Read This before Tossing Old Tax Records

Now that you’ve completed your taxes for 2011, you are probably wondering what old records can be discarded. If you are like most taxpayers, you have records from years ago that you are afraid to throw away. To determine how to proceed, it is helpful to understand why the records needed to be kept in the first place.

Generally, we keep “tax” records for two basic reasons: (1) in case the IRS or a state agency decides to question the information reported on our tax returns; and (2) to keep track of the tax basis of our capital assets so that the tax liability can be minimized when we actually dispose of the assets.

With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25% of the income reported on a tax return. And, of course, the statutes don’t begin running until a return has been filed. There is no limit on the assessment period where a taxpayer files a false or fraudulent return in order to evade tax.

If an exception does not apply to you, for federal purposes, most of your tax records that are more than three years old can probably be discarded; add a year or so to that if you live in a state with a longer statute.


The big problem! The problem with discarding records indiscriminately for a particular year once the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. They need to be separated, and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into this category:

• Stock acquisition data - If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.
  
  
• Stock and mutual fund statements - Many taxpayers use the dividends that they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gains when the stock is finally sold. Keep statements at least four years after the final sale.
  
  
• Tangible property purchase and improvement records - Keep records of home, investment, rental property or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

Have questions about whether or not to retain certain records? Give this office a call first. It is better to be sure before discarding something that might be needed down the road.

Big Changes Coming for Investors in 2013

2013 will bring some big changes for investors, and none of them for the better. Taxpayers affected by these upcoming changes may wish to consider taking actions in 2012 to mitigate the impact of these changes. The following are the changes that will affect investors in 2013.

Long-Term Capital Gains Rates Increase - Taxpayers have enjoyed reduced long-term capital gains rates for several years as a result of the Bush era tax cuts. However, without Congressional action, which is not expected, those reduced rates will return to the higher rates in effect prior to 2003. The table below compares the current long-term capital gains rates to the anticipated rates for 2013 and subsequent years.



Taxpayers with unrealized long-term capital gains may wish to review their holdings and consider whether it is appropriate to sell during 2012 at the lower rates or whether to continue to hold for additional increases in value. Where future increases in value are anticipated, a taxpayer could sell and realize existing gains in 2012 and then repurchase the investment for future anticipated increases. Investment strategies depend on a variety of issues, including existing capital loss carryovers, growth potential of individual investments, and other factors related to each individual, and should be carefully analyzed before taking action.

Regular Tax Rates - In addition to lower long-term capital gains rates, the regular marginal tax rates have been declining since 2001. However, without Congressional action, those reduced rates will return to higher rates in effect prior to 2001. The table below compares the current marginal individual tax rates to the anticipated rates for 2013 and subsequent years.



These increased rates will apply to all varieties of ordinary income including interest, dividends, short-term capital gains, employment income, etc. Marginal tax rates increase as a taxpayer’s overall income increases, taxing the first block of income received at the lowest rate and each subsequent block at ever-increasing rates until the maximum rate is reached. As with assets eligible for the long-term capital gains rates, it may be appropriate for some taxpayers to accelerate ordinary income into 2012 to take advantage of the lower rates.

Surtax on Investment Income - Depending upon what the Supreme Court ultimately decides about the Health Care Law, starting in 2013 a new surtax, called the Unearned Income Medicare Contribution Tax, will be imposed on individuals, estates, and trusts. For individuals, the surtax is 3.8% of the lesser of:

1. The taxpayer’s net investment income or
2. The excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others).

Thus, this surtax will only impact higher income individuals.

“Net” investment income is investment income reduced by allowable investment expenses. Investment income includes:

• Income from interest, dividends, annuities, and royalties,
• Rents (other than derived from a trade or business),
• Capital gains (other than derived from a trade or business),
• Trade or business income that is a passive activity with respect to the taxpayer, and
• Trade or business income with respect to trading financial instruments or commodities.

For surtax purposes, the net investment income does not include excluded items, such as interest on tax-exempt bonds, veterans' benefits, and excluded gain from the sale of a principal residence.

