Stephenson and Warner, Inc

When is a Business Expense a Tax Deduction?

Fri, 25 Jan 2013 08:04:01 EST

Deductible business expenses are those which are “ordinary and necessary” and are incurred or paid during the taxable year in “carrying on” any trade or business. Both these criteria must be met for an expense to be deductible.

An “ordinary” expense is one that is common and accepted in the industry. These are expenses that are needed to run a business and are usually frequent and ongoing.

A “necessary” expense is one that is helpful and appropriate for the trade or business. The term necessary for tax purposes has a wider definition than that found in everyday usage. Necessary does not mean that an expense has to be indispensable.

In addition, the ordinary and necessary business expenses are costs associated with running an existing business. For instance, organizational expenses and start-up expenses are deductible or amortizable under different set of rules. Similarly, cost of goods sold and capital expenses are governed by yet a different set of rules and regulations.

Related taxpayers should be extra careful and not violate the “ordinary and necessary” part of the Section 162 language. Small business owners with more than one entity may inadvertently pay the expenses of another entity or attempt to balance income between entities. These types of maneuvers can get costly should the IRS make a discovery. Co-mingling funds and expenses, whether business or personal, should be avoided at all times.

In most cases the “ordinary and necessary” requirement is straight forward and easily met. Some of the common expenses include: advertising, bank fees on business accounts, bad debts (for those who use accrual accounting),commissions and fees paid, dues for trade organizations and business organizations, casualty and liability insurance, interest on business debt, legal and professional services, office expenses, (supplies, telephone, printing, postage, etc.), pension and profit sharing plans, employee benefits, publications, rent and lease expenses, repairs and maintenance, services performed by independent contractors, utilities, and wages.

Some expenses require additional considerations and/or may be limited or recovered through depreciation and amortization. Examples of these types of expenses are: car and truck expenses (standard mileage or actual expenses, personal and business use of a vehicle), cost of goods sold (determine additional costs allocable to cost of goods sold), depreciation, gifts to customers, office-at-home deduction, business meals and entertainment, and travel expenses.

A partial list of expenses that are not deductible include: bar or professional examination fees, charitable contributions by a business that is not a regular C- corporation, (sole proprietors can’t deduct charitable contributions as a business expense), charitable contribution of time or personal services, country club, social club or athletic club dues, commuting expenses (from home to place of business), estate taxes, expenses ( including interest) to generate tax-exempt income, federal income tax, fines and penalties (federal income tax penalties, traffic tickets etc.), gifts to employees or business contacts valued at more than $25.00, hobby losses, life insurance premiums ( if the business, or business owner is a direct or indirect beneficiary), lobbying expenses, personal, living, or family expenses, and political contributions.

Substantiation

Business deductions require substantiation. While some tax court cases have allowed expenses without substantiation and have relied on credible testimony, the bottom line is that the taxpayer must have evidence proving the amount of the expense and the character of the expense.

Most taxpayers don’t receive canceled checks or copies of the checks anymore. Also, taxpayers pay expenses by transferring funds electronically and pay expenses by credit cards. Rev. Proc. 92-71 addresses these circumstances and provides when an account statement prepared by a financial institution, or other evidence of payment, will be accepted by the IRS as proof of payment. Under check truncation (safekeeping) system, the canceled checks are retained by the financial institution and bank regulations generally require the banks to retain checks for a period of five years. However, requesting copies of the checks can be very costly.

If a taxpayer can’t provide canceled checks to prove payment of an amount, Rev. Proc. 92-71 describes account statements that a taxpayer can provide. If neither a canceled check nor an account statement showing required information can be provided, the Service will require other evidence to prove a payment.

An account statement prepared by a financial institution showing a check clearance will be accepted as proof of payment if the statement shows:

Check number.
The amount of check.
The date of check.
The name of payee. (This is the problem-statements don’t show the payee’s name)

In case of electronic funds transfer and payments made by a credit card, if the statement shows the amount, date, and name of the payee, then a bank statement would be accepted as proof.

