Tax FAQ’s

Tax FAQ’s


Frequently Asked Questions about tax preparation, tax services, tax problem resolution, and other ways taxes affect your normal life.

FAQs

Record Retention How long should I keep my receipts and tax related records?

In general an 8 year retention of all documents should cover most items excepts assets purchased and not yet disposed of (rental property, and long term assets). IRS has the authority to audit taxpayers for 3 years from the time the tax return is filed. Therefore if you file a 2014 tax return on/by 4/15/2015 you must keep the backup records until 4/15/2018.  The taxpayer has the burden of proof for all deductions taken.

If there is an amendment or correction made, the 3 years starts over from the time of the amendment filing.
In the instance of purchasing assets(buildings, stocks, large equipment for business, gold coins, and other long term investments), you will want to keep the records of original purchase, refinance, depreciation and improvements until 3 years from when the tax return was prepared which the asset sold or were disposed of.

Records can be kept electronically (scan and save) rather than hard copies if that is the preferred method for the taxpayer.  As long as they can be produced when/if requested by IRS or other taxing agencies.  State statute of limitations change, you should check with your particular state for the time they require you to maintain records.
Gift tax returns must be kept indefinitely as they record a lifetime total of gifts given, and you will always want to let your tax professional know if you have ever filed a gift tax return.

Employers will want to comply with state and labor department rules for the time to keep payroll records and reports. The U.S. Department of Labor states; each employer shall preserve for at least three years payroll records, collective bargaining agreements, sales and purchase records. Records on which wage computations are based should be retained for two years, i.e., time cards and piece work tickets, wage rate tables, work and time schedules, and records of additions to or deductions from wages. These records must be open for inspection by the Division’s representatives, who may ask the employer to make extensions, computations, or transcriptions. The records may be kept at the place of employment or in a central records office.

Starting a Business What are the basic steps to starting a business?

A Sole Proprietorship (schedule C, Small Business, self employment) is the easiest of all business types to start, and we suggest that your business starts there and evolves into another entity structure as it becomes necessary, unless you are looking for capital from outside investors.  A Sole Proprietorship can change into a Corporation, S-Corporation, LLC, or LLP when the owners determine it is profitable to make that change. Consult with a tax professional and an attorney when you are making this change.  The difference is in the entity structure, the distribution of profits to owners/shareholders, the taxation of the profits and the personal liability protection.

An individual who conducts an activity as a for profit business is allowed to deduct expenses that are ordinary and necessary in carry on the trade or business.  When conducting your business it is advised to use a separate business checking and credit card accounts.  You are not required to have a business name you can operate under your own name “John Smith’s Woodworking” for example, but you can get a DBA “Doing Business As” many sole proprietors do so they can have use names like “San Diego Woodwork”, or “Woodwork Specialists”.  You need to check the state and county records for name availability then follow requirements for DBA filings.   Once you know the name you are operating under you can get an EIN “Employer Identification Number” from IRS using Form SS-4, which you will use instead of your social security number for permits, advertising and banking, etc. Obtain insurance (Liability and Workers Comp if you have employees), register for a Sales Tax License if you are selling any tangible goods or applicable products, and proper licensing needed for the type of business you are operating.

Develop a written business plan to keep on target with your goals and mission, and document periodic evaluations of operations to attempt to improve the business’s profitability.  Record business and personal use of assets in a log books (auto mileage for mixed use), and records of income and expenses should be kept and maintained regularly.  Keep thorough and businesslike books, hire a professional if you are not able to maintain regular books while operating your business, but always keep a watchful eye on anyone who has access to financial or sensitive financial information about you or your clients, always review your financial records for misuse or fraud.

If you are hiring employees you must have a EIN from IRS and register with your state employment agency for an identification number and to comply with reporting employee income and state unemployment taxes. Hire a professional service to assist you with payroll preparation; your review should include receipt and review of your quarterly payroll tax reports prepared on your behalf IRS Form 941 & State quarterly forms and annual forms SSA -W-2/W-3 & IRS Form 940.  There are stiff penalties for delinquent forms and tax liability payments should you not be diligent about the payroll process.

1099 Information Reporting

If you are preparing 1099’s yourself here is a sample of what you need to send to IRS and the vendors: 1099 Preparation Sample, you can order your red forms from IRS free of charge with no delivery fee from their website IRS.gov here is the link to the order page http://www.irs.gov/Businesses/Online-Ordering-for-Information-Returns-and-Employer-Returns. You will also need each of your vendors to complete an IRS form W-9 to gather their tax information.

