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Tax Court Penalizes Self-Prepared Tax Return

Diane Kennedy Tax Loopholes — Sat, 04 Feb 2012 00:00:13 +0000

Tax is tricky. And it often contradicts what you think you know. There rarely is one right answer, because everybody’s circumstances are different and it’s not as simple as reading an IRS tax guidebook. In fact, you need to look at Tax Court cases, memorandums, revenue rulings, revenue proceedings and Treasury Regulations.

My firm pays a lot of money every year for the tax tools we use. It’s not some off-the-shelf Turbo Tax solution.

So I’m always a little skeptical when I see people who insist on preparing their own tax returns if there is any level of complication at all. After all, it doesn’t make logical sense for them to spend the time and money on the research and tax preparation tools we have.

Well, it looks like Tax Court shares my skepticism. In fact, the Tax Court threw a penalty in the mix for the taxpayers who got in over their heads with their tax filing.

In this case, the husband and wife bought a cheap TurboTax program at the local Costco and set to work preparing their own return.

The husband worked as an engineer. The couple owned and managed residential real estate. They offset the real estate losses with their earned income. Because their income was over $150,000, that wouldn’t normally be allowed. In this case, though, they took the deduction because they claimed to be real estate professionals.

The IRS tagged two years – 2005 and 2006 – to audit. The IRS disallowed his passive real estate losses and the whole case moved to Tax Court. All along, the taxpayers maintained they were real estate professionals and thus got the full amount of the loss against their other income.

Unfortunately, the couple continued to represent themselves through the audit, appeal and even at the court case. They made some legal blunders in the case, but the court ruled in their favor and against the IRS. It seemed like the court was really trying to help this couple out with some leniency.

The problem was the taxpayer didn’t realize how his testimony pre-trial could be used against him when he flip-flopped after realizing what the answers should have been. He didn’t have documents to prove the amount of hours he now claimed to meet the real estate professional standard.

And then when it looked like he would not only losing the real estate professional deduction with the resulting tax, penalties and interest, he got even worst news. The IRS is going after him for the even higher negligence penalties (up to 20% on top of everything else).

They blame TurboTax software for failing to notify him as to the requirements of the real estate professional status. The Court didn’t buy it.

In fact, the Court stated, “Petitioners contend that they used TurboTax software to prepare their returns for both years and that the software program is to blame for any miscalculations in their income. However, petitioners have not provided any evidence showing the information that they entered into the software program, a preliminary showing that would be required to decide whether the software program is in any way at fault for petitioners’ underpayment. See Paradiso v. Commissioner, T.C. Memo. 2005-187. Such software is only as good as the information the taxpayer puts into it. See Bunney v. Commissioner, supra at 267. We have held that the misuse of tax preparation software, even if unintentional or accidental, is no defense to penalties under section 6662. See Lam v. Commissioner, T.C. Memo. 2010-82.” T.C. Mem. 2011-69, at p. 15.”

Garbage in means garbage out. It was up to the tax preparer, or in this case the taxpayer/tax preparer, to make sure the information that was put in was correct, the laws were followed and the documentation supported the tax positions taken.

The Court goes on to say, “A reasonable person in Mr. ****’s position, understanding that the tax law governing the deductions he claimed was complex, would have consulted a tax professional instead of merely assuming that he qualified on the basis of his own conclusions.”

Bottomline: They lost the real estate professional deduction. They got hit with the regular penalties and interest plus the more onerous negligence penalties. And they weren’t successful in throwing Turbo Tax under the bus. It was the taxpayer’s responsibility to seek a tax pro and they paid a high price for failing to do so.

UsTaxAid

Important Case Win for Real Estate Investors

Diane Kennedy Tax Loopholes — Thu, 02 Feb 2012 00:00:12 +0000

Real estate tax can be complicated. Unfortunately, there are a few things about the way the IRS categorizes income and losses that don’t make logical sense. And that’s where do-it-yourself real estate investors can get in trouble if they’re also trying to DIY on their business structures and tax plans.

One of the fundamental issues with real estate is that your income and losses could be considered:

Trade or business,
Passive Income/Loss with Active Participation,
Passive Income/Loss with Material Participation or
Strictly Passive Income/Loss.

If your real estate income/loss is trade or business, you’re most likely considered a real estate dealer. That means income will be subject to self-employment tax if you’re in the wrong business structure. Typically a real estate dealer is involved in flipping, wholesaling or just generally buying properties to resell for profit (hopefully). If there is a loss, then the full amount of the loss is allowed as a loss against other active income.

