Tax Tips Blog

The IRS defines a casualty loss as the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual. In general, a sudden event is an event that happens instantly. If you wake up one morning and notice, all of a sudden, that you have wood rot under your bathroom sink due to a slow leak, the IRS would not consider that event a “sudden” event, as it happened slowly over time. In general, an unexpected event is one that happened without warning. Using the same example above, if you were aware that your sink was leaking or may leak, then the event was not “unexpected”. In general, an unusual event is one that is not common. Again, using the same example, if your home is say 20 years old and you’ve never replaced your valves under your sink, it probably wouldn’t be considered uncommon for your sink to leak. As you can see, each casualty has to be reviewed with these three things in mind to determine if a deduction is allowed. If you believe you have incurred a casualty loss and would like to claim a tax deduction for it, please seek the advice of a qualified tax professional because the IRS’s interpretation of what is “sudden, unexpected or unusual” may not agree with yours. From time to time the President of the United States will declare a geographical area a “disaster region”. When this occurs then the disaster losses in that region are casualty losses. The amount of the loss that you are able to deduct is usually the lessor of the cost or fair market value of each item that you lost in the event less any insurance reimbursement you received for the item. After you determine the loss for each individual item, then you add them all together to arrive at your total loss for the casualty event. If your insurance company reimburses you for an amount that they determine is the fair market value of the item that you lost, then you will not have any casualty loss deduction. If your casualty loss is a business casualty loss then the loss is fully deductible. However, if your casualty loss is a personal casualty loss then your loss is an itemized deduction which is first reduced by $100 and then it is reduced again by 10% of your adjusted gross income (AGI).

Robin would like to know: I am holding stock in my IRA. I just received a check from the result of a class action suit regarding one of the stocks I hold in this IRA. Shouldn’t this check have gone to my IRA custodian to put in my IRA, instead of directly to me? Are there any tax implications to this income? Is it okay if I deposit this check? Just so you know, this IRA can no longer be funded because of income limitations and I really don’t want non-deductible money in this IRA. Thanks, Robin My response:Thanks for visiting Robin. The trustee for the class action settlement would not typically know where your IRA money is currently held, or even if you still have an IRA. Because of this the settlement is usually made payable to the IRA, but is sent to your home address. You should deposit the check into your IRA, not your personal checking account. If you do not deposit this check into your IRA, it will be deemed a distribution, and will be subject to income tax and potential penalties. Send the check, along with a letter to your IRA custodian explaining that you received this check as the result of the class auction lawsuit and they will take care of it. Putting this check into your IRA account will not be considered a contribution so your current income level and/or previous contributions are irrelevant. Since this money isn’t a contribution, it isn’t deductible or non-deductible. It’s just an additional return on an investment within the IRA. Best wishes, Gina

Jeff inquires:I had an online internet sales company that I recorded as a Schedule C business, which I sold in 2005. In 2006 I have incurred some expenses relating to this same business (customer refunds, bank fees, interest on a business loan, etc.). Am I out of luck in deducting these expenses since I sold my business? Thank you, Jeff

My response:Hello Jeff! Thanks for visiting my blog. I hope you and your family had a great Thanksgiving. You are allowed to deduct your ordinary and necessary business expenses related to your inactive Schedule C business for as many years as you incur them. Best wishes, Gina

Mike was wondering:I use Quicken which generates a Schedule D into my TurboTax. I just now noticed that on last year’s return it didn’t list the number of shares in ‘box A’ like the example shows on the tax form. It just put a line that says “CHEVRON” for example and then all the rest of the relevent stuff (dates, sales price, cost basis, & gain/loss). Do I need to amend my return and state “150 Shares Of CHEVERON” or is the simple “CHEVRON” suitable for the description? Should I input into Quicken “100 shares of STOCK”, when I buy stock? Thanks, Mike My response:Hello Mike! Thanks for visiting. You just hit the tip of the iceburg on a very touchy subject for me, so stand back, while I jump up on my soapbox…. I am a strong believer that anyone who has stock sales should be seeking the advice of a qualified tax professional as computing the actual gain/loss is usually not as easy as it seems. Yes, software programs have come a long way in helping us track the necessary information to prepare a tax return, but the tax code has to be the most difficult thing to program. I can remember back in the 1980s when makers of accounting and tax packages first began advertising that you could transfer your numbers from their accounting software program into their tax program with a click of a button. I also remember spending endless hours sorting out the mess that it created. Yes, that was 20 years ago and they have gotten better at this, but it still has not been perfected to the point that I would blindly trust it. You need to know where the numbers actually belong, because there is no guarantee Intuit (or whatever company) won’t substitute some other form or line that is easier to program. It has been my experience that Quicken has an extremely hard time properly computing and tracking the correct cost basis and holding period of stocks involved in mergers, spinoffs, or even transfers from one account to another. If Quicken can’t properly compute and track this information how can one believe they are capable of correctly transfering this information into TurboTax? You’d be a fool to believe it. Aside from importing data from Quicken, the most common problem I encounter with new clients who previously did their own returns with TurboTax is that you also can’t trust TurboTax to carryforward capital losses from the prior year. Sometimes they do; sometimes they don’t. Now I’ll jump off my soapbox and say that, it is probably not necessary to amend your return to change the description of your stock, but the details do matter to the IRS and I would make sure that the complete and accurate description is properly documented in your tax return workpapers in case the IRS were to ever question it. In addition, I would make sure that the description is accurate in the future.

