Tax Tips

If there is one thing you as a taxpayer want to avoid, it is being audited by the IRS. While the chances of it are usually very slim, there are certain red flags that do get the attention of IRS officials now and then. Whether it is tax returns for individuals or those connected to a business, an IRS audit will be very detailed, time-consuming, and could potentially lead to criminal charges being filed against you, depending of course on the alleged violations. Rather than have these circumstances occur, it is always best to work closely with your CPA so that you will be aware of these nine red flags that can trigger an audit.

1. Reporting Incorrect Taxable Income

Whether you are a full-time employee or self-employed, reporting an incorrect taxable income will get the attention of the IRS. Since the agency receives copies of whatever W-2 and 1099 forms you receive, it will know exactly how much income you earned. When a discrepancy occurs on your tax return, expect the IRS to start asking questions.

2. Large Donations, Small Income

While making large donations to various charities is always a great thing to do, it will be a red flag to the IRS if you are doing so while reporting a very small income. Since these two things are generally not compatible, you should keep all receipts associated with your charitable donations, and also work with your CPA to ensure you follow IRS guidelines for your donations.

3. Deducting High Business Expenses

If you are a business owner or perhaps a salesperson who regularly takes clients to dinner to finalize important deals, expect the IRS to carefully scrutinize the business expenses you claim as deductions on your tax return. While it is acceptable for you to deduct as much as 50% of the cost of a reasonably-priced business dinner, doing so over and over for large amounts will always be a red flag to the IRS.

4. I Use My Car for Business

One of the oldest red flags for potential audits, stating that you use your car for business purposes will likely have the IRS asking you many questions along the way. To prove your tax return is correct, you should keep detailed records of your mileage as well as dates and times for when you used your car for business. If you can, also write down your starting and ending destinations, since these can lend more credibility to your deductions.

5. Nothing but Round Numbers

While your CPA would love to see a perfect world where everything wound up equaling nice, round numbers, they know that's not how the world works. Unfortunately, the IRS knows this as well, which is why when you always submit tax returns that contain figures such as these, you ensure the red flag rises at the IRS office. In these situations, the IRS will probably think you are either pulling figures out of thin air, or at the least are keeping horrible records of your transactions. To avoid an audit, provide your CPA with all available receipts, since this will let them use the actual numbers on your forms.

6. Your Business Always Loses Money

While it is not unusual for a business owner to report their business lost money now and then, doing so year in and year out will garner the attention of IRS agents. Thus, if you have a full-time business and have reported on your tax returns that your business has lost money for at least three of the past five years, you can probably expect to be audited. To make sure all goes well in the end, have as much documentation as needed to show your business has simply hit a rough patch, and is usually profitable.

7. Unforced Errors

Hey, mistakes happen, even on tax returns. Depending on the type of form you are using when filing, how many deductions you may be claiming, and so forth, it's always possible to make an unforced error on your tax return. From claiming an incorrect tax credit to filing under the wrong status, these types of errors may get you more attention from the IRS than you anticipated. Fortunately, if you work with a CPA when filing your taxes, they can carefully check your returns with your records to ensure no mistakes are made prior to filing.

8. The Home Office

Should you simply have a computer positioned on a desk in your home, this does not constitute an official home office in the eyes of the IRS. However, this doesn't stop people from trying to abuse this deduction each and every year. To be in the clear when claiming a home office, you need to have an area of your home that is used for the majority of your work and for little if any personal use. Should questions arise, listen to the advice of your CPA.

9. Dramatic Change in Your Income

In today's topsy-turvy world, it is of course always possible you could have a dramatic change in your income, either for the better or for the worse. If this should occur and the IRS starts taking a look at your previous tax returns, it may want some answers from you as to what has transpired. This is especially likely if you have made large cash deposits into your bank account recently, so be prepared for additional scrutiny. To protect yourself, keep all records and documentation related to your change in income, and also discuss your situation with a CPA you know and trust.

While most people assume an IRS audit automatically means large fines and possibly criminal penalties will follow, this happens far less often than is realized. Instead, having the proper documentation and being honest about any mistakes or discrepancies will usually help to clear up the matter. By doing so and hiring a CPA who is experienced in these matters, tax season can be one filled with relaxation rather than apprehension.

When the time comes and you decide to hire someone to work for you as a housekeeper, nanny, caregiver, or similar job at your home, it’s vital that you understand the tax implications associated with such arrangements.  While some people who are employers in these situations don’t pay attention to the tax side of things, this is a mistake that may lead to stiff penalties from the IRS.  Rather than create this situation for yourself, here is what you need to know when hiring household help.

Employee or Self-Employed?

To begin with, you should determine whether the person who will be working in your home is legally defined as an employee or as a self-employed individual.  In general, if the worker you hire controls how their work is done or is provided to you by an agency, yet still has control over how the work is done, they are not your employee.  However, if you hire someone and still maintain control over their daily actions while on the job, you more than likely have yourself an employee in the eyes of the IRS. 

Providing Equipment and Supplies 

Along with the question of who maintains control over the job duties, determining who provides various equipment and supplies also makes a difference.  As an example, if you hire a person to be a nanny and perform light housework, who follows your specific instructions about their duties and uses equipment and supplies you provide, they may be considered to be your employee.  However, if you hire someone to perform lawn care services who uses their own equipment and supplies, they are probably not your employee.

