- How can I help prevent Identity Theft?
- What Tax Records should I Save?
- How Long Should Different Kinds of Tax Records be Kept?
Information about Staring a Business
- How Do I Get Started?
- Should I Register My Business?
- What About a Location?
- What About Employees?
- What About Records?
- What About Start Up Costs and Capital Expenditures?
Information about IRS Letters
- What if They Contact Me?
- What about a ‘Don’t have to file’ letter?
- What about an Audit Letter?
- What about an Adjustment Letter?
Information about Home Offices
- What are the Requirements?
- How do I Calculate Expenses?
- What are the Limitations?
- What if I Sell the Residence?
Information about Using Your Car for Business
- What are the Requirements?
- How do I Calculate Expenses?
- What about Keeping Records?
- What Mileage is Deductible?
Information about Buying or Selling a Home
- What About Buying a Home?
- What About Making Improvements?
- What About Selling a Home?
- What About a Divorce?
How can I help prevent Identity Theft?
Be ready before your wallet gets stolen or lost. Photocopy both sides of each license, credit card, id card, health insurance card and any other cards in your wallet. Keep this paper in a safe place. Everyone advises to cancel your credit cards immediately if your wallet is stolen. The key is having the toll free numbers and card numbers handy, so you know whom to call and the necessary information.
File a police report immediately in the jurisdiction where your wallet was stolen. This proves to credit providers you were diligent and this is the first step to an investigation.
Call the three national credit reporting organizations immediately to place a fraud alert on your name and social security number. The alert means any company that checks your credit will know your information was stolen. They will have to contact you by phone to authorize new credit. Thieves will try to to apply for credit cards in your name over the internet!
Experian (form-erly TRW): 1-888-397-3742
Trans Union: 1-800-680-7289
Social Security Administration’s Fraud Line: 1-800-269-0271
What Tax Records Should I Save?
Once the tax return has been filed, everything is finished and there is no need to use these records again, right? Unfortunately, that perception is very dangerous. There are many reasons for saving records. The main reason to save tax records is to substantiate the information reported on the tax return.
The statute of limitations for most federal tax returns is three years. It is helpful, and even required in some cases, to save certain records even longer.
How Long Should Different Kinds of Tax Records be Kept?
Prior Year’s Income Tax Returns
Prior year’s income tax return should be kept for a minimum of 3 years, unless your state requires a longer period. Keeping a tax return is advisable when the reported transactions may affect future years.
Most audits occur within 3 years of the filing of the tax return. The receipts used to document expenses should be kept through the statute of limitations for that return. After that period has expired, the receipts should be examined to see if they fall into one of the areas that need to be saved for a longer period. The receipts that do not need to be kept longer, such as canceled checks, bank statements, and receipts which will not affect future transactions, can be discarded.
If you own a business, you may have records for the sale or purchase of inventory and assets used in the business as well as other operating expenses. After the statute of limitations, you can discard most receipts that deal with operating expenses. Retain the receipts that relate to property you still own to verify the cost for future sales. Payroll records must be retained for a minimum of 4 years.
When your business produces an overall loss on the tax return, this loss is either carried backward or forward depending on the situation. The tax return and the records of the calculation creating the carryover, and the tax return for any year in which part of the carryover loss is absorbed, should be retained for 3 years following the last year the loss is up.
Employee business Expenses
The most common employee business expenses are transportation and travel expenses. The mileage logs, should be saved for the 3 year limitation period. If you are a trucker who claims the standard meal allowance, the logbooks should be retained for 3 years.
Closing Papers from the Sale or purchase of your home
The closing papers from the sale or purchase of your home should be retained for a minimum of 3 years after the sale of the home. If you have previously deferred the gain from the sale of a residence, the closing papers and the tax return from the sale should be retained through the limitation period of your next home sold.
