Avoid IRS Income Tax Filing Compliance Penalties

The IRS has over 140 penalty provisions at its disposal, but only use a handful regularly. The United States income tax system has a pay-as-you go structure. Simply stated, if you don’t pay enough federal tax throughout the year as you earn income, either by payroll withholding or quarterly estimated payments, you may face consequences. On top of underpayment penalties, there are also failure-to-file and failure-to-pay penalties, known as the delinquency penalties, associated with untimely-filed returns.

According to IRS statistics, more than one in ten taxpayers requested an extension to file their 2018 federal tax returns. With all the new tax code changes implemented in 2018, many taxpayers needed additional preparation time. The complexity of the new laws made it very difficult at extension time to estimate whether a taxpayer would expect a refund or owe more.

If you file Form 4868 by April 15, 2020, you will allow yourself an extra six months to prepare your 2019 income tax return. However, this extension period does not include additional time to pay taxes. If you figure you owe taxes, you must still pay by the original April 15 deadline. If you fail to cover your final amount due at that time, the unpaid balance will be subject to interest and a 0.5% per month late payment penalty. Interest accrues quarterly at a varying rate from the original due date until the date of payment. The combined rate for the penalty and interest is roughly 12% per year, and none of it is deductible. In other words, the October 15 federal tax extension deadline is only for filing your tax return, and you must gather enough information to determine taxes owed by April 15. It is better to slightly overestimate taxes because you will get any overpayment back in the end.

If you are one of the fifteen million taxpayers estimated to file extensions for the 2019 tax year, make sure to file timely even if you can’t pay your taxes in full at the original due date. If you owe, the fine for failing to file either an extension or a tax return by April 15 is 5% per month for five months, maxing out at 25%. It is always in your best interest to not ‘borrow money’ from the IRS, but rather pay as much as you can, as soon as you can, to minimize additional government charges. There are payment plans available through the IRS. If you pay within 120 days, you will not be liable for user fees. If a long-term installment agreement is approved, you will be assessed setup and processing fees. Individuals with balances over $25,000 and businesses with balances over $10,000 must use Direct Debit to pay their bills.

Generally, most taxpayers can avoid the accumulation of penalties if they owe less than $1,000, or if they paid at least 90% of the current year’s tax or 100% (110% if adjusted gross income was $150,000 ore greater) of the prior year’s tax. There are also certain qualifying life events that the IRS will consider for waiving a penalty. If you receive income unevenly during the year, you can potentially justify using an annualized installment method to reduce penalties as well. Another option to possibly erase penalties is the agency’s first-time penalty abatement program.

Please contact your Ketel Thorstenson tax advisor to help plan for these types of penalties.

January 13, 2020

What is E-Verify?

E-Verify is a web-based system that allows enrolled employers to confirm the eligibility of their employees to work in the United States. Identity verification is done by electronically matching information provided on the Form I-9, Employment Eligibility Verification, against records available to the Social Security Administration and Department of Homeland Security.

Although E-Verify participation is often voluntary currently, some employers are required to participate due to a legal ruling, federal contracting clauses, or state licensing legislation. Certain states have different industry requirements as well. South Dakota currently has no legal mandates for E-Verify. As this can always be changing, employers should take note of their specific state laws related to this to make sure they are complying.  In the meantime, employers should absolutely be completing an accurate I-9 with their employees prior to putting an employee on payroll.

Once an employer does begin using the E-Verify system or another similar one, it is recommended they consistently use it for every employee to avoid discrimination issues. It is also not usually permitted to just stop using it once you have registered with the system to be submitting information for verification.  The current trend appears to lead to the thought that eventually use of this system, or another like it, will become nationally mandatory. Due to growing popularity, www.e-verify.gov website now has instructional videos, compliance assistance, and business search options.

This system is not however fail proof.  One of the bigger criticisms currently of the system is that it is all information based.  So, in our world of stolen identities and fraud, this could lead an employer being given information that the employee they are verifying is legal to work in the United States, but with it falling short of things like biometrics that could be false if someone has stolen documents or identity.  We are sure this will continue to evolve and improve in the process as time goes on.  If you have questions or would like more information about E-Verify, please contact your at Ketel Thorstenson team member.

