Tax situations that baffled me this year

It is becoming more difficult finding time for blogging now that the tax season is moving into high gear.

To make things more difficult, I’ve had two never-before encountered tax situations arise for two of my clients.

DROUGHT-RELATED SALE OF LIVESTOCK
One client bought a half interest in a cattle business and they formed a new Limited Liability Company. A few months afterward there was a drought and they had to sell off a large part of the herd. This caused a recovery of my client’s investment, but created a potential taxable gain. There is a provision, however, that, under certain conditions, a drought-related sale of livestock qualifies as an involuntary conversion and enables the sellers to avoid paying tax on all or part of the the gain if they reinvest in replacement livestock within a specified time. A lot of research was necessary for this situation.

CANADIAN FORM NR4 INCOME FROM ESTATE
Another client had a Canadian Form NR4 which baffled me. I finally consulted with a Canadian accountant who explained that one line represented Canadian Taxable Income and Canadian Tax withheld. Another line represented U.S. Income and U.S. tax withheld. I decided that it should go on Schedule E, page 2 as Income from a Trust or Estate, but assumed that there would be a problem since a Canadian Estate would not have a U.S. ID number. The Canadian accountant said they probably did have a U.S. ID.

Later when I was looking at the Form again, I discovered a nine-digit number just below the address of the company that issued the form—so that solved my dilemma.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Foreign Income

U S Citizens often invest in foreign securities from Canada, South Africa, Europe and other nations. Some U S citizens take overseas jobs in foreign countries. This type of income has tax implications. For example Canada withholds 15% tax from dividends paid to U S investors. You may be able to deduct this tax on line 47 of your form 1040 but you may need to complete Form 1116 in order to determine if all or what part can be deducted. If you don't deduct it on line 47 of your 1040, you can deduct it as an itemized deduction.

The following is from an IRS "Tax Tip."

INCOME FROM FOREIGN SOURCES

Many United States citizens earn money from foreign sources. These taxpayers must remember that they must report all such income on their tax return, unless it is exempt under federal law.

U.S. citizens are taxed on their worldwide income. This applies whether a person lives inside or outside the United States. The foreign income rule also applies regardless of whether or not the person receives a Form W-2, Wage and Tax Statement, or a Form 1099 (information return).

Foreign source income includes earned and unearned income, such as:

• Wages and tips
• Interest
• Dividends
• Capital Gains
• Pensions
• Rents
• Royalties

An important point to remember is that citizens living outside the U.S. may be able to exclude up to $82,400 of their 2006 foreign source income if they meet certain requirements. However, the exclusion does not apply to payments made by the U.S. government to its civilian or military employees living outside the U.S.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

NOMINEE DIVIDENDS AND INTEREST

Reporting Dividends or Interest you receive for another person.

If a corporation reports dividends in your name that actually belong to someone else, this is called dividends you received as a NOMINEE. You could also receive Interest as a nominee. In such cases, you should not pay tax on such income, but you must follow proper procedures to report the income to the person who actually receives the money from the dividends or interest.

You should prepare a Form 1099-DIV or 1099-INT and send them together with a Form 1096 transmittal to the IRS. You should also give the actual owner of the dividends Copy B of the Form 1099. On these forms, you should list yourself as the Payer and list the actual owner as the Recipient.

You should also report dividends or interest which you received as a nominee on Schedule B of your Form 1040 just as you would any other dividends or interest. You should then add all dividends or interest and put a subtotal on Schedule B a few lines below the last dividend or interest item you have entered.

Below this subtotal, enter “Nominee Distribution” and show the amount received as a nominee. Subtract the total of your nominee distributions from the subtotal. Enter the result on line 6 in the case of dividends. For interest you would subtract the nominee interest from the subtotal and enter the result on Line 2 of Schedule B.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Inherited Real Etate

INCOME FROM SALE OF INHERITED REAL ESTATE

- If you inherit a home or other real estate from a deceased relative, you may actually have a tax loss. Often the heir inherit the home of the deceased and want to dispose of it as soon as possible to avoid paying ad valorem taxes on an empty house.

When they sell it they may reduce the price for a quick sale and incur real estate commissions and other closing costs.

You should value your basis in the inherited property at its value on the date of death, which might be a greater value than you received for the property. A quick and easy way to check its value would be to look at its assessed value on the county tax rolls which are usually available on the internet. That should be a safe assumption if you choose to value it as if that were your cost.

If you think the tax assessor undervalued it, you might need to get an independent appraisal.

When you report it on your tax return, it goes on Schedule D. Instead of entering the date acquired, enter “Inherited.” For the date sold, enter the actual date title was transferred to the purchaser. Even if you sold it a week after you inherited it, you would report it as a long-term capital gain or loss.

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Can you trust the IRS?

Can you trust the IRS?

I noticed something new this year on the first return I prepared for which the taxpayer wanted a check mailed to him instead of a direct deposit to his bank account. Lines 74a and 74b on page 2 of Form 1040 have a place to enter your bank routing number and account number. When I printed the tax return I noticed these lines were filled in with XXXXXXXX. At first I thought this must be a flaw in my tax software.