Building or Improving Your Home
If you build your own home, careful records should be kept of all the monies paid to the outside contractors. This is also true of improvements made to your home. Theses should be kept for at least 3 years after the sale of the home.
Year-end brokerage statements from the purchase of stocks, bonds, and mutual funds should be retained until 3 years after the investment is sold. Theses statements will show the reinvestment of dividends, the purchase of shares, and the purchase of shares, and the redemption of shares.
IRA Contribution and Distribution Records
IRA contribution and distribution records need to be kept indefinitely. Particularly important are records of nondeductible contributions.
If you have received gifts of property other than cash, it is important to find out what the cost to the donor was and obtain receipts to verify the costs. This becomes your cost in the property for future sales consequences.
If you inherit property, you need to keep records that establish the value on the date of death. These records usually come from the fiduciary’s records and should be retained for 3 years after the property is sold.
While the most common statute of limitations is 3 years from the filing of the return, a return that was never filed has no statute of limitations. The statute of limitations for returns where income has been understated by 25% or more is ten years. Saving tax records for a minimum of 3 years is essential. Saving the tax returns for an indefinite period may provide good historical information in addition to providing substantiation.
How Do I Get Started?
Do you have the desire to be your own boss? Do you think you have some good ideas about a business venture? Many people have that desire but they either lack the courage to take the next step or they don’t know where to step. Here is some information that may help guide you.
Once you have gotten past the preliminary stages of deciding what kind of business you want to start, you need to examine the financial side. One of the first items necessary to start a business is to have working capital. This capital can come from assets you may have or it can come from loans you have secured. This capital will be necessary to acquire the items to start your business. If you don’t have the cash or assets you need to seek financing. This financing could come from financial institutions, the Small Business Administration (SBA), friends, relatives, or other investors.
After a financial plan has been established you need to look at other issues.
Should I Register My Business?
From a tax standpoint, you need to decide whether your going to embark on this endeavor by yourself as a sole proprietor or with others as a partnership. You may also want to consider whether you need to incorporate. Depending on which of these you may choose you may have to deal with legal ramification. In some states you can hang out a shingle so to speak and you’re in business. Other state require you to register the type of business and follow certain guidelines before you are able to open the doors.
Location of Business The location of your business could be crucial depending on what type of business you have. Certain business may be easily run out of your home. Other business need to have a fixed location that is easily accessible to your clients. Parking, space, and cost are all important considerations.
Most businesses need to have an employer identification number (EIN). This number is equivalent of the Social Security number for a business. If you have employees you will need to have this number for the payroll reports regardless of what type of business entity you are. If you are an entity other than a sole proprietorship, you will need an EIN to file your income tax return even if you have no employees. In addition, your state will require a state identification number for the same reasons.
A federal EIN is obtained by filling Form SS-4, Application for Employer Identification Number. This form is available from your tax preparer, the IRS, or the Social Security Administration. You can mail it to the IRS service center for your area, fax it to the IRS, or use the tele-TIN phone number listed in the instructions.
If you plan to have employees, you are responsible for payroll taxes. As an employer you generally are responsible to pay Social Security taxes, Medicare taxes and unemployment taxes. In addition you need to collect federal and state (where applicable) withholding and the employee’s share of Social Security and Medicare taxes. You are responsible for making deposits of these taxes at the appropriate times throughout the year. On a quarterly basis you need to file a Form 941 to inform the government of the collections. A Form 940 for unemployment tax information is required on an annual basis.
Some employers decide to avoid the payroll cycle by treating individuals as independent contractors. Before you make this determination, talk it over with your tax advisor. The IRS has a set of criteria it uses to determine whether an individual is an employee as an independent contractor, you may be subject to penalties.
Deposits of employment taxes will need to be made throughout the year. Those deposits may need to include estimated tax payments for business entity. The sole proprietor would be responsible for income tax and self-employment tax on the business profits.
It is important to establish a good record keeping system early in your business. In addition to keeping payroll records, an accurate account of all of the income of the business as well as the expenses is necessary.
