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The Tax Attic with Jerry Coon — March 11, 2010
Five steps to financial security
The income tax business is one of eternal learning. If it’s possible to keep your brain young by always learning, tax professionals’ brains should never get old—tired, maybe, but not old.
Jerry Coon, Enrolled Agent
Tax laws change constantly, both at the federal level and at the Michigan level. We get e-mail newsletters from a variety of sources, and it seems that these newsletters always have new information. It’s not unusual to get 20 pages in a week, explaining the latest changes and clarifications. However, we also read newsletters and books, attend seminars and conferences, and watch DVDs and videos that don’t have one new thing in them. They are all about current and old laws. It’s all about learning more about these current and old laws, so that we can help our clients navigate through our very complicated tax system.
I read in one of those newsletters that there are currently over 14,000 pages in the Internal Revenue Service’s publications and regulations. I can’t verify that figure, but I also don’t doubt it for one minute. I have a reproduction of the 1913 Form 1040 hanging on my office wall. That first Form 1040 was a grand total of one page. The attachments and instructions are a grand total of three more pages. We have gone from four pages up to a potential 14,000 pages in less than 100 years and, unfortunately, the 14,000 pages seems reasonably accurate to me.
Some of those 14,000 pages deal with Individual Retirement Accounts and retirement accounts. There are many experts in the field and there have been a myriad of books written on the subject.
One of the country’s foremost experts on the topic of IRAs is Ed Slott. He has written a multitude of books, gives seminars throughout the year, and writes one of those newsletters I discussed earlier. Mr. Slott is a proponent of education, education, education and more education, not only for tax professionals but also for taxpayers. As taken from his book, “Stay Rich for Life, Growing & Protecting Your Money in Turbulent Times,” Ed’s five steps to financial security are as follows:
1. Know who you are and where you are.
2. Educate yourself.
3. Avoid mistakes.
4. Don’t be shortsighted.
5. Take action in small, consistent steps.
You can’t make these five steps work without educating yourself or, perhaps to put it another way, by doing these five steps, you will educate yourself.
Know who you are and where you are—By working through this step, you find out what type of person you are, what type of investor you are, and you will know exactly what your situation is at the current time.
Educate yourself—Discovering the items in the first step will automatically lead to the second step, and you will become educated. If you are going to hire someone as an advisor, you will do a better job of picking that person because you have knowledge. If you decide to manage your assets yourself, this education will give you a fighting chance of making good choices.
Avoid mistakes—As your knowledge in this important area grows, your choices become better and you will avoid making mistakes. In these turbulent investing times, it is absolutely critical that you don’t make a mistake. His definition of a mistake would include investing in something that is too good to be true. Most Ponzi schemes entice people to invest in a product that is too good to be true or entice people to invest with a person who is too good to be true. Neither is a good reason to invest. As you become educated, you stand a better chance of not making that crucial mistake.
Don’t be shortsighted—By taking the long-term approach, you will make better decisions for the long term and you will avoid the short-term mistakes as noted in step three. Education will cause the thought process of making decisions to be based on the long term.
Finally, step five says to take action in small, consistent steps. Very few people strike it rich in one fell swoop. It happens when someone wins the lottery or when they buy a stock that takes off. These are lightening-in-the-bottle types of events and they do happen. They just don’t seem to happen to you and me. Most of us have to build a plan and stick with it over a very long period of time. By being better educated, those small, consistent steps will lead to a great future. Education is the key. This is Jerry Coon signing off.
Jerry Coon is an Enrolled Agent. Action Tax Service is located on Northland Drive in Rockford. Contact Jerry at Action’s website at www.actiontaxservice.com.
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The Tax Attic with Jerry Coon — March 4, 2010
Jerry Coon, Enrolled Agent
Taxable Social Security income
There are few items on a tax return that are more confusing or more difficult to explain to taxpayers than that of taxable Social Security.
Prior to the late 1980s, Social Security was not taxable. Tax-free income is the best deaa still too good of a deal, because the law was changed to tax up to 85% of gross benefits received.
It seems like the logic in taxing benefits was that this would help extend the time when the Social Security system would go bankrupt. One never knows for sure when trying to figure out where federal tax money ends up, but I find it hard to believe that any of the tax dollars due to taxable Social Security tax end up at the Social Security Administration. I think that big black hole in Washington just sucks up those dollars. I wouldn’t be surprised that at some point in time, 100% of benefits will become taxable just like a distribution from any pension.
