Details on the American Taxpayer Relief Act and What it Means for You

The recently enacted 2012 American Taxpayer Relief Act is a sweeping tax package that includes, among many other items, permanent extension of the Bush-era tax cuts for most taxpayers, revised tax rates on ordinary and capital gain income for high-income individuals, modification of the estate tax, permanent relief from the AMT for individual taxpayers, limits on the deductions and exemptions of high-income individuals, and a host of retroactively resuscitated and extended tax breaks for individual and businesses. Here's a look at the key elements of the package:

• Tax rates. For tax years beginning after 2012, the 10%, 15%, 25%, 28%, 33% and 35% tax brackets reflecting the Bush tax cuts will remain in place and are made permanent. This means that, for most Americans, the tax rates will stay the same. However, there will be a new 39.6% rate, that will apply for income over: $400,000 (single), $425,000 (head of households), $450,000 (joint filers and qualifying widow(er)s), and $225,000 (married filing separately). These dollar amounts will be inflation-adjusted for tax years after 2013.
• Estate tax. The new law prevents steep increases in estate, gift and generation-skipping transfer (GST) tax that were slated to occur for individuals dying and gifts made after 2012 by permanently keeping the exemption level at $5,000,000 (as indexed for inflation). However, the new law also permanently increases the top estate, gift, and GST rate from 35% to 40% It also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion to the surviving spouse. All changes are effective for individuals dying and gifts made after 2012.
• Capital gains and qualified dividends rates. The new law retains the 0% tax rate on long-term capital gains and qualified dividends, modifies the 15% rate, and establishes a new 20% rate. Beginning in 2013, the rate will be 0% if income falls below the 25% tax bracket; 15% if income falls at or above the 25% tax bracket but below the new 39.6% rate; and 20% if income falls in the 39.6% tax bracket. It should be noted that the 20% top rate does not include the new 3.8% surtax on investment-type income and gains for tax years beginning after 2012, which applies on investment income above $200,000 (single) and $250,000 (joint filers) in adjusted gross income. So actually, the top rate for capital gains and dividends beginning in 2013 will be 23.8% if income falls in the 39.6% tax bracket. For lower income levels, the tax will be 0%, 15%, or 18.8%.
• Personal exemption phaseout. Beginning in 2013, personal exemptions will be phased out (i.e., reduced) for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). Taxpayers claim exemptions for themselves, their spouses and their dependents. Last year, each exemption was worth $3,800.
• Itemized deduction limitation. Beginning in 2013, itemized deductions will be limited for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers).
• AMT relief. The new law provides permanent alternative minimum tax (AMT) relief. Prior to the Act, the individual AMT exemption amounts for 2012 were to have been $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for married persons filing separately. Retroactively effective for tax years beginning after 2011, the new law permanently increases these exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. In addition, for tax years beginning after 2012, it indexes these exemption amounts for inflation.
• Tax credits for low to middle wage earners. The new law extends for five years the following items that were originally enacted as part of the 2009 stimulus package and were slated to expire at the end of 2012: (1) the American Opportunity tax credit, which provides up to $2,500 in refundable tax credits for undergraduate college education; (2) eased rules for qualifying for the refundable child credit; and (3) various earned income tax credit (EITC) changes.
• Cost recovery. The new law extends increased expensing limitations and treatment of certain real property as Code Section 179 property. It also extends the bonus depreciation provisions with respect to property placed in service after Dec. 31, 2012.
• Tax break extenders. Many of the “traditional” tax extenders are extended for two years, retroactively to 2012 and through the end of 2013. Among many others, the extended provisions include the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes, the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers, and the research credit.
• Pension provision. For transfers after Dec. 31, 2012, in tax years ending after that date, plan provision in an applicable retirement plan (which includes a qualified Roth contribution program) can allow participants to elect to transfer amounts to designated Roth accounts with the transfer being treated as a taxable qualified rollover contribution.
• Payroll tax cut is no more. The 2% payroll tax cut was allowed to expire at the end of 2012.

