The Best Way to Avoid an Audit: Preparation

The Best Way to Avoid an Audit: Preparation

by | Feb 6, 2018 | Audit, Financial planning, Tax, Tax Tips

Getting audited by the IRS is no fun. Some taxpayers are selected for random audits every year, but the chances of that happening to you are very small. You are much more likely to fall under the IRS’s gaze if you make one of several common mistakes. So what is the best way to avoid an audit?
That means your best chance of avoiding an audit is by doing things right before you file your return this year. Here are some suggestions:
Don’t leave anything out. Missing or incomplete information on your return will trigger an audit letter automatically, since the IRS gets copies of the same tax forms (such as W-2s and 1099s) that you do.
Double-check your numbers. Bad math will get you audited. People often make calculation errors when they do their returns, especially if they do them without assistance. In 2016, the IRS sent out more than 1.6 million examination letters correcting math errors. The most frequent errors occurred in people’s calculation of their amount of tax due, as well as the number of exemptions and deductions they claimed.
Don’t stand out. The IRS takes a closer look at business expenses, charitable donations and high-value itemized deductions. IRS computers reference statistical data on which amounts of these items are typical for various professions and income levels. If what you are claiming is significantly different from what is typical, it may be flagged for review.
Have your documentation in order. Keep your records in order by being meticulous about your recordkeeping. Items that will support the tax breaks you take include: cancelled checks, receipts, credit card and investment statements, logs for mileage and business meals, and proof of charitable donations. With proper documentation, a correspondence letter from the IRS inquiring about a particular deduction can be quickly resolved before it turns into a full-blown audit.
Remember, the average person has a less than 1 percent chance of being audited. If you prepare now, you can narrow your audit chances even further and rest easy after you’ve filed.
Do You Have a Household Employee? Don’t Ignore the Nanny Tax

Do You Have a Household Employee? Don’t Ignore the Nanny Tax

by | Jan 30, 2018 | Financial planning, Tax, Tax Tips

As you review your filing requirements for 2018, make sure you don’t overlook the nanny tax related to household employees. If you have a housekeeper or any other household employee, you could be liable to pay state and federal payroll taxes.

How to know if you must pay the nanny tax

First, you’ll need to determine whether you have a household employee. Generally, this is someone you hire to work in or around your house. It could be a babysitter, nurse, gardener, etc. It doesn’t matter whether they work part-time or full-time, or whether you pay them hourly, weekly, or by the job.

But not everyone who works around your house is an employee. For example, if a lawn service sends someone to cut your grass each week, that person is not your employee.

As a general rule, workers who bring their own tools, do work for multiple customers and/or control when and how they do the work are not your household employees.

Your responsibilities

If you have a household employee, you’ll generally be responsible for 2017 payroll taxes if you paid that individual more than $2,000 last year. However, federal unemployment tax kicks in if you pay more than $1,000 to all domestic employees in any quarter.

It’s not always easy to tell whether you have a household employee, or whether exceptions apply. If in doubt, don’t hesitate to call our office.

Tax Rules for Small Business: Changes to Pass-Through Entity Rules

Tax Rules for Small Business: Changes to Pass-Through Entity Rules

by | Jan 23, 2018 | Business planning, Financial planning, Tax, Tax Tips

One of the most important – and complicated – changes in the new tax reform act is to the tax rules for small business that are treated as “pass-through entities.”

The good news is that if you own one of these businesses you may get as much as a 20 percent reduction to the taxation of business net income under the new rules.  However, calculating the actual deduction can become very complex. It depends upon several factors, including your level of income, your profession, the amount your business spends on wages and property acquired during the year.

Tax reform background

Most small businesses in the U.S. use pass-through business structures, which pass their profits on to their individual owners. Owners pay tax on those profits at their individual tax rates, in conjunction with other income. The new tax rates range from 10 percent to 37 percent in the 2018 tax year. Pass-through business structures include S corporations, partnerships and LLCs. Sole proprietorships handle business income in a similar way using Form 1040 Schedule C and are also covered by the new rules.

