Living together doesn’t always get you benefits

The IRS has won one against folks who are dating and living together. A couple in Massachusetts were dating. She moved into his house that he had purchased by himself. They agreed to share in the expenses of the household, including the mortgage. They improved the house together and agreed to share in any profits from the house if they sold it. They had a child together. He stopped working and became the primary caregiver for their child. So she was paying the mortgage and household expenses by herself. Common enough story, so let’s look at how they filed their taxes.

For several years, she did not ask to be an owner in the home. He claimed the entire home mortgage interest deduction on his tax return. Some time after she started paying all the expenses, they agreed to become joint owners of the home. It took them several months to get the paperwork filed and she became an owner in June of 2007. She claimed the home mortgage interest deduction for the whole year.

The IRS audited her return. They disallowed the interest deduction for the time that she was not listed as an owner of the residence. Their argument was that she did not have the obligation to pay the mortgage nor the risks associated with home ownership prior to June, so she was not entitled to the mortgage interest deduction for that part of the year. The IRS won.

To me, this case highlights the disparity between the law and equality. I can’t change the law (at least not very easily), but I can point out that agreements between two people that make economic sense do not always produce equitable results from a tax perspective. The result would have been different if the couple was married because they would have filed a tax return as married filing jointly. The result would have been different if she had become an owner in the house as soon as she started paying part of the mortgage.

The moral of the story (if there is one) – Living together doesn’t always get you the benefits you think you deserve.

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Taking the fun out of fundraising – Booster Club Fundraising

Friday night lights, football uniforms, cheerleaders, marching bands, nachos with bright yellow cheese served by Booster Club parents. All signs that fall has arrived in Texas. But the summer is when the action begins. The stadium needs a new scoreboard; the band needs new uniforms; the cheerleaders need to go to camp. Booster clubs around the country are actively seeking donations for one need or another.

Here is the situation – the band is invited to march in the Macy’s Thanksgiving Day parade. The band booster club is raising funds. They have determined that it will cost $1,000 per student. Each student is asked to raise funds by selling cookie dough. The students are given individual credit towards the cost of their trip for the amount individually raised. The shortfall is funded by the parent or as a scholarship by the booster club if need is demonstrated.

Lois Lerner, Director of Exempt Organizations for the IRS, issued a directive on June 27, 2011 that clarifies the possible tax consequences for the organization where “a booster club reduces the amount a participant is required to pay based on the amount of fundraising done by that participant.” The news is frankly disturbing – references to private benefit, loss of exempt status, and employment taxes.

The directive suggests that the booster club is providing a private benefit to that participant. Private benefit is a very nasty phrase in nonprofit circles. The directive says “such practices could result in the organization failing to be described in Sec. 501(c)(3).” That could mean loss of exempt status or could mean demotion to a different type of exempt organization with no tax deductible contributions allowed. Either way, not a good result.

Furthermore, the directive hints that the amounts credited to the participant would be income from services. Therefore, the organization could be subject to employment taxes and the student would have taxable income. Double whammy!

The IRS doesn’t tell us how this type of fundraising ought to be done, but I think the issue is that individual accounts are maintained. If a booster club wants to be safe, the fundraising must be done for the group. It can’t matter that 40 kids more than paid for their trip through fundraising and the rest fell short. Each student should be asked to pay the same amount. I believe that scholarships can be available for those with a need with no negative tax consequences to the organization or the student. But the organization needs to have an application and process for determining need.

Just another example of how fundraising really isn’t all that fun.

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Keeping your financial records safe

I helped my mother move about a year ago. Prior to moving she wanted to clean out her file cabinet that had become so congested that it was coughing out papers every time you opened a drawer. She is a fantastic record-keeper, but her record retention policy was a little excessive. Not only were her tax returns available back to the 1970s, but my deceased grandparent’s returns were also neatly filed. She had ALL her bank records, including passbook savings from my childhood. She had payroll stubs, Social Security notices, and investment statements. So, we hauled out the shredder and got a handle on the filing infection before the move.

Related to this situation is a question that I got from a client before they left for their summer home in another state. They asked what records they needed to take with them. They were used to packing up a briefcase of paperwork, shoving it in the trunk of the car, and (almost) never pulling it out in the five months that they were gone. They were considering flying and really did not want to take anything that they didn’t need.

These situations got me to thinking about what I should do with my own financial records. I’ve got my fair share of paper records but a lot of records are on my home computer that I admittedly do not back-up as often as I should. So I’ve been considering my options and have settled on a scanner and a USB flash drive.

Scanners have really improved. I have a very small scanner on my desk that copies the front and back with one pass. One of my colleagues scans every piece of important mail as he comes into the house, electronically files it, and throws the paper copy away. If I could adopt that routine, paper clutter would substantially decrease at our house!

