Our Taxing Times

Paying the Piper - Homebuyer Credit

With all the attention on the extension of the Homebuyer credit through the Worker, Home Ownership and Business Assistance Act of 2009 there may have been something forgotten. The taxpayers who took advantage of the original $7500 credit. I won't be ranting on the inequity of these taxpayers having to pay the credit back over 15 year starting next year while other taxpayers don't have to pay anything back (at least now). I want to focus on one very practical issue: what happens when they sell that house.

Jane Tax buys her first home for $80,000 on May 1. 2008. On her 2008 tax return, she decided to take the $7500 First Time Homebuyer's Credit understanding that she will pay that credit back over 15 years starting in 2010. And of course, her preparer covered all the other points about the credit like what will happen if the home is sold before the end of the payback period. Jane now has a house with a basis of $72,500 (80,000 purchase price-7500 credit). Jane also can't afford the house, or has to move for her job, or gets married. The bottom line is that on October 1, 2009 she sells the house. Now she may have to recapture all the credit (pay it back.)

How much Jane has to recapture will depend on the selling price of the house. If it sells for less than $72,500, Jane is okay because there is no gain on the sale. She sold it for less than her basis in the house. But if she sells it for $76,000, Jane will have to repay of the $3500 credit on her 2009 tax return. Form 5405 has been redesigned to include recapture. The more she sells it for, the more she will recapture up to the full $7500 she received as a credit. But Jane may be in for another surprise. Since she didn't meet the qualification for principal residence exclusion*, she may also have to pay tax on the gain from the sale. Luckily, it's long term capital gains. If she is in the 10% or 15% tax brackets, she will report the sale but should qualify for the 0% capital gains rate for long term capital gains. But if she is in the 25% or higher bracket she will also pay capital gains of 15% in 2009. For her $3500 gain, Jane will pay capital gains tax of $525 on top the tax on the rest of her income. If there is more gain, she will pay tax on all the gain. Capital gains will be paid on the total gain on the house sale. If it is sold for $85.000, Jane will repay the $7500 credit and pay capital gains tax on $12,500. 

Not only has Jane lost her home, but because of a big tax bill, it will take her longer to get back to where she will be able to try again. Of course, she could have been one of those who said they were going to save the money and did. Or, she could have spent the credit on improvements that increased her basis. Or, she waited a few months longer to sell and meet the exclusion requirements. Bottom line, this credit will be haunting preparers and home owners for a while.

*If a homeowner has owned and/or lived in their home for 2 of the last 5 years, any gain from the sale of the home receives special treatment and could be non-taxable.

Surprise! You Will E-File

Ya gotta love our system of government. You have a bill that has passed the House by a pretty good margin. It goes to the Senate where this amendment is added. The Senate passes the bill 98-0. Back to the House. They vote to accept the Senate version by 402 to 12 margin and off to the President it goes. There it is sure to be signed since there are some important economic measures and it's veto proof. Almost like the Schoolhouse Rock segment.

This, however, is HR 3548 - The Worker, Home Ownership and Business Assistance Act of 2009. A bill all expected to pass since it extends unemployment benefits and the First Time Homebuyer's Credit. And now a preparer e-filing mandate. From Section 17:

`(3) SPECIAL RULE FOR TAX RETURN PREPARERS-
`(A) IN GENERAL- The Secretary shall require than any individual income
tax return prepared by a tax return preparer be filed on magnetic media
if--
`(i) such return is filed by such tax return preparer, and
`(ii) such tax return preparer is a specified tax return preparer for the
calendar year during which such return is filed.
`(B) SPECIFIED TAX RETURN PREPARER- For purposes of this paragraph,
the term `specified tax return preparer' means, with respect to any
calendar year, any tax return preparer unless such preparer reasonably
expects to file 10 or fewer individual income tax returns during such
calendar year.
`(C) INDIVIDUAL INCOME TAX RETURN- For purposes of this paragraph,
the term `individual income tax return' means any return of the tax
imposed by subtitle A on individuals, estates, or trusts.'.

Much discussed but not expected to be seen for a while, we now have e-file mandates for preparers of federal returns. That means if you prepare over 10 returns you have to send them electronically. Many states have set up mandates to push preparers into the modern age. But the last time I heard Federal mandates discussed at a workshop, the idea was still sometime away. The IRS was hoping to leading the paper preparers with honey and not legislative vinegar. I honestly didn't expect to see anything until there was a bill for tax preparer registration/licensing. I also expected to see a higher number of returns before the mandate kicked in and then reduced over time.

