News & Articles

New Trade Law Stiffens Penalties for Certain Taxpayers

Posted on Fri, Jul 17, 2015

On June 29, the Trade Preference Extension Act of 2015 (TPE) was signed into law. The TPE mainly focuses on foreign competition and retraining domestic workers. But if you read the fine print, you'll see that it also includes important — but little-noticed — changes to the penalty regime for failing to file required information returns with the IRS and failing to furnish required statements to payees (recipients of payments).

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Tags: EHTC Article, Tax Laws, Newsletter, Penalty Tax, Tax Consequences

How a Deductible Home Office Affects a Sale

Posted on Sun, Jun 29, 2014

If you use part of your home as an office and take deductions for related expenses on your annual tax return, can you claim a valuable federal tax break when you sell? Specifically, can you claim the home sale gain exclusion of up to $250,000 for single taxpayers ($500,000 for married couples filing jointly)? In many cases, you can still take advantage of this tax benefit.

Gain Exclusion Qualification Rules

    If you're single, you can potentially sell your principal residence for a gain of up to $250,000 without owing federal tax. If you're a married joint filer, you can potentially pocket up to $500,000 without paying federal tax. To qualify, you generally must pass these tests:
    1.
You must have owned the property for at least two years during the five-year period ending on the sale date (referred to as the ownership test).
    2. You must have used the property as a principal residence for at least two years during the same five-year period (referred to as the use test).
    To be eligible for the $500,000 joint-filer exclusion, at least one spouse must pass the ownership test, and both spouses must pass the use test.
    If you excluded a gain from an earlier principal residence sale, you generally must wait at least two years before taking advantage again. For joint filers, the $500,000 exclusion is only available when both spouses haven't claimed an exclusion for an earlier sale within two years of the sale date.
    Gain beyond what you can exclude under these rules is generally treated as a long-term capital gain taxed at a maximum federal rate of no more than 20 percent. However, gain caused by depreciation deductions on the part of your home used as a deductible office may be taxed at up to 25 percent.

What Can You Deduct?

If you qualify to take home office deductions, you can deduct part of expenses including mortgage interest, depreciation, utilities, insurance, and repairs. The office must be used regularly and exclusively as your business place, which means personal activities cannot be done there. Other tips:

  • Take photos to prove the room was used for business purposes in case of an IRS audit.
  • To figure the percentage of your home used for business, you can use two methods -- square footage or the number of rooms.
  • Home office deductions can't exceed your income from the related business activity. But if they're greater, you can carry the excess deductions forward to a future year.
  • If a home office is required by an employer, it's a good idea to get a written statement from the company explaining the requirement.

As long as your deductible home office space is in the same dwelling unit as your residence, you can use the gain exclusion to shelter profit from the entire property.

In other words, you are not required to split the sale into two separate deals for tax purposes (one transaction for the sale of the residential part of your property and another for the sale of the office part).

However, you will be taxed on gain up to the amount of depreciation deductions on the office part of your property that were claimed for business use after May 6, 1997. You will owe a maximum federal rate of 25 percent on this profit (called unrecaptured Section 1250 gain).

However, paying tax on this portion of your profit is not really so bad, considering that you collected earlier tax savings from the office part of your property.

A Separate Dwelling

The tax outcome is less favorable when the office is not in the same dwelling unit as the residence.

For example, say you claimed home office deductions for what was formerly a carriage house, garage, or finished basement with cooking and bathroom facilities and a separate entrance. In these cases, even though the office is on the same property or in the same building, it is considered to be a separate dwelling unit that is not part of the residential portion of your property.

In these scenarios, you must pass the ownership and use tests (see right-hand box) for both the office portion of your property and the residential part in order to treat the sale as a single transaction that is eligible for the gain exclusion.

If you fail the tests for the office part (for example, because it was used as a deductible office for the entire five-year period ending on the sale date), you must calculate separate gains for the office and residential portions of your property. Then, you can use the gain exclusion only to shelter profit from the residential part. Any gain on the office part is usually fully taxable.

You will generally owe a federal income tax rate of no more than 25 percent on gain up to the amount of post-May 6, 1997 depreciation. Any remaining profit from selling the office part of your property will be taxed at the regular capital gains rates.

Contact your tax adviser if you are contemplating the sale of property with a home office. Advance planning may be necessary to maximize your tax savings.

 

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Tags: EHTC Article, Tax Laws, Documentation, Home Office, IRS, Articles, Tax Deduction

Inundated with Tax Clutter? Here's What You Can Toss

Posted on Fri, Apr 25, 2014

E-filing is on the upswing. According to the Data Book recently released by the IRS, the agency processed 240 million returns during its last fiscal year, of which 59 percent, or 151 million, were filed electronically. Of the 146 million individual income tax returns filed, almost 83 percent were e-filed.

Business Record Guidelines

Employee earnings

Maintain for at least four years, to meet various state and federal requirements. (However, don't throw away records that might involve unclaimed property, such as a final paycheck not claimed by a former employee.)

Employee time cards

Keep for at least three years if your business is subject to the Fair Labor Standards Act (engaged in interstate commerce). It is a best practice for all businesses to keep the files for several years in case questions arise.

