Filing an Amended Tax Return by Carolyn Flaherty

So you got a jump on things, filed your return early… and then received an unexpected Form 1099 that should be reported. Maybe your investment advisor found a mistake and mailed you a corrected Form 1099 after you filed your return? You filed as married filing jointly and realized later that this year married filing separately generates a lower tax liability. Perhaps you found a mistake when you did the spring cleaning of your finances? Regardless of how the error occurred you need to know how and when to file an amended tax return.

First, you do not typically need to file an amended return for math errors. The IRS automatically corrects the errors and changes your refund or liability for you. Neither do you need to file an amended return if you neglected to attach required forms. The IRS will contact you to request forms if they need them. However, you should consider an amendment if filing status, income, deductions or credits require adjustment.

Amendments generally must be filed by the later of three years from the date you originally filed the tax return or two years from the date the tax was paid. You must prepare a Form 1040X to amend your return. As you compile your amended return, consider the following:

1.       You cannot correct a prior year error on your current year return. You must go back and properly report the item in question in the year that generated the error.

2.       If corrections are necessary for more than one year, you should prepare a Form 1040X for each year and mail them to the IRS separately.

3.       Include support for your changes with Form 1040X. For example the corrected or additional 1099, W2 or other forms should be attached and mailed with the amendment.

4.       Form 1040X cannot be filed electronically.

5.       If you are filing an amended return to claim an additional refund: file after receiving your initial refund. You may utilize the original refund: the IRS will remit the differential after the amendment is processed.

6.       If you are filing an amended return that results in additional tax liability: remit payment with the filing so that penalties and interest can be minimized.

7.       Amended returns will take up to twelve weeks to process.

Mistakes can occur whether you prepare your own return or consult with a CPA to do so. Our blog posted February 19, 2011 “Should I prepare my own tax return,” (direct link: http://www.prrllc.blogspot.com/2011/02/should-i-prepare-my-own-tax-return-by.html), may help you decide how to proceed. As stated in that blog, regardless of whether or not you are confident in your ability to prepare your own returns; we strongly recommend that about every three years you go for a financial “checkup.” If a professional finds missing deductions or mistakes during their review; you will have the ability to amend during the three year period.

In addition, sometimes an IRS Notice will be the catalyst for an amended return. The most important thing to remember upon receiving a notice form the IRS is not to panic. Review our blog published January 19, 2012 “What to do if you receive an IRS Notice,” (direct link: http://www.prrllc.blogspot.com/2012/01/accounting-news-has-been-reporting.html), and consult your tax advisor so they may review your return and properly advise you.

Taxpayer's Burden of Proof by Carolyn Flaherty

Most US citizens understand the concept of criminal law that provides a person is innocent until proven guilty. However, many fail to grasp that the same is not true in tax court. To the contrary, in general, the IRS commissioner’s determinations are presumed to be correct and the taxpayer bears the burden of proving that the positions are erroneous.

The IRS is allowed to reconstruct income using various manners including the commonly used method of bank account analysis. The IRS reconstruction of income is simply required to be reasonable in light of the surrounding facts and circumstances. As established by case law, all bank deposits constitute evidence of income and as such the IRS can simply assert that all deposits made to bank accounts are taxable income. If deposits represent loans, contributions from the owner of a business or transfers between accounts; it is the responsibility of the taxpayer to prove this fact. The Tax Court will not reconcile accounts to match transfers nor attempt to gather evidence to support the source of funds to an account. The substantiation must be efficiently and concisely supported by documentation provided by the taxpayer.

Furthermore, Tax Court Rule 142(a) states that deductions are a matter of “legislative grace” and the taxpayer therefore must prove that they are eligible for the deduction and also substantiate the deduction claimed with appropriate receipts and documentation. If the taxpayer is unable or unwilling to prove eligibility or substantiate the deduction, it will be denied.

Business income and expenses reported on Schedule C are increasingly scrutinized by the IRS. Ordinary and necessary expenses incurred in a trade or business are normally deductible. However, taxpayers should note that banks statements or tables of expenses generated from bank statements are not considered sufficient evidence of eligibility for deduction. The court asserts that the tables do nothing more than summarize purchases and therefore do not prove that they were ordinary and necessary business costs as opposed to personal or other non-deductible business expenditures.  In addition, a memo notation in a check is not necessarily enough to substantiate a payment as a legitimate business expense if it could also be presumed a personal expense.

