Why It’s Important to File an Extension

With a little over a week to go for this tax season taxpayers are facing the critical decision to file an extension or work fast to get their returns filed by the deadline. If you need more time, it’s best to file for an extension. You’re better off taking a little extra time to complete your return accurately the first time around rather than risking a mistake and having to amend in the future.

What is an Extension?

An extension is exactly what it sounds like, an extension of time to file your tax return. Whether you are a taxpaying business or individual, the federal government (and states) allow for an extension of time to file your tax return. Extensions grant you six months from the original filing deadline to complete your return. For example, a calendar-year individual that files an extension by April 15th (typically the original due date) will be allowed an additional six months (until October 15th ) of that same year to file their return.

Not an Extension to Pay!

An extension to file a tax return is NOT an extension of time to actually pay your taxes. Most taxpayers think when they file an extension that they are also extending the time they have to pay their tax bill but that is not the case. At best, any ensuing penalties & interest may be reduced, but any taxpayer that files an extension without making an estimated payment will owe penalties & interest on the unpaid balance once they file.

Why You Should File an Extension (if you need one)

Filing an extension puts the government on notice that you are aware your return is due but that you have yet to prepare it. You don’t need to provide an explanation for extension; you just need to request one. Most everyone is granted an extension automatically at the federal level and almost every state honors the federal extension too. Bear in mind, the states usually follow the same practice as the fed and require an estimated payment at the time of filing or you’ll face penalties & interest. At the very least, you will be absolved of the “failure-to-file penalty” granted you file within the extension window.

How to File an Extension

There are several online services that will let you file for an extension for free. You should never pay to file for an extension. If a preparer requires a fee to file an extension make sure it will be treated as a deposit to your overall tax preparation fee before paying. If it’s not, consider seeking an alternative preparer or filing your own extension and hiring a preparer after you have done so to prepare your return.

Filing an extension requires basic information such as your name (and spouse’s name if married), address, social security number(s), and date(s) of birth. Some other general information may be required, especially if you are making an estimated payment with your extension. Although you have six months from the original deadline, once your extension is filed and approved, you should work diligently to prepare your return (or have it prepared) and file it as soon as possible. There is no need to wait until the extension deadline.

What if You Miss the Extended Deadline

If you miss the extended deadline then you will be in a tough spot, especially if you owe. You will be assessed penalties & interest all the way back to the original due date for any unpaid amounts. You would be better off filing and setting up a payment plan if you don’t have the resources to pay your bill immediately. Making an effort to rectify your tax bill is better than taking no action or ignoring your responsibility all together.

Are you going to be late to file this year? File an extension! Find a preparer that can help you or head over to the IRS website to access any of the online and desktop software vendors to do it yourself!

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The Standard vs. Actual Deduction Methods (Vehicles)

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Every year at tax time self-employed taxpayers are faced with a dilemma; how to deduct their business related vehicle expenses. The IRS allows for a choice between two methods, the standard & actual method. I’m writing to explain the difference and limitations between each method as they relate to business use of personal vehicles.

Vehicle Expenses

As mentioned, the IRS allows for a choice between two methods. The first method, the standard deduction, allows for a set rate per business mile driven of a personal vehicle. For tax year 2016 the rate was $0.54 per business mile driven and for tax year 2017 the rate is $0.535 per business mile driven. These rates change every year but are usually pretty close year-over-year.

Although the rate per mile under the standard method is generous, the rate was established to cover all of the maintenance on a personal vehicle (including but not limited to):

•    Fuel
•    Oil
•    Repairs & maintenance
•    Deprecation
•    License & registration fees
•    Parking fees & tolls*
•    Tires
•    Insurance
•    Vehicle cleaning expenses
•    Towing charges (for repairs only)
•    Auto club dues / roadside assistance service fees
•    Lease payments

Expenses can add up fast depending on the type of vehicle and how much it is used. For taxpayers that choose the actual method, they would be allowed to deduct the expenses incurred for each of the items above (plus any other vehicle-related expenses that might not be listed). Of course there is limitation to the extent the vehicle is used for business purposes. To easily determine the business-use portion of expenses, a taxpayer should track total miles and business miles driven to create a percentage allocation.

