A taxpayer was disallowed dependency exemptions for his son, daughter and grandchild in a January 2015 U.S. Tax Court case. The court also denied him head-of-household filing status.

This decision (Gregory McBride v. Commissioner, U.S. Tax Court, T.C. Memo. 2015-6, Jan. 8, 2015) cost the taxpayer $3,540 in additional federal income taxes and penalties of $708.

During 2010, Gregory McBride and his son, daughter and granddaughter all lived together in McBride’s home.

On Feb. 28, 2011, McBride’s son filed his Form 1040 income tax return, claiming himself as a personal exemption. Also on that date, McBride’s daughter filed her Form 1040. She claimed $11,892 in gross income.

McBride’s daughter claimed a personal exemption for herself and a dependency exemption for her daughter. She received a refund of $5,290, due mostly to a refundable credit of $4,450.

McBride had requested a filing extension for his 2010 return. He timely filed his return on May 23, 2011, claiming head-of-household filing status and dependency exemptions for his son, daughter and granddaughter.

A taxpayer can claim a dependency exemption for someone who is a qualifying child or a qualifying relative.

The IRS requires a taxpayer to meet a five-part test to claim an exemption for a qualifying child. The taxpayer must meet the requirements of all five parts to claim this exemption. One of the parts is an age test.

The dependent child must be under the age of 19 or a student and under the age of 24 as of the end of the tax year, which in this case was Dec. 31, 2010. The facts in this case stipulated that both the son and the daughter were over the age of 24, so the age test was not met and McBride would not be able to claim his children as dependents.

There is an exception – which did not apply in this case – for an individual who is permanently and totally disabled.

McBride could claim neither his daughter nor his son as qualifying relatives because he did not present any evidence that he provided more than 50 percent of their support during the year. A taxpayer must meet the support test to claim someone as a dependent relative. In the case of his daughter, McBride did not meet the support test.

McBride could not claim his granddaughter as a dependent because the mother had already claimed her. The Internal Revenue Code has a special “tie-breaker rule” when multiple taxpayers are claiming the same child as a qualifying child. In these cases, the child is treated as the qualifying child of the taxpayer who is the parent – in this case, the mother.

The court denied McBride’s claim for head-of-household status. To claim this status, a taxpayer must be unmarried at the end of the tax year and provide a home for a dependent for at least half of the year.

Because the son, daughter and granddaughter were not considered to be dependents by the court, McBride did not meet the criteria for head-of-household filing status. Therefore, the court disallowed all three dependency exemptions and the head-of-household filing status.

©2015 CPAmericaInternational

 

Be careful when filling out your W-4 form.

The Internal Revenue Service requires that employees fill out a Form W-4 on or before the first day of employment. The W-4 form determines how much federal income tax an employer will withhold from an employee’s wages. The information on the W-4 is used when calculating the employee’s first payroll check from the employer.

But use caution. There is a $500 civil penalty for employees claiming excess withholding allowances on Form W-4. Criminal penalties can apply when an individual willfully supplies false withholding information or fails to supply withholding information.

Employees are entitled to claim dependency exemptions for themselves and for each of their dependents, including their spouse. Employees who can be claimed as a dependent on someone else’s tax return may not claim a withholding exemption for themselves.

Employees with more than one job may not claim an exemption that is currently in effect with another employer. So, for example, if you are a single person with no dependents and you have two jobs, you would be allowed to claim one exemption on your W-4 form for one of the jobs. Then you would have to claim zero dependents on the W-4 form for the second job.

These rules do not apply if the wages from the second job are $1,500 or less.

If an employee does not fill out a W-4 form, the withholding must be computed as if the employee were single and claiming no other exemptions.

Employees who certify to their employer that they had no income tax liability for the preceding tax year, and don’t anticipate any tax liability for the current year, may claim to be exempt. No federal income tax will be withheld from their wages. They should fill out and file a W-4 form with the employer each year that they are in this situation.

©2015 CPAmerica International

 

When it comes to income taxes, it pays to be organized.

Begin gathering your tax information as early as it is available. You should receive most of your 2014 tax documents by early to mid-February 2015.