Who gets a 1099-Misc? You are required to send a 1099-misc form to anyone who provided $600 or more of services for your business during a calendar year, and as a non-employee.  Generally payments to corporations are not report-able; however you must report payments to corporations for the following: cancellation of debt, medical/health care payments, withheld federal income tax or foreign tax, payments in lieu of dividends and interest, acquisition or abandonment of property, payments of attorney’s fees and gross proceeds paid to attorneys, credits for clean renewable energy bonds, and fish purchases for cash.

You will need the service providers to fill out a form W-9, it will contain the information you need to file the form. The 1099’s are sent to the recipient (service provider), and the IRS.  You will also need to keep a copy for your business records and tax deduction supporting documentation.  If you do not file the 1099, you will be denied the deduction in event of an Audit of your tax return, and you may be fined a penalty for failure to file the required form. If all the payments to the vendor were made by credit or debit card there is no requirement to file a 1099, the credit card processor is required to report that income on form 1099-K.

What kinds of information reporting are there? Other forms you or your business may need to send out include: Payments of non-employee compensation (1099-Misc), Payments to a Foreign Person (1042-S), Dividends and Distributions (1099-D), Patronage Dividends (1099-PATR), Interest (1099-INT), Royalties (1099-Misc or 1099-S), Cancellation of Debt (1099-C), Acquisition or Abandonment of Secured Property (1099-A), Proceeds from Broker or Barter Exchange Transactions (1099-B), Mortgage Interest Statement (1098), Charitable Contributions of large items (1098-C), Student Loan Interest (1098-E), Tuition Statement (1098-T), Changes in Corporate Control and Structure (1099-CAP), Certain Government Payments (1099-G), Health Coverage Tax Credit (1099-H), Long Term Care and Accelerated Death Benefits (1099-LTC), and Original Issue Discount (1099-OID).

When to file: You must furnish recipients with these forms no later than January 31st, and they are due to IRS by February 28, of each year.

What if someone refuses to fill out form W-9 and will not give me their information? They are in violation of the law.  DO NOT USE THEIR SERVICES UNTIL THEY GIVE YOU THEIR INFORMATION! Document your attempts to collect the information necessary for reporting.  It is usually a good idea to collect a W-9 from everyone who provides you services when they begin a job with you. You may be required to withhold income taxes from them if they refuse to provide you with a form W-9. Or pay them by credit or debit card.

Make sure you are not mis-classifying workers, if you are in control of what a worker does, you provide the tools, location and direction for completing tasks you may be an employer and they may be an employee rather than an independent contractor/subcontractor. Recent developments on CA employment determination are in this article Employee or Subcontractor CA info 1.1.2020

You may find more useful information from IRS at irs.gov, and Employment Development Department (EDD) if you are a California Employer.  You may find that they are your employee rather than a vendor.  Who is an employee?

Due Dates 

Personal Tax Returns:

  • Individual Taxes, IRS form 1040 is due April 15th or an Extension of time to file, form 4868, maybe filed by April 15th to extend your tax filing date until October 15th.
  • Gift Tax returns are due by April 15th following the year in which the gift is made
  • Sales & Use tax returns are filed with your CA form 540 at the time you file, unless you are a qualified purchaser with CA, then a separate annual return must be filed by April 30th following the close of that year.
  • Foreign Asset reporting, the FBAR is due April 15th taxpayers are granted an automatic six-month extension to file, no form is required to be filed to grant the extension to the October 15th deadline

Trusts/Estates: Due April 15th, Extension available until October 1st with form 7004

Business Returns: LLC’s, S-Corps, anything with a K-1, due March 15th, Extension available until September 15th with form 7004

Payroll Tax Forms, form 941 and De9/De9c, are due Quarterly, by the last day of the month following the close of that Quarter.  The Year End forms W-2/W-3 and form 940 are due by the last day of January following the years close. These now are required to be electronically filed.

Sales and Use tax Returns, for taxpayers holding a resale license in CA reports need to be filed annually, quarterly or monthly depending on your reporting cycle established by California Department of Tax and Fee Administration (CDTFA) formally the Board of Equalization.  The reports are due by the last day of the month following the close of your prescribed period.

