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.

 

 

Categories
Income Tax

IRS Commissioner Predicts Miserable 2015 Tax Filing Season

“The filing season is going to be the worst filing season since I’ve been the National Taxpayer Advocate {in 2001}; I’d love to be proved wrong, but I think it will rival the 1985 filing season when returns disappeared.”

IRS Commissioner Predicts Miserable 2015 Tax Filing Season.

Categories
Maine

Maine Property Tax Fairness Credit

Maine income tax returns saw a number of changes for the 2013 tax year, including a major revision to the state’s property tax refund program.  In the past, taxpayers needed to file for the property tax and rent “circuitbreaker” relief on a separate application from their income tax return.  For 2013 and later years, that program has been replaced by the Property Tax Fairness Credit.  Certain Maine taxpayers are now able to claim a credit on their state income tax return for a portion of their property taxes or rent paid.Photo of 384 Court Street Auburn, ME 04210

Under the new rules, taxpayers who are Maine residents for at least part of the year and who lived in a home in Maine that they owned or rented can qualify for the credit if they had a Maine adjusted gross income of $40,000 or less and paid more than 40% of their Maine adjusted gross on rent or more than 10% of it on property taxes.

For a taxpayer with a Maine adjusted gross income of $40,000, the credit would likely be available if their property taxes were more than $4,000 a year or their rent was more than $1,250.  This means that the taxpayers most at-risk for overlooking this credit are retirees who have social security or pension income that gets reduced or ignored for figuring Maine income, but may still have a high rent or property tax burden. This credit is generally not available for taxpayers in subsidized housing, unless they also received social security disability income.

This credit is new and hasn’t received a lot of press, so it’s fairly easy to overlook.  Taxpayers who are worried that they might have missed out on this credit should double-check their Maine returns, especially since up to $400 of the credit may be refundable.  That means that the taxpayer may get that much back, even if he or she had no Maine tax withheld during the year.

The Maine Revenue service has a page about the property tax fairness credit, and the worksheet used to calculate it is available on the Maine Revenue Service website.

 

Categories
Federal Income Tax

Don’t incorporate too early!

The decision to incorporate is often one of the first choices new business owners makes, even before they’ve drafted a business plan or secured start-up capital.  In many cases, this can turn out to be a costly mistake.  While it’s true that incorporating a profitable business can sometimes yield tax savings, most businesses lose money during their start-up years and some businesses never manage to become profitable.  Most of the time, these start-up period losses would be more valuable on the owners’ individual income tax returns than they would be on a corporate tax return, and winding-down a business that has been incorporated can be much more expensive than winding-down a business that has never been incorporated. Here are some questions that the business owners should ask themselves before they form a corporation or other legal business entity:

  • What benefit will the business get from incorporating?
  • When will the business become profitable?
  • Does the business include real estate or other property that is likely to increase in value?
  • Where will the money to start the business come from?

Why incorporate?

Sometimes business owners will incorporate just because they think it’s something that people do when they start a business or because they think that they can convert expenses that wouldn’t be deductible without incorporating into business deductions by paying for them as a corporation.  The first is generally not true, and the second is almost always wrong.  A business can operate indefinitely and never  incorporate, and there are very few things that are deductible as a corporation that are not also deductible for an unincorporated business.

 

Corporations do offer tax savings to some businesses, but for a different reason.  A corporation can choose to be either a “C-corporation” or an “S-corporation”.  Both types of corporation can offer tax savings by reducing self-employment taxes. C-corporations have their own set of tax brackets separate from their owners.  C-corporation earnings are not subject to self-employment tax and the first $50,000 of taxable income in a C-corporation each year is taxed at a 15% rate,  but corporations don’t receive a standard deduction or personal exemptions.   This can make  C-Corporation very attractive for business owners when their companies are profitable and retaining some of the earnings to pay for future growth.  They are generally less desirable for business owners who typically take all of the earnings from their companies or each year to pay for personal expenses because these retained earnings cannot be withdrawn forum a C-corporation without being taxable to the owners as dividends.

 

S-corporations don’t offer income tax savings because all of their earnings get reported and taxed on their shareholders’ returns, but they can reduce self-employment taxes.  Unlike an LLC with an operating business, S-Corp profits are not subject to self-employment tax, and unlike a C-corporation,  S-Corp earnings can be withdrawn without a second level of tax. The tax code requires corporate shareholders who work for their companies to receive adequate compensation in the form of a salary or wages subject to payroll tax.  Because S-Corp earnings are not subject to corporate income tax or self employment tax, the IRS reserves the right to reclassify distributions or other payments to shareholders as wages if adequate wages are not paid.

