IRS Resolution

Don’t Do This

There is one financial transaction that I strongly discourage clients from doing and here’s why . . .

Do not withdraw from your retirement accounts early! Here are the reasons why I hear most people want to withdraw from their retirement accounts:

  1. Purchase a house
  2. Pay for expenses while unemployed
  3. As a temporary loan, with the intentions of replacing the money
  4. To pay for unforeseen expenses
  5. You need the money for (fill in the blanks)

The main reason to not do this is because it is one of the major reasons for tax problems. Aside from early withdrawal penalties, additional income taxes are accessed  on the balance, withholdings are not usually taken or not enough, and you may end up increasing your income, which sometimes pushes you into an even higher tax bracket. Once you add up all of the penalties and taxes, then the amount withdrawn can disappear by half for some.

What are some other options as you are most likely withdrawing your retirement funds because you desperately need the money and do not have a cash cushion? If you are employed, you may be able to obtain a retirement plan loan from your employer, which is not a taxable event. Alternatively, you might be able to borrow the money from your home’s equity. In some cases, you may be able to delay what you need the money for if not needed for emergency purposes.

Over the long-term, this is why I stress slowly building up a cash emergency fund. Yes, it’s boring and unexciting, but you will be glad you did when the time comes.

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5 Risks to be Aware of that Will Hurt Your Finances

There are ups and downs in life, good times and bad, and everything in between. Unfortunately, some events can hurt your finances in a significant way and may even be beyond your control. What are some of these risks to be aware of and what can you control?

Health Issues

As we become older, there are more chances of having a serious health issue. What is not commonly thought of is that family members, such as spouses, elderly parents, and children can develop health issues, both physical and mental. We have a responsibility to take care of our family, and the time spent will take time away from our job or business, which will eventually lower our earnings. While you cannot control the health of others, you can take charge of your own health and that of your children by living a healthy lifestyle.

Addictions

Do not think that you are immune to addictions. Aside from alcohol, illegal drugs, and gambling addictions, there are other destructive addictions that will ruin your finances such as prescription drugs, video games, and pornography/sex. The statistics on who has these addictions, how they start, age groups, and the impact on your brain are alarming. Be aware of these addictions and do your best to stop them before they start.

Divorce

Aside from paying legal fees, there are statistics that show that divorced women experience a prolonged loss of earnings and lower standard of living after divorce, even though various studies show that approximately 70% of women initiate divorce. Surprisingly, statistics show that a man’s earnings increase significantly after divorce. Focus on a healthy marriage and your finances will be stronger, plus some studies show that divorce does not lead to a better life.

High Income then Low Income

Inconsistent income patterns can hurt your finances in multiple ways. The first is that if your income is very high in one year, then your spending will probably increase, and once your income drops, your spending will probably not drop as quickly, if at all. Second, if you have a very good year in your business and don’t set aside a reserve for taxes, then you won’t have the money to pay your tax bill, especially if your income is lower in the following year. I have seen this situation happen repeatedly.

Expense Creep

Expenses have a way of increasing faster than your income and are hard to lower once they do. A good rule is to increase your savings in the same proportion as your income, and do not incur additional debt. This way, it does not really matter what you spend, and yes, I really did say that, because mathematically it does not matter. It’s putting first things first.

 

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COVID-19 Tax and Financial Updates 04-10-2020

Here are the latest updates and some reminders:

Tax Updates

  • Tax deadlines: both New Jersey and New York have finally extended the tax deadline from April 15th to July 15th.
  • If you have an existing installment agreement with the IRS, payments due between April 1 and July 15, 2020 are suspended.
  • CARES Act economic impact payments: payments will begin this month and you do not have to take any action if you filed a return for 2018 or 2019.

Paycheck Protection Program Info

  • Sole proprietors, independent contractors, and self-employed persons can start applying for this loan starting today
  • The banks are completely overwhelmed with loan applications and some have temporarily stopped taking new applications, especially if your business does not have an existing relationship with the bank
  • The information required consists mainly of prior year’s payroll filings, loan applications, etc.
  • The program will be available until June 30, 2020
  • We are not sure how long it will take to receive funding, but if you have received funding, then please let us know

Existing SBA Loans

  • The SBA will automatically pay the principal, interest, and fees of current 7(a), 504, and microloans for a period of six months.
  • The SBA will also automatically pay the principal, interest, and fees of new 7(a), 504, and microloans issued prior to September 27, 2020.

