Our Taxing Times

Withholding Change

A quick post to everyone who is receiving their first check of the new year. Yes, your Federal withholding will be a few dollars more. Last year, the $400 Making Work Pay Credit did not start until April. The withholding tables were adjusted to distribute the $400 credit to taxpayers over 9 months. This year the credit is being distributed over 12 months. A longer distribution time means a smaller credit in each paycheck and slightly higher Federal withholding.

At Last - Tax Preparer Registration

Yesterday, the IRS released their recommendations for tax return preparer licensing. In a 55 page report, they put forth their plans for new regulations that will change the industry. The first interesting aspect is that the IRS is not planning on seeking legislative approval. They believe they already have the authority to regulate paid preparers under IRS Code Section 6109.

I've did a quick read of the report late last night and this post will be the highlights version. More detail will come before I get too busy. And then there are the reactions to this proposed changes to the industry. Right now these rules will apply to all paid preparers except CPA, Attorneys and Enrolled Agents. But for starters:

• The IRS is planning on using the PTIN (preparer identification number) to register all tax preparers. This is the number I use instead of my SSN when I sign a return. The registration will be for a three year period and renewable.
• All paid tax preparers will be tested for competency There will be no grandfathering. Two tests will be available but only one has to be passed to be licensed. One will cover just the 1040 with no businesses. The second will cover small businesses reported on the Sch C and F and will include Sch D.
• Once registered, the preparer will be required to complete 15 hours of continuing professional education annually. Those hours will be broken down to 3 hours of tax updates, 2 hours of ethics and 10 hours of general tax education.
• The registered preparers will be answerable to all the rules in Circular 230.
• The IRS will develop enforcement procedures to keep everyone honest. The Office of Professional Responsibility (OPR) will administer the program and staffing will be expanded to handle the new job.
• The IRS will create a public education campaign targeted at both preparers and taxpayers. And they will create a registered tax preparer database that taxpayers can check on a preparer.

There are several areas which will be subject to future study. The report will be looking at the RAL/RAC programs and the use of the debt indicator. Tax software will also be a focus in the future. Nothing is written in stone. While CPAs, Attorneys and EA are getting a pass right now, the report specifically suggests that their automatic exemption from the rules will be re-visited once the program is up and running.

Fun times ahead. Too bad the report wasn't issued on time to give us more time to analyzes and rant before returns take up all my time. There is still one major issue the report did not cover; what will these new preparers be called?

Tax Suprise - 1099C

It is that time of year - resolution time. Everyone is making promises to make themselves better; lose weight, exercise, quit smoking, get out of debt... And all over the TV are companies who are promising to help you meet your goals, for a fee. They want to sell you equipment, special programs, food and services to make your goal a reality. Buyer Beware!

Over the last few days, I have seen several companies which promise to help you with credit card debt. They promise to help you "settle" with the card companies. These companies have been around for a while. Generally, they negotiate with the card company for reduced interest rates and a more forgiving pay back schedule for you. Each company is different and it's up to you to do your research into the company and their program. The last few days I have hear the word "settle" much more often (or it's being pushed more.) It is the word "settle" that is the reason for this post. To me, "settle" seems to be implying a end of the problem (the debt). A forgiveness of the debt. If you owe on a credit card and the card company agrees to forgive that debt, so you don't pay them back all or a part of what your owe them, you will generally owe taxes on the money they forgive. The card company/debt negotiator may not warn you about this. Too often, I have had clients who received this surprise in the mail and they don't know what it is.  Often it is sent with all the papers they receive documenting the debt forgiveness, and they file it with that paperwork.

1099C Cancellation of Debt is the form this surprise takes. It can be issued not just for credit card debt but foreclosures in general. I am sure there are taxpayers who have seen this form for a home they could no longer afford. The bottom line is that if a lender forgives you a debt you can be taxed on the amount of the debt. Why, because it could be a deductible expenses for them and if they deduct it someone has to be taxed for it. So, for the taxpayer, it is income. It is taxed in the year the debt is forgiven. You should receive a 1099C but like I mentioned earlier it could come with all the documents to close the debt. You many need to look for it. Since the lender has issued a 1099C, this income will show on the IRS matching program. If you miss it in the year it is issued, it will catch up with you later with penalties and interest.

If a lender, be it credit card company, bank, credit union, etc., forgives a debt you owe them, you have to understand that there may be tax consequences and prepare for them. Talk to your tax professional.

Filing With a Pay Stub

This is the time of the year where the radio and TV ads and business signs suggest that you can bring in your last pay stub and get money. Implied is that the return is being done and you are receiving all or part of your refund. Buyer Beware! Please check into what you are buying.

