Friday, April 4, 2014

IRA Rollover problems

You have 60 days to rollover your IRA to another IRA (if you receive a check in the mail)  But don't miss the deadline and don't try to do this more than once a year.

The following taxpayer has a bigger problem.  He is not getting paid by his client. So in a desperate attempt to get paid he try's to borrow from his IRA for 60 days to cover the expenses.  The IRS can be very unforgiving of missing a deadline. The taxpayer then argued that his withdrawal was a loan, thank God the court didn't call it a loan or the entire balance of his IRA would become taxable immediately.

David Oase CPA

Court rejects taxpayer argument that custodian was to blame for late IRA rollover

Alexander, TC Summary Opinion 2014-18TC Summary Opinion 2014-18

A taxpayer who had received an IRA distribution, used the proceeds for business, and then applied for a "loan" from the IRA custodian to make a rollover—which wasn't rolled into the IRA until the 66th day after the distribution—was subject to tax and the 10% penalty for early distributions.

Facts. Tom Alexander was owed $130,000 for electrical contracting work he'd completed for a general contractor. Due to financial difficulties, the general contractor couldn't pay Alexander, but proposed a deal to pay Alexander in installments and offered him a promissory note secured by real estate worth $130,000 that the general contractor owned. However, the property was burdened with a past-due mortgage and was subject to imminent foreclosure by Sun Trust Bank (Sun Trust), the lender. To secure the real estate, the general contractor asked Alexander to pay Sun Trust $36,000 to stop the foreclosure. Eager to be paid the outstanding sum for his work, Alexander agreed.

To raise the needed money, Alexander decided to take a distribution from his SEP-IRA (IRA) that he maintained with Charles Schwab (Schwab). To limit income taxation, a Schwab employee suggested that Alexander use the IRA money to halt foreclosure on the property, then get a loan from Schwab and roll the loan proceeds back to his IRA within 60 days. Schwab also told Alexander that the loan would be approved within 30 to 45 days. Alexander followed the instruction, wiring $36,000 from his IRA into his checking account on July 31, 2009 and then paying that amount to Sun Trust.
Alexander, however, didn't receive the loan proceeds until Sept. 30, 2009. On Oct. 1, 2009, Alexander mailed Schwab a personal check for $36,000 for deposit in his IRA account. Schwab deposited the amount in Alexander's IRA account on Oct. 5, 2009, 66 days after Alexander had received the original IRA distribution. And, in January 2010, Alexander received from Schwab a Form 1099-R, reporting a gross distribution of $36,000 from his IRA, coded to indicate an early distribution. However, the Form 1099-R showed no taxable amount. Alexander filed his tax return for 2009 without including the IRA distribution as part of his gross income.

IRS issued a statutory notice of deficiency to Alexander for 2009 in the amount of $14,165, which included a 10% penalty tax for early distribution.

Was there a rollover? Alexander argued that he had effected a rollover of the withdrawn funds, but that Schwab had hindered his compliance with the 60-day deadline.
Rollover contributions, the Tax Court recognized, are an exception to the inclusion of IRA distributions in the income of distributees. But an amount is a rollover contribution only if it satisfies the requirements of Code Sec. 408(d)(3). If an amount is distributed from an IRA to the individual for whom the account is maintained, and some or all of the amount is transferred into another IRA or eligible retirement plan for the benefit of the individual not later than the 60th day after the distributee's receipt of the original distribution, then the amount transferred is a rollover excepted from income inclusion. (Code Sec. 408(d)(3)(A))

Alexander's argument was that, despite his check having been deposited into the IRA 66 days after the original funds had been received, there was nonetheless a valid rollover because Schwab, not Alexander, had caused the loan delay. The Court disagreed.

The Court said that Alexander, by his looking to Schwab, the IRA custodian and lender for the rollover proceeds, appeared to be arguing that the situation was similar to that of the taxpayer in Wood, (1989) 93 TC 11493 TC 114. There, the Tax Court held, where a portion of a profit-sharing plan distribution was properly transferred to an IRA but was not actually credited to the IRA account within the 60-day period because of a bookkeeping error by the IRA custodian, the taxpayer was relieved of the error and the rollover was respected. In Wood, the taxpayer had argued that he had reasonably relied on the custodian's representation and had done everything that could reasonably be expected, and so should not be penalized when the custodian then caused the error. The Court agreed, and said that when bookkeeping entries were at variance with the facts, the decision must rest on the facts.

Here, however, the facts were different, the Tax Court said. The $36,000 had not been deposited within the statutorily-prescribed 60-day period; any error that may have been committed by Schwab was not a bookkeeping error. And, while Alexander argued that his intention was to effect a rollover, his intention could not determine the tax consequences of his transaction. What actually was done would determine the tax treatment.