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COVID-19 Tax and Financial Updates 03-27-2020

There have been a lot of tax and financial announcements due to the COVID-19 pandemic. Here are some highlights of updates as of this writing:

Tax Updates

  • Tax deadlines: The Treasury Secretary announce that the tax deadline for all businesses and individuals is delayed from April 15th to July 15th. Additionally, they will be able to make payments without interest or penalties. This also applies to the first quarter 2020 estimated income tax payment that is due on 4/15/20, however it does not postpone the second quarter estimated tax payment due on 6/15/20. Yes, that is strange, but we are living in unique times. IRA contributions for the year 2019 can be made until 7/15/20. So far, there isn’t any news from the State of NJ.
  • Existing Installment Agreements: For taxpayers under an existing IRS installment agreement, payments due between April 1 and July 15, 2020 are suspended. Taxpayers who are currently unable to comply with the terms of an Installment Payment Agreement, including a Direct Deposit Installment Agreement, may suspend payments during this period if they prefer. Furthermore, the IRS will not default any Installment Agreements during this period. By law, interest will continue to accrue on any unpaid balances.

Families First Coronavirus Response Act: Employee Paid Leave Rights

Generally, the Act provides that employees of covered employers are eligible for:

  • Two weeks (up to 80 hours) of paid sick leave at the employee’s regular rate of pay where the employee is unable to work because the employee is quarantined (pursuant to Federal, State, or local government order or advice of a health care provider), and/or experiencing COVID-19 symptoms and seeking a medical diagnosis; or
  • Two weeks (up to 80 hours) of paid sick leave at two-thirds the employee’s regular rate of pay because the employee is unable to work because of a bona fide need to care for an individual subject to quarantine (pursuant to Federal, State, or local government order or advice of a health care provider), or to care for a child (under 18 years of age) whose school or child care provider is closed or unavailable for reasons related to COVID-19, and/or the employee is experiencing a substantially similar condition as specified by the Secretary of Health and Human Services, in consultation with the Secretaries of the Treasury and Labor; and
  • Up to an additional 10 weeks of paid expanded family and medical leave at two thirds the employee’s regular rate of pay where an employee, who has been employed for at least 30 calendar days, is unable to work due to a bona fide need for leave to care for a child whose school or child care provider is closed or unavailable for reasons related to COVID-19.

Covered Employers: The paid sick leave and expanded family and medical leave provisions of the FFCRA apply to certain public employers, and private employers with fewer than 500 employees.

Eligible Employees: All employees of covered employers are eligible for two weeks of paid sick time for specified reasons related to COVID-19. Employees employed for at least 30 days are eligible for up to an additional 10 weeks of paid family leave to care for a child under certain circumstances related to COVID-19.

Qualifying Reasons for Leave: Under the FFCRA, an employee qualifies for paid sick time if the employee is unable to work (or unable to telework) due to a need for leave because the employee:

  1. is subject to a Federal, State, or local quarantine or isolation order related to COVID-19;
  2. has been advised by a health care provider to self-quarantine related to COVID-19;
  3. is experiencing COVID-19 symptoms and is seeking a medical diagnosis;
  4. is caring for an individual subject to an order described in (1) or self-quarantine as described in (2);
  5. is caring for a child whose school or place of care is closed (or child care provider is unavailable) for reasons related to COVID-19; or
  6. is experiencing any other substantially-similar condition specified by the Secretary of Health and Human Services, in consultation with the Secretaries of Labor and

Important points for employers:

  • The effective date of the Families First Coronavirus Response Act is April 1, 2020 through December 31, 2020.
  • The law is intended to be neutral for employers. Employer pays benefits and recovers the cost of such leave through a refundable, dollar-for-dollar payroll tax credit (up to certain dollar limits)
  • Employer receives 100% reimbursement for paid leave and certain health insurance costs, but
  • the amount is includible in income
  • Paid leave itself is exempt from employment taxes, and if the employer continues the employee’s health insurance coverage while he/she is out on leave, then the credit is grossed up to cover this additional expense

SBA Loans

The SBA is offering low-interest loans of up to $2 million with a low interest rate of 3.75% and long repayment terms. The SBA is waiving the “credit elsewhere” clause. The process should take 2 to 3 weeks and the website to go to is:

https://disasterloan.sba.gov/ela

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What Keeps Business Owners Up at Night?

