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Date Set for Processing Delayed Returns

Jan 21st, 2011
by jblankenship.
1 comment

go wild by hillary h The IRS announced on January 20, 2011, that the delayed returns – those that have itemized deductions on Schedule A, include higher education tuition and fees deductions on Form 8917, and/or that include the educator expenses deduction, can begin processing on February 14.

Many processors (commercial software) will accept these returns now and send them to the IRS beginning on February 14, so there is no reason to delay.  And if your processor (or tax guy or gal) doesn’t allow for the early acceptance, you can still get your information in to them and they’ll submit it when the time is right.

This delay was explained in the article that I wrote earlier about how some returns would be delayed this year due to the late passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

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Credit for Energy Saving Home Improvements for 2011

Jan 17th, 2011
by jblankenship.
2 comments

600px-Windfarm_112This tax credit has undergone a change from previous years.  In 2010, for example, you could achieve a credit for as much as 30% of the cost of your energy-saving home improvements, with a ceiling of $1,500.

Beginning January 1, 2011, the credit rate is now just 10%, and the ceiling has been lowered to $500.  Something important to keep in mind about this credit:  any credit claimed in prior years (2009 and/or 2010) will be used to reduce your ceiling.  In other words, if you claimed the full credit (or any amount up to $500) on a previous year’s tax return, you have no energy-saving home improvement credit available to you.

In addition to the changes above, there are specific item caps in place as well.  For example, if you are putting in a new furnace or water heater, the credit for those units is capped at $150.  If you’re putting in a biomass fuel stove (those are the corn-fueled or pellet-fueled furnaces), then you can claim up to a $300 credit against the purchase price.  And if you’re putting in new energy-efficient windows, the cap is $200.

One area that the credit remains at 30% is with alternative energy systems, such as wind-power or solar panels, so if you’re really into the alternative energy option this could be helpful.

Photo by Wikimedia

Book Review: Small Business Taxes Made Easy

Jan 14th, 2011
by jblankenship.
2 comments

clip_image001This book was a surprise to me – I did not expect to find such a thorough guidebook on the process of starting up a small business, but that’s what Small Business Taxes Made Easy is.  Author Eva Rosenberg, (“TaxMama” to her devotees) has not only the experience, but also the in-depth understanding of both the small business and the small business-person to lead you through this process and help you to succeed, quite possibly in spite of yourself.

The title of the book is misleading, as the first several chapters of the book have little to do with taxes and much to do with all of the administrivia that you need to go through when setting up a small business.  In fact, you really don’t get to tax matters at all until about page 70 (of 261) in the book.

The first few chapters take you through the concepts of business planning – areas that very few small businesses pay any attention to at all.  Clearly Rosenberg has had her share of real-world experience with small business owners going through this process.  She has developed very useful checklists, included in the book, for following step-by-step through the process of business development.

Now, one might say that the process Rosenberg describes is overkill – in fact, a colleague made the comment that “No one creates an advisory board!”… but quite possibly that’s part of why so many small businesses fail in the first year or two.

Secondly, don’t think that this book is solely for the new small business startup.  If you happen to be one of those lucky small businesses that has made it past the first year or so without a formalized plan – you’d be doing yourself a favor to review and pay attention to this book’s recommendations as well.

This doesn’t mean that I give the tax-specific portions of this book short shrift, either.  Rosenberg treats all of the major components of tax “preparedness” with due consideration.  From explaining exactly what should be considered income (versus capital, for example) to who should be considered an employee, with separate chapters set aside to explain what’s deductible and what’s not, use of your home for your business, and the business use of an automobile, this book covers it all.

There is a separate chapter specifically dealing with the issues you might face with your online-only venture, as well, and if you’re in this space or expect to operate in the internet realm in the future, you should pay close attention.  TaxMama has been on the internet for over fifteen years (in evolving forms) and as a tax professional she has seen it all, literally.  She takes you through the concept of nexus (location), internet sales taxes, and legal issues that you might come across.  This chapter (like all the chapters in this book) comes with a checklist at the start and a list of specific resources (including the URLs) at the end of the chapter – vetted resources that are literally worth the price of the book on their own.