Preparers have a year to prepare to convert their office to e-file. The bill goes into effect for returns filed after 12/31/2010. And I am sure we will be hearing a lot about this over the next year.

Tax Simplification?

A small step to tax simplification. The IRS is dropping three forms from the 1040 A series and replacing them with the form from the 1040 series.

Until now, if you filed a 1040A return with interest in dividends over $1500, you used a Sch. 1. On the 1040 side, reporting was done with the Sch B. Now, everyone will be using the same form to document interest and dividends. The same holds true for Schedule 2. Child and Dependent Care Credit will be taken on Form 2441. The third form is the Schedule 3 for the Elderly Credit. For the few who can use this credit, they will use the 1040 Schedule R.

I wonder how many 1040A schedules were sent with a 1040 or 1040 schedules with a 1040A?

The RAL Question

It is that time of year. Leaves are changing, we no long try to save daylight, it's getting colder and tax preparers start to plan for the next season. That brings up lots of questions: do I increase prices, how can I bring in new clients, why can't Congress leave the tax code alone, do I have enough folders/receipts/paper clips, who has the least expensive paper...you get my drift. Usually, one of my questions is which RAL bank will I use but this year it's do I want to beat the rush and drop them now?

I know that RALs (Refund Anticipation Loans) are controversial. They have been abused by the banks offering them, some preparers and many taxpayers. But they are a key reason for the growth of e-filing and they have helped many taxpayers in a time and money crunch. I have always offered them, either as an employee or owner, since the program went national. But RALs have changed greatly in the last couple years and with the IRS introducing modernized e-file refund times are going to go down for everyone.

Bowing to public outcry about the APR and fees, the banks involved (there are just a handful) have reduced their charges. To keep their profits up, they have mostly dropped the incentives to preparers and tax software companies. Until recently, a preparer received a payment for each RAL or RAC (Refund Anticipation Check, no money is advanced but the fees come out of the refund) that was approved. Sometimes there were extra incentives for a particular volume or if it was a new preparer or for a low default rate. They also payed the software company for development of the bank applications and transmission of the completed loan apps. With the cut in loan rates, the banks have cut fees to the people doing the work. I will spend an extra 15 to 30 minutes on a tax return when there is a RAL/RAC involved making sure the taxpayer qualifies, getting IDs, completing the application. Then there is printing the check, contacting the client, explaining why they weren't approved, and keeping all the paperwork for years. Now, if I want to get paid for my extra time, I have to add a fee in myself. (There are restrictions on how I can add a fee. It can't increase the APR.) Until incentives were dropped, I didin't add a fee and I only add about $12 now. But the idea that the banks want to keep their profit while shafting the ones doing the actual work has left a sour taste in my mouth. They want to shift the "bad guy" from them to someone else.

I don't do a lot of RALs. While I offer them, I don't push them. The client has to ask about the program. But I know if I cut them, I will lose some good clients, good people. Ones who won't wait for a couple of weeks to get their refund. I don't like the idea of them paying lots more than I have been charging them to get their money. Not just extra fees for the RAL but a high tax prep fee too.

I've crunched my numbers and found a replacement for the RAC program. All I am waiting for is to talk to the banks at Drake's update school next week. I doubt that they will give me any reason to keep RALs but it's hard to change a 15+year habit.

Buyer Education VI

A couple more tips to protect you from the unscrupulous preparers out there.

Contingency Fees Are a No-No!

Actually, they aren't always but they are on an original return. Ok, let's look at the real world. You call a new preparer and of course you ask about fees. You probably won't get an exact quote but they should explain how they calculate fees. I charge by the forms required to prepare the return. (I'll add a time charge if I need to do bookkeeping first.) Some preparers just use time. Others based their fee on the level of complexity. But if you are told the fee is based on the refund, thank them and keep looking. This is a contingency based fee and the preparer now has a interest in the outcome of the return. The bigger the refund the bigger the fee.

Joe Taxpayer has his W-4 set to about break even. He usually gets a small refund (under $100). If he uses a  preparer charging a 10% contingency fee, he will pay $10 or less to get his return done. Not too many preparers will settle for that fee for even a W-2 only return. So if the preparer wants to make money, it is in his/her best interest to beef up the refund. Legally or not. Remember, if there is a problem with the return, you and not the preparer will have to pay the IRS. If you can find the preparer when the notice comes.