Because the Tax Cuts and Jobs Act signed in late December 2017 changed the corporate tax rate structure to a flat 21 percent rate from a progressive scale with a top rate of 35 percent, that meant many pass-through business structures would pay more than regular C corporations. To offset this, Congress gave pass-through owners the new 20 percent business income deduction.

But Congress also put in place special rules limiting the ability of “specified service trades” to take the full deduction. The list includes health, law, consulting, athletics, financial services, brokerage services, accounting firms, “or any trade or business where the principal asset … is the reputation or skill of one or more of its employees or owners.” An earlier version of the bill included the engineering and architectural professions, but those were later taken off the list, so they are considered exempt from the limits.

How to figure out your deduction – easy cases

First, make a rough calculation of your expected qualified business income (QBI), which is generally your net income other than income in the way of compensation. This figure excludes business losses, as well as factoring in amortization and capitalized expenditures. QBI is figured separately for each business activity, not on a per-taxpayer basis.

Easy Case 1: If your QBI is less than $157,500 as an individual filer, or $315,000 as a married couple filing jointly – you can take the full 20 percent deduction.

Easy Case 2: If your QBI is greater than $207,500 as an individual filer, or $415,000 as a married couple filing jointly, AND you are in one of the specified
service professions (health, law, consulting, athletics, financial services, accounting, brokerage services, etc.) – you can’t take anyof the deduction.

How to figure out your deduction – hard cases

If you don’t fall into either of the easy cases, figuring out your pass-through deduction gets much more difficult.

Who is affected: Small business owners with QBI of more than $157,500 as individual filers ($315,000 for married filing jointly) but less than the phaseout of $207,500 as an individual filer ($415,000 married filing jointly).

After your QBI passes the threshold amount of $157,500 as an individual filer, or $315,000 as a married couple filing jointly, special wage and capital limits that reduce your deduction start to apply.

After your QBI passes the threshold amount PLUS the phaseout amount, which is $207,500 as an individual filer, or $415,000 as a married couple filing jointly, the wage and capital limits are applied fully to reduce your deduction. You’ll still get a reduced deduction (unless you are in one of those specified service professions – then your deduction is eliminated completely).

The formula for calculating the wage and capital limits is based on the greater of 50 percent of the W-2 wages paid by your business, OR 25 percent of the W-2 wages, plus 2.5 percent of the unadjusted basis of all qualified property acquired by your business during the year.
Sound confusing? In most cases the calculation will be straightforward – but not for everyone.

REMINDER: If you’re familiar with the wage and capital limits calculation, it may be because your small business used the Domestic Production Activities Deduction (DPAD) in the past, which uses a somewhat similar calculation. The DPAD was repealed in the Tax Cuts and Jobs Act for 2018 and subsequent tax years, so keep that in mind as you chart your business plans.

The rules are in flux

Every tax reform bill is subject to technical amendments that clarify and adjust what is confusing or not working as lawmakers intended. The Tax Cuts and Jobs Act will likely be no different. The pass-through rules are among the most complicated parts of the act, so many of the moving parts will change over the coming months. We will know more as 2017 taxes are completed and the focus turns to the 2018 rules.
If you own a pass-through business, you will need help navigating the choppy waters of tax reform. When the storm of the recent passage subsides and the details are clarified, reach out to schedule a consultation to chart a course for your business in 2018.
Note: The threshold amounts cited in this memo are for tax year 2018 and are indexed to inflation in subsequent years.

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Bonus Questions and Answers

You likely have more questions about the new 20 percent income deduction rule than anyone can possibly answer right now. Clarification from the IRS is coming in the following months. Until then, here are answers to some common questions businesses are asking.