The fly in the ointment is that today everyone pays into Social Security. These payments made at the rate of 6.2% of earnings are not voluntary. Granted, employers pay in another 6.2% matching contribution, but employers get to deduct this amount on their tax return. The 6.2% each taxpayer pays represents a nondeductible cost to that taxpayer. Taxpayers should be able to recover the amounts they paid in to the Social Security system using one of two options: either the taxpayer would be able to recover his cost as a nontaxable amount received each year over his life, or he would be able to recover his cost in total from the first benefits received before any benefits become taxable. Either approach has tax theory behind it, but there is a larger book of theory that would require taxpayers to recover their cost over their life.
The Social Security system keeps track of how much tax is paid in to the system by each taxpayer. Up to now, it’s just kept for statistical reasons, because benefits are calculated on earnings, not taxes paid in. But it would not take much of a software program to calculate the taxable benefit based on recovering the taxes paid in. I hope I’m wrong.
However, right now, up to 85% of gross benefits are taxable. To determine how much of that 85% is taxable, we start with total income, not including Social Security benefits received. However, included in the total income figure is income that is not taxable in any other equation.
For example, bond interest from Michigan municipalities is not taxable on the federal tax return, the Michigan tax return, or any city tax return. But it is included as income to determine if Social Security is taxable. This is somewhat of a difficult concept to explain. All taxpayers know that municipal bond interest is not taxable and many believe it doesn’t have to be reported on the tax return. That is incorrect. It does have to be reported on the return and, by the way, it is causing Social Security to be taxable—not a happy conversation to have.
To this modified total income figure is added one-half of benefits received. For joint filers, if the grand total is more than $32,000, the benefits begin to be taxed. For single filers, if the grand total is more than $25,000, the benefits begin to be taxed. Joint taxpayers with a grand total falling between $32,000 and $44,000 will be taxed on not more than 50% of their benefit. Once the $44,000 level is reached, up to 85% of the benefits can be taxed. Single taxpayers with a grand total falling between $25,000 and $34,000 will be taxed on not more than 50% of their benefit. Once the $34,000 level is reached, up to 85% of the benefits can be taxed.
Once the calculation is completed, the final nail in the conversation comes when I have to answer the question of how much tax did the taxpayer have to pay on the supposedly nontaxable Social Security. Sometimes that figure is truly shocking. In the future, it might get even more shocking. This is Jerry Coon signing off.
Jerry Coon is an Enrolled Agent. Action Tax Service is located on Northland Drive in Rockford.
Contact Jerry at Action’s website at www.actiontaxservice.com.
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The Tax Attic with Jerry Coon — February 25, 2010
Non-taxable fringe benefit disappearing
Jerry Coon, Enrolled Agent
A non-taxable fringe benefit that appears to be disappearing is the employer-provided vehicle. This type of fringe benefit is called a Working Condition Fringe. It is non-taxable to the employee, because the expense is a deductible business expense whether the employee or the employer is paying for the auto.
For example, General Motors supplies a vehicle to its Grand Rapids regional marketing director. This is a deductible business expense for General Motors on their corporate tax return or, if the director was using his personal auto in his capacity as a General Motors employee, the expenses would be deductible on his personal 1040. Because the company is supplying the auto, the expenses are considered non-taxable to the director. It’s a legitimate Working Condition Fringe. As long as there is no element of personal usage by the director, none of the expenses of the auto will be taxable to him. However, if there is an element of personal usage, there will be some taxable income allocated to the director.
Just what constitutes an “element of personal usage”? The most common element of personal usage occurs when the employee has 24-hour access to the auto, personal use of the auto is not specifically forbidden by the employer, and the employee does incur some personal usage of the auto.
In the example above, because the director is expected to visit dealerships and attend various conferences which entail many overnight stays, General Motors assigns to the director a vehicle for his exclusive 24-hour use. General Motors does not forbid him from using the auto for personal use and he does use the auto occasionally to run personal errands. There will be some taxable income allocated to the director in this case.
Last year, he put 30,000 total miles on the auto. Of this total, 4,500 miles, or 15%, were for personal use. It cost General Motors $15,000 to operate his vehicle for the year. Without any personal usage, this would all be considered a Working Condition Fringe benefit and non-taxable to the director. However, we have to deal with those 4,500 personal miles.
General Motors has a variety of methods it can use to calculate the taxable amount of the personal usage. First, it can require the director to reimburse General Motors at the prevailing federal rate for mileage reimbursements: 55 cents per mile. The director would have $2,475 (4,500 times .55) withheld from his paychecks and that would be the end of this story.
Second, General Motors could include 15% (4,500 miles divided by 30,000 miles) of the total Working Condition Fringe value of $15,000 in his W-2 (15% of $15,000 is $2,250). This would be considered taxable income to the director and he would pay tax on this amount.