*Note that parking fees & tolls are deductible regardless of method used.

Which Should You Choose?

The majority of taxpayers elect the standard deduction because it is simply easier and cuts down on the amount of recordkeeping. It may not always be the most favorable election though. If you don’t rack up miles throughout the year, drive an expensive vehicle, or drive one that has unusually high maintenance costs, you may benefit more from the actual method.

The only way to know which is more favorable is to track both methods each year and do the math. Typically, most taxpayers would find the calculations to be very close to one another. For those circumstances where one significantly outweighs the other, it might be worth changing methods. A pitfall here is that if you elect the actual method in the first year the vehicle is available for business use, then you are permanently locked in until that vehicle is retired. Choose wisely and consider electing the standard method in the first year so you can have the flexibility to switch back and forth between the methods (subject to some limitations).

Recordkeeping Requirements

When choosing the standard method, taxpayers will want to maintain a driving log of business-related miles they drove. This log should include the date, miles driven, the reason for the trip, individuals involved, and starting & ending addresses. Taxpayers can keep a paper written log in their vehicle for easy access and recording or they can create a spreadsheet to track trips. There are also apps such as MileIQ that will track miles automatically. This information will be necessary to accurately calculate business mileage at the end of the year and in case it is ever requested to support a mileage deduction.

If using the actual method, taxpayers should keep receipts for all vehicle expenses. This practice is consistent with that of any other business-related expense and can be tracked on the business’s books the same way. Since the majority of the receipts will be paper copy they can be scanned onto a computer or into the cloud for safe keeping and quick access if they are ever requested. Another idea is to keep them in a folder somewhere in the related vehicle for quick access. This is also beneficial for when the car is sold to prove maintenance history of the vehicle.

Leased Vehicles

A note about leased vehicles. Lease payments can only be deducted when using the actual method. Additionally, if a taxpayer chooses the standard method in the first year of the vehicle’s lease, they are locked into the standard method for the entire life of vehicle’s lease period (including extended terms). The type of vehicle and expected number of miles driven over the life of the lease will play a large part in choosing the most favorable method.

BONUS: Medical & Charitable Service

In addition to the standard mileage rate for business miles, the IRS also allows a standard rate (only) for medical purposes and charitable service. The rates are much lower for each ($0.17 for medical & $0.14 for charity in 2017), but are often overlooked by taxpayers and can add deductions for those that itemize. Note that charitable service includes the miles driven to deliver donated goods or perform services to benefit a 501(c)(3). This is only true if the entire trip is for charitable service only. Any personal stops along the way to or from could disallow the deductible miles in full for that trip.

I hope you enjoyed this write-up on vehicle expenses. They are common deductions that most self-employed taxpayers incur, but are still overlooked. Leave your comments or questions below!
 

The Top Reason Taxpayers With Multiple Jobs Owe On Their Taxes

Did you know that it’s very common for an individual with more than one job to actually owe when they file their income tax return? That’s right, they owe! It’s not a hard and fast rule but often times when taxpayers in this situation owe money it comes as a surprise because they believed they had completed the forms correctly when they started their jobs.

Therein lies the problem, the forms…

The Math

Let’s use a hypothetical example. Assume Jimbo worked three jobs in 2016 and earned $25k at each job for a total of $75k. Jimbo is single with no “above-the-line” deductions, itemized deductions, or dependents. He also elects no tax-deferred options offered by his employers and does not contribute to an IRA. He shows up to work, gets paid, and goes home. Nothing fancy.

When he was hired at each job he was asked to complete Form W-4 and in doing so he assumed one dependent (himself) and completed the form as such. It made sense to him in his head and for the most part it seems reasonable. That is, except for one minor detail; he didn’t earn $25k, he earned $75k. You see, his payroll was calculated separately at each job based on Jimbo earning $25k. Without any other variables in this example, I can tell you that Jimbo will owe.

What Could He Have Done?

