Important Times to Seek Assistance

Waiting for your regular appointment to discuss current tax-related issues can create problems or cause you to miss out on beneficial options that need to be timely exercised before year-end. Generally, you should call this office any time you have a substantial change in taxable income or deductions. By doing so, we can advise you about how to optimize your tax liability, avoid or minimize penalties, estimate and pre-pay required taxes, document deductions, and examine and explore tax options. You should call this office if you or your spouse:

• Receive a large employee bonus or award
• Become unemployed
• Change employment
• Take an unplanned withdrawal from an IRA or other pension plan
• Retire or are contemplating retirement
• Exercise an employee stock option
• Have significant stock gains or losses
• Get married
• Separate from or divorce your spouse
• Sell or exchange a property or business
• Experience the death of a spouse during the year
• Turn 70½ during the year
• Increase your family size through birth or adoption of a child
• Start a business or acquire a rental property
• Receive a substantial lawsuit settlement or award
• Get lucky at a casino, lotto, or game show and receive a W-2G
• Plan to donate property worth $5,000 ($500 if a vehicle) or more to a charity
• Plan to gift more than $13,000 to any one individual during the year

In addition, you should call whenever you receive a notice from the government related to your tax return. You should never respond to a notice without first checking with our office.

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September 2012 Due Dates

Individual Due Dates

September 1 - 2012 Fall and 2013

Tax Planning Contact our office to schedule a consultation appointment.

September 17 - Estimated Tax Payment Due

The third installment of 2012 individual estimated taxes is due. Our tax system is a “pay-as-you-go” system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the “pay-as-you-go” requirement. These include:

• Payroll withholding for employers;
• Pension withholding for retirees; and
• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is equal to the federal short-term rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis.

Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than the $1,000 de-minimis amount, no penalty is assessed. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:

• The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.
• The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for higher-income taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.

Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception.

However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. Since you prepaid $5,600, which is greater than the 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.

This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. Timely payment of each required estimated tax installment is also a requirement to meet the safe harbor exception to the penalty. If you have questions regarding your safe harbor estimates, please call our office as soon as possible.

CAUTION: Some state de-minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call our office for particular state safe harbor rules.

September 2012 Business Due Dates

September 1 - 2012 Fall and 2013 Tax Planning

Contact our office to schedule a consultation appointment.

September 17 - Corporations

File a 2011 calendar year income tax return (Form 1120 or 1120-A) and pay any tax, interest, and penalties due. This due date applies only if you timely requested an automatic 6-month extension.

September 17 - S Corporations

File a 2011 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you requested an automatic 6-month extension.

September 17 - Corporations

Deposit the third installment of estimated income tax for 2012 for calendar year corporations.

September 17 - Social Security, Medicare and withheld income tax

If the monthly deposit rule applies, deposit the tax for payments in August.

September 17 - Nonpayroll Withholding

If the monthly deposit rule applies, deposit the tax for payments in August.

September 17 - Partnerships

File a 2011 calendar year return (Form 1065). This due date applies only if you were given an additional 5-month extension. Provide each partner with a copy of K-1 (Form 1065) or a substitute Schedule K-1. September 17 Fiduciaries of Estates and Trusts File a 2011 calendar year return (Form 1041). This due date applies only if you were given an additional 5-month extension. If applicable, provide each beneficiary with a copy of K-1 (Form 1041) or a substitute Schedule K-1.

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Take Advantage of Education Tax Benefits

The tax code includes a number of incentives that, with proper planning, can provide tax benefits while you, your spouse, or children are being educated. Which of these options will provide the greatest tax benefit depends on each individual’s particular circumstances. The following is an overview of the various possibilities.

Student Loans—A major planning issue is how to finance your children’s education. Those with substantial savings simply pay the expenses as they go while others begin setting aside money far in advance of the education need, perhaps utilizing a Coverdell account or Sec. 529 plan. Others will need to borrow the funds, obtain financial aid, or be lucky enough to qualify for a scholarship. Although student loans provide one ready source of financing, the interest rates are generally higher than a home equity debt loan, which can also provide a longer repayment term and lower payments.

When choosing between a home equity loan or student loan, keep in mind the following limitations: (1) Interest on home equity debt is deductible only if you itemize, and then only on the first $100,000 of debt, and not at all to the extent that you are taxed by the alternative minimum tax; and (2) student loans must be single-purpose loans—the interest deduction is available even if you do not itemize but is limited to $2,500 per year, and the deduction phases out for joint filers with income (AGI) between $110,000 and $140,000 ($55,000 to $70,000 for unmarried taxpayers). After 2012, unless Congress extends the current rules, the income ranges at which the deduction phases out will be $60,000 to $75,000 for married joint ($40,000 to $55,000 for others), and the deduction will be limited to the first 60 months that the interest payments are required.

Gifting Low Basis Assets—Another frequently used tax strategy to finance education is to gift appreciated assets (typically stock) to a child and then allow the child to sell the stock to pay for the education. This results in transferring any gain on the stock to the child at a time when the child has little or no other income; tax on the gain is avoided or is at the child’s low rate. However, with the lowest of the long-term capital gains rates being zero for tax years 2008 through 2012, Congress moved to curtail income shifting to children by making most full-time students under the age of 24 subject to the “kiddie tax.” This effectively taxes their unearned income at their parents’ tax rates and makes the gifting of appreciated assets to a child less appealing as a way to finance college expenses.

Education Credits - The tax code provides tax credits for post-secondary education tuition paid during the year for the taxpayer and dependents. Currently, there are two types of credits: the American Opportunity Credit, which is limited to any four tax years for the first four years of post-secondary education and provides up to $2,500 of credit for each student (some of which may be refundable), and the Lifetime Learning Credit, which provides up to $2,000 of credit for each family each year. The American Opportunity Credit is phased out for joint filers with incomes between $160,000 and $180,000 ($80,000 to $90,000 for single filers). The phaseout ranges for the Lifetime Learning Credit are $104,000–$124,000 for married joint and $52,000–$62,000 for others. Neither credit is allowed for married individuals who file separately. Careful planning for the timing of tuition payments can provide substantial tax benefits. NOTE: Unless Congress takes action, the American Opportunity Credit will not be available for tax years after 2012, but the Hope Credit, which applied before 2009 and allows credit for only the first two years of college tuition and at a lesser amount, will be reinstated.