All in all, it’s my opinion that if you are starting a business or have already started a business and you’re still hammering out the kinks – you could definitely do worse than to read Small Business Taxes Made Easy.  Heck, even if you’ve been in business for a while you can benefit from this book – I picked up a few pointers myself.

The above book review is part of a series of reviews that I am doing in an arrangement with McGraw-Hill Professional Publishing, where MH sends me books with the only requirement being that I read the book and write a review – like it or not.  If you find the information in this review useful, let me (and McGraw-Hill) know!

Staging Your Roth IRA Conversion

Jan 12th, 2011
by jblankenship.
3 comments

on stage at carnegie hall by sun dazedSo you have a substantial IRA (or several IRAs), and you’ve retired.  For the first time since you started your career, you’re in a low tax bracket.  You’re not age 70½ just yet, so you don’t need to concern yourself with Required Minimum Distributions (RMDs).

But then again, maybe you should concern yourself with those Required Minimum distributions…?

Think about it – you’re in a good place, tax-wise, and your IRA money is bound to continue to grow over time.  You are getting along just fine with your pension, Social Security, and other investment income.  This is the perfect time to strategically reduce your future tax bite.

Staging the Roth IRA Conversion

Let’s say for example that your taxable income puts you in one of the lowest tax brackets… say 15% or 25%. You have some “headroom” left in the bracket to spare, meaning that you could realize some additional income without bumping up to the next bracket.  The amount doesn’t seem like a lot, but since you’ve got a few years before you reach age 70½, little by little you could be reducing (or eliminating) the amount of RMDs that you’ll be forced to take later on.

Each year you can convert an amount from your IRA to a Roth IRA that will bring you just up to the top of your tax bracket (but not over).  By doing this, you’re controlling the flow of the money at a point when you can afford to, rather than having income forced on you when you don’t want it.

Then, when you reach age 70½, you have either reduced your IRA down to an easily-manageable amount for RMDs, or completely eliminated the IRA altogether, and the RMDs with it!  Now you don’t have to worry about taking RMDs from the funds that you’ve transferred (converted) to the Roth IRA – and if you want to take money out of the Roth IRA, you can do so tax free!

The funds in the Roth IRA can continue growing over time, and you don’t have to worry about paying tax on the growth at all.  You paid tax at today’s rates and today’s value of the old IRA account before all of that future growth occurred.

If you don’t have a need for the funds in the Roth IRA, you will never be required to take the money out – and your heirs can stretch out the tax-deferral over many years.  This can amount to some very substantial tax savings!

The Downsides

There are a few downsides to such a strategy.  As you convert funds from your IRA to your Roth IRA, the increase in your income for taxable purposes has some additional impacts that you need to keep in mind.  Increasing taxable income can increase the amount of your Social Security benefit that is taxed, for one thing.

Another is that, as your income increases, so does your Adjusted Gross Income (AGI), which controls a lot of your deductions, such as medical expenses.  Your medical expense deduction is limited to any amount greater than 7.5% of your AGI.  If you increase your AGI by converting IRA funds to a Roth IRA, you’ll effectively reduce the amount of your medical deduction by 7.5% of the amount you convert.

In addition, you need to come up with a source to pay the tax – either from your IRA (thus reducing the potential Roth IRA and its potential for growth), or from other investment accounts, which will reduce the available funds from there.

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Earned Income Tax Credit 2011 Style

Jan 10th, 2011
by jblankenship.
2 comments

800px-Bunte-kabelThere have been a few changes to the Earned Income Tax Credit (EITC) for 2011 and years beyond.  Some of these changes are pretty significant, others are more of the common variety.

No More Advance Payments

In the past, if a taxpayer was likely to be eligible to receive the EITC on filing his or her return, the law allowed the taxpayer to apply for and receive advance payment of a portion of the credit.  This is because the credit is refundable – even if you don’t owe any tax on your tax return, you’ll get something back with the EITC.

With the passage of the Education Jobs and Medicaid Assistance Act of 2010 signed into law August 10, 2010, the Advance payment of EITC was repealed, effective after December 31, 2010.