As I mentioned above, Jimbo’s taxes are being withheld separately by each employer assuming he only works that one job earning $25k. Jimbo actually earns $75k per year and therefore he should have adjusted his payroll withholding from each employer once he took on the additional jobs. Sure, he would have received less in each of his paychecks but he also would be less likely to owe come tax time.

How to Make Changes

The instructions to Form W-4 include a calculation that individuals can use to determine their withholding. Unfortunately most taxpayers ignore it which is one reason why tax returns are even a thing. At any point during the year an individual can obtain a new Form W-4 from their employer and make changes to their withholding. Most employers will probably never ask employees to fill one out (aside from when they first hire someone) or help complete the form. This might be where it pays to ask a trusted tax advisor to look over the forms before submitting to an employer, especially when there is a life event or additional employment. My clients frequently reach out to me throughout the year and ask me what they should do when they have life events such as having children, buying a house, or starting a retirement fund.

Does It Really Matter?

Kind of. In most cases, if a taxpayer owes more than $1k to the federal government at the end of the year then there is a penalty that is assessed for underpayment of taxes. Although the penalty is usually insignificant, owing taxes can come as a surprise in itself. Having to pay hundreds or thousands of dollars all at once without being prepared can prove burdensome to most people.

Who Else Might This Impact?

This situation is also commonly found when individuals change jobs during the year or for those who have side jobs which they report on their taxes. When there are significant changes in income taxes that are not considered then there is an increased likelihood that taxpayers might owe when preparing their annual return. This is another great reason why it’s a good idea to work with a trusted tax professional to help you receive every deduction possible each year.

Do you need help with your withholding? Or maybe you have a cautionary tale you would like to share about working multiple jobs. I would love to hear from anyone willing to share. Postin the comments section below!

5 Myths About Tax Returns

If you follow me or have read any of my blogs in the past couple of months then you know I have been writing quite a bit about taxes. I want to share five myths I consistently hear about tax returns.

Myth #1 – I Can Do It Myself

This is less of a myth and more of a question of one’s ability. Everyone is entitled to prepare their own tax return, that’s no secret. But there is much to consider when doing it yourself, primarily, the complexity of your return. That is where the “myth” comes in. There will come a time when you will have a complicated return and really shouldn't do it yourself.

I have seen self-prepared returns from the impoverished to multi-millionaires and I can tell you everyone makes mistakes. It's very rare that I do not find mistakes on self-prepared tax returns. Vendors like TurboTax and H&R Block Online do a great job with their products, but even I have had to cobble my way to the right answer when using their software. There are parts of the tax code that are highly subjective to interpretation, and unless you are well versed in everything tax, then you stand a fair chance of being wrong in your interpretation. This could mean you are leaving money on the table or might have to pay back some of your refund down the road. Know your limits and when it makes sense to bring in a CPA to assist you.

Myth #2 – I Always Get a Refund

Nobody is ever guaranteed a tax refund. Your tax return is an annual reconciliation between what you should have paid and what you actually paid throughout the previous year. If you paid too much then you get a refund, but if you didn’t pay enough, well, then you owe. Some taxpayers treat refunds like found money, but the reality is that it is money overpaid throughout the year. Yes there are credits available to certain taxpayers who meet specific criteria, but they are not available to everyone and a taxpayer’s situation can (and usually does) change each year. If you prepare your own taxes you may not even be aware at how much you are overpaying into the system each month. Again, this is why it’s important to consider working with someone that can explain the results to you each year.

Myth #3 – Tax Preparers are Responsible for the Return

Not true! If you are working with a reputable preparer then you should be receiving an engagement letter or agreement each year. Somewhere in that letter or agreement it should clearly state that the preparer is not responsible for the return and that they only used the information provided by the taxpayer to prepare the return. This is also clearly stated on your return.