Audit Red Flag Myths

Is it really a red flag to have an office in my home?

No, An office in home is a regular deduction that many self employed individuals have and should deduct on their personal business taxes.  You may also have a home office as an employee if there is no regular workplace established or provided.  As an employee this generally must be for the benefit of the employer not the employee.  Meaning that you may not elect to have a home office and take the deduction, if the employer has and offers a work location to you that should be used, therefore it is voluntary to work from home and not deductible.  IRS is more likely to audit you on this issue if you are using more than a customary & reasonable amount of space for your home office.

Reporting a Change of Address

What forms do I need to file if I have moved?
It is important to notify your tax professional, financial institutions, employer, and put in to have mail forwarded when you change your address.  Also your state of record and IRS should be notified with the update.  IRS form 8822 can be filed, however IRS will update your address with the address used on your last filed tax return if this form is not filed.  Depending on when you move this may be the best way to update your address with IRS.

What if I am Audited

What can I expect in an audit?

You may be audited for a variety of reasons.  Generally a taxpayer is selected for audit at random based on a the collective information on their return and a lottery system.  IRS uses a DIF score which gives every item on your tax return a value, from the zip code you live in, how many people are on your return, your income and deductions.  Each item gets a score, then in a given year they will select all returns within a certain score range, and then select at random the returns to review.  The purpose of these audits is to ensure that accurate returns are being filed.  You will get a letter in the mail from the auditor/examiner who is going to be reviewing your tax return.  They will let you know what items they would like to review and how you can contact them.  You may either meet in person, or conduct the audit by mail or fax and provide your backup documentation and any needed explanation then.  If they find you made an error an adjustment will be made and you will have a balance to pay.  If you find you forgot to include a deduction you were entitled to there could be an adjustment in your favor.  It is always the best result to end an audit with no changes, indicating you filed accurately when filing originally.  You can communicate yourself with an auditor or have a professional Enrolled Agent communicate for you.

You may be selected for audit because of something specific on your return, like you made $20,000 of income and deducted $15,000 in charity, this just doesn’t seem reasonable.  It could happen but is not likely.  These types of things would cause you to be selected for audit not at random but because something doesn’t “jive” on your tax return.

Additionally IRS will audit selected groups, like businesses claiming a certain deduction, businesses with a a certain income to cost of goods ratio, businesses in a certain industry to collect overall data on what should be expected from this industry as a standard.  These are called “research audits” and can be very detailed, often looking at all income and expenses in a business.  Although it is expensive to hire a professional to represent you it is often worth it in the end to defend your business position on your deductions when dealing with the IRS.

You could be referred for audit, someone can suggest that you or your business be audited.  For instance someone who wins a game show or contest which is publicized.  IRS agents can look up a person to see if they have reported their $1mil prize if it was not claimed on their tax return they can refer them to be audited. Or if IRS’s computers determine you have forgotten to include some income they have been notified of (you forgot that W-2 for the job you worked at 1 week in January of last year) they will notify you by mail of the omission, propose the change in your tax return, this is actually an audit.

Other audits that you could encounter; state tax return audits (similar to IRS audit), employment audits including 1099 filing, and W-2 reporting, as well as Workers Compensation Audits (these happen annually for most employers to verify the amount of wages estimated are what were finally paid.)

The key things to remember when you are being audited are to be professional, be organized, get the auditors Manager’s contact information (they are required to give this to you), communicate regularly and on time.  Don’t make promises you can’t keep, don’t take it personally, don’t answer questions that aren’t relevant or talk just to fill the silence (they are collecting data with everything you say), and take lots of notes on what is discussed and is determined for your case.  If the auditor seems to be unfair contact their manager with the issue.  Professional help is available to you when you need it.  Auditors speak a certain language and we Enrolled Agents speak that language too.

Collections

What happens if I owe IRS and can not pay them?

Taxing agencies want to be paid, and many ways to get money from you when they determine it is owed, once it has been “assessed.” The best thing to do is contact the agency you owe and ask to establish a payment plan or installment agreement.  This is good for you and also for them.  It will establish a monthly amount and due date to pay a portion of your balance until it is paid in full.  Depending on the agency they will allow you certain time periods to pay with CA they would like you to full pay with in 12 months, IRS will allow you up to 72 months to pay.  There is usually a one time fee to set up the payment arrangement which will come out of the payments made.  Interest and penalties will continue to accrue while the payments are made on the balance remaining until it is paid. If you have trouble setting this up with the agency over the phone, or just don’t want to handle it yourself we can set this up on your behalf as your tax representative.

