Monthly Newsletter Archive

September 2006

Why Pass-Through Entities

Face Much Lower Audit Rate

Organizing a business as a pass-through entity (S corporation, Partnership, or limited liability company taxed as a partnership) rather than a proprietorship can lower its audit risk in two ways.

First, pass-through entities have a much lower audit rate than proprietorships in general.

In addition, some reporting items that can act as audit red flags on a proprietorship’s Schedule C do not exist in a pass-through entity’s tax filings.

Example:  The home-office deduction is considered by many to be an audit red flag on an individual’s tax return.  It is claimed by attaching IRS form 8829 to the Schedule C—thus “announcing” the deduction the IRS and breaking out its component elements (the size of the office relative to the size of the home, amounts deducted for utilities and maintenance, etc.).

Contrast:  If the same business is organized as a one-owner S corporation, the owner can have the same office and deduct the same costs—but won’t deduct them directly on his/her personal return and won’t file Form 8829.

Instead, because he is and employee of the corporation, he will obtain reimbursement for his office expenses from the corporation.  When the documentation requirements of an “accountable plan” are met, the reimbursement is tax free to the owner and deductible by the corporation.

Advantages:  The reimbursement cost reduces the corporation’s income (or increases its loss)—and, since its income is taxed to its owner, this reduction “passes through” to him and effectively provides the deduction on his personal return indirectly.

Meanwhile, no specific “home office deduction’ is claimed anywhere—so the audit red flag does not exist.

June 2006

THE ALTERNATIVE MINIMUM TAX

The alternative minimum tax (AMT), originally targeted at just a few millionaires, today increases the tax bills of millions of people—including ever more in the middle class.

The Problem

It’s estimated that as many as 5.5 million individual taxpayers would have paid AMT on

Their 2005 returns, including about…:

• 17% of taxpayers with income between $75,000 and $100,000.
   

• 39% of those with income between $100,000 and $200,000.
   

• 78% of those with income between $200,000 and $500,000.

By 2010 nearly 30 million people will owe AMT, including two-thirds of taxpayers with adjusted gross incomes between $50,000 and $100,000 and 40% of all married couples.

How It Works

AMT income (AMTI) is computed by taking the taxable income shown on your return and adding back items that are used to reduce tax under regular rules. 

For 2005, there was an exempt amount for AMTI of $58,000 on a joint return or $40250 on a single return.  The AMT applies to AMTI over the exempt amount at a 16% rate on the first $175,000 and 28% on the rest.

However, the exempt amount is phased out by 25 cents for every dollar by which AMTI exceeds $150,000 on a joint return or $112,500 on a single return.

This creates marginal tax rates of 32.5% and 35% during the phase-out range, because for every extra dollar of additional income, $1.25 is taxed.

AMTI Exempt Amounts For 2006

At this time, Congress has not determined the AMTI exempt amounts for 2006.

The AMTI exempt amounts of $58,000 on a joint return and 40250 on a single return were temporary and expired after December 31, 2005.

If there amounts aren’t renewed, or new ones enacted, exempt amounts will fall back to the earlier level of $45,000 for couples and $33,750 for singles—and the number of individuals owing AMT in 2006 may hit 25 million.

 Until Congress acts one way or the other, planning for the AMT will be even more difficult.

May 2006

HOW TO GET OFF THE HOOK
FOR LATENESS PENALTIES

If you don’t take certain required actions—such as filing returns or paying taxes—by the deadline fixed by law, you will be subject to penalties.  Fortunately, these penalties can be waived if you furnish the right excuse for your lateness..

You filed a return late.  Returns that are not filed on time are subject to a penalty of 5% of the amount of tax shown on the return per year, but no more that 25% in total.  The penalty can be waived if the lateness is due to reasonable cause and not to willful neglect.  (Obtaining a waiver of the penalty for late filing does not eliminate the interest and penalties for late payment of taxes.

Examples of reasonable cause..

• Death of a loved one, such as a spouse or dependent.

• Debilitating illness of yourself, your spouse, or a dependent.

• You relied on the advice of an accountant or other tax adviser (e.g., you were told you didn’t have to file a tax return).

• Your relied on the advice of the IRS

Invalid excuses..

• Health problems that do not prevent you from  working full time.

• Forgetfulness.

• Death or illness of your accountant

• Busy on your job.

March/April 2006

ELECTRONIC FILING

Filing your tax return electronically can eliminate filing errors, speed your refund, and make filing easier in future years. 