The following is a simple list to help you remember how long to keep your records for tax purposes:

• Although income tax returns can generally only be audited for 3 years, it is best to keep income tax returns and supporting documents (bank statements, canceled checks, credit card statements, deposit slips, charitable contribution receipts, and medical bills) for at least 4 years and preferably 6 years.
• All escrow closing statements (purchase, sale, and any refinance escrow statements) plus receipts for improvements on your residential property should be kept for at least 4 years after the property is sold.
• Confirmation on the purchase and sale of your stocks, bonds, and mutual funds, as well as a record of stock dividends, splits and reinvested dividends, should be kept for at least 4 years after the asset is sold.
• Records of your retirment plan contributions and withdrawals including non-deductible IRA deposits, employer plan stock purchased, rollovers and KEOGH plan deposits should be kept until 4 years after the plan assets have been withdrawn.
• The cost of business property or rental real estate property, date acquired and schedule of depreciation claimed in previous years should kept until 4 years after the property is sold or exchanged.
• Records that should be kept permanently include estate and gift tax returns, divorce and property settlement agreements, deeds, title insurance policies, and all trust documents.

If you are not sure about something, please ask your tax professional before you discard it.

The IRS believes that taxpayers are not properly deducting their car and truck expenses to the tune of $30 billion in unpaid taxes annually. In an effort to curb this abuse, the IRS has issued another fact sheet, to help educate taxpayers on the proper deductions available for car and truck expenses. Car and truck expenses for trips on behalf of your trade or business are a deductible business expense, but before you can deduct any car or truck expenses you have to determine your “business use percentage”. The IRS has 4 approved methods to determine your business use percentage. All of these methods require that you keep adequate records to support your business use. These methods include:

1. Recording every business mile you drive for the year and then divide the year’s business miles by the year’s total miles to determine your business use percentage.
2. Record all your business mileage for a “typical” 90-day period and calculate your business use percentage for that period and use it for the entire year.
3. Record your mileage for the first week of each month and calculate your business use for that period and use it for the entire year.
4. Record your starting and ending mileage for a 90-day period. Record your personal and commuting miles for that period, and assume all the rest are for business. Calculate your business use percentage for this period and use it for the whole year.

When you record your business use percentage keep in mind that the IRS divides mileage into three categories:

1. personal;
2. commuting; and
3. business.

Miles driven for personal use (taking your child to school, going to the grocery store, etc.) are not deductible. Miles drive during your commute (going to and from your work or business stop and home) are not deductible. Daily trips to the bank, post office, and similar stops where you perform no service are considered commuting miles and are not deductible. It should now be clear that unless you have a car parked and stored at your place of employment that only gets used for business purposes you will not have 100% business use on your car or truck (this includes realtors). Travel between temporary business stops is deductible. So, for example, if you leave your home, make six business stops, meet a client for dinner, then drive home, your mileage between your first stop and the restaurant is deductible. If your home is your principal place of business, then all your business trips are deductible. Once you’ve calculated your business use percentage, you have two ways to calculate your deduction:

1. The standard mileage allowance is 44.5 cents/mile for 2006 (48.5 cents/mile for 2007) plus parking, tolls, and your business use percentage of interest on your car loan and state and local personal property tax on the vehicle.
2. Your business use percentage of your “actual expenses” which include depreciation and interest (if you purchased your vehicle), your lease payments (if you leased your vehicle), car insurance, gasoline, oil, car washes, tires, maintenance, repairs, licenses, tags, personal property tax, parking and tolls.

Before you decide which method you want to take, keep in mind these two points:

1. The American Automobile Association estimates that actual costs for operating popular vehicles range from 47.6 cents/mile for the 2005 Chevy Cavalier to 63.4 cents/mile for the 2005 Mercury Grand Marquis. (These figures assumed 15,000 miles per year, and gas prices of just $1.939/gallon!)
2. You can only claim accelerated depreciation and the large first year expensing (Section 179 expense deduction) on a car that has a business use of at least 50% and you use the actual business expense method.

