Three Tax Takeaways for Friday

There are reasons to file your taxes on time even if you have a refund coming. The 2017 extended deadline passed on October 15. If you had a refund coming, and knew that nothing would happen if you filed after the deadline, would you still procrastinate? Did you know that as long as you pay and file on time for three years in a row, that you qualify for first-time AUTOMATIC late penalty abatement just for the asking? Why miss a chance to beef up your get-out-of-penalty-free-card? File on time whenever you can.

Businesses can no longer write-off entertainment as an expense; meals are still OK though. The TCJA denied business expenses for entertainment, amusement, or recreation, but failed to specifically mention business meals. Interim guidance from the IRS says that until further guidance is forthcoming, business meals are still deductible. The TCJA goes further in not allowing a deduction for any food or beverages unless (1) the expense is not lavish or extravagant under the circumstances, and (2) that taxpayer (or an employee of the taxpayer) is present when the food or beverages are furnished.

The Court of Appeals for the Sixth Circuit reversed a Tax Court decision and held that the economic benefits enjoyed by a taxpayer when their S corporation payed the premiums for split-dollar life insurance were taxable to them. In addition to the premium payments no longer being a business expense but a taxable distribution instead, the increase in value of the policy was also deemed to be taxable income to the owners. S Corporations are pass-through entities. Anything that belongs to the S Corporation ultimately passes-through back into the pocket of the shareholders. Therefore the life insurance for the owners, that was paid for with profits from the business they own, turns out to be taxable to – well, them.

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Three Sales Tax Tidbits for Friday

Not all states impose a sales tax. The five states that do not are Oregon, Delaware, Alaska, Montana and Hew Hampshire.

Thinking about buying or merging with an existing business? You always conduct research for hidden liabilities and sales tax liabilities are a frequent exposure area, especially if the business has sales outside of its home state. Out-of-state retail sales often ignore state registration laws and are a big deal in today’s internet based economy. Compliance continues to be a problem and states are starting to go after their money. Do your research before putting pen to paper, or risk paying somebody else’s bills.

What is use tax? When you buy a retail item, a tax must be remitted to the state; it’s called sales and use tax. If you buy a retail item at a physical store, the store adds a sales tax to your purchase and gives those taxes to the state every month. If you buy an online retail item and the out-of-state seller does not collect sales tax, tax is still owed to your state. The difference is that now you, the user, are supposed to pay the tax; it’s called a use tax. So, um, how long have you been using Amazon Prime?

Estimates for 2012; it takes a while to compile some of these stats, list the top five states in revenues lost to unpaid sales and use tax due to online sales:

California        $4,159,000,000

Texas               $1,777,000,000

New York         $1,767,000,000

Florida             $1,483,000,000

Illinois              $1,058,000,000

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Tax Fraud

IRS examinations can take different forms; from a computer algorithm, a letter audit asking for information, or a full-blown in-person audit. During the process the IRS will be keenly aware that fraud may exist. When indicators (badges) of fraud are uncovered, the matter is serious enough to immediately involve management and technical advisors as the case for fraud is developed. The taxpayer now has the full attention of the most powerful collection agency in the United States.

Allegations of fraud by the IRS could not be more serious. The penalty for civil fraud is 75% of the tax that was not paid (plus interest), and in cases of criminal fraud, the penalty is 100% of unpaid taxes, interest, and possibly jail time. Criminal fraud is often referred to as tax evasion, especially when the fraud involves the willful and intentional concealment of income.

Most cases of fraud are smaller civil cases because proving willful and intentional criminal fraud is difficult. A typical example of civil fraud might be something like a construction contractor who fails to report 1099 income; we had a case like this once. His payer issued a form 1099-MISC reporting about $110,000 of gross income. The IRS got their carbon-copy of the 1099, but because the contractor had moved, and failed to forward his mail, he didn’t get his copy. Since he did not get a 1099 he must not be responsible to report that income, right? The answer is that, 1099 or not, you are responsible for reporting all of your worldwide income.

In this case the IRS re-computed the tax and added the 75% civil fraud penalty with interest. Because he was basically caught red-handed, the only thing we could do was amend the original tax return to at least include business expenses, and protect his rights. The tax owed was about $22,000, add the 75% penalty at $16,500, other smaller penalties, and interest that started at April 15, and the liability was about $44,000.