Flash drives are virtually indestructible and easily transportable. This will make it easier to go between the home computer, the laptop and the office. Unfortunately, they are also easy to misplace, so I’ll have to attach it to an obnoxiously colored keychain (maybe with a little bling) and hang it on the wall away from the mischievous pets.

So, I have a plan that should keep my records safe, easily move with me, and substantially cut down on paper files – now I just need to time to implement it. National Clean Off Your Desk Day is the second Monday in January. Not sure I can or should wait that long!

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Who’s in the group?

As a tax professional who has worked a lot with nonprofits, you’d think that I would understand group exemptions better – but, frankly, they have always been a bit mysterious to me.

There are evidently over 4,300 group exemptions that cover more than 50,000 subordinate organizations. These groups include churches (ex., the Catholic Church, Presbyterian Church USA), youth organizations (ex., 4-H), national nonprofits (ex., American Cancer Society, Habitat for Humanity), labor unions (ex, Teamsters), and many others.

I know that a group of organizations with enough common affiliation and purpose can file one form requesting exempt status for all the organizations in the group. This filing prevents each organization from having to file for exemption separately. Makes sense.

There are procedures to file annual tax returns either as a group or individually. Makes sense.

The central organization is required to annually submit a list of their affiliates to the IRS. Makes sense.

However, the lists of subordinate organizations are not distributed by the IRS and each affiliate is not individually included in Pub 78 (an IRS publication that lists all nonprofits eligible for tax deductible charitable contributions). That has always bothered me. How does a donor know that the affiliate is actually covered by the group exemption? Who’s in the group?

Turns out, it has bothered other folks too. So, the IRS Advisory Committee on Tax Exempt and Government Entities (ACT) studied the problem and submitted their recommendations to the IRS.

Very reasonable (in my mind) solutions have been recommended. The theme, not surprisingly, is transparency. Each recommendation is offered to improve transparency within the tax-exempt sector. The recommendations are:

1. Retain the group exemption mechanism – A central organization can still file for tax exempt status for the entire group. Bravo! No need to make this process more painful.

2. Eliminate group returns – Each organization will independently file a tax return. Again, this makes sense because most subordinate organizations have their own board of directors and are financially independent from the central organization. Having worked with large corporate organizations with multiple subsidiaries, the ability for a stakeholder to figure out the financial results of any particular subsidiary from the tax return is difficult at best. Since transparency is the goal, each organization should stand alone in their tax filings.

3. Better define “general supervision and control” – This suggestion is made for purposes of determine whether the subordinate organization is covered by the group exemption. Some of these very large central organizations may not get enough information from their affiliates to hold them accountable for maintaining the tax-exempt status given to the group. I’ve served on nonprofit boards where the group has gotten away from the mission of the organization as it was described to the IRS. In a group exemption setting, it is important for the central organization to maintain supervision of the affiliates to make sure they haven’t strayed from the path.

4. Enhance Form 990 for central organizations – Each central organization would be required to file a full-blown Form 990 (not just a 990EZ or 990N) and attach a list of their affiliates covered by the group exemption. Since all of these filings are public (available on several websites but I most often use The National Center for Charitable Statistics), this would certainly improve transparency.

5. List the subordinate organizations in Pub 78 – YEA! The answer to my question that sparked me to read the recommendations in the first place.

So, if these recommendations are implemented, we’ll be able to figure out who’s in the group! Stay tuned…

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Tax exemption revoked for 275,000 organizations

The IRS has released the list of over 275,000 nonprofit organizations that have lost their tax-exempt status as a result of failing to file a tax return for the last three years. Many of these organizations are no longer in operation, but some are operating with volunteers that change frequently and have little experience with tax filing responsibilities.

The loss of exemption may not mean that the organization will have much income tax to pay since many small nonprofit organizations do not have much net income. However, without tax exemption, donors will not receive a charitable contribution deduction for money given to these organizations. This could significantly impact their ability to operate.

Although the IRS gave plenty of notice to organizations and made several attempts to directly contact organizations about their filing responsibilities, it still makes me sad that so many organizations are on the list. It is not inexpensive to file for exemption – currently the IRS fee alone is $800. This does not count professional time (accountants and lawyers) and the time for internal personnel to pull together this information needed to file for exemption.

The good news is that there is a limited window to apply for retroactive reinstatement of their tax-exempt status. Organizations with annual gross receipts of not more than $50,000 (meeting certain other restrictions) can submit a Form 1023 by December 31, 2012 and seek reinstatement of exempt status retroactive to the date exempt status was revoked. Thankfully, the IRS is requesting a reduced fee for this filing of only $100.