September 30, 2019

Disallowed “Double-Dipping” in Education Tax Benefits

The IRS disallows “double-dipping,” which means utilizing more than one tax benefit on the same expenditure. For example, a taxpayer cannot take both the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC) for themselves, or for the same dependent, in the same tax year.

Also, for example, if a taxpayer spends money on tuition and is able to claim one of the education credits, then those same tuition costs cannot be used to offset a Qualified Tuition Program (529 plan) distribution to make it nontaxable. Distributions from a 529 fund in excess of Qualified Higher Education Expenses (QHEE) are considered taxable income to the extent the distribution exceeds the basis in the fund. As such, any QHEE expenses used to calculate the AOTC cannot also be used to calculate the nontaxable portion of the 529 distribution.

QHEE includes any amounts paid for tuition, fees, books, supplies, or any related expense required for attendance at a postsecondary institution by an eligible student who is enrolled at least half-time. Necessary books, supplies, and equipment for a class are qualified, even if these expenses are not paid directly to the school. However, they must be paid directly to an eligible education institution for the LLC.

Here’s your planning opportunities: first, room and board expenses are only considered qualified for the 529 plan distributions, and not AOTC; second, only the first $4,000 of QHEE are needed to qualify for the AOTC. As such, use the 529 plan funds for all room and board and any tuition and QHEE in excess of $4,000.

All of these expenses must be paid for an academic period that begins during the tax year, or the first three months of the following year. QHEE can be paid by cash, check, credit card, or loans. If paid with money from a loan, the expenses qualify in the year you actually make the education-related payment, not the year you obtain or repay the loan. You must reduce QHEE by any amount paid with tax-free grants and scholarships. The AOTC can still be claimed in the same year that a tax-free 529 distribution is made, as long as there are enough expenditures to calculate both separately. A taxpayer will want to determine which option is most advantageous to them in each applicable tax year. Generally, a tax credit that increases a refund or decreases any tax due is better than solely reducing taxable income. Contact your tax professional at Ketel Thorstenson, LLP if you have any questions.

June 6, 2019

The New Kiddie Tax Rules

Big changes are happening to the kiddie tax for the years 2018-2025. The Tax Cuts & Jobs Act repealed the kiddie tax policy and replaced the tax rates applicable on dependents’ unearned income with the same rates that apply to trusts and estates. Unearned income includes taxable interest, ordinary dividends, capital gains, rents, unemployment compensation, etc. Scholarships are exempt. The new structure will be unfavorable for most children, as it causes more kids to file tax returns and likely pay more tax than ever before. In the past, income subject to kiddie tax was taxed at the parents’ marginal rate. Now, in attempt to simplify the old complex process, the parents’ rate and any siblings’ unearned income will no longer matter. Instead, investment earnings in excess of an annual amount ($2,100 for 2018) will be taxed using the compressed rate brackets below:

  • Up to $2,550 10%
  • $2,550 to $9,150 24%
  • $9,150 to $12,500 35%
  • Over $12,500 37%

To calculate the kiddie tax, a child’s net earned income is added to net unearned income, then reduced by the standard deduction amount, to arrive at taxable income. The portion of taxable income that consisted of earned income is taxed at regular single taxpayer rates, while the unearned income portion that exceeds the threshold is subject to the above trust and estate tax rates.

The kiddie tax applies when the following requirements are met:

  • The child is required to file a tax return for the year
  • The child does not file a joint tax return
  • At least one parent is alive
  • Net unearned income exceeds the annual threshold ($1,050 in 2018)
  • The child has positive taxable income
  • At least one of these age rules are met:
    • Age 17 or under at 12/31
    • Age 18 at 12/31and does not provide half their own support
    • Age 19-23 full-time student and earned income does not equal half his or her support

Even if a dependent files his or her own tax return, the parent can still claim the child on their tax return, assuming the dependent did not provide over half their own support during the year. In some cases, it is more beneficial for a parent to elect to claim a dependent’s income on their tax return, as long as certain criteria are met. This would be accomplished using Form 8814 (Parents’ Election to Report Child’s Interest and Dividends). Although the kiddie tax laws were designed to discourage the shifting of income-generating assets into children’s names, these recent changes could actually have the opposite effect under some circumstances.