Aside from worrying about everything, there are really just a few timeless concerns of most business owners. If you don’t have at least one of these concerns then that is probably a concern. Here they are with a few solutions:

Employees: No matter how well you run your business, it will always be a challenge to manage employees. Common problems are: finding good employees, keeping good employees, and making sure that they are productive. There are several ways to address these concerns that are simple, but no way full-proof. The first step is to take your time hiring and to hire the right people from the beginning. Next, treat your employees well and fair. Lastly, spend the time to train your employees properly so they are productive. It sounds so simple, but maybe that is why it is so difficult.

Taxes: Who wants to overpay their taxes? Not only paying taxes, but staying compliant with all of the numerous tax filings can be a huge burden. Having a good accountant can help to alleviate this concern.

Growing: If you are not growing then your expenses will soon eat up a good portion of your profits. Growing sales is a major concern, however, the focus should be to grow your sales profitably. Aside from smart marketing, each new dollar of sales should be profitable to you, otherwise something is wrong.

Cash flow: Either not knowing where your cash is going or not having enough are both problems. Your accountant should help to explain where your cash is going and why there is a shortage. Common solutions are to improve your accounting systems and procedures, increase sales, implement better collection processes, increase your profit margins, and obtain a line of credit.

Too many hours: I don’t think that you are allowed to stop thinking about your business so technically you work 24 hours a day. How can you work less hours? There are dozens of ways, but a few easy to implement solutions are: better scheduling, delegation, and a commitment to work smarter, not harder.

There are a few other closely-related concerns, such as health insurance for employees, feeling burnt out, and the economy. Unfortunately, we cannot control the economy.

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What’s Your Chance of an IRS Audit?

The IRS publishes statistics regarding the percentage of returns that have been examined by type of return. Not surprisingly, some taxpayers have a greater chance of being audited than others according to the latest statistics. Let’s take a look at some stats:

The majority of audits, 74.8%, were conducted via correspondence, and the remaining 25.2% were conducted in the field.

Overall audit rate: The overall audit rate is .5%, but the audit rate of individual returns is .6%.

Corporate audit rates:

.9% for all corporate returns, excluding s-corporations

8.1% for large corporations with assets of $10M or more

.2% for s-corp returns

Individual audit rates:

2.4% for returns with business income and gross receipts of $100,000 to $200,000

3.2% for returns with positive income of $1M or more

.2% for returns with income lower than $200,000, no Earned Income Tax Credit, no business income or rental income.

If you read the footnotes of the statistics, it appears that 37% of individual returns that were selected for examination were due to a taxpayer claiming the Earned Income Tax Credit (EITC). Also, the statistics do not include several million CP2000 notices that are sent to taxpayers each year when there is a mismatch between what is reported on their tax return and what is reported to the IRS. If those notices were included, then the audit rate would be much higher.

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What Should You Do When You Receive a Notice from the IRS?

Did you notice that the title states “when” and not “if” you receive a notice? The volume of notices received from the IRS, along with those from the states, has steadily increased over the years, which means that the odds of you receiving a notice are pretty high. What are some of the steps you should take?

Don’t ignore the notice: This may sound basic, but do not ignore the notice. Usually, there is a deadline for your response, and if you do not respond then the issue may get worse and more complicated. If you do not understand the notice or have an accountant, then quickly send the notice to him/her.

Make sure it belongs to you: Sometimes, the notice may not even be yours. Sometimes the IRS or the states have an old address on file, which happens to now be yours. If the notice does not belong to you then ask the post office to return to sender. That is an easy fix, but not as common as one could hope for.

Time period and type of tax: The notice should show what periods and type of tax the notice relates to. Common notices are for Form 1040 (individual taxes), Form 941 (payroll taxes), and various states’ sales and payroll taxes.