The restriction against contingency fees is on an original return. Jane Taxpayer's preparer has read about a new ruling that might benefit Jane if a back year is amended. That return, since it is not the original return, may be subject to a contingency fee. If the IRS approves the change and refunds Jane, she will pay her preparer. If the IRS doesn't approve the change, the preparer is not paid.

The idea behind contingency fees is why a taxpayer needs to be careful with all the car lot and pawn shop type businesses offering tax preparation. They have a vested interest in the size of refund and that can make it very tempting to create a few deductions.

Receive But Not Cash.

Some tax practitioners can receive your refund check. But, they have to be able to practice before the IRS. This means an Enrolled Agent, CPA or Attorney. They have to have a signed  Power of Attorney (Form 2848) filed with the proper box checked. But they can't cash the check even with your permission. And an un-enrolled preparer (anyone not specifically mentioned above) can't receive it at all. Do not have your refund sent to anyone but yourself. This is a good way to lose your refund. Besides your refund, this will be the address the IRS and state revenue office will send notices.

Buyer Education V

Just a reminder, this is an intermittent series highlighting what you need to know about  dealing with a tax professional. This is from my vantage point. The IRS has a page of tips for chosing a preparers.

Your W-2's Can't Be Held Hostage...

...but there's not much you can do about it if they are. You've had an interview with a new preparer and for some reason you are not satisfied or you are concerned about the return. You have the right to ask for your original documents back and the preparer can't charge you. Circular 230 mostly covers enrolled preparers (E.A., CPA, attorney) but does set forth a few rules for all preparers and this is one of those rules. If a client asks for his W-2s, 1099s and notes back, I have to give them back to them. I don't have to give them anything I have prepared with out payment but I have to give them their documents back.

The challenge is actually getting your papers back. If the preparer holds tough and refuses to release your documents back, there is no quick way to force them. You may be able to negotiate a lower price but you may be stuck ransoming your W-2 and other info. You can complain to the IRS Office of Professional Responsibility but any action will depend upon other complaints and the IRS workload. And it will take time. 

So, my advice is to take a minute and make a copy of whatever you give to the preparer. If there is a problem and you choose to try another preparer, ask for your papers back. If the preparer refuses, you have a backup.

From W-2 to 1099Misc

I will get back to my education series after the 15th but just a quick reminder based on a phone call I received this morning.

With unemployment so high many people are at the point of taking the best job they can find not the the job they want. It has also forced many employers to make cuts in employee benefits and expenses. To save money, many employers have chosen to change wage jobs to contract labor jobs. Whether this is a legitimate change or not is not the discussion here, what I want to talk briefly about is the responsibility of the new contractors. 

If you do take a contract labor job, your taxes will change. The biggest change is you will not be able to rely on your employer to withhold for you. You will have to put aside money from each paycheck yourself. Making this harder is that you will have to hold back even more than disappeared from your employee check.  Let's say you are currently making $800 a week and at the end of the year break about even on your 1040. From your check, your employer will take Federal and State tax withholding of say $100 and your half of Social Security and Medicare of $49.60 and $11.60. This results in a take home of $638.80. But if you take a contract labor job with the same $800 a week payday, you will get a check for the full $800. So you put aside $161.20 a week and you think your taxes are covered. Nope. You could owe over $3000 at the end of the year. A contract laborer has to pay both sides of the the Medicare and Social Security on their 1040. Unless you add another $61.20 to the money you set aside, you haven't taken care of your "employer contribution". Remember you are now both the employer and employee. So, if you take a contract job, be aware that you may actually be taking a pay cut unless you factor in the added self-employment tax expense. 

Also, simply putting aside your tax money for the end of the year is not a good idea. You need to get in the habit of making estimate payments. First, it is too easy to "borrow" from the tax money and too hard to put it back. Then, at they end of the year, the money isn't there to pay your taxes. The second reason to prepay with estimates is that it could save you some money. There is an Underpayment of Estimate Taxes, Federal and most states, that can come into play if you owe too much at the end of the year. So, prepayment can save you some money. Your tax professional can help you set this up.

There are more tax issues when you make the change from employee to contract labor, and I'll cover them soon. But if you are aware of the self-employment tax issue and estimates, you have the knowledge to not get a nasty surprise at the end of the year.

