Can Spouses Help each Other Lower Their Self Employment Tax?

Posted on April 22 2014 by admin

Can an accountant who loses money and his wife, a realtor who makes money, combine their businesses in order to lower their self-employment tax? No.

A recent case in the Tax Court involved such an issue. Donald Fitch, a self-employed CPA who worked part-time while recovering from a medical condition, and his wife Brenda, an independent contractor with Remax, reported the income from their businesses on separate Schedule Cs but netted the income from the real estate business with the loss from the accounting business to compute self-employment tax.

The IRS recalculated their self-employment tax, determining Brenda owed self-employment tax for her realty business and Donald’s self-employment tax was zero.

In Tax Court, the Fitches claimed that income from the real estate business should be attributed to Donald and that Brenda did not substantially manage and control the business. Unfortunately for the Fitches, during testimony Brenda repeatedly referred to the real estate business as “my business” and Donald also referred to it as “her business”. The Tax Court concluded that the real estate business was not jointly operated by the couple and, therefore, self-employment income had to be calculated separately.

While it may be tempting to try to net gains and losses from a spouse’s business in order to reduce taxes, the law favors going the other way. Even spouses in partnership in a single business can split the income based on their ownership. Each reports their own share of business income and self-employment separately. Why? To maximize credits toward social security.

By Janet Berry-Johnson, CPA

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Temporary Regulations Provide Guidance on Form 5471

Posted on April 16 2014 by admin

Effective December 31, 2013, the IRS issued temporary regulations providing guidance on the reporting by U.S. officers, directors, and shareholders of foreign corporations. Generally, this information is required to be reported on Form 5471, Information Return of U.S. Persons with Respect to Foreign Corporations.

Under the constructive ownership exception, if the U.S. person does not own a direct interest in the foreign corporation, but the only requirement in filing is due to attribution of stock ownership from another U.S. person and that other U.S. person from whom the stock ownership is attributed files the 5471, then the exception to filing is met. In the past, if the constructive ownership exception was met, the U.S. owner had to attach a statement to their return indicating the reporting requirements have been met by another filer and had to identify the tax return in which the 5471 was filed. Under the new temporary regulations, the IRS found this to be an unnecessary procedure and no longer requires this statement.

The original Internal Revenue Code section issued in 1962 mandated a 5471 filing when a U.S. person’s stock ownership in a foreign corporation reached 5%, or if a U.S. person acquired at least 5% stock in the foreign corporation during the year. In 1997, the Taxpayer Relief Act revised the stock ownership reporting requirements to 10%. The new temporary regulations update the code and the examples in the code to reflect the 10% ownership threshold as stated in the Taxpayer Relief Act.

By Jill A. Helm, CPA

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New Like-Kind Exchange Reporting Required for California (IRC 1031)

Posted on April 15 2014 by admin

As the economy improves, taxpayers use Internal Revenue Code (IRC) Section 1031 to postpone paying tax on their property sales by exchanging their property for other qualified property. This allows the taxpayer to defer the gain recognition until the replacement property is sold sometime in the future.

To guarantee that taxpayers are reporting all California income, California has added new reporting requirements in 2014 for taxpayers who exchange California properties for like-kind properties in other states.

Effective January 1, 2014, all taxpayers who defer gain or loss under IRC Section 1031 (1031-exchanges) by selling California relinquished properties (CA RQs) and acquiring like-kind, non-California replacement properties (Non-CA RPs) will have to file a new annual information return (California 1031 information return) to track their deferred California sourced gain or loss.

This California 1031 information return will be filed annually until the deferred California source gain is recognized, typically when the replacement property is sold. The new California 1031 information return is not yet available but is currently being developed.

California’s new law will help taxpayers and especially the Franchise Tax Board (FTB) keep track of California sourced gain deferrals from 1031 exchanges.

The Franchise Tax Board has indicated that it intends to track the following information:

  • Distinguish California property from non-California like-kind replacement property;
  • Quantify the deferred California sourced gain or loss amount as compared to the total; deferred gain or loss amount from all sources;
  • Track the allocation of deferred California sourced gain or loss from each exchange to the non-California replacement property;
  • Other examples of specific information the FTB might request for each property and like-kind replacement property include:
  • address or description of the property; parcel number, VIN, or HIN of the property; contract prices for each property and like-kind replacement property exchanged; California adjusted tax basis for each property; and debt amounts to which the exchanged properties were subject.

Additional information is available on the FTB website at CA 1031 reporting requirements.