After making inquiries, someone suggested that it might be something the IRS asked tax software companies to add to these lines. But why? The reason suggested was that some unscrupulous IRS employees might fill in their own bank account numbers if these lines were left blank.

Has this actually happened? I don't know and the IRS isn't likely to admit that your confidential information isn't safe in their hands.

This brings some related risks to my mind.

• Don't make your check out to 'IRS" Some female employee at the IRS might change the "I" in IRS to "M" then add 'rs' and the check would then be to Mrs. XXX.
• Be cautious in selecting a tax preparer. I heard that some employee of a large tax-preparation company was caught after having using the clients' information such as credit card numbers and social security numbers in an identity theft scheme

Where there is a will, there is a way----to cheat.

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IRS-related phishing scams

IRS-related phishing scams
If the IRS doesn't get you, the scammers will (if they can).
Taxpayers to be on the lookout for bogus e-mails claiming to be from the tax IRS.

Scammers send e-mails, which are designed to trick the recipients into disclosing personal and financial information that could be used to steal the recipients’ identity and financial assets.

“The IRS does not send out unsolicited e-mails asking for personal information,” said IRS Commissioner Mark W. Everson. “Don’t be taken in by these criminals.”

The IRS has seen a recent increase in these scams. Since November, 99 different scams have been identified, with 20 of those coming in June – the most since 40 were identified in March during the height of the filing season.

Many of these schemes originate outside the United States. To date, investigations by the Treasury Inspector General for Tax Administration have identified sites hosting more than two dozen IRS-related phishing scams. These scam Web sites have been located in many different countries, including Argentina, Aruba, Australia, Austria, Canada, Chile, China, England, Germany, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Poland, Singapore and Slovakia, as well as the United States.

The current scams claim to come from the IRS, tell recipients that they are due a federal tax refund, and direct them to a Web site that appears to be a genuine IRS site. The bogus sites contain forms or interactive Web pages similar to IRS forms or Web pages but which have been modified to request detailed personal and financial information from the e-mail recipients. In addition, e-mail addresses ending with “.edu” — involving users in the education community — currently seem to be heavily targeted.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Are you missing the point(s)?

If you bought a new house in 2006, you may be overlooking some tax deductions.
Take a look at your settlement statement (HUD Form).

Lines 801 and 802, Entitled Loan Origination Fee and Loan Discount - These are points charged to either the buyer or the seller - or both. The buyer can deduct these charges as interest on Line 11 or 12 of Schedule A (itemized deductions). Even the seller-paid points are deductible by the buyer, since, theoretically, the seller has priced the house high enough to cover these expenses.

However, you should check your Form 1098 to see if the Mortgage company lists the points. If it does show them, then the points go on line 11 and you don't get to deduct the same amount twice.
If the Form 1098 does NOT list the points, then you should enter them on line 12 of Schedule A.

Some other items listed on the settlement statement that are deductible by the buyer:

• line 106 and 107 Taxes charged to the buyer to reimburse the seller for prepaid taxes
• Line 901 Interest in buyer column. (not deductible if reported on Form 1098)

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Corporartion Sole

TAX AVOIDANCE SCHEMES-Corporation Sole

A few months ago someone asked me about doing business as a Corporation Sole to minimize his tax burden. He was skeptical since it sounded too good to be true. I checked with the IRS and here is what I found:

Taxpayers should be wary of promoters offering a tax evasion scheme that misuses “Corporation Sole” laws. Promoters of the scheme misrepresent state and federal laws intended only for bona-fide churches, religious institutions and church leaders.

"This scheme shamelessly tries to take advantage of special tax benefits available to legitimate religious groups and church leaders," said IRS Commissioner Mark W. Everson. "Unscrupulous tax promoters always look for ways to game the system and prey on unsuspecting victims. Taxpayers should be on the look-out for these and other scams."

Scheme promoters typically exploit legitimate laws to establish sham one-person, nonprofit religious corporations. Participants in the scam apply for incorporation under the pretext of being a “bishop” or “overseer” of the phony religious organization or society. The idea promoted is that the arrangement entitles the individual to exemption from federal income taxes as an organization described in Section 501(c)(3) laws.

The scheme is currently being marketed through seminars with fees of up to $1,000 or more per person. Would-be participants purportedly are told that Corporation Sole laws provide a “legal” way to escape paying federal income taxes, child support and other personal debts by hiding assets in a tax exempt entity.

While fraudulent Corporation Sole filings have happened sporadically for many years, the IRS has recently seen signs the scam could be starting to spread with multiple cases seen recently in states such as Utah and Washington. The IRS is concerned about this increase and is taking steps to pursue Corporation Sole promoters and participants.

Used as intended, Corporation Sole statutes enable religious leaders — typically bishops or parsons — to be incorporated for the purpose of insuring the continuation of ownership of property dedicated to the benefit of a legitimate religious organization. Generally, creditors of a Corporation Sole may not look to the assets of the individual holding the office nor may the creditors of the individual look to the assets held by the Corporation Sole. Currently, 16 states permit Corporation Sole incorporations. The IRS suggests that individuals considering becoming involved in any kind of tax avoidance arrangement obtain expert advice from a competent tax advisor not involved in selling the arrangement. Do not rely on legal opinions obtained or provided by the arrangement’s promoter. Start by asking the following questions:

• Is the arrangement designed to hide income or assets?
• Is the arrangement designed to evade income taxes?

