Tax Tips Blog

If you use your vehicle for business purposes, you are allowed to deduct the loss in value due to time, and general wear and tear in the form of depreciation. When you deduct this depreciation you are reducing the basis in your vehicle by the amount of the depreciation you deducted.

When you use an accelerated method (section 179 expense, bonus depreciation, MACRS) to depreciate your vehicle you are actually reducing your basis in the vehicle faster than it’s normal wear and tear. This may cause you to have a taxable gain when you sell, trade in your vehicle or your business use drops to 50% or less.

When you have a taxable gain, you may have to recapture, or include in your income, the part of the depreciation that you took that was in excess of the normal loss in value. When you use the standard mileage allowance, part of the rate is for depreciation.

This is why you can’t take an additional amount specifically for depreciation when you use the standard mileage rate. If you are using the standard mileage allowance you may still be subject to recapture.

For each year you used the standard mileage rate, you must multiply your business mileage for the year by the depreciation component shown in the table below, and then reduce your car’s tax basis (and increase your potential taxable gains) by that amount.

If part of the depreciation you have taken is subject to recapture, it is recaptured at your ordinary income rates, not at the more favorable capital gains rates. In order to avoid this recapture you should consider how long (and how much) you intend to use the vehicle for business purposes before you decide which method of depreciation you want to take.

A reader asks: “If I amend my return will it be flagged for audit?” Although an amended return will draw some additional IRS attention to your return, if you do it right, your chances of being audited may actually decrease. I recommend supplying the IRS documentation for the change you are making with the amended return. If you received a late or correct K-1 (income from a partnership or S-Corporation), 1099 or W-2, send a copy of it in with the amended return. If you are changing your filing status, explain exactly why you qualify for a different status. If you are claiming a credit that you never applied for, attach the properly completed form(s). If you are claiming additional deductions attach proof of those deductions. If it’s additional mortgage interest, attach the 1098. If it’s additional medical expenses, attach copies of the receipts. Additional charitable deductions, attach the receipt from the charity. When the IRS receives an amended return an agent compares it to your originally filed return. If attached to your amended return is proof that you know the rules and just made an honest mistake, what reason would they have to audit you? With a couple of exceptions, the IRS will allow you to amend your return within three years after the date you filed your original return or within two years after the date you paid the tax on your return — whichever is later. Also, amending your return usually does not extend the statute of limitation. The exception is when you amended your return within 60 days before the statute expires, then the IRS has 60 days to assess the additional tax shown on your amended return. If you are reporting your correct tax obligation, don’t worry, just file the amended return.

I was reading JLP’s post, “The 7 Habits of Highly Defective Investors” on his blog, AllThingsFinancial and thought I could easily come up with 7 Habits of Highly Defective Taxpayers and here they are:

1. They don’t have a tax plan

Many taxpayers are upset about how much they pay in taxes, but few actually take a proactive approach by having a tax plan. A tax plan is a road map that helps show you how to complete a taxable transaction such that taxes are legally eliminated, reduced or deferred. It’s your step-by-step guide of what options you have today to reduce your taxes.

2. They plan for the current year, by ignoring the effect on future years

Many taxpayers get all excited when they hear about the latest tax deduction or credit and demand that they utilize it without ever considering if that’s the best approach for their specific situation. The most common example is small business owners, who pay self-employment taxes and have a loss in the current year, who insist on taking the large Section 179 deduction, when they would actually save more in taxes, over the life of the asset, had they taken the ordinary depreciation deduction.

3. They don’t check in with their tax advisor often enough

Too many taxpayers wait until the year is over to ask their tax advisor what they have to do to save on the prior years’ taxes. It’s too late by then. The year is over. Whatever you did is done and cannot be undone. Now you’re left to preparing the return based on what you did, instead of what you could have done.

4. They get tax advice from anyone and everyone

I keep a file of all the creative tax tips and advice that people have given my clients over the years, thinking someday it would make for a great book, but after sharing some of the information in this file with a friend or two, I realize it’s only funny to me. For example, last year one client told me that her florist said she could write off the flowers she bought for her wedding as a tax deduction. The most common one, however, are people asking to write off their speeding tickets as donations. Although these tips may sound great to you, they could land you in big trouble with the IRS.

5. They are envious of other’s large refunds

Taxpayers who get a refund are getting back money they previously loaned to the government interest free. This is money you could have put in a savings account or invested and made money on it. Instead you let the government use it, free of charge. Taxpayer’s who plan either adjust their withholding accordingly or have their tax advisor compute their quarterly tax installments, utilizing the annualized method. This way the taxpayer has their money working for them, not the government.