By Melinda Nelson, CPA

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Survey Suggests Taxpayers are Overconfident in Their Tax Prep Skills

Posted on April 10 2014 by admin

Even as the tax code becomes increasingly complex, more and more Americans are preparing their own tax returns. A recent survey conducted by BMO Harris Financial Advisors found that nearly 48% of Americans prepare their own tax returns. Eighty-three percent of the taxpayers surveyed are confident that their returns take advantage of all the deductions, credits, and other tax savings that are available to them.

Despite their high confidence, 45% of these taxpayers stated that they do not consider themselves knowledgeable about investments designed to reduce their tax liability, such as 401(K) plans and IRAs. Fifty-three percent of respondents admitted that they do not understand how dividend income is treated on a tax return, and 56% indicated that they do not understand how capital gains are taxed.

It’s likely safe to assume that these numbers would be even higher if more complicated scenarios were brought into play, such as depreciation on a rental property, home office deductions, or properly reporting K-1 income.

With readily available software programs such as TurboTax to do most of the legwork for a DIY tax preparer, it’s easy to understand the overconfidence. And while a professionally prepared return may be overkill for many taxpayers with relatively simple returns, it is important for anyone planning on preparing their own return to do a bit of research in order to fully understand their tax situation.

By Austin Bradley, CPA

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Timing Rules for SEPs and SIMPLE-IRAs Part II

Posted on April 9 2014 by admin

For the most part, SEPs (Simplified Employee Pensions) and SIMPLE (Savings Incentive Match Plan for Employees)-IRAs live up to their billing as easy ways to set aside tax-favored retirement funds for employees and employers. However, contribution rules for these plans are not necessarily straight-forward. To read part I of this post dealing with SEPs, click here.

SIMPLE-IRAs: A SIMPLE-IRA retirement plan can be adopted by an employer that meets both of the following requirements: a) it has 100 or fewer employees who received at least $5,000 of compensation from the employer for the preceding year; and b) it doesn’t have another employer-sponsored retirement plan (except for a collectively bargained plan covering employees ineligible to participate in the SIMPLE plan) to which contributions were made or benefits accrued for the year.

Employees designate contributions to be made to a SIMPLE plan under a “qualified salary reduction arrangement.” This is a written arrangement under which an employee may elect to have the employer make elective employer contributions (expressed as a percentage of compensation, or, if the employer permits, a specific dollar amount) to a SIMPLE-IRA on behalf of the employee, or to the employee directly in cash. The amount that an employee may elect for any year can’t exceed $12,000 for 2013 or 2014. SIMPLE-IRA participants who are age 50 or over by the end of the plan year may make additional catch-up contributions of up to $2,500 for 2013 or 2014.

The employer must make either:

  1. A matching contribution equal to the amount the employee contributes, up to 3% of the employee’s compensation for the year; or, electively, as little as 1% in no more than two out of the previous five years, if the employer timely notifies the employees of the lower percentage; or
  2. A nonelective contribution of 2% of compensation for each employee eligible to participate who has at least $5,000 of compensation from the employer for the year.

The employer’s contributions for himself or herself must be the same type and rate as the contribution made for common-law employees.

Timing of contributions:

Salary reduction contributions for regular employees must be deposited no later than the close of the 30-day period following the last day of the month in which amounts otherwise would have been payable to the employee in cash. Salary reduction contributions to these plans must be made to the SIMPLE-IRA as of the earliest date on which the contributions can reasonably be segregated from the employer’s general assets, but in no event later than the 30-day deadline described above. Alternatively, salary reduction contributions may be made within seven business days after the employee would have otherwise received the money, to meet the DOL’s 7-day safe harbor for plans with fewer than 100 participants.

Salary reduction contributions for business owners, however, may be made within 30 days after the end of the tax year. For most people, this means salary reduction contributions for a year must be made by January 30 of the following year.

Employer contributions, whether matching contributions or nonelective contributions, whether for the owner or his or her employees, must be deposited by the due date (including extensions) of the federal income tax return for the tax year that includes the last day of the calendar year for which the employer made the contributions.

By Jeremy Smith, CPA

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Timing Rules for SEPs and SIMPLE-IRAs Part I

Posted on April 8 2014 by admin

For the most part, SEPs (Simplified Employee Pensions) and SIMPLE (Savings Incentive Match Plan for Employees)-IRAs live up to their billing as easy ways to set aside tax-favored retirement funds for employees and employers. However, contribution rules for these plans are not necessarily straight-forward.