Tuition Deduction - Prior to 2012, another option—and one that could possibly be extended by Congress—was an above-the-line deduction for qualified higher education tuition and related expenses of the taxpayer, spouse, or dependents. The maximum deduction annually was $4,000 if income was no more than $130,000 for married joint filers or $65,000 for others. A lesser maximum deduction of $2,000 applied for joint filers with income over $130,000, but not more than $160,000; for other filers, the income range was over $65,000 and up to $80,000. No deduction was allowed if married filing separately. Whether this deduction will be extended by Congress is uncertain at the time of the writing of this article.

Education Savings Programs—For those who wish to establish a formalized long-term savings program to educate their children, the tax code provides two plans. The first is a Coverdell Education Savings Account, which allows the taxpayer to make $2,000 annual nondeductible contributions to the plan. The annual contribution limit will revert to $500 after 2012 unless Congress acts. The second plan is the Qualified Tuition Plan, more frequently referred to as a Sec. 529 plan, with annual contributions generally limited to the gift tax exemption for the year ($13,000 in 2012). Both plans provide tax-free earnings if used for qualified education expenses. When choosing between a Coverdell or Sec. 529 plan, keep the following in mind: (1) Coverdell accounts can be used for kindergarten through post-secondary education through 2012 and become the property of the child at age of majority, and contributions are phased out for joint filers between $190,000 and $220,000 ($95,000 and $110,000 for others) of income (AGI); and (2) Sec. 529 plans are only for post-secondary education, but the contributor retains control of the funds. If Congress does not extended current rules for Coverdell accounts, tax-free use of the funds for elementary and secondary school expenses will not apply after 2012, and the income phaseout ranges for limiting contributions by married joint filers will be lower.

Educational Savings Bond Interest—There is also an exclusion of savings bond interest for Series EE or I Bonds that were issued after 1989 and purchased by an individual over the age of 24. All or part of the interest on these bonds is exempt from tax if qualified higher education expenses are paid in the same year that the bonds are redeemed. As with other benefits, this one also has a phase-out limitation for joint filers with income between $109,250 and $139,250 ($72,850 and $87,850 for unmarried taxpayers, but those using the married filing separately status do not qualify for the exclusion). The exclusion is computed on IRS Form 8815, Exclusion of Interest from Series EE and I U.S. Savings Bonds Issued After 1989.

If you would like to learn more about these benefits and how the impending tax changes may affect your use of them, or to work out a comprehensive plan to take advantage of these benefits, please give our office a call.

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Middle-Class Tax Cuts: Will Congress Act Soon?

So who does President Obama see as the middle class? He has repeatedly used earnings of $250,000 for married couples and $200,000 for single individuals as the threshold for what he considers the wealthy and those who should not benefit from tax cuts.

He reiterated that on July 9 by calling for a one-year extension of the Bush-era tax cuts for those earning under $250,000 per year. However, the Republicans continue to insist on a one-year extension for all taxpayers. The Republicans argue that no one should see a tax hike this year, not families, not small businesses and other job creators.

The Republican-controlled house has indicated its intent to pass a one-year extension of the Bush-era tax cuts for all taxpayers while the Democratic-controlled Senate intends to pass an extension limited to taxpayers with incomes under $250,000 before the August recess. The result will be a stalemate. That means we will have to wait for a compromise bill later in the year.

This spring, at a speech before the National Press Club, the Commissioner of the Internal Revenue Service, Doug Shulman, warned of “a real disaster” if Congress misses the December 31 deadline to decide on major tax provisions. Mr. Shulman reminded everyone that the 2010 “lame duck” session deadlock to extend the Bush tax cuts for 2011 resulted in a delayed start for the 2011 tax season.

The Bush tax cuts currently set to expire at the end of 2012 include:

• Reduced individual tax rates (10%, 15%, 25%, 28%, 33%, and 35%).
• Reduced long-term capital gain rates (maximum 15%, but 0% for some taxpayers).
• Reduced qualified dividend rate (15%/0%).
• No phase-out for personal exemptions (the personal exemption phase-out, or “pep,” limitation).
• No phase-out for itemized deductions.
• Expanded tax credits, including the earned income tax credit (EITC), child tax credit, adoption credit, and dependent care tax credit.
• Reduced marriage penalty (i.e., increased standard deduction and upper limit of the 15% bracket for married taxpayers to 200% of that for singles and an increased income level at which the EITC begins to be phased out).
• Modified education tax incentives (including Coverdell education saving accounts, the American Opportunity Credit, the student loan interest deduction, favorable tax treatment of certain scholarships and fellowships, and an exclusion for employer-provided educational assistance).

What happens if those provisions are allowed to expire and what happens to taxpayers who earn more than $250,000 if Obama’s proposal succeeds?

• Individual income tax rates will rise to 15%, 28%, 31%, 36%, and 39.6%.
• Long-term capital gains will be taxed at a maximum rate of 20%.
• Dividends will be taxed as ordinary income.
• The limit on personal exemptions will be restored such that, for higher-income taxpayers, the total amount of exemptions that can be claimed will be reduced by 2% for each $2,500 by which the taxpayer's adjusted gross income (AGI) exceeds a certain inflation-adjusted threshold.
• The limit on itemized deductions will be restored such that, for higher-income taxpayers, the total amount of itemized deductions will be reduced by 3% of the amount by which the taxpayer's AGI exceeds a certain inflation-adjusted threshold.
• The child tax credit, adoption credit, and dependent care tax credit will all be cut back.
• The standard deduction and upper limit of the 15% bracket for married couples will fall from 200% to 167% of the deduction and upper limit for unmarried taxpayers, and married taxpayers will be subject to the same EITC phase-out levels as unmarried taxpayers.
• The education incentives will disappear altogether or be significantly cut back.

The Bush tax cuts are not the only things at stake. There are a number of other provisions that will change, most notably the alternate minimum tax, which, without an extension of the increased exemption amounts, will ensnare millions of middle-income taxpayers.

If you have questions or wish to explore strategies to hedge against whatever Congress decides to do – or not do – please give our office a call.

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Raising Cash in Tough Times

A housing market that has not recovered from the big price drops that began several years ago, long-term unemployment, and a still wobbly economy mean tough times for cash-strapped individuals seeking to raise money for an immediate financial need. Compounding the misery is the fact that many people have locked away the lion's share of their savings in a tax-favored retirement vehicle, such as a company profit-sharing or 401(k) plan, IRA, SEP, SIMPLE IRA, or Roth IRA. And getting at that money in order to resolve a pressing financial crisis before 59 1/2 years of age is not easy and can be financially painful.

