the remaining documentation for:

• what (e.g., food, drinks, golf);
• when (date);
• where (name and address of the place); and
• how much.  

If you operate as a corporation, you need to turn the documentation in to the corporation, and the corporation needs to either pay for the entertainment and travel expenses directly (say, with a corporate credit card) or reimburse you for the amounts spent. Make certain the corporation pays. You do not want to claim deductions for these expenses as employee business expenses.

Remember this:

For all expenses, from the purchase of your desk to pens for your office, keep these two points in mind:    

• You need to prove what you bought; and
• You need to prove that you paid for what you bought.  

Step 1: What you bought. Generally, the receipt or invoice will prove both the description of what you bought and how this purchase relates to your business. With entertainment at a restaurant, the receipt that proves what you bought is the receipt that shows the details of what you had to eat and drink. 

Step 2: What you paid. Tax law considers the charge to a credit card as payment, regardless of when the card gets paid. Thus, you can prove payment by credit card with either the credit card receipt that shows the total charge or the credit card statement.   The canceled check proves payment by check. The bank statement proves payment by electronic transfer. 

As a general rule, don’t pay in cash. These are the first questions an auditor will ask about a cash payment: 

• Where did the cash come from?  
• How good is the trail of cash to the payment?  
• Was an ATM withdrawal evident before the cash payment?  
• Did the taxpayer really spend the cash or just make up this deduction?

You face no such questions for payments by check or credit card. 

Petty Cash   

For most small businesses, a petty cash system is a disaster and we discourage our clients from using one. If you have such as system and it works well for you, be pleased to know that you are the exception rather than the rule. We strongly recommend using the reimbursement method.

Under the reimbursement method, if you or an employee spends money on behalf of the business, you simply have the business write a check to reimburse the expense based on documentary evidence such as a receipt for the expenditure, and an expense report for the auto mileage, if applicable.   The reimbursement method is direct, clear, and less subject to mistakes than the petty cash system. 

Next time, we’ll discuss How Long to Keep Records.

First Rule in Series - Checking Accounts - Audit-Proof your Records

You may hate the ‘records keeping’ part of the tax system, but it’s critical to your tax health. It’s also important the health of your business. Good records help you monitor and improve your business (says your humble CPA).

Do not depend on the IRS for mercy when it comes to your tax records. You will never find the word “mercy” in the same sentence with the IRS. It does not exist in the code or the regulations.  I have yet to meet a “merciful” IRS agent. Where there is no mercy, you have no choice but to play defense and keep your records correctly. 

Getting your tax records right is not difficult when you know what to do. We’ve prepared a series of messages to give you the record-keeping basics you need and helps you spend less time keeping records.  Here is the first rule in the series:

Checking Accounts

The 1st rule to keeping good records: Do not commingle activities in your checking accounts.  Most taxpayers should maintain separate checking accounts for:

• Family account or accounts,
• each separately reported Schedule C business,
• each corporation, and 
• each rental property (if there are substantially different types of rentals, then additional separate accounts may be necessary here).

Example: You operate your business as a proprietor and cover your spouse with a Section 105 medical reimbursement plan. If you have only one checking account for the family and the proprietorship, writing the reimbursement check to yourself likely would destroy the Section 105 plan.

That’s how Darwin Albers lost his Section 105 plan deductions.  The Albers case is just one example of how using a joint account for both business and personal reasons causes a loss of deductions.

Rule #1: Maintain a separate checking account for each business activity. 

Deposit Receipts in the Account for the Business That Earns the Money   

You may not earn income in your personal name and then assign that to your corporation. Income is taxed to the person or entity that earns it. You don’t want business receipts in your personal accounts or personal receipts in your business accounts. The separate checking gives you the ability to avoid commingling which is something to avoid always.
When the IRS gets confused looking at your accounts, it simply taxes all the income. True, you might be able to undo that assertion and prove that all the deposits are not taxable, but that takes time and effort. By simply getting the deposits right to begin with, you save yourself from confusing the IRS—which saves the IRS, in turn, from frustrating you. 

Record Deductible Expenses Daily   

Yea, we heard your groan when you saw the word “daily” above. Don't worry, the daily requirement, which actually existed for auto expenses in 1984, was repealed and replaced with an adequate records requirement. So the IRS now gives you a week to meet the “timely” and “adequate” records requirements for vehicles, travel, entertainment, and listed property.

We doubt that you will, but you probably should thank the IRS for the one-week rule. Why? Because recording your business expenses within one week makes good business sense. After all, if you wait too long, you won’ t remember the nature or reason for the expenses. 

Next time, we’ll discuss Logs and Receipts.

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A "close to retirement" IRA question

Q:      I retired from my full time job in 2013 but I plan to keep working part-time for at least a three or four more years.  How much can I deduct in an IRA contribution?

A:       The answer is: it depends!  Generally, for 2013 and 2014 you can contribute the lesser of your annual compensation or $5,500 to a traditional Individual Retirement Account (“IRA”) or to a Roth IRA.  For folks over the age of 50, that amount increases to $6,500 because of the special “catch up” provisions for IRA contributions.  http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-IRA-Contribution-Limits

In addition, deductible amounts are reduced or eliminated if you (or your spouse if you’re married) actively participate in an employer sponsored retirement plan (like a 401(k), 403(b), SEP or Simple Plan).  In addition to this “active participation” rule, there are limitations to the deductibility of your traditional IRA contributions if your adjusted gross income (AGI) exceeds certain amounts. For more information about these limitations, visit this page on the IRS website:  http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits

You can’t make deductible contributions to a traditional IRA in the year you reach the age of 70½ and for every year after that.  You can still make contributions to a Roth IRA and you can still make rollover contributions to your traditional IRA or Roth IRA regardless of your age (*).