Reg from Bourbriac, France writes: After many decades as a salaried wage slave, I am a freelance journalist again. The trade that paid my way through college. Although I am in France, I must (also) report my income to the U.S. IRS in pretty much the same way as anyone in the same line of work would in the US. On schedule C to Form 1040. So, the answer (if there is one) may be of interest to freelancers in the US. The question: How do I go about correctly assigning telephone and internet charges to the business? (And differentiate them from personal use?) I have a digital line which is the French version of the old ISDN line. It gives me two analogue voice lines and a digital data line that I use to connect to the internet. I pay a monthly fee to an Internet Service Provider (ISP). I also have one mobile phone (cell phone to those in North America). I think business use accounts for about 60% to 80% of my usage of these communications services. What am I required to do to get the numbers right on Schedule C? What records must I keep to make the IRS happy with what I have done? Reg My response:Reg, Thank you for visiting my blog. I am glad you decided to cut your ties with the corporate world and venture out on your own. You have an excellent question! If you are working out of your home, and as a freelance journalist I will assume you are, then the IRS does NOT allow you to deduct the FIRST line (telephone) into your home as a business expense. So, if you are working out of your home and only have one line in, then it is all personal no matter how much time you spend using it for businesses purposes. You said that you have 2 analog voice lines and one digital line used for the Internet. I am not familiar with how these items are installed or billed in France, but if one of the two analog voice lines is a business line and itemized that way on your bill, then you should be able to deduct the full cost of that line. The other analog voice line and the single digital line would be considered personal and therefore not deductible. As for your mobile (cell) phone, that is considered listed property and as such you would have to keep a log of your business calls and then you are able to deduct the business portion of the use of that phone. A log of your business calls would include the date and time of the call, the length of the call, the person you spoke with and the business purpose of the call. Thanks again for visiting my blog, Gina

Zack sold his investment property to Nicholas for $150,000. Zack’s investment property had a mortgage on it of $50,000 that Nicholas assumed. Nicholas will pay the remaining $100,000 in 10 equal annual installments of $10,000, plus interest. Zack’s basis in his investment property was $75,000 and he had no selling expenses. Zack’s gross profit is $75,000 ($150,000 less his basis of $75,000). The selling price of $150,000 is reduced by the mortgage assumed by Nicholas of $50,000 to arrive at a contract price of $100,000. Zack’s gross profit percentage is 75% (profit of $75,000 divided by contract price of $100,000). When Zack receives his annual payment of $10,000 plus interest he will report the interest received as interest income, $7,500 (75% of each $10,000 annual payment) as gain attributable to the sale and $2,500 ($10,000 - $7,500) as recovery of basis. Installment sales are rarely this cut and dry. In reality, they are usually much more complex, which is why you should always seek the advice of a qualified tax professional when you are involved in an installment sale. For example, if interest was not paid in addition to the $10,000 annual payment then interest must be imputed prior to computing the portion attibutable to gain and basis. If the mortgage was greater than Zack’s basis in the property than Zack’s gross profit would be 100%.

Chad asks:I recently formed a LLC with my brother as equal partners. I contributed land worth $5,000 and my brother contributed $4,000 of cash and his old computer, which we agreed was worth the other $1,000 he needed to make us equal partners. Now our accountant is telling us that we aren’t equal partners, how can this be? My reply:I’m glad to hear you have an accountant because partnership taxation is a very complex area. This is something your accountant should have explained to you, when he or she told you that you weren’t “equal partners”. Since he or she didn’t automatically explain this to you; you should have felt comfortable enough to ask him or her right then. If you’re not comfortable talking to your advisor it may be time to find a new one. Now to your question. You most likely have a partnership agreement that says that you and your brother will be sharing equally in the capital and profits of your partnership and therefore you believe you are equal partners - and you are. However partnership taxation is anything but straight forward. Partnership taxation has what is called “inside basis” and “outside basis”. “Inside basis” refers to the partnership’s tax basis in its assets. “Outside basis” refers to the partners’ tax basis in their partnership interest. The land that you contributed may have been worth $5,000, but your basis in that land (close to what it cost you to buy it), prior to contributing it to the partnership, was probably much less. Whatever your basis was in the land that you contributed is now your basis in your partnership interest. Your brother contributed cash plus his computer. His basis in his partnershp interest will be the amount of cash he contributed $4,000 plus his basis in his computer (not what it was worth to the partnership, which you said was $1,000, but generally his original cost, which was probably higher). As I said previously stated, partnership taxation is a very complex area and I have simplified the rules to give you my best guess as to why your basis in your partnership interests are different even though you both contributed the same value to the partnership and intend on being equal partners in the profits. Best of luck with your partnership, Gina

Ted asks: I just incorporated my business last week. How long do I have to make my S-Corp election? My response: Excellent question Ted! The IRS has two general rules for determining when to make your S-Corporation election:

1. If you want your S-Corp. election to be effective for your current tax year, then you have until the 16th day of the third month. When a corporation begins its tax existence within 2-1/2 months of the end of the first tax period, then the full 2-1/2 months remain for the S status election.
2. If you want your S-Corp. election to be effective for a future year, then the election must be filed at any time during the preceding taxable year.

So, if you started your business on Nov. 1st, you intend to have a December 31st year end, and you want your S election to be effective in 2006, then you have until January 15, 2007 to file your S-Corporation election. If instead, you started your business on Nov. 1st, you intend to have a December 31st year end, and you want your S election to be effective in 2007, then you have until December 31, 2006 to file your election.