For planning purposes, existing law favors tax-exempt bond interest, which avoids both the surtax and the regular income tax. However, you should be aware that President Obama’s tax plan would also tax the income from “tax-exempt” bonds for higher-income individuals at generally the same threshold as this surtax kicks in.

It is not too early to start planning for the 2013 tax increases. Prudent planning can significantly reduce the tax bite. At the same time, keep a watchful eye on Congress. Since this is an election year, tax changes are most likely to come after the November elections.

Please call this office if we can be of assistance in your investment tax planning.

Identity Theft and Tax Fraud Are Growing Problems

Cyber criminals have been using stolen identities to file tax returns and obtain fraudulent refunds. Tax preparers have reported an increase in e-file rejections because the taxpayers’ or their children’s SSNs have already been used in a previously e-filed return, which results in the e-filed return being rejected.

Generally, identity thieves use personal data to steal financial accounts and run up charges on the victim’s existing credit cards. However, identity theft can also affect your tax records as follows:

• Undocumented workers or other individuals use your Social Security number to get a job. The employer then reports W-2 wages the workers earned under your Social Security number to the IRS. When you file your return based on your real W-2 income, it appears that you failed to report part of your income on your return.
  
  
• An identity thief files a return using your Social Security number to claim refundable credits. This can be lucrative for cyber thieves who take advantage of the Earned Income Credit or the American Opportunity Education Credit, both of which are refundable credits. Generally, credits can only be used to offset a tax liability. However, these two credits are refundable even if the taxpayer has no tax liability.
  
  
• An identity thief may also use your Social Security number or your children’s SSN to claim additional tax return exemptions. Each exemption claimed on a return provides a deduction worth $3,800 (2012) and can be used to claim head of household status.

How do the thieves obtain this information? Some buy it from other thieves who collect identity information by hacking into firms that have those records or by using ingenious ways to trick you into disclosing the information. This is often done by sending you an e-mail disguised to look like an e-mail from a trusted source. This practice is referred to as “phishing.” An example of phishing is an e-mail with a fake IRS header claiming to have a refund for you and directing you to a site that requires you to enter your SSN and other information to verify your claim for the refund.

Don’t be a cyber-victim. Here are some tips you should know about phishing scams.

1. The IRS and legitimate businesses never ask for detailed personal and financial information such as Social Security numbers, PIN numbers, passwords or similar secret access information for credit card, bank or other financial accounts.
   
   
2. The IRS does not initiate contact with taxpayers by e-mail to request personal or financial information. If you receive an e-mail from someone claiming to be a representative of the IRS or directing you to an IRS site:
   
   
   • Do not reply to the message.
     
     
   • Do not open any attachments. Attachments may contain malicious code that will infect your computer.
     
     
   • Do not click on any links. If you clicked on links in a suspicious e-mail or phishing website and entered confidential information, you may have compromised your financial information. If you entered your credit card number, contact the credit card company for guidance. If you entered your banking information, contact the bank for the appropriate steps to take. The IRS website provides links to additional resources that can help. Visit the IRS website (www.irs.gov) and enter the search term “identity theft” for additional information.
     
     
3. The address of the official IRS website is www.irs.gov. Do not be confused, misled or respond to sites claiming to be the IRS but ending in .com, .net, .org or other designations instead of .gov.
   
   
4. If you receive a phone call, fax or letter in the mail from an individual claiming to be from the IRS, but you suspect he or she is not an IRS employee, contact this office immediately. You should also call the IRS at 1-800-829-1040 to determine if the IRS has a legitimate need to contact you. Report any bogus correspondence. You can forward a suspicious e-mail to phishing@irs.gov.

If you receive a notice or letter from the IRS or state tax authorities, you should always contact this office. This is especially true if you believe someone may have used your Social Security number fraudulently or stolen your identity.

Is Your Child a Full-Time Student?

If you have a qualified child you can claim an exemption for that child on your tax return, which results in a $3,800 deduction for 2012 (up from $3,700 in 2011). Depending upon your tax bracket, that deduction can produce a substantial tax savings. To be treated as a qualified child, a child must be under the age of 19 or a full-time student under the age of 24.