The IRS may impose a 20% accuracy-related penalty when there is a substantial understatement of tax. Substantial understatement is considered to exist when it exceeds 10% of the tax required to be shown on the return (unless the understatement is less than $5,000). The penalty will not be imposed on any portion of the understatement which resulted due to reasonable cause and in good faith. To establish reasonable cause and good faith, the most important factor is the extent of effort the taxpayer has taken to arrive at the correct tax liability.

Therefore, careful record keeping and documentation are imperative. Moreover, business and personal expenditures should be maintained independently through separate bank accounts and credit cards. For more information on how to document and defend your tax position, contact a tax advisor.

Deducting Home Office Expenses by Carolyn Flaherty

The home office deduction can prove to be a valuable deduction; particularly for self-employed taxpayers. The deduction may convert otherwise non-deductible expenses, (such as utilities, home owner’s insurance, association fees and more) into deductible business write offs that will reduce self-employment tax liabilities. However, the deduction is one that has been scrutinized by the IRS due to abuses by taxpayers and proper record-keeping can be onerous.

Therefore, for tax years starting in 2013, the IRS has provided an optional safe-harbor method to calculate the home office deduction. Under the safe-harbor method the taxpayer will look to the square footage of the area used exclusively for business and simply multiply that by $5. The maximum allowable square footage for figuring the safe-harbor deduction is 300. As such, the maximum safe-harbor deduction is $1,500.

Interestingly, taxpayers are allowed to switch back and forth from year to year between the safe-harbor and the actual expense method. Therefore, in a year when significant repairs and maintenance work was done: the taxpayer may wish to use actual expenses whereas in other years, it may be easier to use the safe-harbor. Note that the safe-harbor election once made for a tax year is irrevocable for that year.

Depreciation expense cannot be taken in a year the safe-harbor election is made, but may be taken in subsequent years when the actual expense method is used.

Whether the safe-harbor or actual expense method is used, the home office deduction cannot reduce the qualified business income below zero. However, the actual expense method allows the unused deduction to be carried forward to subsequent profitable years. The safe-harbor rules do not. Additionally, the actual expense carry over can NOT offset business income in a year when the safe-harbor rules are used. The carry forwards may only be applied to a future tax year when the actual method is utilized.

Regardless of the method used, your home office must be used exclusively for business and must also be your principal place of business. Exclusive use specifies that the personal use of your home office is no more than would be permitted in an office building. If you work at multiple sites, your home office is still your principal place of business if you regularly meet customers or clients there.

List of potential costs deductible under actual expense method:

·         Direct expenses such as business phone lines, computer equipment etc.

·         Indirect expenses (in proportion to the square footage of the office as compared to the total home), the following are common expenses considered in the deduction calculation:

1.       Utilities

2.       Home owner’s insurance

3.       Association fees

4.       Security costs

5.       General repairs and maintenance

6.       Depreciation or rent

7.       Mortgage Interest

8.       Property taxes

PREPARING FOR TAX CHANGES IN 2013 by Karla Hopkins

2012 was a year of negation and election.  Many of us were watching and waiting for our congressional leaders to come to agreement on the terms of our federal budget and especially changes that would impact our tax liabilities in 2012 and future.  Here are a few highlights on these changes which will be important for you to consider for 2013:

• A 3.8% additional tax on the lower of net investment income  or the amount of  modified adjusted gross income over the $250,000/$200,000 threshold.  Net investment income includes, interest, dividends, rents, and gains.

• Additional .9% Medicare Tax for employees (not employers) on compensation over a $250,000/$200,000 threshold.  Because the threshold amounts are based on filing status and combined wages for a joint return, not all employees will have the correct amount of withholdings.

• The top federal  tax rate will return to 39.6% for a married couple with in excess of $450,000 of income and a single taxpayer with $400,000 of income.

• Capital gain rates will return to 20% based on a threshold again of $450,000/$400,000.

• Phase outs of personal exemptions and itemized deductions will return for taxpayers over a threshold of $300,000/$250,000 in income.

• The payroll tax holiday has ended.  Employees' FICA withholdings will return to a 6.2% rate from the reduced 2012 rate of 4.2%.