                                                                                                                                                                  

Limits on deductions and exemptions in the 2012 American Taxpayer Relief Act
Among the tax increases in the recently enacted 2012 American Taxpayer Relief Act are provisions that impose, or in some cases reinstate, caps on tax breaks for top earners. The new rules reinstate the personal exemption phase-out (PEP) and so-called Pease limit on itemized deductions — named after its author, former Ohio Democratic representative Don Pease. Both were created in 1990 in an effort to generate more government revenue without raising the marginal tax rates but were phased out by 2010. Now they are back. Here's how they work:

PEP limitations to apply to “high earners.” 

Taxpayers claim exemptions for themselves, their spouses and their dependents. Last year, each exemption was worth $3,800. Under the new law, for tax years beginning after 2012, the Personal Exemption Phaseout (PEP), which had previously been suspended, is reinstated with a starting threshold for those making $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 (one-half of the otherwise applicable amounts for joint filers) for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold. These dollar amounts are inflation-adjusted for tax years after 2013.

Pease limitations to apply to “high earners.” 

For tax years beginning after 2012, the “Pease” limitation on itemized deductions, such as the ones taken for mortgage interest, charitable giving and state and local taxes paid, and which had previously been suspended, is reinstated with a starting threshold for those making $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 (one-half of the otherwise applicable amounts for joint filers) for married taxpayers filing separately. Thus, for taxpayers subject to the “Pease” limitation, the total amount of their itemized deductions is reduced by 3% of the amount by which the taxpayer's adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. These dollar amounts are inflation-adjusted for tax years after 2013. 

Brief overview of the AMT. 

The AMT is a parallel tax system which does not permit several of the deductions permissible under the regular tax system, such as property taxes. Taxpayers who may be subject to the AMT must calculate their tax liability under the regular federal tax system and under the AMT system taking into account certain “preferences” and “adjustments.” If their liability is found to be greater under the AMT system, that's what they owe the federal government.

Originally enacted to make sure that wealthy Americans did not escape paying taxes, the AMT has started to apply to more middle-income taxpayers, due in part to the fact that the AMT parameters were not indexed for inflation. In recent years, Congress provided a measure of relief from the AMT by raising the AMT “exemption amounts”—allowances that reduced the amount of alternative minimum taxable income (AMTI), reducing or eliminating AMT liability. (However, these exemption amounts are phased out for taxpayers whose AMTI exceeds specified amounts.)

For 2011, the AMT exemption amounts were $74,450 for married couples filing jointly and surviving spouses; $48,450 for single taxpayers; and $37,225 for married filing separately. However, for 2012, those amounts were scheduled to fall back to the amounts that applied in 2000: $45,000, $33,750, and $22,500, respectively. This would have brought millions of additional middle-income Americans under the AMT system, resulting in higher federal tax bills for many of them, along with higher compliance costs associated with filling out and filing the complicated AMT tax form. 

New law provides permanent fix. To prevent the unintended result of having millions of middle-income taxpayers fall prey to the AMT, Congress has once again applied a “patch” to the problem by extending the 2011 exemption amounts, increased slightly, but this time the patch is intended as a permanent fix. Under the new law, for tax years beginning in 2012, the AMT exemption amounts are increased to: (1) $78,750 in the case of married individuals filing a joint return and surviving spouses; (2) $50,600 in the case of unmarried individuals other than surviving spouses; and (3) $39,375 in the case of married individuals filing a separate return. Most importantly, these amounts will be indexed for inflation after 2012, meaning that the annual “patches” will no longer be needed. 

Personal credits may be used to offset AMT.  Another provision in the new law provides AMT relief for taxpayers claiming personal tax credits. The tax liability limitation rules used to provide that certain nonrefundable personal credits (including the dependent care credit and the elderly and disabled credit) were allowed only to the extent that a taxpayer had regular income tax liability in excess of the tentative minimum tax, which had the effect of disallowing these credits against the AMT. Temporary provisions had been enacted which permitted these credits to offset the entire regular and AMT liability through the end of 2011. The new law extends this provision permanently, so that the credits are allowed to offset both regular and AMT tax liability.   