If you have real estate that you hold for rental and you have a loss, you have a passive loss. If you make less then $100,000 in adjusted gross income, and you actively participate in the business you can offset up to $25,000 of the loss against other income.

If you make more then $100K, you will need to materially participate plus qualify as a real estate professional to get the full loss offset against other income.

Otherwise, your loss is strictly a passive loss and can only go against passive income.

In a recent case, a real estate investor had been holding property as rentals. He bought a few properties that didn’t fit as rentals and so he decided to sell. He claimed that the gain on these sales would be the same as the losses on other properties. It was all ‘one business.’ The IRS disagreed. And the owner disagreed with the IRS, so it was up to the Tax Court to sort it out.

The Tax Court agreed with the owner. Normally, gain from property that was bought simply for resell could not offset passive loss from rentals. But the intent of the investor was to hold it as rentals. He just changed his mind. And the Tax Court said he could.

This is an important ruling for a couple of reasons. One, the intent turned out to be more important than the strict facts of the case. Second, and this is important for anyone who wants to use this case to back-up their tax facts, make sure you have good documentation of what you’re doing and why.

Are you sure your tax strategy is up to date with the latest tax rulings? Our USTaxAid Services CPAs keep up to date on the latest in tax strategies, tax court rulings and other important tax considerations for real estate investors and others.

Embezzlement Stats Are Out

Diane Kennedy Tax Loopholes — Sun, 29 Jan 2012 00:00:15 +0000

The 2011 embezzlement stats are out. This is a list you don’t want to be on! It means that you, your business and/or your state is more at risk for employee theft.

When you consider all of the challenges with running a business today, what with state and federal tax complexities and increases, global competition and reduced demand, it is horrible to think that you could lose everything because you hired someone who stole from you.

And make no mistake, as much as someone may try to minimize the crime by calling it “white collar”, embezzlement is stealing. And it’s stealing from you.

The biggest and most common embezzlements are from your financial staff.

Small business owners are most likely to suffer a loss because of their bookkeeper. In fact, a small business owner is more at risk than a big business owner. That’s because a small business typically only needs one person in the internal bookkeeping office. So there is no separation of duties. One person does it all, and controls it all. And unless you, the owner, are trained in spotting irregularities or have expensive outside reviews or audits performed every year, you’re likely going to miss the problem.

At the end of this article, I’m going to share with you two recommendations for protecting your small business from a bookkeeper embezzlement.

I have one warning, though. Please don’t think it can’t happen to you. It can happen to you. I’ve had to have the “your staff is stealing from you” conversation way too many times lately. No owner wants to hear. I’m sure you don’t want to hear it either.

#1 State for embezzlers: Vermont

Followed by:

Connecticut

Pennsylvania

Montana

Virginia

Iowa

Idaho

Most embezzlers state that gambling was the motivating factor. And, surprisingly, almost 2/3s of the embezzlers were women. But the guys who embezzle take 25% more. By far the most common scheme was forging check signatures or issuing checks to nonexistent companies. Over ¾ of the incidents were done by the bookkeeper. And the schemes usually lasted for at least 5 years.

Embezzlement Solutions:

#1: If you’re not big enough to have at least two people in your bookkeeping department, then hire an outside bookkeeper. The outside bookkeeper needs to be completely separate from your ongoing business, or you run the same risks.

#2: Analyze your financial statements each and every month to note where costs appear out of line. This will spot areas you need to watch as well as look for items that might be seeing fraud.

At Cash Flow Accounting, we have solutions to help you keep more of your hard-earned money. Our virtual bookkeeping services provide that extra step of protection and expertise at an incredibly affordable price. Plus, our virtual CFO analysis can help you narrow in on what you need to do to help your business really grow.

Drop Richard an email at Richard at USTaxAid.com or give him a call at 888-592-4769 to find out more about our bookkeeping and CFO solutions.

Three Sets of Financial Statements

Diane Kennedy Tax Loopholes — Wed, 25 Jan 2012 00:00:17 +0000

You may have heard about the three financial statements: Balance Sheet, Income Statement and Statement of Cash Flows. That’s not what I’m talking about here, but let’s go over this really quickly.

The Balance Sheet is like a snapshot of your assets, liabilities and equity as of a certain date. Assets are things you own such as your bank account, inventory, accounts receivable and other items that have a value. Liabilities are amounts you owe. It includes your accounts payable, mortgages, notes payable and credit cards payable. Equity is what is left.

Your Income Statement shows income and expenses for a specific period. It could be for the month of October, for example, and show the income and expenses for October 1 through the end of the month. Or it could be year-to-date through the end of October.