If a taxpayer can’t provide canceled checks or account statements described above, then other evidence of payment is required. An invoice marked paid, check register, payment acknowledgements, and an account statement showing the amount, date and check number. Even though the IRS often requests canceled checks they are not required if other acceptable proof can be provided.

Time after time we have witnessed denial of legitimate business expenses due to lack of substantiation and proper documentation. Therefore, it is extremely important that complete records to substantiate income and expenses are kept at least for 3 years after the filing of a tax return.

Should you have any specific questions and would need more detailed answers, please give us a call.

tags: business expense tax deduction sustantiation

CPA's Provide Varying Levels of Financial Statement Assurance

Fri, 04 Jan 2013 07:48:35 EST

Clients inquiring about assurance or audit services, often assume that their organization requires a financial statement audit. This assumption is made without fully understanding all the available assurance services that a CPA can provide. A CPA may compile, review or audit an organization’s financial statements.

The level of service is often determined by the client’s needs and what their creditors, investors, funding sources or government agencies require. The higher the level of service required, the more time the CPA needs to complete the engagement and therefore the more costly the engagement. Complied statements will usually be sufficient for management use, owners who are not active in management probably prefer reviewed statements and banks and other creditors usually want an audit.

Compiled financial statements represent the most basic level of service a CPA may provide with respect to financial statements. In a compilation engagement, the CPA assists management in presenting financial information in the form of financial statements without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements.

The CPA issues a reporting stating the compilation was performed in accordance with Statements on Standards for Accounting and Review Services; and that the CPA has not audited or reviewed the financial statements and accordingly does not express an opinion or provide any assurance about whether the financial statements are in accordance with the applicable financial reporting framework.

Reviewed financial statements provide the user with comfort that, based on the CPA’s review, the CPA is not aware of any material modifications that should be made to the financial statements for the statements to be in conformity with the applicable financial reporting framework. In a review, the CPA designs and performs analytical procedures, inquires and other procedures, as appropriate, based on the accountant’s understanding of the industry, knowledge of the client, and awareness of the risk that he or she may knowingly fail to modify the accountant’s review report on financial statements that are materially misstated. A review does not contemplate obtaining an understanding of the organization’s internal control; assessing fraud risk; testing accounting records; or other procedures ordinarily performed in an audit.

The CPA issues a report stating the review was performed in accordance with Statements on Standard for Accounting and Review Services; that management is responsible for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework and for designing, implementing and maintain internal control relevant to the preparation and fair presentation of the financial statements; that review includes primarily applying analytical procedures to management’s financial data and making inquiries of management; that a review is substantially less in scope than an audit that the CPA is not aware of any material modifications that should be made to the financial statements for them to be in conformity with the applicable financial reporting framework.

Audited financial statements provide the user with the CPA’s opinion that the financial statements are presented fairly, in all material respects, in conformity with the applicable financial reporting framework.

In an audit, the CPA is required by auditing standards generally accepted in the United States of America (GAAS) to obtain an understanding of the organization’s internal control and assess fraud risk. The CPA is required to corroborate the amounts and disclosures included in the financial statements by obtaining audit evidence through inquiry, physical inspection, observation, third-party confirmations, examination, analytical procedures and other procedures.

The CPA issues a report that states the audit was conducted in accordance with GAAS, the financial statements are the responsibility of management, provides an opinion that the financial statements present fairly in all material respects the financial position of the company and the results of operations that are in conformity with the applicable financial reporting framework (or issues a qualified opinion if the financial statements are not in conformity with the applicable financial reporting framework. The CPA may also issue a disclaimer of opinion, if appropriate).

Another type of engagement that clients often find useful and less costly is an agreed upon procedures engagement. An agreed upon procedures engagement is generally an engagement that involves applying procedures that have been agreed upon by specified parties (for example the client and a government agency). A report that details the procedures performed, and states the CPA’s findings. Such an engagement is useful for an organization that has no need for financial statement assurance, but would like a CPA to evaluate certain matters significant to the organization.

