Thieving Thoughts

Recently I’ve worked with a number of clients who were the victims of employee theft.  While I like to emphasize prevention, this is so commonplace that it’s also worth visiting what to do if (when?) it happens to you.   Employee fraud is a huge problem, and in difficult economic times it’s not on the decline. In retailing alone, employee theft accounts for almost 44% of total losses.  That’s about 10% less than what stores lose to shoplifting.  Guess which one is easier to do?

Loss of property to theft is generally tax deductible.  As with everything else involving taxes, you have to be prepared in case the deduction is challenged.  For a theft loss to be deducted the event that caused you to lose property or money has to be illegal in your state.  A conviction is not required. The IRS is pretty broad in its definition of theft including:  blackmail, embezzlement, extortion, kidnapping and fraud on their list.  Employee fraud and theft usually qualifies.

In a rare show of common sense, you can deduct the theft loss in the year it is discovered, which doesn’t have to be the year in which it occurred.  However, you have to be prepared to prove that the property was yours, when you discovered it was lost, and that you didn’t just lose track of whatever went missing.  Also, if you are eligible for an insurance claim, or have some other possible means of recovery you need to do that first.  You can’t deduct the loss until it’s completely clear how much you have lost and that it’s permanent.

Other things to keep in mind are that inventory loss can be managed on your tax return by either raising the cost of goods sold or reducing the value of your inventory.  You don’t need to file a special form for either method.  Also, if you lose money on a stock due to accounting fraud or other malfeasance on the part of that company, that’s considered a capital loss instead of a theft loss.  Finally, if you’re the victim of a Ponzi scheme, your ability to deduct the loss is constrained by whether the transaction was part of your trade of business (in that case you’re fine) or a personal loss (this is worse).  If it's personal, you won’t get everything back, and you’ll probably want to hire an accountant to figure out how to calculate the deduction.

On that cheery note I’ll go back to tracking the Frankenstorm headed our way. Hopefully my next topic won’t be about deducting casualty losses.   

Tax Truths

This past week I was at a lunch where a real estate professional was bemoaning the “house tax” associated with the Affordable Care Act.  When I suggested that the health care legislation didn’t include a house-tax I was met with much skepticism.  I explained there was a capital gains tax change that could involve houses, but that didn’t get much traction.  Finally someone used their iPhone to visit an Internet site that confirmed that the tax increase relates to capital gains.  While it’s possible to pay capital gains tax on the sale of your primary residence – it’s unusual. (Right now it’s unusual for a house to sell for more than it cost in the first place!)  In an effort to expand my outreach on this subject, I thought it would be helpful to go into more detail here.

Part of the health-care overhaul legislation includes a new 3.8% Medicare tax on “unearned” net investment income.  (This piece was actually added in the second bill, called the Health Care and Reconciliation Act of 2010.)  It will impact taxpayers with incomes greater than $200,000 (or $250,000 for people who are married).  This is a 3.8% tax on income from sources that are not from the ordinary course of trade or business.  There’s a long list of examples in the legislation (Section 1402 if you want to read it for yourself) but basically we’re talking about investment income here.   While I don’t expect to do many tax returns with a house that gets this tax, it is likely to create more taxes for people with investment income.  Call it a stock-tax or mutual-fund-tax and I’ll be nodding in agreement.

This is where the home issue comes up.  When you sell your primary residence, most people do not pay a capital gains tax on the sale. The reason is there is an exclusion  for the first $250,000 (for married people it’s $500,000) of profit on the sale.  That means if you sell a half million dollar home for $700,000 you don’t pay any taxes on the difference – even though you got $200,000 more than you paid for it.  Now let’s say you sell this same house for more than a million dollars.  You would have to pay capital gains tax on the amount of profit that exceeded your threshold for the exclusion.    You would pay the Medicare surcharge tax (the additional 3.8%) on the profit that was more than the exclusion amount, if the combination of that and your income adds up to more than $200,000 ($250,000 married).  OK I get that it’s confusing.  Clearly I should really reconsider my complaints about congress and taxes.  Without such convoluted provisions, being an accountant could get boring. 

1099 More Ways to Have Tax Troubles

While most of my conversations about taxes at this point have to do with getting information about the return itself, an article in the Wall Street Journal reminded me of a change to returns this year that has big implications.  As indicated in this blog before, the IRS is falling ever deeper in love with third party reporting, and they are getting more serious about making sure it gets done.  The Service did back off on some of the more heinous aspects of making business owners reconcile the reporting they are getting from credit card companies (otherwise known as form 1099K).  Still, the reporting will be used to audit small businesses that accept payments via credit and debit cards.  What also hasn’t gone away is that if you pay for services with a credit card, and then have to issue a 1099, you need to subtract out what you put on the credit card.  Your vendor is already getting that income reported from the merchant bank that processed the transaction. Giving the IRS opportunity to double count income isn’t the best way to build business relationships.

This brings me to the matter of the 1099 Miscellaneous.

 

If you file taxes using a Schedule C, Schedule E, Form 1065 or Form 1120S there’s a question you have to answer for the first time this year asking if you did business with anyone who should have received a form 1099.  That would be anyone who you paid $600 or more to provide a service and they’re not incorporated.  Answer this question incorrectly, and if you get audited, you will face penalties, even though the form 1099 that you send has nothing to do with your gross income.  So your tax liability could be correct to the penny and you could still be in trouble with the IRS.  (Just when you thought you understood how bad this tax season was going to be!)  And the bad news doesn’t stop there.  Let me quote from the article.