Probably the most important document you need to locate is a copy of last year’s tax return. The tax situation of most individuals does not change dramatically from year to year. The information shown on last year’s return is a good guide to what you need to look for this year.

On the other hand, if you experienced a life event during 2014, your tax situation could be in for a big adjustment. Life events include marriage, divorce, birth of a child, retirement, a business startup or a change in employment.

Everyone’s situation is different, but most people receive some common tax documents in the mail:

• Employers will send you W-2 forms.
• If you freelance, clients that you completed at least $600 worth of work for during2014 should send you a 1099-MISC form.
• If you’ve earned dividends on mutual funds or other investments, you should receive one or more 1099-DIV forms from the account administrator.
• If you received a distribution from an IRA or a company retirement plan, you should receive a 1099-R form.

You may receive other income tax-related forms as well:

• Receipts or acknowledgments for charitable donations
• Real estate and personal property tax receipts
• A 1098 form from your mortgage company
• A 1098-T form if you paid college tuition costs

All of these forms will be needed to determine whether you qualify to itemize your deductions.

If you are self-employed, you will also need to gather receipts for all deductible business expenses. Check out IRS Publication 535 for more information about business expenses.

While you’re digging up all these records, look ahead to next year at this time. Sort everything and create files to hold:

• Bills
• Bank, credit card and retirement account statements
• Receipts for deductible items and charitable donations

Then keep items sorted as they come in during 2015. Using this method, next year’s income tax return should be easier.

©2015 CPAmerica International

 

On June 10, 2014, the IRS implemented the Taxpayer Bill of Rights. In an effort to make it easier for taxpayers to understand and access their rights when dealing with the IRS, this Taxpayer Bill of Rights arranges the numerous existing rights established in the Internal Revenue Code into ten basic rights. These rights include:

1. The right to be informed – This gives taxpayers the right to be aware of and understand what is required of them to comply with the tax laws. This right also entitles taxpayers to be notified of any determinations the IRS has made regarding their tax accounts and how those determinations were made.
2. The right to quality service – This right entitles taxpayers to be treated in a timely, polite, and professional manner when dealing with the IRS. Furthermore, it allows taxpayers to speak with supervisors if they have experienced incompetent service.
3. The right to pay no more than the correct amount of tax – Taxpayers must pay only the amount of tax legally due, which may or may not include interest and penalties.
4. The right to challenge the IRS’s position and be heard – When the IRS initiates actions against taxpayers, this right entitles taxpayers to object and present further documentation in support of their positions; expect that their objections will be taken into account swiftly and impartially; and to be informed of the IRS’s decision and its underlying reasons.
5. The right to appeal an IRS decision in an independent forum – Taxpayers have the right to an unbiased appeal of most IRS decisions, including several penalties, and to be informed of the Office of Appeals’ decision.
6. The right to finality – This right entitles taxpayers to know the time frames regarding how much time they have to dispute the IRS’s decisions as well as how much time the IRS has to audit a specific tax year or collect a tax debt. This right also includes informing the taxpayer when an audit has been completed by the IRS.
7. The right to privacy – When conducting an inquiry, examination, or any other enforcement action against a taxpayer, the IRS must comply with the law and conduct itself in a way that is no more intrusive than necessary. In addition, it must ensure that it does not violate any of the taxpayer’s due process rights.
8. The right confidentiality – The IRS may not reveal any information provided by taxpayers unless permitted by law or the taxpayers themselves. This right also allows taxpayers to expect that action will be taken against those employees who violate this right.
9. The right to retain representation – Taxpayers have the right to employ a permitted representative when dealing with the IRS. If they cannot afford one, taxpayers have the right to seek help from a low income taxpayer clinic.
10. The right to a fair and just tax system – This right permits taxpayers to expect that the facts and circumstances surrounding their liabilities, abilities to pay, or abilities to supply information in a timely manner will be taken into account by the tax system. This right also entitles taxpayers to obtain help from the Taxpayer Advocate Service if they are experiencing financial difficulties.

