Archive for Tax Policy

Trailing Nexus – Constitutional?

We know that a physical presence in a state can create sales tax nexus (per Quill decision).  When does that nexus end?  What if you had a sales office and then closed it?  What about income tax nexus?

Some state laws specifically say that nexus can continue even after it looks like it ended. This is called “trailing nexus.”  It seems odd.  But, perhaps if you close your office and continue to fulfill orders from catalogs people picked up in your store when it was open or have a coupon you gave them that expires after you left the state, it makes some sense. Maybe.

For more, see my 21st Century Taxation blog post with some links – http://21stcenturytaxation.blogspot.com/2012/12/trailing-nexus-constitutional.html.

Have you had an auditor raise this issue?  How do you advise clients as to when nexus ends?

Written by | Posted in Tax Policy

Penny Taxwise – The Skinny on Self-Employment Taxes

Hola, my tax-conscious compadres! Penny Taxwise here, back again with another installment of tax-tacular advice for your reading pleasure. This week, I chose an answered question from another Tax Connections member – the query was one I’ve pondered myself quite a bit lately. I want you to take a look at the original question before we get into the discussion portion of the program:

What is Self-Employment Tax and is this in addition to other taxes I pay as a small business owner at the end of the year?

This question is extremely relevant to my own situation – I’ve been doing the freelance writing thing for some time now, but this past year will be the first tax cycle I’ll have officially done it full-time (pause for applause). I myself have wondered how the whole tax thing should go down for the work-at-home crowd. I guess some part of me understood that my income taxes would be separate from the self-employment taxes I’d need to pay, but I was a bit fuzzy on the specifics.

Tax Pros to the Rescue

One of the dynamite Tax Connections gurus, Gary Carter, rushed right to the rescue with a fantastic (and not confusing – whew!) answer to the question. He’s the President of GW Carter, Ltd, Certified Public Accountants in Minnesota.

According to Carter:

Self-Employment tax is Social Security and Medicare tax for self-employed individuals. The rate is 13.3% of your self-employment net income for 2012 (10.4% for Social Security tax and 2.9% for Medicare tax).

Essentially, Carter’s saying that self-employment tax is the money that would be taken out of your paycheck automatically if you worked for an outside employer. When you work for yourself, your tax liability is the same as those who are externally employed, you’re simply responsible for paying into the system on your own.

Carter continued his answer by enlightening the asker about some upcoming changes to the tax code. “Beginning in 2013,” he says, “the rate for Social Security tax will increase by 2%, so the combined rate will be 15.3%.”

He also warns that self-employed individuals should be aware that their self-employment net income is the net income shown on Schedule C of Form 1040 – and not their taxable income. That’s why a self-employed person could have no taxable income yet still owe self-employment tax.

Make sense?

Yeah, it kind of confused me too. Luckily, Carter provided an example in his answer for those of us who need a little help wrapping our brains around this info. Gotta love those TC Tax Pros! Here’s what he said: “[L]et’s say your net income on Schedule C is $27,000 in 2012, and you are married filing jointly with two dependent children. Your taxable income is zero after your 4 exemptions and the standard deduction ($27,000 – ($3,800 x 4) – $11,900), but you will owe $3,591 in Self-Employment tax.”

That illustration really hit home for me because – jackpot – he described my exact tax situation. No joke. So now I understand – even though my income taxes will be zilch, I’ll still need to pony up a few thousand to cover my Medicare and Social Security. Makes sense… I’d better start padding the ol’ savings account before the tax man comes calling.

Bracing for the Blow of a Big Tax Bill

Now that we’re clear on the semantics of self-employment taxes, let’s shift the focus to footing the bill. Many self-employed people (cough, cough… myself included) fail to save adequately for the taxes that will inevitably find them each and every year they work for themselves. That’s why implementing some sort of system to set aside money for Uncle Sam is vital to protecting your bottom line – and your biz.

Once you pay self-employment taxes for the first time, you’ll be able to figure out roughly how much you’ll owe for the upcoming year. That is, unless you expect your income to sharply rise or fall. If you’re confident that everything will indeed stay consistent, however, then you have a solid figure with which to work.

Here’s my plan. I’m opening a dedicated savings account strictly for my tax savings. I won’t allow myself easy access to the funds – in fact, I’m planning to request that my bank limit my ability to transfer money from the account to my checking, if at all possible. I’ll dump a portion of everything I earn into the account – before I deposit the remaining money into my checking. If I overestimate my tax bill a bit one year, no problem. The leftover dough will be a great cushion for the following year’s bill.

Self-employment taxes are no joke, and neither is self-employment. I’m learning that the hard way. Without a boss hanging over your shoulder barking orders or a payroll department to neatly deduct taxes from your paycheck before you see it, it’s tough to regulate yourself. That’s why it’s so important to set up systems to regulate your business behavior. No one’s gonna catch you if you fall, so you might as well build yourself a net.