Assuming that your business and family survive this blow, it can take as long as 10 years to recover from a pitfall like this. If something like this happens to you, or the IRS is proposing a charge of fraud, this is the time to seek out professional help and it needs to come from a licensed tax professional.

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Three Quick Tax Tips for Friday

Tax scams continue to be rampant and the IRS predicts that they will increase as the October 15 deadline gets closer. Scam artists continue to impersonate IRS employees making threatening phone calls. If you receive a phone call from someone claiming to be an IRS agent demanding immediate payment for a tax debt, hang up the phone. The IRS will never call to threaten or demand a payment. Your first contact with the IRS is always a notice or letter that you receive in the mail.

IRS Notice 2018-77 announced per diem rates that are effective October 1, 2018. Taxpayers may use these new rates to substantiate the amount of expenses for lodging, meals and incidental expenses when traveling from home. There are also special rates for the transportation industry. You can find the Notice here:

We recently gained a client who was planning on offsetting S corporation income with a substantial year-end purchase of inventory. We informed the client that retail inventory is NOT an expense when it is purchased; it is an expense when it is sold. When you buy inventory, you are exchanging a cash asset for an inventory asset; there is no expenses event in the transaction. At the time of the subsequent sale, Sales are recognized as well as a Cost of Goods Sold expense. The Cost of Goods Sold expense decreases your total inventory. The basic equation is Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold.

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Quarterly estimated tax payment is coming up

For those who make quarterly estimated tax payments, September 17 is your deadline to make your tax payment for the quarter comprised of June, July and August. Your final quarterly estimated tax payment for September, October, November and December is due January 15, 2019.

For Federal taxes use form 1040-ES. Your state will have its own form. Whenever you send a check to any taxing agency you should always legally assign that payment. You can accomplish legal assignment by writing your SSN and what the payment is for in the memo section of your check. For this quarter write, “SSN: XXX-XX-XXXX, 2018 Form 1040-ES.” This action will assure that your payment goes where you want it and not to any other unpaid balances.

Whenever you owe Federal taxes for multiple years or periods and the IRS receives an unassigned payment, they will try to apply that payment to your oldest balance. If you fail to assign your payment, generally you will first receive a Notice asking you where you want your payment applied but IRS notices are, for some reason, often ignored until the time allowed to respond has passed. Assign your payments and you won’t have to worry about it.

You can also pay on-line. We recommend using the IRS’ Direct Pay because there are no fees. The other online method uses a credit/debit card service provider that charges a fee. Be sure to choose the correct form and year; that will assign your online payment.

There are other ways you can pay like by phone, or in person using cash, but these methods are out of the ordinary and not recommended. Many states now have online portals where you can manage your tax account and make payments. The IRS has also begun using similar account portals.

We have a pay-as-you-go tax system and if you wait until April 15 of every year you will be penalized for not paying as you earn. If you need help in projecting your taxes, proper planning, and paying for a consultation with your tax accountant generally costs less than the late payment penalties. And if you are in business, it’s an expense.

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Proposed IRS rules affecting SALT limitations

To counteract the $10,000 State And Local Tax (SALT) limitation, some states are drafting plans for a work-around to allow their citizens to continue to enjoy the overall tax deductions they are accustomed to. They are doing it by allowing a charitable contribution in lieu of paying state and local taxes, thus shifting a portion of federal deductions from the line for State and Local Tax deductions to the line for Charitable deductions. Proposed IRS regulations would allow a charitable deduction for the transfers to a state agency or charitable organization, but only if the taxpayer did not receive anything in return.

Charitable contributions have to be free and clear in order to be deducted on your federal tax return. The rule for charitable contributions where you receive something in return, like a DVD in exchange for your contribution to PBS, is that you have to reduce the amount of your schedule A deduction by the value of whatever it is you received.

Some states are proposing awarding tax credits to taxpayers who make donations to certain funds. The IRS rules say that if a taxpayer receives or expects to receive something in return for their contribution, like tax credits, then their federal charitable donation must be reduced by the value of the received benefit. Credits are considered to be a received benefit. The proposed rules do however allow for a dollar-for-dollar state or local tax deduction. So it appears that the states will need to fine tune their mechanisms.

The rules would apply to contributions made after the TCJA and any preexisting programs crated before the TCJA. If SALT a material part of your tax planning strategy, a consultation with your licensed tax professional would be cost-effective.

