Tag Archives: tax returns

Heading Toward Tax Season

xena110708As filing season approaches for the 2012 tax year, I am presenting here a few selected tax tips and updates that are often overlooked by traditional tax sources, hopefully brief enough to not induce boredom but complete enough to give you some valuable information:

The 1099 Matching Nightmare Continues

  • 1099-MISC:  Don’t forget to EXCLUDE payments to vendors made with credit cards from your total 1099-MISC payments.  Those payments will get reported to vendors on Form 1099-K.  If you do get 1099s that are wrong, ask the payer to correct the 1099.  If that is a pain, then report the full amount on your tax return, and then back out the erroneous portion somewhere on your expense lines.  And, make sure you can document why the 1099 you received is wrong.
  • 1099-K:  Even though IRS claims it is not now or ever going to match 1099-K payments into your tax returns, there’s a reason you are getting a 1099-K and that is to tap the underground economy by making sure that all businesses are reporting their gross income.  If you report less gross income than is shown on your Form 1099-K you will be subject to IRS inquiry, for which they have developed new notices related to Form 1099-K.  Be sure to provide all Forms 1099-K to your tax preparer so that they can help you avoid receiving these notices.
  • 1099-B:  If you receive broker 1099s related to your investments, you are by now used to receiving corrected 1099s, often long after you have filed your returns.  Due to new basis matching requirements, you will need to seriously consider whether you are better off extending your tax returns while you wait for all the corrections to come through, rather than having to amend your returns later for the corrections, or having to respond to IRS notices.  IRS plans to match all 1099-B reporting on the new Form 8949, first developed in 2011.  There are now 6 different ways to report capital gains and losses, and there are 21 different codes to use when reporting.  Due to the extra time involved, investors should seriously consider consolidating their brokerage accounts in order to save on accounting fees at tax time.

Charitable Contribution Receipts Must Contain Required Language       

Even if you have a “contemporaneous” receipt (one that you have in hand at the time you file your tax returns), it may be defective and result in the complete disallowance of your charitable deductions.  It MUST contain required language concerning whether or not the donor received any goods or services in exchange for a contribution.  If it doesn’t your contribution deduction will be disallowed in full.

W-2 Reminders to include HSA payments and Health Insurance Premiums

Don’t forget to include ALL H.S.A. payments on the W-2 Form, Box 12, not just payments made by employees through a cafeteria plan.  The purpose of this is to make sure that taxpayers are not contributing beyond the maximum amounts allowed in 2012 to their H.S.A. plans.

For 2012, you don’t have to report the value of health insurance premiums on the W-2s if you issue fewer than 251 W-2s.  If issue more than 250 W-2s, you must report the value of the health insurance premiums on Form W-2.  The reporting is “informational only” and is not subject to income or payroll taxes.

City of Portland Business Tax Rental Property Exemption Is Gone, Gone, Gone

If you own a few rental properties in Portland, but have no other business activities you may be blissfully unaware of the long reach of the City of Portland Business Tax.  Beginning in 2012, the City successfully changed its tax code to include ALL rental activity, not just owners with over 9 rental units within the City.  Don’t panic yet:  there’s a new exemption of $20,000 in gross income with 1 or 2 rentals, but you still have to file a special new Form to receive your exemption.  More info is available at the City’s website.  Remember that the City of Portland has its own special version of taxation without representation:  the gross receipts exemption means gross receipts EVERWHERE, including rentals you own in other states and capital gains on ANYTHING except securities, and includes all activities of your spouse if you file jointly, even if your spouse does not live in the City or have any business interests or activities there.

City of Portland School Arts Tax – You owe the City $35

This was the infamous Measure proposed by Mayor Adams which even arts and education groups such as Stand for Children opposed, mainly because only about ½ of the revenue raised will go to fund arts teachers for our public schools.  It did pass, however, so beginning in 2012 a new form is required of EVERY CITY RESIDENT AGE 18 AND OVER, accompanied by a $35 payment, or an exemption request for those below the poverty level.  The City of Portland is administering the tax, and the filing form has not even been developed yet.  However, the city has designated this link which will go live when the forms are ready:   http://www.artstax.net

Congress Approves 11th-Hour Agreement to Avert Fiscal Cliff

doomsday-clockHere is a link to CCH’s synopsis of the American Taxpayer Relief Act of 2012.

Other tax resources are available on our website.

Happy New Year!