What does this mean? Well, if you provide facts and circumstances that are inaccurate, you are on the hook for additional taxes as well as penalties and interest if you are ever audited. But if your return preparer misinterprets the law using accurate information you provided, then the liability might be shared. One thing I can assure you is that the IRS is indiscriminate with their notices and audit selection and it is usually unrelated to who prepared the return. Speaking of the IRS…

Myth #4 – I Received a Notice from the IRS, it’s my Preparer’s Fault

In most cases, you didn’t receive a notice because you changed who was preparing your tax return. More likely, you may have received a notice requesting additional information to validate a tax return line item. Typically it has something to do with earning significantly more or less money, or not paying enough taxes.

There is little correlation between who receives notices based on their tax return preparer. That being said, the IRS looks favorably upon CPAs and tax attorneys because they usually possess an advanced understanding of the tax code versus their peers. An IRS agent reviewing a return may choose to forego any further action if they see that a return has been prepared an individual with one of those designations.

Myth #5 – Tax Elimination Plans

This myth is by far my favorite because hands down it is a complete lie. I have heard industry experts claim they can eliminate your tax liability and I know how they do it. Rather than have you pay the government what is owed, they have you invest the money into a tax-deferred investment account such as an IRA (or SEP if you’re self-employed) so that you don’t have to pay taxes on that money today. Well, it’s true that you may not owe today, but your tax bill hasn’t actually been eliminated. Any tax due on the money you invested is just deferred until 70 1/2 when Required Minimum Distributions “RMDs” kick in. You're also still out of pocket that cash so you still have to come up with the money, you're just sending it elsewhere for the time being. The term tax elimination is misleading and if you ever encounter someone who tells you they can do it then you should be skeptical.

Share Your Thoughts!

I’m really interested to hear what other taxpayers (and preparers) think or have heard about taxes. As part of my service I try to educate my clients to understand how the system works so they are better informed for the future. Leave your comments in the section below.

 

Stock Wash Sales

Have you had a bad year in the stock market? Are you still holding on to losing investments in the hope that they will rebound and make you rich? Or maybe you just can’t bear to “take the loss” by selling them. I could make a case to hold, sell, or buy more, but I’m not writing about that this week. Instead, I’m writing to warn you about something called wash sales.

A wash sale occurs when you sell an investment at a loss, and then buy a substantially similar investment within 30 days after the sale. Notice the word substantially, a term not clearly defined by our friends over at the IRS, so I’ll do my best to explain. Wash sales can occur for investments other than stock, but for the purpose of this article, I will focus specifically on stock related wash sales.

Let me explain

Imagine it’s December 30, 2016 (the last trading day of 2016), you have some poorly performing investments, and you decide that “2017 will be a better year”, so you bite the bullet and dump your shares of fictitious entity, XYZ Corp. You know you’ll get a tax deduction for your losses (up to $3k) so you’re not 100% down and out. Until January 3, 2017 (the first trading day of 2017), when XYZ Corp announces a revolutionary breakthrough and suddenly their stock price surges. You could have been in good fortune if you had only held on to your shares, but because you sold, you’re stuck with that 2016 stock loss. You decide to buy back your shares and ride the upward trend.

Not so fast…

If you choose to buy back your shares, the tax loss you thought you would receive in 2016 will vanish. The IRS would prefer that taxpayers don’t game the system year-after-year by recognizing stock losses for tax benefits just to buy the shares back right after the New Year. This rule applies all year, not just at year-end (when this buy/sell strategy is more commonly found).

Substantially similar

In our example we used the same investment, which is blatantly a similar investment. But what if XYZ Corp is in the medical devices sector and competes directly with ABC Corp? You think the sector has potential, but maybe XYZ Corp has had some bad news in the press and is specifically not doing as well as its peers. You could stay invested in the sector by swapping your investment in companies and probably survive an IRS auditor. You couldn’t sell your XYZ Corp shares and pick up call options on XYZ Corp without risking a wash sale though. No one will stop you from actually placing the trades, and your broker may not catch the wash sale, but doing something like this is probably not going to pass under an audit or review. They are substantially the same.

They’re watching

The wash sale rule can dramatically reduce your allowable tax loss from stock sales. Your broker is required to designate wash sales on broker statements issued each year, so yes, the IRS knows about each wash sale that occurs in your account. Even if you open two separate brokerage accounts and buy & sell the same securities in each, the wash sale rule still applies. The two brokers would not know you are doing this and thus not report it, but that doesn’t make it any less of a violation of the rule.