Employment Eligibility Verification

Whether you hire an employee temporarily, have them live-in at your home, or they work for you on a long-term live-out basis, you are responsible for verifying they are either a U.S. citizen or an alien who is legally allowed to work in the United States (unless you hire through an agency).  To do so, you and your worker must complete Form I-9, USCIS Employment Eligibility Verification.  Once your worker fills out their part of the form and you verify their documents, you complete the employer part of the form.  Upon doing so, do not send the form to USCIS.  Instead, keep it for your records. 

Severe Consequences

While Form I-9 may not sound terribly important to you, it is, in fact very important.  Under U.S. law, it is illegal for any person or company to knowingly hire or continue to employ any person who is not legally authorized to work in the United States.  If you do so and are caught by authorities, you could face severe penalties from the IRS and possibly even face criminal charges.

Employment Taxes

When you have any type of household employee, you may be required to withhold both Medicare and Social Security taxes, as well as federal unemployment taxes.  Under current regulations, if you paid your employee cash wages exceeding $2,200 in 2020, you are required to withhold and pay Medicare and Social Security taxes.  In addition, if you paid at least $1,000 in cash wages to your employee during any quarter of the calendar year in either 2019 or 2020, you are required to also pay the federal unemployment tax.  Should none of these apply to you, it is possible you may still be required to pay state unemployment taxes. Consult with your CPA for details. 

Social Security and Medicare Taxes

As for Social Security and Medicare taxes, you as an employer are required to pay in not only your share as the employer, but also your employee's share of the taxes.  Currently, as the employer, your share totals 7.65 percent, which is broken down into 6.2 for Social Security and 1.45 for Medicare.  The amount is the same for your employee, so keep this in mind when paying the taxes.  While you have the option of either withholding your employee's share from their wages or paying it directly out of your own funds, you should not count wages you pay to your spouse, your parent, or any child you have who is under age 21 as Social Security and Medicare wages. 

Exceptions to the Rule

As with many tax-related matters, there are of course exceptions to the rule regarding the payment of Social Security and Medicare taxes with regard to payments made to a parent or an employee who is under age 18 at some point during the course of the year.  Regarding a parent, these wages should be counted if they care for your child and the child is under age 18 or suffers from a physical or mental condition requiring personal care from an adult.  In addition, you can only count these wages if you are divorced and have yet to remarry, are widowed or a widower, or are married but have a spouse whose mental or physical condition prevents them from providing childcare.  As for employees less than 18 years of age, wages should only be counted if this job is their primary occupation, which would not be considered the case if the person you employ is a student. 

Maximum Taxable Earnings

Should the Social Security and Medicare wages of your employee reach $137,700 during 2020, any wages paid the remainder of the year should not be counted as Social Security wages when figuring the Social Security tax.  However, wages should continue to be counted toward the figuring of Medicare taxes.  Also, be aware that meals and lodging provided by you at your home to your employee for your convenience and as a condition of their employment are never counted as wages in these situations. 

Needless to say, the tax issues involved when hiring household help can be complex and confusing.  To make sure you don’t make costly mistakes along the way, it is best to consult with a CPA who can advise you on how to proceed in these matters.  In doing so, both you and your employees or contract workers can have peace of mind.

With the recent coronavirus outbreak, discussions of paid leave, and states of emergency, more attention has been paid to sick time and paid time off than ever before. If you’re a small business owner with just a few employees, you might not have an official sick time policy. Or, you might not have paid much attention to tracking employees’ time off, relying on the honor system.

A lot has changed in the past few weeks. With a focus on self-isolation and quarantine, you might have realized that it’s time to look at your policies on sick time and absences. 

What Does the Law Say about PTO?

The Fair Labor Standards Act governs small businesses labor policies. While companies with fifty or more employees must offer up to 12 weeks of unpaid leave to some employees, there’s no requirement to give them paid time off or vacation. It’s up to the employer’s discretion.

However, state and local laws may mandate sick time - such as in the city of Minneapolis, which requires that employers offer sick and safe paid time off for part-time employees. Always check the laws with your local labor department when writing human resources policies. 

Even though there is not a legal requirement to offer PTO, many businesses know that PTO attracts qualified workers, keeps them motivated and engaged, and protects the health of their overall workforce. Offering sick days and vacation time is just good business, which is why employees have come to expect it. 

When you first started, you might not have written formalized policies. But, if you grow, they will become necessary. 

What Should go Into a PTO Policy?

Given that it’s up to your discretion how much PTO to offer employees, as long as you are in compliance with state and local laws, you can formulate your own PTO policy. In it, you should include information on who receives paid time off, how hours accrue, and how many hours employees are eligible to receive annually. 

Here are a few questions that your policy should answer so that you know how to account for the PTO your employees earn and use properly.

Who Receives PTO, and When?

A comprehensive PTO policy should first address who’s eligible for PTO. 

Will you only offer it to salaried employees, or will hourly workers be eligible? Then, ask yourself when they can take the PTO and if they need supervisor approval. If your business would be severely disrupted if all four hourly workers took the same day off, you might want to require supervisor oversight and approval of PTO requests. 

When they take PTO also relates to years or months of service. Will you only allow a new employee to start taking time off after they’ve been with you for six months? 

How Will Hours Accrue?

Do you want to track accrued PTO by hours worked or years of service? Does a new employee receive all their PTO benefits on their start date? If they earn PTO as they work, you’ll have to track hours. For some businesses, this doesn’t make sense. 

Does Vacation Time Carry Over?

