Author Archive

Failure to File and/or Pay Taxes

Most people know April 15th (April 17th in 2012) is the due date of your individual income tax return.  You may request a six month extension allowing you to file your return by October 15th without penalties.  However, if you fail to request the extension timely or if you don’t file your return by the extension date, you may be subject to late filing penalties.  The penalty is 5% (on the net amount of tax due) for each month not filed up to 25%.  If the return is more than 60 days late, the minimum penalty is the lesser of $135 or tax due.  Interestingly enough, there is no penalty if the return shows a refund.  I suppose this is because the IRS would be happy to keep your money, and the only way you can get it, is to file your return.

We remind our clients that even though the IRS will grant you an extension to file your return, the extension does not allow you more time to pay taxes.  You must pay your taxes on time.  Don’t ignore it because it will only get ugly!  You can set up an installment agreement with the IRS to pay your tax over time.  While it won’t eliminate the fee, they may reduce the rate by 50%. 

The failure to file timely penalty is 5% per month to a maximum of 25%.  The penalty for failure to pay timely is also 5% per month.  However, both penalties do not apply on the same liability.  If you are subject to both penalties in the same month, the failure to file penalty will be reduced by the failure to pay penalty.  (Aren’t they so kind?)  However, the entire time these penalties are running, additional interest is accruing on all tax and penalties owing.

My advice; file your return on time, even if you don’t have the money to pay the tax.  Contact the IRS to set up the installment agreement.  Don’t run from it.  It won’t help the situation.

As always, consult with your tax advisor!

B is for Bad Debt (Personal)

We often think of bad debt in the business sense.  However, from time to time we run into a non business or personal bad debt.  Believe it or not, the IRS allows you to deduct this loss… but there’s a catch.  It is treated as a short term capital loss and therefore is subject to the capital loss limitations (you cannot deduct more than $3,000 of net capital losses from income per year).

In order to deduct the loss, you must prove the debt had value at the beginning of the year and no value at the end of the year.  You must make a reasonable attempt to collect the debt and make a demand for repayment in writing.  If the debtor is unable to pay, request a written statement from him stating that he will not be able to meet his obligation and the reason why.

 A statement outlining the following must be attached to the tax return in order to take the personal bad debt.

  1. Description of the debt, amount and date due
  2. Debtor’s name and taxpayer’s relationship to debtor (cannot be a child or similarly related party)
  3. Description of efforts made to collect the debt and,
  4. Explanation of why the debt is now worthless (such as bankruptcy)

As always, seek advice from your tax preparer when writing of a non business bad debt.  If prepared improperly, the IRS likely will not allow the deduction.

B is for Bad Debt (Business)

In some instances bad debts may be written off.  Here we’ll look at what factors must be present in order to take a deduction.

For Accrual Method Taxpayers:

When using the accrual accounting method, management estimates an allowance for bad debts based on several factors such as prior experience, industry comparisons, the debtor’s ability to pay and/or appraisals of current economic conditions.  This is known as the allowance method.  Keep in mind; this is an estimate of an event that has not yet occurred.  When it comes to tax, the IRS does not allow you to make this estimate.  As you can imagine, it would be abused as a “tax planning” strategy.  Therefore, for tax purposes, we can only deduct actual bad debts.  The following factors must exist in order to deduct a bad debt:

  1. It must be a creditor-debtor relationship
  2. There must be a legal obligation to pay a fixed sum of money
  3. There must be an actual loss of money (loss of time spent rendering services is not a loss of money unless the uncollected fee has already been included in taxable revenues on the accrual method)
  4. Proof that the debt is and will remain uncollectible
  5. A business purpose for the debt

When using the specific charge-off method to deduct bad debt (unlike the allowance method previously discussed), management has to prove that the debt is uncollectible to expense it.

Recovery of previously written off bad debts in subsequent years is recognized as other income in the year received.  As always, see your tax preparer when determining what your business can deduct for bad debt expense.

For Cash Method Taxpayers:

Cash basis businesses cannot deduct bad debt since the related revenue was never recognized.  There would only be bad debt for actual cash lost, i.e. because it was paid in cash to a vendor, etc.

A is for AUTO EXPENSES

Business auto expenses… it’s an area of the tax law that can be confusing and lead to abuse.  Businesses have two methods available for determining the most beneficial expense.  The following will explain each approach.