What is the notice asking for: A commonly received notice from New Jersey and New York is one requesting additional information to process a refund after filing your tax return. You should provide the information requested and send a cover letter via certified mail. Other common notices state that there was additional income that was not reported, such as stock sales or pension income, and now there is a proposed change to your tax return. The scariest notices are levy notices or lien notices, which are supposed to come after no action has been taken on previous notices.

Compare the notice to your records: In many cases you want to verify the validity of the notice and should compare the information in the notice to your own records. It is possible that the notice may be incorrect or only partly correct.

Always respond timely: Make sure to always adhere to the timeline of the notice and to send any correspondence by certified mail as timely proof of a response. Even though you may respond timely this does not mean that the IRS or states will respond timely to you, and you may have to be patient.

As a warning, the IRS will never email you nor will they ask you to purchase prepaid gift cards from CVS to provide to them. Also, they will not threaten to deport you or throw you in jail. If you did something criminal then they will just show up at your house at 6 AM or possibly 5 AM, and I am sure that you already know why they are there.

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Do This to Avoid a Big Tax Surprise

If there is one recurring theme from this tax season that caused the biggest tax surprise it is this:

Double-check your withholdings: The withholding tables were revised and many taxpayers were under withheld, which caused them to owe taxes versus receiving a refund. The easiest way to correct this is to see how much you owed and then divide it by the number of paychecks left in the year. Then, either ask your employer to withhold this extra amount or complete a new Form W-4 to request this additional amount to be withheld from your paycheck.

Remember, a lower refund does not mean a lower tax liability. A refund is a function of your withholdings and estimated tax payments versus your tax liability.

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8 Red Flags That Could Trigger an IRS Small Business Audit

My colleague, Brad Paladini, has granted me permission to post this article that was originally posted on his blog: 

Last year, the Internal Revenue Service (IRS) audited just over one million returns. That’s a lot less than the 1.74 million returns they audited in 2010, but it’s still no fun for the millions of taxpayers that had to go through the process!

Overall, the IRS audits only about 1 in 200 returns. But some returns attract much more scrutiny than others. The IRS doesn’t want to waste its time getting blood out of a stone, and so they focus their investigative efforts on those returns and taxpayers that are statistically more likely to have discrepancies, such as small business owners.

Common Red Flags

Here are some of the major ‘red flags’ that can increase the likelihood of attracting IRS attention in the form of a small business audit:

1)  Higher Personal Income

While the average taxpayer has a 1-in-200 chance of getting audited in any given year, those with incomes of over $1 million are looking at odds of 1-in-20. That is, if your income is greater than $1 million, the probability of your return being selected for audit is ten times greater than it is for the average taxpayer.

At the same time, if you have an income of less than $200,000, the chances of your return being audited falls to just 1 in 154, based on 2016 numbers. But if your income was above $200,000, your chances of being audited increase to 1.70 percent, or 1 in every 59 returns.

So, if you’re showing an unusually high personal income, you are more likely to face an IRS small business audit. If you own a flow-through entity, such as an S-Corporation or LLC, the audit is likely going to extend to your New Jersey business as well, and any other business interests you own.

The same is true of partnership income. If you are showing substantial income from a limited or general partnership, and the IRS flags you for an audit, the audit very well may extend to the partnership – especially if you are the managing general partner in a limited partnership and your K-1s are showing a lot of suspicious losses.

2)  Owning an All-Cash Business

Owners of businesses like restaurants, food trucks, convenience stores and other businesses that deal a lot in cash sometimes fall to the temptation to take cash transactions “off the books” in order to conceal income. Your credit card processor submits a 1099-K to the IRS detailing the credit card payments they’ve made to your business account. The IRS has a pretty good feel for how much of a business’s receipts are going to be in cash vs. credit cards, checks and other forms of payment. If your numbers are way out of whack for similar businesses in your industry, you can expect some additional IRS scrutiny.

3)  Suspiciously Low Salary Income for Corporation Owners

This is a common red flag for New Jersey business owners. Some business owners try to report as much income as possible as dividend income and little or no salary income in order to sidestep FICA taxes. The IRS is wise to this trick, and will often look closely at business owners who report W-2 salary as suspiciously low, compared to the size and profitability of their businesses.