Third-Child EITC

The American Recovery and Reinvestment Act (ARRA) increased the EITC by 5% for families with three or more children.  The original law provides for EITC equal to 40% of the family’s first $12,570 when there are two or more children, and ARRA provided this additional credit for a third child (or more).  This provision was set to expire at the end of 2010, but the 2010 Tax Act extended the provision through the end of 2012.

Annual Limits

For 2011, the maximum EITC that can be claimed is increased to $5,751 from the 2010 level of $5,666.  In addition, the maximum income limit for EITC is increased to $49,078, up from $48,362 for 2010.  The credit varies by family size, filing status, and other factors, with the maximum credit going to joint filers with three or more children.

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Property Flipping Gains Deemed Ordinary Income, Not Capital Gains

Jan 3rd, 2011
by jblankenship.
1 comment

fixer upper by mike t ormsbySince the housing market downturn, the national pastime of “property flipping” has fallen in popularity – heck, I haven’t seen a TV show on property flipping in ages.  But the activity of buying a fixer-upper, applying a little sweat equity, and then reselling for a profit has been going on ever since Gog first rehabbed and sold that condo-cave with a view.

If you (or someone you know) are involved in flipping, there was a recent tax case that you may want to pay particular attention to.  In this particular case, the question of how the sales receipts are classified was addressed, and how the Tax Court responded should be of interest to anyone involved in flipping.

Here’s how it played out:  the taxpayer asserted (among other things), that the activity of buying, rehabbing, and then reselling the properties was an investment activity, and so any gains should be treated as capital gains.  The IRS disagreed that this was investment activity, but rather a purchase and re-sell of inventory, and that the income from the activity should be treated as ordinary income.

The Tax Court agreed with the IRS.  The nature of the taxpayer’s buying and reselling activity, given that they bought and sold between four and eight properties per year, holding them for two to three months in most cases.  According to the Tax Court Memo, the following factors are used to determine whether an asset is a capital investment or if it is an item purchased with the sole intent to resell:

  1. The taxpayer’s purpose in acquiring the property
  2. The purpose for which the property was subsequently held
  3. The taxpayer’s everyday business and the relationship of the income from the property to the total income
  4. The frequency, continuity, and substantiality of sales of property
  5. The extent of developing and improving the property to increase the sales revenue
  6. The extent to which the taxpayer used advertising, promotion or other activities to increase sales
  7. The use of a business office for the sale of property
  8. The character and degree of supervision or control the taxpayer exercised over any representative selling the property
  9. The time and effort the taxpayer habitually devoted to the sales

For the full text of TC Memo 2010-261, click the link. But only do this if you’re a tax- or law-nerd, or if you’re having trouble sleeping.  Do not operate heavy machinery while reading this document.  You’ve been warned.

Apparently the factor in the above list that caused the greatest damage to the taxpayer’s assertion of investment activity is #4, frequency of sales.  In addition, the absence of any intent to lease the properties to generate returns underscores the case that the property was purchased solely to re-sell.

Since the taxpayer purchased and sold fifteen properties within three years and did not attempt to lease or hold the properties for a significant period of time, the Tax Court deemed that the taxpayer’s business activity would be most appropriately classified as “dealers of real estate”.  With that classification, the profits derived from sales (above the purchase price and rehab expenses) would be deemed to be ordinary income, subject to self-employment tax and ordinary income tax.

Other factors weighed on this decision, not the least of which was the fact that the profits from sales of properties constituted the primary source of income for the taxpayer during the period.

Understandably, given the much lower tax rate on capital gains versus ordinary income tax rates (not to mention the self-employment tax incurred), it would have been far better for the taxpayer if the profits had been considered capital gains.

As I understand it, in order to be truly successful at property flipping, volume is important.  Turning over properties quickly at a profit while putting as little money at risk for as short a period of time possible is the name of the game.  This can hardly be described as capital gains oriented activity – at least that’s what the Tax Court says.