Answering “yes,” or even “maybe,” to either of these questions should raise red flags for taxpayers.

Tax guidelines for churches and religious institutions can be found in Publication 1828, “Tax Guide for Churches and Religious Organizations”.

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Missing Form 1099

MISSING A FORM 1099?

If you receive certain types of income, you may get a Form 1099 for use with your federal tax return. Form 1099 is an information return provided by the payer of the income. You should receive your Form 1099-series information returns by January 31, 2007. The payer deadline to mail Form 1099-series is January 31, 2007.

If you have not received an expected Form 1099 within a few days after that, contact the payer, to secure the missing information. If you still do not receive the form by February 15th, call the IRS for assistance at 800-829-1040.

In some cases, you may obtain the information that would be on the Form 1099 from other sources. For example, your bank may put a summary of the interest paid during the year on the December or January statement for your savings or checking account. If you are able to get the accurate information needed to complete your tax return, you do not have to wait for the Form 1099 to arrive.

Form 1099-series is not a required attachment to your return, except when you receive a Form 1099-R, or Form 1099-INT that shows federal income tax withheld. You will not usually attach a 1099-series form to your return, except when you receive a Form 1099-R that shows income tax withheld. You should keep a copy of all the 1099s that you receive with your tax records for the year. There are several different forms in this series, including:

• Form 1099–B, Proceeds From Broker and Barter Exchange Transactions
  
• Form 1099–DIV, Dividends and Distributions
  
• Form 1099–INT, Interest Income
  
• Form 1099–MISC, Miscellaneous Income
  
• Form 1099–OID, Original Issue Discount
  
• Form 1099–R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
  
• Form SSA–1099, Social Security Benefit Statement

If you file your return and later receive a Form 1099 for income that you did not fully include on that return, you should report the income and take credit for any federal income tax withheld by filing Form 1040X, Amended U.S. Individual Income Tax Return. Form 1040X and instructions are available on the IRS Web site at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Form 1040X, Amended U.S. Individual Income Tax Return (PDF 123K)
• Instructions for Form 1040X (PDF 43K)
• Forms and Publications

Energy saving credits

TAX CREDIT FOR ENERGY-SAVING COSTS
-If you made your home more energy-efficient you may be entitled to a tax credit.
There are two categories that qualify for the credit:
1. Energy efficiency improvements
2. Residential energy property costs.
Energy efficiency improvements:
The first category includes
· Insulation that reduces heat loss
· Energy-saving exterior windows and doors
· Metal roofs pigmented with heat-reducing coatings.
Residential energy property costs:
The second category includes
· Qualified solar electric-generating equipment
· Solar water heating equipment
· Fuel cell equipment which converts a fuel into electricity by electrochemical means.

The energy efficiency credit is 10% of the cost subject to certain dollar limitations.
The Residential energy property costs credit is 30% of costs with dollar limitations.

The above is only intended to provide a broad general discussion of the subject. For further details--if you have made any such improvements-- you should look at Form 5696 and the related instructions at http://www.irs.gov/

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Construction Acctg

TAXATION OF CONSTRUCTION CONTRACTS:

For construction costs you would report income and expense under either the Percentage-of-completion method or the Completed Contract method.
If you begin and complete a construction contract in the same tax year, you would report all income and expense on that year’s tax return. However if the construction period laps over two years, even if the total time is less than a year, you then use a different approach.

PERCENTAGE OF COMPLETION METHOD:
If you choose, or are required to use, the Percentage-of-completion method, you must calculate a percentage to be used in reporting income. The percent is determined by dividing the cost incurred during the year by the total estimated cost to be incurred for the entire contract. Suppose you had a contract to build something for $ 3 million. If you expect the total costs to be $2 million and have incurred $ 1 million in costs during the year, you would report half of the $ 3 million as income for the year. Your income would be $ 1.5 million and your expense would be the $ 1 million cost actually incurred and the profit would be $ 500,000 minus some overhead expense.

COMPLETED CONTRACT METHOD:
A small contractor can use the completed-contract method which seems less complicated. Under the completed contract method, you would report no income or expense until the contract was completed. You would report everything in the year it was completed.

PROGRESS PAYMENTS:
Generally a contractor receives progress payments based on percentage of completion regardless of how he reports his income. These payments would not be income. They would never exceed the total contract price, and would probably be less than the income reported if the percentage-of-completion method were used. If the completed contract method is used, any unused funds would be considered a loan from the buyer until the contract was completed.

Accounting entries to record income and expense:
Percentage-of-Completion method

• Debit Construction in Progress and Credit Cash or Accounts payable to record costs.
• Debit Cash and credit 'Progress Billings' or some similar liability account to record progress payments received.
• Debit Construction in Progress and Credit Income for profits recognized.
  
• Debit 'Progress Payments' and credit 'Construction in Progress' when the contract is completed.