As you can see, management and third parties relying on the financial statements of an organization can obtain a varying degree of assurance depending on the service they request from their CPA. How much assurance does your organization need? Contact us to discuss.

tags: financial statements assurance compilation review audit "agreed upon procedures" CPA

If an IRS Employee/Agent Shows Up at Your Door

Tue, 23 Oct 2012 15:42:20 EST

An increasing number of IRS employees/agents are showing up at taxpayers’ homes and businesses unannounced and unscheduled. The doorbell rings and there he or she is. What do you do? What to do? This can be very intimidating and unnerving to the taxpayer.

First, you need to be aware of the two types IRS employees/agents who might be at your doorsteps. One, an IRS Revenue Agent, also known as RA, or a Revenue Officer, and the other type is IRS Special Agent. The Special Agents tend to investigate tax offences and tax crimes. They carry badges and also carry guns and tend to travel in pairs. In these cases, say only one sentence, “I want a lawyer.” And, say nothing else.

In this blog we are discussing the IRS Revenue Agent/Officer visits and your rights and not the gun carrying Special Agents who are taking you “downtown.”

A Revenue Agent/Officer has limited powers and they are not law enforcement officers. They carry a plastic IRS ID cards and their job is to collect past due money from taxpayers. Typically, their job is to collect on larger cases rather than smaller cases, although not always the case. Their emphasis is on collecting unpaid payroll taxes. But, collecting on unpaid income taxes is not outside of their scope.

These agents also collect information on you. They assess where you live, how you live, and value of your assets. They like to barge their way in your residence. They ask questions and they want to pin you down then and there. However, you are under no obligation to answer their questions, and in many instances, you may not even know the answers.

Should you encounter this kind of unpleasant surprise, you should know that these Revenue Agents are not entitled to enter your residence unless you have a public area in your residence. How many private homes would have a public area? So, just keep them away from entering your home and call your tax professional immediately. It’s very appropriate and within your rights to tell the agent that you will contact your CPA and you will be back shortly. He or she may not like it, but it’s your right to do so. You also may hand the phone to the agent after you reach your CPA or other professional and have the IRS agent talk with your CPA on the spot. If you don’t reach your CPA or your tax professional while the agent is there, you should do as follows: Be polite and you indicate that you will be getting representation, if you don’t already have a Power of Attorney with your CPA or other professionals authorized to deal with the IRS matter. You should request to see their ID card again, and please write down their name and ID number, and ask him or her to pencil a note regarding the tax matter, Form number and tax period(s) in question. If we, your CPAs, don’t have the information, we can’t prepare a valid Power of Attorney for you and the IRS, in most cases, will not talk to us.

Our staff at Stephenson and Warner is only a phone call away.

513-868-8600

tags: IRS revenue agent tax representation

Identity Theft and the IRS

Mon, 01 Oct 2012 07:58:26 EST

Identity theft is what happens when someone uses another person’s personal information without their permission to commit fraud or other crimes. Usually it involves using the victim’s name, Social Security number or other personal information. It not only involves using the victim’s good name and credit rating, but can also include filing fraudulent tax returns, claiming erroneous deductions and receiving large refunds.

Identity theft cases are among the most complex cases that the IRS handles. As such, the IRS is constantly reviewing its processes and policies in order to minimize identity theft incidents as well as to help victims deal with the consequences of identity theft. Identity theft has increased to the point that the IRS created a special unit dedicated to dealing with its victims. The IRS is focused on preventing, detecting and resolving identity theft cases as soon as possible. They are also trying to balance delivering tax refunds in an acceptable timeframe while ensuring controls are in place to minimize errors and fraud.

If you receive correspondence from the IRS that states more than one return has been filed for you, IRS records indicate you received wages from an unknown employer, or you have a balance due, refund offset or collection actions for a prior year tax return, you may be the victim of identity theft. You could also receive a notice form the IRS indicating identity theft, because the IRS has put numerous steps in place to prevent, detect and stop such activity. You should respond immediately to either of these notices by contacting the name and phone number shown on the notice or letter.