For a business, a vehicle can be deducted in two ways; actual expense and mileage.  When using actual expense, the vehicle can be depreciated and maintenance, insurance, gas and other expenses can be deducted. When using the standard mileage rate to calculate the deduction, depreciation expense is  included, therefore separate depreciate expense would not be taken.  When you purchase a new vehicle we will calculate the deduction using both methods (assuming all information is provided) and the method that gives the higher deduction will be used.  You should keep a log for each company owned vehicle recording the mileage and expenses for each.  This can become tedious but it will be one of the first items requested by an IRS auditor

If your employees are allowed to use company owned vehicles on personal time, it is considered a taxable fringe benefit.  We collect certain data and use an IRS table to determine the taxable amount.  This allows the business to deduct one hundred percent of the auto expense.  The employee pays tax on the personal use of the vehicle.  The IRS table for this taxable fringe is so beneficial that this is often the best method for both employer and employee.  The most important pieces of information needed are the annual business and personal miles on the vehicle.

As always, see your tax preparer in considering your tax situation.

This is Your Blog Too!!

I can’t believe this blog will celebrate its two year anniversary in April.  I think we should have a party!  Oh wait, we already do… it’s our “end of tax season” party.  We’ve had our ups and downs but I’m proud of us for sticking with it.  Our staff stays very busy and sometimes posting a blog is challenging.  Things got pretty quiet during my four months of maternity leave last year, but I’m back!  I know you are excited! 

We created this blog to help you; our readers, our clients, our friends.  We know you are bombarded with information.  Tax and accounting can sometimes be intimidating topics.  Our goal is to keep you informed so you can be better business owners, employees and asset managers.  You can help us by giving us your feedback and requests.  If you have a question related to a particular blog already posted, leave a comment.  You can always email us questions on requested topics.  There are no dumb questions.  I’d bet money that if you have a question, many others have the same one.

One of my personal goals this year is to ramp up the blog again.  I want it to be resource for our readers. 

So bring on the questions!

A-Z Series – A is for Adoption Expense

We are starting two A to Z series (one for individual taxes and one for entity taxes) which will run through tax season.  We hope to bring you some useful information about the tax world.  As always, if there is a topic you’d like us to write on, please e-mail us your requests!  We love input!

Our first one is A for Adoption Expense.  Adopting a child is a noble act and unfortunately a costly one.  However, you may be eligible for a tax credit if you meet certain criteria.

  1. The child must be under the age 18 or
  2. Physically or mentally incapable of caring for himself/herself
  3. The credit is phased out for taxpayers with a modified Adjusted Gross Income  between $185,210 and $225,210 (tax year 2011) 

 Qualifying expenses include: 

–          Adoption fees

–          Attorney’s fees

–          Court costs

–          Travel expenses

The tax credit is limited to $13,360 (tax year 2011) per child.  You cannot take the credit until the year in which the adoption is final.  You will be required to attach a copy of the adoption order or decree to your tax return.  After the adoption is final, you can take the credit in the year in which you pay the expenses.  Keep in mind, the limitation amount is cumulative for each child.  It is not an annual amount.

Some employers offer adoption assistance programs to their employees (what an incredible benefit if you have this!).   If you receive assistance payments from your employer, the IRS will allow you to exclude up to $13,360 per child from income.  Both the credit and exclusion can be claimed for the same adoption; however, both cannot be claimed for the same expense.  Thus, for example if you spent $30,000, you could exclude $13,360 and take a credit of up to $13, 360.  The limit applies separately to the credit and exclusion if both are taken (meaning you can utilize both the $13,360 credit and the $13,360 exclusion from income.

If an adoption is unsuccessful, the expenses are combined with expenses of a later successful adoption for dollar limits.

If you adopt a special needs child, you are able to claim the full credit of $13,360 even if you don’t have $13,360 in qualified adoption expenses.

NOTE:  Adopting your spouse’s child or costs related to a surrogate parenting arrangement does not qualify for the credit or exclusion.

As always, see a tax professional when dealing with unique situations such as this.  There are additional facts to consider in each case which cannot be covered in one blog.

Nonprofits: Expense Classifications

Over the summer, I found myself consumed with nonprofit work.  It’s the time of year when that is pretty much all I do.  It is occasionally broken up with other jobs, but they seem few and far between.  The following blog post is  focused on nonprofit topics:

Nonprofit entities are required to classify expenses between three categories: Program, Management & General, and Fundraising.  Determining how to classify expenses in these categories is usually a matter of judgement. 

The IRS does provide some guidance, but not much.  Hopefully the following will help answer some questions. 

The following descriptions come straight out of the Form 990 instructions

Program Services (Expenses) are mainly those activities that further the organization’s exempt purposes.  What is your exempt purpose?  How are you accomplishing that purpose?  What are the programs you run?  

Management and General are expenses that relate to the organization’s overall operations and management, rather than to fundraising activities or program services.  Overall management usually includes the salaries and expenses of the organization’s chief executive officer and his or her staff, unless a part of their time is spent directly supervising program services or fundraising activities.  In that case, salaries and expenses should be allocated among management, fundraising, and program services. 