Initially, the Taxpayer Bill of Rights was only released in English and Spanish. However, in August, to reach as many taxpayers as possible, the IRS published it in four additional languages: Chinese, Korean, Russian, and Vietnamese. The Taxpayer Bill of Rights has also been included in IRS Publication 1, Your Rights as a Taxpayer, which is sent to countless taxpayers across the nation with various IRS notices. Only time will tell whether or not this new Taxpayer Bill of Rights will fulfill the IRS’s mission, which is to “Provide America’s taxpayer’s top-quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.”

 

California has always been notorious for their high cost of living combined with high income taxes. These tax rates are as high as 13.3% for high earners with income over $1,000,000. And to make matters worse, in 2012 California took the precedence of retroactively raising rates at the beginning of 2012 for a law that passed on November 6, 2012. Running numbers, an average household earning $100,000 in California, would pay close to $7,000 in taxes to the State.

The good news is that it is easy to just hop over the border, move to Nevada, and save the $7,000. This is especially true for a retiree with no job holding them down. Your $100,000 income would also go a lot further in Nevada than California!

So how would you go about moving to Nevada to not have to pay California’s onerous tax? This is easy if you own no property in California and retire in Nevada. You just sell your house and move your life to the Silver State. However, you might want to keep your home in California, which makes things more complicated as the Golden State does not want to forego any of their tax revenue (but remember, any income sourced in California will always be subject to their tax).

So what to do? First, spend less than nine months in California every year as California presumes you’re a resident of their State if you spend more than nine months there. Second, if you own a home outside of California and your presence in California is less than 6 months you are not considered a resident if you can prove that your activity is just as a guest. Further, there are additional factors that California considers in the instance that you are audited. These primary factors include:

• the size of the homes in California compared to Nevada
• where your personal property is located
• family connections
• and active business involvement.

Secondary factors, which are easy to conform to, include having a CPA and attorney in Nevada, registering your vehicles in Nevada, getting a Nevada driver’s license, and where you spend your money as California could request to look at your credit card statements.

Moving to Nevada can be a huge leap, but one that keeps more money in the bank to protect your wealth or have a more meaningful life as a retiree.

 

 

Can you imagine waiting for your tax refund – and it never arrives?

Not because you don’t deserve it or the IRS didn’t send it, but because your tax preparer substituted his bank routing number for yours after you signed the form.

And then, worse news, the IRS doesn’t reimburse you for your loss.

That scenario has happened to hundreds of taxpayers who made the mistake of trusting unscrupulous, uncredentialed preparers.

But preparer fraud victims are at the back of the line when it comes to getting a refund from an IRS barraged with hundreds of thousands of identity theft cases it is processing.

In fact, the IRS has generally declined to issue refunds to victims of preparer fraud at all, according to National Taxpayer Advocate Nina Olson.

“The IRS has consistently dragged its heels, making one excuse after another, because providing relief to these victims just is not a high enough priority, or more disturbingly, because the IRS simply does not want to provide relief,” says Olson in the report she submitted to Congress and the IRS entitled “Areas of Focus, Return Preparer Fraud: A Sad Story.”

Between 2000 and 2011, the IRS Office of Chief Counsel issued four opinions and other guidance authorizing the IRS to issue replacement refunds to the victims of tax preparer fraud.

But no refunds have been issued by the IRS, Olson said.

Some victims have been waiting since 2008 to be reimbursed, the advocate’s office reports.

One section of the new Taxpayer Bill of Rights adopted recently by the IRS states, “Taxpayers have the right to expect appropriate action will be taken against employees, return preparers and others who wrongfully use or disclose taxpayer return information.

“Nowhere has the IRS failed to abide by the Taxpayer Bill of Rights more than with respect to the issue of return preparer refund fraud,” Olson said.

Olson’s report said IRS Commissioner John A. Koskinen decided in March that the IRS would issue refunds to victims who have filed police reports and met certain other substantiation requirements. To date, the IRS hasn’t implemented that decision or given a date for victims to expect refunds, Olson said.