Until next time, my taxpaying friends!

Making Cents Count,

Penny

Written by | Posted in Individual • North America • State And Local Tax (SALT) • Tax Policy • TaxConnections

Becoming a Weatherman

Despite being a “taxman” for the past 22 years, I find my role in today’s economic climate making me feel more like a “weatherman” assessing a coming storm. The weatherman talks about the huge storm coming and for people to take cover and prepare for the worst. Who listens to the weatherman anyway? The storm sometimes seems so abstract that most people just cannot fathom what potential it carries, and generally believe it will hit somewhere else.

The IRS has been releasing more information about the new taxes in the Affordable Healthcare Act that will be implemented in 2013. Just like the “weatherman,” the tax professional should be reviewing their client’s situation to see if this coming storm will affect them, where, and how hard: preparedness mitigates damage, and saves resources.

The role of the tax professional has changed over the years, and the Affordable Healthcare Act just reinforces the need for your tax professional to be more focused on tax planning for immediate consequences, as well as making adjustments for coming changes in the future.

On the immediate horizon is the new 3.8% Medicare surcharge tax on net investment income for taxpayers with income over $200,000 / $250,000 (single / married filing jointly). One of the key planning hurdles was waiting for what the IRS definition of “net investment income”, which includes most passive income activities. Although this additional tax will not hit the majority of taxpayers, poor planning may make it a trap for some. One very real area is anyone considering doing a Roth Conversion (I rarely advise) after December 31, 2012, which has the potential to make lower income folks subject to the new tax by raising their adjusted gross income (AGI) above the threshold.

Higher income taxpayers will be subject to an additional 0.9% Medicare tax on their wage income over $200,000. If their AGI surpasses the thresholds above, their net investment income will be subject to the 3.8% described previously, and will subject interest, dividend, capital gains, royalties, rental income, as well as any other passive activity income to the additional tax.

The clairvoyant tax planner may also see many other changes on the horizon that taxpayers should mitigate. My senses tell me that we will see fringe benefits like employer-paid healthcare became taxable in the future, as these tax-free benefits become a larger portion of employee compensation. There will also be a coming debate on taxation between those that pay for insurance after-tax from government exchanges versus those that get it from their employer tax-free. The haven of the Subchapter S Corporation will likely end, or be modified so that all income is subject to self-employment tax. As personal tax rates climb, and both political parties talk about reducing corporate rates, partnerships and S Corporation may find the traditional C-Corporation more advantageous. Moreover, if conditions continue to align, it may even challenge the taboo of individual taxpayers holding their rental real estate (passive activity) in a corporation (active trade), which is generally frowned upon because it makes it difficult to refinance property and take tax-free distributions.

Yes, tax planning is the future emphasis on the tax professional. I hope that we do better than the weatherman, who only gets it right 50% of the time. At this point though, with most taxpayers experiencing declining wages and less disposable income, tax planning may be low-hanging fruit to put more dollars back into the taxpayer pocket.

Taxpayers should find an experienced Enrolled Agent in their area that focuses on tax planning and taxpayer representation. Enrolled Agents are the only federally licensed tax professionals with unlimited rights to practice before the IRS and focus solely on taxation. Attorneys and CPAs are licensed to practice by their state only, while Enrolled Agents are licensed in all 50 states.

Written by | Posted in Federal • Individual • Tax Policy

Base broadening for all – not just others

We have been hearing from both parties on base broadening as a way to pay for continued tax cuts and perhaps even to reduce our debt and deficit. While many people likely think base broadening means someone else will lose special rules, all taxpayers will likely have existing deductions, exclusions, credits and lower rates cut back.

For more on this topic, please see Tax Reform and Base Broadening.

Written by | Posted in Tax Policy

Penny Taxwise’s Boomerang Niece

Howdy, folks! Penny Taxwise here, back ‘atcha with another fun-filled tax adventure! Hope your Thanksgiving was loads of fun – I know Mr. Taxwise is still comatose from his turkey-induced stupor.

Today, we’ll be looking at my poor sister’s parenting conundrum and how it relates to the topic de jour: taxes, of course! Ever heard of a “boomerang kid”? It’s a new-fangled term that’s sprung from the sagging job market these days, and it refers to college grads who move back in with their parents after a failed job hunt.

Well, my sister is dealing with a slight variation on the term. Her little bundle of joy is now a woman who is (blessedly) gainfully employed. She’s working before attending college, but her job doesn’t pay enough to make ends meet. My sister, being the good mom she is, stepped up to the plate to pad my niece’s bottom line, but now sis is wondering how this will affect her own finances come tax time.

