Individual Tax

Why you won’t be audited?

Last year, the US saw a huge fall in the tax audit rates by 5.3%. This reduces the probability of individuals being audited.  This research was conducted by the Transactional Records Access Clearing system.  This trend is due to the cuts in the federal spending.  This process is called sequestration and this is a process which cuts down the employees who are eligible for tax audits so that the fraudulent individuals can be tracked down easily. Kevin Brown, leader of Pricewaterhouse Coopers ‘tax controversy and dispute resolution practice, rightly said that if the number of individuals decrease then it correspondingly decreases the number of audits.

The National Treasury Employees Union conducted a survey and it was found out that these cutbacks could impact enforcement actions. The audits usually conduct its audits on days when the works have five to seven unpaid furlough days in the summer. The cuts are also timed in that part of the season, where there is a recruitment freeze which prevents the agency to fill up jobs.  In 2011, the IRS had 7000 full time employees lesser than what it had during the year 2010. The staffing and other enforcement actions were lesser by 6% last year.

The lesser number of individuals to be covered for auditing does not mean that the defaulters can make merry. On the contrary, it is tougher to escape this way because being one among 10,000 people definitely has more visibility than being one among 100,000 people.  The way the audits are being conducted has also changed. Earlier, face to face audits were the fashion. However, this has now been reduced and audits through email correspondence are the order of the day recently.  Audits through emails have increased to almost triple the amount of quantity around 20 years ago.

The IRS has effective software systems to track if the income is not reported rightly. Most of the cases of under reporting of income is tracked through this software by matching the income filed in the form 1099 and other related paperwork, while tax filing. Fewer audits are not necessarily a reason for the defaulters to enjoy. The fewer audits take a longer time to get completed than the frequent speedier audits that was the process some time back.

If a defaulter is found to have misreported income or done fraudulent tax filing in the new long audit process, then the interest and the penalty charges that he needs to pay is exorbitant than what the frequent audits charged. This puts the cheaters in a great fix, as in the current scenario, they not only have to pay taxes due for years together but also have pay very high penalty charges of each year’s missed payments.

Though the audits on individuals have been reduced drastically in the year 2012, the frequency of the audits on the corporate organizations has not changed according to the recent IRS survey. More than 17% of the organizations were qualified for audit in 2012.

The Super Rich’s Offshore Tax Avoidance Strategies

Most of the business tycoons use the trusts or holding companies in a different country to represent a majority of their income, thereby showing very low taxable income in their native countries. This is a strategy that is being employed by quite a few very rich people and the governments of the native and the offshore countries are devising measures to stop this practice completely.

Most of the billionaires are using these offshore holding companies and trusts to manage their assets which are worth hundreds of thousands of dollars, hold these assets till any further notice and obscure them, if needed. A survey was conducted in 2011 by Tax Justice Network, an UK based organization which fights for transparency in the tax rules and payments. The results of this survey were quite alarming. It was found out that the amount which all the rich people had stacked in their offshore companies were running into $32 trillions.

The purpose of these offshore trusts or holding companies is to protect the incomes from the higher tax brackets of the native governments and also to keep a check on the government’s seizure policies.  Bloomberg had analyzed and proved that around 30% of the world’s richest 200 people had assets outside their native countries and these were managed and controlled by the holding companies abroad in an indirect way.

The world saw one of the worst financial crises in the year 2008 and that changed the way the tax system in the US operated. Most of the countries re-visited their tax laws and imposed quick and reasonable changes in them so that the tax payer could not easily manipulate the loopholes of the rule and evade payment of tax.  In the year 2009, Liechtenstein brought out a law which instructed all the financial institutions to release the all the details of their accounts across countries, whenever requested.

Andorra and Switzerland also got influenced by Liechtenstein and hence they also offered concessions to institutions who give a detailed report of all their customer’s accounts held worldwide in all the branches.  With effect from July 1st, Singapore would also join the race to discourage money hoarding in other countries, by making it a criminal offence. Luxembourg is aiming to gradually bring down these kinds of accounts by the year 2015.

Cyprus was the most preferred by most of the Russians to set up offshore holding companies and stack cash in. However, when Cyprus was bogged down in a serious financial crisis in March, the European Union bailed them out upon a condition. The condition was that Cyprus had to introduce a tax on all deposits into its bank that crosses more than 100,000 pounds. This tax component discouraged many wealthy individuals and hence Cyprus saw a huge reduction of deposits to the tune of $2.4 billion in that particular month.