While the new “Kiddie Tax” is easier to calculate, it can be more expensive for children with significant unearned income. Please contact your tax professional at Ketel Thorstenson if you have tax planning questions.


January 14, 2019

New Standard Deduction vs Itemized Deductions

It’s no secret how impactful the new Tax Cuts and Jobs Act (TCJA) has been, and will be, for taxpayers and accountants alike. Many taxpayers are analyzing what it means for their personal tax position.  For one of the most important parts of an individual return, there are two options to consider: Utilize the “standard deduction” amount or itemize various deductions on Schedule A.  As may be obvious, the option that offers the most tax savings should be used. Calculating your tax liability each way is simple; however, there are tricks available that can sometimes control which route you go.

Under the TCJA, the standard deductions have nearly doubled from 2017 (now $24k married filing jointly, $12k single, and $18k for head of household filers in 2018), and personal exemptions have disappeared.  And for each spouse over 65, add $1,600 more to the standard deduction amounts. For most people, the higher standard deduction will more than offset the loss of their personal exemptions. This also means fewer taxpayers will itemize deductions because it is less likely the sum of their itemized deductions will exceed the large standard deduction, especially with new limitations on certain itemized deductions. For example, state and local tax (SALT) deductions, which can include property, income, and sales tax, are now capped at $10,000 for any given year. Deductible mortgage interest also has new rules discussed in another article in this newsletter.

One of the most commonly claimed itemized deductions are your contributions to charities. For any one year, the TCJA allows these donation deductions up to 60% of adjusted gross income (AGI) – up from the old 50% limit.  Excess amounts carry over five years. An unfortunate side effect of the expected drop in “itemizers” is that these taxpayers may decide to forego donations when they are no longer receiving a tax benefit. A strategy to work around this lost benefit is to “bunch” donations in specific years to help meet the itemizing threshold. This means people can combine multiple years’ worth of contributions into a single year to increase the likelihood of exceeding the standard deduction and thus achieve more tax savings. This method will obviously result in less chance to itemize deductions in the following year.  If your standard deduction exceeds your itemized deductions, any unused amounts are lost forever; they don’t accumulate and carry over to future years.

An anticipated consequence of this accelerated giving idea, however, is that nonprofit organizations could experience revenue shortfalls in the coming years, or possible surpluses in others. These organizations may need to budget differently in order to maintain their missions.

One valuable trick with the TCJA is the ability to phase yourself back into the Qualified Business Income (QBI) deduction (a highly complicated piece of the tax law discussed in previous newsletters) by making charitable donations. If a business owner’s taxable income is too high for the new 20% deduction, they can take advantage of additional charitable deductions and reduce their income enough to allow the QBI deduction. This potential double benefit lowers taxable income AND provides the extra deduction.

Another way to maximize itemized deductions in a specific year is to pay as many medical expenses as realistically possible. This deduction is subject to a 7.5%-of-AGI floor going forward that is sometimes difficult to beat. By “bunching” costs into one year, you are more likely to exceed this threshold. If someone in your family is considering an elective surgery or expensive procedure, combine them into the same year you plan to itemize. Consider stocking up on prescriptions, buying new eyeglasses, and making medically-advised home improvements. This can allow a greater possibility of itemizing deductions and taking the standard deduction in alternate years. All miscellaneous itemized deductions, such as tax preparation fee, unreimbursed employee expenses, hobby costs, theft losses, and investment management fees, have been eliminated under the TCJA.

If you are an employee with high unreimbursed expenses, you should negotiate with your employer to receive reimbursement in return for a lower reported W2 wage.  That way you effectively receive the deduction.

Many cash-basis taxpayers used valuable timing techniques last year to boost their 2017 deductions. Several taxpayers nationwide took advantage of the opportunity (if applicable in their state) to ‘prepay’ their previously-assessed 2018 real estate taxes by the end of 2017. After the TCJA passed and it was announced that SALT would be limited to $10,000 starting in 2018, taxpayers who did not want to lose future deductions essentially “doubled up” payments. Several taxpayers also reportedly made large personal purchases while the sales tax deduction was still unlimited in 2017.

At Ketel Thorstenson, LLP, we are here to help with any uncertainties regarding the new tax laws. Please contact us if you have any questions.