Third, General Motors could include 100% of the Working Condition Fringe value of $15,000 in the taxable income of the director. The director would then use Form 2106, Employee Business Deductions, to deduct the 85% business portion of the expenses, or $12,750, on his personal tax return. Fortunately, we very infrequently see this third option used. These expenses claimed on Form 2106 are deducted on the Schedule A of the taxpayer, so the taxpayer must itemize to get any benefit. Plus, employee business expenses are subject to a reduction of 2% of adjusted gross income.
For example, our director has adjusted gross income of $150,000 (2% of that figure is $3,000). The first $3,000 of Form 2106 expenses are non-deductible and the director gets a net deduction of $12,750 minus $3,000, or $9,750—$15,000 gets included as income and $9,750 gets deducted. That leaves the director paying tax on $5,250 of income. In addition, the director pays tax on this $5,250 to Michigan as well. This isn’t as good a deal as the other two options, but it would be a lot easier, accounting-wise, on General Motors. They just throw all of the expense on the director’s W-2 and let him deal with it.
But General Motors was called Generous Motors for many reasons. In all actuality, they probably ignored the personal usage of our fictitious regional marketing director and didn’t allocate any income to him at all—not technically legal, but probably real world. I wonder if they also ignored Tiger Woods’ personal usage? This is Jerry Coon signing off.
Jerry Coon is an Enrolled Agent. He owns Action
Tax Service, located on Northland Drive in
Rockford. Contact Jerry at Action’s website,
www.actiontaxservice.com.
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The Tax Attic with Jerry Coon — February 11, 2010
Words on tax refunds
Jerry Coon, Enrolled Agent
The tax season is well under way. As is usually the case, each tax season takes on a flavor of its’ own. Some tax seasons are known as early filing tax seasons. Everyone’s refund seems to be large and they want it today. We find that some seasons have so many changes that affect their tax returns; it seems that people put off filing their returns and the season becomes known as a late filing season. Neither of those scenarios applies to this year.
Allow me to make an observation about this year. Even though it was projected that refunds would be smaller or non-existent this year; so far that doesn’t seem to be totally the case. Some taxpayers are getting smaller refunds than they expected but others are being pleasantly surprised by the size of their refunds. It’s been an orderly tax season with the Internal Revenue Service and the State of Michigan efficiently processing the returns as they are submitted. No big technical snafus have taken place.
As always, there are one or two legislative changes put into place that effect many returns. This year, we are seeing many taxpayers taking advantage of the return of the Residential Energy Credit and the upgrade of the Hope Education Tuition Tax Credit (HOTC) to the new American Opportunity Tax Credit (AOTC). Much has been written about the Residential Energy Credit but I have not read much about the American Opportunity Tax Credit. It’s really a misnomer to say the AOTC upgraded the HETC. It totally replaced the credit. Since so many taxpayers claim the tuition tax credit on their returns, I’m going to hit the high points and the differences between this year and the past years.
First, the Hope Credit resulted in a maximum of $1,800 credit, none of which was refundable. The American Opportunity Tax Credit can result in a maximum credit of $2,500. 40 percent of the credit, up to $1,000 is refundable. This is a huge change. Many taxpayers paying tuition in past years zeroed out their tax liability without using the full $1,800 of credit. Now, they will at least get 40 percent as a refundable amount.
Second, the HOTC credit was based only on tuition and fees paid. The AOTC expands the definition of eligible expenses to include not only tuition and fees but also we can include required course materials in the calculation. Course materials can include books and supplies and also a computer. This is also huge. Let me re-state. Student’s books and, if a computer is required, can also be included. We as tax preparers are not limited to the tuition paid on the college statement. This is such a radical change that we have to concentrate on asking about books and a computer. Those expenses don’t show up on the college’s statement. I’m not sure exactly what year the HOTC was instituted, but books and a computer were never allowed to enter into the equation. Now these books and a computer can result in a much larger credit.
For taxpayers using a tax professional, don’t forget to mention those expenses to your preparer. F or taxpayers using commercial software such as TurboTax, don’t forget to include those expenses on the appropriate worksheet. For the ten people in West Michigan completing your return by hand, the form to use is Form 8863.
Third, the AOTC can apply to the first four years of post-secondary education. The HOTC only applied to the first two years of post-secondary education. This is another huge change. It only takes $4,000 of tuition, fees, books, and a computer to get $2,500 of credit with $1,000 of the $2,500 refundable. Under the old rules, in the third and all following years, taxpayers would qualify only for the Lifetime Learning Credit. $4,000 of qualifying expenses for a Lifetime Learning Credit results in a credit of $800, none of which is refundable. Let’s see: $800 of non-refundable old credit or $2,500 of new credit of which $1,000 is refundable.