6. They stay with a poor tax professional out of fear

When taxpayers select their tax professional because he’s a relative or he was recommended by a relative, friend, neighbor or colleague they have a tendency to stay with the tax professional even when they know the professional isn’t very good. They will subject themselves to poor quality, poor service and higher taxes because they don’t want to hurt or offend the person who recommended this professional. The irony is that if they actually found someone with good service and high quality work, they could save taxes and feel good about recommending this professional to others.

7. They select their tax professional based on fees instead of quality

An dear friend once told me a story about why rich people are rich and poor people are poor. She said that rich people will spend as much as they need to in order to get high quality products and services. The poor will shop around until they find the cheapest product or service and end up paying more in the long run. If you want to save on taxes, don’t choose a tax preparer based on fees; choose a professional based on the quality of their work. As a first step, I urge everyone read Kerry Kerstetter’s article on “Selecting a Tax Professional”. Quality is what matters.

The time has come once again for Texas shoppers to save some tax dollars, and lawmakers to feel good about it. On August 4, 5 & 6 anyone shopping in Texas will not have to pay state or local sales tax on most clothing and footwear priced under $100. This $99.99 limit applies to each item you buy, not your total bill. Many advertisers promote this weekend as a way to save on back to school supplies (sorry, backpacks are taxable), but these savings also apply to baby clothes, diapers, jogging apparel, pajamas, work clothes, uniforms and more. For a complete list of what is taxable and what is not visit http://tinyurl.com/4mcbv. A couple of tips for retailers:

1. If you plan on selling qualifying clothing or footwear tax-free during this year’s sales tax holiday, include the amount in Total Sales (Item 1), but not Taxable Sales (Item 2) of your sales tax return. However, if you collected tax, then you must send it to the state.
2. If you have qualifying items that are $100, you may want to discount these items to $99, such that your customers don’t have to pay the sales tax. It just might generate you an extra sale.

A car salesman told my client that if she purchased the Honda Accord Hybrid instead of a new Honda Accord, she would recoup the additional sticker price by the end of the year. She asked me how this worked. I explained that he was probably referring to the Alternative Motor Vehicle Credit and for the Accord Hybrid AT w/updated calibration that amount is $1,300.

The difference between the sticker of the 2006 Honda Accord Hybrid and the 2006 Honda Accord is $3,700, so the salesman is assuming her tax situation is such that she will be able to claim the credit AND that she will save $2,400 in gas between now and the end of the year. That equates to a monthly gas savings of $200. I summarized some of the more relevant information, assuming that she would trade-in her car, in the following table:

As you can see I added in the Honda Civic (regular gas version) for good measure. Excluded from the above table are the annual maintenance costs of the different vehicles, the respective long term values of all the vehicles and the driver’s personal preferences, all of which are factors to be considered, when purchasing a car. The table shows that there is no way my client is going to recoup the difference in the sticker price by the end of the year. If fact, my client would have to drive 10,000 miles per month to see a $200/month savings in gas. And she will have to incur the additional monthly cash outlay for her new loan, which was never considered by the salesman.

If my client is serious about saving money, and wants to buy a Honda, she should consider the 2006 Honda Civic. If her personal preferences tell her that she’ll be more comfortable in an Accord her monthly payments will be about $45 less than the Hybrid version, but she will not be eligible for the Alternative Motor Vehicle Credit.

Even if she does purchase a Hybrid vehicle, although she may be eligible to receive the Alternative Motor Vehicle Credit, depending on the rest of her tax situation she may not be able to claim it. This is often true with tax deductions and credits - something that salesmen never seem to mention when they are trying to sell you something.

The credit does reduce your regular income tax liability, but not below zero. If you are eligible for multiple tax credits, the hybrid vehicle credit is taken last after all the other credits (child care tax credit, retirement savings credit, etc.) have been taken. Any tax liability left over by these reductions will be the maximum dollar limit of your hybrid vehicle credit. If your hybrid vehicle credit exceeds your maximum dollar limit, the excess is not refundable, and is lost forever. And any amount of credit actually received may have to be recaptured if you sell your hybrid before the end of it’s useful life. I’ve only discussed the Honda Accord Hybrid and how that compares to the Honda Accord and Honda Civic; however, the Alternative Motor Vehicle Credit is available, in different amounts, for many different vehicles - including a truck! Hybrid vehicles are trendy and environmentally friendly, but they may not be as economical as you think. To read more on the Alternative Motor Vehicle Credit visit the IRS.

www.GLGcpa.com

If you had to pay alternative minimum tax (AMT) due to deferral (timing) adjustment items, you are entitled to a minimum tax credit (MTC) which you can claim in a year that your regular tax is greater than your AMT. The MTC prevents the double taxation of income and the disallowance of deductions due to the relationship between the regular tax structure and AMT structure. The MTC has an unlimited carryforward period. Deferral adjustment items are usually the result of having a different basis (usually your cost less depreciation or commission plus improvements or other items) under the regular tax system than the AMT system. Deferral adjustment items can either increase or decrease alternative minimum taxable income (AMTI) and include:

• Depreciation after 1986
• Exercise of Incentive Stock Options (ISO)
• Gain or Loss on the sale of property
• Loss Limitations (limited due to at-risk rules and basis rules)
• Passive Activities
• Long-Term Contracts
• Intangible Drilling Costs (IDC)
• Circulation costs
• Electing large partnerships
• Mining Costs (other than oil and gas)
• Estates and Trusts
• Research and Experimental Costs

It is very important to keep track of both your regular tax basis in these items as well as your AMT basis, such that you do not overpay your taxes or miss out on the MTC. There are other items, called AMT exclusion items which include claiming a large number of exemptions, the standard deduction, interest from private activity bonds or large itemized deductions that can cause you to have to pay AMT, but you don’t get to claim MTC for these items. Most taxpayers have a combination of deferral adjustment items and AMT exclusion items. This is an area of the tax code which is very complex and best left to your tax adviser to determine the exact amount of MTC you are entitled to receive.

The Offer In Compromise (OIC) has always been considered a last resort because the criteria for accepting an offer has always been strict and very few are accepted each year. The IRS has made major changes to the OIC, effective July 17, 2006, making them even less attractive to taxpayers. Most taxpayers pay their taxes and file their tax on time, but some do not have the cash available to pay the taxes they owe with their returns. If you do not pay your taxes when they are due, the IRS will charge you interest and penalties. The IRS’s current interest rate is 8% on any unpaid tax from the due date of the return until the date of payment. Assuming you filed your return on time, but just didn’t pay the tax owed, the late payment penalty is equal to 0.5% of the tax you owed and increases to 1% if you’re more than 10 days late up to a maximum penalty of 25% of the amount of tax you owe. If you failed to file a return on time, the total late filing penalty is usually 4.5% of the tax owed each month, that your return is late up to five months. This equates to roughly 13.5% in interest and penalties if your more than 10 days late. Usually the amount a bank would charge you is less than the amount assessed by the IRS. If you are unable to taking out a loan you should consider what assets you have that you might be able to sell to pay the taxes that you owe. As a last resort, you can submit an Offer in Compromise (OIC) to the IRS. There are two types of offers allowable with an OIC include:

• Lump-sum offer: an offer to pay taxes owed in 5 or fewer installments and
• Periodic payment offer: an offer to pay taxes owed in 6 or more installments

Under the new law a taxpayer filing a lump-sum offer must pay 20% of the offer amount with the application and a $150 application fee. A taxpayer filing a periodic-payment offer must pay the first proposed installment payment with the application plus a $150 application fee, and pay additional installments while the IRS is evaluating the offer. In order to avoid defaulting the OIC, you must file and pay all required taxes for a period of five years, or until the offered amount is paid in full, whichever is longer. Failure to file and pay your taxes causes you to be in default of the OIC and tax liability is reinstated. The statute of limitations is extended, if necessary, until the OIC is accepted, rejected, returned withdrawn or under appeal.

The new Qualified Domestic Production Deduction (QDPD) allows businesses who make, produce, grow or extract the products it sells or businesses who construct or substantially renovate buildings an extra deduction up to 3% of their taxable income before the deduction. This deduction is scheduled to double in 2007 to 6% and increase again in 2010 to 9%. The application and computation for this deduction is very complex (feel read to read IRS Notice 2005-14) so please see your tax adviser if you believe you may be entitled to this deduction. Due to the complexity of this calculations, the IRS has graciously announced safe harbors, de minimus rules and simplification methods, especially for cash basis taxpayers and taxpayers with average annual gross receipts of $5,000,000 or less. The sad part is that even with the simplification methods many otherwise qualified small businesses won’t be able to take advantage of this deduction due to the deduction’s limitations. One of the limitations is 50% of the related W-2 wages. The other is to either taxable income or adjusted gross income. Bob makes beautiful handcrafted solid wood furniture. He has no employees and is a sole proprietor, so even though he personally provides all the necessary labor to produce his product due to the wage limitation, he cannot take advantage of this new deduction. Dean grows hay and other grains. He files a schedule F and has no employees. He does all the work on his farm, but he too will not be able to take advantage of this deduction due to lack of W-2 wages. John and Mary have a small architectural firm and design custom homes. They chose to incorporate; therefore they each receive a W-2 salary from the corporation. However they have a corporate policy of giving bonuses based on their production, as incentive to generate more income for the corporation. This often results in the corporation showing little to no taxable income, which makes them unable to take advantage of this deduction. Ray and James are construction engineers who design commercial buildings. They formed a LLC taxed as a partnership. They pay each other guaranteed wages, but no W-2 wages, so they are not able to take advantage of this deduction. Donna and Jennifer create elegant beaded jewelry. They have organized as an S-corporation and take most of their income in the form of distributions. They do pay each other a modest W-2 salary and their deduction will be limited to half of these wages up to 18% of their income from this activity. This makes me wonder if the objectives of the IRS aren’t to make:

