Posts Tagged ‘Tax’

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.

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!

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

Do you own a small business using QuickBooks or Peachtree as your accounting software?  Most likely you have stored critical unrelated financial information within the framework of the software.  By unrelated financial information we are referring to customer/client lists, personnel data, confidential client information, and other information used for business purposes.

Jump forward a few months from now and imagine receiving a letter from the IRS giving your business an examination notice (meaning you’re under audit).  How concerned would you be, or your clients for that matter, if the IRS requested your software database containing all this unrelated financial data?  Unfortunately this request is occurring more frequently and is being explained as the IRS’ attempt to modernize.  The IRS has purchased copies of various small-business accounting software to accomplish this task.  Requesting the electronic files is now standard operating procedure.

In recent years the IRS has ramped up efforts to more aggressively collect taxes from small businesses.  Statistics show that small businesses are one of the largest contributors to the “tax gap” (taxes owed but not paid or reported).  What better way to close the gap than to increase audits on small businesses where non-compliance is an issue?  Let’s face it…large corporations have their own accounting armada to keep everything straight with laws, regulations, and the taxes they pay.  Small businesses don’t have that luxury.

The main concern we have in providing IRS access to an accounting database is whether the auditor will stay within the scope of the requested information.  Do you want to IRS potentially contacting one of your clients?  Seeing what they purchase from you? Seeing what you purchase from vendors?  The fact that you are being audited is not something to brag about, but client relationships could be affected if some of their private information is handed over.  How would you feel if your personal information was handed over to IRS?  What would you do if you found out?  Another concern would be your reputation if  word got out that your business was under audit.  Questions could arise regarding the circumstances of the audit (randomly selected as opposed to improper filing). 

If a company turns over complete electronic records, there is no way of knowing what the IRS will do with that information.  The IRS has not addressed this issue except to say “privacy of return information” is of utmost importance to the agency.  Virtually all professional organizations in our industry are vehemently opposing this policy.

In subsequent posts we will discuss ways to approach this dilemma if you are audited and IRS requests your data base.

In order to deduct charitable contributions, the charitable organization must be created or organized in the US (including the states, District of Columbia and possessions of the US) or must be provided by a treaty (side note – have you ever tried to read a treaty?  Not fun!).  Many generous people want to give for causes around the world and there is absolutely nothing wrong with it.  It is commendable!  However, in order for charitable contributions to be tax deductible, you need to give it to a bona fide US charitable organization which can direct the funds to those in need around the world.  Some think that Catholic churches located in other countries would qualify because they are arms of the Roman Catholic Church, a universal organization.  Tax courts have repeatedly rejected this argument. 

 Also beware of giving money to an individual or earmarking a donation for a specific individual.  You cannot give money to your church or other charity to give to a specific family in need. While it is a charitable act, it is not tax deductible.

The 2010 Tax Relief Act reinstated the estate tax for deaths on or after January 1, 2010, and before January 1, 2013. Under this new law, the maximum estate tax rate is 35%, with an exclusion amount of $5 million.

 The executors of decedents who passed away in 2010 may elect the reinstated estate tax option or the no estate tax, carryover basis / limited step-up basis provisions.

 For estates under $5 million in taxable value, executors will probably choose the estate tax option with a $5 million applicable exclusion and the full step-up in basis.  These estates will pay no estate tax and the heirs will inherit the assets at fair market value. 

For very large estates, the election to apply the no estate tax and carryover basis provisions as if the 2010 Tax Relief Act was never enacted will probably render the most savings.  These large estates will not pay estate tax but will have a step-up basis limited to $1.3 million for non-spouse heirs, and an additional $3 million for surviving spouses.

For mid-sized estates (estates between $5 million and $10 million) the analysis will be more complicated.  Executors will need to take into account many factors to determine whether it is better to pay estate tax in 2010 or inherit most assets with carryover basis. 

See your tax professional if you have lost a loved one in 2010.

To all you tweeters out there, did you know that the IRS is a tweeter?  That’s right!  IRS has jumped into social media.  Now you can get federal tax news on your iphone!  I wonder how much of our tax dollars this costs the US annually? 

We are far too busy to “Tweet” even in the slow summer months! How many federal employees do you think are needed for the IRS to keep up in Tweets? 

The IRS Twitter news feed, @IRSnews (http://twitter.com/IRSnews), provides the latest federal tax news and information for taxpayers, including tax tips, tax law changes and information on IRS programs.  They also have a Twitter feed for tax professionals, @IRStaxpros (http://twitter.com/IRStaxpros). 

I wonder how many followers they have?

On December 17, 2010, the Tax Relief , Unemployment Insurance Reauthorizations and Job Creation Act of 2010 (2010 Tax Relief Act), was signed by President Obama. The 2010 Tax Relief Act extends the Bush-era individual and capital gains/dividend tax cuts for all taxpayers for two years. The bill also provides for an AMT “patch”, a one year payroll tax cut, bonus depreciation for 2011 and 2012, a top federal estate tax rate of 35 percent with a $5 million exclusion, and more.

For most individuals , the most immediate impact of the new law will be  the payroll tax cut and  the extension of the reduced individual income tax rates.