Personnel records

Retain three years after an employee has been terminated.

Employment tax records

Keep four years from the date the tax was due, or the date it was paid -- whichever is longer.

Employee business expenses

For travel and transportation expenses supported by mileage logs and other receipts, keep supporting documents for the three-year statute of limitations.

Sales tax returns

State regulations vary. For example, New York generally requires sales tax records to be retained for three years, while California requires four years, and Arkansas, six. Check with your tax adviser.

Business property

Records used to substantiate the cost and deductions (such as depreciation, amortization and depletion) associated with business property must be maintained to determine the basis and gain (or loss) on the sale. Keep these for as long as you own the asset, plus seven years, according to IRS guidelines.

You might think those numbers suggest we are close to becoming a paperless society, at least when it comes to the IRS. That would be a wrong assumption. Even if you recently filed your 2013 tax return electronically, you probably printed out a hard copy for your files. Add that paper to the financial reports, bank statements and other documents you've been holding on to for years and it is likely your filing cabinets are overflowing with paper.

Now that you have filed your tax return, take time to do some spring cleaning.

But you cannot just dump old tax records without giving the process some thought. Some of the documents may still be valuable in case the IRS ever comes calling.

Audits and Amended Returns

You should generally keep records supporting items claimed on your individual tax return until the statute of limitations runs out. Typically, that is three years from the due date of the return or the date you filed, whichever is later. So this year you can generally toss out your tax records for the 2010 tax year and most paperwork you have left from earlier years, but keep your files for the past three tax years.

This is because the IRS can audit your returns for a minimum of three years. You can also file an amended return on Form 1040X during this time period if you missed a deduction, overlooked a credit or misreported income.

But you are not necessarily safe from an audit after three years have passed. There are a couple of key exceptions to this general rule:

1. The statute of limitations increases to six years if the IRS has reason to believe you understated your income by 25 percent or more, and

2. There is no time limit if the IRS suspects fraud or you do not file a tax return.

Various Retention Requirements

Keeping records for three years is the general rule. There are exceptions for certain records. Perhaps not surprisingly, there is no easy answer to the question of how long you should keep specific papers. The IRS does not require you to keep records in any particular way. But here are some basic guidelines for individuals to follow. (See right-hand box for business guidelines.)

Completed tax returns. Some tax advisers recommend that you hold onto copies of completed, filed returns for your lifetime. The reason is so you can prove to the IRS that you actually filed if there's ever a question about it. Even if you don't keep the returns indefinitely, you should hang onto them for at least six years after they are due or filed, whichever is later.

Backup records. Any written evidence that supports figures on your tax return, such as receipts, expense logs, bank notices and sales records, should generally be kept for at least three years.

Exceptions. There are times when you may be entitled to more than the usual three years to file an amended return. For instance, you have up to seven years to take deductions for bad debts or worthless securities, so don't toss out records that could result in refund claims for those items.

Real estate records. Keep real estate records for as long as you own the property, plus three years after you sell (or otherwise dispose of) it and report the transaction on your tax return. Throughout ownership of the property, keep records of the purchase, as well as receipts for home improvements, insurance claims, and documents relating to refinancing. These may help prove your adjusted basis in the home, which is needed to calculate the taxable gain at the time of sale, or to support calculations for rental property or home office deductions.

Securities. To accurately report taxable events involving stocks and bonds, you must maintain detailed records of purchases and sales. These records should include dates, quantities, prices, dividend reinvestment, and investment expenses, such as broker fees. Keep these records for as long as you own the investments, plus the statute of limitations on the relevant tax returns.

Individual Retirement Accounts (IRAs). The IRS requires you to keep copies of Forms 8606, 5498 and 1099-R until all the money is withdrawn from your IRA accounts. Now that Roth IRAs have been added into the mix for some retirement savers, it's more important than ever to hold onto all IRA records pertaining to contributions and withdrawals in case you're ever questioned. If an account is closed, treat IRA records with the same rules as securities. Don't dispose of any ownership documentation until the statute of limitations expires.

Issues affecting more than one year. Records that support figures affecting multiple years, such as carryovers of charitable deductions, net operating loss carrybacks or carryforwards or casualty losses, should be saved until the deductions no longer have an effect, plus seven years, according to IRS instructions.

These general recordkeeping guidelines are for individual tax purposes. Businesses, insurance companies and creditors may have other requirements. Contact your advisers for more information.

Last word: One critical step to take when cleaning out financial documents is to shred them thoroughly before you toss them out.

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Tags: Tax, EHTC Article, Tax Laws, Tax Documents, Articles

IRA Rollover Court Case Contradicts Longstanding Interpretation

Posted on Tue, Feb 25, 2014

As we all know, tax law is often convoluted. To illustrate the complexity, the U.S. Tax Court recently ruled against what is clearly stated in an IRS publication designed to explain the law to citizens. In the new case, the Court stated that the one-rollover-a-year rule applies to all of an individual's IRAs rather than on an account-by-account basis. Here is an explanation of the controversial decision and the rules involved in transferring money from one IRA to another. 

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Tags: EHTC Article, Tax Laws, IRA Rollover, U.S. Tax Court, Individual's IRAs, business consulting, CPA Firm