June 1, 2018

Unreimbursed Employee Business Expenses

You may be able to deduct certain work-related expenses if you meet both requirements of being an employee and you itemize on your tax return. If you incur costs “ordinary and necessary” for your job that are not reimbursed by your employer, keep records to prove the ones you paid and plan to deduct. These expenses are included on Form 2106: Employee Business Expenses, which flows into Schedule A: Itemized Deductions on your Form 1040. Eligible expenses are limited, as they are subject to a 2% floor rule – meaning they are only deductible in the amount that exceeds 2% of your Adjusted Gross Income.  Also beware, that if you are paying alternative minimum tax (AMT), then these deductions will not save you any income tax, as they are not deductible for AMT.

Unreimbursed employee business expenses can be combined with other miscellaneous deductions such as tax preparation fees, investment expenses, and safety deposit box expenses to meet this threshold. Some common business expenses that qualify include the following:

  • Professional dues, memberships, licenses, subscriptions, and publications
  • Cell phone costs at an estimated business use percentage
  • Tools and supplies
  • Uniforms and safety gear required for your job
    • Any clothing deducted cannot be suitable for everyday wear
  • Continuing education if it doesn’t qualify you for a new trade
  • Union dues
  • Job-searching expenses if within the same occupation
  • Business liability or malpractice insurance premiums
  • Rent paid for business equipment or space
  • Parking and toll fees
  • Home office expenses if you use part of your home regularly and exclusively for business, you are required to work at home for the convenience of your employer, and you do not have an office at another job site
    • A simplified method is available rather than using actual expenses with an indirect allocation
  • Overnight business travel away from home, such as transportation and lodging expenses
  • Business mileage either using the standard rate or actual expense method
    • Commuting between your home and main workplace is not deductible
  • Incidental expenses, such as baggage fees or hotel tips
  • Standard meal allowance for overnight business travel
    • “Per diem” rates vary by area, but averages $51/day
  • If the above mentioned allowance is not used, you can deduct 50% of all actual business meal and entertainment expenses, regardless of location
    • A bona fide business-related discussion must take place before, during, or after

Please consult with your tax professional at Ketel Thorstenson, LLP if you have questions regarding deductible unreimbursed employee business expenses.

May 25, 2017

Tax Breaks for Taking Care of Aging Parents

If you are caring for an elderly parent, likely the last things on your mind are federal tax breaks. However, there are three different ways, potentially all three in one year, for you to reduce your federal income tax. First, you may be eligible to claim a parent as a dependent on your tax return, thus getting a personal exemption for them. Second, you may also qualify for the Dependent Care Credit. Third, you may be allowed to claim as itemized deductions, medical expenses incurred for the care of a qualified parent.

For the 2016 tax year, the exemption deduction for each taxpayer, spouse, and dependent is $4,050. To claim someone as a dependent, they must be related to you, must not have income over $4,050, and rely on you for more than half of their financial support during the year. In-laws and step-parents are allowed as well. Gross income does not include Social Security. Unlike claiming a child as a dependent, it is not necessary that your elderly parent live with you. Some factors to consider in determining support include: fair market rent of the space they occupy, utilities, food, clothing, necessary equipment, doctor bills, prescriptions, supplemental Medicare coverage, recreation fees, and transportation. If you and other siblings collectively pay more than half of the parent’s total support and you pay at least 10% of that portion, you may also claim them; however, nobody else could do so in the same year.

In this situation, the Child and Dependent Care Credit is sometimes referred to as the Elderly Dependent Care Credit or the Aging Parent Tax Credit. If you file a joint return, both spouses must have earned income. Allowable expenses cannot be greater than the income of the lower-earning spouse. One filer must pay at least half of the qualifying person’s financial support. Requirements for the person in need of care include: the inability to physically and mentally care for him/herself, reside with the tax filer for at least half of the year, and receive less gross income than the personal exemption (currently $4,050). There is no relation requirement, nor is there an age restriction.

The tax return must identify a qualifying person by name and social security number, and also list the care provider’s name, address, and tax ID number. In-home care or adult day care costs are examples of allowed expenses, whereas nursing facility and assisted living residence fees are not. The intended purpose of care must be to free the taxpayer to enable them to work or actively search for a job while ensuring the well-being of the individual. Hiring someone to come into your home to provide the care may make you a “household employer”. In this case, you would be subject to pay Social Security, Medicare, and unemployment taxes for the employee. The caregiver cannot be your spouse or any other dependent you claim on your return.