Fourth, the other change made increased the amount of income that can be earned without losing the credit. The HOTC phased out $58,000 for a single taxpayer and $116,000 on a joint return. The AOTC phases out at $90,000 for singles and $180,000 for joint filers. This allows many, many more taxpayers to take advantage of this credit. These changes came too late for Deb and Jerry Coon since both of our daughters, Kimberly and Stephanie, have graduated from college, but for those taxpayers who do qualify for the American Opportunity Tax Credit, it is a welcome credit. This is Jerry Coon signing off.
Jerry Coon is an Enrolled Agent.
He owns Action Tax Service on Northland Dr. in Rockford.
Contact Jerry at his website: www.actiontaxservice.com
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The Tax Attic with Jerry Coon
Jerry Coon, Enrolled Agent
What exactly can be done if you receive a 1099-MISC as a subcontractor when you think you should receive a W-2 as an employee? Receiving a 1099-MISC is not always a negative, but as my discussion of last week pointed out, we just have to say the tax implications are immense. But, regardless of the tax consequences, does the Internal Revenue Service have a procedure to follow if you are convinced that you should have received a W-2? The answer is yes. It is a common problem, because it is almost always advantageous to a payer to report payments made to someone as a subcontractor instead of an employee.
Why is it more advantageous to call a recipient a subcontractor and not an employee? First, payments to an employee are subject to a matching Social Security and Medicare tax of 7.65%. Payments to a subcontractor are not subject to this 7.65%, so the payer instantly adds 7.65% to his bottom line.
Second, payments to an employee are subject to federal and state unemployment tax. The federal unemployment tax rate is normally 0.8% of the first $7,000 of wages, or $56 per person. Since Michigan owes the federal government billions of dollars, there is a 0.3% surcharge, or $21, added for the year of 2009. Michigan unemployment rates are variable, but a new business will pay 2.7% of the first $9,000, or $256. The maximum rate is 11%, so $256 could be very low. Payments to subcontractors are not subject to these two taxes. This adds a few more hundred dollars to the bottom line.
Third, payments to subcontractors are not subject to workman’s compensation insurance. For construction employers, that rate of insurance could be as high as $30 per thousand of payroll.
Fourth, employees are quite often covered by those items called fringe benefits. They might be covered by health insurance, receive paid vacation and personal time off, receive time-and-a-half pay for hours worked over 40, be paid a premium amount for working on weekends and holidays, receive an automobile as part of their compensation package, and be paid for continuing training, etc., etc. A subcontractor receives none of these benefits.
Fifth, the employer might have some type of retirement plan set up. An employee participates in this plan. A subcontractor does not.
Add all of these differences up and it can be a whole lot cheaper to give a person a 1099-MISC and say he is a subcontractor even if he is really an employee. It happens often enough that the IRS has developed a form to submit when a person receives a 1099-MISC when he thinks he should receive a W-2.
The form, an SS-8, is entitled “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” It can be obtained at the forms link on the IRS’ website at www.irs.gov. It is a three-page form that goes through several factors to determine employee-versus-subcontractor status. The factors are grouped into four major headings, Behavioral Control, Financial Control, Relationship of Worker and Firm, and For Service Providers
or Salespersons.
As the form is completed, it will indicate how much control the company has over the taxpayer. The more control a company has over the person, the more it will look like the taxpayer is an employee. Less control will look more like a subcontractor. The SS-8, by answering a variety of questions, will indicate that a person is an employee or a subcontractor.
If the IRS receives an SS-8 from an individual taxpayer, it will be processed as one side of the story. The identified company will be sent an SS-8 and the company will get to tell the other side of the story. As we all know, there are usually two sides to most stories. In these cases, the IRS is the judge. If they find that the taxpayer is indeed an employee, there are a whole lot of employment forms that have to be amended and a whole lot of payroll taxes that have to be paid.
Of course, the IRS is not always the final judge. The company can appeal to a tax court judge and, from time to time, there are some very large court cases that come down the pike. As you might imagine, if there are 500 people involved, the payroll tax implications could run into the millions of dollars.
By the way, the IRS estimates that it takes 23 hours, 58 minutes to complete the three-page SS-8. It’s not an easy form to fill out and, of such things, court cases are made. This is Jerry Coon signing off.
Jerry Coon is an Enrolled Agent. He owns
Action Tax Service on Northland Drive in Rockford.
Contact Jerry at his website at www.actiontaxservice.com.
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