Categories
Income Tax

Appointments Limited

Due to the Covid-19 situation I’m limiting office visits for the immediate future. Existing clients are still welcome to drop off and pick-up work by appointment, but substantive discussions will take place by phone and email, and unscheduled visits are discouraged. While I’m not closed to new clients, the majority of my effort for the remainder of tax season will be focused on completing work for existing clients. New clients bringing in work now should expect to be placed on extension or completed after the traditional April 15 due-date if that date is postponed without the need for an extension due to Covid-19. Thank you for understanding.

Additionally, I have suspended my online scheduling through the April 15 due-date. All appointments for the remainder of the season will need to be scheduled by phone or e-mail.

Thank you for your patience during this difficult and complicated time.

Categories
Federal Income Tax

Small Business Form 1099 Requirements

Who needs to file a 1099?

A 1099 is a form that a business or non-profit (both referred to as businesses for the rest of this post) files to inform to both IRS and one of their vendors of the amount of reportable payments that the business made to them during the year. Most Forms 1099 are due by January 31, 2018, although it is possible to extend the date for filing with the IRS by 30 days.  Payee copies remain due January 31.  .

Form 1099 is a business form, so payments made for personal purposes do not need to be reported. Payments made to corporations also don’t usually need to be reported.  Most small landlords do not need to file form 1099, but there has been some confusion about that which is discussed in a separate post.

Businesses need to report several different kinds of payments made to non-corporate payees, but the two most commonly overlooked are rent and non-employee compensation. Basically any time a business makes six hundred dollars or more in reportable payments during the calendar year to one payee, they need to file form 1099.  Payments made to pay for legal or medical expenses for business purposes need to be reported on form 1099, even if made to a corporate payee.

 

Timely Filing More Important than Ever Before

Although congress repealed the provisions of the 2010 which would have expanded the categories of payments that need to be reported and who needs to report them, it did not repeal the increased penalties for failing to file a 1099 when required.  Small businesses, defined as businesses with gross receipts below $5,000,000 per year, have lower penalties for late 1099s than larger businesses.  For small businesses, the penalty for failing to file a 1099 with the recipient or the IRS by their respective due-dates is now $50 if less than 31 days late.  If more than 30 days late, the penalty becomes $100 for the payee copy and $100 for the IRS copy as long as the forms are filed by August 1.  Forms 1099 filed after August 1 incur a penalty of $260 per return, and intentional disregard of the rules can result in penalties of $530 per return.  Additionally, the IRS has added questions to schedule C, schedule E, and the corporate and partnership tax forms which ask if the taxpayer is required to file form 1099, and if they have done so (IRS).  This essentially compels taxpayers who may be filing their income tax returns in March or April to turn themselves in if they forgot to file 1099s in January

1099s for Rent Paid

Businesses don’t always realize when a 1099 is required, and 1099s for rent are especially problematic. Rents payed to a single payee for business proposes must be reported if the total rents payed to that person exceed $600 for the year. Rents paid to a real estate agent do not need to be reported on a 1099, but the agent must file form 1099 to report report the amounts collected and remitted to a landlord. Self-rental income must also be reported on form 1099.   Paying rent to the shareholder can be a great way to get cash out of a closely-held corporation, but many small businesses fail to file a 1099 to report that income.

1099s for Non-employee Compensation

Businesses sometimes run into trouble when it comes time to issue 1099s because they haven’t gathered the information that they needed to during the year.  For example, they may not have asked a contractor for his or her employer ID number or social security number at the time when services were provided, they may not even have gotten an address where they should send the 1099 to, or they may not have maintained a list of which vendors are individuals or partnerships and which are corporations.

It’s a good idea when hiring a vendor for any sort of service to ask if they are incorporated, and to collect their name, address, and employer ID number or social security number.  Some accounting programs, such as QuickBooks, include all of the necessary fields in the vendor record, and also include a check box that can be marked to indicate that the vendor needs a 1099.  If this information is captured when the vendor is hired, then the company can quickly and easily print a report with all of the information they need to file their 1099s at year-end.