One Cutback- Two Benefits

In a time of state budget shortfalls for Kansas, it comes as no surprise that Kansas Department of Revenue has not only cut back on workshops but they have also decided to cut the free tax forms they send out to preparers.

Taxpayers who have been preparing their own returns will still receive a modified tax book in December. As I understand it, it will be the forms and the basic instructions. The full instructions will be online or can be requested. What KDOR will not be sending out are the blank forms that grocery stores, banks and the Post Office gave out. And the free forms it sends to tax preparers.

Tax professionals have been able to place an form order with KDOR for the blank forms and addressed envelopes. For many of us, it was a standing order that was sent out in the fall. I didn't order forms but I did take advantage of the free envelopes. Not any more. If I want to buy forms or envelopes, KDOR will be glad to sell them to me for a reasonable cost. 

Besides saving the state some money, making it harder to get forms and envelopes may be the extra kick some preparers need to start e-filing. Last year, Kansas mandated e-filing for preparers who filed 50 or more returns a year. There were 215 mandated preparers who didn't e-file at all. They were responsible for over 25,000 returns filed. E-filing is easier than mailing a return but for many preparers it is a mental hurdle to get over. Hopefully, this will convince the holdouts to give e-filing a try.

If they do, it will save KDOR the money and maybe they will bring back the free workshops. I love free CPEs

Buyer Education IV

What do you want a tax professional to do for you? That is not a trick question. Anyone with a little tax knowledge can prepare a return but can they prepare the return you want and do they offer the services you need?

Do They Have the Skills You Need?

When you are talking to prospective tax preparers, they need to know how complex the return is you need. I don't know how many times I have been told that, "It's a simple return." when it had rentals or a business. I can handle those forms without a problem but they aren't what I classify as 'simple". Is there more than the local state? Are there special issues like injured spouse or EITC after disallowance? Newer preparers may not have prepared these before. Some preparers do only basic 1040 returns. Others will take any 1040 return but nothing else. You have to ask. This goes when your tax situation has changed because you have started a business or sold a property. Check with your current preparer to make sure they can do your new return. It is hard to return paperwork to a client when you discover it is over your head. We want to please (and earn the money) and it is tempting to try to muddle through. If the preparer says "no" to the return, don't push. You have to live with the results.

What Comes With the Return?

What other services do you want or need? A lot of tax professional provide other services. Bookkeeeping, investments and insurance are the major sidelines. But don't forget about services as part of the return. E-filing, bank products, extra copies of the return, off season availablity should also be a concern. How do they handle customer contact or interview? Many preparers have you drop it off your documents and they set an appointment for pick up. Others complete the return on the spot or interview upfront. Don't assume that the way your last preparer handled your meeting is the way the new preparer does it. Are they doing the return or is it someone in the back room? And what is their guarentee? You might not find someone who offers everything you dream of in a preparer but you can get close and everyone works better when they are on the same wavelength.

What Do You Really Want the Preparer to Do For You?

Do you want a big refund/low tax or an accurate return? They aren't mutually exculsive. But if that big refund or low tax is your primary goal and you're willing to let accuracy slide, you need to be cautious in choosing someone to do your return. Most of us are working hard to prepare an accurate return where you legelly pay the least in tax the code allows. So if you are looking for someone who'll take liberties with the tax code, you really need to work friends and family for suggestions of the crooks. Don't get mad at us when we won't do what you want. I don't work for you, I work for me and provide you a service in the form of an accurate tax return. I don't care what your other preparer did. And remember, just because you haven't gotten caught, yet, doesn't make your cheating right. There are plenty of people out there who will be glad to get you the refund you think you deserve.

Putting Back RMD

A quick note from materials I received at an IRS/KDOR Tax Symposium I attended yesterday.

Thanks to a law changes last year, taxpayers over 70 and 1/2 are not required to take a required minimum distribution (RMD) from their IRA or pension plan in 2009. But what happens if you did and have changed your miind (or your plan executive didn't tell you about this year's special rules)? You can put it back. There has always been a 60 day rollover to repay a distribution. But this year the rollover has been extended to Nov. 30th. So if you took a distribution in 2009, you can put back up to the amount of your RMD and not pay taxes on the returned money if you can get it back in 60 days or Nov. 30th which ever is later. Rollovers are limited to one a year from each account and this hasn't been changed. And it only applies to taxpayers required to take RMDs. If you have questions about this, check with your tax professional.