Month: April 2018

Tax credits can reduce your tax bill or give you a bigger refund but not all tax credits are created equal. While most tax credits are refundable, some credits are nonrefundable but before we take a look at the difference between refundable and nonrefundable tax credits, it’s important to understand the difference between a tax credit and a tax deduction.

Understanding the Difference between a Tax Credit and a Tax Deduction

Tax credits reduce your tax liability dollar for dollar and are more valuable than tax deductions that reduce your taxable income and tied to your marginal tax bracket. Let’s look at the difference between a tax credit of $1,000 and a tax deduction of $1,000 for a taxpayer whose income places them in the 22% tax bracket:

• • A tax credit worth $1,000 reduces the amount of tax owed by $1,000–the same dollar amount.

• A tax deduction worth the same amount ($1,000) only saves you $330, however (0.22 x $1,000 = $220). As you can see, tax credits save you more money than tax deductions.

Tax Credits: Refundable vs. Nonrefundable

A refundable tax credit not only reduces the federal tax you owe but also could result in a refund if it more than you owe. Let’s say you are eligible to take a $1,000 Child Tax Credit but only owe $200 in taxes. The additional amount ($800) is treated as a refund to which you are entitled.

A nonrefundable tax credit, on the other hand, means you get a refund only up to the amount you owe. For example, if you are eligible to take an American Opportunity Tax Credit worth $1,000 and the amount of tax owed is only $800, you can only reduce your taxable amount by $800–not the full $1,000.

Refundable Tax Credits

• The Earned Income Tax Credit
• The Child and Dependent Care Credit
• The Saver’s Credit

Nonrefundable Tax Credits

Examples of nonrefundable tax credits include:

• Adoption Tax Credit
• Foreign Tax Credit
• Mortgage Interest Tax Credit
• Residential Energy Property Credit
• Credit for the Elderly or the Disabled
• Child Tax Credit (tax years prior to 2018)

Partially Refundable Tax Credits

Some tax credits are only partially refundable such as:

• Child Tax Credit (starting in 2018)
• American Opportunity Tax Credit

Questions about tax credits or deductions?

If you have any questions or would like more information about either of these tax topics, please call.

• By Leon Clinton
• April 16, 2018

Compiled annually by the IRS, the “Dirty Dozen” is a list of common scams taxpayers may encounter. While many of these scams peak during the tax filing season, they may be encountered at any time during the year. Here is this year’s list:

1. Phishing

Scam artists continue to victimize taxpayers during filing season using a steady onslaught of new and evolving phishing schemes. Email phishing schemes target payroll professionals, human resources personnel, schools as well as individual taxpayers and even tax professionals, deploying various types of phishing emails in an attempt to access client data. Thieves may use this data to impersonate taxpayers and file fraudulent tax returns for refunds.

In the most recent scam, thousands of taxpayers have been victimized by an unusual scheme that involves their own bank accounts. After stealing client data from tax professionals and filing fraudulent tax returns, the criminals use taxpayers’ real bank accounts to direct deposit refunds. Thieves are then using various tactics to reclaim the refund from the taxpayers, including falsely claiming to be from a collection agency or representing the IRS.

Fake emails and websites also can infect a taxpayer’s computer with malware without the user knowing it. The malware gives the criminal access to the device, enabling them to access all sensitive files or even track keyboard strokes, exposing login information.

2. Phone Scams

Aggressive and threatening phone calls by criminals impersonating IRS agents remain a major threat to taxpayers. Many phone scams use threats to intimidate and bully a victim into paying. They may even threaten to arrest, deport or revoke the license of their victim if they don’t get the money. Since October 2013, the Treasury Inspector General for Tax Administration (TIGTA) reports they have become aware of over 12,716 victims who have collectively paid over $63 million as a result of phone scams.

Con artists claiming to be IRS officials call unsuspecting taxpayers and demand they pay a bogus tax bill. Scammers often alter caller ID numbers to make it look like the IRS or another agency is calling. The callers use IRS titles and fake badge numbers to appear legitimate. They may use the victim’s name, address and other personal information to make the call sound official. They convince the victim to send cash, usually through a wire transfer or a prepaid debit card or gift card. They may also leave “urgent” callback requests through phone “robocalls,” or send a phishing email (see above for more information about phishing).

3. Identity Theft

Tax-related identity theft occurs when someone uses your stolen Social Security number to file a tax return claiming a fraudulent refund. While the IRS has made significant progress in deterring tax-related identity theft (from 2016 to 2017 identity theft decreased by 40 percent), criminals continue to devise creative ways to steal even more in-depth personal information to impersonate taxpayers. As such, taxpayers and tax professionals must remain vigilant to the various scams and schemes used for data thefts. Business filers should also be aware that cybercriminals file fraudulent Forms 1120 using stolen business identities as well.