 

Questions about legal liability should be directed at attorneys rather than accountants, but a common reason to incorporate is for liability protection.  A sole proprietor is generally on the hook for any debts incurred by his or her business, including debts that could result from a business-related accident.  Operating as a corporation or an LLC can offer a degree of protection for the shareholders’ personal assets if the businesses is unable to pay its bills.

Why not to incorporate

While there can be some very good reasons to operate a business as a corporation,  there are also a lot of good reasons not to.   Corporations have more tax filing and administrative burdens than unincorporated businesses.   Business losses from an unincorporated business often yield more tax savings than similar losses inside of a corporation.   Additionally, property can generally be placed in a corporation without a tax cost but usually can’t be taken out without the shareholder having to recognize taxable income.    These disadvantages tend to be greatest early in a businesses life.

 

First,  the paperwork burden of a corporation is more than most business owners can handle without paying for outside help.  Corporations must file income tax returns separate from their owners.  Even if the shareholder is the only employee, a corporation must file payroll tax returns and collect and remit payroll taxes and income tax withholding on the shareholders compensation from the corporation.   Most states require corporations to file an annual report each year to remain in good standing and keep its legal protection.  Finally,  a corporation generally needs to hold annual meetings, maintain minutes, and keep other records that just don’t apply to unincorporated business.

Second,  losses in a corporation are often worth less than losses in an unincorporated business.   This author has seen more than one case where a married taxpayer starts a business and runs losses for the first several years.  Self-employment losses not only reduce taxable income, but also earned income and adjusted gross income.   Sometimes this can result in an earned income credit, even when the wage-earning  spouse earns more than the earned income credit phase out.  The deduction of losses from AGI also helps taxpayers with other income avoid the AMT and claim other deductions and credits that are unavailable to high income taxpayers.

Finally,  the tax laws surrounding incorporation are basically a one-way deal.   the owners of a corporation can add assets to it all day long without incurring a tax,  but most withdrawals from a corporation will be taxed as salaries or dividends.  When a shareholder takes something other than money out of his or her business, the IRS considers the property to be sold for whatever it is worth and the cash distributed.  This can result in tax for both the shareholder and the corporation.

New Businesses Hit Hardest

Operating as a corporation can save a business money on income taxes and give it’s owners some liability protection but incorporating too soon can cause an unnecessary burden and unexpected tax costs.   The benefits of incorporating are greatest for profitable,  established businesses.   New businesses that are just starting our are often better off staying sole-proprietors for a while.

 

 

photo credit: Tyler Merbler via photopin cc

Categories
Charitable Contributions Federal Income Tax

Contributions for Specific Individuals

The tax code doesn’t allow a charitable contribution deductions for gifts made for a specific individual.  This is true even when a qualified charity collects the donation for the individual.  Donations made directly to a member of the clergy to be used for their own purposes are also not deductible.  Sadly, this restriction also extends to the payment of medical or other expenses for a needy individual.

Whether or not a contribution is deductible shouldn’t be the last work in whether or not to make a contribution.  Keep in mind that a portion of most donations made to charitable organizations has to be spent on overhead.  When a donation is made directly to someone in need presumably 100% of the donation amount goes to helping them.  That means you can  often do as much good with a non-deductible contribution to an individual as you could with a gift to a church or non-profit group.  Just don’t make the mistake of deducting it on your taxes.

The person who inspired this post is Wynter Przybylski, the 7-year-old daughter of a high school friends and the subject of a recent Bangor Daily News article.  Wynter is battling childhood leukemia and the Pryzbylski’s have a page up seeking donations to help with her care.  I’ve included a couple of links about Wynter’s story below.  The donations they receive for this are not tax-deductible, but can do a lot of good!

http://bangordailynews.com/2014/04/12/news/bangor/community-rallies-behind-brewer-girl-battling-cancer/

http://wabi.tv/2014/04/09/brewer-girl-fighting-leukemia-finds-community-support/

http://www.youcaring.com/medical-fundraiser/cancer-messed-with-the-wrong-girl/154540/update/150281

 

photo credit: N08/6510934443/”>asenat29 via photopin cc