The Court also noted that Code Sec. 408(d)(3)(I) permits IRS, in its discretion, to waive the 60-day requirement under certain circumstances, following the instructions of Rev Proc 2003-16, 2003-1, C.B. 359. It said that, as a result, Alexander would be free to pursue that relief with IRS, but not in the Tax Court.

Was there a loan? Alexander's second line of defense was that the distribution was a permissible loan from the IRA account, and not a distribution. This the Tax Court found implausible.

The Court also warned Alexander that this argument fell into the realm of "be careful what you wish for." Code Sec. 408(e)(2) provides that if the individual for whom the IRA was created, or his beneficiary, engages in a transaction prohibited by Code Sec. 4975, such as a lending between a disqualified person and the plan, the account will no longer be treated as an IRA as of the first day of the tax year. And, under Code Sec. 408(e)(2)(B), the IRA would be treated as having distributed all of its assets to the distributee in that year.

Thus, while the Court concluded that Alexander had not borrowed from his IRA, had he done so, the Court said, the entire IRA value would have been taxable, not just the distribution.

Additional 10% tax for early withdrawal. Code Sec. 72(t)(1) imposes a penalty tax on an early distribution from a qualified retirement plan, like an IRA, equal to 10% of the portion of the amount that is includable in gross income. The Court determined that IRS had been correct in assessing that tax. None of the enumerated exceptions set forth in Code Sec. 72(t)(1) applied. 

Thursday, February 13, 2014

Refund delays for EIC

Refund Delays for taxpayers who claim the Earned Income Credit

The IRS is "Where is my Refund" tool is showing delays to EIC refunds based on Code 1121.

Basically the IRS is doing some additional fraud prevention and reviewing these returns more closely.  This is delaying the refund for the taxpayer.  According to Kelly Phillips who has spoken to the IRS and Intuit (the maker of Turbo Tax) the delays appear to be solely due to the IRS increased scrutiny of the tax credit.

The EIC has be the subject of much abuse over the years.  Including people claiming to be single (instead of married) in order to get a bigger credit, the sharing of children with other tax payers to get a bigger credit, etc.  The governments internal auditors have found many instances of fraud. Last year the IRS put more burden on the tax preparer by asking us to gather evidence that the children live with the taxpayer such as School Records.  I expect this area of the tax code to increase each year as the IRS attempts to weed out the fraud.

David Oase

Tuesday, February 4, 2014

Are Arizona School Tax Credits deductible on my Federal Return?

Arizona School Tax Credits
January 14, 2014
If you make a donation to a public school or private school you can qualify for a great tax deduction on your Arizona return.  However if you recommend a student to benefit from it then you cannot claim a Charitable deduction on your Federal return.

Here are the rules from the IRS website.

Contributions to Individuals

You cannot deduct contributions to specific individuals, including the following.

  • Contributions to fraternal societies made for the purpose of paying medical or burial expenses of members.
  • Contributions to individuals who are needy or worthy. You cannot deduct these contributions even if you make them to a qualified organization for the benefit of a specific person. But you can deduct a contribution to a qualified organization that helps needy or worthy individuals if you do not indicate that your contribution is for a specific person.
    Example. You can deduct contributions to a qualified organization for flood relief, hurricane relief, or other disaster relief. However, you cannot deduct contributions earmarked for relief of a particular individual or family.
  • Payments to a member of the clergy that can be spent as he or she wishes, such as for personal expenses.
  • Expenses you paid for another person who provided services to a qualified organization.
    Example. Your son does missionary work. You pay his expenses. You cannot claim a deduction for your son's unreimbursed expenses related to his contribution of services.
  • Payments to a hospital that are for a specific patient's care or for services for a specific patient. You cannot deduct these payments even if the hospital is operated by a city, state, or other qualified organization.

Help because you want to help.

David Oase CPA

Office in the Home - Simplified Deduction

Office in the Home
January 10, 2014
The IRS has added a new way to deduct your office in the home for those of you who don't want to track all of the details.  If your home office is less than 300 square feet they will allow a deduction of $1,500.  There are some advantages to this program.  First you get to deduct All of your Mortgage Interest and Real Estate taxes on your schedule A.  You don't lose part of it to Schedule C.  However, on the down side, if your business has a loss you don't get to carry the deduction forward to next year.

Remember the basic rules still apply.  The room or space must be "Regularly and Exclusively" used for business.  You can't pick your dining room table unless you won't use it for anything else.  One Thanksgiving Dinner (personal use) ruins your deduction.  