Working from paystubs, there are businesses offering to advance part of what they estimate you will be receiving in a tax refund. There also may be a restriction on how you use the advance you are offered. It may have to taken in a debit card or applied to a car/furniture purchase. Whether you get cash or a purchase credit, you will have to meet other qualifications. There may be a credit check, you may have to be a prior customer, your employer may be contacted. Once the advance is issued, you still have to file a return. Sometimes this can be done through the business who issued the advance or you may have to do it on your own and take the re-payment to that business. These advances were a rage a few years ago but after the RAL banks lost lots of money they stopped giving cash. Now you have to settle for a pre-paid debit card or purchase credit. Do your homework to make sure you understand exactly what you are buying. And don't forget to file your return.

By the middle of January, I will have received a half a dozen calls wanting to file from their pay stub (I've already received one). Can't do it. IRS requires me to have a copy of every W-2 on any return I file. (There is an exception to that but it can't be used until the middle of February.) If you can find someone who says they will file from a paystub, don't assume you are okay since they are the ones breaking the law. You will have to sign the e-file authorization which says you are filing a correct return. If you are filing from a paystub, you may not have an accurate return. W-2s and paystubs seldom match or there may be other income you are ignoring or forgotten about. Also, if the preparer is ignoring the rules and filing with a paystub, what other rules are they ignoring and could those have a consequence for you? Is getting your refund a few days/weeks early worth the potential problems and costs?

The IRS doesn't open e-filing until January 15, 2010. If you find someone who will complete a return from a paystub, it can't be e-filed before then. And mailing it will set off questions right off since then the W-2 has to be attached to the paper return. Employers have until January 31st to get W-2 in the mail. Even if an employer waits that long, filing with a pay stub will only gain you a couple of weeks. Is it worth the hassle?

Send Chocolate...

...it's going to be a crazy tax year and I'm going to need lots of the good stuff. Tax season is just a few weeks away for my business and it's already shaping up to be a stressful 3.5 months.

This is my time to get all office stuff done. Stuff like the client newsletter, documents for the client packets printed and some packets made up, archive last year's sig forms, order office supplies, test the software, hire a receptionist and set my ads. Oh, and clean the office. But I am still doing tax returns. Hopefully, by the time I open next Monday, I will have 9 returns completed. I don't want to be doing past year returns between 941s, W-2s, 1099MISCs and the early 2009 returns. With any luck, all those forms will be done by the time we can electronically file on the 15th.

Then it really will get stressful. I have made changes in office procedures that will have to be explained to the clients, several times for some. The biggest change is dropping Refund Loans. I expect some serious cussing and carrying on from a couple clients. Then there are all the consent documents and engagement letter to be explained and signed.

But the major stresses have been provided by Congress and the Administration. Tax changes are part of the job but this is the craziest year I remember since the big reform of 1986 went into effect in 1988.  The Making Work Pay credit is sure to hurt taxpayers who will vent, loudly. Right now, we don't know what info Social Security will give us about the $250 they sent out. From experience, I am sure most clients won't remember what they received especially since most received the money by direct deposit. I'll have to explain to new homeowners that they will have a long wait for their Homebuyer's Credit since we can't e-file that form and we now need documentation of the purchase. Then there is the education credit/deduction confusion, clients wanting to know about Roth IRA conversions and changes in the documentation for Energy Credits. Tax planning for next year will have to be put on hold until Congress gets back to work on the tax extenders and the estate tax.

Then there are the stresses of running a tax business. We have licensing of preparers, the new e-file mandates, the introduction of Modernized e-file, and the RAL issues. While many of these changes might not directly affect me, I'll have to cope with the problems and possibilities they create.

Yeah, this will definitely be a major chocolate season.

Bad News Before Christmas

All over the country, small tax offices and Jackson Hewitt franchisees received a nasty Christmas present 22 days before 2010 electronic filing begins.

On December 24th, Pacific Capital Bancorp announced that they want to sell their tax business to a private equity fund because regulators have barred it from originating any Refund Anticipation Loans in 2010. The thrust of the article is the impact on Jackson Hewitt which relies on Pacific Capital's tax business (Santa Barbara Bank and Trust) for 75% of their RAL funding. Beside Jackson Hewitt, SBB&T has a large part of the independent RAL market.

Another bank faces the piper for it's operating practices - so what? Because the service they offer is relied upon by small business owners all over the country. No matter what you think about RALs, millions of taxpayers use them and that is why JH, H&R Block and independents alike offer them. Had RALs been stopped across the board, taxpayers and business owners would have been effected but without the confusion and side effects this announcement could cause. If JH and Pacific Capital can't get this solved soon, we might see:

• Independents will be scrambling to find a new RAL bank. There are only a few options and from what I have heard, some might be in financial trouble too.
• Once the season begins, I think approvals will be down. If JH and many independents loose the ability to offer RALs, many clients will go to any tax office that can. The extra requests may put pressure on the remaining banks to be more cautious with money since they don't have a history with the new clients. This caution with funding has been happening already and one of the reasons I stopped offering RALs this year was the long time RAL clients who were denied a loan for no reason. The preparer will take the brunt of the taxpayer's anger at being denied.
• I think tax preparation prices will go up. The clients want RALs. There are limits to fees associated to them because of APR issues. The alternative is to raise tax preparation fees to take advantage of the demand. This effects all that preparer's clients not only the RAL client.
• As taxpayers look for a preparer who is still offering RALs, the no show dance will intensify. Joe wants a RAL but can't get in office A for 3 days. He makes an appointment and tries office B which has a wait of 2 days. Another appointment is made and a third office is tried. Of course no appointment is canceled. Those offices get a no show.