Generally, children under the age of 19 who have investment income, such as interest and dividends, are also subject to the so-called “kiddie tax,” which, except for small amounts, causes the child’s income to be taxed at the parent’s marginal rates. The “kiddie tax” was implemented several years ago to curtail parents from shifting income to a child to take advantage of the child’s lower tax rates. Full-time students under the age of 24 who are not self-supporting are also subject to the “kiddie tax” rules.

So what is the definition of a full-time student? Well, the tax law definition is more liberal than you might imagine. A full-time student is one enrolled for some part of five calendar months (whether or not consecutive) in a given year for the number of hours or courses considered full-time attendance by the school that the student is attending.

The enrollment in school needn't be for full months—or for five consecutive months. So, if the student is enrolled from mid-February to mid-June, the five-month qualification is met. On the other hand, if the student is enrolled from September to December or February to May, the student has been enrolled for only four months, and there must be full-time enrollment during at least one other month during the calendar year to meet the definition.

The full-time student designation also applies when claiming the lucrative American Opportunity Education Credit, which is based on payment of college tuition and related fees. For all but certain qualified children, claiming the credit only requires attendance for an academic period (semester, quarter, etc.). In order for parents to claim the credit for a qualified child who is over the age of 18 and under the age of 24, the qualified child must also be a full-time student.

If you have questions, please contact this office.

Is Your Hobby a For-Profit Endeavor?

The tax treatment for a hobby is substantially different than it is for a business, which sometimes makes it difficult to distinguish one from the other. The IRS provides appropriate guidelines when determining whether an activity is engaged in for profit, such as a business or investment activity, or is engaged in as a hobby.

Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”

This article provides information that is helpful in determining if an activity qualifies as an activity engaged in for profit and what limitations apply if the activity was not engaged in for profit.

Is your hobby really an activity engaged in for profit? In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income. Trade or business activities and activities engaged in for the production of income are activities engaged in for profit.

The following factors, although not all-inclusive, may help you determine whether your activity is an activity engaged in for profit or a hobby:

• Does the time and effort put into the activity indicate an intention to make a profit?
  
  
• Do you depend on income from the activity?
  
  
• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
  
  
• Have you changed methods of operation to improve profitability?
  
  
• Do you have the knowledge needed to carry on the activity as a successful business?
  
  
• Have you made a profit in similar activities in the past?
  
  
• Has the activity made a profit in past years?
  
  
• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

An activity is presumed to be for profit if it made a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).

If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts and S corporations. It does not apply to corporations other than S corporations.

Hobby deductions - If it is determined that your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.

Deductions for hobby activities are claimed as itemized deductions on Schedule A. They must be taken in the following order and only to the extent stated in each of three categories:

• Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
  
  
• Deductions that don’t result in an adjustment to the basis of property, such as advertising, insurance premiums and wages, may be taken next, to the extent that gross income for the activity is more than the deductions from the first category.
  
  
• Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent that gross income for the activity is more than the deductions taken in the first two categories.

If you have questions related to your specific business or hobby circumstances, please give this office a call.

How Business Website Expenses Are Deducted

With the explosion of online businesses, one would think that there would be a standard method of deducting the cost of your business website. But some questions still exist as to what part of a website is considered software, and to date, the IRS has not fully clarified that issue for tax purposes.

Purchased Websites - If the website is purchased from a contractor who is at economic risk should the software not perform, the design costs are amortized (ratably deducted) over the three-year period, beginning with the month in which the website is placed in service. For 2012, non-customized computer software placed in service during the year qualifies as Sec 179 property and can be written off in full up to the limits of this special expense deduction.

In-House Developed Websites - If, instead of being purchased, the website design is “developed” by the company or designed by an independent contractor who is not at risk should the software not perform, the company launching the website can choose among alternative treatments, one of which is deducting the costs in the year that the costs are paid, or accrued, depending on the taxpayer's overall accounting method. Or, as an alternative, the costs may be amortized under the three-year rule.