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Contract soldiers now qualify for the foreign earned income exclusion

If you are a U.S. citizen, and your tax home is in a foreign country during 2018, and you meet all the other rules, you can exclude up to $104,100 of your foreign earned income from being taxed in the U.S. However, the foreign earned income exclusion was not available to U.S. Military contractors.

The Bipartisan Budget act of 2018 changed the tax home requirement, and now eligible taxpayers can claim the earned income exclusion even if their tax home is within the United States. Eligible taxpayers consist of certain U.S. citizens or resident aliens working as contractors or employees of contractors supporting the U.S. Armed Forces in designated combat zones.

See your licensed tax professional for further guidance.

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Check your 2018 withholding

With so many changes to the tax laws, we have had a lot of recent requests for tax planning. Every projection I have made this year has resulted in a lower total tax amount for 2018 compared to 2017. Despite losing some deductions, the lower tax rates and other areas of the equation have resulted in a lower total tax. That is lower, “Total tax;” I said nothing about refunds.

These projections can be flawed unless our client provides us with a current pay stub so that we can measure current withholding to compare to the projected total tax amount. Because of the expected lower 2018 tax, standardized withholding table amounts are lower this year and most employees are having lower amounts withheld from their paychecks. If your take-home pay went up around February, then this applies to you. I can only speculate as to the government’s intention, but it probably has to do with Parkinson’s Law, which says that expenses always rise to meet income. So if people have more money in hand, they are likely to spend it, thus adding fuel to the economy.

Think of it like this, the government wants to aid the economy so it lowers the income tax. But it wants results now, not on April 17 of next year, so how do you get results now? By decreasing the withholding from people’s paychecks and putting a fraction of their usual refund into their hands now instead of later.

If you are one of those people who expect or rely on your annual refund, you do not want to break even, or worse, have to pay in. You need to review your 2018 withholding now so that you can overpay now in order to get that refund come April 17, 2019. For us accountant’s this is an illogical way to save, but we understand why some folks do it this way.

If you are already used to living without it, and you rely on your refund, you should immediately inform your employer to increase your withholding to previous levels. That will fix your refund for the long term but you will have a shortfall for the months February through now, so plan for that and save money using your bank account rather then doing it as part of your payroll function. You can use the new IRS withholding calculator here: to see if you are going to have a shortfall. Contact your licensed tax professional for tax planning if your situation is complicated by a business, or you expect a major taxable event such as selling capital assets.

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Update on the 20% pass-through/qualified business income deduction

The IRS recently released proposed regulations aimed at setting out the rules and regulations for the new Section 199A 20% business deduction; , all 184 pages of them.

The new laws and regulations pertain to domestic businesses operated as sole proprietorships, partnerships, S corporations, trusts, and estates; corporations do not qualify. The rules are effective for tax years after 2017 and before 2026. One reason for pressing ahead on the release was to set out procedures for taxpayers who need to aggregate separate business activities for the calculation. There are a great number of specific rules and ownership percentage tests, so meet with your tax professional for guidance that is appropriate for your business structure as you plan.

The deduction is for the lesser of the “Combined qualified business income amount” of the taxpayer, or 20% of the excess of taxable income for the tax year over the sum of net capital gains and aggregated amounts of qualified cooperative dividends. Again, there are a number of qualifications, especially for the trusts and estates, and you will want to consult with your licensed tax professional when making planning decisions.

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2018 Long-term capital gains rates

The TCJA keeps the 0%, 15%, and 20% LTCG rates for capital gains and qualified dividends but these rates now have their own brackets that you need to be aware of. The LTCG rates used to be tied to the tax bracket for your taxable income. Now the LTCG rates have their very own brackets. The new LTCG brackets are:

The columns are for      1. Single,   2. Joint, and  3. Head of household

0% bracket                          $0-$38,600      $0-$77,200      $0-$51,700

15% bracket begins at        $38,601              $77,201             $51,701

20% bracket begins at        $425,801            $479,001           $452,401

Trusts, estates and kiddie tax computations are different and you should contact your tax practitioner for guidance as these calculations have their own peculiarities. Those brackets are:

0% bracket covers $0-$2,600

15% bracket starts at $2,600

20% bracket starts at $12,701

Short-term capital gains are taxed at ordinary income rates just like wages or interest income. If you are an investor, understanding your average level of income and remembering the LTCG brackets above will keep you abreast of your estimates of the related tax liabilities. Contact your licensed tax practitioner for further guidance.

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