The 2011 Dirty Dozen Tax Scams (Abridged)

It’s a sad fact that there are people out there who look to take advantage of innocent taxpayers, in ways you may not have thought of. Unfortunately, they’re not the only ones who are scamming the ‘tax system’. IRS recently published its annual list of “dirty dozen” tax scams, and this article briefly discusses a handful of them.

Hiding Income Offshore-Taxpayers have tried to avoid or evade income tax by hiding income in offshore bank or brokerage accounts, among other ways. IRS currently has a voluntary disclosure initiative, which is designed to bring offshore money back into the U.S. tax system.

Identity Theft and Phishing-With an individual’s personal information, a criminal can file a fraudulent tax return and collect a refund. IRS reminds people that they never contact taxpayers by email, and that IRS impersonation schemes are out there. Never give out personal information to anybody claiming to be from IRS.

Return Preparer Fraud-Most tax return preparers (including yours truly) are professionals who provide honest and excellent service to their clients. As with other businesses/professions, there are rotten apples. Dishonest return preparers can skim or divert a portion of a client’s refund, charge inflated fees, or attract clients by making false promises.

Filing False or Misleading Forms-IRS is seeing instances in which scammers file false or misleading returns to obtain improper tax refunds. One way is by claiming incorrect amounts of tax withholding, based on fabricated information returns (1099s, for example).

Frivolous Arguments-You’ve probably heard this one before; filing a tax return is voluntary, or the income tax system is unconstitutional, or it’s against somebody’s religion. Don’t believe any of these.

Abuse of Charitable Organizations and Deductions-This isn’t a matter of deducting the $5 you put in the Salvation Army kettle last Christmas, but can be overvaluing the broken down car that was donated to charity. Penalties have increased for inaccurate appraisals, and IRS has cracked down on deductions for donated cars.

The title of this article includes the word “Abridged”, and you don’t need a calculator to see that I’ve only included a half dozen out of the Dirty Dozen Tax Scams. Drop me a line if you’re interested in hearing about the other six, and please, feel free to leave a comment.

The Risk of Fraud in Small Businesses

As small business owners, we wear many hats. For example, a restaurant owner can also be the procurer of supplies, chef, maitre d’, waiter, and bottle washer. One hat many small business owners tend to not wear is the bookkeeper’s, and therein lies the risk of fraud. To many, the lack of bookkeeping knowledge, hatred or fear of numbers, the need to focus on growing the business, or lack of time, drives the need for employing a bookkeeper.

In the accounting world, there’s a term called “segregation of duties”. In a nutshell, this refers to having different people do different accounting functions. For example, the person receiving customer payments isn’t also the person writing (or signing) checks. The problem in many small businesses is that they can’t afford to have an entire accounting department (such as accounts receivable, accounts payable, payroll), so all the functions are performed by the one bookkeeper. The danger here is that you’re entrusting someone with your money (i.e. your checkbook), and if that person isn’t honest, embezzlement can be the result. It’s beyond the scope of this article to get into the numerous ways a bookkeeper can “rob you blind”, but the point is that regardless of how busy the small business owner is, she/he needs to pay very close attention to what the bookkeeper is doing with deposits and payments, as it’s possible for both money coming in and money going out to be diverted. Bank statements should be reviewed for irregularities when received, blank checks should never be pre-signed, internal financial statements (such as a balance sheet and profit & loss printed from QuickBooks) should be reviewed, and payroll needs to be monitored, both for false employees and for pay rates. There are too many ways of misdirecting company funds, and the small business owner needs to be mindful of the possibilities.

I hope you’ve found this article helpful, and that it’s got you thinking. Please contact me if you have any questions, and if you know of any real life “horror stories” involving employee fraud, please leave a comment.

How Long Do I Have To Keep This Stuff?!

Now that the April 18th tax filing deadline has passed (and your returns are filed…hopefully), you may have a pile of W-2s, 1099s, and all sorts of other papers sitting in a stack, and you’re wondering whether you need to keep it all. The short answer is yes! You’re probably also thinking about the papers sitting in your filing cabinet/boxes/closet/attic/storage, gathering dust over the last five or twenty years. Is it really necessary to schlep this stuff around every time you move? Unfortunately, there’s no short answer to this question.

IRS recently issued Tax Tip 2011-71 “Tips for Managing Your Tax Records”. Unlike me, they don’t use the word ‘schlep’ in a sentence, but, like me, they do give some good advice. The first tip is one that you may have heard before, that is, tax records should be kept for three years. The reason for this is that IRS generally has a three year statute of limitations to audit a tax return. This is three years from the due date of the return, or when you file the return, whichever is later. It would follow, then, that if there’s a chance that your 2010 return could be audited within the next three years, keep your supporting papers for the next three years.

Now before you go tossing all your 2010 stuff out three years from now (or tossing out all of your 2007 papers now), check out IRS’s second tip, which is “some documents-such as records relating to a home purchase or sale, stock transactions, IRA and business or rental property-should be kept longer”. This article would be way too long if I gave you examples for every one of these things, but the idea here is that you need to keep any documents that will help you compute a gain/loss claimed on a tax return (such as a capital loss on a sale of stock, or gain on the sale of a home). So while you’re in the heat of spring cleaning, before you toss out those boxes of papers, make sure they don’t contain something you’ll need in the future.

As far as the types of records you need to keep, IRS’s tip says “…bills, credit card and other receipts, invoices, mileage logs, canceled/imaged/substitute checks, proof of payment, and any other records to support deductions or credits you claim on your return”. For this, personally, I like to work backwards. If I have an accordion file full of papers, I’ll toss out anything that had absolutely nothing to do with either my business or personal taxes. And when I say ‘toss out’ I mean shred… you can’t be too careful these days. Whatever’s left I’ll keep for at least three years.