Larger organizations also have an opportunity to request retroactive reinstatement. These organizations will have to file a Form 1023, but they must show proof that they had a reasonable cause for failing to file the required returns. In addition, they must complete all tax returns that had not been filed. The request for retroactive reinstatement must be submitted within 15 months of the later of the date of the IRS revocation letter or the date on which the IRS posts the name of the organization on the IRS revocation list. There is no reduction in the fee ($800) to file the Form 1023 but the reinstatement will be retroactive.

I urge you to review the list on the IRS website and see if you recognize any organizations. If you do, make contact with the organization to let them know. Seems obvious, but I have first-hand experience with very thankful organizations that I called when the “in danger” list came out and who successfully avoided revocation. You could be the difference to a small volunteer-run community organization.

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Don’t look a gift horse in the mouth (Part II)

I talked about gift tax returns in Part I of this blog (a long time ago, I know, but one thing leads to another and you are a month behind). Back to business…Sometimes a gift doesn’t look exactly like a gift. Gifts don’t have to come with a shiny bow to be a gift for gift tax purposes. The one that catches a lot of people by surprise is money put into 529 plans to save for educational expenses.

By now, most everyone has heard of Qualified Tuition Programs (also know as 529 plans for the Internal Revenue Code Section it is referenced in) which are used to save for college expenses. The earnings in these accounts accumulate tax free and the beneficiary (student) does not have to pay tax on the distribution. These plans are a favorite for grandparents who want to help with future college expenses.

But money put into a 529 plan is a gift for gift tax purposes and is not eligible for the educational exclusion. The educational exclusion is for payments made directly to the school for tuition. It doesn’t include amounts paid for books, housing, etc – just tuition. This is a great way to make a gift but not have any gift tax consequences.

Although money put into a 529 plan does not qualify as this type of gift, it does have some special benefits. Remember that you can give up to $13,000 per person annually without gift tax consequences. With a 529 plan gift, you can elect to treat up to $65,000 put into the plan in one year as made over 5 years. You will have to file a gift tax return in the first year to make the election. As long as you don’t give that person any additional gifts in the next four years, you do not have to file a gift tax return. To say it another way, once you’ve made this election, you’ve used up your annual gift tax exclusion for five years and cannot give any additional amount without filing a gift tax return.

In this season of graduation and advancement to the next grade, college starts to draw nearer for many students (and money worries for their parents). If you have extra money to gift, education is a great way to use your annual exclusion!

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Don’t look a gift horse in the mouth (Part 1)

Tax season has ended. Maybe you got a big refund and are feeling particularly generous. Or maybe you have a family member that didn’t get a refund and is feeling panic about how he will pay. How about a gift?

Each of us can give away $13,000 per year to any person that we want. This includes our kids, our grandkids, our parents, our favorite Aunt Fanny or neighbor Fred. Free to them, free to us – possibly no strings attached but definitely no tax attached.

Sometimes gifts are made in cash, but other times they are property. I love watching Antiques Roadshow where the person admits that she got the broach from an elderly neighbor who didn’t have any kids or the painting that no one likes from an uncle who lived with them for a while. Turns out the broach is a Tiffany with diamonds and emeralds and the painting is by a lesser known but highly collectible American artist. Gifts with high value and probably no gift tax return was done.

A gift tax return (Form 709) is required when total gifts in a year are more than the annual exclusion amount – or $13,000 per gift recipient for 2010. There are several exceptions to this rule. Gifts to charity are not gifts for this purpose. Gifts to your spouse don’t count either (unless your spouse is not a US citizen). The best exception though is for tuition or medical expenses paid directly to the educational or medical institution. As long as you make the payment straight to the school or doctor, it is not a gift to the person that you paid them for.

If you are married, you and your spouse can gift up to $26,000 to a third party without making a taxable gift. The gift can be considered as made one-half by you and one-half by your spouse. This is called gift-splitting. Gift-splitting is very common in community property states (like my home state of Texas). If a gift is made from community property, it is considered a gift from each spouse and gift tax returns are required. If you elect gift-splitting, generally both you and your spouse must file gift tax returns (two separate returns) to show that you have agreed to the gift splitting. You cannot file a joint gift tax return with your spouse. There are exceptions where only one spouse has to file a gift tax return – but like a lot of rules in tax, they are too complicated to discuss in a blog. Definitely talk to your tax advisor.

Back to that fabulous broach from the neighbor. Cash is easy to value; property is more difficult. The value to be used for gifts is “fair market value” or the price that would change hands between a willing buyer and a willing seller. The Antiques Roadshow appraisers almost always give a range for value with qualifying statements like “if it were in the right auction with the right collectors” or “if I had it in my shop”. The best advice I can give is to have the item appraised by a qualified appraiser at the time of the gift. Let the person know that you are requesting the appraisal for purposes of gift tax. You’ll have to attach the appraisal to the gift tax return if the value is over $13,000. If it is under the annual exclusion amount, put the appraisal in a safe place in case there is ever a question.