Will vacation time carry over? This is one of the biggest questions, from an accounting perspective, that you must answer. If employees can carry over accrued vacation, you will carry that liability on the books from year to year. It adds a layer of complication to closing the books at year-end. 

Will you pay out employees for unused time off? 

If an employee quits and hasn’t used five hours of vacation time, will you pay them for those hours? Again, this has accounting and cashflow implications. Accrued PTO is a liability on your Balance Sheet, so it’s important to track it accurately. And adding an extra ten hours of pay to a last paycheck could harm your ability to pay suppliers one week. 

What about Longer Absences?

If you have decided to revisit your sick leave policy in the light of coronavirus, consider the following; will you allow employees to work from home? If an employee goes negative on sick time or PTO, how will you handle it? It’s important to answer these questions before they become an issue. 

Accounting for Sick Time

Accrued PTO is a liability on your balance sheet. As employees earn hours, you must increase this liability. 

For example, if you have a policy where they earn one hour for every eight hours worked, at the end of a 40 hour week, you would record 5 more hours of PTO in your liability account. Proper time tracking is essential, both for accruing and using PTO.

When an employee takes a sick day or goes on vacation, it reduces the liability. Note that you only need to record a liability if the employee earns the vacation time in one period but defers using it until another - if they use it as they earn it, it rolls into compensation. 

When booking accruals, you can factor in anticipated forfeitures. Many PTO policies state that employees must have been with the company for a certain time to take vacation. If you’ve been dealing with a high turnover rate and PTO forfeitures, then it wouldn’t make sense to book 100% of the vacation that new employees accrue. Your accountant can help calculate a forfeiture rate.

Small or large - no matter your company size, there are many variables you must consider when formulating a PTO policy. Paid time off and sick leave impacts everyone in your organization, and also has a financial impact. It will appear on your balance sheet and affect your cash flow. 

A documented sick time and PTO policy, fairly applied to all employees, protects you from lawsuits, and helps your business keep running smoothly. 

Getting a divorce can be one of the most stressful times in your life. In addition to the emotional toll, it costs, on average, $15,500. As you split your assets, including cars, homes, and retirement accounts, don’t forget to think about the financial implication of your custody decree.

There are financial considerations related to your children that go beyond child support and that you would be wise to include them. From everything to the federal dependent tax credit to your daughter’s piano lessons, here’s what you should think about when it comes to kids, divorce, and taxes.

Child Tax Credit

The child tax credit allows you to claim an annual credit for any dependents in your home. It can be up to $2,000 per child and $500 per qualifying dependent. For many families, this is a big help on their tax return. Once your divorce has been finalized, however, you’ll be filing singly. So, who takes the child tax credit on their taxes?

For simplicity’s sake, most couples with 50/50 custody agree to trade the deduction off every other year. The father gets the deduction in odd years, the mother in even years, for example. If, however, custody is not 50/50, the parent who has more time also usually gets the deduction.

In some instances, if there is a large income discrepancy, the parent who makes a significantly higher income could cut a deal with the other parent. In order to keep the child tax credit every year, they may offer more money in the settlement or higher alimony payment.

Another thing to consider is whether or not the deduction should be tied to child support. If it’s an odd year and the father gets the dependent care deduction, but he’s behind or hasn’t paid child support, you can put in your decree that the mother can take it that year. Discuss all options with your lawyer before agreeing to a plan.

Daycare or Afterschool Care

If your children are young, and still in daycare, or need before and after school care, don’t forget to include these costs and their associated deduction in your decree. While the expenses can be split evenly, in some states (such as Minnesota), they’re often divided up by either the parent’s income levels or custody time. If your ex makes significantly more than you do, they’ll pay more for daycare.

The federal government does allow you to deduct either daycare or before and after school care expenses. Your deduction amount will be a percentage of the total, and that percentage is based upon your income. If you live in a state with income taxes, talk to your accountant about both limits and deductibility of daycare and afterschool care. It varies by state and could depend upon your income.

And don’t forget about the summer! While overnight camps aren’t tax-deductible, summer day camps for children under the age of 13 that allow you to work can be deducted.

Extracurricular Activities

Even if you’ve been splitting costs amicably during the divorce, it’s a good idea to put everything in writing. If your son loves his swimming lessons, ask your lawyer to include in the decree that he’s allowed to continue them for as long as he wants. Also, include any other sports, or other opportunities, you want your children to experience.

This language can be broad, such as “one additional afterschool activity,” if your child hasn’t chosen a sport yet. But it should provide for both continuing or starting new activities and cover who will pay for them. It’s an unfortunate reality that some parents choose to become petty about money once they’ve split. A good co-parenting relationship can change once your ex-spouse remarries, and they could decide to stop splitting bills they once paid without argument.

Negotiate to add clauses about extracurricular activities, transporting your kids to them, and who will pay. If you’re concerned about the cost, you can set a cap on quarterly or annual expenditures. The IRS considers extracurricular activities to be personal expenses, and will not allow you to deduct them. But it’s still not something to overlook for your own peace of mind.

Further Education

While you can’t always get the other party to agree to who will pay for college or education beyond high school, it’s good to think about adding it to your decree. Some parents decide to split the costs 50/50, others agree to split three ways between the parents and the child. Either parent can deduct up to $4,000 of higher education tuition and fees, so it’s something else to address with your lawyer.