Taxes in the Twilight Zone

twilight-zone-spiralI love watching Twilight Zone episodes because it is fun to imagine a world where the usual laws of nature are slightly askew and anything becomes possible.  Fanciful minds can do a lot with that.  Yet, some of those episodes are a bit creepy, even scary and sometimes disturbing.

Congress’ failure to act timely to provide any kind of certainty about tax law both for 2012 and for future years has definitely defied the usual laws which govern rational behavior.  Clearly Republican lawmakers would rather tax the poor and middle class than allow taxes to become progressive again on the top 1%, and it is quite clear that they wish to further the shameful increase in wealth and income inequality in the U.S.

Thanks to this failure, we have wandered across the obscure boundaries of normal reality into twilight zone of taxation.  Here is an overview of our current creepy, scary, and disturbing tax system:

Creepy

  • The zero percent tax rate for millionaires.  How is it possible that millionaires could pay no tax even though they have taxable income?  The zero percent rate was carefully crafted by Bush-era policy makers to permit this by allowing ordinary deductions to first offset ordinary income.  If ordinary deductions, such as charitable contributions, mortgage interest, state income taxes and investment management fees offset an investor’s interest income in full, that investor can be in a position to pay zero percent on all capital gain and dividend income up to the bottom of the 15% bracket.  This is up to $70,700 per year (Married Filing Joint) that is being taxed at zero percent.  The rest of us will pay tax on all of our capital gain and dividend income, because we are working for a living, and can’t possibly manipulate our tax bracket to get below the 15% level.  For investors, this is easy to control, through timing of capital gains, and through investment choices such as the use of municipal bonds or non-dividend paying stocks. And, how many working poor do you know that have an investment portfolio?  Creepier still:  Obama’s tax proposal will not impact this bizarre anomaly – the only hope for this provision to die is for us to fall off the fiscal cliff and keep diving.

Scary

  • The Alternative Minimum Tax affecting some 33 million taxpayers this year, compared to 4 million last year.  Thanks to Congress’ failure to enact the annual “AMT patch” – something it has been doing for decades – means that the AMT exemption amount will revert back to its non-inflation-indexed amount.  This is because the original law failed to index the exemption for inflation.  Rather than fix this permanently, Congress continuously “patches” the exemption amount each year by indexing it to inflation for that year only.  This is because actually fixing the AMT would be far too rational, and remember, we are in the Twilight Zone.  So, millions of taxpayers will see dramatic increases in their tax bills for 2012, and it will especially hit those with incomes between $100,000 and $200,000, with an average increase of about $3,000.  Not only that, failure to patch the AMT has caused IRS to delay being able to finalize its tax forms for 2012.  The latest news from the IRS Commissioner is that one hundred million taxpayers will not be able to file their returns until sometime in March of 2013.

Disturbing

  •  Unfair income matching rules which target low income taxpayers, while failing to tax the bulk of the underground economy.  I have always found it interesting that Congress and the IRS have gone to great lengths to make sure that baby sitters, housekeepers, and child care providers report their income and pay their taxes.  Yet, construction contractors are not subject to 1099 requirements when payments to them are non-business related, such as when they are remodeling your house.  In order to claim a child care credit or compensate your nanny, IRS makes sure that everything gets reported on a W-2 or is otherwise matched to the worker’s tax return.  Also, they are hell-bent on making sure that restaurant servers report their tips.  Why don’t we have these same kinds of requirements for plumbers, builders, and construction contractors.  Ever wonder about how construction workers can be paid “under the table?”  It might be because the contractors themselves are not reporting their income, so paying someone under the table becomes a piece of cake.  Most industry observers are well aware of this kind of outrageous noncompliance, but nothing has been proposed to tax what is probably a huge portion of the underground economy.  I’m not just picking on contractors, though.  A legitimate tax system is one in which all income is taxed, not just the income of the poor and working class.

Wealth Inequality: the American Dream?

According to a recent poll by Atlantic Monthly, none of us really knows the degree of income and wealth inequality in the U.S., nor do we know how it has dramatically worsened in recent times.  I think this is partly because each of us (except possibly for a few Buddhists) craves a bit of inequality for ourselves.

How much income and wealth inequality is too much?  Here is a chart that shows how income inequality has changed over the last 100 years:

You can see that a dramatic drop in inequality began in the late 1930’s, leveled out in the 1960’s, and then began surging again in the early 1980’s.