SEP plans: Business owners can set up and fund their SEP by the due date of their business tax return (including extensions). For businesses using the calendar year as their tax year, the deadline to set up and contribute to a SEP plan is March 15th or April 15th, depending on what type of entity they are, or their extended due date if an extension is filed

SEPs may be an attractive alternative for smaller businesses because they can be set up (as a SEP-IRA for each participant) for little or no cost at a bank, investment firm or insurance company; and they offer relatively high contribution and deduction limits, minimal paperwork and no annual Form 5500 filing. The plan must cover employees who are at least age 21 and have performed service for the business in at least three of the last five years. All eligible employees must participate in the plan, including part-time employees, seasonal employees, and employees who die or terminate employment during the year.

SEPs aren’t so simple, however. Although an SEP promises streamlined requirements and flexibility, it does, however, exhibit some unusual quirks that businesses should be aware of before adopting one. A key quirk is the differentiation between the maximum contribution rate for employees and a self-employed employer. Whether for the employer or employee, contributions may be based only on the first $255,000 of compensation for 2013 ($260,000 for 2014).

For employees, the maximum annual contribution is the lesser of (1) 25% of the employee’s compensation, or (2) $51,000 for 2013 ($52,000 for 2014).

For the self-employed employer, when figuring the contribution for his or her own SEP-IRA, compensation is net earnings from self-employment (i.e. earnings net of one-half of the employer’s self-employment tax), less contributions to the employer’s own SEP-IRA.

Thus the calculation of item (1) above for a self-employed person involves a circular calculation; a simpler way to express that calculation for a self-employed person is: his compensation multiplied by [contribution rate (expressed as a decimal) ÷ (contribution rate +1)].

Illustration – Sam, a self-employed individual who owns the entire interest in an unincorporated business, wants to make the maximum deductible contribution to a SEP, where the SEP plan contribution rate is 25%. The maximum deductible amount that Sam (as an employer) may contribute is .25 ÷ 1.25. This is .200, or 20%. Assume that Sam’s net earnings for the year from this business are $100,000 (net of one-half of the social security tax and one-half of the Medicare tax, which are deductible under Code Sec. 164(f)). The maximum deductible contribution that Sam can make for the year is $20,000.

Note, however, that under Code Sec. 164(f)(1), net earnings are computed without regard to the additional 0.9% additional Medicare self-employment tax.

By Jeremy Smith, CPA

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Are You an Identity Theft Victim?

Posted on April 3 2014 by admin

The amount of identity theft cases continues to increase each year and could even affect your tax return and/or refund. Identity thieves will use another individual’s social security number in order to file a false tax return to claim a refund. This tends to happen early in the tax filing season. You may be a victim if the IRS notifies you via notice or letter of the following issues:

  • They have received more than one tax return with your social security number
  • You owe money, have fallen into collections, or have had additional taxes assessed offsetting your refund
  • The IRS has received additional wage information from sources you never worked for or with

If you suspect that you are a victim of identity theft, contact the IRS at 800-908-4490 and fill out Form 14039, IRS Identity Theft Affidavit at Once this form is submitted, the IRS will issue a new identification number to be used in addition to your social security number. You will be required to put the Identity Protection PIN that the IRS issued to you next to your signature on the second page of Form 1040. CAUTION: Your tax preparer needs a copy of this number in order to file your taxes moving forward! Tax returns will no longer be accepted using just your social security number once the IRS has issued an Identity Protection PIN.

Happy Filing!

By Julie Duley

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Supreme Court Decides Severance Pay is Subject to FICA Tax

Posted on April 2 2014 by admin

In a unanimous decision (with Justice Kagan recused), the Supreme Court, reversing the Sixth Circuit Court of Appeals, has held that severance payments that were made to involuntarily terminated employees and that weren’t tied to the receipt of State unemployment insurance, are subject to tax under the Federal Insurance Contributions Act (FICA). The Court easily concluded that the severance payments at issue fell within Code Sec. 3121′s broad definition of “wages” for FICA tax purposes and rejected the taxpayer’s argument that the payments’ tax treatment was altered by a special withholding provision in Code Sec. 3402.

The Supreme Court settled the split Court rulings on whether severance payments should or should not be included as wages for FICA tax purposes. See the prior blog post Filing Deadline: 2010 FICA Protective Refund Claims for Severance Pay for additional information.