Enacted 2012 American Taxpayer Relief Act extends a host of important tax breaks for individuals 

The new law extends the following items for the period indicated beyond their prior termination date as shown in the listing:

... the deduction for certain expenses of elementary and secondary school teachers, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;

... the exclusion for discharge of qualified principal residence indebtedness, which applied for discharges before Jan. 1, 2013 and which is now continued to apply for discharges before Jan. 1, 2014;

... parity of the monthly dollar limitation for the exclusions for employer-provided mass transit and vanpooling, with the exclusion for parking benefits, which had applied before 2012 and which is now revived for 2012 and continued through 2013;

... the treatment of mortgage insurance premiums as qualified residence interest, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;

... the option to deduct state and local general sales taxes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;

... the special rule for contributions of capital gain real property made for conservation purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;

... the above-the-line deduction for qualified tuition and related expenses, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013; and

... tax-free distributions from individual retirement plans for charitable purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013. Because 2012 has already passed, a special rule permits distributions taken in Dec. 2012 to be transferred to charities for a limited period in 2013. Another special rule permits certain distributions made in Jan. 2013 as being deemed made on Dec. 31, 2012.

American Opportunity tax credit for college costs.  

Added to the tax code in 2009 as a temporary replacement of the previous Hope tax credit, the American Opportunity tax credit both increased the tax relief available for students from middle-income families and also extended relief for the first time to students from lower-income families. Now that the American Opportunity tax credit has been extended for five years, it might be a good time to review the tax benefits available under that credit, with an eye to how it compares with the Hope credit, which would have been in effect over the next two years had the American Opportunity tax credit not been extended.

• Families with a family member in college can benefit from a tax credit for tuition and fees. From a taxpayer's point of view, a credit is almost always preferable to a deduction, because a credit reduces taxes owed, while a deduction only reduces taxable income. The maximum amount of the American Opportunity tax credit is $2,500 (up from a maximum credit of $1,800 under the Hope credit). The credit is 100% of the first $2,000 of qualifying expenses and 25% of the next $2,000, so the maximum credit of $2,500 is reached when a student has qualifying expenses of $4,000 or more.
• While the Hope credit was only available for the first two years of undergraduate education, the American Opportunity tax credit is available for up to four years.
• Under the Hope credit, qualifying expenses were narrowly defined to include just tuition and fees required for the student's enrollment. Textbooks were excluded, despite their escalating cost in recent years. The American Opportunity tax credit expands the list of qualifying expenses to include textbooks.
• The Hope credit was nonrefundable, i.e., it could reduce your regular tax bill to zero but could not result in a refund. This meant that if a family didn't owe any taxes it couldn't benefit from the credit, which prompted critics to argue that the credit was thus denied to those families most in need of help affording college. The American Opportunity tax credit addresses this criticism by providing that 40% of the credit is refundable. This means that someone who has at least $4,000 in qualified expenses and who would thus qualify for the maximum credit of $2,500, but who has no tax liability to offset that credit against, would qualify for a $1,000 (40% of $2,500) refund from the government.
• The Hope credit was not available to someone with higher than moderate income. Under the credit's “phaseout” provision, taxpayers with adjusted gross income (AGI) over $50,000 (for 2009) saw their credits reduced, and the credit was completely eliminated for AGIs over $60,000 (twice those amounts for joint filers). Under the American Opportunity tax credit, taxpayers with somewhat higher incomes can qualify, as the phaseout of the credit begins at AGI in excess of $80,000 ($160,000 for joint filers).

Expensing and additional first-year depreciation in the 2012 American Taxpayer Relief Act
The recently enacted 2012 Taxpayer Relief Act includes a wide-ranging assortment of tax changes affecting both individuals and business. On the business side, two of the most significant changes provide incentives to invest in machinery and equipment by allowing for faster cost recovery of business property. Here are the details.

Enhanced small business expensing (Section 179 expensing).

Generally, the cost of property placed in service in a trade or business can't be deducted in the year it's placed in service if the property will be useful beyond the year. Instead, the cost is “capitalized” and depreciation deductions are allowed for most property (other than land), but are spread out over a period of years. However, to help small businesses quickly recover the cost of capital outlays, small business taxpayers can elect to write off these expenditures in the year they are made instead of recovering them through depreciation. The expense election is made available, on a tax year by tax year basis, under Section 179 of the Internal Revenue Code, and is often referred to as the “Section 179 election” or the “Code Section 179 election.” The new law makes three important changes to the Code Section 179 expense election. First, the new law provides that for tax years beginning in 2012 or 2013, a small business taxpayer will be allowed to write off up to $500,000 of capital expenditures subject to a phaseout (i.e., gradual reduction) once capital expenditures exceed $2,000,000. For tax years beginning after 2013, the maximum expensing amount will drop to $25,000 and the phaseout level will drop to $200,000. Second, the new law extends the rule which treats off-the-shelf computer software as qualifying property through 2013. Finally, the new law extends through 2013 the provision permitting a taxpayer to amend or irrevocably revoke an election for a tax year under Section 179 without IRS's consent.