Always use security software with firewall and anti-virus protection and make sure security software is always turned on and set to automatically update. Encrypt sensitive files such as tax records stored on the computer. Use strong passwords. Do not click on links or download attachments from unknown or suspicious emails. Protect personal data. Treat personal information like cash; don’t leave it lying around. Don’t routinely carry a Social Security card, and make sure tax records are secure.

4. Tax Return Preparer Fraud

About 60 percent of taxpayers use tax professionals to prepare their returns. The vast majority of tax professionals provide honest, high-quality service, but there are some dishonest tax preparers who set up shop each filing season. Well-intentioned taxpayers can be misled by tax preparers who don’t understand taxes or who mislead people into taking credits or deductions they aren’t entitled to in order to increase their fee. Avoid tax preparers who base fees on a percentage of their client’s refund or boast bigger refunds than their competition.

Illegal scams can lead to significant penalties and interest and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice (DOJ) to shutdown scams and prosecute the criminals behind them.

5. Fake Charities

Taxpayers should be aware that phony charities use names or websites that sound or look like those of respected, legitimate organizations. For instance, following major disasters, it’s common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers. Scam artists use a variety of tactics including contacting people by telephone or email to solicit money or financial information. They may even directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds. They may also attempt to get personal financial information or Social Security numbers that can be used to steal the victims’ identities or financial resources.

6. Inflated Refund Claims

Taxpayers should be on the lookout for unscrupulous tax return preparers pushing inflated tax refund claims. Scam artists routinely pose as tax preparers during tax time, luring victims in by promising large federal tax refunds or refunds that people never dreamed they were due in the first place. They might, for example, promise inflated refunds based on fictitious Social Security benefits and false claims for education credits, the Earned Income Tax Credit (EITC), the Additional Child Tax Credit (ACTC) or the American Opportunity Tax Credit (AOTC), among others. They may also file a false return in their client’s name, and the client never knows that a refund was paid.

Filing a phony information return, such as a Form 1099 or W-2, is an illegal way to lower the amount of taxes owed. The use of self-prepared, “corrected” or otherwise bogus forms that improperly report taxable income as zero is illegal. So is an attempt to submit a statement rebutting wages and taxes reported by a third-party payer to the IRS. In some cases, individuals have made refund claims based on the bogus theory that the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS.

Because taxpayers are legally responsible for what is on their returns (even if it was prepared by someone else), those who buy into such schemes can end up being penalized for filing false claims or receiving fraudulent refunds.

7. Excessive Claims for Business Credits

Improper claims for business credits such as the fuel tax credit and the research credit are also on the IRS “Dirty Dozen” list this year. The fuel tax credit is generally limited to off-highway business use or use in farming. Consequently, the credit is not available to most taxpayers. Still, the IRS routinely finds unscrupulous tax preparers who have enticed sizable groups of taxpayers to erroneously claim the credit to inflate their refunds.

Fraud involving the fuel tax credit is considered a frivolous tax claim and can result in a penalty of $5,000. Improper claims for the fuel tax credit generally come in two forms. An individual or business may make an erroneous claim on their otherwise legitimate tax return. It is also possible for an identity thief to claim the credit as part of a broader fraudulent scheme.

Improper claims for the research credit generally involve a failure to participate in or substantiate qualified research activities and/or a failure to satisfy the requirements related to qualified research expenses. In addition, qualified research expenses include only in-house wages and supply expenses and 65 percent (typically) of payments to contractors. Qualified research expenses do not include expenses without a proven nexus between the claimed expenses and the qualified research activity.

To qualify for the credit, a taxpayer’s research activities must, among other things, involve a process of experimentation using science with a goal of improving a product or process the taxpayer uses in its business or holds for sale or lease. Certain activities specifically excluded from the credit including research after commercial production, adaptation of an existing business product or process, foreign research and research funded by the customer. Qualified activities also do not include activities where there is no uncertainty about the taxpayer’s method or capability to achieve a desired result.

8. Falsely Padding Deductions on Tax Returns

The vast majority of taxpayers file honest and accurate tax returns on time every year. However, each year some taxpayers fail to resist the temptation of fudging their information. That’s why falsely claiming deductions, expenses or credits on tax returns is on the “Dirty Dozen” tax scams list for the 2018 filing season. The IRS warns taxpayers that they should think twice before overstating deductions such as charitable contributions, padding their claimed business expenses or including credits that they are not entitled to receive.