• Personal tax credits including the $1,000 child tax credit and advanced opportunity college tax credit are extended.

• The elective contribution to a 401(K) plan has been increased to $17,500.

• The elective contribution to an IRA account has been increased to $5,500.

Because many of these came so late in the year, it will be critical in 2013 for all taxpayers to play an active role in their tax planning during the year.  Follow our newsletters and blogs for the most up-to-date information and as always, contact our office with questions and we will gladly assist you with your tax planning: http://www.prrllc.net/ 508-553-3091.

MA Septic Credit by Carolyn Flaherty

The cost to repair or replace a failed septic system can be financially crippling to home owners. As such, the Title V testing that is required as part of the sale of all Massachusetts homes can be a nerve racking undertaking. Should you find yourself the unfortunate owner of a failed system, you may find some consolation in the MA Septic Credit.

The MA Septic Credit is equal to 40% of the actual costs (actual costs not to exceed $15,000), incurred to repair or replace a failed system. The credit is available on your primary residence located in Massachusetts.

Actual costs include materials, equipment, demolition, relocation, design, engineering, testing and inspection paid to upgrade, replace or connect a failed system to a sewer system.

The maximum septic credit is $6,000 (40% of $15,000), but the maximum allowed for any one tax year is $1,500. The remaining credit is carried forward for a period not to exceed five tax years after the initial credit is claimed. The initial credit is taken on MA Schedule SC in the year in which the repair or replacement of the failed system is completed. A Certificate of Compliance or verification letter stating that the system complies with the Title V Department of Environmental Protection requirements along with the bills for costs incurred to cure the system, must be kept for your records to substantiate the credit.

Massachusetts also offers qualified home owners low interest loans and betterment for the repair or replacement of failed systems. The interest subsidy associated with any such loan or betterment will be subtracted from the Septic Credit. The reduction of the Septic Credit is generally equal to the difference between the annualized non-subsidized state interest rate (as determined under General Law c. 62C, s. 32(a)) and the state subsidized rate.

Note: The taxpayer claiming a MA Septic Credit cannot be a dependent of another. In addition voluntary repairs or replacements of a cesspool or septic tank do not qualify for the MA Septic Credit. However, if a federal or state court order or similar mandate causes the taxpayer to pay for connection to a municipal sewer system, the credit is allowed.

Form 990 Audit Triggers by Carolyn Flaherty

Each year the IRS announces its exempt organization work plan. Evaluation of the plan reveals exempt organization audit triggers. For 2013 the IRS will be scrutinizing entities with the following characteristics:

1. Organizations with high foreign expenditures.

2. Medium to large organizations that report substantial fundraising income but proportionally small fundraising expenses.

3. Entities that report high annual gross receipts but low compensation of directors, trustees, officers and key employees.

4. Organizations reporting considerable unrelated business income for three or more consecutive tax years with little or no related taxable income.

5. Exempt organizations that have potential impermissible campaign spending.

6. 501(c)(4), (c)(5) and (c)(6) filers including social welfare organizations; labor, agricultural and horticultural groups; and trade associations that have self-declared themselves tax-exempt without an IRS determination.

Because the IRS continues to use analytical evaluators of Form 990 responses to select organizations for audit and review: filers should take care to review and follow Form 990 instructions.

Refinancing Your Rental Property by Carolyn Flaherty

Mortgage interest rates have been trending downward for many years. As such, many people have taken the opportunity to re-finance their loans to ascertain shorter terms or lower monthly payments. Although you are only allowed to deduct qualified points and interest on your primary residence: you may be able to deduct more from a rental property you own.

The fees associated with the refinance are deducted over the term of the loan. However, if the refinance is done to take equity out of the property in order to make substantial improvements on the property; the fees may be deductible in the year they are paid.

Some of the settlement expenses that can be deducted include the following:

• Abstract fees
• Appraisal fees
• Attorney fees
• Bank fees
• Mortgage commissions
• Notary fees
• Points
• Recording fees
• Title search fees
• Underwriting fees

These amounts can be found on your closing statement and again, should be amortized over the life of your loan.

The remaining balance of charges from the previous loan that were being amortized may be deducted in full the year you refinance if you refinance with a new lender. On the other hand, if you refinance with the same lender, you should deduct your unamortized balance of old charges over the life of the new loan.