In the case in front of the court, U.S. v. Quality Stores, Inc., et al, Quality Stores sought a refund of approximately $1 million. According to the government’s petition, the total dollar amount at stake (i.e., including other pending refund claims and litigation) was over $1 billion, which news outlets and industry insiders speculated was conservative.

A sigh of relief was heard from the federal government.

By Melinda Nelson, CPA

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Mamma Mia! Who Can Deduct That?

Posted on April 1 2014 by admin

I couldn’t help click on a headline the other day “Abba Wore Flashy Clothing as a Tax Deduction”. The article discussed the Swedish pop group Abba’s on stage outfits. In a new book published to mark the 40th anniversary of the band, they have revealed that the costumes the band wore on stage were influenced by Swedish tax code. According to Swedish tax code, the outfits could only be deducted if they were not suitable to be worn on the street.

Believe it or not, this is very similar to the rules in the United States for deducting uniforms. According to IRS Publication 17, “Your Federal Income Tax for Individuals”, work clothes and uniforms are deductible if they meet two requirements:

  1. You must wear them as a condition of your employment
  2. The clothes are not suitable for everyday wear

The publication goes on to say that it is not enough that the clothing just be distinctive, nor is the fact that you would not be caught dead wearing the work clothes away from work! The clothing must not be suitable for taking the place of your regular clothing.

The most common example of deductible uniforms are police officers; however, there are others that would qualify.

Believe it or not, Publication 17 even mentions that musicians and entertainers can deduct the cost of theatrical clothing and accessories that are not suitable for everyday wear.

I guess Liberace and Elvis may have been motivated by more than fashion when they were picking out their wardrobe!

By Dale Jensen, CPA

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IRS Releases New Requirements to Claim the Earned Income Tax Credit

Posted on March 27 2014 by admin

Recently, the IRS released new requirements for taxpayers to be eligible to claim and take advantage of the Earned Income Tax Credit (EITC). The online and interactive EITC Assistant has been upgraded to assist you in determining whether you qualify based on your household income, family size and filing status.

You may be missing out on refundable dollars even if you owe no tax or do not have to file a tax return!

2013 adjusted gross income (AGI) must be less than:

  • $46,227 ($51,567 for married filing jointly) if you have three or more qualifying children,
  • $43,038 ($48,378 for married filing jointly) if you have two qualifying children,
  • $37,870 ($43,210 for married filing jointly) if you have one qualifying child, or
  • $14,340 ($19,680 for married filing jointly) if you do not have a qualifying child.

If you meet the AGI test, and you have the following:

  • Social Security Numbers: Taxpayer and qualifying children must have valid social security numbers.
  • Filing Status: Single or Head of Household only. Married filing separately does not qualify.
  • Citizenship: Must be a U.S. citizen or resident alien all year.
  • Investment Income: Must be $3,300 or less.
  • Qualifying Child: Your child must meet the relationship, age, residency and joint return tests.
  • No Qualifying Child: You must be at least age 25, but under age 65 as of December 31.

You may be eligible to claim the maximum credit even if you do not have a tax filing requirement.

Tax Year 2013 maximum credit:

  • $6,044 with three or more qualifying children
  • $5,372 with two qualifying children
  • $3,250 with one qualifying child
  • $487 with no qualifying children

Tax Year 2012 maximum credit:

  • $5,891 with three or more qualifying children
  • $5,236 with two qualifying children
  • $3,169 with one qualifying child
  • $475 with no qualifying children

For more information to determine whether a child qualifies you for the EITC, the IRS Publication 596 offers helpful tips. Some common mistakes to avoid include:

  • Claiming a child who does not meet the relationship, age or residency tests
  • More than one person claiming the same child
  • Filing as “single” or “head of household” when married
  • Over or under reporting of income and/or expenses
  • Social Security number missing or last name mismatch for both taxpayers and the children

If you have questions regarding how to claim the Earned Income Tax Credit or would like to speak to one of our tax advisers, please give us a call today.

By Livonia Winkles, EA

References & Related Articles
IRS Publication 596 – Earned Income Credit (EIC) – click here!

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There is nothing more complex than the world of taxes. We know this and yet we chose careers where we face these issues everyday. We get questions day in and day out about new tax laws, forms and news items and how they affect everyday people and businesses. Well, here at Henry & Horne, LLP we have set out to do what we do best; help everyday people understand what is going on in the world of state, local, federal, estate and international taxation. We will provide these weekly posts and we encourage you to give us feedback on those posts as well as letting us know what else you would like to know more about. Welcome to "Tax Insights." We hope you find this blog informative and worthy of your time.

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