In general, tapping into a profit-sharing plan, IRA, SEP, or SIMPLE IRA requires a taxpayer to pay the tax on the amount withdrawn and, unless a taxpayer meets one of the limited exceptions, a 10% early withdrawal penalty. To make matters worse, if the taxpayer lives in a state with an income tax and possibly a state early withdrawal penalty, the overall amount of the withdrawal that goes to pay taxes and penalties can approach 50% of the amount withdrawn. (Note: Certain amounts of Roth IRAs and some Traditional IRAs can be withdrawn without paying tax or penalty).

There are generally only two ways for active employees who are under 59 1/2 years of age to tap into their account balances in 401(k) plans: take a loan from the plan or take a hardship withdrawal, if they are eligible to do so. But just because the plan may permit a withdrawal for hardship does not mean that the withdrawal will avoid either being taxed or subject to the early withdrawal penalty.

401(k) Loans—Borrowing money is not considered a taxable event since it is merely a loan. However, loans must be paid back, and if a taxpayer subsequently defaults on a 401(k) loan, the loan becomes a taxable distribution that is subject to tax and penalties. An often-overlooked hazard to a 401(k) loan is the possibility of leaving employment with the plan’s sponsoring employer, at which time the loan would need to be paid in full or it would become a taxable distribution that is subject to the usual penalties.

Hardship Distributions—The law places limits on distributions to participants of 401(k) and similar plans, which are usually granted when the employee separates from service (retires, changes jobs), dies, becomes disabled, or reaches 59 1/2 years of age. For some plans, a hardship distribution may be permitted. A distribution is treated as made after an employee's hardship only if it is made on account of the hardship, which in turn requires the distribution to be:

• Made on account of an immediate and heavy financial need of the employee; and
• Necessary to satisfy that financial need.

What is an immediate and heavy financial need? According to IRS safe harbor rules, a distribution is treated as made on account of an immediate and heavy financial need if made for:

1. Expenses for (or necessary to obtain) deductible medical care (which includes expenses for the care of a spouse or dependent);
2. Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
3. Payment of tuition, related educational fees, and room and board expenses for up to the next 12 months of post-secondary education for the employee or the employee's spouse, children, or dependents;
4. Payments necessary to prevent the employee's eviction from his or her principal residence or foreclosure on the mortgage on that residence;
5. Payments for burial or funeral expenses for the employee's deceased parent, spouse, children, or dependents; or
6. Expenses for the repair of damage to the employee's principal residence that would qualify for the casualty deduction.

Maximum Distributable Amount—A hardship distribution cannot exceed the maximum distributable amount, which includes the employee's total elective contributions on the distribution date, reduced by any previous distributions of elective contributions. It also may include employer contributions, depending on how those contributions are made (i.e., matching or non-elective) and how the plan is organized. Not all plans are the same; thus, the employer will need to be consulted.

Obtaining a hardship distribution from a 401(k) plan is not easy and should not be used as a means of rising needed cash if other sources are available. The plan participant should keep in mind that:

• The taxpayer’s definition of hardship may not correspond with the plan's definition.
• If the plan uses the safe harbor method of treating a distribution as necessary to meet an immediate and heavy financial need, the plan participant will be barred from making elective contributions (and will therefore forfeit any matching contributions from the employer) for a period of at least six months.
• The taxpayer may need to take a loan from the 401(k) plan first before he or she can take a hardship distribution.
• Depending on how the plan is organized, the taxpayer may not be able to withdraw his or her entire balance.
• The taxpayer will lose the tax-deferred earnings buildup forever that would have accrued on the hardship withdrawal had it not been made.
• The taxpayer will have to pay tax at ordinary income rates on the withdrawal (assuming that he or she has made no after-tax contributions) and most likely a 10% premature withdrawal tax as well.

Using funds meant for your retirement can have long-term consequences that should be carefully considered. Before tapping into your retirement funds, we urge you to contact our office so that we can help minimize the damages and avoid penalties wherever possible.

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Keep Track of Your Basis

Regarding taxes, there is a saying to the effect that “those who keep records win.” If you are an investor, you may have a variety of securities, including stocks, bonds, and mutual funds. When you sell those securities, you want to minimize your gains or maximize your losses for tax purposes. Gains or losses are measured from your tax basis in the investment (asset), making it important to keep track of the basis in all of your investments.

What is Basis? Generally, your basis in an investment begins with the price that you paid to purchase the investment. However, this will not be the case if the investment was acquired as a gift or through an inheritance For inherited assets, the basis generally begins with the FMV of the asset on the decedent’s date of death or an alternative valuation date, if chosen by the executor of the estate (special rules not covered in this article apply to property inherited from a decedent who died in 2010, if the executor elected the “no estate tax” provision. In such cases, the executor will have advised the beneficiaries of the basis of each inherited asset.)

Assets acquired as gifts actually have a basis for gain (the donor’s basis) and a basis for loss (the fair market value of the asset on the date of the gift). When an asset is acquired through a division of property in a divorce, the asset retains the basis it had when it was owned jointly by the divorcing couple.

Basis is not a fixed value; it can change during the time an asset is owned and is adjusted by certain events. For an investment asset, these events include:

• Reinvested cash dividends
• Stock splits and reverse splits
• Stock dividends
• Return of capital
• Additional investments
• Broker’s commissions
• Interest previously taken into income under an election under the accrued market discount rules
• Interest taken into income under the original issue discount rules
• Attorney fees
• Acquisition costs
• Depletion
• Casualty losses, etc.

These events can increase or decrease the tax basis of an investment, which makes adequate record keeping very important.

Another issue associated with basis arises when only a portion of an investment is sold. For example, in a scenario where 100 shares of a particular stock were purchased in 2008 at $10 a share and another 100 shares in 2010 at $20 a share, and the investor plans on selling 100 shares of the stock at $30 a share, using the general rule of “first in - first out,” there would be a $20 per share gain. However, if the investor can identify each specific block of stock sold, such as the 100-share block purchased in 2010, there would only be a $10 per share profit. This is known as the “specific identification” method.

Beginning with stock purchased in 2011 and mutual funds purchased in 2012, stock brokers are required to keep records of investor purchase prices and report them to the IRS when stocks or funds are sold. If an investor switches brokers, the former broker must pass this information over to the new broker. However, there will still be instances when the basis in the broker’s records may not be accurate. For example, if stock was acquired in a joint account and one of the owners dies, the basis is adjusted as of the date of death. If the broker is unaware of this change, the amount reported to the IRS will be incorrect. Additionally, for purchases made prior to 2011 (or 2012 for funds), the broker is not required to report the basis to the IRS, but many brokers do provide an annual schedule of realized gains and losses as a convenience to their clients. Ultimately, however, the taxpayer is responsible for reporting the correct basis on their tax return when a stock is sold, so even if your broker provides basis information for stocks or funds that you’ve sold, you should verify the information’s accuracy with your own records.