The Statement of Cash Flows starts with the net income and makes non-cash adjustments to reconcile to the actual cash. In some ways, this is the most important statement you have because it will show where cash is coming from and going to. If your Operations are consuming cash, that’s a warning sign and this is the statement that will tell you.

But that’s not what I’m talking about when I talk about three sets of books.

Accrual-basis. This means you will record income when you have earned it, not when you receive it. It also means you will record expenses when you owe them, not when you pay them. It’s a more accurate representation of your income.
Cash-basis. This is most likely how you will report your income and expenses for your tax return. The good news is that you can get both accrual-basis and cash-basis statements from one set of QuickBooks, if you’ve set up the systems and are making entries correctly.
Real Operation & Owner’s Perks. Face it, part of the beauty of ownership is the perks. But if you hired all outside people, the perks might be a lot less. Keep track of those benefit items that aren’t necessary to the operation of the company separately in your books.

In effect, you have three sets of books. But if you set the records up correctly, it won’t be any harder to produce the three sets then it would with one.

This is where the real business owners get separated from those who are happy to stay small. Or rather, they are happy to keep their income small.

In order for your business to grow, you must grow.

That means picking up new skills and new advisors. We can help! Drop us a note at Cash Flow Accounting or give Richard a call at 888-592-4769 to find out how affordable our bookkeeping and new virtual CFO services can be.

Series LLC – Okay for Solo 401(k) Pensions?

Diane Kennedy Tax Loopholes — Sat, 21 Jan 2012 00:00:20 +0000

I’m seeing strong interest in Series LLCs these days. Real Estate investors are coming to the Series LLC in numbers, fascinated by the idea of having solid asset protection without paying to form and maintain multiple state entities. Business owners are also looking at the Series LLC as a great way to start multiple businesses, or create separate business identities quickly and easily, and without spending thousands in legal and filing fees.

Recently, Series LLCs got another boost – this time in terms of acceptance by a pension custodian, in connection with a Solo 401(k) plan.

Using an LLC to manage your self-directed Solo 401(k) plan is nothing new. The strategy works like this – basically, you invest pension funds into the LLC, and use those funds through the LLC to invest in real estate, business ventures, and so on. The profits flow back through the LLC to your pension fund and grow, tax-deferred (or tax-free, if you’re using a Roth). You are allowed to act as the Manager of the LLC, making high-level decisions, including where and when to invest that money. The LLC structure keeps you from direct contact with your pension funds (making the IRS happy) and the fact that you make only high-level decisions (i.e., you can decide to fix the roof on a rental, but you can’t swing the hammer) keeps you safe from accidentally getting caught up in the headache of prohibited transactions.

The Solo 401(k) LLC has been a great strategy for seasoned investors, who know what they are doing, and who need to act fast. But up until now, there has always been a question on whether or not you could use a Cell in a Series and make that Cell act as the Solo 401(k) LLC. Remember, even though Series LLCs have been around for 14+ years now, they aren’t accepted in every state, and in legal terms, they’re still a newborn. That means the Series receives very conservative treatment, particularly in the hands of banks (who just don’t seem to get it). But at least as far as one major Solo 401(k) plan custodian is concerned, all is well.

If you want to learn more about how the Series LLC operates, check out our product, Series LLC: the Ultimate in Business Structure Flexibility. And, to learn more about pension investing, especially how you can self-direct your own pension, try our book, Insider’s Guide to Tax-Free Real Estate Investment.

Next Wave of Walk Away Real Estate Owners

Diane Kennedy Tax Loopholes — Sat, 21 Jan 2012 00:00:20 +0000

In the past week, I’ve had two different people ask me questions about walking away from their seriously underwater real estate.

Real estate started its nosedive in 2007, but as long as no one lost their job, had reduced business income or had to move, the market value could seem irrelevant. As long as you could afford the payment and were prepared to stay put until the market recovered, you could just hold on.

But then the market decline drug on and on and on. There are a lot of people who are in properties now with loans that are as much as double what the house is worth. It may take years for the value to come back to the pre-2006 year limits and equal the amount they owe.

For some people that’s too long to wait and they want to make strategic defaults. They are defaulting and walking because it just doesn’t make business sense anymore.

Still others are forced to walk away from a house they can never hope to sell because of other business or life reasons (job transfers, family changes, loss of job, loss of business income, etc).

No matter what your reason might be, there are some basic things to consider before you walk away from bad real estate.

There are a number of pieces of information you’ll need to collect first.