What will happen with the IRS if you are the victim of identity theft? You will need to complete the IRS Identity Theft Affidavit and follow instructions on the back of the form depending on your specific situation. You will also need to provide proof of your identity with a copy of your government-issued identification (such as Social Security card, driver’s license, or passport) and a copy of a police report. A special Identity Protection Personal Identification Number will be issued to you, which will be used to designate your tax return as a valid tax return, not a possibly fraudulent return. The IRS is currently working to speed up case resolution, further train its employees in assisting identity theft victims and stepping up outreach efforts to inform taxpayers about identity theft.

There are several ways that identity thieves can access your personal information. Among these is theft of a purse or wallet, looking through your trash for personal information and accessing information you provide on an unsecured internet site. Identity thieves also use information from deceased persons.

IRS tips on avoiding identity theft include the following. The IRS does not contact taxpayers by phone, email or social media. If you receive an email claiming to be from the IRS, forward that email to the IRS at phishing@irs.gov. If you find a website that claims to be the IRS but does not begin with www.irs.gov, forward that to phishing@irs.gov also. Do not carry your Social Security card or anything with your Social Security number on it with you. Don’t give a business your Social Security number unless required to do so. Check your credit report annually. Secure your personal information. Protect personal computers with constantly updated fire walls, anti-spam/virus software, security patches and regularly changing internet passwords. Never give out your personal information over the phone, via mail or on the internet unless you initiate the contact or are sure with whom you are dealing.

tags: identity theft IRS pin phishing refund

Revenue Neutral Tax Reform

Fri, 21 Sep 2012 09:46:31 EST

Income Tax Reform – creates a strong response in everyone doesn’t it? There are currently several commercials airing by the presidential candidates that attack the other candidate’s plan. What should American voters’ response be rather than, “It’s about time!”? We need to ask, “How would that work?”

I recently read an article regarding whether revenue neutral plans are feasible, and the reasons wherein. The contributors to this article are “nationally recognized experts in tax, budget, and social policy who have served at the highest levels of government”. This being said, I read the article, then reviewed the statistics to see if they made sense to me with my level of experience and whether they supported the conclusions drawn in the articles. The answer to both questions was yes.

What is a revenue neutral plan? It is one in which we will maintain current tax revenues, ensure a progressive tax system, and maintain/lower marginal tax rates. This necessarily creates a situation where these goals are in competition with each other.

How would revenue neutral tax reform work? First, for corporate tax rates to remain revenue neutral while the tax rate is reduced, the loss of income to the government through lower corporate tax rates would be offset by reductions in corporate tax preferences. Revenue neutral, right?

In putting together the revenue neutral model for individuals, several assumptions were made. These included that tax expenditures aimed at promoting savings and investment would not be reduced, tax expenditures would be reduced or eliminated starting with the top tax brackets and working downward, the 2001, 2003 and 2010 tax cuts would be permanently extended, and no spending cuts would be made.

The plan examined by the article proposed reductions in individual and estate tax rates of approximately 20%. This would decrease federal tax revenues by about $360 billion. In order to remain revenue neutral, tax preferences would have to be reduced, the same as for corporate taxes.

In order to offset this loss in revenues, tax expenditures, read deductions/credits, would have to be reduced by approximately 65%. This would be unprecedented, and to accomplish this would require deep reductions in popular benefits, including mortgage interest deduction, exclusion of employer-provided health insurance from income, charitable contributions, the Earned Income Tax Credit and Child Tax Credit.

OK, so now you are really shocked! The bottom line is that the majority of tax expenditures are going to individuals in the middle and lower income tax brackets. It is not possible to design a revenue neutral plan that does not reduce “average” tax burdens even when made as progressive as possible.

And on that note, consider the difference of tax burdens in taxpayers with similar incomes. For example, families with children currently receive 57% of the available tax expenditures, but only 23% of the revenue reductions (as calculated in the article). What this means is that an across-the-board reduction in tax expenditures would increase taxes on families much more than on childless adults.

I am not posing an attack on revenue neutral tax reform, but wanted to highlight some surprising results as posed in the article I read. That being said, I do not necessarily feel that raising taxes on higher income taxpayers is the complete answer either. The fiscal crisis that is looming has been a long time coming.

tags: tax reform