• Eliminates most mistakes that occur on paper returns that can delay a refund or bring extra scrutiny to a return from the IRS.
• Speeds up refunds.  When e-filing is combined with electronic deposit of a refund in a bank account, the refund will be delivered in about two weeks.
• Eases future filings.  Once you enter your data for an e-filed return, it is carried forward automatically to returns that are e-filed in future years.                                       

This saves the need to manually reenter the same data (names, Social Security numbers, employer id numbers, etc.) and also ensures that tax carryover items are correctly entered on a subsequent year’s returns automatically.

• Provides proof of filing.  When a return is e-filed, you receive an electronic receipt that is proof of filing.  You eliminate the risk that a return will be delayed in the mail and be received late by the IRS – or be lost in the mail and not received by the IRS at all.

February 2006

Home Heating Fuel Deduction

Massachusetts is allowing a deduction for home heating fuel. Income eligible taxpayers may claim a home heating fuel deduction up to a maximum of $800. The Act requires that the deduction may be used only for the cost of home heating oil, natural gas and propane purchased between November 1, 2005 and March 31, 2007.”

A taxpayer who qualifies for the deduction may apply the deduction in taxable year 2005 for purchases made between November 1, 2005 and December 31, 2005. If the taxpayer does not take the full $800 deduction in taxable year 2005, the taxpayer may take the remainder in taxable year 2006 for purchases made in 2006 through March 31, 2006. A monthly budget fuel plan spreads the cost of fuel over 12 months; the monthly budget payment is calculated based on estimated usage and expected average fuel price for the upcoming heating season. Only the payments made during the period November 1, 2005 through March 31, 2006 qualify for the home heating fuel deduction.

Where a taxpayer purchases fuel using a credit card to make payments, the transaction dates relating to fuel purchases must fall during the period November 1, 2005 through March 31, 2006 for the purchases to qualify for the home heating fuel deduction; the dates on which the taxpayer pays the credit card bills for fuel do not control.

A single person may claim the deduction only if his of her adjusted gross income is equal to or less than $50,000. Married persons and Head of household claim the deduction only if his or her adjusted gross income is equal to or less than $75,000. If a married couple files separately, no deduction is allowed.

January 2006

Cost-of-living Adjustments for 2006

Based on changes in the Consumer Price Index for all Urban Consumers, the tax brackets are adjusted and other tax items are projected for 2006 to be as follows (official figures typically are not available until year-end)…

The standard deduction will increase to $5150 for singles and $10,300 on a joint return (up from $5000 and $10,000, respectively, for 2005).

The personal exemption will be $3300 (up from $3200 in 2005).

Note: The “loss of exemption” amount for high-income taxpayers is reduced slightly in 2006 because of a law change

The first-year expensing limit will be $108,000 (up from $105,000 in 2005)

AGI limits for the adoption credit, education credits and the exclusion for interest on US savings bonds used for higher education are increased.

The gift tax exclusion will be $12,000 ($24,000 for an electing married couple).  For gifts to non-citizen spouses, the limit increases to $120,000 (up from $117,000 in 2005).

December 2005

IRS INCREASES DRIVING DEDUCTION MILEAGE RATE

The IRS has increased the standard mileage rate for deducting business use of a car from 40.5 cents to 48.5 cents from the period from September 1 through the end of 2005.  The rate for medical and moving expense deductions is increased from 15 cents to 22 cents per mile.  The deduction increases reflect the increased cost of gasoline after Hurricane Katrina.

Note:  The deduction rate for charitable driving to aid Katrina victims is 70% of the business rate from August 25, 2005, through the end of 2006.

Taxpayers should keep a written diary of mileage for business, medical and charitable purposes.

November 2005

The IRS is actively pursing some non-filers. They have identified 2.8 million with potentially "high income" for enforcement action.

The process...

Notices are mailed to the non-filer. Starting with a a soft notice and then increasing in urgency. 

If there is no response from the non-filer, the IRS will attempt to place a call.

If unable to reach the non-filer the case is turned over to field staff to contact the tax payer in person. 

Finally the IRS will file a substitute tax return on behalf of the non-filer based on their calculations and collect on that amount.

The IRS is also trying to make it easier for non-filers who owe large tax bills to re-enter the system by offering installment agreements and compromises.

The IRS also ensures non-filers that stiff penalties for evading taxes will not be imposed on those who voluntarily report their taxes even when in arrears.

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