To help prevent future fraud, Olson reiterated her longstanding recommendation that a meaningful preparer standards program must contain four components:

1. Registration to promote accountability
2. A one-time “entrance” examination to ensure basic competency in return preparation
3. Continuing education courses to ensure preparers keep up to date with the many frequent tax-law changes
4. A taxpayer education campaign to help guide taxpayers to credentialed practitioners such as CPAs, attorneys and Enrolled Agents.

 

U.S. income tax is basically pay as you go. As you earn income during the year, you’re expected to pay your taxes on it – or you’ll be penalized.

You may pay taxes in basically two ways:

➤ Through withholding from your paycheck

➤ By making estimated payments if your withheld tax is insufficient

Those needing to make estimated payments are self-employed individuals who run their own businesses or professionals in business for themselves, as well as investors and retirees who receive interest or gains, among others.

For 2014, estimated tax deadlines for individuals are April 15, June 15 and Sept. 15, 2014, and Jan. 15, 2015. The January payment may be skipped without penalty if you file your 2014 tax return and pay all taxes due by Feb. 2, 2015.

If you do not pay enough tax throughout the year, penalties may apply. But with proper planning, the penalties are avoidable.

You won’t be penalized if you owe less than $1,000 in taxes after subtracting withholding and credits. You also won’t be penalized if you pay at least 90 percent of the tax you owe for the current year, or 100 percent of the tax shown on your tax return from the prior year.

If adjusted gross income for 2013 was more than $150,000 for married taxpayers, 110 percent of the 2013 tax liability must be paid for 2014, or there will be a penalty.

There are special rules for farmers and fishermen. If two-thirds of income comes from farming or fishing, only 66 2/3 percent of the current-year tax owed is payable in one installment due Jan. 15.

In general, your estimated tax payments should be made in four equal amounts to avoid a penalty. But if your income is received unevenly during the year, annualizing your payments and making unequal payments may enable you to eliminate or lower your penalty.

If it appears that you will be subject to an underpayment penalty, you may be able to reduce or eliminate the penalty by initiating or increasing your quarterly estimated tax payments or by adjusting your withholdings.

A quirk in the penalty rules treats withheld taxes – even those withheld late in the year – as if they had been taken evenly throughout the year. So, if you’re employed, instructing your employer to withhold more from your pay can even eliminate penalties that accrued earlier in the year.

While most people want to avoid unnecessary penalties, it is seldom a good idea to pay more than the law requires or to pay your taxes earlier than necessary. Why let the government hold your money only to return it to you next year as a tax refund – with no interest?

Your goal should be to pay just enough to avoid an underpayment penalty but not so much as to create a large refund. Consult with your tax adviser to optimize your tax payments to avoid penalties.

©2014 CPAmerica International

The IRS is increasing the penalties on U.S. taxpayers who attempt to hide assets overseas, while lowering or eliminating penalties for those who unintentionally failed to disclose offshore accounts.

The IRS has announced in Information Release 2014-73 major changes to its Offshore Voluntary Compliance Program (OVDP). The changes include:

1. Modifications to the 2012 OVDP

2. An expansion of the “streamlined” filing compliance procedures announced in 2012

There are a number of reporting requirements for taxpayers with foreign accounts. Affected individuals must fill out and attach Schedule B with their tax returns. Schedule B asks about the existence of foreign accounts.

Some taxpayers have to fill out Form 8938, Statement of Foreign Financial Assets. Other filing requirements apply to foreign trusts.

In addition, taxpayers with foreign accounts whose aggregate value exceeds $10,000 must file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR), electronically through the Financial Crimes Enforcement Network’s BSA E-Filing System. Failure to comply with applicable reporting requirements can result in civil and criminal penalties.

On July 1, 2014, a new information reporting regime instituted by the Foreign Accounts Tax Compliance Act went into effect. Thousands of foreign financial institutions will begin to report to the IRS the foreign accounts held by U.S. persons.

Under the 2014 OVDP, taxpayers who do not meet certain deadlines will be subject to a 50 percent penalty under one of the following circumstances:

1. If it becomes public that a financial institution where the taxpayer holds an account, or another party facilitating the taxpayer’s offshore arrangement, is under investigation by cooperating with the IRS or Department of Justice in connection with U.S. accounts, or
2. If such institution or the account facilitator has been identified in a court-approved “John Doe summons.”