These kinds of changes succeed in reducing offshore money hoarding activities to a small extent, however as more and more countries participate in this drive; this tax evasion process can be completely abolished.

Writing off your summer vacation

Summer vacations can burn a big hole in one’s pocket; however avoiding them is not the long term solution. Working without taking any vacations can kill a person’s work life balance. One has to sneak away to small trips now and then and yet have a check on the travel expenses. Here are a few ways on how to travel yet claim deduction on some of the expenses.

Combine business with pleasure

If a person travels to trips for business meeting he can also combine the trip to do something for his personal interest. There is no hard and fast rule to identify if a trip is for business or personal purposes. If the time spent for official reasons is more on a trip, then it is a business trip. Air fares are deductible expenses. Driving to the venue of meeting gives a whopping deduction of 56.5 cents per mile with the added benefits of parking and toll charges. The key to get travel expenses deducted is excellent documentation.

One must have a very good control of his travel expenses and know all the rules of the IRS thoroughly so that he can answer any query regarding his claim for deductions.  Business trips help to write off the entire transportation and lodging expenses can be claimed for deductions. 50% of the meal expenses spent on working days is also deductible. Hence if one travels with his wife, only the meal expenses have to be taken care of. There should be some reasonable justification to be provided before claiming some expenses as deductions.

Learn something

Enrolling in some courses while travelling is another way to save travel expenses. As long as the course is to improvise on one’s skills at work, the education expenses and the travel expenses can be written off.  One has to regularly attend these classes while travelling and have good records about all the paperwork that might be needed while claiming for deductions. These courses could be a business related seminar or a professional course that would help the person climb his corporate ladder effectively.

Lend a hand

Volunteering to do charity work while travelling can help in claiming tax deductions. This is one way to prove that the aim of travel is not for pleasure or personal purposes. One can choose to do charity work after office hours and get a deduction for all the out-of-pocket expenses one spends. Driving one’s car to the venue of the charity work also helps in deducting car expenses of 14 cents per mile. The parking and other toll expenses are also covered in these deductions.

Get healthy

If a person is suffering from a severe obese condition, then he can get himself treated at a spa for weight reduction and improving his general health. These medical expenses are deductable provided there is a statement from the doctor that the treatment was purely medical and not for pleasure. Driving to the medical center can help to deduct up to 24 cents per mile with the combined benefits of parking and toll expenses.

More states charging taxes for iTunes and eBooks

The highly popular category of iTunes and eBooks has just got more expensive. Millions of people use these applications to download music and books of their choices and the decision of nearly 25 states to levy a sales tax on these downloads, has not gone down well with the phenomenal number of loyal end users of these applications. A recent announcement informed that these states were going to charge sales tax for any kind of digital service like downloading music, e book, selecting ring tone, streaming television shows online etc.

As the digital industry is booming, millions of people have been hooked to the internet for buying their daily needs, books, movies, music, television shows etc. Some state governments felt that the digital industry was eating up a lot of their state revenue that they would have earned otherwise. This thought led to the idea of levying sales tax for the digital market as well, so that the governments would not face any loss in revenue. Minnesota is the latest state to come under the radar for these revised sales tax rules.

Sales through eBooks rose to around 41% as compared to last year, digital music increased to around 9% from last year and the total transactions made online rose to a whopping 37% as compared to last year. Hence some states have introduced sales tax on digital products with immediate effect. The nature of transactions that are taxed differs from state to state. For example, some states tax anything that is bought digitally irrespective of the mode of delivery. However, some states levy tax on music that is downloaded, but not on music that is brought from serviced websites like Netflix or Spotify.

The tax rates differ according to the states. For example, a $12.99 purchase made from the iTunes website, carries a tax of 4% in Wyoming, 6% in Vermont and 7% in Mississippi. EBooks is another major application that took the digital world by storm by attracting huge number of visitors every day. On a $9.99 purchase on eBooks store, the tax levied is 7% in New Jersey and 4.7% in Utah.