There is much dispute among experts as to the cause of this dramatic increase in wealth and income inequality.  But generally, the increase in wealth inequality has been attributed to the following:  monetary policy, tax policy, deregulation of certain industries, effective lobbying by highly paid interest groups, the greater role of large campaign donations in electoral politics, failures in the public education system, and the simple but true notion that wealth begets wealth.

In fact, once the wealthy have accumulated enough to not care about health care costs, mortgage debt, or even the economy, and once every election is determined solely by campaign spending, then you say goodbye to any semblance of capitalism tempered by democracy, as envisioned by Adam Smith, who not only believed in the invisible hand of the market, but in progressive taxation, stating:  “The rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.”

While there is dispute about just how much tax policy has contributed to the increase in wealth and income inequality, there is no question that tax policy is one result of it.  Here is a chart showing how our U.S. Senate has in recent times dealt with lobbying efforts on behalf of various income groups:

As you can see, the poor actually were served by our Senators with negative responsiveness.  Not only were their efforts useless, they were in fact, better off not making them.  Only the wealthy were highly effective in accomplishing their objectives.  This is another example of how wealth paves the way for the wealthy to achieve their legislative and policy goals, so that they in turn can become more wealthy.  So, if we look at tax policy as a result of wealth and income inequality, the result should be that tax policy helps the wealthy accumulate even more wealth.  Clearly, this has been the case, as shown in the chart below:

From this chart you can see that the top .01% (that’s point zero one percent) have seen the most dramatic drop in their income tax rates, with their rates dropping by more than half since the 1970’s.  Coupled with this drop in tax rates are special tax breaks that only the wealthy can avail themselves of:  a zero percent tax on capital gains under certain circumstances; a low 15% rate on the rest of their dividend and capital gain income; and favorable estate taxes allowing each wealthy couple to pass $10 million tax free to their heirs, and that’s the value after employing costly estate planning strategies that only the wealthy can afford.  With favorable tax policy comes a favorable regulatory environment, and with more money to spend on elections, and no one to put a cap on campaign donations, thanks to the Supreme Court, the momentum for wealth and income inequality is fully underway.  What can stop it now?

Sources:  Wikipedia article: “Wealth Inequality in the United States“, The Wealth of Nations by Adam Smith, The Atlantic Monthly.

To Group or Not to Group: That is the Tax Question

IRS recently came out with new rules regarding how taxpayers must elect to group passive and active business and rental activities together.  Grouping a passive activity with an active one can help taxpayers avoid the dreaded “material participation rules” – designed to blur your eyes and make you sleepy and irritable.  Oddly, the passive activity rules upon which this new required grouping election is based were enacted back in 1987 with the infamous Tax Reform Act.  Um…that was 25 years ago. 

 Importantly, for tax years 2011 and forward, the new guidance from IRS makes it necessary for all business owners with more than one “activity” to consider whether and how to apply these rules to their undertakings.  Here is an overview of how the rules work:

  1.  You can group rental or other passive activities with trade or business activities where one is insubstantial to the other and if they constitute an “appropriate economic unit.”  This involves analyzing factors identified in Regulation 1.469-4:  similarities and differences among the business activities, extent of common ownership, geographic location, and interdependence.  (However, you cannot group rental real estate activities with personal property rental activities.)  Example:  a manufacturing S corporation produces waste metals that can be recycled or sold for scrap.  For business reasons, the corporation’s owners form a separate S corporation to handle the recycled material, either selling it or ensuring its proper disposal.  The recycling company’s revenues are miniscule compared to the manufacturing company, and it tends to generate losses.  The owners don’t spend much time managing the recycling company, but if they elect to group the two companies together, they can treat the recycling company as active, never again worrying about the passive activity rules.
  2. You can group a rental activity with a trade or business activity if the rental is to the business, and all the owners have the same ownership percentages in each entity.  Example:  an LLC owns a building, rented out to a printing company, also an LLC.  The owners of the printing company own the rental LLC in the same proportions as their ownership in the printing company.  Each individual owner can decide whether or not to group the two activities together, which results in converting LLC rental losses and income to active status, and avoids suspended rental losses where the owner’s incomes are too high to take advantage of the losses. 
  3. You can’t change or revoke your grouping election unless there is a material change in the underlying facts, or unless the original grouping was clearly erroneous.  You can, however, add to the group.
  4. If you don’t decide which activities to group for 2011 by attaching the required statement, IRS will take the position that nothing has been grouped (but you may carry on with prior groupings and are not required to disclose prior groupings to IRS.)  Grouping elections can be made in future years, but they cannot be retroactive.  Groupings made prior to 2011 will not be disturbed, so long as the taxpayer consistently maintains the grouping.
  5. You must disclose to IRS, by attaching the required statement from Rev. Proc. 2010-13 all:  new groupings for 2011; additions to prior groupings; changes to ANY groupings.  You do not have to disclose grouping elections made prior to 2011.
  6. Grouping elections can be made first at the entity level and then at the individual level, but an owner in an S corporation or partnership cannot un-group an activity that has already been grouped at the entity level.