Although the wash sale rule is in place, losses that are disallowed are rolled into the basis of the re-purchased investment until that investment remains sold for longer than 30 days. This means you don’t outright lose the tax benefit of stock losses, but you do not get to recognize the benefit until the appropriate amount of time has passed.

Conclusion

This is a sticky area of the tax code, especially when you get outside of stock related wash sales. There is no definitive ruling in place about what constitutes a substantially similar investment; so much is left to judgment. Obvious violations of the rule will be caught and enforced. Work with your broker to understand what will be flagged as a stock wash sale so you don’t lose expected tax losses at year-end.

Do you have a strategy for the end of the year to avoid wash sales? Feel free to share or comment below.

Independent Contractors: A Definition and Some Tax Insight

I’m excited to write about a subject that I come across far too often – the independent contractor status and the tax impact of being one.

Many people may associate the term independent contractor with that of someone who works on a house (think of a plumber, an electrician, or handyman). Although these individuals may fall into this category, the reality is that anyone can be an independent contractor. The IRS has pretty clear guidance on how to determine if an individual is an independent contractor. Simply stated, an individual is considered an independent contractor if the payer has the right to control or direct only the result of the work, and not what will be done, or how it will be done.

What does this mean?

Well, let’s use an example. Let’s say I hire someone to help me with my social media. She is hired with the understanding that she has full access to my social media accounts using her own devices (computer, smartphone, or tablet) and all that I have explained to her is that I want her to respond to questions and actively market my firm. How, when, and from where (geographically) she does this is up to her. We establish some rules such as no profanity or bias, but other than the rules we set, it’s all within her control. She gives me daily reports of her work but that’s about it. She’s likely considered an independent contractor for tax purposes. I control only the results of her efforts (responding to questions and actively marketing my firm), but how she does it or by what means is out of my hands. Of course, if I don’t like how she does her job I can always terminate our agreement.

What about employees?

But what if we changed a few things. Instead of working with her own devices she instead agrees to meet me at my office a few hours per week and uses my firm’s computers to access my social media accounts. She can only do her work from my office, no remote access is allowed. In addition, I establish a standard set of guidelines for marketing my firm including how, when, and about what to post. I give her the exact words I want used on my social media accounts. She’s really only there to go through the process of posting on my accounts. Since she’s at my office though, I also have her answer the phone, prepare client deliverables, and even reply to my e-mail. She’s working under my direction, having been told what to do, and how to perform tasks. She is now more likely considered an employee for tax purposes.

Why is this a big deal?

The tax difference between an employee and an independent contractor could be significant. At the time of this writing, employers are responsible for 50% of the FICA tax which is 7.65% (Social Security tax of 6.2% plus Medicare tax of 1.45%) on each employee's first $118,500 of salary and wages. The employee covers the other half. You may never even notice this if you receive a steady paycheck because it’s all taken care of through the payroll processor.

On the other hand, if you’re an independent contractor, you’re on the hook for the whole amount of 15.3% (Social Security tax of 12.4% plus Medicare tax of 2.9%). It may not sound like much but on $10,000 in earnings one would owe $1,530 just in Social Security & Medicare taxes, not to mention the federal and state (if applicable) income taxes to be paid. The payer has no responsibility to assist independent contractors with withholding. What’s worse is that inexperienced individuals who are considered independent contractors don’t know they have been classified as one until they receive a 1099-MISC at tax time. By then it’s too late to file estimated taxes on the income and the taxpayer receives a crushing year-end tax bill that they may not be prepared for. Luckily you can write-off expenses against income earned as an independent contractor, but there are rules and limitations around that too and poor planning may mean lost deductions or hours of work to recreate expense statements.

Ask questions.

Whenever you agree to work for someone you should always ask if the position is contract or employment. Some telltale signs are if you are asked to complete a W-4 or a W-9. A W-4 is typically requested for employees and a W-9 for independent contractors. Your social security number is required for your employer to file the necessary forms for tax reporting purposes. Don’t provide any information or sign anything until you understand the consequences of what you’re getting into. If you are signing on as an independent contractor, it’s best to begin the habit of paying estimated income taxes. Check back soon for a post on filing estimated income taxes.