Some people fill out their Schedule C (Business Profit and Loss) forms to show just enough income to qualify for an earned income tax credit or other lucrative tax credit, but not much more. This also attracts IRS scrutiny.

4)  Large Cash Transactions

Merchants must report cash transactions in excess of $10,000 to the IRS. Banks also report these transactions. Failure to report these transactions, or repeated transactions just below the threshold, could trigger IRS interest.

5)  Reporting Net Losses in Multiple Years

Reporting net losses in more than two years out of any given five-year period may attract a small business audit – especially for sole proprietorships, and any time business owners are trying to flow-through those losses to their personal income tax returns.

To qualify as a bona fide business, as opposed to a hobby, your enterprise needs to show a profit in at least three out of five years. The IRS presumes that if you can show a profit at least three out of five years, you are running a bona fide business set up to make a profit. Otherwise, the IRS will look closely at your claimed deductions, and you could run afoul of hobby loss rules, and get some deductions disallowed. See IRC 183 for more information.

6)  Net Operating Loss Carrybacks or Carry-Forwards

Business losses can be carried back or carried forward to apply against income in other years. But the IRS is interested in these transactions. Be sure to document any such carrybacks or carry-forwards carefully to withstand an IRS small business audit.

7)  Excessive Deductions for Vehicle Use

The IRS looks closely at 100 percent business deductions for car expenses.

First, you can deduct the IRS standard mileage rate for business use – 54.5 cents per mile for tax year 2018 (as of this writing, the 2019 mileage deduction has not been released yet.) Alternatively, you can deduct your actual vehicle operating expenses, including fuel, maintenance, repairs, and upkeep. You cannot deduct both. If you try, you may attract IRS scrutiny.

Secondly, be sure to carefully document the miles you drive and their purpose, and make sure the mileage you claim is genuinely deductible. For example, you can deduct expenses attributable to miles you drive to meet a client at a remote location, but you cannot deduct for mileage incurred driving from home to your office. That’s a personal commuting expense, not a business expense.

8)  Suspiciously High Rental Property Expenses or Rental Loss Claims

Rental losses are unusual and attract IRS attention. The IRS may look carefully at any deductions you make for depreciation, and at attempts to deduct improvement and renovation expenses entirely in the first year, rather than spreading these deductions out over a period of years under MACRS rules.

You can deduct repair expenses that are designed to restore the property to a functional condition in the year in which you incur them, but you cannot take a first-year deduction for improvements and renovations designed to enhance the value of the property. These you must deduct over a period of years, depending on the project.

Labor expenses on capital improvement projects must also be amortized over the life of the repair. Failure to adhere to these rules can trigger IRS scrutiny.

Facing an IRS Small Business Audit?

If you’ve received a notification for a pending small business audit from the IRS, the tax attorneys at Paladini Law are ready to work for you. Attorney Brad Paladini has spent his entire career helping individuals and businesses solve complicated tax problems. Brad is highly trained to negotiate and fight with the IRS on your behalf. Schedule a consultation to have your case reviewed and explore your legal options. Contact Paladini Law through our online form, or call (201) 381-4472 today.

Be Careful When Making Online Payments to the IRS

We usually recommend that taxpayers make their tax payments online to the IRS and states. Here are the benefits, but a few caveats to watch out for:

Benefits: When making payments online, your payments are generally credited on the day that you make the payment. Additionally, you can clearly apply your payments to a prior tax year, current tax year, or for estimated tax payments. This helps to minimize errors when the IRS receives your payments, such as applying them to the wrong tax year and the date the payment was made.

Beware of these issues: Recently, we discovered that it is imperative to use the primary taxpayer’s social security number when making payments online to the IRS, otherwise your payment may sit in limbo and not be applied to your account. Other tips include:

  1. Make sure that you specify the correct year that a payment should be applied to.
  2. Double-check your banking or credit card information to ensure that your payment actually gets processed.
  3. Save the confirmation that you paid your taxes as a pdf document or print it out

Overall, we have seen a much lower number of issues when clients make their payments online. Just make sure to adhere to the tips above.

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