Posts Tagged ‘tax audits’

For taxpayers who die in 2010, when estate tax has been completely repealed, the basis of property acquired from a decedent will be the lesser of:

1)      Adjusted basis of the property in the hands of the decedent immediately prior to death.

2)      Fair market value as of the date of death, or

Each estate will receive $1,300,000 of basis step-up adjustment that can be applied to assets selected by the executor. 

In addition to the $1,300,000 basis step-up, there will be additional increases in asset value in an amount equal to the sum of the following:

1)      The decedents unused capital loss carry forward

2)      The decedents unused net operating loss carry forward

3)      Passive activity losses unused as of date of death

In addition to the above mentioned increases, the estate is entitled to another $3,000,000 of basis step-up for transfers to the surviving spouse.

The Internal Revenue Service is designing Form 8939 “Allocation of Increase in Basis for Property Received from a Decedent” to report the transfers of property taking place in 2010.  Form 8939 is not available yet, but it must be filed with the decedent’s final income tax return for 2010.

Here are 2 illustrations:

John, a single man, dies in with the following estate:

FMV (Fair Market Value)                              $ 8,000,000

Decedent’s Basis                                            2,000,000

Heir’s carryover Basis                                     2,000,000

Plus step-up                                                    1,300,000

Heir’s total basis                                            $ 3,300,000 

If heirs were to sell the assets right away, they will incur a gain of $4,700,000 (difference of 8,000,000 – 3,300,000). 

Joe, a married man, dies in 2010 with the following estate: 

FMV (Fair Market Value)                              $ 8,000,000

Decedent’s Basis                                            2,000,000

Plus spousal step up                                       3,000,000

Plus step-up                                                    1,300,000

Spouse’s total basis                                      $ 6,300,000

If spouse were to sell the assets in 2010 she will incur a gain of $1,700,000 (difference of 8,000,000 – 6,300,000).

These are simplified illustrations but when preparing the actual form 8939, you will need to allocate the step up in basis to the specific inherited assets.  See your tax professional to find out how this may affect you if you’ve lost a loved one in 2010.

In Part I of the Schedule C “Hot Buttons” we touched on Gross Receipts and Cost of Goods Sold (COGS), as well as an explanation of why the IRS salivates over Schedule C audit opportunities.  Remember, once the IRS begins an examination of your tax return, expect them to dig deep.  All those personal expenses you’ve been running through as a Schedule C deduction will likely be found and subsequently removed, causing a chain reaction of increasing taxes and penalties you owe.

Part II of the “Hot Buttons” has 2 points of emphasis:  Automobile Expenses and Contract Labor.

1)      Automobile Expenses – You can deduct the actual expenses of running your automobile or take the standard deduction rate for business miles driven (whichever is higher).  Most important is to keep a log of the business miles driven, as well as an odometer reading on January 1^st and December 31^st of each year.  This will help determine the business use of the vehicle.  (WARNING to California Residents:  the Franchise Tax Board typically finds a noncompliance rate of 80% each year, so they scrutinize automobile expenses extensively).  Keep good records or risk losing the deduction all together.  No proof, no deduction.

a)      Actual expenses can include depreciation, registration fees, gas, insurance, repairs/maintenance, lease payments, personal property taxes, and parking fees.  If business use of the vehicle is less than 100 percent, expenses must be allocated between business and personal use.

b)      The standard mileage for 2010 is 50 cents per mile.  This can only be applied to business miles.

2)      Contract Labor – This area can cause headaches for those attempting to avoid payroll taxes, worker’s compensation insurance, etc.  If it is determined by an IRS auditor that the hired help is actually considered an employee, be expected to pay unpaid payroll taxes and penalties.

a)      If you are unclear on whether the worker(s) you hire are considered employees or non-employees, fill out Form SS-8 and send in for a final determination.  When in doubt, consider the worker as an employee until it is determined otherwise.  Contact your accountant if you have any questions about filing payroll taxes and any other employee or payroll related forms.  Also take a look at our previous blog on making the determination.

Most of you will not read this on December 31st and say ,”I better get a log book placed in the glove compartment of my business vehicle in the morning!”  But what about for 2010?  The answer is that it’s best to start now and estimate what the first part of the year was like, and do it sooner rather than later so that the likelihood to reasonably estimate what occurred will be as accurate as possible (especially for those of you who like to extend to October 15^th to file your personal tax return).

Up next for the Schedule C “Hot Buttons”, Part III – Depreciation, Other Expenses and the Home Office Deduction.

Part 1:  Gross Receipts and Cost of Goods Sold

Ever wonder what makes the “tax man” tick?  Unfortunately for you sole proprietors out there, you’re a high profile target for an IRS inquiry or examination.  The IRS has concluded that the most frequent contributors to noncompliance and false reporting are the small business taxpayers.  Based on what IRS examiners have found, roughly 60% of sole proprietors underreport their net business income.

So how is it possible to avoid getting a lovely examination letter in the mail from the IRS?  In short, you can’t.  However, you can limit your exposure by accurately and consistently reporting your business activities.  The main purpose for accuracy is not only honesty, but in the event of an IRS examination you will have nothing to be concerned about.

The first 2 points of emphasis are Gross Receipts and Cost of Goods Sold.

1)      Gross Receipts – What are considered gross receipts?  If there is any connection between any income received and a business, it’s considered business income and must be reported.  A Form 1099-Misc will usually be sent to the sole proprietor if amounts received were for $600 or more for services performed.  A copy is also sent to the IRS, so if your gross receipts on the Schedule C are less than the total from reported 1099’s…you may have just red flagged yourself.

a)      A good rule of thumb for those who don’t keep accurate records would be to go through the business’ bank statements for the year and add up all deposits.  Those deposits should be close to what is reported as gross receipts on the schedule C.  (WARNING:  separate your personal and business bank accounts.  You don’t want deposits to your personal account to be considered business income.)

2)      Cost of Goods Sold (COGS) – The simple formula for COGS is (beginning inventory + purchases + related labor costs + related materials and supplies – ending inventory).  Unless the sole proprietor is a manufacturer or involved in mining operations, the only parts of this calculation that will be used are inventory and purchases.

a)      Are you a sole proprietor with average annual gross receipts of $1 million dollars or more?  You may need to report on the accrual basis of accounting.  Contact your tax preparer for more information regarding proper accounting methods.

At the end of it all, your Gross Receipts minus your COGS will give you Gross Profit.  If everything is being reported accurately and consistently, the percentage of Gross Profit over Gross Receipts (gross profit percentage) should be relatively consistent from year to year.

Up next for the Schedule C “Hot Buttons”, Part II – Automobile Expenses and Contract Labor.