There are certain big cities like New York, which levy sales tax on download of mobile applications but do not levy any tax on the digital purchases from iTunes. New York levies a tax of 12 cents on a @2.99 purchase of Angry Birds application, however, music download and purchase from the iTunes is free of tax here. Streaming websites like Netflix are also used widely for downloading music. In most of the cities, these do not carry any tax. However, Washington levies a 6.5% tax for a $7.99 monthly subscription of Netflix streaming, while Florida imposes a slightly higher 6.75% tax for the same amount of subscription. A digital seller can impose sales tax only in those states, where the seller owns a store or a warehouse. A recent change in law, the seller can also impose taxes on those states, where he has a minimum of $1m sales a year

IRS using tracking to understand more about the tax payers than just their tax returns

The Internal Revenue System (IRS) is an organization that is responsible for collecting the taxes of the general public. It holds a highly reputed position and is constantly improving on its techniques to ensure that the taxpayers are loyally paying their taxes every year. However, even if they take immense precaution, cases of tax fraud cannot be avoided. Every year, there always remains a section of people who evade tax and cheat the government in millions.

Hence the IRS has come up with the technologically sophisticated tracking tools that help them understand more about the tax payers than just their tax returns. These tracking tools, keep a check on the digital transactions of the defaulting tax payer like his eBay transactions, Facebook settings and one of the most recently developed technique to track the tax payer’s online payment details, his credit card number and other personal data. This data is essential for the IRS personnel to track down the defaulting customer and make him pay the dues that he is rightfully liable to pay.

Big cities like Washington are reeling under losses to the extent of $300 billion dollars caused to the state’s exchequer because of fraudulent people. Hence the IRS has brought in new models like the robot audit and third party audit to bring these faulty people to justice and make them cough up their shares.  There has been a little apprehension among the people, for these techniques, because the personal details like bank, card details etc of the loyal tax payers are also scrutinized while analyzing the details of the tax evaders. This has not gone down well with the general public, however other than implementing this method; tax evasion cannot be controlled properly.

The IRS big data tracking system is an efficient tool for tracking the digital background of the tax evaders. Here the social networking transactions are tracked, electronic payments are monitored and auditing is conducted for those individuals who are regular defaulters. The internet browsing pattern is also tracked here. This tool is used to study the digital and the economic behavior of the individual and around 1 million unique attributes are attached with these individuals. Relationship analysis, statistical and agent based modeling are employed in this method to know about the defaulter better.

The computing power of the IRS is increased in huge proportions. Of the entire storage capacity of the IRS, only 1.5% is used to store tax returns of an entire year. This gives huge amounts of empty storage space which can be used for more productive purposes like tracking the individual and forming a pattern around his transactions.

During last year, the behavior and the profiling test study conducted by the tracking mechanism of the IRS, helped to identify around 1500 people with past records of tax evasion. These people were tracked down to where they live, were constantly chased upon and around $200 million was recovered from them. This is enough proof to explain the efficiency of the auditing and tracking tools of the IRS.

Four commonly missed tax breaks

 

Once the tax returns are filed, people generally want to forget income taxes for a while. This is not the right approach. The time just after filing the returns, is the apt time to think over and reflect on the process, what could have saved tax and what to do better next year to reduce tax payments in a big way. This is the time, when the rules and policies are fresh in the minds so as to proceed with the tax saving benefits analysis. Here are some of the benefits, which people usually miss to consider while filing returns.

Roth IRA – The retirement benefits of IRA can be considered as a good option to invest money in, thereby reducing the taxable income portion for the current year. However one tends to forget that future withdrawals from the 401K plan attracts at least minimum tax rates. This is the reason why most of the younger generation today opts for the Roth IRA schemes.

The youth, at the start of their careers are eligible for a lower tax bracket and they contribute to the Roth IRA schemes from after tax money. The best benefit of this scheme is that in future, when these people become old and tend to withdraw money, both the contribution and the earnings of this scheme that can be withdrawn is totally tax free.

Flexible Spending accounts – These accounts are the only way out to save taxes on expenses related to medical, child care and other personal reasons.  Most of the companies offer their employees, a part of their salary in the form of these FSAs. The traditional IRS rule does not allow any deductions for medical expenses, if these expenses do not exceed 7.5% of the adjusted gross income. Hence this scheme is taken by people who do not have huge medical expenses and yet need deductions that can be offset by other deductions that are not allowed like property tax and state income tax.

Proper Asset Location – Classifying assets is more important than holding the assets themselves. It is important to classify the assets correctly into the taxable, tax –deferred and tax free pockets of one’s portfolio. It is a smart move to place the bonds in the tax deferred category as even if one gets to sell these instruments, the tax need not be paid immediately. It is also wise to keep stocks in the taxable category, because this is sold rarely and tax needs to be paid only upon sales.

Performing a Roth conversion in a Low income year – When income levels drop, there is an option to convert the benefits from the IRA model to the Roth model for a nominal charge. This converts the income from taxable category to tax free category. Partial conversion of benefits into the Roth model is also possible.