The Final Decree

Divorce is a complicated, messy business. Depending upon your children’s ages, you might have to live with the final decree for years to come. Talk with your lawyer and your accountant about every financial aspect of raising your children that you should include. Going back to court to address an omission can be quite expensive.

Tax laws also change, as do deduction limits and percentages. While you can’t predict what the government will do in the future, you can have your lawyer draft language which leaves room to re-negotiate at certain milestones. You can tie reassessments to kindergarten, high school, college, or other times when it might make sense to revisit your original agreement.

Does it sometimes feel like your accountant is speaking an alien language? You hired a CPA in the first place so you could benefit from their many years of experience and expertise. Obviously your CPA knows more than you do when it comes to taxes and taking advantage of the most beneficial financial strategies. But at the same time, you do want to understand what they’re trying to help you with and what they need you to do on your end of the finances. Learning a few common accountant terms will really help you to get a firmer grasp on your own financial situation while enabling you to more efficiently communicate with your tax professional.

1. Cash Basis Accounting and Accrual Basis Accounting

One of the first questions your CPA will ask is if your business operates on a cash basis or accrual basis. Newer business owners often take on a “deer in the headlights” look because they don’t know what the terms mean. These terms simply refer to the timing of when you record your business income and expenses. If you use cash basis accounting you record income when you actually get paid and expenses when you send the payment. With accrual basis accounting, you record the income as soon as you earn it and expenses when they’re incurred. Depending on your organization type, there are certain advantages to using either cash basis or accrual basis accounting, so consult with your CPA about which one works best for your business.

2. Balance Sheet 

Have you ever gotten a call from your CPA and they say they don’t like the looks of your balance sheet? If you only knew what a balance sheet was you might not like it either, but you don’t so you just nod and say “Oh.” The balance sheet is a snapshot of your financial position at any point in time. The balance sheet takes into account your assets and equity minus your liabilities. The balance is your net worth. It’s valuable for diagnosing cash flow problems in addition to other things. 

3. Depreciation 

Depreciation is a simple word with a complex meaning. Most people know that a car depreciates in value the moment you drive it off the lot. But when your CPA starts talking about spreading out the depreciation on your assets over time do you really know what they’re talking about? Depreciation is a loss of value over time. Things like expensive business equipment and fleet vehicles are often depreciated over several years’ tax returns as a tax saving strategy. You may also hear your accountant talk about accelerated depreciation, straight-line depreciation and accumulated depreciation. Calculating depreciation on an asset can be complicated, so it’s best left to your tax  professional.

4. Fixed Costs 

Just as your grandmother may have a fixed income, your business has fixed costs. Fixed costs are those that remain the same no matter how much or how little business you do. Examples of fixed costs include rent and salaries. If your CPA advises you to reduce your fixed costs, you’ll need to make a major change such as move your business location.

5. Journal Entry 

Do you hear the words journal entry and get an image of Bob Cratchit penciling in the ledger in Ebenezer Scrooges’s office? You’re not entirely off base. When accounting practices first began, numbers were entered into journals called ledgers. Later on, those ledgers took the form of those wide green and white-striped books you can still find in many office supply stores. Modern accounting is done with software on a computer, but the ledger entries are still called journal entries. And even if you use an accounting software at home and never see a “journal,” it’s still there, operating in the background. Don’t worry, though. You don’t need to know how to make a journal entry by hand – your CPA can take care of it for you.

6. Acid Test Ratio 

If your CPA talks about wanting to do an acid test, don’t worry. It’s not rocket science. An acid test ratio, also called a quick test ratio, measures the relationship between  business’s current assets that can be quickly liquidated and the business’s liabilities. The acid test ratio is frequently used in conjunction with the balance sheet to study the health of the business’s cash flow.

7. Comfort Letter 

If you applied for a business line of credit and they ask for a comfort  letter, don’t worry; your CPA will know exactly what this is. A comfort letter is a letter supplied by your CPA to an underwriter to make a declaration about the stability of your company’s financial position. It’s basically used to allay concerns about your financial stability. Just pass on the request to your CPA and they’ll take care of it for you.

8. Debt-to-Equity Ratio 

The debt-to-equity ratio is is another measurement that can be used to help assess the stability of your business. This ratio calculates the relationship between your company’s debt financing and your company’s equity financing. This ratio will reveal if you’re over leveraged or under leveraged so you can  make the necessary adjustments.

9. Retained Earnings

Don’t get too excited if your financials show that your retained earnings are some astronomical figure. Retained earnings are earnings that have been accumulated by the company and are being retained for future needs or owner distribution. In other words, that money is earmarked for something in particular. 

10. Predetermined Overhead Rate 

The predetermined overhead rate is calculated and used prior to the end of an accounting period to estimate and assign overhead costs related to products  your company sells, departmental jobs or operating units.

Understanding these ten accountant terms will not only help you better understand what your CPA is saying; they will also help you to make smarter business decisions by enabling a fuller comprehension of how your CPA views your company financials. At the end of the day, working in synergy with your CPA is healthy for you and and your business concerns.

Travel and entertainment are legitimate deductions, but few business owners take full advantage of them. One reason may be that they fear that the deduction will be challenged by the IRS and they’ll have to undergo the scrutiny of an audit. Another reason may be because the owner is unsure of how to take the deductions or what’s allowed and what’s not allowed. To be clear, travel and entertainment are allowable deductions. the IRS understands that much of business is conducted over drinks, meals or on the golf course. Travel is also an obvious necessary to conduct business. If you’ve been hesitant about taking travel and entertainment deductions, here is a guide to maximizing the benefits of these deductions.