Q.  Why is there a wage and service business limit calculation in the deduction?

A.  Lawmakers were concerned that the owners of service businesses would change how they pay themselves in order to reduce their tax burden. They said they intended to “deter high-income taxpayers from attempting to convert wages or other compensation for personal services to income eligible for the 20-percent deduction.”

Source: U.S. Congress Conference Report, page 37.

Q.  I’ve heard that rental property owners could possibly get this deduction. Is this correct?

A.  Yes, in all likelihood Schedule E filers will also be eligible for the deduction. While most of these entities do not have wages, the capital portion of the calculation may result in a deduction for these businesses.

Q.  What about losses? Do they affect my ability to get the deduction?

A. Yes, losses will lower your eligible income. Excess losses will carry over to future years, limiting your ability to take the deduction in the future.

Q.  How is qualified property calculated? How does bonus depreciation and Section 179 expensing affect the 2.5 percent property calculation?

A.  These answers can get pretty complicated and will require clarification from the IRS. While we wait for that, here is a short explanation based on what we know now: Qualified property must be tangible property subject to depreciation and available for use in a qualified trade or business. The calculation for businesses subject to limitation will be based on 2.5 percent of the property value. The value of the property appears to be its basis after it is placed into service, and it must be actively used as of the end of the year. There will be provisions to account for the leveling out of different recovery period calculations and the prior use of accelerated depreciation methods. But stay tuned; this area could be full of further clarifications and guidance.

Q.  Where is the deduction taken on Form 1040?

A.  The deduction probably will be taken on page 2 of Form 1040, following the calculation of adjusted gross income.

Q. What about my hobby activity, does it get this deduction?

A.  Probably not. It’s likely that you would need to pass the threshold rules relating to hobby versus business activity. But this area too, could use some help with clarification.

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This brief summary of the pass-through rules in the tax reform act is provided for your information. Any major financial decisions or tax-planning activities in light of this new legislation should be considered with the advice of a tax professional. Call if you have questions regarding your particular situation. Feel free to share this memo with those you think may benefit from it.

Last Minute Tax Moves for 2017

Last Minute Tax Moves for 2017

by | Dec 22, 2017 | Financial planning, Tax Tips

While the clock is ticking down to 2018, you still have a few weeks left to make some last minute tax moves. Take a look at these five tips and save a little more this year.

  1. Check the amount of 2017 tax you have prepaid through withholding and quarterly estimates ASAP. If you’ve underpaid, consider increasing your withholding before year-end. Withholding is considered to have been paid evenly throughout the year. This is to help prevent you being charged underpayment penalties for 2017.
  2. Make sure you have the correct tax status. If you got married or divorced this year, be aware that your marital status as of Dec. 31 determines your tax status for the whole year. If you are in the process of a marital status change, know that altering the dates of a year-end event to the new year may affect your taxes.
  3. Plan for losses. Check your basis in any S corporation in which you are a shareholder and where you expect a loss this year. Be sure you have sufficient basis to enable you to take the loss on your tax return.
  4. Use this year’s annual gift tax exclusion. If you make annual gifts to family members or others, make sure you complete your gifts for 2017 by Dec. 31.
  5. Consider equipment purchases before Dec. 31. Taxpayers must usually deduct the cost of business property over several years. The Section 179 election allows taxpayers to expense up to $510,000 of new and used property purchased and put into service in 2017. Property such as machinery, equipment and furnishings usually qualify. Be careful with special rules that apply to vehicles and personal computers.

Contact our office today if you’d like more last minute tax moves or have questions about year-end tax savings. We are always here to answer your questions and serve your tax and financial planning needs!

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Hawkinson Muchnick & Associates PC

New Year New Job: 5 Tax Tips for Job Changers

New Year New Job: 5 Tax Tips for Job Changers

by | Nov 24, 2017 | Financial planning, Tax Tips, Uncategorized

There are a lot of new things to get used to when you change jobs, from new responsibilities to adjusting to a new company culture. You may not have considered the tax issues created when you change jobs. Here are tips to reduce any potential tax problems related to making a job change this coming year.