There are other tips that IRS has, but we’ve run out of time. I’d be happy to tell you about them; just contact me for more information. And please, leave a comment, to let others know how you deal with your records.

Tax Refunds

Everybody who wants an interest free loan, raise your hand. While that hand is raised, those of you who got a big tax refund, use that hand to smack yourself over the head! Why, you ask? It’s because you just gave the government an interest free loan. Let me ask you this; would you give a complete stranger a loan, and not expect to get at least some sort of market rate interest on that money? I didn’t think so, but why are you so quick to give the government your money for free? Even having that money in a savings account earning .25% (you know how low rates are these days) is better than earning zero.

For years I’ve heard clients tell me that they look forward to that big check at tax time, and how they have too much tax withheld on purpose, and it’s ‘forced savings’, blah blah blah. My reply has always been “if you want to force yourself into saving money, why not just cut a check (or set up an automatic debit) every month to invest in a mutual fund, or fund an IRA”? It’s such a no brainer that can only help people, which is why it’s confounded me for years. Obviously my job is to advise my clients, and of course they’ll do whatever the heck they want anyway (much the same way as I ignore advice!).

With proper tax planning/projecting, it’s possible to get to the end of the tax year at close to a breakeven (i.e. either very small refund or very small balance due), without incurring penalties, and having more money saved (and no interest free loans to Uncle Sam or Uncle Governor-of-your-state). By changing your withholding exemptions, you’ll have more money in your pocket each paycheck, and won’t have to wait until tax time to get your loan money back from the government.

I have a challenge; allow me to bug you on a monthly basis, to send me a check, payable to the mutual fund/investment of your choice, and I’ll make sure that check gets deposited to your account, so you can earn something on your money…more than the zero percent the government’s giving you. Better yet, you can loan me the money interest free, I’ll invest it, keep the income, and then pay back your loan at the end of the year! Just kidding, but you understand my point.

With that raised hand, give yourself one more smack over head. O.K., you can put your hand down now! Now that your hand is down, please leave a comment. I’m interested in hearing your thoughts on this.

Love and Taxes

It’s spring, and love is in the air. You may be planning for the big June wedding right now. All the details; what caterer to choose, what color are the bridesmaid’s dresses, who sits next to whom, filing joint or separate tax returns, where to honeymoon, where to live. Whoa, back up…did I just say ‘filing joint or separate tax returns’? I sure did, and I bet you haven’t given that as much thought as you have about who gets stuck sitting next to Aunt Sophie! Well, as they say (whoever they are), there’s no time better than the present. So while you’re stressing out about which band to pick, add this to the list, and get the valium ready!

I thought this would be an interesting topic to write about, because over the years I’ve had to explain to countless newlyweds why they now owe taxes, when, in their single days, they always got refunds.

First thing to understand; when you’re married, you cannot file your tax return with the ‘single’ filing status. To quote IRS “If you are considered married for the whole year, you and your spouse can file a joint return, or you can file separate returns. There are a few examples that IRS gives for what’s considered ‘married for the whole year’, all of which pertain to the last day of the year. To simplify it, if you were married on December 31, you’re considered married for the whole year. This article isn’t meant to be political, so I would like to recognize all the same-sex partners reading this, and please don’t shoot the messenger; IRS makes the tax laws, not me.

Being a numbers guy, I threw together a very simple Excel worksheet, to compare the tax bite between single, married filing jointly (MFJ), and married filing separately (MFS). Even though you can only file jointly or separately if you’re married, I imagine there are people out there who might put off getting married if it’ll save them taxes, which is why I’m including single in this comparison.

Our love struck couple (let’s call them Bristol and Levi) each earn $100K/year in wages, each receives $3K/yr in interest and dividend income, and each have a rental property that generates $5K/yr net rental income. On single returns, they both have adjusted gross income (AGI) of $108K. On a MFJ return, their AGI will be $216K, since all of their respective income items will be on one return. On the MFS returns, they’ll each have AGI of $108K, same as single. Both claim a standard deduction, which will be $5,700 apiece, for either single or MFS. For MFJ, the standard deduction will be double, $11,400. They will each get one exemption of $3,650 on the single and MFS returns, and the MFJ return will have two exemptions (one for each) for a total of $7,300. When standard deductions and exemptions are subtracted, on the single and MFS returns, our lovebirds will each have taxable income of $98,650. On the MFJ return, the taxable income will be $197,300. Now comes the fun part!

Going to the tax charts/tables, the tax on taxable income of $98,650 will be $21,338 for single taxpayers. For MFJ, the tax on taxable income of $197,300 will be $43,488. Let’s summarize; two single returns will generate a total tax of $42,676, compared to a joint tax return which will generate a tax of $43,488. So being married and filing a joint return costs $812 more in federal tax! But wait, it gets worse. When filing separately, each return will generate a tax of $21,751, for a total of $43,502 for the two returns, or $14 more than filing jointly. Now if that isn’t a kick in the pants!

For all my unsuspecting newlywed clients, I’ve had to explain the “phenomenon” of the marriage penalty. Regardless of any attempts or claims by congress to mitigate this, it’s still there. The reason for this is that tax brackets for MFJ aren’t exactly double the brackets for single. What winds up happening is that on a joint return, more dollars wind up being taxed at a higher bracket than on a single return. And MFS is even more, which is why it comes out with the highest tax.

The moral of this story is, Bristol and Levi got scared off by the taxes, and decided to not get married! For all the “real” people out there; obviously there are a lot of other factors to consider when getting married, but when tax time comes, at least you’ll understand better why you just got smacked with taxes. Now go and enjoy that wedding. I’ll be here to talk taxes when you return.