What’s Really Allowed?

The first thing is to feel more confident about what’s really allowed with travel and entertainment expenses. That will enable you to recognize the expense when it occurs and to fully take advantage of every possible deduction.

Travel Expenses Allowances

Travel expenses related to your business activities are allowed in the following two categories:

1. Travel to and from business activities

2. Meals and related expenses relating to the travel you do for business.

For example, if you are an engineer, and you have to visit construction sites to monitor work, all your travel expenses to and from the job site are deductible. If you drive there, you can deduct your mileage. If you fly there, you can deduct the price of your airline ticket.

When you are away from home traveling on business, you can’t make meals for yourself, so you’re allowed to deduct meal expenses. Say you’re staying in a hotel during your business trip. The hotel and room service charges are tax deductible. You have to get your suit pressed for your meeting, so that’s deductible, too. The tip you give to your taxi driver that takes you to the meeting is also deductible. The tip you give to the waitress who serves your meals while you’re on your business trip away from home is deductible, as well as the drinks you order while waiting for your meal. Note that these things are deductible while traveling away from home on business, not necessarily while you’re having meals outside the home where you live.

Travel Expenses Not Allowable

There are some business travel expenses that aren’t allowable, or that might be questionable. For example, if it’s raining when you leave your hotel to go to your meeting and you buy an umbrella, that may not be deductible. If you buy reading material to keep you occupied because your client is running late for the meeting, the book or newspaper likely  isn’t tax deductible.

Meals Expenses Not Allowable

If you eat lunch at home to prepare for a meeting, that cost isn’t deductible. If you buy a snack to eat in the car on the way to your meeting that’s near your home, that’s likely not deductible.

Maximizing Entertainment Tax Benefits

It’s very important to understand what’s allowed as an entertainment deduction and what isn’t. Knowing this will help you take advantage of allowable deductions and feel more confident about how you spend when you’re with clients.

The first thing to remember with entertainment deductions is that the entertainment must be directly related to your business or directly associated with it. And the entertainment expense must be substantiated with receipts.

The second thing to remember is that only half of what you spend on entertainment is deductible. And, they must be reasonable and not overly lavish.

For example, if you buy tickets for you and your client to attend a sporting event and you talk about business beforehand or after, you can deduct half that cost. But if you go out of your way to book a charter flight to the Bahamas for you, your client and your client’s family, that’s definitely going to get some scrutiny.

If you belong to a country club so you can network with prospective clients, your club membership isn’t deductible. But if you pay for a one-day pass to a club so you can entertain your client on the golf course, that’s deductible.

When You’re Not the Owner

Finally, if you are the employee and not the owner, you may get reimbursed for business expenses through your employer. In that case no travel and entertainment expenses are directly deductible on your tax return, except ones that aren’t reimbursed. For those, be sure to keep your receipts and submit them to your tax professional for closer inspection at tax time.

Extra Tips For Maximizing Benefits

If you really want to make sure you’re getting all the advantages you’re entitled to, here are three extra tips:

1. When in doubt, add it to your list of deductions and keep your receipts. Your tax professional can make the final decision on whether or not to deduct it. But if they do, they’ll have the receipt to back it up.

2. Don’t mix business and pleasure. Avoid running errands to and from business meetings. Don’t invite your spouse or kids to business meetings unless it’s that kind of event. Don’t use your business credit card for personal items. Have separate loyalty cards for business and personal.

3. Get tip receipts. If you tip in cash on business trips, ask for a receipt. Business hotels are accustomed to this practice. For restaurants and taxis, you may have to ask for a receipt.

You’re entitled to take tax deductions for travel and entertainment but the key to maximizing this benefit is to know the rules and follow the rules. As long as you stay within the law you never have to worry, even if you do ever get audited. Your receipts will back up your returns. And remember, your tax professional is always a good resource if you ever have any questions about whether or not an expense is an allowable deduction. All you have to do is ask.

As we get deeper into the 2019 tax season, some taxpayers are experiencing a delay in receiving their tax refunds.  The old adage that if you are expecting a refund you should file early seems to be coming under fire a bit in recent years, but none so much as the 2019 tax season.  But why?

The delay has little to do with the 2019 tax season itself.  The IRS processes returns on a first come, first served basis and  identity theft has been an increasing issue in the last few years.    If the thief obtains your information, they  want to file as soon as possible to get their fraudulent version of the return in to the IRA before your actual return is sent.  The upsurge in identity theft filing has increased so much that Congress passed a law (Protecting Americans from Tax Hikes Act) that forced the IRS to delay any tax returns that contained certain deductions.  These deductions were determined to be most likely and easily targeted by identity thieves.  The two biggest of these deductions are the Earned Income Tax Credit (ETIC) and the Child Tax Credit.

The Earned Income Tax Credit provides support to low- and moderate-income workers equal to a percentage of their earnings up to a maximum (that varies by family size) until it reaches a phase-out threshold.  The Earned Income Tax Credit assists families with children far more than workers without offspring.   The Child Tax Credit is a credit that provides up to $2,000 per qualifying child, with up to $1,400 of the credit being refundable.  With the elimination of the dependent exemption in accordance with the Tax Cuts and Jobs Act of 2017, these two deductions may become more widely used.  By law, the IRS must hold returns with these deductions until at least February 15th of each year.  However, for the 2018 tax year filings, the IRS has stated that it will hold these until at least February 27, 2019.  According to the IRS, returns that are filed after this date that contain these deductions will not be delayed. 