You will need to determine what accounting method is appropriate for you. Most businesses have the option of choosing the cash method, the accrual method, or a hybrid method. If the IRS were to audit your return you may have to prove expenses by producing receipts. Accurate records of travel expenses are very important.
Some expenses may need to be separated. The two categories are: 1) expenses incurred in exploring and setting up the business, and 2) expenses incurred from the time the business officially begins. The first group may be amortized over a 60 month period beginning with the start of the business, while the other group is currently deductible. Start up expenses may include training wages, pre-opening utilities, rent, advertising, and any exploration costs.
Capital Expenditures and Other Considerations
Not all of the expenses paid for a business are currently deductible. Items which have a life of more than one year are depreciated rather than currently deductible. Equipment and real estate are common examples of depreciable assets.
If you’re in a business that requires you to maintain an inventory of the items you sell or use to make a product, these costs are deductible as you sell the product. It is necessary to keep accurate records of the beginning and ending inventory each year.
- Liability and asset protection.
- Fringe benefits desired (if any).
- State and local requirements such as permits and registration of the business.
The IRS normally communicates with taxpayers by letter, but occasionally by telephone. Telephone calls are usually made just to clear up very minor questions. Letters come in a variety of styles, each with their own purpose. Common letters include:
“Here’s is your refund”
“An adjustment has been made to your return”
“We have received your change of address request”
“Please come visit us at the above scheduled time”.
First, remain calm. The return address showing “Internal Revenue Service” is enough to scare anyone, but the letter may be totally harmless. Even if it states you are being audited or you owe thousands of dollars, STAY CALM. Going into a panic does not make it disappear.
Second, read the letter carefully. DO NOT IGNORE IT. Most of the trouble taxpayers get into occurs when they receive IRS communications and ignore them. The top right hand corner will indicate which year’s return the letter is addressing. It may be something simple like “Here is your tax refund check”, in which case you will immediately know what to do. It could be asking you to verify Social Security numbers for yourself or your dependants. Many simple things like this can be handled on your own, but make a copy of your records and for your tax preparer, who will also want to know everything that happens to your return.
If the letter is confusing to read or the idea of reading it causes you to panic, then make an appointment to see your tax preparer.
Third, respond to the letter.
Regardless of the type of communications received, stay calm. Do not ignore any IRS communications. Unless you are very comfortable with what the IRS wants, discuss the matter with your tax preparer before responding.
This is simply a letter stating that the IRS doesn’t want you to file if you don’t have to. This letter is harmless, since there are no penalties for continuing to file, even if it’s unnecessary. If circumstances change you may have to file, so it is still important to check the filing requirement each year.
This is a request to meet with the IRS to discuss your tax return. To prepare, total your receipts for the expenses in question, attach the calculator tape to the receipts , and label it with the type of expense. Obtain documents to verify other request such as church offerings, leases, loans obtained or paid back, bank statement, contracts, Social Security cards, etc.
You may want to visit your tax preparer for help in preparing or reviewing your records and the audit process prior to the actual audit. The tax preparer may accompany you to the audit or he/she may want to represent you with “Power of Attorney” , thereby saving you time and aggravation of having to attend personally. Some tax preparers charge for this service.
If your tax preparer is going to the audit without you, he/she will need to be able to answer questions about your tax and financial matters. Provide him/her with the full and accurate information. For example, if the IRS letter asks about property you own and you don’t tell your tax preparer you own in another state, the IRS may doubt anything your tax preparer says.
IRS auditors are trained to thoroughly cover the items shown on your tax return and also items which may have been missed. They will occasionally discuss nonbusiness items which can help them discover some income which they may have been missed. For example, they may ask if you’ve had any good vacations lately. Since these are not normally deductible for tax purposes, they seem harmless. But, if you’ve been to Europe twice this year as well as other exotic places with your family, you must have had assets to pay for these trips. If the income on your return is not large enough to pay for the trips, the auditor may start to question where you got the money and whether it was taxed. Be careful how you answer questions. Auditors are people just like you, but they also have a job to do.