The following is a discussion of commonly encountered basis adjustments where record keeping is essential:

• Reinvested cash dividends – Investors are frequently given the opportunity to reinvest their dividends rather than taking them in cash. By participating in these plans, investors are actually purchasing additional shares with their taxable dividends. Generally, the first shares acquired are considered to be the first ones sold. However, if certain conditions are met, investors may use an average cost basis for shares acquired in a dividend reinvestment plan after December 31, 2010. In either case, unless records are kept, an investor will be unable to prove how much he or she paid for shares or establish the amount of gain that is subject to tax (or the amount of loss that can be deducted) when shares are sold.
• Stock dividends – It is possible to receive both taxable and nontaxable stock dividends. Stock dividends that are taxable provide the investor with additional stock, with a basis equal to the taxable stock dividend. If the dividends are nontaxable, the number of shares that are owned increases, but the basis remains unchanged. If the investor can associate the dividends with a specific block of stock, then the basis of that block can be adjusted accordingly. If not, the adjustment will apply to the entire holdings in that particular stock.
• Return of capital – A return of capital is a nontaxable return of a portion of an investment. Thus, a return of capital will reduce the investor’s basis in a security. Suppose, for example, that an investor has 100 shares of XYZ Corporation at a cost of $1,000 ($10 per share), and the corporation distributes to him a $100 nontaxable return of capital. His basis in the stock will be reduced to $900 ($1,000 - $100), or $9.00 per share. If, over a period of time, the return of capital exceeds his basis in the investment, then the excess becomes taxable because he cannot have a negative basis.
• Stock splits – Stock splits can be confusing if they are not tracked as they occur. Let us assume that an investor owns 100 shares of XYZ Corporation, for which he paid $2,000 ($20 a share). Later, the corporation splits the stock, 2 for 1. The result is that he now owns 200 shares, but his basis in each has been reduced to $10 per share (200 shares times $10 equals $2,000 – what was paid for the original shares). This generally occurs when the “per share value of stocks” becomes too high for small investors to purchase 100 share blocks. Also, watch for reverse splits, which have the opposite effect.
• Stock spin-off – Occasionally, corporations will spin-off additional companies. The most classic such example is the break up of AT&T many years ago into regional phone companies, who themselves later split into additional companies or merged with others. Every time one of these types of transactions takes place, the corporation will provide documentation as to how to split the prior basis between the resulting companies. Tracking these events as they happen is very important, as it may be difficult to reconstruct the information several years down the road.
• Broker fees – Although broker fees are a deductible expense, they are generally already accounted for in most stock and bond transactions. The purchase price of a block of stock generally includes the broker fees, and the sales price reported to the IRS (gross proceeds of sale) is the net of the sales costs.

Depending upon the investment vehicle, tracking the basis of an investment can be quite complicated. If you have any questions, please contact our office.

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Inheritances Can Be Tricky

If you have received an inheritance or anticipate receiving one in the future, this article may answer many of the questions you might have. The process of claiming an inheritance can be quite complex, and it helps to understand the basics and be aware of potential tax liabilities. NOTE: Special rules, not covered in this article, will apply if the decedent’s death occurred during 2010 and the executor elected to apply the “no estate tax” rules available at that time (usually this occurred only if the estate was valued at more than $5 million). If you are a beneficiary under this condition, the executor should provide you with additional information as to the basis of the property you inherited.

An inheritance is generally received after all applicable taxes have been paid, along with any outstanding liabilities the decedent may have had. Exactly how the estate is handled will depend upon whether the assets were owned individually or in a trust. Without going into the intricacies of estates, trusts, and probate, the result for a beneficiary will generally be the same. Inherited items on which the decedent had already paid taxes and which the estate tax (if any) has been paid will pass to the beneficiary tax-free. On the other hand, items of income that have not previously been taxed to the decedent, as well as any appreciation or depreciation of assets acquired from the decedent, will have tax implications. Some possible scenarios are provided below:

• Bank Account – Take for instance, an inherited bank account worth $25,000, where the funds are not immediately distributed to the heir. The $25,000 account earns $375 of interest income after the decedent’s date of death. Out of the $25,375 that is received, the $25,000 is tax-free but the $375 is taxable as interest income. Any future earnings on the $25,000 inheritance are also taxable.
• Capital Asset – The basis for gain or loss resulting from the sale of an inherited capital asset, such as stock, real estate, collectibles, and so forth, is generally based on the value of the asset at the time of the decedent’s death. That is one reason that qualified appraisals are so important.

To explain this further, let us assume that a vacant parcel of land is inherited, with a date of death appraisal that values it at $15,000. If that property is sold for a net price of $15,000, there will have been neither gain nor loss and the $15,000 is tax-free to the beneficiary (the transaction, however, must still be reported by the beneficiary on his or her tax return). If, on the other hand, the net sales price is more or less than the $15,000, there would be a reportable capital gain or loss. For capital gains tax purposes, the holding period is important. Assets held for over one year are generally taxed substantially less than those held for shorter periods of time are. However, for inherited property, the beneficiary receives long-term treatment immediately, whether or not the decedent or the beneficiary has held it for over one year. If there are expenses associated with selling the asset, then those expenses are deductible in calculating the gain or loss.

• IRA or other Qualified Plan – Suppose the decedent had a traditional IRA account and the distributions from that account were taxable to the decedent. If you were to inherit that account, the distributions would be taxable to you as the beneficiary. Why is that? Because the decedent never paid taxes on the income that went to fund the traditional IRA, and therefore you, the beneficiary, will be stuck with the tax liability. The good news is that there are options for payment over a number of years, which can soften the tax blow.
• Life Insurance Proceeds – Generally, the proceeds from a life insurance policy are tax-free to the heirs. However, if the policy is not paid immediately, as most are not, the insurance company will include interest. That interest is taxable to the heirs.
• Annuities and Installment Sale Notes – If the decedent purchased an annuity or had an installment sale note from the property he previously sold, the decedent’s basis would be tax-free but the heirs would be obligated to pay the tax on any amount received in excess of the decedent’s basis. For an annuity, the decedent’s basis would be what he or she paid for it. For an installment note, payments include: (1) a return of a portion of the asset’s cost (basis) which is not taxable, (2) a portion from the prior sale of the asset that is taxable as a capital gain, and (3) taxable interest on the note.