The IRS generally considers the following expenses to be management and general:

Costs of board of directors meetings, committee meetings and staff meetings (unless they involve specific program services or fundraising activities)

  • General legal and accounting
  • General liability insurance
  • Office management
  • Human resources
  • Management of investments 

Fundraising expenses are the expenses incurred in soliciting contributions, gifts and grants.  If you have contributions revenue, you should have some fundraising expenses.  These expenses include:

  • Publicizing and conducting fundraising campaigns
  • Soliciting bequests and grants from foundations, other organizations or government entities
  • Participating in federated fundraising campaigns (such as United Way)
  • Preparing and distributing fundraising manuals, instructions and other materials 

Expenses will either be direct expenses or indirect.  The direct expenses are easy, they are identified specifically with an organization’s activity or project and can be assigned with a high degree of accuracy.  Indirect expenses are costs that are not identified specifically to one category or another and must be allocated accordingly.  If the CEO spends time in management, programs and fundraising, compensation must be allocated among the three categories.  Oftentimes using a percentage based on hours spent in each activity is the most realistic approach. 

I wish I could say it’s easy to make the determination between these expense categories in all cases.  The fact of the matter is, we run into the grey areas with most returns we prepare and discussion is needed to make the determination.  Seek advice from your tax preparer when trying to make the distinction.  Have an in depth conversation about the activities. 

One way to simplify the process is to prepare an annual budget determining in advance the types of expense activity to be included in each category.

Debt Deal but no new taxes… for now

Well, it finally happened.  Sort of.  A deal has been made on the debt ceiling issue and supposedly there will be no new taxes.  Congress agreed to make $917 billion in spending cuts (over 10 years) and the President is able to raise the debt ceiling by $400 billion.  Future debt ceiling increases of $500 billion have also been authorized.  No one actually likes the deal, but apparently it is as good as it’s going to get according to Congressional leaders.

Where are the $900 billion in spending cuts going to hit?  Well, that is up to a joint committee to determine.  This “committee”, which has not yet been established, has until November to make its recommendations for a vote by Congress.  If unsuccessful, automatic spending cuts would occur which have already been established.

They say that there will be no tax increases.  The problem is, those Bush-era tax cuts that were extended last minute… (remember that chaos?) are set to expire December 31, 2012.  Do you think they forgot about that?  I highly doubt it.  In addition, there are tax increases which will mostly affect the high income earners that are set to begin in 2013.  I’m sure Congress is counting on those tax increases. 

I personally struggle with the continued last minute deals that really don’t make a difference except to calm down the immediate crisis.  Politicians are letting their political aspirations limit their actual potential impact for good in our government.  Everything they do and pass is for a temporary fix.  They extended the Bush tax cuts for only two years… they extended the estate tax and AMT issues out for two years… they refuse to actually take on the tax system and give it a much needed tax reform.  I can’t be too harsh.  The “Gang of Six”, made up of six Senate members, has been working on a comprehensive tax reform plan.  However, it’s far from being ready for proposal to Congress.  At this point, it’s hard to say where those efforts will lead us. I understand that with the two main parties having such differing opinions on tax issues, this task is not an easy one.  But no one can deny that something has to be done.  

For more information see the ‘Debt Ceiling breakdown of deal’ on CNN’s website

Deductible Auto Mileage Expense Increase

The IRS has issued the new mileage rates.  Beginning July 1, 2011, the standard mileage rate for business purpose is 55.5 cents per mile (was 51 cents from January 1 through June 30).  The most common uses of the rate include:

  • Mileage reimbursement to employees using an accountable reimbursement plan (can be less than the federal rates, but never greater)
  • Mileage deducted on schedule C
  • Unreimbursed business miles deducted on Schedule A 

The IRS publishes these rates as a guideline, not a requirement.  Businesses are allowed to use a lower rate if they choose.  However, you cannot use a higher rate.  If a business reimburses its employees using a higher rate, the difference would be taxable to the employee. 

The mileage rates for medical or moving expenses also increased 4.5 cents from 19 cents to 23.5 cents per mile.  The charitable mileage rate remains at 14 cents per mile.

Sales Tax Break for Californians

You may remember a few years ago when the sales tax in California increased by 1%.  That increase expired June 30, 2011 and as of July 1, 2011, we are back to a 7.25% state sales tax.   We’ve been waiting to see if the California legislature was going to extend it, since they can’t balance the budget. 

In San Diego, we have an additional 0.50% local tax which brings our sales tax to 7.75% in most areas.  Vista has an additional 0.50% city sales tax on top of that, bringing the new rate to 8.25%.  Click here to view the Board of Equalization’s chart of all cities in California and the sales tax rates effective July 1st.  

Make sure your accounting software, POS systems, accountants, etc. are updated on the change. 

Be sure to see your tax advisor if you are uncertain of your responsibilities.  Any excess sales tax collected must be remitted to the state.

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