Another reason for the delay in refunds comes from the government shutdown that occurred and carried on  into the early part of 2019.  This affects tax return filing because 2018 had numerous tax reform changes.  The tax reform is only part of the equation causing a delay in returns.  Another part comes from integrating those changes into the tax software and forms used by taxpayers to file their returns.  While the IRS began accepting tax return filings on January 28, 2019, much of the software still had to be upgraded  with updated forms.  Additionally, while the government may be at full capacity again with staffing, it still must wade through the backlog of work that piled up during the shutdown.

Additionally, the IRS is operating with a  decreased budget and staff.   This will create delays in  processing returns and refunds and  also in helpdesk and support calls.  The good news is that  the IRS projects less audits for taxpayers going forward, but the delay in refunds will impact  many taxpayers.  Paper filed returns will take even longer to prepare and process and can have an expected delay of up to seven weeks, rather than the normal four to six week turn around.

States are also reporting delays in producing tax refunds this year, due to  the government shutdown, as states often look to the federal tax codes for guidance and may even have laws that are affected by federal regulations.  States need to receive Federal rulings before they can add new laws to their tax code, and this is delayed when the government is not in session.  Most software will allow the taxpayer to complete the state filing but will notify the taxpayer of any delays in processing.

While it still may make sense to file early to avoid as much of the backlog as possible, even with the potential delays, most taxpayers with business returns will not file until after March 15th in order to take advantage of the new 199(a) deduction.

So how long will a taxpayer have to wait for their refund?  The IRS is still estimating that it will take around twenty-one days for most taxpayers to be issued their refunds.   If you feel that your refund is taking more time than even the expected delay, there are a few things you should do.  First,  verify that your return was received by the IRS and/or state.  If it was filed electronically, the software will have an electronic acceptance verification.  If you manually filed it, it is important to have a tracking format put on the return. Of course, if you filed a paper return, it will need to be manually entered on the IRS’s end and that will take time depending on the backlog of returns for the IRS to work though.  The next step would be to go to the Where’s My Refund page on the IRS website to verify the date of your expected refund.  If there is another reason for the delay, it would be a good idea to check in with the IRS or have your tax preparer do so.  It is possible that there is an error in your return that is holding up the refund.

A participating tax return preparer create a Tax Refund Anticipation Loan for you, which is an advance on your tax return refund.  In most cases, you receive a portion of your tax refund upfront in exchange for signing over the return to a company and for a fee.  Another method of receiving your refund faster is have it direct deposited into your bank account when submitting your return.  This will eliminate the need to wait for the mail to deliver your refund check and for the bank to cash it.

The bottom line is - your refund will take more time than usual this year, regardless of how you file.

Taxpayers know that there are tax deductions out there to be utilized to reduce the taxes paid on your income.  Most are aware of the common deductions, but there are many deductions that simply get overlooked by most taxpayers. 

Gifts to charity is a good place to start.  Most taxpayers know that when you give a gift of money or items to a qualified charity, you can deduct the value of this gift, with proper documentation.  One common item that gets missed is the miles that you drove or out-of-pocket expenses you paid for the charities benefit.

Most taxpayers also consider mortgage interest.  Though less taxpayers are claiming the interest on their mortgage (due to no longer taking itemized deductions with the increase in the standard deduction), mortgage interest still remains a large deduction.  An additional deduction that is sometimes missed are the points associated with refinancing your mortgage.  Additionally, when you pay-off or refinance a mortgage that has points still remaining, you can deduct those points in full.  Be aware that using the same lender for another mortgage often means that the remaining points simply get rolled into the new mortgage and are therefore not deductible.

State and local taxes, along with real estate or property taxes are a deduction most people are aware of.  Sometimes, smaller taxes paid for  your car or other vehicle fees or licensing costs are deductible in some states. 

EITC, or Earned Income Tax Credit, is taken by many taxpayers each year.  It is a refundable credit and not a deduction.  Many taxpayers think that it applies only to low-income payers, when in fact it covers many circumstances that get over looked.  These can include the loss of a job, a pay cut, or working fewer hours.

Most taxpayers have heard of education credits.  These credits consist of the American Opportunity Credit and the Lifetime Learning Credit.  The American Opportunity credit applies to undergraduate studies and covers up to $2,500 in qualified spending on college expenses.  The Lifetime Learning credit is for continuing education and covers up 20% of qualified expenses up to $10,000.  In other words, a max credit of $2,000 on eligible expenses.  Qualified expense can include tuition, fees, room and board, books, supplies, lab fees, tutors, transportation, and more.  If you are a teacher, you may be eligible for a deduction of up to $250 for out-of-pocket expenses paid for school supplies, books, computers, etc.  Anything over and above the $250 deduction can be taken in your itemized deductions but is limited to 2% of your adjusted gross income.  This deduction is limited to K-12 teachers, counselors, principals and aides.  To qualify for this deduction, you must work at least 900 hours in a school year.  Student loan interest of up to $2,500 can also be deducted.

Now let’s focus on the lesser known credits.  A savvy taxpayer will review these credits with their tax preparer to see if they qualify.

Military reservists who travel more than one-hundred miles and stay overnight for meetings or drills qualify  to deduct lodging, mileage and 50% of meals.