David Oase CPA

What Bookkeepers should know about the new Repair & Capitalization Regs

What Bookkeepers should know about the new Repair & Capitalization Regs
January 10, 2014
What Bookkeepers Need to Know for the New Repair Regs.

Starting 1-1-14, your job has just become more difficult as you will need to look at the detail of invoices in order to know how to classify the company’s repairs.  In your bookkeeping, you now need 2 new materials & supplies categories, 2 specific ways to categorize repairs of vehicles & equipment, & new repair categories for buildings with up to 9 subcategories.

Material & Supplies (non-inventory & not Cost of Goods Sold):
1.  Classify as Materials & Supplies any non-inventory item that either a) costs less than $200 OR b) is expected to be used within 12 months.  For the most part, nothing has changed here for you. 
2.  But if the business buys, for example, a 2 year supply of propane for your forklift, costing over $200 – then you need to capitalize it.  That means you have to classify it as an asset instead of an expense account.  This would also include those expensive tools that you buy that you expect to last more than 12 months.    If you have these, we suggest setting up two asset accounts:
a.  “Materials  & Supplies - over 12 month supply” (In QuickBooks, this is a Fixed Asset)
b.  “Tools lasting over 12 months” (In QuickBooks, this is a Fixed Asset)

Repair & Maintenance - Equipment:
1. Classify as “Repairs & Maintenance – Equip.”  equipment repairs that cost less than $500. 
2.  If the equipment cost more than $500, then you have to ask three questions.  Did the repair restore a non-functioning asset to use (like a transmission on a car)?  Did the repair change the way that the asset was used?  Did the repair make the equipment better than it was to start with (you restore used equipment you purchased to its original condition)?  .  If the answer to all three questions is no, then you can classify it as “Repairs & Maintenance – Equip.”   If you answered yes, to any of these questions, you cannot classify it as a repair.  You must pick it up as an asset.  If it’s a vehicle repair, you must classify it as if you purchased a vehicle.  If it’s an equipment repair, you must classify it as if you purchased a piece of equipment.  Please make sure you note in your bookkeeping what equipment (or vehicle) was affected.

We suggest setting up the following accounts (if you don’t already have them set up):

                Repair “Expense” Accounts:
                a.  “Repairs  – Equip.”
                b.  “Repairs  – Vehicles.”

                Repair “Fixed Asset” Accounts:
                a.  “Equipment Purchased & Major Repairs”
                b.  “Vehicles Purchased & Major Repairs”

Repair & Maintenance to Building by Renters (Self-renters too):
The new regs are more simplistic for renters than owners of buildings.  If you rent the building that you use for your business, you can deduct repairs if: 1) the repair is not something that “restores” or “betters” the property and 2) you expect to make the same repair in less than 10 years.  An example of this would be carpeting as it’s not something that normally lasts 10 years.  But if you expect the repair to last more than 10 years – like with tile, or a hot water heater - then it must be written off over 39 years.  These are repairs to the building & its components (hot water heater, A/C etc.).  These long lasting repairs go into a fixed asset account called:    “Leasehold Improvements” (in QuickBooks this is a Fixed Asset)  Short term repairs go into “Repairs to Building & Components” (In QuickBooks this is an expense).

Repair & Maintenance to Building by Owners (including Landlords):
For building owners, this is the hardest type of repair to categorize.  First of all, we’re talking about repairs to the building & its 8 components.  That would be the building structure, HVAC, Plumbing system, Electrical System, Escalators, Elevators, Fire protection, Security & Gas Distributions.  Not a washer and dryer, refrigerator or stove.  Those are classified as equipment. 

Examples of common components of a building:
The hot water heater is part of the Plumbing System. 
Heating, ventilation and air conditioning is part of the HVAC system. 
The electrical panel is a part of the electrical system. 

The rules for deductibility of these expenses are complex and we will deal with them at tax time.  What we need is for you to track them in such a way, so that we can see exactly what was repaired.
Please create the following expense accounts for these repairs:
“Repairs to Building Structure”
“Repairs to HVAC”
“Repairs to Plumbing System”
“Repairs to Gas System”    etc.

When you enter these expenses, let us know what you repaired, and if you expect to repeat this repair in less than 10 years. 
Example: “Paint the building – expect every 5 yrs”, “Roof Recoating – expect every 3 years”, “Hot water heater repair- infrequent repair” etc.  Where “infrequent repair” means you expect it to be more than 10 years before you will repair this again.
If you don’t keep track of these repairs, then the regulations state, we must deduct them over 39 years (or 27.5 if residential rental property).