Photo by mike t ormsby

A Good Reason to Not Convert to Roth

Dec 29th, 2010
by jblankenship.
2 comments

Claudius 41-54 AD by woody1778aWhile there are many reasons that it may be in your best interest to pay tax and convert funds from a traditional IRA to a Roth IRA, there are a few situations that you might want to keep in mind as you consider converting.

I covered Three Reasons You May Not Want to Convert to a Roth IRA in an earlier article, and here we’ll be talking about another – the probability of paying medical expenses from your traditional IRA.

Under current tax law, you are allowed to deduct medical expenses to the extent that the expenses exceed 7.5% of your Adjusted Gross Income (AGI).  In effect, if you utilized IRA distributions to pay for these medical expenses, everything above 7.5% of your AGI can be tax free after deduction.  This is much better than paying up to 35% on a Roth conversion and then using those funds later at no tax.

Since many of us can expect to pay a considerable amount for future medical expenses – whether for doctors and hospitals, or for nursing home costs, or even for in-home nursing care – it might make good sense to maintain a balance in a traditional IRA rather than converting all of it to a Roth IRA.

Either way, since the removal of the income limitation on Roth conversions is not restricted to 2010, you can do a conversion in 2011 or later years with no restrictions (at least under current law).

Photo by woody1778a

Tax Filing for 2010 Returns Will Start A Little Late for Some

Dec 27th, 2010
by jblankenship.
2 comments

799px-Glass_delay_lineSince the 2010 Tax Act was passed so late in the year, the IRS is having to delay the start of processing for some returns, since their systems have to be updated.  While most returns can begin being processed pretty much immediately in January, there are some that will have to be delayed for processing until sometime in mid- to late-February.

The three specific areas that will cause the delay are:

  • Taxpayers claiming itemized deductions on Schedule A.  Itemized deductions include mortgage interest, charitable deductions, medical and dental expenses, as well as state and local taxes.  In addition, itemized deductions include the state and local general sales tax deduction extended in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  The primary benefit is for folks who live in areas without state and local income taxes and is claimed on Schedule A, Line 5.
  • Taxpayers claiming the Higher Education Tuition and Fees Deduction.  This deduction for parents and students – covering up to $4,000 of tuition and fees paid to a post-secondary institution – is claimed on Form 8917.  However, the IRS emphasized that there will be no delays for millions of parents and students who claim other education credits, including the American Opportunity Tax Credit and Lifetime Learning Credit.
  • Taxpayers claiming the Educator Expense Deduction.  This deduction is for kindergarten through grade 12 educators with out-of-pocket classroom expenses of up to $250.  The educator expense deduction is claimed on Form 1040, line 23, or Form 1040A, line 16.

For those that fall into these categories, whether filing electronically or on paper, returns will not be processed until mid- to late-February.

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More On the One-Rollover-Per-Year Rule

Dec 24th, 2010
by jblankenship.
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Beethoven,_Ludwig_van_3This particular rule is one that can really cause you a lot of problems – and there’s no reason to run into problems with it, if you plan ahead and do things right.

One of the big reasons why this rule can cause so much heartache is because there is no way, procedurally, for the IRS to grant an exception, no matter what the circumstances are.  For example, in the 60-day-rollover rule, often the IRS may be in a position to grant an exception, especially if something awful happened to make you miss the deadline.  This sort of exception is not even a consideration for the One-Rollover-Per-Year rule. It just can’t be done.

Key Features of the One-Rollover-Per-Year Rule

You are allowed to roll over funds from one IRA or Qualified Retirement Plan to another, that’s a given… but you’re limited in how often you can do this, if you use the 60-day-rollover.  A 60-day or indirect rollover is when you take distribution from an IRA in the form of a check (or a deposit into a non-IRA account), and then within 60 days you deposit the funds into another IRA (or back into the same IRA).

The other way to rollover funds between IRAs, the preferred method, is called a trustee-to-trustee or direct transfer, where you don’t actually receive a check – the transfer is done between the first IRA and the second IRA, with no one else handling the money in between.  There is no limit to how many trustee-to-trustee rollovers you can do per year.