A trust or estate is required to file an income tax return and to report income earned by the estate or trust after the decedent’s passing and prior to distribution of the assets to the heirs. Each heir will generally receive a form called Schedule K-1(1041), which will include specifications regarding the heir’s share of income that must be included on the heir’s individual tax return. Although infrequently occurring (because the taxes are generally higher), the trust or estate may pay the income tax on the income. The executor or trustee is responsible for making sure the required tax returns are filed, and for sending K-1s to the heirs.

There may be taxable income to the heir even though the inheritance has not yet been received. In addition, there are other factors to consider that have not been discussed.

If you have questions regarding the treatment of an inheritance you’ve received or are expecting to receive, please contact our office.

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How the Health Care Law Will Impact Your Taxes

There has been a great deal of media coverage related to the US Supreme Court upholding the Affordable Care Act, also known as the Health Care Law. The media coverage was generally political and failed to explain the details of how the law will impact individuals. If you are interested in political rhetoric as to whether it is a tax, penalty, or a forced purchase, look no further. The intent of this article is to explain how the Affordable Care Act will impact your pocketbook in 2013, when the health care taxes kick in, and in 2014, when the mandatory insurance requirement becomes effective. Here are the details for 2013:

• Increased Hospital Insurance Tax—Part of the taxes withheld on employees’ wages covers the Hospital Insurance (HI) portion of their contribution to Medicare; self-employed individuals pay the HI tax as part of the self-employment tax that is included in their tax return. The HI tax rate (currently at 1.45% for employees and 2.9% for self-employed individuals) will increase by 0.9 percentage points on individual taxpayer earnings (wages and self-employment income) in excess of compensation thresholds for the taxpayer’s filing status. Thus, the wage withholding HI rate will be 1.45% up to the income threshold noted below and 2.35% (1.45 + 0.9) on amounts in excess of the income thresholds. The hospital insurance portion of the SE tax rate will be 2.9% up to the income threshold and 3.8% (2.9 + 0.9) on amounts in excess of the threshold. The income threshold at which this increase begins is $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers. Impact: Higher income working families.For married taxpayers, this additional tax is based upon their joint income. However, if both spouses work, their employers will only base the withholding on the employee’s individual earnings. Thus, married taxpayers who both work may find themselves under-withheld on HI taxes and will therefore be required to pay the uncollected HI tax on their income tax return when it is filed. They may need to take steps to increase income tax withholding or pay or increase estimated taxes in order to compensate.
• Surtax on Unearned Income—A new surtax called the Unearned Income Medicare Contribution Tax is imposed on the unearned income of individuals, estates, and trusts. For individuals, the surtax is 3.8% of the lesser of:
1. The taxpayer’s net investment income or
2. The excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others).
   
   "Net” investment income is investment income reduced by allowable investment expenses. Investment income includes income from interest, dividends, annuities, royalties, rents (other than those derived from a trade or business), capital gains (other than those derived from a trade or business), trade or business income that is a passive activity with respect to the taxpayer, and trade or business income with respect to the trading of financial instruments or commodities. For surtax purposes, modified adjusted gross income does not include excluded items, such as interest on tax-exempt bonds, veterans' benefits, and excluded gains from the sale of a principal residence. Impact: Higher income families.In order to avoid or minimize this new tax, higher income taxpayers may wish to alter their investment portfolios to include more of the non-taxable investments mentioned above.
   
   Homeowners should be aware that the gain from the sale of their primary home in excess of the homeowner’s gain exclusion or gain from selling a second home is treated as investment income and would be subject to this new tax.
• Deductible Medical Expenses Threshold Increases—Beginning in 2013, for taxpayers under the age of 65, the AGI threshold percentage for claiming medical expenses on a taxpayer’s Schedule A will increase from 7.5% to 10%, which is the same as the current threshold percentage for alternative minimum tax (AMT) purposes. Individuals (and their spouses) age 65 (before the close of the year) and older will continue to use the 7.5% rate through 2016. Thus, it may be appropriate to pay outstanding medical bills or pre-pay such things as orthodontics for a child before the AGI threshold increases to 10%. In addition, if you are considering elective deductible medical procedures, such as laser eye surgery, it may be beneficial to have the procedure and pay for it in 2012. Impact: All taxpayers (except seniors for now) who itemize their medical expenses.
• Employer Health FLEX-Spending Plan Contributions Limited—In order for a health flexible spending account (FSA) to be a qualified benefit under a cafeteria plan, the maximum amount available for the reimbursement of incurred medical expenses of an employee, the employee's dependents, and any other eligible beneficiaries with respect to the employee under the health FSA for a plan year (or other 12-month coverage period) cannot exceed $2,500. Impact: All taxpayers participating in health FSAs.
  Some taxpayers or employers may wish to consider establishing Health Savings Accounts or Medical Expense Reimbursement Plans to write off newly-disallowed medical expenses as a result of the increased medical deduction AGI limitation and the reduced benefits from the employer’s health flex-spending plans.

Beginning in 2014, all U.S. citizens and legal residents, except for those who are exempt from the requirement, will have to maintain minimum essential health insurance coverage or pay a penalty. Generally, individuals who are covered by health insurance through their employers will have met the mandate. Impact: Lower income individuals and families not exempt from the requirement.

Those exempt from this requirement include low income individuals and families (for whom the cost of minimum required coverage exceeds 8% of their annual income), those not required to file a Federal tax return because their income is below the filing threshold, those who are unlawfully present in the United States, incarcerated individuals, Indian tribal members, religious objectors, and individuals with hardship waivers.

Minimum essential coverage generally includes:

• Private market plans
• Government sponsored programs (e.g., Medicare, Medicaid, Veterans Administration, etc.)
• Eligible employer-sponsored plans
• American Health Exchange “bronze” coverage (pays 60% of covered expenses)

According to the American Health Benefit Exchange, by 2014, each state must establish an Exchange to help individuals and small employers obtain coverage. Benefit options will be in a standard format, and a single enrollment form will be used for all policies. Plans offered through an Exchange must provide essential health benefits, limit cost sharing, and provide specified accrual benefits (i.e., the percentage amount paid the insurer). Out-of-pocket deductibles are limited to the same amounts as the caps for Health Savings Accounts and are further limited to $2,000 ($4,000 for families) in the small group market. Plans in the individual and small group markets use a metallic designation for the accrual benefits provided:

• Bronze 60%
• Silver 70%
• Gold 80%
• Platinum 90%

The law provides a premium assistance credit for low-income families whose household income is at least 100%, but not more than 400% of the federal poverty line, and who do not receive health insurance under an employer plan, Medicaid, or other acceptable coverage. Based upon the 2011 poverty levels, the credit would phase out at $43,560 for individuals and $89,400 for a family of four. Eligibility for the premium assistance credit will be based on the individuals income for the tax year ending two years prior to the enrollment period.

