Friday, January 27, 2012

What will you do with your refund?

Many people think tax preparers are boring accountants, mired in numbers from dawn 'til dusk.  While that may be true for some, I think there is a large human component as well.  We meet so many people, from all walks of life, with all sorts of occupations and family situations, that you never know who you'll meet next.

One of my favorite things during tax season is asking what someone will do with their refund. Whether it's their usual refund amount, or an unexpected windfall, most people have a plan for at least part of it.

Many people use their refund for a home improvement. Some have the philosophy is that since the refund is largely due to the house and related deductions, the refund goes back into the house. Either a necessary repair or some type of improvement, they now have a chunk of funding for their project. I've heard about a lot of plans and they run the gamut from building a dream man cave to just keeping the water out. The least exciting repair has to be the new garage door, followed closely by a new roof. The most fun are the plans for a kitchen or bathroom remodel. Even new appliances are fun to think about.

Some people will use their refunds for vacation. I love to hear about travel plans.  One client had been going through some really tough times, raising three children on her own. An unexpected refund of several thousand dollars practically brought her to tears.  She had always wanted to take her kids to Disney World. But things were very uncertain and she didn't know what would happen from one day to the next. She decided to hold off, and if she still had the money at Christmas, she would surprise her kids with the trip then. And she did it. She told me about it the next tax season. What an inspiration. She held on to the refund for almost a whole year and made a wonderful family memory.

There are always a some folks who will wisely save their refund, either in an IRA or for emergencies.  Many people will pay off bills, pay down credit cards or a car loan, or even just make rent for that month. More and more folks mention some type of gambling adventure as part of their plans.

The worst refund story (and you know who you are) has to be a young lady working her way through college.  She got an unexpected refund of over $1000.  When I asked her plans for it, she said she could now afford to get her wisdom teeth removed.  Her insurance didn't cover it, but she need to get it done. Yikes! While any refund is a good refund, wisdom tooth removal has to be about the worst thing I could think of to do with my refund.

What will you do with yours?

Monday, January 23, 2012

Oh, the funny questions...

We get a lot of questions at the tax office at this time of year.

Some are specific: I took money out of my 401(k), am I still going to get a refund? What's this 1099A I just received? Do I have to report that? Will I still get a refund? We had a baby this year - how much more refund will we get? By the way, there are no easy answers to refund questions. We can explain the general trend, but to get specific, we have to run the numbers.

Some are sad:  My son's in jail, can I claim his little girl?

Some are frustrating:  I don't have my W2 but I have my last paystub and I really need my refund now. Can't you prepare my taxes?  Answer: NO!  By law, we can't prepare a return based on only a paystub, we have to have the W2.   I believe H&R Block used to allow their clients to bring in a pay stub and advance a refund based on that. But that was not a tax return, nor was it a refund, it was an advance, a loan. Now if your employer has skipped town and didn't issue any W2s, you can file after February 15 using the paystub figures and Form 4852.

One of the funniest questions we've had is the guy who received a $7000 bonus. He didn't tell his wife about it.  He's afraid if she knew about it she'll just go spend it.  So he wanted to hide it. He had several ideas and schemes for how to hide it from his wife.  He had no problem reporting it and paying his fair share of taxes, but just didn't want her to see it.  Other than filing separately, which would not be to his benefit taxwise, there was nothing he could do, except hope she didn't notice it when she signed the returns.

Don't be afraid to ask questions of your tax preparer.  I'm sure we've heard them all before!

Tuesday, January 17, 2012

New Requirements for Tax Preparers

Beginning last year the IRS required all paid tax preparers register with the IRS (and pay $64.25 for the privilege.) As part of the registration process, they checked to make sure tax preparers were current on their own taxes.  They now have an exam that all preparers must pass by the end of 2013, as well as continuing education requirements. Background checks and fingerprinting are planned but have not yet been implemented.  They want to ensure a "basic competency" in the profession - which is great. There are some preparers out there who just shouldn't be doing taxes. Now perhaps they will either get the knowledge they need or get out of the business.

I have difficulty with the next step in the process - making the tax preparer comply with due diligence requirements and stiffly penalizing them if they do not. Tax preparers will have to start asking some potentially prying questions of their clients.