These are the schemes that are part of the daily lifestyle of the tax payers. However one needs just to twitch in here and there to maximize these for one’s benefits.

 

 

Rental property Depreciation Explained

 

The main reason for anybody to invest in real estate is to save taxes. However, it is important to know the rules and regulations that govern real estate so that one can claim the maximum deductions available and save taxes to a reasonable extent.

Concept of depreciation

While filing income tax returns on form 1040, all expenses and income are recorded on the Schedule E form. The total of net profit or loss is recorded on this 1040 form. If one incurs a loss, then it can help to lower the total taxable income. Depreciation is one of the major source of expenses that is recorded in the form 1040.

When one owns a property, there are two kinds of expenses that one incurs. One of them is the maintenance expenses which are quite infrequent. These could be gardening, repairs, electricity and other expenses which is related to maintaining a particular property. The other type is the cost that is incurred for improvement of the property like setting up a new kitchen or developing sidewalks along the pavement of the property. These costs have value for more than one year and hence these needs to be capitalized and depreciated.

The usual practice is to divide the total improvement costs by the life of these costs and to write off one part of the expenses every year. For example, if these expenses are $15,000 and the useful life is 15 years, then $1000 can be written off every year as part of depreciation expenses. When a rental property is purchased and is aimed to be used for more than one year, then the costs must be depreciated. One should note that only the price of the building can be used for claiming depreciation and not the price of the land as the land portion is not used up as much as the building portion.

The actual calculation

For example, if the total value of the property is $200,000 of which the land cost is $75,000 and the building cost is $125,000, then the depreciation can be calculated only for $125,000. For residential properties, the IRS allows a useful life of 27.5 years. Hence the total depreciation cost that is incurred every year is $4,545 ($125,000/ 27.5). This depreciation when multiplied with the incremental tax component, can give a tax savings of a maximum of $2,000 for the depreciation amount.

The calculation of the property value and the depreciation expenses for a year looks pretty simple, but it can get really complicated when analyzed further. The tax payer should have a flair for number crunching to get the basics and the calculation right. The IRS suggests that having a licensed and professional tax advisor comes in handy during these times. It is not only important to know the tax rates but also to know how to claim these costs so as to get some tax savings. To know these tricks, one should be highly fluent in the residential property tax rules.

Summertime child care expenses might result in Tax Savings

Children lesser than 13 years of age require adult support and care, during their summer vacations. Parents who are working or looking for employment opportunities must enroll their kids at a child care centers. These expenses qualify for a tax credit. These tax credits help to minimize the impact created by paying income taxes.

Either of the parents must be fully aware of these child care center rules to avail these tax credits provided by the IRS. The first and foremost condition that needs to be satisfied is that the parent must declare that the child for whom the expenses are incurred is his/ her dependant. The only cases where this rule gets an exception is where the parents are divorced or living separately.

The child care expenses incurred during the summer vacations and the entire year can be claimed for deductions and qualified for tax credits. However there are certain rules to get this tax credit, and these are explained below:

Day care facility – These are centers where parents pay a certain amount and leave the kids to be cared for until the time they return from work. Parents who are interested to get the tax credit should choose day care facilities that care for a minimum of 6 kids and those that follow all the regulations of that respective state. Expenses paid to such facilities will qualify for the tax credit.

Day camps – A day camp is where the kids are encouraged to engage in diverse fields for an entire day for a fee. The fee paid to the day camps is considered to be child care costs for the dependent child. Hence they qualify for tax credits. However, for the day camp to be recognized as an eligible institution, it should provide camps at least for 6 kids and should follow all the state government norms.

Overnight camp or tutoring – Expenses paid for overnight camps or tutoring expenses will not qualify for any tax credit.

School expenses – Education expenses will get a tax credit provided it is paid for children below the kindergarten levels. Expenses over and above the kindergarten levels will not qualify under the IRS rules. The child care expenses would still continue to qualify whether it is after the school hours or before the school hours.

In Home care – If the kid’s caretaker is employed at the parent’s home, then the parent should file payroll taxes as the care-taker is considered to be the employee of the parent.

Minimum Qualifying expenses – To get the tax credit, the parent can use up to $3000 of the non reimbursed amount of 2012 for one individual or $6000 for two or more qualifying kids.