Completed-Contract Method:
The first two entries would be the same.
Upon completion, you would debit a Cost of Sales account and credit Construction in Progress and would Debit Progress Billings and Credit Income. If there were a final payment not included in progress billings, you would debit Cash and Credit the final payment to Income.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

EDUCATION-RELATED DEDUCTIONS AND CREDITS

-TUITION AND FEES - DEDUCTIONS AND CREDITS

There are several options. A professional tax-preparer can easily select the best option if his software works like mine does. I enter the amount of the education expenses and check a box to select the Hope credit and check the tax result. Then I deselect the Hope credit and check the box for the lifetime learning credit and see if that increased or decreased the tax. Finally, I check the box for the deduction and see what that does. I then select the one that reduces the tax the most. Sometimes one or more of these methods results in a zero amount due to the taxpayer’s income, the student does not qualify, or the expense does not qualify.

If you do it yourself, then you need information beyond the scope of this blog, and should download publication 970 from www.irs.gov Just type in 970 in the search box. Also, you should look at Forms and instructions for Form 1098-T, Form 8815, Form 8863. If you made an early withdrawal from an IRA look at the codes for penalty exclusions for Form 5329.

A Credit is not the same thing as a deduction.

There are several education-related tax provisions related to education expenses. Two arise frequently and can be confused with each other. One type is a credit and the other type is a deduction. A credit reduces your tax by the amount of the credit, but a deduction would only reduce your taxable income which only reduces it by a percent of the deduction.

Which should I take?

You may or may not qualify for all options .

Generally the credit is better than the deduction, but not always. There are two different credits, the Hope credit and the Lifetime learning credit. The credits have different income-related limitations than the deductions

Income limits for credits:
The credits are not available if your Adjusted Gross income (AGI) exceeds $ 110,000 on a Joint Return or $ 55,000 on other returns.

Income limits for the deductions:
Your AGI can be as high as $ 160,000 on a Joint return or $80,000 and still qualify for the deduction.

There are two different credits

The two credits are the Hope credit and the Lifetime learning credit. The Hope credit usually provides the best tax reduction, but the rules may prevent you from taking the Hope credit. The Hope credit is only available for the first two years of post-secondary education. The Lifetime learning credit does not have this limitation.

Rules That Apply to Both Credits and Qualified Education Expenses
Generally, qualified education expenses are amounts paid in
2006 for tuition and fees plus, in some cases, books, supplies and other costs as explained in Publication 970 .

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

EFTPS

You can save time and trouble by paying your taxes online. If you file estimated taxes through the mail, you have to fill out four quarterly Form 1040ESs, make sure you mail them before the due date and hope the mail arrives on time. Using Form 1040ES you are not limited to making your payments quarterly. Some people prefer to pay monthly.

I like to pay as many bills as possible online so I don't have to worry about forgetting to put a stamp on the envelope or having it lost or delayed in the mail. Once I sent a credit card payment in before it was due, but it was delayed over a month in the mail. Then I was charged interest on the card. I thought it had been lost, so I added it to my next bill and ended up with a credit balance due to paying about $1000 more than the amount I owed.

The IRS prefers that you pay electronically. It is less work for them and less trouble for you.

You can enroll in the IRS electronic payment program, (EFTPS) and pay quarterly, monthly or however you choose. You can prearrange payments to be charged to your bank account when due. If you need to change the scheduled payments you can do so and you can send in an extra additional payment for unanticipated extra income (in case you win the lottery or something).

After you enroll in EFTPS, you will receive a confirmation package by mail. In a separate mailing you will receive an EFTPS Personal Identification Number (PIN) with instructions for activating your enrollment. Employers who apply for and receive a new Employer Identification Number and have a federal tax obligation are automatically enrolled in EFTPS Express Enrollment to make their Federal Tax Deposits.

For more information you can visit IRS.gov. Click on the e-file logo and look for "Electronic Payment Options" and the EFTPS logo. To enroll, visit EFTPS.gov or call EFTPS Customer Service at 800-555-4477.

Link: EFTPS Web Site

TAX SIMPLIFICATION as we once knew it-

-TAX SIMPLIFICATION (it started out pretty simple)

The 1913 Form 1040 was four pages long.

Page 1 summarized everything in 8 lines:

1. Gross Income
2. General Deductions
3. Net Income
4. Dividends and corporate-related income
5. Tax Withheld
6. Exemptions $ 3000-$4000)
7. Taxable Income
8. Tax (1% if your taxable income was $20,000-$50,000) If you made over $ 500,000 the tax was a whopping 6%.

Page 2 was a summary of nine categories of income which were to be included in lines 1 and 4 of page 1.

Page 3 was a summary of “general deductions” consisting of six categories. One category was “a reasonable deduction” of depreciation. They didn’t even use the word depreciation, but called it an allowance for wear and tear.

Page 4 was the instructions.

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LATE 1099s FROM BROKERS

LATE 1099s FROM BROKERS

Over the past couple of years, many brokerage companies send amended 1099 Form often after their clients have already prepared their tax returns based on the first 1099s.. Many investors receive as many as of three amendments, with the latest ones being received well after the April 15 tax deadline.