The Elderly Dependent Care Credit cannot be claimed in conjunction with the medical expense itemized deduction for the same expenses. Typically it is most advantageous to apply the maximum ($3,000 for one individual and $6,000 for two or more) towards the credit on Form 2441 first, and the remainder as medical expenses on Schedule A. The credit reduces your taxes owed dollar for dollar, whereas a deduction reduces your taxable income. The credit is calculated based on 20-35% of the work-related care expenses depending on your Adjusted Gross Income. Itemized medical expenses are only deductible if they exceed 10% of adjusted gross income (7.5% threshold exists through December 31, 2016 if you or your spouse are 65 years or older by the end of the tax year). You can now deduct your elderly parent’s medical expenses on Schedule A, even if they do not meet the income requirement to be claimed as a dependent.

Please consult your tax professional at Ketel Thorstenson, LLP to see if you can benefit from any of these options for your loved one.


January 27, 2017

Fraud Protection

LindseyNolan 5x7x300dpiThe national tax system experiences extreme challenges with data theft. Identity theft is the top complaint filed with the Federal Trade Commission, occurring every two seconds in the United States. The financial burden of identity theft now exceeds all other property crimes combined, making it a top criminal investigative priority. Keep in mind – not all data theft is identity theft, and not all identity theft is related to the filing of fraudulent tax returns.

IRS Commissioner John Koskinen has revealed these facts:

  • 100 million+ Social Security Numbers (SSNs) were stolen in 2015
  • 104,000+ taxpayer accounts had been compromised by hackers as of June 2015
  • 220,000+ taxpayers have been offered credit protection and an Identity Protection PIN
  • 19 million suspicious returns were reviewed between 2011-2014
  • $63 billion fraudulent refunds were rejected between 2011-2014
  • Nearly 1,800 investigations were initiated in the last two years; over 1,500 of these led to prison sentences

The IRS has taken more precautionary measures in recent years and improved cooperation with law enforcement. Pre-refund fraud filters have increased from 11 in 2012 to 200 in 2015. Direct deposits are now limited to three refunds into a single bank account. Electronic Filing Identification Number (EFIN) policies have been improved to prevent abuse; the IRS encourages preparers to monitor their number of returns filed using their EFIN to be able to detect any excessive use. Internal use of SSNs has been reduced, and prisoner tax fraud has also steadily declined. Nearly 29 million deceased taxpayer accounts have been locked to avoid further activity. The IRS has worked with 286 financial institutions in the past three years to identify fraudulent refunds; $3 billion worth of refunds were recovered this way. More than 20 new data elements were added to the filing verification process in an effort to limit fraud.

Tax return preparers are prime targets for fraudsters seeking personal and financial data. We are trained to treat this information like cash – don’t leave it lying around – and you should follow this same guideline too. The Internal Revenue Code imposes criminal and monetary penalties for anyone knowingly or recklessly making unauthorized disclosures. Types of scams that can lead to data loss include: phishing emails, fake phone calls, embedded text messages, Wi-Fi breaches, and bugged software. Forward IRS-related scam emails to [email protected] and report IRS-impersonation calls at www.tigta.gov.

Employers can do their part in reducing fraud risk as well. The following is a list of ways to address potential theft in the workplace:

  • educate employees
  • hire additional staff
  • immediately notify clients if a data breach occurs
  • obtain credit protection services
  • ensure good insurance policies
  • create strict password standards
  • use top-rated security software
  • protect wireless connections
  • backup taxpayer data on external hard drive with limited access
  • set up automatic shutdown of company computers

If you or your firm experiences taxpayer data loss, call your local stakeholder liaison listed on the IRS website (www.irs.gov). They will note your account, alert major credit bureaus, notify appropriate authorities, and help determine whether an investigation should be launched. The IRS is working hard with state officials, tax software providers, and tax preparers to combat the threat of compromised information. Cybercriminals are constantly evolving, but the IRS is also making progress. Remember the IRS will only initiate contact with you regarding a tax matter via mail, not any type of electronic communication. If you are concerned you may have suffered identity theft, contact your KT representative for assistance.

February 3, 2016