This is a great idea on your part to beef up your retirement nest egg.  I would suggest that you consider making your annual retirement contribution to a Roth IRA instead of contributing to a traditional IRA.

Like the traditional IRA, income generated inside the Roth IRA is not taxed as it’s earned. The real benefit to the Roth is that, when you are older than 59½ years of age, funds withdrawn from the Roth IRA are never subject to tax. There are significant financial, tax and estate planning benefits to utilizing a Roth IRA. Before making your final decision, consider the Roth IRA for the contributions you have inquired about.

* * * * * * * * * * * * * * * * * * * *

* - There can be significant tax consequences to either rolling over your employer retirement account or converting your traditional IRA to the Roth IRA so make sure you know all the facts & consequences before you make a Roth conversion.

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Standard Mileage Rates to be reduced slightly in 2014

Optional standard mileage rates for use of a vehicle will go down by one-half cent per mile for 2014, the IRS announced on Friday. Taxpayers can use the optional standard mileage rates to calculate the deductible costs of operating an automobile (see http://www.irs.gov/pub/irs-drop/n-13-80.pdf).

For business use of a car, van, pickup truck, or panel truck, the 2014 rate will be 56 cents per mile. Driving for medical or moving purposes may be deducted at 23.5 cents per mile. Both rates are one-half cent lower than the rates for 2013.  The rate for service to a charitable organization is unchanged, set by statute (Sec. 170(i)) at 14 cents a mile.

The portion of the business standard mileage rate that is treated as depreciation will be 22 cents per mile for 2014, down one cent from the 23 cent rate in effect in 2012 and 2013.

For purposes of computing the allowance under a Fixed And Variable Rate (“FAVR”) plan, the maximum standard automobile cost for 2014 is $28,200 for automobiles (not including trucks and vans) or $30,400 for trucks and vans, increases of $100 and $500, respectively, from 2013.

Under a FAVR plan, a standard amount is deemed substantiated for an employer’s reimbursement to employees for expenses they incur in driving their vehicle in performing services as an employee for the employer.

Please feel free to contact us directly if you have any questions.

Here's a link to our email regarding the standard mileage rate

Key Tax Changes to note for 2013

As the year draws to a close, it is a good time to take stock of your tax situation and identify possible opportunities to minimize your tax liability. Many of the provisions associated with the American Taxpayer Relief Act of 2012 ("ATRA") became effective in 2013, which means they will have an impact on this year’s tax return.

ATRA extended numerous benefits for middle-income taxpayers that can help minimize your tax bite if you qualify. Tax benefits include many credits and benefits for families, some deductions for state and local taxes and tax credits for making energy-saving improvements to your home. If you are a higher income taxpayer, ATRA increased your need to plan to lower the impact of higher rates.

We encourage you to contact us at your earliest convenience to discuss how these laws affect your tax situation and develop a strategy that makes sense for you. Among the issues you should be considering:

Health Care Reform

The Affordable Care Act ("ACA") has generated a great deal of confusion and concern. Although no tax considerations for individuals are involved, taxpayers who don’t have health care coverage may be subject to a penalty. Even if you already have coverage, you may want to consider alternatives. We can help you assess what reform means to you and offer the advice you need to make the best choices.

New Tax Laws in Effect

·          High-income individuals will pay more in taxes under the new law in 2013.  Period.  You should consider options for minimizing this tax burden. The highest individual income tax rate rose to 39.6% in 2013 and taxpayers at this income level also saw the dividend and long-term capital gains tax rates rise from 15% to 20%. 

·          In addition, the new 3.8% net investment income tax applies to single taxpayers with adjusted gross income of $200,000 and joint filers earning $250,000. This new tax may affect the effective after-tax return on the sale of your investments, but proper planning may serve to minimize the impact.
 

·          Although the alternative minimum tax ("AMT") originally was aimed at high-income taxpayers, it increasingly has affected more and more middle-income taxpayers. ATRA indexed the AMT for inflation but the use of certain tax breaks could still subject you to the tax.

·          Phase-outs of personal exemptions and the limitation on itemized deductions have been reinstated. As a result, joint filers with adjusted gross income greater than $300,000 and single taxpayers whose adjusted gross income exceeds $250,000 will see a decrease in both of these deductions.

·          After several years of uncertainty in the estate tax area, ATRA created some permanency. The amount that an heir can inherit without owing estate tax is now set at $5 million and will be indexed for inflation in future years. In addition, the estate tax was raised to 40%.

·         Under ATRA, taxpayers age 70½ and older can once again make up to $100,000 of tax-free distributions from an IRA directly to qualified charities.

For those paying college tuition, there is some good news. Several education-related benefits were extended by ATRA, including the American Opportunity Tax Credit, which allows eligible taxpayers to claim a tax credit for some higher education expenses. Given skyrocketing tuition costs, families should not overlook these credits and deductions as they plan for college.

We can help you understand your tax situation and determine the best steps to address your tax challenges and any other financial concerns. We are also available after tax season to advise you on the financial strategies and planning decisions that will help you meet your goals. 

Please don’t hesitate to contact us today to schedule an appointment to begin discussing your options.