Extension of additional first-year depreciation.

Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, by permitting an additional first-year write-off of the cost. For qualified property acquired and placed in service after Dec. 31, 2011 and before Jan. 1, 2013 (before Jan. 1, 2014 for certain longer-lived and transportation property), the additional first-year depreciation was 50% of the cost. The new law extends this additional first-year depreciation for investments placed in service before Jan. 1, 2014 (before Jan. 1, 2015 for certain longer-lived and transportation property).The new law also extends for one year the election to accelerate the AMT credit instead of claiming additional first-year depreciation. The new law leaves in place the existing rules as to what kinds of property qualify for additional first-year depreciation. Generally, the property must be (1) depreciable property with a recovery period of 20 years or less; (2) water utility property; (3) computer software; or (4) qualified leasehold improvements. Also the original use of the property must commence with the taxpayer – used machinery doesn't qualify.   

Various energy credits extended include:

• The nonbusiness energy property credit for certain energy-efficient property installed in existing homes is retroactively extended for two years through 2013. A taxpayer can claim a credit of: (1) 10% of the amount paid for qualified energy efficiency improvements, and (2) the amount of residential energy property expenditures, with a lifetime credit limit of $500 ($200 for windows and skylights).
• The alternative fuel vehicle refueling property credit (for non-hydrogen qualified alternative fuel vehicle refueling property) is retroactively extended for two years through 2013 so that taxpayers can claim a 30% credit for qualified alternative fuel vehicle refueling property placed in service through Dec. 31, 2013, subject to the $30,000 and $1,000 thresholds.
• The credit for 2- or 3-wheeled plug-in electric vehicles is modified and retroactively extended for two years through 2013.
• The cellulosic biofuel producer credit is modified, retroactively restored, and extended one year through 2013.
• The income and excise credits for biodiesel and renewable diesel are retroactively extended for two years through 2013.
• The production credit for Indian coal facilities placed in service before 2009 is extended one year. The credit applied to coal produced by the taxpayer at an Indian coal production facility during the 8-year period beginning on Jan. 1, 2006, and sold by the taxpayer to an unrelated person during such 8-year period and the tax year.
• The credits with respect to facilities producing energy from certain renewable resources is modified to include, as qualified facilities, certain modifications, improvements, or additions to qualified facilities under construction before Jan. 1, 2014. A facility using wind to produce electricity will be a qualified facility if it is placed in service before 2014.
• The credit for energy-efficient new homes is retroactively extended for two years through 2013.
• The credit for energy-efficient appliances is retroactively extended for two years through 2013.
• The additional depreciation deduction allowance for cellulosic biofuel plant property is modified and extended one year.
• The special rule for sale or disposition to implement federal energy regulatory commission (FERC) or State electric restructuring policy for qualified electric utilities is retroactively extended for two years through 2013.
• The excise tax credits for sale or use of alternative fuels and alternative fuel mixtures are retroactively extended for two years through 2013.

I hope this information is helpful. If you would like more details about these changes or any other aspect of the new law, please do not hesitate to call.

Posted by Bob G. Dellinger, CPA 

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Form 1099 Reporting for 2012

Questions often come up from clients as to when they need to issue 1099's and what the requirements for filing are. You are required to prepare a Form 1099-Misc for any payments made to individuals, vendors, subcontractors, and independent contractors if you paid them $600 or more during the year. This includes LLC's treated as a partnership or sole proprietorship. You do not need to issue a 1099 to a corporation, unless payments were made to an attorney, a law firm or a health care provider.