MAY GET WORSE THIS YEAR
It will probably be worse this year since tax-exempt interest has to be reported on Forms 1099-INT and many brokers will be late adapting to this new requirement.

NOT JUST ONE OR TWO BROKERS
The problem is not with just one brokerage firm, but, I’ve been told that it is almost universal.

CAN’T MEET APRIL 15 DEADLINE
If you get amended 1099s meeting the April 15 filing deadline may not be a realistic goal. But if you file late, you could be penalized for both late filing and late payment.

YOU CAN FILE AN EXTENSION REQUEST
If you don’t owe any tax, then there is no penalty, even if you file late. You could calculate your tax based on the initial set of 1099s you receive, but instead of filing the return, you could request an extension with Form 4868 and send a payment with the extension request if you expect to owe. This would give you until October 15 to file.

IF YOU DON'T SUBMIT AN EXTENSION REQUEST AND FILE LATE
Even if you file late and don’t send the extension request, there is no penalty or interest if you do not owe any tax.

YOU CAN FILE AN AMENDED RETURN
If you are substantially overpaid and want the refund, then you might file before April 15, then submit an amended return, Form 1040X, if late 1099s indicate changes are necessary.

PAYING MOST OF YOUR TAX NEAR YEAR-END COULD TRIGGER PENALTIES
Unless you indicate otherwise by filing Form 2210, the IRS assumes your income was received equally throughout the year. If your payments are skewed toward the end of the year, you could be penalized even if you paid a sufficient amount in total. However, if you request an extension and pay MORE than you owe, the IRS may send the refund without checking to see if you paid in equal installments.

YOU CAN PAY YOUR TAXES ONLINE
If you sign up for the Electronic Federal Tax Payment System (EFTPS), you can make your tax payments using the internet. To look into that option, go to http://www.eftps.gov/

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NONTAXABLE IRAs

NONTAXABLE IRAs CAN BE CONFUSING

The form you must prepare is not worded in a way that is easy to interpret. If you have made both deductible and nondeductible contributions to traditional IRAs, then part of your withdrawals are attributable to the nondeductible IRAs and can be withdrawn without paying tax again. But to make it complicated, you have to calculate the percent that can be withdrawn tax-free using Form 8606.. All withdrawals have to be allocated between taxable and nontaxable every year in which you make a withdrawal. You must also update your basis every year in which you make a contribution.

You must update your nondeductible IRA basis, using Form 8606, whether you made withdrawals or not.

NOTE: The allocation applies only to traditional IRAs, not Roth IRAs which do not enter into this calculation. Traditional IRAs are any IRA other than a Roth IRA.

The first line of Form 8606 seems self-explanatory. It asks for nondeductible contributions for the tax year, including those made through April 15 of the year after the tax year.

Line 2 is somewhat confusing.
It asks for your basis in traditional IRAs. The key word is basis. You only have a basis if you paid for it with after-tax money. If you deferred the tax by deducting an IRA contribution, your basis is zero.

So, ENTER just the value of your nondeductible IRAs on line 2

Line 6 asks for the value not basis of your traditional IRAs. The value is both the basis of your nondeductible IRAs plus the value of your deductible IRAs. This amount is the value of your IRAs as of December 31 of the tax year for which you are reporting.

Line 7 asks for distributions you received during the tax year. This amount is added back to the year-end value to get the total you would have had if there had been no withdrawals.

Line 8 asks for anything you converted to a Roth IRA. This is also to be added back to the year-end value since a conversion would be equivalent to a withdrawal.

Line 9 is the Total of Lines 6+7+8.

Line 10 is line 5 (nondeductible IRA basis) divided by line 9 (total value at year-end plus withdrawals and conversions) divided.

The rest of the form is used to calculate the taxable and nontaxable portion of your IRA withdrawals for the year and to calculate the remaining basis of your nondeductible IRAs which will become Line 2 on next year’s Form 8606.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

UNREIMBURSED PARTNERSHIP EXPENSES

-If your partnership agreement requires you to pay expenses under the partnership agreement, you can deduct these items.
If your partnership interest is nonpassive,

• Enter "UPE" (unreimbursed partnership expenses) in column (a) then go to col. (h)
  

• deduct the unreimbursed expense on a separate line in column (h) of line 28, nonpassive loss from Schedule K-1. This amount should not be combined with your other K-1 gain or loss from this activity -- it should be separately stated.

If your expenses are passive, enter "UPE" in column (a) and enter the expense in column (f) of line 28.

These deductions should be ordinary and necessary expense of the partnership, not items which should go on Schedule A as itemized deductions.

STARTING A NEW CORPORATION OR LLC

STARTING A NEW CORPORATION OR LLC

The first thing you need to determine is whether a C Corporation, an S Corporation or LLC would be the best way to go. You should explain the nature of the business to a CPA and get his thoughts on whether to incorporate or set up an LLC.

If you incorporate, you will need to file Form 2553 if you want to be taxed as an S Corporation. This would be done after you get your corporate charter.

After you decide between a corporation and LLC, the next step would be to get a corporate charter from the state.

After you get your charter, you need to file a form SS-4 with the IRS to get an Employer Identification number--whether you will employ anyone or not. The EIN is used by the company instead of using a Social Security Number for an individual.