If you have any further questions, please give us a call.  
(520) 790-2738.      

David Oase CPA                                                                                                                                           Revised 12-13-13

Repair and Capitalization Policy - Sample

Repair and Capitalization Policy
January 10, 2014
Here is a sample of the policy which should be in place by January 1st 2014.  Please fill your name (or company name) in the top two blanks.  Sign on the bottom and keep this with your tax records for 2014.

David Oase CPA

Repair and Capitalization Policy

"___________________________ hereby adopts for book and Federal income tax purposes the following policy regarding capitalization expenses for the year beginning January 1, 2014. In accordance with Internal Revenue Code Sections 167 and 168 and related Regulations _______________________ has determined that amounts whose individual cost (including tax, installation and delivery costs) does not exceed $500 will be deducted as incurred as an operating expense. Amounts exceeding this dollar limit will be examined individually to determine if their use or purpose requires capitalization under the betterment, adaptation or restoration rules used by the Internal Revenue Service and will be capitalized or expensed as incurred as a result of the application of those rules."

X___________________________________     ________________
Title _________________________

Repair and Capitalization Regulations

Repair and Capitalization Regulations

December 11, 2013

On September 19, 2013 the Internal Revenue Service issue new final Regulations which go in to effect for tax years beginning on or after January 1, 2014.  These incredibly complex Regulations require you to keep much better records for repairs, maintenance and supplies, and require you to specifically analyze each of these items costing over $500, assuming you do not receive audited financial statements.  We are writing you this letter to help you understand that if you do not analyze these individual items and classify them appropriately we will be required to spend substantial additional professional time, with substantial additional fees to analyze all items.  Here is a summary of the new rules and what you will need to do to comply with the new IRS requirements.

Policy Required
You must have a policy in place on January 1, 2014 or all of your repairs may not be deducted as an expense.  We have attached a sample policy for you to review.   Please fill in your business name and sign it before the New Year and send us a copy (we must provide this to the IRS next year.)    

Materials and Supplies  
You are now allowed to write off any individual supply costing $200 or less, lasting less than 12 months, or fuel, lubricants or similar items that will be used in 12 months or less.  Please add a new expense account to your accounting system titled “Materials and Supplies” and enter any expense meeting the above category in this account.  Anything costing more than that will need to be individually analyzed under the rules below to determine if they are qualified expenses or treated as equipment that must be depreciated over several years.  Special rules apply to spare parts that you keep around.

Equipment, Repairs, and Maintenance
You are now allowed to write off any individual equipment item or equipment repair or maintenance item costing $500 or less.  For buildings a different rule applies as discussed below.  We also suggest entering individual items costing this amount or less into your repairs account, but refraining from adding any items above that cost to this account.  Items costing more than this will generally be required to be individually analyzed under the rules below to determine if they are qualified expenses or treated as equipment that must be depreciated over several years.

Building Repairs & Maintenance - For Rental Properties
If your building has a cost basis of $1,000,000 or less a special rule applies.  Any repairs that are expected to be made more than once in ten years, and costing less than $10,000 individually may be written off as repairs.  Items that are not expected to be replaced more once in ten years must also be examined individually under the rules below to determine if they may be treated as expenses or depreciable assets.

Expenses Above the Limits
The IRS now requires you to examine each individual item outside of the above limits to determine if it has been a betterment, restoration or adaption of the main unit of property.  A unit property is now defined as the inter-related parts composing one larger unit.  For example a unit of property is a car composed of inter-related parts, so any repairs to the car must be examined as to whether they are a betterment, restoration or adaptation of the car as a whole rather than its individual components.  For buildings the test must first be applied to the building as a whole and then applied to its components of HVAC, plumbing, electrical, structure, elevators, security, fire protection or gas distribution.  Anything considered a betterment cost, restoration, or adaptation under these rules must be depreciated and listed as equipment, otherwise it may be expensed as repairs.

David Oase

A betterment is defined as fixing a condition that existed at purchase, or an increase in the physical size or capacity of an asset.  Betterments must be capitalized and depreciated so they should be added to your equipment account.

A restoration is generally defined as a cost to return a non-functional asset to use, the cost of rebuilding an asset after the end of its depreciable life or replacing a major component of the unit of property.  For example a transmission replacement would be the replacement of a major component of a unit of property of a truck and must be capitalized and depreciated.

Finally an adaptation cost is one incurred to change the function of a piece of equipment or property to a different use and must also be capitalized and depreciated.

Many additional nuances and applications apply to these new small business unfriendly Regulations and we would be happy to discuss them in an appointment with you or your bookkeeper to help you keep the costs of IRS compliance down.