In 2010 Congress stiffened the penalties on taxpayers who neglect to provide 1099 forms. The higher penalties took effect in 2011, and now the penalty for nonfiling is $100 per violation—$200, in most cases, because two forms are due, one to the IRS and one to the provider. The penalty for "intentional failure to file" is $250.

It’s a hassle to file these forms, as I know from personal experience filling them out.  However, this is a way for the government to raise more revenue without raising taxes.  That’s another way of saying it is a sure recipe for increased government action. 

Roth Around the Clock

I remain a big fan of the Roth conversion – that is converting a traditional IRA into a Roth.  Still it’s worth noting that if you converted to a Roth in 2010, the time to change your mind about that move ends on October 17^th of this year.  The reason to convert in the first place is a belief that you’ll pay less tax on the money in the IRA if you pay taxes now rather than when you are forced to take minimum distributions of that money.  (IRAs defer taxes, but they don’t prevent them.)  If anything has happened since 2010 to change that belief, now is the time to act.    

When you convert an IRA you have to pay the taxes Uncle Sam didn’t collect when you first salted that money away.  In 2010 our Uncle was feeling generous, so he provided the option to pay those taxes over two years.  Also, there are income restrictions that stop some people from contributing to a Roth (For 2011, Adjusted Gross Income of $179,000 if married filing jointly, $122,000 for singles and $107,000 for married filing separately).  A rollover though, is open to everyone.  So if you think the Roth version of tax deferral is good for you, but can’t qualify for regular contributions, conversion is a back door that remains perpetually open.   

The problem is the time lag between the conversion and the tax payment.  Let’s say when you cashed out of the IRA in 2010 the value of your account was higher than it is now.  If you stay put, you’ll pay taxes on money you may never get to spend.  Given the recent market volatility this is not just an academic argument.  The other area of risk is the protracted recession has put financial pressure on people who might not have expected to be short on funds when tax bills come due in 2012.  For those folks the idea of paying the taxes early may still look good, but may be impractical.

 You are allowed to undo or “recharacterize” the conversion.  You can put the funds back in an IRA.  If you made the move in 2010 though, the clock is ticking.  The Wall Street Journal article on this topic says Vanguard Group had a 423% increase in conversions in 2010 and Fidelity reported similar results.  If you recharacterize, the money goes back into a traditional IRA.  You can change your mind a second time, but you can’t reconvert in the same year you “unconverted” (I’m not sure that’s actually a word, but presumably context communicates the meaning).  If you’ve already filed your 2010 return, you’ll have to amend that as well as deal with the 2011 paperwork. 

The Journal article goes on to say that the conversion levels in 2011 were way down, and the number of recharacterizations hasn’t spiked despite the reasons to think they might.  The thought is that people who had the wherewithal to pay all those taxes in 2010 are generally still doing well enough to handle the commitment.  Also, the same market volatility that can cause one to recharacterize can raise the value of the account when you’re required to take minimum distributions and increase your tax bill yet again.  If you’re interested, there are more details about this on my most visited website (sad but true) http://www.irs.gov, look for Publication 590. 

One other “gentle reminder” in terms of dates…  October 15^th is drop dead for filing individual 2010 taxes.  No exceptions. 

Tax Cut Confusion

One to the many nice things about blogging is it tends to provoke me to look at what’s being discussed in print and on line, using that to shape the topic for the week.   Usually there’s something that emerges as worth more attention than I’ve given it – and that brings motivation to learn and then to share.  That said – I am burnt out on this tax the rich / jobs bill stuff.   I must admit part of my problem is that this is a complex issue.  So, in an effort to overcome my nascent attention deficit disorder and to better understand what is actually a consequential topic to my pocketbook, I am considering the following question.    Do tax cuts really help the economy? 

The Tax Foundation says not unless there’s a sense of permanence associated with the cut.  We all know that nothing is certain but death and taxes.  However the new twist on that is “what taxes and when” tends to be an open question.  The Tax Foundation article suggests the temporary nature of  the proposed payroll tax cuts is a problem.  The argument is, in an uncertain economy when it’s a one-time deal, tax cuts don’t stimulate the economy.  People are on a budget, and don’t expect things to get better, so rather than spend the “windfall” they put the money in an emergency fund.   

The question of whether tax policy is effective if it’s not permanent is a popular topic.  The blog A Taxing Matter takes issue with the pressure to make the R&D credit permanent arguing that companies that need to do research anyway shouldn’t get a special deduction for doing it.  The New York Times did a scathing piece on this topic earlier this month, targeting the video game industry.   In both these articles they argue the specific tax cut is bad, but ineffective when temporary.   The same Tax Foundation piece I referenced earlier uses that logic for saying a temporary tax cut to encourage jobs is useless.  When people with such different views come to essentially the same conclusion, it’s usually a sign they’re on to something.

The only missing piece I see in this discussion is that these temporary tax cuts aren’t being imposed from outer space.  We (since I vote I have to include myself in this group) keep electing people who see temporary tax cuts as a way to get re-elected.   As a mom I think we voters have to admit that the child- like behavior in Washington didn’t occur without our participation, and won’t stop unless we take appropriate action.

Speaking of being appropriate – I should mention that Christina Romer, whose work I cited last week as an argument against the tax hike portions of the jobs bill, has a piece in the New York Times Business Section today defending the bill.  (Though notably she doesn’t say good things about the tax hikes.)  Here’s the link if you’d like to know more.