Love Letters from the IRS and Estimated Payments

Love letters from the IRS.  Every year, a handful of our clients receive correspondence from the IRS and/or state agencies regarding discrepancies with their tax filing. Normally, a client has forgotten to include a 1099 or W2, and being that the IRS is primarily on an electronic audit system, they know if something is missing, and are usually quick to notify you. But sometimes it can be a couple years before the error is discovered, which can lead to a balance of tax due, including penalties and interest.

Forgetting you worked that side job for a couple weeks, or that you sold some investments, happens. The tax document could have gotten lost in the mail, or went to a wrong address. Or you may have filed it away and forgotten about it. Whatever the reason, the answer is not to ignore the letter, but to call us immediately and provide us with a copy of the letter, so that we can assess the situation and rectify it quickly.

However, the number one reason we find our clients receive a correction notice is that the IRS’s record of estimated payments received are different than what was reported. Taxlink has tried to figure out the best way to ensure we have the right information. Usually when we ask the question “Did you make estimated payments last year?”, the response is “I did whatever you told me to.”

You would be surprised how often this is NOT the case! So, what happens is that the IRS sends a letter, you (angry, confused) call us, and we try to figure out what happened, sometimes calling the IRS which, if you’ve ever called the IRS, could leave you on hold for an hour or more. In most cases, we find that the information our clients provided us with is inaccurate, and the IRS and/or state agency is correct in their adjustment.

The other issue is applied overpayments. If you had an overpayment from the current tax filing that was applied to the following year, we automatically record that in our system. However, if the IRS makes an adjustment to that amount for whatever reason, we need to know in order to update our files. This can also cause a discrepancy when we finalize the return.

So, what to do? At this time, the IRS and most state agencies do not offer a “checks and balances” mechanism to look up payments on-line. We’ve decided that the best way to ensure we have the right information is to request copies of the cancelled checks that you send. In addition, if you receive any type of adjustment letter from the IRS for a previous year overpayment, we need to know that as well.

Why are estimated payments necessary? From the IRS website:

“The United States income tax system is a pay-as-you-go tax system, which means that you must pay income tax as you earn or receive your income during the year. You can do this either through withholding or by making estimated tax payments. If you didn't pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and refundable credits, or if they paid withholding and estimated tax of at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller.”

If you are one of our clients who make estimated payments, please feel free to send over copies of your payments for our files throughout the year.

Selling Your Business

Know the tax consequences beforehand

The tax consequences of selling a business depend on whether you operate as a sole proprietor or a corporation. As a sole proprietor, selling your business means you are selling the individual assets of the business. The sale of a business is not usually a sale of one asset. Instead, some or all of the business’s assets are sold. When this occurs, each asset is treated as being sold separately for determining the treatment of gain or loss.

If you are incorporated, you can either sell your stock to another individual, or the corporation can sell the assets. If the assets are sold, the corporation pays the tax on any gain. You, as a shareholder of the corporation, do not have a tax consequence unless the corporation liquidates and distributes the proceeds of the sale to you in exchange for your stock.

In any case, if you sell your business, you may need to complete additional tax forms with your annual tax return. When sold, these assets must be classified as capital assets, depreciable property used in the business, real property used in the business, or property held for sale to customers, such as inventory. The sale of capital assets results in capital gain or loss. The sale of inventory results in ordinary income or loss.

It’s important to determine what the potential tax consequences are prior to signing the sales contract. If you want to defer the gain on the sale, an installment agreement might be an option. Let me help you understand your options so we can discuss the tax consequences before you sell.

Working with Your Spouse

Is your spouse your employee?

One of the advantages of operating your own business is hiring family members. However, the employment tax requirements for family employees can vary from those that apply to other employees. There are a couple of different ways a married couple can operate a business together.

If you operate a sole proprietorship and you hire your spouse as an employee, you have an employee/employer relationship. This means one spouse substantially controls the business in terms of management decisions and the other spouse is under his or her direction and control. If such a relationship exists, then the non-owner spouse is an employee subject to income tax withholding, social security and Medicare tax, but not to FUTA tax. If this type of arrangement exists, you can provide benefits to your spouse and deduct them on your business return. One of these benefits can be health insurance. If your spouse is a bona-fide employee and is paid a reasonable wage for the services that he or she performs, you can provide health insurance to your spouse with a policy that covers both of you. This way you are allowed a deduction for the coverage on your business return and, in turn, reduce your self-employment tax. You can also provide retirement benefits to your spouse.