This letter usually claims that some income (such as interest or dividends) does not appear to have been included on your return. It also includes a “balance due” amount to pay if you agree. The letter lists the income amounts which appear to be missing along with who paid the amounts. Cross check the figures shown on the W-2s and 1099s received that year with the return and IRS letter. Pay special attention to the income item(s) which the IRS says have not been reported under another name.
If you did receive the amount of income shown and it was not reported on your return, you may indeed owe the amount the IRS is requesting. If you did not receive the amount of income shown or it was reported on your return, a letter of explanation needs to be sent back to the IRS. Your tax preparer may have more experience in writing these letters and may be able to resolve the issue quickly, thus avoiding seemingly endless correspondence between you and the IRS.
With the increasing use of computers, modems, and job sharing, more and more people work from their homes. Whether you are self-employed or work for someone else, the home office can give extra deductions on your tax return, but can create extra headaches when you sell your home.
The Internal Revenue Code allows taxpayers to claim a deduction for expenses incurred in operating a business from their home if they meet certain requirements.
This home office must be used regularly and exclusively 1) as the principle place of business for a trade or business; 2) as a place to meet with patients, clients, or customers in the course of the trade or business; or 3) in connection with the taxpayer’s trade or business if the location is in a separate structure not attached to the dwelling unit. The “regular and exclusive” requirement does not have to be met if you are operating a day care business in your home.
In addition, if you are an employee, the business use of your home must be required by your employer for his/her convenience.
Prior to 1999, the courts had interpreted the “principal place of business” very narrowly and disallowed a deduction if the office was only used for administrative and management activities rather than for the actual generation of income. However, the Taxpayer Relief Act of 1997 changed this, effective 1/1/99. Now a deduction for an office used only for those activities is allowed if there is no other location available to perform them.
In addition, a deduction may be allowed for inventory storage if the product is regularly sold to others and there is no other fixed location for the business.
The home office expenses can represent a significant amount in computing your tax liability. If you think your situation meets the requirements, talk to your tax advisor for more specific details on how to qualify for this deduction.
How Do I Calculate Expenses?
The expenses that are considered when making the home office calculations include both direct and indirect expenses. Direct expenses are things that pertain exclusively to the home or office, such as painting the walls or putting in new carpeting. Indirect expenses are those that pertain to the entire residence, such as rent, mortgage interest , taxes, insurance, repairs, utilities, casualty losses, and depreciation. Indirect expenses must be allocated between the business and nonbusiness portions of the home.
The most accurate method of allocation is to divide the square footage of the office by the total amount of usable space in the home. If rooms are of approximately equal size, you can divide the number of rooms used for business by the total number of rooms.
In the case of a day care business, you multiply this percentage by the fraction obtained by dividing number of hours the home is used for business by the total number of hours in the year (8760 hours except in leap years).
Once these figures are known, the indirect expenses are multiplied by the business percentage in order to apply the limitations.
What Are the Limitations?
The amount of expenses that can be deducted are subject to specific limitations and ordering provisions. The overall limitation is based on the taxpayer’s net income from his trade or business. For an employee, this is wages less other business expenses on Form 2106. For a self-employed person, this is the net income on Schedule C without the home office deduction. If there is a loss, no deduction is allowed and the expenses are carried forward to future years when there is net income.
However, three deductions are allowed in full regardless of the net income limitation. Mortgage interest, real estate taxes, and casualty or theft losses are allowed under other code sections and may create a Schedule C loss. They must be claimed in full before using any other expenses.
Once net income has been reduced by the otherwise deductible expenses, the other business expenses are deducted. If there is still net income at that point, depreciation is deducted. Any time the net income reaches a balance of zero, the balance of the expenses is carried forward. If the taxpayer goes out of business before using these amount, they are lost.