Generally, there is no good reason to group rental activities together into one passive group.  Doing so would mean that passive activity losses would remain suspended until each property in the group is finally sold.

Unfortunately, there is neither a bright line test, nor a safe harbor, to help taxpayers determine which activities can be grouped.  So, it’s a good idea to carefully review the rules with your CPA firm to evaluate the best course of action.

My Hideous Tax Reform

(With apologies to economist and author Joel Slemrod, author of the paper, My Beautiful Tax Reform)

As an accountant, I get involved in the practical and tedious task of applying tax laws (and related loopholes) to our clients’ fact situations.  Rarely do accountants get the time to contemplate (or fantasize about) tax reform, nor to consider systems used effectively by other countries.  But, before tax season gets truly underway this year, I have been spending some time educating myself about these matters so that I can combine my practical knowledge with the wisdom of economists and policy analysts around the world.

Professor Slemrod has spent many years evaluating our tax system and expresses the view that a business Value Added Tax (VAT), combined with a highly progressive but simplified individual income tax would deliver the best combination of Fairness and Simplicity (my two objectives for tax reform), and would achieve what he calls “elegance”.  He proposes an individual income tax that would exempt most individuals from filing returns, basically by eliminating all deductions and credits, thus broadening the tax base, and then relying on wage withholding to create the proper and equally applied tax to all labor income.  The VAT tax would apply to ALL business income, and at a flat rate.  Shareholders of corporations would be able to get a credit from the portion of their income already taxed at the corporate level, with the goal being to eliminate all double taxes, and to eliminate all preferential treatment now available through special deductions, credits and business entity selection.

Our current system attempts to tax income (roughly defined as increases in consumption power) by dividing it into 3 pots:  labor income, business income, and income from the employment of capital.  However, there is little consistency in how these different categories actually work.  For example, if I am Mitt Romney and earn my income from “carried interest” I get to pay taxes at a flat capital gains rate of 15%.  If I am Warren Buffet’s secretary, I get to pay taxes at much higher rates, depending on my income and deductions, and I also have to pay social security taxes.  Publicly traded corporations are subject to a double tax whenever they pay dividends to their shareholders, whereas when they pay interest to their bondholders, they are not.  If I lose money on a capital transaction, I can’t deduct the loss unless I have made money on other capital transactions.  If I sell my home at a profit, I can exclude the gain up to $500,000 if I am (legally) married.  If I earn all my income from dividends and capital gains, I might not have to pay ANY taxes.  And, if I am a worker earning a good living, I may be subject to the Alternative Minimum Tax and lose the deductions that my neighbor, who earns less, gets to deduct, thus vastly increasing my marginal tax rate.  These are just a few, selected examples of the way our tax system is both complex and unfair.

Fairness in taxation by definition would have to include progressivity as its underpinning.  In fact, Professor Slemrod rejects consumption taxes outright, as they can never be made progressive enough.  By taxing only consumption, such as through a national sales tax, those who would pay the highest effective rate of tax would be the poor and middle classes, who have to consume certain basic amounts in order to survive.  That would be highly unfair, but would admittedly be a simpler tax to administer than our current income tax.

One reason tax reform is so hideous is that anything that affects the federal system will also affect all the states who are connected to the federal system for purposes of defining and determining taxable income.  Any major reforms at the federal level will require these states to seriously evaluate and reform their own systems of taxation.  Another reason is that by trying to achieve simplicity, one may introduce unfairness, and vice versa.  For example, it might be fairer to measure and subtract inflation before taxing capital gains, but now you have introduced a highly complex calculation into the system.  You can eliminate this problem by using a consumption tax instead of an income tax, but as noted previously, a consumption tax is a regressive tax, and thus, unfair.