 

The credit, which will be paid by the government directly to the insurance company, is based on the taxpayer's household income level relative to the federal poverty line. The calculation is computed on a sliding scale starting at 2.0% of income for taxpayers at or above 100% of the poverty line and phasing out to 9.5% of income for those at 400% of the poverty line. The reference premium will be the second lowest cost silver plan available in the individual market in the rating area in which the taxpayer resides.

 

The penalty for individuals required to purchase insurance who fail to do so will be phased in beginning in 2014 and will be fully implemented in 2016. The penalty for noncompliance is the greater of:

• The sum of the monthly penalty amounts for months in the taxable year during which 1 or more such failures occurred, or
• An amount equal to the national average premium for qualified health plans that have a bronze level of coverage, provide coverage for the applicable family size involved, and are offered through Exchanges for plan years beginning in the calendar year with or within which the taxable year ends.

The monthly penalty amounts are based upon a complex formula (what else would one expect?) and is equal to the greater of an inflation adjusted flat dollar amount, which is $95 for 2014 and increases to $625 in 2016, or 1% of income increasing to 2.5% in 2016. However, in either case, the annual family penalty cannot exceed 300% of the individual maximum penalty for the year ($1,875 in 2016).

Household income refers to the sum of the incomes of the taxpayer and all individuals accounted for in the family size required to file a tax return for that year. Income includes all tax-exempt interest and foreign earned income.

The penalty will be included on the taxpayer’s individual income tax return for each year in which the individual has not complied with the insurance coverage requirement. Although the IRS is charged with the responsibility of collecting the penalty, the law prohibits the IRS from jailing taxpayers or seizing their property if they fail to pay it.

The foregoing is a very brief overview of the health care provisions for individuals and of how your pocketbook may be impacted beginning in 2013. However, the health care provisions not yet cast in stone. In fact, this is a hot political issue, so be sure to watch for further developments.

If you have questions or would like to schedule a tax planning appointment, please give our office a call.

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Important Due Dates to Remember in August

August 2012 Individual Due Dates

August 10 - Report Tips to Employer

If you are an employee who works for tips and received more than $20 in tips during July, you are required to report them to your employer on IRS Form 4070 no later than August 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.

August 2012 Business Due Dates

August 10 - Social Security, Medicare and Withheld Income Tax

File Form 941 for the second quarter of 2012. This due date applies only if you deposited the tax for the quarter in full and on time.

August 15 - Social Security, Medicare and Withheld Income Tax

If the monthly deposit rule applies, deposit the tax for payments in July.

August 15 - Non-Payroll Withholding

If the monthly deposit rule applies, deposit the tax for payments in July.

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What to Do If You Receive an IRS Notice

It’s a moment many taxpayers dread. A letter arrives from the IRS and it’s not a refund check. But don’t panic; many of these letters can be dealt with simply and painlessly.

Each year, the IRS sends millions of letters and notices to taxpayers to request payment of taxes, notify them of changes to their accounts, or request additional information. The notice you receive normally covers a very specific issue about your account or tax return. Each letter and notice offers specific instructions on what you are asked to do to satisfy the inquiry.

However, the letters also have to advise you of your rights and other information required by law. Thus, these letters can become overly lengthy and sometimes difficult to understand.

Here are dos and don’ts to follow if you receive correspondence from the IRS or state tax authority:

• Do immediately get a copy of the correspondence to this office so it can be reviewed and timely responded to.
• Don’t respond if the correspondence requests personal information. There has been substantial identification theft related to scam artists pretending to be the IRS or another authority, especially correspondence by e-mail. Let this office take a look before responding.
• Don’t procrastinate or throw the letter in a drawer, hoping the issue will go away. Most of these letters are computer-generated and, after a certain period of time, another letter will automatically be generated. And, as you might expect, each succeeding letter will become more aggressive and less easily dealt with.
• Don’t automatically pay an amount the correspondence is requesting unless you are positive you owe it. Quite often, you will not owe what is requested, and it will be difficult to get your payment back.

Most notices are computer-generated after comparing the income items reported on your return with those reported by the payers. For example, your employer sends you a W-2 every year and also sends a copy to the government so that your wages are on the IRS computer. Your bank sends the 1099-INT to the IRS showing how much interest you earned. Your brokerage firm reports your dividends with Form 1099-DIV and stock transactions with 1099-B forms. If you are self-employed, those who pay you $600 or more during the year are required to send you and the IRS a 1099-MISC, and if you have credit card transactions, the clearing house will issue a 1099-K. If you are retired and collecting a pension or drawing on your own IRA, a 1099-R will be sent to you. Lenders report how much interest you paid on your home loan during the year. If you are lucky enough to hit it big in Vegas, you will receive a 1099-G for your winnings. The list goes on and on, and if what you reported on your return doesn’t match what is on the IRS’s computer, you will receive a computer-generated notice.

One big problem that has developed over the years is the IRS’s willingness to allow payers to use substitute forms that are unrecognizable as income-reporting documents. Many of the brokerage firms are now providing their substitutes in letter-size documents printed front and back on multiple sheets that almost take a financial expert to understand. This results in frequent errors.

There are times when you may receive an income item and it appears to be taxable to the IRS, when in fact it is not. Here are some frequently encountered situations.

• Sold a security with no profit − Whenever you sell a security, the brokerage house will report the gross proceeds of sale to the IRS. In other words, the IRS has on their computer what you sold it for. For purchases made before 2011, they have no clue what you paid for it, which means you must report the sale on Form 8949 and Schedule D on your tax return. If you fail to report it, the IRS treats the entire sales price as a profit. Let’s say you sold 200 shares of stock, which originally cost you $5,050, for $5,000. You actually have a loss of $50. Unless you report the transaction and show that you paid $5,050 for the shares, the IRS is going to assume you had a $5,000 profit. This frequently occurs when taxpayers overlook a transaction or simply omit it because there was no profit. If this is what caused the notice, you will need to respond to the IRS to explain the mistake and provide verification of the stock’s original cost.
• Rollovers − Another frequent error is when you rollover an IRA, 401(k), etc. from one plan to another or one trustee to another. If you don’t show on the tax return that the distribution was rolled over, the IRS assumes the entire amount to be taxable. If these funds are transferred between trustees, a 1099-R is not supposed to be issued, but sometimes they still are. It is better to make sure. On the other hand, if you take possession of the funds and then redeposit them into another IRA, a 1099-R will be issued, and the rollover must be accounted for on the return. If this is what caused the notice, you will need to provide verification of the rollover to the IRS with your response.
• Shared accounts − Generally, banks and other financial institutions only have the capability of having one taxpayer ID as the primary owner on an account, even though it may be a joint account with others. These financial institutions will issue the 1099 or other reporting documents under the social security number (SSN) of the primary owner, and the total will be reported to the IRS under that SSN. This also will affect married or separated taxpayers who do not file jointly. The IRS expects to see the same amount that was reported on the 1099 on the return of the individual whose SSN was used on the 1099. When there’s a mismatch, the IRS will send out a notice of unreported income. When responding to the IRS notice, you will need to provide the names, addresses, and SSNs of the other owners and a statement to the fact that they each reported their appropriate share.