On the other hand, if your spouse has an equal say in the business affairs, provides substantially equal services to the business, and contributes capital to the business, then a partnership relationship exists and the business’s income should be reported on Form 1065. When spouses carry on a business together and share in the profits and losses, they are partners in a partnership regardless of whether they have a formal partnership agreement. They should not report the income on a Form 1040, Schedule C, in the name of one spouse as a sole proprietor nor should they file a joint Schedule C. In a partnership, each spouse reports their separate share of the partnership income and pays their own self-employment tax. This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based.

An Age To Remember

Quick tips

Knowing key tax birthdays can help trim your annual tax bills. Below are some ages worth noting:

0

If your child is born during the year, even as late as 11:59 p.m. on December 31, you can claim a dependency exemption for your child. This comes with one catch. You need to file for the child’s social security number (SSN) and include it on your tax return. If you don’t, the dependency exemption is denied, along with any potential for certain tax credits. If your dependent doesn’t have and can’t get an SSN, you must show the individual taxpayer identification number (ITIN) or adoption taxpayer identification number (ATIN) instead of an SSN.

0-12

The good news is you gain tax advantages by contributing to your employer’s flexible spending account to cover child care expenses, or you may qualify for a child care credit on your tax return. The bad news is that any investment income over $2,100 in your child’s name is taxed at your rate until the child reaches age 27. There is relief coming with this, however, beginning in TY2018. Be watching after the busy season for some information regarding the changes under the Tax Cut and Jobs Act of 2017.

13

Once your child reaches age 13, you no longer qualify to take the child care credit. Eligibility is determined on a daily basis.

16

This is the last year your child qualifies you for the $1,000 child tax credit.

18

If you own a business, you can pay your children to work for you and avoid paying Social Security and Medicare taxes on their wages. Once they reach age 18, you are required to withhold payroll taxes like any other employee.

27

At this age, children are taxed at their own rates on investment income. In addition, they are no longer eligible for their parents’ health insurance benefits.

50

Congratulations. Not only have you reached the half century mark, you can contribute an additional $1,000 to your IRA, bringing the total contribution limit to $6,500.

55

You and your covered spouse are eligible to make an additional $1,000 contribution to your HSA.

59.5

This is the magic age when you may take money from IRAs and retirement plans without incurring the additional 10% penalty for early distributions. There are exceptions to the penalties if you are younger, but this is the age when you may take penalty-free distributions for any reason.

65

Once you reach age 65, you qualify for an additional standard deduction and, if certain conditions exist, a tax credit. For tax purposes, you are considered to reach age 65 on the day before your 65th birthday.

70.5

At this age, you are required to begin distributions from your traditional IRA. If you have a Roth IRA, this rule doesn’t apply. If you have a retirement plan with your employer, you are still working, and you do not own more than 5% of the company, you can delay distributions even if you reach age 70½.

Automobile Expenses

Which is better, deducting the standard mileage rate or claiming actual expenses?

With the standard mileage at 53.5 cents per mile for 2017, it might be time to revisit what yields the more substantial deduction—the standard mileage rate for each business mile, or your actual car expenses. If this is the first year you have business use of an automobile, you don’t have to decide which method yields the better result until you file your return. If this is not the first year you have business use of an automobile, you cannot switch to the standard mileage rate in a later year if you started with deducting the actual expenses. On the other hand, if you started with deducting automobile expenses using the standard mileage rate, you can switch to the actual expense method.

Admittedly, claiming the standard mileage rate is a lot easier for most of us. All we have to do is keep track of our business miles and multiply them by the current rate. In addition, you may also deduct your costs for parking and tolls and, if you are self-employed, the interest on your car loan. Claiming actual expenses requires a bit more diligence in your recordkeeping. Doing so, however, may pay off in the end by giving you a larger deduction.

First, you must keep receipts for all your gasoline and oil, repairs, tires, licensing and registration fees, insurance, garage rent, lease fees, parking, tolls, and rental fees. If you are self-employed, you may also take the business portion of any interest you are paying on a car loan. Luxury and sales taxes are not deductible under any circumstance, although the amounts you pay can be added to your cost and recovered through depreciation.

Regardless of the method you choose, the expenses are limited to your business-use percentage. This percentage is calculated by dividing your total business miles by your total miles driven for the year. It’s wise to make note of your odometer reading on January 1 and again on December 31.