IRS Scrutiny

The IRS uses 1099s submitted to them to verify if the recipients report the income on their tax returns.  Failure to comply with 1099 filing requirements may result in substantial penalties.  The IRS added two new questions on the 2011 individual and business tax forms.

1. "Did you make any payments in 2011 that would require you to file Form(s) 1099?"
2. "If 'Yes', did you or will you file all required Forms 1099?"

Two penalties may apply to 1099 filings:

• Failure to file 1099s with the IRS
• Failure to provide copies of 1099s to payment recipients

The penalties increase the longer the filing failure continues and ranges from $30 to $100 per form.  If you fail to file 1099s with both the IRS and the recipient, the penalties may be double the standard penalty rates.

Examples of situations where 1099 reporting may be required

• You paid rent to an individual or partnership for services provided to your business
• Your business paid over $600 to an individual, sole proprietorship, or partnership for services
• You paid over $600 to an attorney or law firm for legal services (even if the law firm is incorporated)
• You paid rent for pasture lease

So how do you know if a business is incorporated or not

The IRS form W-9 "Request for taxpayer number and identification" should be used to obtain information from all of your vendors to determine whether they are operating as a sole proprietor, corporation, or partnership and to obtain their federal taxpayer identification number.

The due date for furnishing most types of 1099s for 2012 payments is January 31, 2013.  If you think your trade or business activities may require you to file a 1099, you can go to the IRS website at www.irs.gov/form1099misc where it gives more in-depth information on 1099-misc or contact us.

Posted by Bob G Dellinger, CPA

Tax Breaks

IRS Audit Red Flags: The Dirty Dozen

Here are twelve hot spots on your return that can raise the chances of scrutiny by the IRS.

By Joy Taylor, Assistant Editor, The Kiplinger Tax Letter

January 2012

 

 

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The IRS audits only slightly more than 1% of all individual tax returns annually. The agency doesn't have enough personnel and resources to examine each and every tax return filed during a year. So the odds are pretty low that your return will be picked for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.
However, the chances of being audited or otherwise hearing from the IRS increase depending upon various factors, including your income level, whether you omitted income, the types of deductions or losses you claimed, the business in which you're engaged and whether you own foreign assets. Math errors may draw IRS inquiry, but they'll rarely lead to a full-blown exam. Although there's no sure way to avoid an IRS audit, you should be aware of red flags that could increase your chances of drawing unwanted attention from the IRS.

1. Making too much money

Although the overall individual audit rate is about 1.11%, the odds increase dramatically for higher-income filers. IRS statistics show that people with incomes of $200,000 or higher had an audit rate of 3.93%, or one out of slightly more than every 25 returns. Report $1 million or more of income? There's a one-in-eight chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Only 1.02% of such returns were audited during 2011, and the vast majority of these exams were conducted by mail. We're not saying you should try to make less money -- everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.

2. Failing to report all taxable income

The IRS gets copies of all 1099s and W-2s you receive, so make sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.

3. Taking large charitable deductions

We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag. That's because IRS computers know what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for donations over $500, the chances of audit increase. And if you've donated a conservation easement to a charity, chances are good that you'll hear from the IRS. Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. And attach Form 8283 if required.

4. Claiming the home office deduction

Like Willie Sutton robbing banks (because that's where the money is), the IRS is drawn to returns that claim home office write-offs because it has found great success knocking down the deduction and driving up the amount of tax collected for the government. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That's a great deal. However, to take this write-off, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children's playroom as a home office, even if you also use the space to do your work. "Exclusive use" means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night. Don't be afraid to take the home office deduction if you're entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.

5. Claiming rental losses

Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. But this $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation. But the IRS is scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. The agency will check to see whether they worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business.

6. Deducting business meals, travel and entertainment

Schedule C is a treasure trove of tax deductions for self-employeds. But it's also a gold mine for IRS agents, who know from experience that self-employeds sometimes claim excessive deductions. History shows that most underreporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorships and smaller ones.
Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.

7. Claiming 100% business use of a vehicle

Another area ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use of an automobile is red meat for IRS agents. They know that it's extremely rare for an individual to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. IRS agents are trained to focus on this issue and will scrutinize your records. Make sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the revenue agent to disallow your deduction. As a reminder, if you use the IRS' standard mileage rate, you can't also claim actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has seen such shenanigans and is on the lookout for more.