I could be wrong but if Pacific Capital and JH can't get this worked out soon, a lot of small business owners will not be seeing a happy new year as their income drops and clients are lost. These was shaping up to be a difficult tax season already but for some, this could be a killer.

W-5 - Advance EIC

A few days ago, I posted about checking your W-4 for 2010. While you are checking that, it might be a good idea to look into advance on your 2010 Earned Income Credit.

Earned Income Credit (EIC) is a program which started as a way to give lower income taxpayers with children back some of their FICA and Medicare withholdings. Since then, the program has been expanded with inflation adjustments, adjustments for additional children and filing Married Joint and a credit for taxpayers without children. EIC can be very lucrative. It is also a major source of tax fraud. For most lower income taxpayers, EIC is a life saver. It is the little extra that allows them to payoff debts, prepare for large expenses and even save a little. It makes tax refunds an anticipated event. But with Advance EIC, the taxpayer can get some of their EIC in their pay check and less at the end of the year.

Here's how it works. The taxpayer completes a W-5 and give it to their employer. They verify on the W-5 that they expect to have at least one child and qualify for EIC for that year. (That means taxpayers without a qualifying child can't get advance EIC.) They also specify if they are single or married and if married if their spouse is also filing a W-5. The employer uses that information and the IRS charts to give the taxpayer part of their EIC in their pay check. The amount the taxpayer received in their check is dependent on how often they are paid, how much their pay is for that period and if they are single, married and if married if both taxpayers are taking advanced EIC. The maximum advance for 2009 was $1826. The W-5 is only good for that calendar year and must be done on an annual basis.

Example - (Based on 2009 figures)

Mary Taxpayer is a single mom providing a home for her son Timmy. Mary qualifies to file Head of Household and claim Timmy as a dependent. She has W-2 wages of $12,000 paid bi-weekly, unemployment of $3223 ($823 taxable in 2009) and $50 in bank interest. This makes her AGI (adjusted gross income) $12,873. By the time her standard deduction and two exemptions are subtracted she has no income to tax. With no tax, Mary will receive a refund of $4443 ($400 Making Work Pay Credit, $1000 Additional Child Tax Credit and $3043 in Earned Income Credit). Had she elected to take advance EIC payments for the whole year she still would have a refund of $2647 but she would have had an extra $69 in her pay every two weeks.

That is a very simple example but it gives you an idea how the program works. Now for the real world issues. If Mary had 2 or more children living with her, her advanced EIC would have been the same. However, she would have received more EIC on her return. If her income was much higher or lower, the advance would have decreased. The example was created to get the maximum advance. She also has to make sure she qualifies for EIC. If she fills out a W-5 and receives advanced EIC payments then doesn't qualify for EIC she will have to pay back the advance. If she had submitted a W-5 and them realized she doesn't qualify for EIC, Mary would have 10 days to give her employer a new W-5 revoking the payments. It is also Mary's responsibility to monitor her pay checks to make sure the advance payments stop.

Advanced EIC is more work for the employer. If an employee gives them a signed and completed W-5, the employer has to give the advanced payments. These payments are reported on the employee's W-2 in box 9. Advance EIC payments are subtracted from the employer's tax deposit. Say Mary's employer has withheld $250 for Federal withholding, FICA, and medicare from all his employees that pay period. He would subtract her advance EIC of $69 and reduce his deposit to $181.

When Earned Income Credit is discussed, forcing recipients to take advance payments is often proposed. My concern is that these taxpayers assume they qualify for EIC and taking the advance payments then not qualifying and having to pay the money back. 

Advance Earned Income Credit payments can be a help to lower income families struggling to make ends meet. But, they should be requested only if there is no doubt that the taxpayer will qualify for EIC and understands how the program works. I have to be honest, in 20+ years of tax preparation, I have never had a client bring in a W-2 with advance EIC payments.

Your W-4

When I was still working seasonally doing taxes and had another job full time, every year my employer gave us a W-4 to complete for our file. For most of us, it was a inconvenience. But looking back it was a good idea. Besides making sure they had a current address, it made us think about our taxes and if we needed to make changes to our withholding. It forced many to do what they had put off all year, adjust their withholding. I don't know how many times I have suggested changing withholding to a client and the next year they still have the same problem because they never got around to taking a new W-4 to Human Resources.