• more sole proprietors, farmers and partnership consider incorporating,
• more S-corporations consider paying larger salaries, and
• more corporations consider giving less bonuses, such that the corporation will show a taxable income
• all entity types consider eliminating their contract labor workers and pay everyone a W-2 wage.

One of my clients has a daughter who suffers constantly from allergies. Recently, her doctor prescribed a central air conditioner with a special filtration system for my client to install in their home. The system, including installation, is estimated to cost $5,800. Thankfully my client called me before they installed the air conditioner and asked if they could deduct it. I advised them to get their home appraised before and after they install the air condition, so they will know exactly how much this $5,800 expenditure will increase their home’s value, as they are only allowed to deduct the cost in excess of the increase in home value. In order to show my client their potential tax savings I had a realtor estimate the increase in their home value for installing this air condition. The realtor estimated that their home would increase about $1,000. The difference between the cost of the air conditioner and the increase in the home’s value is a medical expense, estimated at $4,800. My client is in the 28% tax bracket, which would makes their tax savings $1,344. In addition, the system maintenance costs are also medical expenses as long as their daughter is their dependent and her medical condition persists. My grandmother has been living with my parents for over two years now. Recently she has declined in health to the point that she is no longer able to use any stairs, so my parents removed the stairs leading to their front door and installed a ramp for her. The cost of grading the ground, installing the ramp and handrails are a capital expenditure that qualifies in full as a medical expense deduction. However, my mother didn’t like how it looked so she had decorative wainscoting installed on the wrought-iron handrails and redid all the landscaping surrounding the new ramp. The decorative coating and landscaping was for her personal reasons and not a medical condition, so that is not deductible. You can claim a medical deduction for the cost of special equipment that you install in your home or improvements that you make to your home, if the main reason you are installing the equipment or making the improvement is to accommodate either your, your spouses or your dependents’ medical needs. Once the capital expenditure for the home qualifies as a medical expense, its operating costs and upkeep also qualify as medical expenses as long as the medical requirement continues. How much you can deduct depends on whether or not your improvements increase your home’s value. If the improvement may increase your home’s value then you should get an appraisal before and after you make any permanent improvements to you home. You can deduct the amount your cost are greater than the increase in your home’s value as a medical expense. The IRS has recognized some improvements that usually do not increase the value of your home. The cost of these items can be included in full as medical expenses. These improvements include: • Constructing entrance or exit ramps • Widening doorways at entrances or exits • Widening or otherwise modifying hallways and interior doorways • Installing railings, support bars or other modifications to bathrooms • Lowering or modifying kitchen cabinets and equipment • Moving or modifying electrical outlets and fixtures • Installing porch lifts and other forms of lifts (elevators add value) • Modifying fire alarms, smoke detectors and other warning systems • Modifying stairways • Adding handrails or grab bars anywhere • Modifying hardware on doors • Modifying areas in front of entrance and exit doorways • Grading the ground to provide access to the residence

Beginning August 1, 2006 everyone who has long distance service will enjoy a lower telephone bill. Not only that, but the IRS will refund you for the amount of Federal Excise Tax you paid, plus interest, on your long distance bills (including cell phone bills) Since March 1, 2003. The current rate is 3% of the charges billed for these services. Taxpayers may request a refund on their 2006 income tax return (filed in 2007). The IRS has promised to announce a “safe harbor method” that individuals may use to figure out the amount of refund they are due so they don’t have to dig through their old phone bills and compute it, but they have yet to do so. The IRS has also promised that their simplified method will be “simple and fair”. As for other entities (C-Corporations, S-Corporations, Multiple Member LLCs, Partnerships, Non-profits, Estate & Trusts) they will have to spend some time going through their old telephone bills and computing the amount of Federal Excise Tax they paid for nontaxable service and keep the documentation just in case the IRS wants to verify it. I have already notified my clients so they can start this tedious task and have it completed in time for filing. As of right now, the only way to get this refund is to file a 2006 Federal Income Tax return. Even if you are not required to file a Federal Income Tax return you will have to, if you want the money you are due for being forced to overpay your telephone taxes. If you wish to read more about this you can read IRS Notice 2006-50.