8. Writing off a loss for a hobby activity

Your chances of "winning" the audit lottery increase if you have wage income and file a Schedule C with large losses. And if the loss-generating activity sounds like a hobby -- horse breeding, car racing and such -- the IRS pays even more attention. Agents are specially trained to sniff out those who improperly deduct hobby losses. Large Schedule C losses are always audit bait, but reporting losses from activities in which it looks like you're having a good time all but guarantees IRS scrutiny.
You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. For you to claim a loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you're in business to make a profit, unless IRS establishes otherwise. If you're audited, the IRS is going to make you prove you have a legitimate business and not a hobby. So make sure you run your activity in a businesslike manner and can provide supporting documents for all expenses.

9. Running a cash business

Small business owners, especially those in cash-intensive businesses -- think taxis, car washes, bars, hair salons, restaurants and the like -- are a tempting target for IRS auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income. The IRS has a guide for agents to use when auditing cash-intensive businesses, telling how to interview owners and noting various indicators of unreported income.

10. Failing to report a foreign bank account

The IRS is intensely interested in people with offshore accounts, especially those in tax havens, and tax authorities have had success getting foreign banks to disclose account information. The IRS has also used voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean -- in exchange for reduced penalties. The IRS has learned a lot from these programs and has collected a boatload of money ($4.4 billion so far).
Failure to report a foreign bank account can lead to severe penalties, and the IRS has made this issue a top priority. Make sure that if you have any such accounts, you properly report them when you file your return.

11. Engaging in currency transactions

The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. A report by Treasury inspectors concluded that these currency transaction reports are a valuable source of audit leads for sniffing out unreported income. The IRS agrees, and it will make greater use of these forms in its audit process. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as persons depositing $9,500 in cash one day and an additional $9,500 in cash two days later).

12. Taking higher-than-average deductions

If deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don't be afraid to claim it. There's no reason to ever pay the IRS more tax than you actually owe.

Highlights of upcoming 2012 tax season

Compared to some prior years, Congress has made few tax changes this year. Following are highlights of chan
Compared to some prior years, Congress has made few tax changes this year. Following are highlights of changes and facts for the upcoming tax season.

Opening day for electronic filing. The IRS starts accepting returns for electronic filing on Jan. 17th.

Due Date of Return The end of tax season is April 17, 2012 for returns not on extension.

New Form 8949 and Schedule D All capital transactions will now be reported on the new Form 8949. Schedule D-1 is no longer used. Sales of securities in 2011 that were purchased in 2011 should have a basis on the 1099 from a broker. The preparer must indicate on Form 8949 if a basis was shown on 1099-B, not shown on 1099-B, or no 1099-B was issued. A separate form is required for each case.There is also a column to report an adjustment to basis/sales price and the reason for the adjustment. As of today the form does not show the gain or loss on each transaction. Instead columns for the total cost, sales price, and adjustments are transferred to schedule D.

Standard Mileage Rates were changed mid-year. From 01/01/2011 to 06/30/2011 the rate was 51 cents per mile; after 06/30/2011 it went up to 55 cents per mile. The rate for use of a vehicle to get medical care also changed in midyear. From 01/01/2011 through 06/30/2011 the rate is 19 cents a mile and is 23.5 cents a mile for the remainder of the year. The 2011 rate for use of a vehicle to do volunteer work for certain charitable organizations remains at 14 cents a mile.

Schedule SE For 2011, the FICA portion of SE tax is reduced from 12.4% to 10.4%. The Medicare (HI) portion of the SE tax remains 2.9%. As a result, the SE tax rate is reduced from 15.3% to 13.3%.

Net self-employment income is no longer reduced by the amount of the self-employed health insurance deduction.

Earned Income Credit Before 2011 preparers were required to complete Form 8867, Preparer’s EIC Checklist, and keep it in their records. Now this due diligence form must be submitted to the IRS. Paid preparers failing to meet their due diligence requirements on EITC claims face higher penalties for returns required to be filed after December 31, 2011. The United States-Korea Free Trade Implementation Act amended IRC section 6695(g) raising the amount to $500.