But it doesn't do any good to fill out a new W-4 if you are just going to put same status and exemptions as the preceding year without at least considering making changes. Why should you make changes to your W-4?

• The Making Work Pay Credit is still in effect for 2010. This credit raises a lot of situations where a taxpayer may want to change their withholding. Please see my post on this.
• If you didn't like the results of last year's return and didn't make changes before, now is the time to plan for 2010. A little extra out of each paycheck is easier for your budget to absorb than a big balance due. And it works the other way too. A bigger than planned tax refund is a good reason to give yourself a little raise.
• Think about the changes coming in your life. Marriage, divorce, new baby or children growing up can all impact your taxes and should force a re-evaluation of your withholding.
• Other income will effect your taxes. Some can't be planned for in advance, like gambling winnings, but may trigger the need for a new W-4 during the year. A second job or a spouse taking a job or unemployment can cause a larger change to your taxes than withholding on the new income can cover.

The W-4 is the best tool the average taxpayer has to protect against a nasty tax surprise. It can't reduce their actual tax but it can allow the working person a method of easily fullfilling their tax obligations. But it's up to you to maintain the tool and keep it working for you.

First Time Homebuyer - Part 3

Last month I did a quick post about the extension of the First Time Homebuyer's Credit and promised more info. Sorry, it took so long.

The $8000 credit has been extended to April 30, 2010 for the first time buyer but this time all it takes to meet the cut off is a binding contract in place by the April 30th date. The buyers then have 2 months, until June 30th to close. Military and certain federal employees who are serving out of the country have an extra year to buy a home and still qualify. Also to aid purchasers, Congress increased the upper income cap. For married filing joint taxpayers, they can have modified AGI (adjusted gross income) of $225,000 before the credit begins to be reduced. Above $245,000, the homebuyer's credit is not allowed. Everyone else is limited to income of $125,000 before the credit is reduced and it's gone by $145,000. While the phaseout limits were increased, there is now a cap on purchases. The maximum purchase price for the credit is $800,000. Buy a more expensive home and no credit.

Added to the bill (Worker, Homeownership and Business Assistance Act of 2009), is the ablity to qualify for a reduced credit if you already own a home. Taxpayers who have lived in their home for 5 consecutive years in the last 8 and meet the income and purchase guidelines can take advantage of a $6500 credit. The new home must still be used as their primary residence but the old home does not need to be sold. The taxpayer can convert it to a rental or investment.

The credit can be taken on either 2009 or 2010 returns but there is a new Form 5405 being created that is to be used. As mentioned in the earlier post, this form can't be electronically filed because a HUD statement must be included in the return to document the sale. This has been an issue with amended 2008 returns taking advantage of the credit this summer. Many taxpayers have been asked to send a wide range of documents to verify they qualify for the credit. This program has been a victim to widespread fraud and it is hoped that this will help cut the fraud.

A reminder

If you sell or stop using as a personal residence a home that you have taken the 1st Time Homebuyer's Credit, you might be subject to some recapture (repayment) of the credit. Since the recapture depends on which credit you took and details of the sales, please check with your tax professional for how your specifics affect the repayment.

MSRRA

On November 11th, the President signed into the law the Military Spouses Residency Relief Act. MSRRA gives taxpayers who follow a military spouse to a new location because of orders the option to designate their home state as their legal residence and pay state taxes there not in the state of current residence.

Legal residence generally is the state in which you live, vote and have a driver's license. For most of us, that is the state where we current reside. Not so with military taxpayers. When a taxpayer enters the military, they specify their state of legal residence and this determines what state income tax they pay. It is shown on their Leave and Earnings's statement (LES). So, Jane enlists in Kansas and sets Kansas as her legal residence. While she is in the service, Jane will not be subject to any state's tax but Kansas. If, Bob, her husband, follows her to a post in California from Kansas, he would pay state taxes based on the states' residency rules. The first year, he could be subject to both Kansas or California depending on where his income came from. After that, generally he would be subject to California taxes. Jane would be considered to be a resident of Kansas and Bob a resident of California.

With the passage of MSRRA, Bob can elect to become a legal resident of his military spouse's legal residence as shown on her LES. Bob would then maintain a Kansas driver's license, vote in Kansas elections and pay taxes on the income earned in Kansas and not in California. This goes into effect in 2009. If there was CA withholding in 2009, Bob is entitled to get that money back. The catch is that there will be no withholding for the legal residence state and this could result in a balance due.

There are still a lot of details to be sorted out. Each state will have to work out how to handle the refunds of withholding. There are also issues taxpayers with self-employment income. To keep updated on this, there is a Facebook page dealing with MSRRA.