Avoid the temptation of falsely inflating deductions or expenses on your return to underpay what you owe and possibly receive larger refunds. Taxpayers may be subject to criminal prosecution and be brought to trial for actions such as willful failure to file a return, supply information, or pay any tax due; fraud and false statements, preparing and filing a fraudulent return and identity theft.

9. Falsifying Income to Claim Credits

This scam involves inflating or including income on a tax return that was never earned, either as wages or as self-employment income, usually in order to maximize refundable credits. Falsely claiming an expense or deduction you did not pay, claiming income you did not earn could have serious repercussions. Con artists often argue that the proper way to redeem or draw on a fictitious “held-aside” account is to use some form of made-up financial instrument, such as a bonded promissory note, that purports to be a debt payment method for credit cards or mortgage debt. Scammers provide fraudulent Form(s) 1099-MISC that appear to be issued by a large bank, loan service and/or mortgage company with which the taxpayer may have had a prior relationship.

Well-intentioned individual taxpayers who don’t understand taxes or unscrupulous return preparers who mislead people into taking credits or deductions they aren’t entitled to do this to secure larger refundable credits (e.g., the Earned Income Tax Credit) to charge a higher fee; however, it can have serious repercussions. Taxpayers can face a large bill to repay the erroneous refunds, including interest and penalties. In some cases, they may even face criminal prosecution.

Remember: Taxpayers are legally responsible for what’s on their tax return whether it is prepared using tax software or a tax professional.

10. Frivolous Tax Arguments

Taxpayers are also warned against using frivolous tax arguments to avoid paying their taxes. Examples include contentions that taxpayers can refuse to pay taxes on religious or moral grounds by invoking the First Amendment or that the only “employees” subject to federal income tax are employees of the federal government, and that only foreign-source income is taxable.

Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. These arguments are wrong and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or disregard their responsibility to pay taxes. The penalty for filing a frivolous tax return is $5,000.

11. Abusive Tax Shelters

Abusive tax shelters, particularly those involving micro-captive insurance shelters, are on the list again for 2018. Phony tax shelters and structures to avoid paying taxes continues to be a problem and taxpayers should steer clear of these types of schemes as they can end up costing taxpayers more in back taxes, penalties, and interest than they saved in the first place.

Another tax shelter abuse involving a legitimate tax structure involves certain small or “micro” captive insurance companies. In the abusive structure, unscrupulous promoters, accountants, or wealth planners persuade the owners of closely held entities to participate in these schemes. The promoters assist the owners to create captive insurance companies onshore or offshore and cause the creation and sale of the captive “insurance” policies to the closely held entities. The promoters manage the entities’ captive insurance companies for substantial fees, assisting taxpayers unsophisticated in insurance, to continue the charade from year to year.

For example, coverages may insure implausible risks, fail to match genuine business needs or duplicate the taxpayer’s commercial coverages. Premium amounts may be unsupported by underwriting or actuarial analysis may be geared to a desired deduction amount or may be significantly higher than premiums for comparable commercial coverage. Policies may contain vague, ambiguous or deceptive terms and otherwise, fail to meet industry or regulatory standards. Claims’ administrative processes may be insufficient or altogether absent. Insureds may fail to file claims that are seemingly covered by the captive insurance.

Micro-captives may invest in illiquid or speculative assets or loans or otherwise transfer capital to or for the benefit of the insured, the captive’s owners or other related persons or entities. Captives may also be formed to advance intergenerational wealth transfer objectives and avoid estate and gift taxes. Promoters, reinsurers and captive insurance managers may share common ownership interests that result in conflicts of interest.

The bottom line: Don’t use abusive tax structures to avoid paying taxes. The IRS is committed to stopping complex tax avoidance schemes and the people who create and sell them. The vast majority of taxpayers pay their fair share, and everyone should be on the lookout for people peddling tax shelters that sound too good to be true. When in doubt, seek an independent opinion if offered complex products.

12. Unreported Offshore Accounts

Through the years, offshore accounts have been used to lure taxpayers into scams and schemes. Numerous individuals have been identified as evading U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities and then using debit cards, credit cards or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.

While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirements that need to be fulfilled. U.S. taxpayers who maintain such accounts and who do not comply with reporting requirements are breaking the law and risk significant penalties and fines, as well as the possibility of criminal prosecution.