ONE: Don’t forget about in-between pay. It is easy to forget to account for pay received while you’re between jobs. This includes severance and accrued vacation or sick pay from your former employer. It also includes unemployment benefits. All are taxable but may not have had taxes withheld, causing a surprise at tax time.

TWO: Adjust your withholdings. A new job requires you to fill out a new Form W-4, which directs your employer how much to withhold from each paycheck. It may not be best to go with the default withholding schedule, which assumes you have been making the salary of your new job all year. You may need to make special adjustments to avoid having too much or too little taken from your paycheck. This is especially true if there is a significant salary change or you have a period of low-or-no income. Keep in mind you’ll have to fill out a new W-4 in the next year to rebalance your withholding for a full year of your new salary.

THREE: Roll over your 401(k). While you can leave your 401(k) in your old employer’s plan, you may wish to roll it over into your new employer’s 401(k) or into an IRA. The best way is to get your retirement funds transferred directly between investment companies. If you take a direct check, you’ll have to deposit it into the new account within 60 days, or you may be assessed a 10 percent penalty and pay income tax on the withdrawal.

FOUR: Deduct job-hunting expenses. Tally up your job-seeking expenses. If they and other miscellaneous deductible expenses total more than 2 percent of your adjusted gross income for the year, you can deduct them on an itemized return. This includes things like costs for job-search tools, placement agencies and recruiters, and printing, mailing and travel costs. A couple caveats: you can only use these deductions if your expenses were to search for a job in the same industry as your previous job, and you were not reimbursed for them by your new employer.

FIVE: Deduct moving and home sale expenses. If you moved to take a new job that is at least 50 miles farther from your previous home than your old job was, you can also deduct your moving expenses. There’s another benefit for movers, too. Typically, you can only use the $250,000 capital-gain exclusion for home sales if you lived in your primary residence for two of the last five years before you sold it. But there is an exception to the rule if you sold your home to take a new job.

Finding a new job can be an exciting experience, and one that can create tax consequences if not handled correctly. Feel free to call for a discussion of your situation.

How You Can Trim Both Estate Taxes and Income Taxes This Year

How You Can Trim Both Estate Taxes and Income Taxes This Year

by | Nov 10, 2017 | Financial planning, Tax Tips

Giving on a yearly basis could trim both your estate and income taxes. First, there’s the annual exclusion for gifts. Currently, you can give $14,000 annually to any number of recipients without paying federal gift tax. Married couples can double this amount by gift-splitting – a gift of $28,000 from one spouse is treated as if it came half from each.

Why giving is a two-way street

Gifts do more than help out children who need the money. They also reduce your estate so your estate will pay less estate tax upon your death. Apart from annual gift giving, you can currently transfer (during your lifetime or through your estate) a total of $5.49 million with no estate or gift tax liability. On amounts above this threshold, you or your estate will be faced with taxes at the current top rate of 40 percent. So a consistent program of annual gift giving might create substantial tax savings.

Note that gifts to individuals do not entitle you to an income tax deduction. A gift isn’t a charitable contribution. Conversely, a gift doesn’t constitute taxable income to the recipient. Gifts of income-producing property may, however, reduce your taxable income. Once you’ve given the property away, the recipient (not you) receives the income it produces and pays any income tax due on it.

Giving can be easy

One advantage to annual gift giving is that it is relatively simple to do, especially if you’re giving away cash. Another advantage is flexibility. You’re not locked into anything; you can see how much you can afford to give away each year. You can give away anything – cash, stock, art, real estate, etc. Valuation is the fair market value on the date of the gift. Subsequent appreciation, if any, belongs to the recipient’s estate (not yours).

Before you give away assets, be sure you will not need them yourself to provide income in later years. Consider the impact inflation will have on your resources.

Proper planning is essential in this area; get professional assistance before you do any gift giving. Contact our office if we can help.

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