The foregoing are just a few of the more common examples of computer mismatches that can cause computer-generated notices. Even though the IRS feels the notices are readily understandable, experience has shown that taxpayers can become confused and that the experienced eye of a tax professional is usually required to decipher the notices. That is why we highly recommend that this office review any notice you receive prior to your taking any action or responding.

A Word of Caution − The IRS routinely provides state tax agencies with the results of the correspondence audits. Generally, if the IRS’s notice proves to be correct, the results of the correspondence audit will need to be dealt with on the state level through an amended state return, or you can wait to receive the state notice. However, if you wait for the state notice, additional interest and penalties may possibly accrue for the state return.

Please give our office a call if you have questions related to a correspondence you received from the IRS or state authority.

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Social Security Administration Launches New Online Tool

If you go back a few years, you may remember that every year, about three months before your birthday, you received an earnings and benefits statement from the Social Security Administration providing you with a history of your earnings and projected benefits. Then, along came a recession and the accompanying budget cuts and the mailing out of the statements stopped, except for workers age 60 and over.

The earnings and benefits statements provided a valuable annual reminder of what you can expect to receive and how benefits are calculated. It also prompts us all to make Social Security part of our long-range retirement plans.

New Retirement Tool Now Available - On May 1st, Michael J. Astrue, Commissioner of Social Security, announced that an online version of the Social Security Statement is now available at the Social Security Website. The new online statement provides eligible workers with secure and convenient access to their Social Security earnings and benefits information. The online statement also provides estimates for disability and survivors benefits, making the statement an important financial planning tool. People should get in the habit of checking their online statement each year, around their birthday.

In addition to helping with financial planning, the online statement also provides workers a convenient way to determine whether their earnings are accurately posted to their Social Security records. This feature is important because Social Security benefits are based on average earnings over a person’s lifetime. If the earnings information is not accurate, the person may not receive all the benefits to which he or she is entitled. The online statement also provides the opportunity to save or print the personalized statement for financial planning discussions with family or a financial planner.

To get a personalized online statement, people age 18 and older must be able to provide information about themselves that matches information already on file with Social Security. In addition, Social Security uses Experian, an external authentication service provider, for additional verification. People must provide their identifying information and answer security questions in order to pass this verification. Social Security will not share a person’s Social Security number with Experian, but the identity check is an important part of this new, robust verification process.

Once verified, people will create a “My Social Security” account with a unique user name and password to access their online statement. In addition, the portal also includes links to information about other online services, such as applications for retirement, disability, and Medicare.

It is important to note, however, that Social Security anticipates some members of the public will not be able to be verified through this process. Some people may not correctly answer the security questions based on information on file with Experian, and others may supply identifying information that does not match their Social Security records. In instances where this occurs, people will have the option to request that a hard copy of their Social Security Statement be mailed to them. People who cannot verify online initially also may visit their local Social Security office and present an identity document in order to create an account and gain access to the online version of the statement.

In February 2012, Social Security resumed mailing paper statements to workers age 60 and older if they are not already receiving Social Security benefits. Later this year, the agency plans to mail paper statements to workers in the year they reach age 25. For more information about the new online statement, please go to www.socialsecurity.gov/mystatement.com.

If you need more information related to Social Security credits and taxation of Social Security benefits please give our office a call.

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IRS Liberalizes Position on Local Lodging

In the past, a business deduction was allowed only for lodging when a taxpayer traveled away from his or her “tax home.” A taxpayer’s tax home is generally the location (such as city or metropolitan area) of a taxpayer’s main place of business (not necessarily the place where he/she lives).

This has long created problems for individuals attending conferences and training sessions within their tax homes that include extended-hour events that preclude traveling back home between days of the events. In 2007, the IRS announced that it would amend the regulations to allow certain temporary local lodging expenses to be treated as business expenses; now, five years later, the proposed regulation changes have recently been announced.

Proposed Changes - The IRS has issued proposed reliance regulations permitting certain non-away-from-home lodging expenses to be treated as deductible business expenses by employers and tax-free working condition fringe benefits or accountable-plan reimbursements to employees. The proposed regulations provide a safe harbor; local lodging expenses are treated as ordinary and necessary business expenses if all of these conditions are met:

1. The lodging is necessary for the individual to participate fully in or be available for a bona fide business meeting, conference, training activity, or other business function.
2. The lodging is for a period that does not exceed five calendar days and does not recur more frequently than once per calendar quarter.
3. If the individual is an employee, his or her employer requires him or her to remain at the activity or function overnight.
4. The lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.

Example: A business conducts business-related sales training sessions at a hotel and conference center near its main office. The employer requires both its field and in-house sales force to attend the training and stay at the hotel overnight for the bona fide purpose of facilitating the training. If the company pays the lodging costs directly to the hotel, the stay is a working condition fringe benefit to all attendees (even to employees who live in the area who are not on travel status) and the company may deduct the cost as an ordinary and necessary business expense. If the employees pay for the lodging costs and are reimbursed by the company, the reimbursement is of the accountable plan variety and is tax-free to the employees and deductible by the company as an ordinary and necessary business expense.

Example: If a locally-based self-employed consultant were required by a company to attend the sessions and stay at the hotel, he or she could deduct the expense if he or she paid for it himself or herself or exclude the expense if he or she were reimbursed by the company after accounting for it in full for his or her costs.

The new rules apply to expenses paid in prior years in cases in which the statute of limitations for claiming refunds is still open (generally, after 2008). Thus, returns can be amended for refund where a lodging deduction would have been allowed.

If you have questions related to how this change affects prior filed returns or how it will affect your business deductions going forward, please give our office a call.