FYI, the IRS doesn’t even refer to these direct transfers as rollovers, generally speaking – they call them trustee-to-trustee transfers.  The “R” word is generally reserved for the indirect, 60-day type.

So – if you use an indirect rollover to move funds from one IRA to another, you now have limited yourself, with regard to those two IRAs.  You cannot rollover money from either IRA to any other IRA for 12 months – actually 365 days, 366 in leap years.

How about an example to ‘splain this a little better?

Examples

Situation 1: You have 3 IRAs: IRA A, IRA B, and IRA C.  There is $100,000 in each account. You wish to move half of the money from IRA A into IRA B.  If you take a withdrawal from IRA A of $50,000 and receive a check for it, you can then deposit the check into IRA B within 60 days, and the rollover is complete.

At this point, you cannot rollover any the remaining $50,000 in IRA A into IRA B or IRA C for 12 months.  You furthermore cannot rollover any of the current $150,000 that is now in IRA B into IRA A or IRA C for 12 months.  What you could do is rollover any amount you wish from IRA C into either IRA A or IRA B -  as long as IRA C hasn’t been involved in an indirect rollover within 12 months.

Situation 2: Same situation as above, except that you do a direct, trustee-to-trustee rollover of $50,000 from IRA A to IRA B.  You are not limited at this point for making any other move with the funds in any of your IRAs.  You could rollover the same $50,000 back into IRA A from IRA B if you wanted using either method, but the indirect rollover would put you back into the limit mode described above.  You are free to make any rollovers you wish at this stage, since you used the trustee-to-trustee transfer.

Situation 3: Same facts as in Situation 1 above, except that you change your mind about the rollover a week after you requested the check from IRA A, and you deposit it back into IRA A (without ever depositing into IRA B).  Regardless of the fact that you’re back where you started, this action is considered a rollover.  This has now limited your ability to successfully rollover any amount from IRA A for a period of 12 months.  The other IRAs are unaffected.

Situation 4: This one will be more complex, showing what might happen if you aren’t paying attention.  Same starting facts as the others. You do an indirect rollover of $50,000 from IRA A to IRA B on September 1, 2010.  So far so good.  But then, you decide you want to rollover the remaining $50,000 from IRA A into IRA C, and you do this on December 1, 2010.  Then in January of 2011, you figure out that what you’d really like is to rollover all of the funds from IRA C into IRA A instead, so you take the distribution of $150,000 from IRA C and deposit into your IRA A account within 60 days.

What is going to happen?  Well, if all of those things happened and none of the custodians stopped you, you would have to pay tax on a distribution of $50,000 (plus any growth on that amount) from IRA A in 2010.

Since the rollover of $50,000 from IRA A to IRA C was within the 12 month period, this would be considered a disallowed rollover and therefore a taxable distribution.  Since you pulled the money out before taxes were due, there is no additional consequence for your 2010 actions.  If you had waited until after April 18, 2011 you might have had to pay an additional 6% excess contribution tax on the $50,000 disallowed rollover, since this would be considered a regular contribution to IRA C.

But part of the rollover from IRA C to IRA A, the amount less than the disallowed excess contribution and any associated growth, would be allowed as a completed rollover.  Remember the prohibition is on rollovers from the involved accounts, and since IRA C had not been involved in a valid rollover within 12 months (since the rollover from IRA A had been disallowed), this amount is a valid rollover.  You’d still have to pull out the $50,000 (plus growth) from IRA A to avoid excess contribution tax.

In all of the situations above where the distribution became taxable, there could also be the 10% early distribution penalty applied unless one of the exceptions is met.

Admonition

So – what’s the lesson here?  Never, ever, ever do a 60-day rollover unless there is some mitigating circumstance that requires it.  And if you have to do the indirect 60-day rollover, make sure that you mind your p’s and q’s with the accounts involved, so that you don’t get hung up on the one-rollover-per-year rule.  Often, the IRA custodian will step in and explain the prohibition to you, but not always, and they’re not responsible for your actions.  If you do this and they let you get away with it, the entire tax bill is yours and yours alone.

Photo by Wikimedia
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