You can download all forms and instructions at http://www.irs.gov

After you fill out as much as you can on Form SS-4, call the IRS at the number indicated in the instructions for the form and get the EI Number over the telephone. You can now begin filing returns under that number.

Another important point is that you may need to report both an income statement and a balance sheet on your corporate or LLC tax return. That means you may need to maintain a set of double-entry books, or get someone to do your accounting. Most CPAs do some bookkeeping work of that type (they call it write-up work). There are also many unlicensed bookkeepers who do this type of work for their clients.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

FAILURE TO FILE YOUR TAX RETURN

FAILURE TO FILE YOUR TAX RETURN

-You should file your tax return by the deadline even if you can’t pay the tax. There is both a failure to file penalty and a late payment penalty. If you file and don’t pay, at least you have filed. Here is what the IRS says about failure to file:

The failure to file a federal tax return can be costly — whether you end up owing more or missing out on a refund.

There are several reasons taxpayers don’t file their taxes. Perhaps you didn’t know you were required to file. Maybe, you just kept putting it off and simply forgot. Whatever the reason, it’s best to file your return as soon as possible. If you need help, even with a late return, the IRS is ready to assist you.

Here are some things to consider:

• Failure to File penalty. If you owe taxes, a delay in filing may result in a "failure to file" penalty, also known as the “late filing” penalty, and interest charges. The longer you delay, the larger these charges grow.
• Losing your Refund. There is no penalty for failure to file if you are due a refund. However, you cannot obtain a refund without filing a tax return. If you wait too long to file, you may risk losing the refund altogether. The deadline for claiming refunds is three years after the return due date. For example, the last day for claiming a refund for your 2003 tax return will be April 15, 2007.
• EITC. Individuals who are entitled to the Earned Income Tax Credit must file their return to claim the credit even if they are not otherwise required to file.

Whether or not you must file a tax return will depend upon a number of factors, including your filing status, age, and gross income.

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TEXAS MARGIN TAX

TEXAS MARGIN TAX

For years the state of Texas has subjected Corporations to a Franchise tax which has gradually evolved into an income tax which the law euphemistically calls income earned surplus rather than admitting the State of Texas imposes an income tax. The tax used to be a tax on capital rather then income, then it became a tax on income, now it is being converted into a tax one either gross profit or a couple of alternatives.

The first margin tax will be due May 15, 2008. The tax rate is 1% of the taxable amount.

The tax does not apply if revenues are less than $ 300,000 or the tax amounts to less than $ 1000.

The taxable amount is gross revenue minus your choice of one of the following:

• Cost of Goods Sold
• Compensation (wages and officer compensation subject to limitations)
• 30% of Gross revenue

The maximum salary allowable to be deducted for a single individual is $ 300,000.

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HOME OFFICE EXPENSE FOR S-CORP SHAREHOLDER

-If you are a shareholder in an S Corporation there are two possible ways of deducting home office expenses (an allocated share of utilities, repairs and other home costs).

You can deduct employee business expense, using Form 2106 and listing it as a miscellaneous deduction on Schedule A. This method requires that you subtract 2% of your adjusted gross income from your miscellaneous deductions. Also, you might get more by using the standard deduction, making the whole thing useless.

A better way, assuming you receive a reasonable salary from the corporation (which you may control or own 100%) would be under an accountable plan in which you provide an accounting to the corporation for the expense and receive reimbursements from the corporation. This would, if done properly, make the expense deductible by the corporation and tax-free to you as an employee.

BUT BEWARE:
In an August 2005 court case the accountable plan approach was disallowed. The corporation had adopted a resolution requiring the shareholder/employee to provide home office facilities and incur other expenses without obligating the corporation to reimburse the employee/owner. Even if the corporation voluntarily reimbursed the employee, it was considered by the court as taxable income to the employee and he could only deduct it by taking it as an itemized deduction (reduced by 2% of his Adjusted Gross Income).

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WHAT'S IN A NAME? THE IRS MAY QUESTION IT.

-THE IRS MAY REJECT YOUR RETURN-
In the past, I’ve had electronically-filed tax returns rejected by the IRS because the wife’s social security number did not match the IRS data base. Often a woman would begin using her husband’s last name for everything but would not change it on her Social Security Card. The IRS might not question it if the return was paper-filed, but electronically-filed returns are only accepted if the social security number and other information matches their data base.

Here is a recent “Tax Tip” from the IRS:

Newlyweds and the recently divorced should ensure the name on their tax return matches the name registered with the Social Security Administration. A mismatch could unexpectedly increase a tax bill or reduce the size of any refund.

• For recently married taxpayers, the tax scenario begins when the bride says "I do." If she takes her husband's last name, but doesn't tell the SSA about the name change, a complication may result. If the couple files a joint tax return with her new name, the IRS computers will not be able to match the new name with the Social Security Number.
• After a divorce, a woman who had taken her husband’s name and made that change known to the SSA should contact the SSA if she reassumes a previous name.

It's easy to inform the SSA of a name change by filing Form SS-5 at a local SSA office. It usually takes two weeks to have the change verified. The form is available on the agency's Web site, www.socialsecurity.gov, by calling 800-772-1213 and at local offices. The SSA Web site provides the addresses of local offices.