In order to restore legitimacy and moral authority to our government and its system of taxation, the current system MUST be reformed, and it must become fairer and simpler, yet still provide adequate funds.  Any steps in those directions are to the good, hideous or not.  President Obama’s recent budget proposals include some movements in the right direction:  indexing and making permanent AMT exemptions,  taxation of carried interest as ordinary income (too bad, Mitt), and simplification of the earned income credit.  However, when you read the summary of the President’s budget (spanning 215 pages) you start to feel pretty queasy.  More and more tax expenditures (credits and deductions) are being proposed in a desperate effort to insert more fairness into the system, but the end result is more, and much more, of the same highly complex and unfair system that we currently have.  Can we give up our favorite deductions and tax credits in exchange for lower and more progressive tax rates?   What might be beautiful is restoring the portion of total income taxes once borne by corporations in 1950 (30% of total revenues) from the shockingly low 7% today, something which could be achieved through a VAT tax.

The Coming 1099/IRS Matching Nightmare

2011 heralds the beginning of several new 1099 requirements, including the new Form 1099-K, new Form 1099-B, and new requirements for 1099-MISC. 

New IRS Form 1099-K requires 3rd party settlors of merchant credit card and other payment transactions, such as Paypal, to report those payments to all payees who receive at least $20,000 per year in payments and who have more than 200 transactions per year.  The new form requires reporting the totals by month, so that fiscal year filers can still be subject to IRS matching.  It doesn’t matter who the payee is:  a person, a corporation, an LLC, a trust, or a partnership—all of these entities will begin receiving these new forms in early 2012 for amounts paid to them in 2011. 

The amounts reported on these forms MUST MATCH the amounts reported on the entity’s tax returns.  A new line for reporting these totals has been inserted in all relevant IRS schedules and forms.  If the amounts do not match, the payee will receive an IRS notice assessing tax on unreported income.  Which, of course, was the whole purpose of this new requirement – to tap into the underground economy, and very specifically, Ebay and other on-line sellers who have long been suspected of not properly reporting their income to IRS.

Related to this new requirement is a change to the rules for reporting payments to service providers using IRS Form 1099-MISC.  Beginning in 2011, payers must EXCLUDE any credit card or Paypal-type payments made to vendors when reporting their 1099 totals for 2011.  This is because the vendor will theoretically already be receiving a 1099-K which includes all credit card and other 3rd party payments.  IRS has modified its instructions for Form 1099-MISC to reflect this new requirement, but it is highly likely that many 1099 issuers will not bother to read this year’s instructions.  That is why we expect the coming 2012 1099 season to result in many, many unmatched 1099s, and thus many IRS notices to taxpayers.  More work for us accountants, yes?

In addition to these two new requirements, another new 1099 form will be required for 2011 – new IRS Form 1099-B.  The 1099-B has historically been used to report gross proceeds from sales of securities.  Now, the new Form 1099-B will also potentially include cost basis information, separate reporting for “covered securities”, “non-covered securities”, wash sale reporting, short sales, and a number of other items.  It will mean that instead of receiving one 1099-B from your broker, investors will receive multiple 1099-Bs which must be analyzed and reconciled to year-end reports, and then must flow to new Schedule D – consisting now of potentially 6 new types of transactions, separately reported on new Form 8949:  short term sales of securities with cost basis reported, short term sales of securities without cost basis reported, all other short-term securities transactions; and the same break-downs for long-term sales of securities.  In addition, for EACH transaction, taxpayers must indicate one of 21 NEW CODES to tell IRS more information about the transactions.

IRS will then attempt to match the totals reported on the new Schedule D and Form 8949 to the filed 1099-B.  Because these requirements are both new and highly complex, we anticipate many, many matching errors and plenty of IRS notices to deal with.  In addition, investors can anticipate that their tax return preparation fees will increase substantially this year.  Essentially, all broker transactions will be analyzed and reported in 6 separate ways, instead of one, and investors who have multiple brokerage accounts will want to consider whether now is the time to consolidate their accounts.  CPA firms are going to be very busy.  Meanwhile, are you having nightmares yet?

Update (2/24/12):  IRS has now announced that they will NOT attempt to match any 1099-K payments for 2011, 2012, nor into the future.  Here is the quote from their website: “IRS announced in October that separate reporting of these transactions for other business receipts or income payments is not required for 2011. Taxpayers should follow the form instructions for reporting their gross receipts or sales. Report items that qualify as a trade or business expense on the appropriate line item of Schedules C, E and F. There will be no reconciliation required on the 2012 Form 1099-K, nor do we intend to require reconcilation in future years. [Added 2/10/12]” .