You do not want to ignore a balance due to a tax agency.  They can levy bank accounts, and garnish wages.  A levy will take all your funds on a certain day, this can be devastating to a family.  A garnishment is filed with your employer, it will withhold a certain amount from your paychecks, this can be embarrassing and more than you may be able to negotiate in a payment plan.  With CA if they initiate a garnishment it can not be lifted, it will run its course until the account is paid in full.  IRS will release the garnishment if other payment arrangements are made. Several attempts to collect the debt will be made before they resort to these measures, do not ignore the notices you receive about your balance due.

IRS is working with private debt collectors on some collections cases, the companies they are using are CBE, Perfomant, ConServe, and Pioneer.  If you get any letters from them please do not ignore them, either call the contact info on the letter, call IRS or call your Enrolled Agent to work on your collections matters.

IRS will not call or email you to collect a debt.

Closing a Business

What are the things I need to know to properly close my business?

If you are running a sole-proprietorship (schedule C) business it is very easy to close your business.  You do not have a final tax return to file, you just simply no longer report the Schedule C business on your personal return.  If you had a sales tax account, and payroll for the business “final returns” do need to be filed with the appropriate agencies to let them know you will no longer be in business and filing to them. There is usually a place to mark “final” on the regular tax return you file, and indicate the date your business closed.

For Business Entities, LLC’s, Partnerships, Corporations, and S-Corporations a “final” income tax return needs to be filed.  Final employment/payroll returns, and sales tax if applicable.  Additionally there is usually a formal dissolution or cancellation needed with the state where the corporate charter is held.  For California this is the Secretary of State, they have specific forms that need to be filed to formally close the entity.

FBAR & FACTA Information

Do I have to file a report for my interest in foreign bank accounts or assets?

US Citizens who have any interest or ownership in foreign assets or bank accounts need to report those assets annually.  This is not a tax but a reporting of assets.  If your foreign accounts have collectively had over $10,000 at any time during the year this triggers the reporting requirement.  For example, you transfer $100,000 into a Mexican bank account for 1 day to use to purchase a property in Mexico.  Even though the money was only in the account for 1 day it needs to be reported.  Simply holding real estate doesn’t trigger the reporting requirement but bank account do.  If you have real estate and it is producing income (you rent it out sometimes) then the income from renting it should be reported on your tax return, and the bank account which the rent is deposited should be reported on the FBAR return.  There are different thresholds for Non-residents who file US tax returns for reporting foreign assets and accounts.  If you think this could apply to you please seek out a tax professional to help you with this.  There is a significant penalty for failure to comply with this reporting requirement, and the requirement as well as forms for reporting can be complex.

Identity Theft

What should I do if I think my Identity has been compromised or if someone has filed a tax return with my social security number?

If you think you may have been a victim of Identity theft there are several things to do to mitigate the fallout;

  • Respond to any IRS or tax agency notices you receive, they may be trying to verify your identity if some else is trying to file a return on your behalf
  • File form 14039, Identity Theft Affidavit with IRS and any similar forms with your state tax agency
  • Contact credit Bureaus to put a fraud alert and freeze on your credit records (Equifax, Experian, and TransUnion)
  • Contact your financial insitutions
  • Change your passwords for all accounts that have any personal information or financial information in them
  • Obtain an IP PIN from IRS
  • Request a copy of any fraudulent return filed on your behalf

Contacting the IRS

How can I contact IRS? How will IRS contact me?

You can contact IRS by phone at 1-800-829-1040.

IRS will contact you by mail with a letter or notice.  IRS will not contact you by email or phone.  If you are actively working with an IRS agent or representative on a particular case or matter then you may communicate by phone, but this will be after you have an established relationship, you will have their number as well.

Death and Taxes

What happens when someone dies? Do they have to do their taxes?

When someone dies it is important to file a final individual tax return.  If they are married when they die, this will be filed usually by their spouse on the Married Filing Jointly return.  This will notify the IRS and other tax agencies that the person has died, it will help to close out things tied to their social security number with these agencies and protect against fraud.  Additionally if the deceased person owes any money on the final return that needs to be paid before any assets are distributed pursuant to their will or wishes.  If this is not done, then the beneficiaries who receive and money or assets will be ultimately liable to pay the debt when it is discovered.  By that time there will be penalties and interest, and the beneficiary will have likely used up all the funds.  It is much easier to pay any debts of the decedent before distributing the assets of the estate.