Keep in mind that a company cannot avoid payroll taxes or other obligations by classifying a worker who should be considered an employee as an independent contractor.

 

RESOURCES

Hill, Claudia.  (2013, March 6). Should Landlords be Filing 1099s for Service Providers. Forbes.com.  Retrieved 6, January, 2014 from http://www.forbes.com/sites/irswatch/2013/03/06/should-landlords-be-filing-1099s-for-service-providers/

Internal Revenue Service.  (2018).  Increase in Information Return Penalties https://www.irs.gov/government-entities/federal-state-local-governments/increase-in-information-return-penalties-2

Internal Revenue Service.  (2018).  Instructions for Form 1099-Misc. Retrieved from  http://www.irs.gov/pub/irs-pdf/i1099msc.pdf

 

 

Categories
Federal Income Tax

Keep Real Estate Out of Your Corporation

Including the wrong kinds of assets in a corporation can be an expensive mistake. Things that are worth more over time, like investments, collectibles, and especially real estate, should be kept out of a closely-held corporation.  This mistake costs more for C-corporations than for S-corporations, but even  S-corps should be cautious about what assets they hold.  Business real estate is generally best owned personally, in a single-member LLC, or in an LLC taxed as a partnership.

Real Estate in C-corporations

A family’s biggest asset is usually its home, and a business’s biggest asset is usually its real estate.  This might be the corporate offices, a workshop, a garage, or retail space.  It may seem normal that a business would own its own building, but that’s often a bad idea.  Closely held corporations usually shouldn’t own any kind of real estate.  If a small business needs real estate, the shareholder should buy it, not the corporation.  Here’s why:

Photo of 384 Court Street Auburn, ME 04210

If the corporation is organized as a C-corporation, the profits get taxed twice.  Any business profits are taxed at the corporate level, and then taxed again when they’re paid out to the shareholder as a dividend.  If a company owns its real estate, it probably bought it because owning was be cheaper than renting.  That means that owning the property drives up the amount of income that gets taxed twice.

The opposite happens when the shareholders own the real estate.  When the shareholder owns the real estate, the rent expense is a deduction for the corporation and the shareholder’s rental profits are only taxed once.  The business can’t pay more than market rent for the space, but paying rent near the high end of the market is a great way to get money out of a c-corp.

Owning land or buildings inside the corporation might be a minor mistake while the business is operating, but it can be a disaster when the owner retires.   With a little bit of luck, retirement means usually means selling the business for lots of money.  If a buyer can’t afford the property or wants to move the business, the shareholder can be stuck owning an empty building in the corporation or renting it out.  This creates an ongoing tax and paperwork burden that would be much easier if the real estate was held personally.

The real pain comes when the shareholder sells the property.  C-corps don’t get capital gains rates, so selling the corporate real estate can quickly drive the corporation’s income into the higher tax brackets.  How big a of a a problem is that?

It’s a big one.  With a top marginal rate of 39% kicking in for corporate incomes between $100,000 and $335,000, and a top Maine corporate tax rate of 8.93%, a C-corp shareholder who sells property inside of the corporations might lose 40% of their gains to taxes before they even get the money out of the company.

 

Withdrawing the after-tax profit from the corporation will trigger a federal tax on dividends as high as 20%.  For Maine residents, the state taxes top out at 7.15%.  For a high-income shareholder, the dividends could also be subject to new federal Net Investment Income Tax of 3.8%.  Altogether, this means that a corporate shareholder might be left with as little as 42% of his or her gains.  This is all just because the shareholder made the wrong decision about how to buy the property corporation decades earlier.  These estimates simplify a few things, but are ballpark accurate.