What if I Sell the Residence?
When you sell the home that had been the location of your home office, new problems can arise.
First of all, if you have used part of residence for business purposed, that part is no longer a principal residence. This means you cannot exclude the gain on that part unless it had not been business property for more than two years in the five years prior to the sale.
Secondly, the depreciation allowed to be claimed on your home office is subject to taxation even if you meet the personal use rules. This depreciation is considered “unrecaptured Section 1250 gain” and will be taxed at a maximum rate of 25%.
These potential tax situations are avoided if you are renting your principal residence.
Your car may provide you with several tax deductions that may lower your income tax. As with all deductions, it is important to maintain accurate records of your expenses. You cannot deduct commuting mileage that is, mileage from your home to your regular job.
If you use your car for business purposes, you may use either the standard mileage rate or actual car expenses. If you are self-employed and maintain an eligible office in your home, you can deduct the mileage to and from your client’s/customer’s place of business as well as between jobs. As an employee, you can deduct mileage to your second job or to a temporary assignment. A temporary work assignment is defined as lasting a few days or weeks, but less than a year. If you do not have a regular place of business, you can only deduct your transportation expenses to a temporary location outside your general area of employment.
If you are an armed forces reservist, you can generally deduct your transportation expenses to attend meetings. The meetings must take place on a day that you normally work. You cannot deduct expenses for transportation on a day you normally do not work. If you travel overnight to attend a guard or reserve meeting, you can deduct your travel expense.
How Do I Calculate Expenses?
There are two ways to calculate your auto deduction-the standard mileage rate or actual expenses. These methods are available whether you own or lease your vehicle.
For most taxpayers, the standard mileage rate is easier to use. From January 1 to March 31,1999, the rate is 32 cents per mile. For business miles on or after April 1, 1999, the rate is 31 cents per mile. You multiply the rate by your business miles to come up with your deduction. In addition to the standard mileage rate, you can also deduct the cost of business related parking fees and tolls.
The actual expense method is a little more complicated and requires a lot more detail record keeping and receipts. Actual expenses include such cost as gas, oil, insurance, repairs, maintenance, tires, washing, licenses, and depreciation or lease payments. In addition, you can deduct the cost of business related parking fees and tolls.
If you use your car for personal and business purposes, you will have to divide the expenses between the personal and business portion.
Example: if you use your car 50% for business use and 50% for personal use, you will only be able to deduct half of the cost of your eligible expenses.
What About Record Keeping?
You will need to maintain an accurate record of miles you use your car for business purposes, date of business use, destination and business purpose. You also need odometer readings at the beginning and end of the year to determine the total miles for the year for all uses. The business percent of interest is allowed if you are self employed. This can be figured by keeping a record of this information in a notebook in the glove box of your vehicle or by purchasing a logbook from your local office supply store or department store. The important thing is to make sure you maintain accurate records. The IRS may disallow a deduction for mileage if you are unable to substantiate your deduction. If you use the standard mileage rate, you cannot use your actual expenses.
What Mileage is Deductible?
You can deduct 10 cents a mile if you use your car to obtain medical care. This can be to the doctor’s office, dentist’s office or to the hospital to get medical treatment. You can also deduct the cost of parking fees and tolls. If you choose to use actual car expenses, you can only deduct the cost of gas and oil, not depreciation, repairs, etc. These expenses are added to your other medical expenses and deducted on Schedule A subject to the normal limitations (7.5% of AGI)
You can deduct 14 cents per mile if you use your car for charitable purposes. You can also deduct parking fees and tolls. If you choose to use actual expenses, you are again limited to unreimbursed expenses for gas and oil. You cannot deduct mileage or expenses for charitable purposes if a significant part of the travel is for personal pleasure. Moving Mileage
If you move and qualify for the moving expense deduction, you are allowed either the actual expenses for the move itself or 10 cents a mile \ for the actual relocation.