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Do You Have a Financial Interest in or Signature Authority over a Foreign Financial Account? Better Read This! June 30 Is a Critical Date

Every U.S. person who has a financial interest in or signature or other authority over any foreign financial accounts (including bank, securities and other types of financial accounts in a foreign country), if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, must report those relationships to the U.S. government each calendar year.

The government uses this reporting mechanism as a means to uncover hidden foreign accounts and ensure that investment income earned in foreign countries by U.S. taxpayers is included on their U.S. tax returns. The Treasury Department has placed a new emphasis on foreign accounts, and taxpayers with a financial connection to a foreign country should determine whether they have a reporting requirement.

Reporting is accomplished by filing a Report of Foreign Bank and Financial Accounts form—more commonly referred to as the FBAR—which must be received by the IRS at its Detroit office on or before June 30 of the succeeding year. Thus, the FBAR filing for the 2011 year must be received by the IRS no later than June 30, 2012. This report is filed separately from the taxpayer’s income tax return, and no extensions of time are available for filing this form. In addition, taxpayers generally are required to answer “yes” or “no” to questions related to foreign bank and financial accounts on their tax returns.

Penalties for failing to comply can be draconian. For non-willful violations, civil penalties of up to $10,000 may be imposed; the penalty for willful violations is the greater of $100,000 or 50% of the account’s balance at the time of the violation. A reasonable cause exception to the penalty is available for non-willful violations but not for willful violations.

Overlooked Accounts — Many taxpayers overlook the fact that they have a reporting requirement in situations such as the following:

• Family Accounts — Recent immigrants to the U.S. may still have parents or other family members residing in the “old” country, and those relatives may have included them on an account in the foreign country. This is common practice for some ethnic groups. The taxpayer does not really consider the account his or hers, but it falls under the reporting requirement if he or she has signature or other authority over the account and the value exceeds $10,000.
• Inherited Accounts — Inherited accounts in a foreign country fall under the FBAR reporting requirement even if the funds are subsequently transferred to the U.S. The FBAR rules state that reporting is required if at any time during the year the foreign account exceeds $10,000.
• Business Accounts — An officer or board member may have signature authority over a business account held in a foreign country and overlook the need to meet the FBAR reporting requirements.

In addition to including any reportable foreign income on his or her tax return, the taxpayer must ensure that the foreign account questions are completed correctly on the tax return and that the FBAR is filed when required.

If you have questions regarding this reporting requirement, please contact our office.

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Are You an Employee or an Independent Contractor?

The distinction has significant implications for both the employer and the employee. Employers like to treat individuals as independent contractors because they avoid having to match the employees’ payroll tax, pay benefits, pay unemployment insurance, etc. This results in a significant savings for employers.

When you are an employee, the employer pays you a net amount after making all the required tax withholdings and provides you with a W-2 for tax reporting that shows your taxable wages and details all of the withholding amounts. If you are an independent contractor, the employer will pay you a gross amount without any withholding and will issue you a 1099-MISC. 

Independent contractors must pay self-employment (SE) tax instead of having FICA (Social Security and Medicare program contributions) deducted from their wages. The SE tax rate is generally twice the amount of the FICA rate. Independent contractors are generally treated the same as self-employed individuals, so the SE tax and income tax are based on their net earnings after deducting any allowable expenses incurred to earn the income.

The problem here is that employees generally do not have tax-deductible expenses related to their jobs, so employees who are incorrectly classified as independent contractors find themselves essentially paying both the employer’s and their own share of the Social Security and Medicare taxes. To make matters worse, as an independent contractor, no federal or state income tax was withheld, leaving the independent contractor with a sometimes unexpected tax liability.

Classifying a worker as an employee or independent contractor is not discretionary for the employer. The employer must follow federal guidelines when making the determination. Basically, it boils down to whether the employer has direction and control over the individual, which includes, among other guidelines, specifying working hours, how to perform the work tasks, the right to fire, etc. If the employer does have direction and control, the individual is probably an employee.

If you have been treated as an independent contractor and think that you are really an employee, you do have recourse. You can file Form 8919. If the IRS agrees with you, you only have to pay the employee share of FICA/Medicare not the self-employment tax. You still have to pay the income tax. The filing will make life miserable for your presumably former “employer,” so it might turn into a bridge-burning exercise. 

If you have questions, wish to explore alternatives, or need assistance filing Form 8919, please give our office a call.

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Forgot Something on Your Tax Return? It’s Not Too Late to Amend the Return

If you discover that you forgot something on your tax return, you can amend that return after it has been filed. The need to amend can include a number of issues:

• Receiving an unexpected or amended K-1 from a trust, estate, partnership, or S-corporation.
• Overlooking an item of income or receiving a corrected 1099.
• Forgetting about a deducible expense.
• Forgetting about an expense that would qualify for a tax credit.

These are among the many reasons individuals need to amend their returns, whether it is for the just-filed 2011 return or prior year returns.

Here are some key points when considering whether to file an amended federal (Form 1040X) or state income tax return.

1. If you are amending for a refund, you should be aware that refunds generally won’t be paid for returns if the three-year statute of limitations from the filing due date has expired. Thus, with the exception of amending a return to carry back a business net operating loss (NOL), the IRS will pay refunds only on returns from 2009 through 2011. Some states have a longer statute.
2. Generally, you do not need to file an amended return to correct math errors. The IRS or state agency will automatically make those corrections. Also, do not file an amended return because you forgot to attach tax forms such as W-2s or schedules. The IRS or state agency will send a request asking for the missing forms.
3. If you are filing to claim an additional refund, wait until you have received your original refund before filing Form 1040X. You may cash that check while waiting for any additional refund.
4. If you owe additional 2011 tax, file Form 1040X and pay the tax before the due date to limit interest and penalty charges that could accrue on your account. Interest is charged on any tax not paid by the due date of the original return, without regard to extensions.
5. When amending multiple returns, send them in separate envelopes. Sometimes when filed together, they are mistaken for a single return, and the additional returns filed in the same envelope are not processed.
6. If the changes involve another schedule or form, it must be completed and included with the amended return. In addition, it may be appropriate to include documentation to avoid subsequent correspondence from the IRS or state agency.
7. A detailed explanation of the changes must also be attached. This is required to explain to the processing staff the reason for the amendment. In insufficient explanation can lead to additional correspondence and delays.
8. Depending on why you file an amended federal return, you may be required to amend your state return. However, if the federal amendment is filed to claim or correct a tax credit that the state does not have, no state amended return will likely need to be filed. In most other circumstances, you will need to amend the state return as well as the federal.

An amended return can be more complicated than the original, so please contact our office for assistance in preparing your amended returns.

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