In case you weren't aware, there is a big "tax gap" out there.  Latest release from the IRS (IR-2012-4, January 6, 2012 at,,id=252038,00.html?portlet=107) estimates the tax gap at $385 billion.  That's what the IRS thinks should be paid in taxes if everyone fully and accurately reported all of their income and expenses. Essentially, it's what they think cheaters cost the government. People who use someone else's child as their own so they can claim the kid. Businesses that don't report all of their income or exaggerate their expenses. Or even people who bump up their charitable contributions. The IRS also estimates that these cheaters make up about 16.9% of us (i.e., about 83.1% of us are in compliance with tax laws.) The IRS has struggled for years trying to reduce this tax gap.  They have a new approach now.  Make tax preparers find it.

I've always been of the philosophy that a taxpayer is responsible for their own tax return.  I will prepare the return based on what they tell me.  I can get all the numbers on the right forms and lines and help them find legal deductions and credits. If the client says they made $10,000 in their landscaping business, that is what I'll report.  I will gently educate about keeping good business records, mileage logs, etc., but I will not audit their records.  The IRS due diligence requirement now says that if I know, or have reason to know, that a client's information is incorrect, inconsistent, or incomplete, I have to ask and document additional questions.  For example my landscaper, who's only income is the $10,000 (an awfully round number, isn't it?), is driving a brand new truck and has four children, I have to ask how they are paying for their living expenses. If I don't ask, I can be penalized up to $5000 for negligence.

This is a big change for many tax preparers.  This will be a big change for some taxpayers (perhaps that 16.9%).  If you don't want your tax preparer asking prying questions, make sure you have good records and your information is complete and consistent. Don't say anything in front of your tax preparer that could be misleading.  Just like you can't joke around at the airport about having a gun, you can no longer joke about your Swiss bank account at the tax office.

I would like everyone to be honest on their tax return, and most are.  I pay every dime I owe and recognize that if some are cheating, the rest of us are paying their way. I'll do what I reasonably can to eliminate cheaters.  I just hope the IRS doesn't take this due diligence thing too far against honest tax preparers.  I'd much rather spend my time with clients finding legal tax savings. That's what's fun about doing taxes!

Wednesday, January 11, 2012

Don't ignore the IRS

No one likes to get a letter from the IRS, unless it's with their refund check. But if you do happen to get a letter, what should you do?

Basically there are three types of taxpayers. When Taxpayer A receives a letter from the IRS, he can't imagine why, so he opens the letter, reads it, and takes appropriate action. Now Taxpayer B knows he's done something wrong, or knows he owes taxes or penalties. He immediately tosses the IRS letter aside when it arrives. Taxpayer C receives his letter, can't imagine why, so he opens it.  He reads the letter, but it doesn't make any sense, so he just tosses it aside.  Which taxpayer are you?

We all know we should behave like Taxpayer A. But what if it doesn't make any sense?  Or when the IRS says you owe $90,000, and there are 14 encrypted pages of small print?  That just can't be.  Maybe if I just ignore it, it will go away. Maybe we intend to investigate later, but the days keep passing us by and we never get to it. It happens.

I had a client who received a letter from the IRS stating they thought she owed them $89,000+.  Imagine getting that in the mail! She didn't ignore it. She brought it in and we figured out why they thought she owed that much. She had sold some bonds and other securities and did not report them on her return. IRS doesn't know what she paid for the bonds and securities (cost basis). Since you only have to pay tax on your gain on sales of securities, we figured that out, and reduced her $89,000 bill to a couple thousand dollars. I've seen other cases, particularly in this economy, when the sale is actually for a loss, and the taxpayer ends up getting a refund!

You should address any correspondence from the IRS  They will not go away.  It will just get worse and more difficult to resolve. Follow the steps below.
Step 1 - Open the letter.
Step 2 - Read it.
Step 3 - If it makes sense, take appropriate action.  Generally this will either be to send them information or money.
Step 4 - If it doesn't make sense, investigate. Call the IRS and ask them to explain. Yes, you will have to wade through various menus to get to an actual person. If it still doesn't make sense, contact a professional. They should be able to tell you exactly what the IRS is looking for.
Step 5 - If you owe, pay it.
Step 6 - If you can't pay it, set up an installment plan. This is a crucial step! The IRS actually does have some sympathy for you when your chips are down. Call them. Depending on your situation, they might put your account on hold and stop bugging you for a while.  

A last note on installment agreements. Your penalties and interest continue to accumulate while you have a balance due, but the IRS has different rates depending on your error. The lowest penalties are for those who set up an installment agreement.  If you don't want to pay at all, why would you pay more than you have to? Set up the installment agreement, select an amount to pay that you can pay every month, and stick to it. It takes a phone call.