Since 2009, tens of thousands of individuals have come forward to voluntarily disclose their foreign financial accounts through the Offshore Voluntary Disclosure Program (OVDP), taking advantage of special opportunities to comply with the U.S. tax system and resolve their tax obligations. The IRS recently announced that this voluntary program will end on September 28, 2018.

If you think you’ve been a victim of a tax scam, please contact the office immediately.

• By Leon Clinton
• April 13, 2018

If you’ve been procrastinating when it comes to preparing and filing your tax return this year you might be considering filing an extension. While obtaining a 6-month extension to file is relatively easy–and there are legitimate reasons for doing so–there are also some downsides. If you need more time to file your tax return this year, here’s what you need to know about filing an extension.

What is an Extension?

An extension of time to file is a formal way to request additional time from the IRS to file your tax return, which in 2018, is due on April 17. Anyone can request an extension, and you don’t have to explain why you are asking for more time. It simply requires answering a few questions on Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Part I of the form asks personal information such as name, address and Social Security number. Part II is tax related and asks about estimated tax liability, payments and residency.

Note: Special rules may apply if you are serving in a combat zone or a qualified hazardous duty area or living outside the United States. Please call the office if you need more information.

Individuals are automatically granted an additional six months to file their tax returns. In 2018, the extended due date is October 15. Businesses can also request an extension. In 2018, the deadline for most businesses (whose tax returns were due March 15) is September 17th (October 15 for C-corporations).

Caution: Taxpayers should be aware that an extension of time to file your return does notgrant you any extension of time to pay your taxes. In 2018, April 17 is the deadline for most to pay taxes owed and avoid penalty and interest charges.

What are the Pros and Cons of Filing an Extension?

As with most things, there are pros and cons to filing an extension. Let’s take a look at the pros of getting an extension to file first.

Pros

1. You can avoid a late-filing penalty if you file an extension. The late-filing penalty is equal to 5 percent per month on any tax due plus a late-payment penalty of half a percent per month. Furthermore, by filing an extension a taxpayer can avoid paying the late-filing penalty, which can be 10 times as costly as the penalty for not paying.

Tip: If you are owed a refund and file late, there is no penalty for late filing.

2. You can also avoid the failure-to-file penalty if you file an extension. If you file your return more than 60 days after the due date (or extended due date), the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a late-filing or late-payment penalty if you can show reasonable cause for not filing or paying on time.

3. You are able to file a more accurate–and complete–tax return. Rather than rushing to prepare your return (and possibly making mistakes), you will have an extra 6 months to gather required tax records. This is helpful if you are still waiting for tax documents that haven’t arrived or need more time to organize your tax documents in support of any deductions you might be eligible for.

4. If your tax return is complicated (for example, if you need to recharacterize your Roth IRA conversion or depreciate equipment), then your accountant will have more time available to work on your return.

5. If you are self-employed, you’ll have extra time to fund a retirement plan. Individual 401(k) and SIMPLE plans must have been set up during the tax year for which you are filing, but it’s possible to fund the plan as late as the extended due date for your prior year tax return. SEP IRA plans may be opened and funded for the previous year by the extended tax return due date as long as an extension has been filed.

6. You are still able to receive a tax refund when you file past the extension due date. Filers have three years from the date of the original due date (April 17, 2018) to claim a tax refund. However, if you file an extension you’ll have an additional six months to claim your refund. In other words, the statute of limitations for refunds is also extended.

Cons

And now for the cons of filing an extension…

1. If you are expecting a refund, you’ll have to wait longer than you would if you filed on time.

2. Extra time to file is not extra time to pay. If you don’t pay a least 90 percent of the tax due now, you will be liable for late-payment penalties and interest. The failure-to-pay penalty is one-half of one percent for each month, or part of a month, up to a maximum of 25 percent of the amount of tax that remains unpaid from the due date of the return until the tax is paid in full. If you are not able to pay, the IRS has a number of options for payment arrangements. Please call the office for details.

3. When you request an extension, you will need to estimate your tax due for the year based on information available at the time you file the extension. If you disregard this, your extension could be denied, and if you filed the extension at the last minute assuming it would be approved (but wasn’t), you might owe late-filing penalties as well.

4. Dealing with your tax return won’t be any easier 6 months from now. You will still need to gather your receipts, bank records, retirement statements and other tax documents–and file a return.

Need to File an Extension? Don’t Wait.

Time is running out. If you feel that you need more time to prepare your federal tax return, then filing an extension of time to file might be the best decision. If you have any questions or are wondering if you need an extension of time to file your tax return, don’t hesitate to call.

• By Leon Clinton
• April 11, 2018