Alternative Minimum Tax The exemption amount has increased to $48,450 ($74,450 if married filing jointly or a qualifying widow(er); $37,225 if married filing separately).

New Form 8938 Taxpayers with foreign assets above certain thresholds may have to file this new form, Statement of Specified Foreign Financial Assets. Unmarried taxpayers living in the US need to file if the total value of specified foreign assets exceeds exceed $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. For married taxpayers living in the US the threshold is $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year. The thresholds for filing are generally four times higher for taxpayers living outside the US.

PTIN's All tax preparers need to have a PTIN. The fee for renewal is $63. CPA's and enrolled agents are also required to have a PTIN although they are exempt from the competency tests which will be required.

Electronic Filing Requirements Starting Jan. 1, 2012, the 100-return threshold will be reduced to 11 or more income tax returns that the preparer, or the preparer’s firm in the aggregate, expect to file in 2012 for individuals, trusts and estates. In 2011 over 65 million returns were prepared professionally and about 90% of them were filed electronically.
ges and facts for the upcoming tax season.

Keeping Accurate Tax Records

That time of year is fast approaching. Christmas and New Years are on our minds and then we have to file our taxes. One of the questions we receive every year has to do with records retention. What to keep? How long to keep it? Why keep records? Here is an interesting article from AccountingWEB.com that addresses the topic:

Taxes are finished; which documents should you keep or pitch?
May 11, 2011You’re done with the taxes for another year. Time to dump the all the receipts and paperwork associated with preparing the return, you think. Not so fast, cautions the Minnesota Society of Certified Public Accountants. You might need some of that documentation if you get audited; without it, tax benefits that you claimed could be disallowed.

“The IRS generally has three years after you file your federal return in to commence an examination of that return,” said Robert Lynn, a MNCPA member with Charles M. Bartley, CPA, Ltd. “The major exceptions are cases where a large portion of income is omitted (a six-year limit can apply then) and cases of willful failure to file returns or purposefully fraudulent returns (where no time limit applies).”

In Minnesota, the general time limit is 3 and one-half years, not three years, with extended time limits similar to those in federal tax law. Here’s what Minnesota CPAs recommend for record retention for income tax purposes. What you keep to satisfy loan agreements, for employment in certain industries or government, or for other specialized purposes may be more involved.

• Six to seven years – Tax returns and backup documentation for both income and deductions. Pay special attention to mutual fund and brokerage year-end statements which are often revised. Keep cancelled checks and receipts or acknowledgements to support deductions.


• One year – Monthly bank records, brokerage statements, pay stubs and other financial data summarized at year-end by a Form W-2, 1099 or other official tax reporting form. Verify that your monthly activity agrees with amounts on those forms.


• Indefinitely – until at least three years after disposing of a particular property – Employer retirement plan documents (even if you no longer work for the company, as long as you are entitled to benefits); IRA contribution records for any accounts that include “after-tax” amounts; purchase records for stocks, mutual funds or any other securities; documentation of the purchase price and major improvements for your home and any other real estate; and similar documentation for big ticket items such as jewelry, antiques or collectibles. Keeping these records also helps to prove value in the event of loss or damage), both for tax and insurance purposes.

Why Keep Records?

There are many reasons to keep records. In addition to tax purposes, you may need to keep records for insurance purposes or for getting a loan. Good records will help you:

• Identify sources of income. You may receive money or property from a variety of sources. Your records can identify the sources of your income. You need this information to separate business from nonbusiness income and taxable from nontaxable income.


• Keep track of expenses. You may forget an expense unless you record it when it occurs. You can use your records to identify expenses for which you can claim a deduction. This will help you determine if you can itemize deductions on your tax return.


• Keep track of the basis of property. You need to keep records that show the basis of your property. This includes the original cost or other basis of the property and any improvements you made.


• Prepare tax returns. You need records to prepare your tax return. Good records help you to file quickly and accurately.


• Support items reported on tax returns. You must keep records in case the IRS has a question about an item on your return. If the IRS examines your tax return, you may be asked to explain the items reported. Good records will help you explain any item and arrive at the correct tax with a minimum of effort. If you do not have records, you may have to spend time getting statements and receipts from various sources. If you cannot produce the correct documents, you may have to pay additional tax and be subject to penalties.