Generally the donor is responsible for filing the gift tax return and paying any gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax. So if you get a large gift, it is in your best interest to confirm that a gift tax return was done.

Most of the time, gift tax returns do not generate any gift tax because each of us also has a lifetime exclusion amount. More about this and gifts into Qualified Tuition Programs (529 Plans) in Part 2 of this blog.

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March Madness

March Madness is in full swing. I’m not talking about basketball, but certainly that madness has overtaken office cooler talk everywhere. You should have heard the shouting from my husband when St. John’s went down in the first round, then Texas in the second. He is glued to the TV even as he mourns for his favorites.

But for tax preparers and their clients, March Madness refers to the rush to collect tax information to get individual tax returns filed by (this year) April 18th. Sometime near the end of March, we, like many small firms, simply have to draw the proverbial line in the sand. Clients who bring their information in after that date will most likely be filing an extension. We don’t publicly declare what day that is because it depends on our workload, but clients who have been with us for a while seem to sense that the “deadline” approaches. We get a lot of apologies for “bringing it in so late” as they rush to be on the right side of the line. But is this rushing around really necessary?

Let me go on the record by saying that I’m a fan of the extension. For individuals, the IRS offers an extension of time to file to October 15th. You have to prepare a good estimate of tax owed before you extend to avoid a late payment penalty, but that’s pretty easy to do. My theory is that it doesn’t have to be perfect, just comfortably close, with a bit of reserve. Pay your first quarterly estimate for the next year as an extension payment and penalties for the current year should be kept to a minimum.

You also have to decide on IRA contributions. These have to be made by April 15th to get credit for the previous year. Your deduction may be influenced by your adjusted gross income, so you have to massage the numbers to understand what tax benefits you get. But generally folks know whether they want to make an IRA contribution or not.

One reason that extensions make sense is that passthrough business returns have to be prepared before the owner’s individual returns can be finished. For small business owners, I’d really recommend focusing on getting the business information tied down soon after year end. It is just too difficult to remember what happened if you let this drag out long after year end. By focusing on the business return during the season, the individual return can be prepared soon after the madness passes.

The main reason I see to file an extension is to reduce the panic. More mistakes are made when folks rush. Not all the charitable contributions get summarized. Not all the medical expenses are collected. Business mileage is forgotten. When we used to have to give an “excuse” for filing an extension, the typical reason was “the taxpayer respectfully requests additional time to file in order to collect the information needed for a complete and accurate return.” Extensions are automatic now, but the reason is still valid. Take your time. Collect complete information. File an accurate return. There is really no need for March Madness.

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Time is running out

The IRS recently released a notice that $1.1 billion (yes, with a B) in refunds may be waiting for people. They estimate that 1.1 million people did not file a federal income tax return for 2007 and may be owed money. To collect the money, a 2007 tax return must be completed and mailed (postmarked) by April 18, 2011.

Who are these people? They are likely employees who had taxes withheld from their pay who did not make enough to be required to file a tax return. This includes high school and college students with part-time jobs. Or they might be elderly people who had some withholding from a pension but also didn’t have enough taxable income to file. Or maybe they just haven’t gotten around to filing and know that their withholding was sufficient to cover any tax due. Rarely is withholding EXACTLY equal to tax due, so they may actually be due a refund.

Even if there is no prospect of refund, a person may want to file anyway. Until a return is filed, the three-year statute of limitations for the IRS to start an audit won’t begin. Maybe there was a capital loss from investments that can be carried forward to offset future capital gains. Or maybe there was a net operating loss from a Schedule C business that can be used to offset future taxable income.

There is no time limit for filing in one of these scenarios, but time is running out if you are due a refund. The luck o’ the Irish won’t help you – the IRS will not issue a refund without a tax return. Don’t let April 18th pass without considering your claim.

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Get a piece of the pie

If you own a small business or manage a small nonprofit, you should be excited about the small business health care tax credit available for 2010 tax returns. This credit is available to small business employers that provide health care coverage to employees. By small, they mean employers with less than 25 full-time equivalent workers (FTEs) who are paid average annual wages of less than $50,000. There is a phaseout for the credit, with the maximum credit going to employers with 10 or fewer FTEs, paying annual wages of $25,000 or less.

The credit is worth up to 35% of the health insurance premiums paid (25% for nonprofits, including churches) by eligible small business employers. It is claimed on Form 8941 and attached to the employer’s annual tax return (1120, 1120S, 1065 or 990T for nonprofits). You can get more detailed information on the IRS website.

President Obama said to the Chamber of Commerce on February 7, 2011, that “the non-partisan congressional watchdogs at the CBO estimate that health care tax credits will be worth nearly $40 billion for small businesses over the next decade—$40 billion, directly to small businesses who are doing the right thing by their employees.” The credit requires gathering some detailed information and doing some calculations, but your business should definitely get a piece of the pie!

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