What state is the property in?
Is this your principal residence?
Have you refinanced?
If you have refinanced, did you use the funds for improvements?

Depending on the state, the lender may not have recourse against you for any deficit when a sale doesn’t cover the loan. This is most likely if the property was your principal residence and you have not refinanced. However, law varies from state to state.

There are a number of options at this point. You can just walkaway and let the lender foreclose. You could attempt to deal with them for a deed-in-lieu-of foreclosure. You could try a loan modification. And you could try to get a short sale approved.

Based on what I’m hearing from our USTaxAid members, it’s next to impossible to get a deed-in-lieu-of through because the banks make more money on foreclosures.

Most loan modifications never get approved these days. That leaves two options: short sale or foreclosure.

If you have a loss on your property and it’s your principal residence, there is no tax loss available. If it’s been a rental property, then you have a loss you can take against other income.

At some point, you may receive a Form 1099-A and/or a Form 1099-C on the transactions. Most lenders either don’t prepare them or prepare them wrong. Each wrong move has its own headache for the taxpayer.

Probably the biggest problem that I’ve seen is people who jump too quickly into bankruptcy, thinking this is their only solution. Do NOT file bankruptcy without consulting an attorney first. It’s tricky and can cause additional problems.

It’s not right and it’s not fair. A lot of good people are getting taken down by this economy. If you’re in that boat, the best advice I can give is to face facts as soon as possible, get good advice and keep moving. The sooner you’re through it, the better it will be.

Tax Survival for 1099-A and 1099-C Recipients

Tax Implications of Real Estate Losses

The 2011 IRS Survival Guide for Real Estate Professionals with Real Estate Investments

UsTaxAid

Coach, Advisor, Mentor – Who Do You Really Need On Your Team?

Diane Kennedy Tax Loopholes — Fri, 13 Jan 2012 00:00:16 +0000

These days a lot of seminar guys throw around the terms “coach” (as in I’ll coach you for thousands of dollars), “mentor” (as in I’ll mentor you for thousands of dollars) and even “mastermind partner” (as in I’ll be your mastermind partner for thousands of dollars.

These terms have been used, and misused, so many times, that it’s pretty much just turned into a way for many to just take money and provide uneven or uncertain results.

Here’s how I choose to use the words:

Coach: A coach is someone who helps you do something better. Your gymnastic coach has expertise and helps you land the dismount better. Your life coach has tools that help you identify what is important in your life and then focus on getting results where you need them.

We’ve just re-vamped our coaching program at USTaxAid to provide affordable support on key tax and business structure issues for the person who wants to do-it-yourself. Got questions? Here are three ways to get hold of us:

Send Richard a message at Richard at USTaxAid.com.

Give Richard a call at 888-592-4769.

Let Aaron know you’d like more information through the ‘chat’ box that comes up on this page.

Mentor: A mentor is someone who has accomplished the thing you want to accomplish. A mentor doesn’t charge for services, but there has to be an exchange. Often mentors can be found through internships or through joint ventures with the mentee providing the sweat equity for the deal.

I am taking a limited number of people on to mentor now. It’s done in line with a side business that I’ve begun. Get hold of me through Diane at USTaxAid.com if you’d like more information on that.

Mastermind Partner: The concept of a mastermind comes from Napoleon Hill in “Think and Grow Rich.” The idea is that when two or more like-minded people get together and when they focus together in a positive, action-oriented environment, a ‘master mind’ is created that is bigger then each individual together.

You shouldn’t need to pay more than a nominal fee to belong to masterminds. These are people banding together to help each other and create something better.

Advisors: An advisor is someone who has specialized training and who sells that advice. So, Joe Blow off the street who is good at seminars is not an advisor, unless he’s advising you on how to put together a seminar. He isn’t a legal advisor unless he has the specific training, education and experience in legal issues. And he’s not a tax advisor unless he has specific training, education and experience in tax issues.

Generally we think of advisors as people who have degrees and credentials, like a CPA certification.

The point where most people get in trouble is when they take advice from someone who shouldn’t be an advisor or they get coaching from someone who has never had good results. Or they hire someone to mentor them who has no real experience.

Take your time to make sure you’re working with people who are ethical and have the experience and education you need. Otherwise, you’re wasting your time and your money.

The 60-Minute Handbook

How to Get Money for Your Business

2011 Operation Guides Special

Four Words That Will Change Your Business Life Forever

Diane Kennedy Tax Loopholes — Fri, 13 Jan 2012 00:00:16 +0000

If you have a business, please attention to these next few paragraphs. Following these guidelines will make one huge difference in your business: You can run your business or it can run you.