I told her not to fear – Tax Connections would come to the rescue and answer her question lickety-split. Here’s the question, just as I asked it, on the platform:

My sister’s 18 year old has a job and just moved out, but she’s still providing considerable monetary support for her. What are the rules surrounding my sister claiming the kid as a dependent on her taxes?

Claiming Dependents – An Answer from a Pro

In no time flat, a tax pro right here on Tax Connections stepped up to the plate. Patrick O’Hara , EA answered my sister’s plea thoroughly and clearly, and she couldn’t be happier with his response.

O’Hara began by warning that questions regarding filing status and exemptions can become quite complicated in a hurry.

Why?

Simple – the right classification hinges on a variety of factors. You can find a detailed review of these stipulations in IRS Publication 501.

According to O’Hara, if my sister wants to claim her daughter as a dependent, she must be a “qualifying child” under the IRS’s definition. There are five tests the IRS sets forth which my sister can use to determine whether her daughter meets the definition – stuff like age, residency, support, and relationship. Sounds simple enough, right?

There’s also a stipulation that a dependent cannot have a joint return filed. This was easy enough – my niece is 18 and unmarried, so big check mark in that department. The next test – relationship – was a win as well since (obviously) there is a mother-daughter relationship in this case. The age requirement stipulates that the dependent in question must be under 19 or a full-time student. A win there, too – in our case, she’s 18.

The living requirement made us nervous, but luckily, in our circumstance, my niece had moved out of my sister’s house later in the year, so she just squeaked by with the residency requirement. She’d lived in the house a little over half the year. Phew.

The fourth requirement centered on the taxpayer (my sister) paying more than half of the child’s support. This one made us laugh a bit. Half!? My sister’s been footing the bill for more like three quarters of that kid’s expenses! Check mark there, too.

Finally, as we touched on earlier in this post, my niece had not previously filed a joint return (she’d have some serious explaining to do if she had). This would have been a deal-breaker, but we met this requirement as well.

Therefore, in my sister’s case – her daughter was her dependent in the eyes of the IRS. Yay! According to O’Hara:

In the case you describe, it would appear that the child is a qualifying child. The ability to claim the qualifying child may also make your sister eligible for head of household status, assuming she is not married, which provides a greater standard deduction and lower tax rates.

This was fantastic news for my sis, and she’s currently looking into the “head of household” matter to see if she can qualify for even greater savings on this year’s tax bill.

True Boomerang Kids

This economic climate is no picnic, and having a child move back into the nest after leaving home is both emotionally and financially tumultuous for any parent. Of course, we try to do what’s best for our kids, and the government understands that (sometimes).

If you’re dealing with a boomerang kid of your very own, then take solace in the fact that you can likely claim your child on your taxes and snag that coveted dependent exemption, which will effectively reduce the amount of your taxable income by $3700 (in 2011). Now that’s enough to ease the blow of a newly-returned member of the household cranking up your thermostat and driving you wild.

In Conclusion

If you are thinking of claiming your own boomerang kid, then make sure to discuss the tax situation with your child before you file. According to O’Hara, many times a child will file a return on his or her own and (incorrectly) claim a personal exemption. This could be bad news if you claim your kids, too – it will raise red flags that may trigger you and junior for an audit.

Simply remind your kids that they cannot claim themselves if they qualify as your dependent. Nip this in the bud by suggesting that you sit down and file your taxes together when that time of year rolls around. Nothing brings people together like crunching numbers [dramatic pause for laughter].

Until next time, my tax-conscious comrades!

Making Cents Count,

Penny

Written by | Posted in Individual • North America • Tax Policy • TaxConnections

FATCA Intergovernmental Agreements

We originally posted on Thursday, November 8, 2012, U.S. Engaging with More than 50 Jurisdictions to Curtail Offshore Tax Evasion “Global cooperation is critical to implementing FATCA in a way that is targeted and efficient,” said Treasury Assistant Secretary for Tax Policy Mark Mazur. “By working cooperatively with foreign governments and financial institutions, we are intensifying our ability to combat tax evasion while minimizing burdens on financial institutions.” BNA has a good analysis of the of the composition of current (and future?) specifics of FATCA Intergovernmental Agreement.

Written by | Posted in Africa • Asia • Australia/Oceania • Caribbean • Corporate • Europe, Middle East • Expatriate • FATCA • Federal • Individual • International • South America • Tax Policy

A Forgotten Provision in Need of Reform

Have you ever noticed two pie charts include in the 1040 instructions? They have been included since 1991.  But who looks at instructions today?  It is well past time for IRC Section 7523 to be brought into the modern era with the two pie charts (one shows government revenue and the other government expenses) to be required to be posted on government websites.  For more and to see the 1990, 2000 and 2010 pie charts, see a short article here – http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2012/Tax/Timetomove_Sec7523.jsp.

Written by | Posted in Tax Policy
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