If that same shareholder had held the building in his or her own name and leased it to the corporation, the profits from selling the building would only be subject to capital gains tax, ordinary income tax on depreciation recaptured, and state income tax.  2013 regulations clarify that gains from selling real estate that is rented to a shareholder’s active trade or business will not be subject to the net investment income tax.  Therefore, the same shareholder who would lose 58% of his or her real estate gains to taxes if the building were held by the corporation might pay less than half of that in taxes if the building were held personally.

Real Estate in S-Corporations

S-corporations don’t pay tax at the shareholder level.  Owning property in an S-corp isn’t as bad, but even S-corporations should still keep real estate in the shareholder’s name.

 

Holding real estate inside of an S-corporation can create problems when a shareholder joins or leaves the business.  Imagine that one shareholder is running a business and someone else wants to buy-in and run it with them.  If the business owns the real estate, the new shareholder needs to come up with enough money to by their share of the business and their share of the property at the same time.  If the shareholder owned the land or buildings, the new shareholder could buy stock in the business now, and wait years before buying the property it occupies.    This makes it easier for new owners to buy-in to the operating business because they don’t have to come up with payment for their share of the real estate value at the same time as their share of the business value.

Even sole-shareholder can run into problem with real estate in his or her S-corporation when they go to sell their business or when it makes sens for the business to move on to a new location.  The shareholder can’t re-purpose the real estate for personal use without triggering a taxable event, and if he or she sells the business, the new owner may not want the real estate to go with it.

Conclusion

Avoid tax headaches by keeping real estate out of your closely-held corporation.  Any corporation thinking of buying real estate in its own name should talk to its tax professional, and any tax pro worth his or her salt will probably have one piece of advice.  “Don’t do it”.

 

 

Categories
Federal Income Tax

Identity Verification Letters (IRS 5071C)

Have you received an identity verification letter from the IRS??  While there are always a lot of scammers trying to impersonate the IRS, the IRS does send identity verification letters out to some taxpayers.  Real identify verification contacts will always come by paper mail.  are never sent by telephone or e-mail.  A real identity verification request will identify itself as IRS letter 5071C.  The only site a legitimate Letter 5071C will direct the taxpayer to is idverify.irs.gov.  For more information, see the article on Forbes and the IRS page about letter 5071C.

When a taxpayer gets one of these letters, it means that the IRS has received a tax return their information on it and needs to verify the taxpayer’s identity before it finishes processing the return.   Taxpayers need to respond to these identity verification letters promptly or their refunds will be delayed.  Taxpayers should also never give out information that an identity thief could use to impersonate them, unless they are absolutely certain that they are talking to the IRS.  When in doubt, call the number for telephone assistance for individuals, 1-800-829-1040, to verify that the contact did actually come from the IRS.  To be doubly certain, they can verify that it is telephone assistance number listed on the IRS Telephone Assistance page.

This year (2015) in particular, there has been a definite increase in identity theft and tax return fraud.  The increase in fraud has affected both federal and state returns.  One major tax software company even had to suspend e-filing of state tax returns because it was being used to file so many fraudulent returns.

To read further about IRS identity verification and the IRS’s efforts to fight identity theft, visit their Identity Protection resource page.

 

 

Categories
Income Tax

What is a CP2000

What is a CP2000?

A CP2000, also known as a Notice of Under-reported / Over-reported Income or a matching notice,  is a letter that the IRS sends out when it has information on file that it can’t match up with the corresponding tax return.  The IRS typically sends CP2000s by regular mail, and they generally relate to the most recent tax year or one of the previous two years.  Just because you’ve received a CP2000 doesn’t necessarily mean that your tax return was wrong or that you owe additional money, but it does mean that you’ll need to respond promptly to resolve the notice.

Common Reasons for CP2000s

A CP2000 is an automated notice.  It’s generated by computer when the IRS matching software can’t reconcile the information in the tax return to what was reported to the IRS by third parties.  By far the largest source of information that the IRS works from to generate CP2000s is the 1099 reporting requirements.