Depending on the assets help by the decedent at the time of their death,and their marital status there may also be a requirement to file an estate or trust tax return.  Consult a tax professional to determine what is required, and what is beneficial (filing for portability/DSUE.)  Any growth on the assets from the date of death tot he time of liquidation or disbursement is taxable to the estate or the beneficiary.  Estates with a gross value over annual limits will also have estate tax that needs to be paid.

Establishing Fair Market Value 

Do I have to get an appraisal on the property I am inheriting? When inheriting any property the value is subject to IRS scrutiny and could have negative results if you cannot produce an appraisal that is prepared by a state-licensed appraiser. The appraisal is honored by the IRS and there is no guessing.The following example has a rental property that was left to the adult children at death, the family assumes the property is worth $600,000 at the time of death but they don’t feel it is necessary to obtain an appraisal.

If you use  $600,000 for rental reporting purposes and depreciate 60% (assuming 40% land that is not depreciable) that represents a $13,090 depreciation expense per year ($360,000 divided by 27.5 years-allowable depreciation life for a residential rental property). Then let’s assume you sell it in 5 years for $900,000. You have depreciated a total of $65,450 (5 years @ $13,090). Capital gain is calculated using the cost of $600,000 minus the depreciation taken over 5 years of $65,540=$534,550 is the adjusted cost basis at the time of sale. So $900,000 minus the cost of $534,550 leaves a capital gain of $365,450. At today’s maximum tax rates, the taxes for IRS and CA would be about $180,000. This does not take into consideration capital gains rates for each beneficiary based on their individual income tax rates. It is merely for illustration purposes.Now let’s say, under audit, IRS determines the date of death value to be only $500,000. Besides the problem of taking more depreciation each of the 5 years as an expense against rental income, you have a capital gain issue. If the capital gain is $100,000 more than in the scenario I outlined in the previous paragraph, there would be an additional tax of approximately $50,000. If that audit takes place 2 years after you file and pay the $180,000 (approximate taxes with the property valued at $600,000) and all the beneficiaries have spent their inheritance based on the net sale proceeds after taxes and now the beneficiaries have to come up with an additional $50,000 as a result of the audit.Let’s say after a couple of years, you find that the house should have been valued at $700,000 based on what you’ve heard in the neighborhood about the specific attributes of the house. Now, in order to take the additional depreciation expense of $2,182 per year, you must amend those tax returns. But when you sell it after 5 years your adjusted cost basis is $623,645 and your capital gain is only $276,355. Taxes would be approximately $138,000 ($42,000 less than if you used the $600,000.)

Resources  for Employers

  • The Internal Revenue Service has lots of information on income and expenses, recordkeeping, publications and instructions for forms, and resources for employers. www.IRS.gov
  • Sign up for Electronic Funds Tax Payment Systems EFTPS to pay your corporate taxes, estimated tax payments/Quarterly tax payments, and to pay employment taxes electronically

the Department of Labor has the information on Overtime pay, Hiring and Firing concerns, industry related special pay situations. etc. What you need to know about being an employer, Human Resources related materials at www.dol.gov

Employee Withholding Form W-4 should be updated annually

  • An Form I-9 is required at the beginning of employment

Other internet resources for CA taxpayers:

  • Pay your CA taxes, set up a payment plan or check on your balance due, as well as get forms at www.FTB.ca.gov
  • Information on Sales Tax reporting and Use tax in CA can be found at The CA State Board of Equalization, www.BOE.ca.gov
  • Payroll Taxes, Employer payroll accounts and report filing information go to the Employment Development Department www.EDD.CA.gov
  • Check for LLC and Corporation information, name availability, register, get forms, and complete your annual Statement of Information with the Secretary of State www.SOS.CA.gov
  • Starting July 1st 2015 CA employers are required to accrue “Paid Sick Leave” for employees at a rate of 1 hour of sick leave accrued per 30 hours worked.  This is accrued for all levels of employees on all hours worked .0334 hours of sick leave need to be accrued.  The employees are entitled to accrue up to 24 hours of sick leave per year and can carryover the amount un-used at the end of the year into the next year and continue to accrue additional sick leave up to 48 hours max accrual.