Generally, taxpayers must provide SSNs for each dependent claimed on the tax return. For adopted children without SSNs, the parents can apply for an adoption taxpayer identification number, or ATIN, by filing Form W-7A with the IRS. The ATIN is used in place of the SSN on the tax return. The form is available on the IRS Web site, IRS.gov, or by calling 800-TAX-FORM (800-829-3676).

These Forms are available at www.irs.gov
Form SS-5 Application for a Social Security Card
Form W-7A Application for Taxpayer Identification Number for Pending U.S. Adoptions

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Telephone tax refund - Business and personal phone

-HOW TO CALCULATE TELEPHONE TAX CREDIT:

FOR YOUR BUSINESS:
If you are filing a Schedule C with Form 1040, if you are filing Forms 1065 or 1120 or 1120S, then you should claim a refund or tax credit for telephone excise tax.

This tax on long-distance calls was enacted to finance the Spanish-American war. Someone finally noticed the war is over and this tax should no longer to be collected.

You can go through a lot of receipts which I won’t go into, or you can do it the easy way.

[1] First, you take your April 2006 phone bill and divide the federal excise tax by the total phone bill. This bill includes the tax on both local and long-distance service.

[2] Next you take your September 2006 phone bill and divide the federal excise tax by the total phone bill for that month. This bill only includes the tax on local service.

[3] Then you subtract the percent in September from the percent in April which indicates the percent applicable to long-distance only. This percent is limited to 2% --or 1% if you have more than 250 employees.

[4] Now you apply the percent calculated in step 3 to a 41-month period:

10/12 X your 2003 phone bills X the appropriate percent.

100% of your 2004 phone bills X the appropriate percent

100% of your 2005 phone bills X the appropriate percent

7/12 of your 2006 phone bills X the appropriate percent

You don’t have to add all those phone bills if you have your tax returns for those years. Just look up how much you deducted for telephone expense each year.

Enter these amounts on Form 8913 (using the same figure per month within each year, and enter them in the appropriate line of your Form 1040, 1065, 1120 or 1120S (for example, line 71, Form 1040 or line 23d of Form 1120S)

This is NOT for the refund of tax on your personal telephone which is determined by another method.
For your personal telephone tax refund:

1 exemption ----------- $30

2 exemption------------$40

3 exemptions-----------$50

4 or more---------------$60

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CAN YOU ROLL OVER AFTER-TAX MONEY FROM A 401k INTO AN IRA?

-You cannot rollover money from a 401K to an IRA.

An IRA is not the same thing as a Qualified Plan.

A qualified plan is established by an employer to provide retirement benefits for employees and their beneficiaries. Unlike SEP and SIMPLE IRAs. A qualified plan is not IRA- based nor subject to the same rules concerning contributions and distributions.

A business may chose either a Qualified OR an IRA-based plan, but an IRA and a Qualified Plan are not the same thing, and some of the rules affecting them are different..

What’s a rollover?

Rollover means to move money from a qualified retirement plan such as a 401(k), 403b or 457 Planinto an IRA. If you receive a payout from your company-sponsored retirement plan, a rollover IRA could be to your advantage. You will continue to receive the tax-deferred status of your retirement savings and will avoid penalties and taxes.

After December 31, 2006 you can roll over both pre-tax and after-tax contributions from one qualified plan to another qualified plan. The rollover from one qualified plan to another must be a direct rollover and the receiving plan must separately account for the after-tax contributions and earnings.

But keep in mind: an IRA is not a Qualified Plan so you cannot roll over after-tax money from a 401K or other qualified plan into a Rollover IRA

You can roll over all except after-tax money from a 401K or 403B Plan into a Rollover IRA

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FLIPPING HOUSES - TAX IMPLICATIONS-

-Depending on whether you do it as a sideline or as a full-time business, the tax treatment would differ. If it is a sideline then you could consider it as an investment and sales would result in capital gains or losses. If you own it more than a year, then it would be a long-term capital gain and profits would not be taxed at more than 15%. A short-term gain would be taxed at your regular tax rate. You would capitalize taxes and interest and add them to the basis of the property.

If it is a year-round activity rather than a sideline, then you would be operating a business. Those fixer-uppers would be considered inventory rather than capital assets. Your gains would be taxed as ordinary income. Costs of upgrading the property would become part of ‘inventory’ and would be deducted as a cost of sale when you sell the property. You could write off the taxes and interest you pay while you hold the property.

Income from this type business would be subject to 15.3% self-employment tax

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HE WHO SELLS WHAT ISN'T HIS'N GOES TO PRISON

-Usually he who sells what isn’t his’n goes to prison. But if it’s on Wall Street then it’s called selling short. IRS rules on short sales are discussed in chapters 3 and 4 of Publication 550 .

If you sell short you are selling borrowed stock and must pay the dividend to the person from whom your broker borrowed it. In some cases you may deduct it as investment interest expense on line 13 of Schedule A. In other situations you cannot deduct it as interest expense, but must add it to the basis of the stock when you buy to cover your short position. Here are some excerpts from Pubication 550:

Short sales. If you cannot deduct payments you make to a lender in lieu of dividends on stock used in a short sale, the amount you pay to the lender is a capital expense, and you must add it to the basis of the stock used to close the short sale.