Those four words:

Measure Results, Change Activities

It really is that simple to have a business that works.

Measure Results: You need an accurate set of financial statements within 30 days of month end.

We also recommend that you have them prepared using a complete accrual method. You likely will file using cash basis for your tax return, but you still need the accrual basis so you can make good decisions. It’s all about the financial statement analysis.

That’s how you measure results.

You need to have a set of tools to use to assess what you see in the financial statements. I really recommend Keith Cunningham’s new book “The Ultimate Blueprint” for step-by-step guidelines on how to assess your financial statement.

Change Activities: Once you know what you financial statements say about your business, you need make decisions. What do you need to do more of? What do you need to do less of? Do you need more cash flow now or in the future? Do you need more income? What is the best way to do that, based on what you see with your financial statements?

Our affordable and easy bookkeeping service Cash Flow Accounting provides virtual bookkeeping so you can count on having accurate and timely financial statements you can use. Every one of our bookkeepers has a 4-year business degrees and experience in working with small business just like yours. You’ll be surprised at how affordable putting our team to work for you can be! Learn more at Cash Flow Accounting.

The difference between good and bad results can often be seen in the financial statements of companies.

http://www.cashflowaccounting.com/

One Day That Cost a Business Owner $20,000 in Extra Taxes

Diane Kennedy Tax Loopholes — Sat, 07 Jan 2012 00:00:17 +0000

December is always my busiest month of the year. My clients are looking for final tweaks to their year-end tax planning, and prospective clients call us looking for solutions before the final bell sounds for the end of the year.

At the last minute, we had someone contact us who had a Schedule C business that had had a sudden increase in income.

There are four reasons why I’m not a fan of Schedule C businesses:

Schedule C business structures put everything you own at risk. If you have a business that little risk, then this isn’t a problem. But the problem is that most businesses do have risk. There are employees who could run into someone while performing duties for the company. There are products that might harm someone. There are services you or others might perform that don’t have the right results. And if you have the misfortune to have an error with someone who like to sue – look out! You can lose your house, your savings, your kid’s college fund….everything you have. A corporation or an LLC will protect your personal assets.
Schedule C business structures cost you more in taxes. There is no disputing this one. You’ll pay 15.3% extra in self-employment tax if you have a Schedule C. (The temporary payroll tax cut reduces this somewhat, but remember that payroll tax cut IS temporary.) You don’t pay self-employment tax with a corporation.
Schedule C business structures have a 1 in 3 chance of being audited. Compare that to a corporation that has a 1 in 100 chance (small business) to 1 in 50 chance (larger business).
Schedule C businesses can’t get business credit. The credit cards you get in the business names are just disguised personal credit cards. You aren’t building business credit.

In this case, the wrong business structure, coupled with no pension plan in place by the end of the year, meant an extra $20,000+ in taxes. We could have fixed it, if the prospective new client had called our office one day earlier.

As it was for this new prospect, we can make sure 2012 is a whole lot better for him.

Moral of the story: Tax planning is a year-round activity. If you wait too long, it’ll cost you.

Filing Your Schedule C Tax Return

Filing Your S Corporation Tax Return

Filing Your C Corporation Tax Return

Is Contractor vs Employee the IRS’s Next Easy Target?

Diane Kennedy Tax Loopholes — Thu, 05 Jan 2012 00:00:20 +0000

Let’s be really clear here. The IRS would love for every single one of your workers to be classified as employees. That means you’d have to pay payroll taxes and it means they’ll have to pay Social Security and Medicare tax.

On the other hand, if you’re an employer you can pay a lot less in taxes and benefits if you have independent contractors instead of employees. You also have more benefits that you can take yourself. Yes, that’s right, as you hire employees, you as the owner lose benefits.

The trick is to win the independent contractor agreement. There are two main tests to determine whether you have independent workers or employees.

The 20 Question test. This test has been around the longest and explores who is in control of the employee, his/her work and environment, training, results, tools and the like. An employee will have little control. An independent contractor has a lot of control.
The Three Control Test. The IRS attempted to simplify the 20 Questions into three types of controls.

These are:

Behavioral control

Financial control

Type of relationship

The IRS has stated that they believe most independent contractors really are employees. In fact, they have a special form they send out to independent contractors asking if they really are contractors, and not really employees.

Protect yourself by making sure you’re following the rules PLUS make sure you have an Independent Contractor Agreement in place.

Winning the Independent Contractor Argument in 2011

How to Write Off Your Car

The IRS Audit Survival Guide