Non-Software Expenses - Some website design costs, such as graphics, may not be classified as software and must be deducted over the useful life of the element. Non-software portions of the design with a useful life of no more than a year are currently deductible.

Advertising Content - Advertising costs are generally currently deductible. Thus, the costs of website content that is advertising are generally, currently deductible.

Cost Before Business Starts - Business expenses that are incurred or accrued prior to the actual activation of the business are generally not deductible until the business is terminated or sold. However, a taxpayer can elect to deduct up to $5,000 of the costs in the year that the business starts and amortize the costs in excess of $5,000 over a period of 180 months (15 years), beginning with the month that the business starts.

As you can see, deducting the expenses of a website can be complicated. Please call this office if you have questions.

Cutting Expenses Key To Profitability, But How? Some Tips

It may seem like a no-brainer – cut expenses to make more money – but many small changes can result in significant savings.

It looks like the economy may finally be looking up. Still, this is no time to loosen the purse strings in terms of your business expenses. Rather, why not re-double your efforts to cut costs and boost your profitability?

Excessive expenses cause debt, which in itself can be very costly. So any money-saving actions you take will be doubly rewarding.

More Effective Money Management
To cut expenses significantly, poke into every corner of your company's finances. Inventory is a good place to start. If you sell multiple units of the same item and reorder regularly, you should be using QuickBooks' inventory-tracking tools. Go to Edit | Preferences | Items & Inventory | Company Preferences.



Figure 1; Make sure that these settings are correct. If you need advanced features like FIFO costing, serial number and lot-tracking or inventory management at multiple locations, contact us about upgrading to Enterprise Solutions.

You should be stocking your inventory to match the pace of sales. You don't want to be caught short, nor do you want to be sitting on too much and tying up money unnecessarily. QuickBooks can help, but you'll need to calculate the sweet spot for each item. Several built-in reports can help, including:

• Inventory Valuation Summary. Displays the current asset and retail value of each item and inventory as a whole
• Inventory Valuation Detail. Shows how individual transactions have affected the value of your inventory
• Inventory Stock Status By Item. Helps you set up smart reordering procedures
• Open Purchase Orders. Outlines each purchase order and its expected delivery date

Figure 2: To maintain profitable inventory levels and minimize expenses, you'll need to study QuickBooks' related reports regularly. When you're making buying decisions, consider factors like reorder turnaround time and seasonal sales upticks.

Ratio reports, like profit over sales, can also be very telling. QuickBooks does not supply these, but we can help you create them in Excel.

Using Available Tools
The efforts you make toward reducing expenses in other ways can result in more savings than you might think. Here are some actions you can take that will accelerate your cash flow:

Use QuickBooks' budgeting tools. This doesn't need to be as onerous as you might expect – you can start by pulling in your real data from the previous year as a base. Build in line items for ongoing accounting support like QuickBooks maintenance. Click on Company | Planning & Budgeting | Set Up Budgets.



Figure 3: Selecting this option simplifies your task.

Minimize your April 15 obligation with year-round tax planning. Work with us throughout the year on the next year's taxes to, for example, make smarter quarterly payments, and we'll help you reduce your tax bill by making better decisions every day.

Get discounts by paying invoices early. Set up a custom field in vendor records to track this.



Figure 4: Get to know which vendors offer early discounts – and take advantage of them.

Analyze the cost-effectiveness of your transportation. Can you replace some in-person sales calls with web-based communication? Make sure that your delivery routes and sales call paths are efficient.

Change product/service prices to build in your own cost increases. Do it across the board, in small increments. It may not even be that noticeable to customers.

Talk to us about establishing a line of credit. We'll help you determine if this is a viable option for emergencies. It's cheaper than using credit cards.

Cross-train employees. Have employees train each other on their tasks where it makes sense. You can avoid costly temp help and relieve overworked departments.

Don't try to change everything at once. Establishing these new procedures will require some extra work. And you may not notice a reduction in expenses immediately. But over time, you will see a positive change – one that will give you extra dollars and hours to invest in making your company flourish.