Records required – The parent must furnish complete details of the kid’s social security number, the care provider’s name, address and the tax identification number. Tax credit will not be allowed for parents who furnish incomplete information as it is very difficult to credit savings without correct information.

New York Times gets so- called “Cadillac Tax” wrong

Healthcare-Now! is an online portal that specializes on the health schemes of US and helps the people to understand the schemes better and ways to access the same. Recently it clarified a mistake that was done by New York Times about the coverage and purpose of the Cadillac Tax. Healthcare-Now! explained the right concepts and insisted that the article by New York Times was clearly misleading to the general public.

They insisted that thought the publication was right about the perils of this tax, it had gone wrong about who can use this tax and how the employers are looking out for ways to evade the same.  The tax was incorrectly said to punish the employers who provided high end health welfare plans to their workers. However, in reality, the tax actually punishes plans that have huge premium charges. ($10,200 for individuals and $27,500 for families).

It was also found out that the coverage of the insurance plans had no relation to their premium amounts, which means that plan with high premiums do not necessarily offer a wide coverage and plans with low premium do not necessarily offer a small coverage. Recent studies reveal that only 3.7% of the entire premium differences could be related to the difference in coverage. This tax would not give any impact for people, who already have a good coverage, but this could affect older patients who might be required to pay up to three times the premium amounts of what the younger patients pay and it could also mean more premiums to pay for people who live in states that have expensive health care.

The Times had explained that this tax would encourage the employers to lower their employees’ premium cost through various health and wellness centers to monitor the employees’ health. However lots of research was done on this subject lately and it was found out these health centers only act as a tool through which the employers transfer costs onto workers with lifelong illnesses. These employees are either exorbitant rates of premium or their benefits are withheld.

Healthcare-Now insists that a single payer tax system  is a better way to reduce healthcare costs  as it would take off the burden of huge costs from the employer’s shoulders and ensures that all employees get reasonable coverage for their premiums. A publication as reputed as the New York Times should act more socially responsible and stop publishing wrong information about the Cadillac Tax as millions of people get misled due to this.

Hence, this portal requests and encourages the readers to submit a short 150 page letter to the editor of the New York Times explaining about any recent article and requesting them to change their stand on the Cadillac Tax. People who are interested and write to the editor must mention their names, addresses and phone numbers so that it is easy for tracing. A huge collective effort like this would surely stop people from misinterpreting the properties of the Cadillac tax.

How to fix taxes – after you file

There are chances of mistakes to happen while filing an income tax return. In the hurry to file tax returns, people may tend to miss out basic details and realize it once the filing is done. In such cases, there is a guideline issued by the Internal Revenue System which explains what needs to be done if the errors are found out after filing the returns. Eric Smith, spokesman at the IRS explains briefly about this process.

Whether filing an amended return is necessary or not, depends on the nature of errors of the tax payer. Some of them make mistakes in the arithmetical calculations or miss to attach a form. These errors do not need amended returns because there is a step by step process in the IRS to check for calculation errors or missing forms. These kinds of errors are automatically spotted by the IRS and letters are sent to the tax payers to revise their filing. The public need not spend their time and effort for filing amended returns for these kinds of errors.

There are certain other gross mistakes like misreporting of income. This error changes the final tax amount payable by the tax payers the government. These errors need an amended return. Benson Goldstein, who is the senior technical manager at the American Institute of Certified Public accountants, suggests that errors like people finding a forgotten 1099 Form or incorrect filing status, deductions or credits require amended returns from the tax payers. The IRS has an inbuilt system in place to find out the non reported income, missing to include all the 1099 forms etc. and these people are picked up for questioning and audit.

Some may file returns to claim deductions, which they were not aware of earlier or to correct a deduction or claim that they had incorrectly applied for earlier, but were not actually eligible. However, Goldstein pointed out, a majority of the tax payers file amended returns so that they can claim extra refunds, if any. However, Mr Goldstein insists that, while filing for extra refunds, the tax payers must wait for the original refunds to hit their account, and then file for the revised return and then get the increased refund. However, after the amended return and revised tax calculations, if it is found out that the tax payer needs to pay more tax to the government, then it would invite some extra penalty charges.

Another benefit is that the IRS gives up to 3 years time from the date of filing a wrong return, to correct the same. For example, if a return is filed wrongly in 2012 incorrectly, then the tax payer can correct the same till the year 2015. An amended return must be sent only by email. Multiple amended returns can be sent, however, separate envelopes should be used to differentiate the year for which the return is filed. There is an option available on the IRS website to check the progress of a particular filing.