If you have moved more than 50 miles away from your previous residence to take a job, your moving expenses may be deductible.  This can include movers, truck rental, and the mileage.  Additionally, some states offer a deduction for the rent you pay for your primary residence.  If you sold your home, but made improvements to it while you owned it, these improvements may increase the value of the home and reduce the taxable gain on the sale.

If you pay for childcare so that you can work, a portion of your total child care costs can be deducted.  This includes qualified camps and other programs.  It is important to note that if your employer offers reimbursements with pre-tax dollars, this may be a greater tax advantage than taking the deduction.

Out of pocket medical expenses also qualify, provided they are over the 7.5% floor.  There is a list of qualified medical expenses produced by the IRS if you are unsure about deducting nontraditional medical expenses.  If you have dependent children and parents that qualify, it is important to remember to add their medical costs as well.

There are many business-related deductions for taxpayers as well.  If you work from home and are self-employed or are not reimbursed by an employer, you may deduct a portion of your home that is designated and solely used for a home office.  Home office expenses can include a portion of depreciation, utilities, taxes, interest, insurance, etc.  You may also deduct 50% of your self-employment taxes, Social Security and Medicare, if you are self-employed.  If you belong to a union, union dues are deductible, as  are fees associated with licensing and certifications.  If your job requires you to purchase certain items like protective gear, you may be able to deduct these as well.  Travel for business can potentially be deductible, but be careful to only expense the travel used solely for business. 

If you were on jury duty and got paid for it, but your employer also paid you for jury duty, you must turn your jury duty check over to your employer.  However, you do get to deduct the amount of the jury duty pay given to you by the government.  If you spent money on a job search, that is also deductible, although this does not apply if it is your first job or if you are switching careers.  These costs can include transportation, recruiter fees, some food and lodging, printing costs, and more.

Theft or casualty losses are also deductible.  Things that qualify for this are theft, vandalism, fires, storms and car accidents.  You must subtract any funds received from the insurance company against the amount being claimed.  There can be deductions for  fees paid to your investment broker, tax preparation fees, gambling losses up to the amount of winnings, and may other credits. 

Seeking the advice of a tax professional to see which ones you may qualify for is vital in not missing a possible deduction or credit.

In recent years, the economy has been having its share of ups and downs.  When businesses and private citizens want to secure financing from financial institutions to make large purchases, the economy can greatly influence the bank’s willingness to loan funds.  In an unknown or down-turned economy, the installment sale lends itself as a great alternative option.  An installment sale occurs when property is sold with at least one payment being made in the year of the sale, and at least one payment being made in the tax year after the sale is completed.  Generally, the buyer will make regular payments to the seller to complete the debt owed on the sale.  This is mostly done in the real estate environment but may also transpire in business sales as well.  To qualify under the IRS definition, the property sold must be something other than publicly traded securities, and the seller cannot be a dealer of that particular piece of property.

If done correctly, this type of sale can be beneficial to the buyer and the seller.  While you may have to wait a year or more to receive the full value of what was sold, installment sales offer the seller key tax advantages.  Instead of paying taxes on the entire gain in one year, only a portion of the gain is taxable in the year of the sale.  The remainder is taxable in the year(s) the remaining payments are received.  The taxable portion of the payment is for the gross profit ratio, which can be calculated by dividing the gross profit from the sale by the price.  This percentage is then applied to each payment as it is received.  Since the gain is spread out over many years, you may gain the benefit of the different tax rates in each year.  Additionally, if the installment sale concerns real estate that you have owned longer than one year, any gain is taxed as tax-favored long-term gain.  Another advantage is that you can collect interest on the sale.  The interest is taxed separately at ordinary tax rates.

With this type of arrangement, the buyer can also benefit from this transaction.
One of the biggest benefits is they do not have to come up with all the cash at one time.  If they have a long enough term, they may avoid borrowing money from a traditional lender.  This could allow them to keep their credit lines open and it may allow them to purchase a property if their credit is poor.

Installment sale methods cannot be used if: the property is sold at a loss; if it is for the sale of inventory in the normal course of business; if it is a sale of property by a dealer; a sale of personal property or a sale of stock, bonds or other investment securities.  There are special rules concerning depreciable property, like-kind exchange property,  property contingent on future events,  understated interest rates,  transfer of the Installment Note,  or repossession of the property.  If a sale does qualify as an installment sale, then the gain must be reported under the installment method.  The only exception to this rule occurs when the seller chooses to “elect out” and thus report all income as gain in the year of the sale rather than spreading it out over time.   There are several possible reasons why this may be of benefit.  You might expect to pay lower tax rates in 2019 than 2020, given other parameters in your income sources in that year.  In that case, you may prefer to pay the full amount of tax due on your 2019 tax return.  Or you might have capital losses or suspended passive losses that will offset the tax on an installment sale gain.  Therefore, you may benefit by reporting all your gain in the year of the sale, instead of spreading it out over time.