The 2010 Tax Relief Act reduces the Social Security (FICA) portion of payroll taxes collected from employees and self-employed individuals from current 6.2 percent to 4.2 percent for 2011 only.  So what does this mean in real dollars?

If you earn the maximum amount of $106,800 that is subject to FICA tax, you will save $2,136 next year. Anyone earning less will save 2 percent of wages or net self–employed income.  See your tax professional with any questions you may have regarding the new legislation.

IRS has issued proposed regulations which will eliminate the use of paper-based federal tax deposit coupons after 2010.

Under current regulations, taxpayers whose aggregate annual deposits exceed $200,000 must generally use electronic funds transfer (EFT) to make federal tax deposits. Depositors not currently required to use Electronic Federal Tax Payment System (EFTPS) for deposits may instead use the paper-based FTD coupon system to make a deposit by presenting a check and a federal tax deposit coupon to a bank teller at one of the financial institutions authorized as a government depository or a financial agent.

The proposed regulations require all deposits of the following federal taxes to be made via EFTPS beginning January 1, 2011:

-          Corporate income and corporate estimated taxes;

-          Unrelated business income taxes of tax exempt organizations;

-          Private foundation excise taxes;

-          Taxes withheld on nonresident aliens and foreign corporations;

-          Estimated taxes on certain trusts;

-          FICA taxes and withheld income taxes;

-          Nonpayroll taxes, including backup withholding;

-          Federal Unemployment Tax Act (FUTA) taxes; and

-          Excise taxes reported on Form 720, Quarterly Federal Excise Tax Return.

Some business paying a minimal amount of tax can, however, continue to make their payments with the related tax return, instead of using EFTPS.

The proposed regulations are expected to be finalized by the end of this year.

In early January we will send our business tax update letter to all business clients.  We will also post this update on our website.  If you are not already using the EFTPS system for tax deposits, watch for important information regarding this change in Treasury Department policy in our annual letter.

In my previous blog on this matter, I explained some tax exclusions available for debt forgiveness on a rental property used in trade or business.  Let me explain what qualifies as trade or business and then tell you what the tax impact is for rental properties that don’t qualify. Keep in mind, if you are insolvent, none of this matters.  Your insolvency will make all debt forgiveness a non taxable event. 

First, there is no definition provided by the IRS for the term “trade or business”.  But what’s new?  However, the courts have developed two definitional elements.  First, you have to be trying to make a profit.  You can’t buy a house with an outrageous mortgage and not collect enough rent to pay for it.   This commonly happens when parents buy a house for their kids and don’t charge the kids enough rent (and in some cases, no rent at all).  The second element relates to the scope of the activities.  If you only have one rental and collect net rents (meaning a management company handles all transactions and provides you with the monthly distribution of the net amount), then it is not truly a trade or business.  On the flip side, if you own 10 properties, you handle collecting rent, paying the expenses and managing the properties, that would likely qualify as a trade or business.  Now, making the determination for the situations in the middle… you’ll need to sit down with your tax preparer and look at the facts. 

So now you’ve determined that your rental property does NOT qualify as a trade or business.  What are the tax implications of the short sale or foreclosure? 

First determine if your loan is a recourse or nonrecourse loan:  A nonrecourse loan is one where the lender has no recourse against the borrower if the proceeds from foreclosure are less than the outstanding mortgage.

• Nonrecourse loan is almost always the case of the ORIGINAL loan you took out to acquire the property.  The loan is secured by the property and has never been refinanced.
• Recourse debt is usually the case when you refinanced the loan – regardless if you pulled out money or not. There are some limited cases in which a refinanced loan is not a recourse loan… you probably need a lawyer to figure it out for you. 

The easy one is nonrecourse debt.  The amount of nonrecourse debt forgiven in nonrecourse debt is NOT taxable cancelation of debt (COD) income.  Therefore, you only need to calculate the gain/loss on the property in which the total debt becomes the sales price in the case of a foreclosure. 

Example:

                Nonrecourse debt                                                         $300,000

                Basis (purchase less depreciation)                             (250,000)

                Gain                                                                           $  50,000

 The foreclosure is treated entirely as an exchange with gain.  There is no COD income, only gain or loss. 

Recourse debt is more difficult.  You must consider both cancelation of debt income and the income from disposing of the property.

• If the fair market value (FMV) of the property is higher than the basis, there is a gain on the disposition of the property.(Example 1)
• If the outstanding debt exceeds the FMV of the property, there is taxable cancelation of debt (COD) income.  In a foreclosure, the FMV of the property is always less than the debt forgiven. (you would have sold it if you could and saved your credit). (Example 2)

 Example 1:

                Recourse debt                                                                    $300,000

                FMV                                                                                    (275,000)

                COD income                                                                    $  25,000           

                FMV                                                                                     $275,000

                Basis                                                                                   (250,000)

                Gain                                                                                   $  25,000 

Example 2:

                Recourse debt                                                                    $300,000

                FMV                                                                                     (250,000)

                COD income                                                                     $  50,000  

                FMV                                                                                     $250,000

                Basis                                                                                    (275,000)

                Loss                                                                                  $  (25,000) 

As always, see a professional when considering your personal situation.