Each time you receive a 1099 from a customer, a bank, or any other business, that business has also sent a 1099 to the IRS to tell them that you’ve gotten one.  Once your return has been filed, computers at the IRS try to match all of those 1099s up to information that’s been reported on your tax return.  If there are any left over after it’s matched what it can, you’re probably have a tax notice in your future.

In most cases, it will be easy for the IRS to match the return that you’ve filed to the information that it has.  Bank interest, dividends, and even most rental income and business payments don’t usually trigger a matching notice because taxpayers rarely forget about them and typically list them in exactly the place where the IRS expects them on the tax forms.

Here are a few common reasons why the 1099s or other pieces of information don’t match up.

  • Forgetting to include income on a return.
    • Contest winnings, early 401(k) or IRA withdrawals, and other one-time income are easy to forget.
    • People who file their returns as soon as they get their W-2s are often surprised when they get a 1099 a few days later.
    • If they fail to amend their returns before the IRS does its matching, they can expect a matching notice.
  • Netting income and deductions that needto be shown separately.
    • I see this most often with gamblers who don’t include their jackpot winnings because they have a net loss for the year.  Gambling winnings and gambling losses need to be reported separately in a return.
    • Likewise, some hobbies generate income and expenses, but don’t rise to the level of a trade or business.  The income and expenses still need to be shown separately, and netting them can trigger a CP2000.
  • Receiving income for someone else
    • I most often see this with partners in partnerships, when customers issue 1099s directly to the partner they work with.
    • If the partner just leaves this out of their return, it will trigger a CP2000, even if the partnership reports the income.
    • To avoid the CP2000, it’s possible to report the income on the return of whoever got the 1099 and then deduct it as a nominee payment to the proper recipient on a separate line, along with their social security or employer ID number.  Unless the other person is your spouse, you must also issue a 1099 to the person or entity that was supposed to receive the income.
    • When this happens, consider asking for a corrected 1099, or at least notifying the customer of the mix-up to keep it from repeating in future years.
  • Reporting information differently than the IRS expects
    • Sometimes the correct way to report information may not be what the IRS was expecting.
    • This can happen when a payment or deduction is properly spread across multiple forms.
    • Sometimes the only way to handle this is to respond to the CP2000 when it comes.

Is a CP2000 a tax bill?

A CP2000 is not a tax bill, but if the proposed change is an increase in tax and you don’t respond, it will result in the change being made and a bill being issued.  Even when a CP2000 results from an error in a return, it often over-estimates the increase in tax due.  If taxpayers don’t respond, or trust that the IRS figured the correct amount of tax, they often end-up overpaying.

For example, a gambler who forgot to report his or her winnings during the year may still have deductible losses.  The IRS will propose changes to the return which report the income, but do not deduct the losses.  It will be up to the taxpayer to figure out how much they lost during the year and deduct that amount, up to the amount of the winnings, as an itemized deduction.  A similar situation often happens with income-producing hobbies.

If capital gains information from stocks is left off of a return, the matching notice will typically re-figure the tax on the proceeds as though the taxpayer paid nothing for the securities when they bought them.  Once the correct tax is figured, sometimes the IRS even owes the taxpayer an additional refund!

How to Respond to a CP2000

Obviously, if you received a 1099 that you failed to include in your return, there’s not much to except complete the response form and send-in a check.  However, CP2000s have a very high error rate.  They’re generated by a computer without a lot of human interactions, and computers aren’t able to exercise any judgement or understanding.  When you receive a matching notice, you have 30 days to respond.  The IRS will generally give you an additional 30 days if you call them up to ask for it.

The exact nature of the response depends on what the CP2000 is about.  If you agree with all of the changes, you’ll simply complete the response form to that affect.  When the CP2000 is not 100% correct, you’ll complete the form to indicate that you do not agree to some or all of the changes.  Generally, you’ll want to include a letter that references the CP2000 and explains why you think the return is correct as-filed or the required changes are different from what the IRS is proposing.  You’ll also want to include copies (not originals!) of any information that supports your position.