For most people, buying a home is the single most expensive purchase they will ever make. It is important to make the most of dollars spent. Negotiating the sale can involve the payments of points. If you can get the seller to pay the points, you will save money. Points, whether paid by you or the seller, are deductible by as long as you pay at least that amount of money at closing.
Many people who buy a home expect the purchase to lower their taxes. Some are disappointed in the first year when they cannot itemize their deductions. This may happen because the interest and property taxes are for only a portion of the year. Keep in mind that mortgage interest is deductible only if the loan is secured by the residence. If you borrow the money from a relative as a nonsecured creditor, the interest would not be deductible.
Property taxes paid on the homes are a deductible expense. In the year of purchase those taxes are split between you and the seller. In many states, you will have to put in escrow the prorata share of the taxes. If you agree to pay delinquent property taxes of the seller, those taxes are not deductible since you were not liable for the taxes. The taxes increase your cost of the home.
What About Making Improvements?
The more years you live in a house or the older the home is when you buy it, the more work you will normally do. Sometimes this work is ordinary maintenance and sometimes it is improvement. It is important to keep track of the amount spent on improvements along with the receipts for the future reference. These expenses increase the total cost invested in your home.
To determine if an expense is an improvement or a repair, consider whether the work done on the home increases its value. If so, the expense is an improvement. If it merely retains the value, it is probably a repair. Normal painting and wallpapering are repairs. If these are done in connection with a renovation project, the total cost of the project would be an improvement. Replacing the carpeting, the furnace, or storm windows is an improvement. Adding shrubbery, fencing, or a storage shed is an improvement. Fixing the roof may be a repair but replacing the roof is an improvement.
What About Selling a Home?
The cost invested in the home should be one factor taken into account to help you establish selling price. This cost will also be needed to correctly calculate your gain or loss on the sale. The closing statement of the original purchase contains important information that you will need. In addition to the purchase price, closing costs such as appraisal fees, commissions, and the title insurance, which were not deductible when you purchased the home, are part of the cost of the home. Improvements made to the home after the purchase are added to determine the total cost in the home. Painting and repair costs associated with the sale do not add to the cost but may reduce the amount of gain under certain circumstances.
If the sales results in a loss, you will report the sale as a nondeductible personal loss. If the sales results in a gain, you may be able to gain up to $250,000. You must have owned and used the property for two years out of the previous five years. You cannot have used the exclusion for any house sold in the previous 24 months. The excludable gain increases to $500,000 if you are married and both of you lived in the house for two years out of the previous five years. If any portion of your house has been used for business or rental at any time since May 7,1997, some of the gain will be taxable.
Tax planning may be an important part of the sale. If you have high income and a large taxable gain on the sale, you may want to receive payments under the installment sale method. Using this method, only the gain from the payments made in the current year would be taxable. If the proceeds of the sale are needed immediately, that option would not be available. Receiving the entire proceeds, paying the tax, and investing the money may be a better option. Your tax advisor or investment counselor should be consulted to determine your alternatives.
What About a Divorce?
When divorce occurs, the ownership of home may change as well. The home can be sold to a third party or it can become the sole property of one the spouses.
If one of the spouses receives the house due to divorce, either by purchase or property settlement, no sale occurs for tax purposes. The cost of the house for the future sale purposes is the same as it was to the couple prior to divorce. Money paid to the departing spouse does not increase that cost.
If the home is sold as a result of the divorce, the sale must be reported by the owners. If both individuals share the title to the home after divorce, both will report their portion of the sale on their individual returns. If one spouse gave up the home before the sale, the sale is solely the responsibility of the other spouse even though the decree may assign a portion of the proceeds to the ex-spouse.
In the event that joint ownership is retained by the couple after divorce, both spouses may be able to take advantage of the $250,000 exclusion.
Before you sell your home see your tax advisor to help determine your best course of action.