Taxpayers already in the 2012 OVDP may be able to take advantage of certain of the new procedures.

The expanded streamlined procedures are intended for U.S. taxpayers whose failure to disclose their offshore assets was not willful. Key expansions in the streamlined procedures will accommodate a wider group of individuals living outside the United States and, for the first time, certain U.S. residents who have unreported foreign financial accounts.

If you are already in the 2012 OVDP, you should consult your tax adviser to determine whether you qualify for the new streamlined program. If you live outside of the United States and qualify, there are no penalties.

If you live in the United States and qualify, there is a maximum penalty of 5 percent – down from the previous 27.5 percent.

 

The Tax Court recently concluded that, when the taxpayers in the case asserted that they had reasonable cause and acted in good faith as a defense to penalties assessed by the IRS, they forfeited their privilege protecting attorney-client
communications.

In this case (Ad Investment 2000 Fund, LLC, et.al. v. Commissioner, 142 TC No. 13, April 16, 2014), the IRS asserted that the taxpayers engaged in transactions designed to create artificial tax losses. The IRS also assessed penalties attributable to:

➜ A substantial understatement of income tax;
➜ A gross valuation misstatement; and/or
➜ Negligence or disregard of rules and regulations.

Anticipating the taxpayers’ argument that the penalties should not apply because they acted with reasonable cause and in good faith, the IRS asked the court to compel production of six tax opinion letters the taxpayers had obtained from their law firm.

The taxpayers objected to the disclosure on the grounds that the letters were privileged attorney-client communications. The IRS argued that the taxpayers waived any privilege under the common-law doctrine of implied waiver by relying on affirmative defenses to the penalties that turn on the taxpayers’ beliefs or state of mind. The taxpayers contended that they had developed their reasonable belief by analyzing the pertinent facts and authorities and not by any reliance on advice from their attorneys.

The court concluded that, by putting the taxpayers’ legal knowledge and understanding into contention to establish good-faith and state-of-mind defenses, the taxpayers forfeited the privilege protecting attorney-client communications relevant to the content and formation of their legal knowledge, understanding and beliefs.

The court reasoned that the taxpayers must show that they analyzed the pertinent facts and legal authorities and, in reliance upon that analysis, reasonably concluded in good faith that there was a greater than 50 percent likelihood that the tax treatment would be upheld if challenged. This put into contention their knowledge of the pertinent legal authorities, their understanding of those legal authorities and their application of the legal authorities to the facts.

The court noted that the taxpayers received the opinions well before their tax returns were due and they did not claim that they ignored the opinions. If the opinions formed the basis for the taxpayers’ beliefs, the court concluded that it is only fair to allow the IRS to review those opinions.

©2014 CPAmerica International

 

Most of us would be happy if the IRS never knew who we are or where we live.

But sometimes it’s a good idea to keep the government informed.

If you or one of your dependents had a name change last year, you should notify the Social Security Administration (SSA) before you file your federal income tax return. Otherwise, the name on your tax return will not match SSA records, which will likely result in a letter from the IRS inquiring about the mismatch.

If you overpaid your taxes, your refund could be delayed until the discrepancy is resolved.

Be sure to contact SSA if:

• You got married or divorced and changed your name.
• A dependent you claim had a name change.
• You adopted a child and that child’s last name changed.

Your return must list the Social Security number of every dependent. If you have not obtained a Social Security number for a newborn child, you should process the necessary paperwork before you file your 2013 return.

You can effect a name change by filing Form SS-5, Application for a Social Security Card, with the SSA. It is also a good idea to let the IRS know about a change in address by filing Form 8822, Change of Address.

For individual, gift, estate or generation-skipping transfer tax returns, file Form 8822 or Form 8822-B, Change of Address or Responsible Party – Business, for your business. Note that Form 8822-B should be filed no later than 60 days after a change or by March 1 if the change occurred in 2013 and was not previously reported to the IRS.

2014 CPAmerica International