The installment sale method is basically a play on the timing of income.  Should you spread out the income over multiple years?  Should you  take the tax hit all at once?  The "right" answer depends on the specifics of your financial situation.  As a tax strategy, installment sales are about managing the tax rates that apply to the capital gains' income.  Installment sales can also be used to manage other tax-related impacts.  For example, spreading income out over multiple years can help a person manage their adjusted gross income, which may be important in qualifying for deductions or tax credits that are based on income.  Increasing income by reporting a large capital gain in one year can potentially move ordinary income into a higher tax rate bracket,  move capital gains income into a higher tax rate bracket, result in more social security benefits being subject to tax,  reduce or eliminate deductions that are based on income,  reduce or eliminate how much can be contributed to a retirement or educational plan,  reduce or eliminate tax credits that are phased out from income, and/or increase net investment income tax and/or alternative minimum tax.  Conversely, spreading income out over multiple years can potentially keep income within a desired tax rate bracket,  keep capital gains income within the desired brackets,  result in fewer Social Security benefits being subject to tax,  keep income within range for taking the full amount of student loan interest deduction, itemized deductions, personal exemptions, or other deductions that are limited by income,  keep income within range for taking the premium assistance tax credit, or other tax credits,  and/or avoid or lessen the impact of the net investment income tax and alternative minimum tax.

The bottom line is that installment sales aren’t right in every situation.  But when applied correctly, they can be of great benefit.  Seeking the assistance from your tax advisor will help you determine if this is the right method for you.

For most standard wage earners, preparing for your tax filing is fairly simple.  You receive a Form W2 in the mail and unless you have other rental properties or other complications, your return is relatively straightforward.  But for the freelancer, things aren’t quite as simple.

When you are a sole proprietor, independent contractor, freelancer, or other self-employed person, your will not receive a paycheck and subsequent W2 from the companies you work for.  Instead you will receive a Form 1099-Misc for any payments received via check or cash.  If you accept credit cards, these amounts will be reported to you by your processing company on Form 1099-K.  The amounts on these forms will be the gross amounts paid to you, as companies you work for will not deduct taxes from your pay.  The processing company will not indicate their fees on the form.  Both of these forms are also reported to the IRS.  This gross income needs to be reported on your annual tax filings.  It is important to note that you should keep separate records of your payments as well both for verification as well as the fact that companies are not required to report payments to you if they are made by credit card or under $600.  Income tracking is made easier if you keep a set of books and a separated bank account for your business.

After you have tracked and gathered all of your income, you will also need to report your expenses.  These items will help you reduce the income that results in your taxation.  It is important to remember that because expenses reduce your tax, the Internal Revenue Service scrutinizes what you are reporting. But what is a legitimate expense?  Legitimate deductions are ones that are necessary, helpful and appropriate for your trade or business.  Easy ones are things like office supplies, computer, advertising, banking and credit card fees.  Basically, if you need it to operate your business, then it is most likely a valid expense.  Always keep in mind that the IRS will require receipts for purchases that you are deducting.  For easy referencing at tax time, try to keep your expense by category with an efficient filing system throughout the year.  The standard categories will be broken down into:  accounting and banking, advertising, auto expenses, contract labor, computers and other equipment, meals and entertainment, memberships and dues, education and training, rents, insurance, interest, office expenses, supplies, repairs and maintenance, professional fees, cost of goods sold, and more. 

While some of these fees are straightforward, others are a bit trickier.  Take meals and entertainment for one.  The support of this type of expense could be an entry in a business calendar that you keep with all of your appointments, etc. Be sure to note who was at the event, when was it, what was the purpose, and how much was the cost. You also need to prove you spent the money by a debit card entry in a bank statement or a credit card statement. You get half of the total amount of the expense in this category, unless it meets other requirements.

Another area of contention is the home office.  One of the freedoms of being a freelancer is the potential to work from home.  But what makes up a true home office in the eyes of the IRS?  The office that is part of your home in eligible provided you can show that it is your principal place of business and used exclusively for your business.  So, if your office doubles as the kids’ homework center or a guest room, the IRS is not going to allow it.  If your space does qualify, you need to know the space used for your freelance work and the total space in your home.  Things like mortgage interest and real estate taxes or rent, utilities, insurance and repairs related to the space can be reported here.

There are many programs that can assist with tracking and categorizing your expenses.  When things get complicated or you get busy enough, it is advisable to see professional help.  Yes, a good accountant can be expensive, but they can also help you save time, money and a headache.  Often programs such as Turbo Tax ask questions that seem easy on the surface but are actually much more complicated.  For example, many of these self-filing programs will ask, do you have educational expenses?  And if you purchase manuals and other materials to educate yourself or your clients, you may click yes.  But unless you are a K-12 teacher, this deduction is not for you.

If you do not yet have an accountant or are not at the point where you feel you need one, but sure that you understand the tax requirements in your state as well as the federal ones.  Prepayment penalties are the biggest hits that most self-employed individuals take.  Without the withholding you receive from a W2 wage, you will need to pay into taxes throughout the year using estimated tax payments.   The tax rate for Self-Employment Tax is 15.3 percent, which puts 12.4 percent toward social security and 2.9 percent toward Medicare. Just remember, the SE Tax does not include all of your tax liability. You have to pay regular income tax on top of that 15.3 percent.  A good place to start is setting aside thirty percent.  While the actual amount may be higher or lower, this will put you in the ballpark.  If you live in a high-income state, aren’t married, have no other deductions or a variety of things that will give you a high-income amount, you may need to adjust this percentage.  Be sure to make your prepayment quarterly on the required dates.

Even though you made payments to the IRS throughout the year, you haven’t yet filed an annual return. There is a difference between those two actions.  You are still required to file an annual tax return just like a traditionally employed person. You probably also need to file a Schedule C, which reports the income or loss you generated from your business. Your tax return is due the same day as your traditionally employed friends, which for your 2019 tax return is April 15, 2020.