Payments in lieu of dividends. If you borrow stock to make a short sale, you may have to remit to the lender payments in lieu of the dividends distributed while you maintain your short position. You can deduct these payments only if you hold the short sale open at least 46 days (more than 1 year in the case of an extraordinary dividend as defined below) and you itemize your deductions.

You deduct these payments as investment interest on Schedule A (Form 1040). See Interest Expenses in chapter 3 for more information.

If you close the short sale by the 45th day after the date of the short sale (1 year or less in the case of an extraordinary dividend), you cannot deduct the payment in lieu of the dividend that you make to the lender. Instead, you must increase the basis of the stock used to close the short sale by that amount.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

IRA LIQUIDATION AT A LOSS

- IRA LIQUIDATION AT LOSS
In this blog, I will use situations covered in the last two blogs regarding taxable social security modified to illustrate a new point: taxability of an IRA redeemed at less than its cost and how the loss may or may not qualify as a tax deduction.

INCOME SITUATION:

Social Security ……......$32,000

Tax Exempt Interest...…16,000

IRA Withdrawal…….…12,002

Capital Gain…………...100,000

Total Income…………..160,002

Adjusted Gross Income:

Social Security ……......$27200 (85% X 32,000)

Tax Exempt Interest.……..…0

IRA Withdrawal…….…12,002

Capital Gain…………...100,000

Adjusted Gross Income..139,202.

Tax after exemptions and standard deduction = 13194 minus $ 40 refund of telephone excise tax.

SITUATION: Suppose that IRA withdrawal of $12,002 came from stocks purchased in the IRA that cost $52002 and resulted in a $ 40,000 loss.

Can the loss be deducted? Not unless this withdrawal completely liquidated all IRAs.

But let’s suppose that it DID liquidate his IRA completely. As a result of complete liquidation, he can deduct it as an itemized deduction.

By doing so, he will lose his standard deduction, so he only benefits to the extent his itemized deduction exceeds his standard deduction. The $ 40,000 loss would be reduced by 2% of his $ 139202 AGI, leaving a deduction of $ 37,216

Result: This reduces the tax from $ 13,194 to $ 8178. So the $ 40,000 loss saved him $ 5016 in tax.

HOW THE TAX WAS CALCULATED:

AGI ………………………….....…..…$ 139202

Allowable IRA Loss…$ 37,216

Personal Exemptions….6,600………43816

Taxable Income…………...…………….95386

TAX CALCULATION

Tax on $ 61300 = $61,300 X 5% or $ 3065

Tax on $ 34086 = $34086 X 15% or $ 5113

Tax on $ 95386 = ………........……………$8178

The taxable income was taxed based on reduced rates for capital gain

The top of the 15% bracket is $ 61,300, so this much of the income was taxed at 5% which is the maximum capital gain rate for people in the 10% or 15% bracket.

After subtracting the $61,300 from taxable income the remaining taxable income is taxed at 15%.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

85% OF SOCIAL SECURITY TAXED

IF YOUR INCOME EXCEEDS $60,000 part may be taxed at 50% and part at 85%
NOTE: Most often you hear that $32,000 is the starting point for the 50% taxability and $ 44,000 for the 85% level. This refers to half of your Social security ($32,000 X 50%) + another $16000--which is the same as $ 32,000 if you omit half the SS as non-taxable. Your Adjusted Gross income would be $32,000 derived by taking half the SS plus 16,000 of other income.

The same principal applies to 60,000 vs 44,000 for calculating the point at which 85% becomes taxable.

EXAMPLE--USING TOTAL INCOME:
Social Security ……........$32,000

Tax Exempt Interest...…16,000

IRA Withdrawal…....….…12,002

Total Income………....…...60,002

Taxable Social Security $ 6002

(60,000 –48,000) X 50% =6000

($ 60002 – 60000) X 85% = $1.70 (rounded to $ 2)

$6000 + $ 2 = $6002 taxable social security..

Adjusted Gross Income:

IRA Withdrawal…...$ 12,002

Taxable SS…………...…..6002

Taxable Income……..$ 18004

There is no tax due since the standard deduction and exemptions exceed the adjusted gross income.

SITUATION No 2 Income is same as previous Situation plus $ 100,000 Capital Gain.

Income from Example No. 4 = $ 60,002

Capital Gain……………......………100,000

Total Income…………….......……160,002

Taxable Social Security = $ 32,000 X 85% = 27,200

NOTE: Instead of taxing the entire excess over $ 48,000 at 85%, the tax is limited to 85% of total social security.

Adjusted Gross Income:

Social Security ……......$27200

Tax Exempt Interest.……..…0

IRA Withdrawal…….…12,002

Capital Gain…………...100,000

Adjusted Gross Income..139,202.

Tax after exemptions and standard deduction = 13194 minus $ 40 refund of telephone excise tax.

TOMORROW’S BLOG WILL show the effect of withdrawing an IRA purchased for more than its value when withdrawn.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.