Confused? Have an opinion? Leave a comment below or give me a call.

Trump's Tax Plan

With the 2016 presidential election behind us I thought it would be a good idea to address the sudden 800lb gorilla in the room; Trump’s tax plan. Trump has released an aggressive tax plan that his administration believes will stimulate economic growth in the United States. Although the question remains whether part, or all, of the proposed changes will be passed into law, it’s best to be prepared and understand the consequences.

Given the number of changes in the proposal, I am only highlighting those that could have an impact on the average taxpayer and business owner.

This article is a good read but it does get a bit technical at points so brace yourself.

Individuals

Tax Bracket Changes
There are currently seven income tax brackets starting at 10% and topping out at 39.6%. Trump’s plan condenses those seven brackets into three; 10%, 20%, and 25%.

Deductions & Personal Exemptions
Trump’s plan would increase the standard deduction from $6,300 to $15,000 for single filers and from $12,600 to $30,000 for joint filers. This would result in fewer taxpayers itemizing their deductions. For those able to itemize, single filers would be capped at $100,000 in itemized deductions and joint filers would be capped at $200,000. An allowance for personal exemptions and the head-of-household filing status would also be eliminated as a result of the plan.

Childcare
Under Trump’s plan, taxpayers would be entitled to an above-the-line deduction for children under the age of 13 for childcare expenses, but the proposed deduction would be capped at the state average for the age of each child. For example, if a taxpayer lived in GA and the average cost for childcare were determined to be $4,000 for a 10-year-old child in GA, a taxpayer with a 10-year-old child would be entitled to a deduction up to that amount. Any excess costs would presumably not be deductible. The childcare exclusion would not be available to single filers with total income over $250,000 or joint filers with total income over $500,000, and would be limited to four children per taxpayer per year. Additionally, any deduction for an eldercare dependent would be capped at $5,000 per year.

Something interesting to note is that this proposal would also be provided to taxpayers who use stay-at-home parents or grandparents as caregivers (as well as those who use paid caregivers).

Businesses

Tax Rate
Under President-elect Trump’s plan, the current corporate tax rate of 35% would be reduced to 15%, and the corporate alternative minimum tax rate would be eliminated. As a result, most business deductions would be eliminated. This rate would become available to all businesses, regardless of size, primarily to encourage them to retain profits within their business (and in theory stimulate more spending within the business).

Perhaps the biggest change to corporate tax rates would be for LLCs, partnerships, and S corporations, commonly known as “pass-through” entities. The proposal would make the pass-through portion of income taxable at the new corporate rate of 15% as well. This could have a huge impact on business owners depending on their income bracket.

Depreciation
There has been some discussion in the tax community about Trump’s proposal to eliminate depreciation, but I’m skeptical. Such a revolutionary change to a long-standing accounting principle seems unlikely. There is, however, a proposal in his plan, which would allow manufacturing firms to expense capital investments entirely in the year of purchase, but at the same time forgoing a deduction for interest expense on the same asset(s). Essentially, you would not be able to finance an asset, deduct the entire asset in the year of purchase, and continue to receive an interest expense deduction for the same asset.

How things shake out on the subject of depreciation will be interesting for sure.

On-site Childcare
If your business offers on-site childcare then you are aware of the tax credit that currently provides your business up to $150,000 for a portion of the costs associated with providing the childcare. Trump’s proposal would raise this credit to $500,000. Amounts paid to employees for childcare would still be considered business deductions, but would not be used to calculate this credit.

Concluding Remarks
I hope readers have found this article insightful. Tax changes are never easy to navigate or understand but my goal was to make readers aware of some of the changes that could potentially be coming to us in the near future. There will undoubtedly be tax changes, which will have an impact on individuals and businesses beginning in 2017.

Confused? Concerned? Unsure? Feel free to comment below or send me a message to keep the conversation going.