If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions, and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.

Facts of the case

In the case, a married couple claimed $13,596 in car and truck expenses, supported only by mileage logs that weren’t kept contemporaneously and were made using estimates rather than odometer readings. The court disallowed the entire deduction, stating that “subsequently prepared mileage records do not have the same high degree of credibility as those made at or near the time the vehicle was used and supported by documentary evidence.”

The court noted that it appeared the taxpayers attempted to deduct their commuting costs. However, it stated that “expenses a taxpayer incurs traveling between his or her home and place of business generally constitute commuting expenses, which … are nondeductible.”

A taxpayer isn’t relieved of the obligation to substantiate business mileage, even if he or she opts to use the standard mileage rate (65.5 cents per business mile in 2023), rather than keep track of actual expenses.

The court also ruled the couple wasn’t entitled to deduct $5,233 of travel, meal, and entertainment expenses because they didn’t meet the strict substantiation requirements of the tax code. (TC Memo 2022-113)

Stay on the right track

This case is an example of why it’s critical to maintain meticulous records to support business expenses for vehicle and meal deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:

DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.

DON’T reconstruct expense logs at year-end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.

DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.

DON’T be surprised if the IRS asks you to prove your deductions. Vehicle and meal expenses are a magnet for attention. Be prepared for a challenge.

With organization and guidance from us, your tax records can stand up to inspection from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (called “the Cohan rule”), if your records are lost due to a fire, theft, flood, or other disaster. Contact us now to understand your options.

© 2023

Are you getting ready to retire? If so, you’ll soon experience changes in your lifestyle and income sources that may have numerous tax implications.

Here’s a brief rundown of four tax and financial issues you may contend with when you retire:

Taking required minimum distributions. These are the minimum amounts you must withdraw from your retirement accounts. You generally must start taking withdrawals from your IRA, SEP, SIMPLE, and other retirement plan accounts when you reach age 73 if you were age 72 after December 31, 2022. If you reach age 72 in 2023, the required beginning date for your first RMD is April 1, 2025, for 2024. Roth IRAs don’t require withdrawals until after the death of the owner.

You can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income except for any part that was taxed before or that can be received tax-free (such as qualified distributions from Roth accounts).

 

Selling your principal residence. Many retirees want to downsize to smaller homes. If you’re one of them and you have a gain from the sale of your principal residence, you may be able to exclude up to $250,000 of that gain from your income. If you file a joint return, you may be able to exclude up to $500,000.

To claim the exclusion, you must meet certain requirements. During a five-year period ending on the date of the sale, you must have owned the home and lived in it as your main home for at least two years.

If you’re thinking of selling your home, make sure you’ve identified all items that should be included in its basis, which can save you tax.

 

Getting involved in new work activities. After retirement, many people continue to work as consultants or start new businesses. Here are some tax-related questions to ask if you’re launching a new venture:

• Should it be a sole proprietorship, S corporation, C corporation, partnership, or limited liability company?
• Are you familiar with how to elect to amortize start-up expenditures and make payroll tax deposits?
• Can you claim home office deductions?
• How should you finance the business?

 

Taking Social Security benefits. If you continue to work, it may have an impact on your Social Security benefits. If you retire before reaching full Social Security retirement age (65 years of age for people born before 1938, rising to 67 years of age for people born after 1959) and the sum of your wages plus self-employment income is over the Social Security annual exempt amount ($21,240 for 2023), you must give back $1 of Social Security benefits for each $2 of excess earnings.

For individuals who reach full retirement age this year, your benefits will be reduced $1 for every $3 you earn over a different annual limit ($56,520 in 2023) until the month you reach full retirement age. Then, your earnings will no longer affect the amount of your monthly benefits, no matter how much you earn.

Speaking of Social Security, you may have to pay federal (and possibly state) tax on your benefits. Depending on how much income you have from other sources, you may have to report up to 85% of your benefits as income on your tax return and pay the resulting federal income tax.

 

Tax planning is still important

As you can see, you may have to make many decisions after you retire. We can help maximize the tax breaks you’re entitled to so you can keep more of your hard-earned money. Contact Us!

© 2023

If you’re a crypto investor or user, you may have noticed something new on your tax return this year. And you may soon notice a new form reporting requirements for digital assets.

Check the box

Beginning with tax year 2022, taxpayers must check a box on their tax returns indicating whether they received digital assets as a reward, award, or payment for property or services or whether they disposed of any digital assets that were held as capital assets through sales, exchanges, or transfers. If the “yes” box is checked, taxpayers must report all income related to the digital asset transactions.

New information form

Under the broker information reporting rules, brokers must report transactions in securities to both the IRS and investors. Transactions are reported on Form 1099-B. Legislation enacted in 2021 extended these reporting rules to cryptocurrency exchanges, custodians, and platforms and to digital assets such as cryptocurrency. The new rules were scheduled to be effective for returns required to be filed, and statements required to be furnished, for post-2022 transactions. But the IRS has postponed the effective date until it issues new final regulations that provide instructions.

In addition to extending this reporting requirement to cryptocurrency, the legislation also extended existing cash reporting rules (for cash payments of $10,000 or more) to cryptocurrency. That means businesses that accept crypto payments of $10,000 or more must report them to the IRS on Form 8300. These rules apply to transactions that take place in 2023 and later years.

Existing rules and new reporting for digital assets

Currently, if you have a stock account, whenever you sell securities, you receive a Form 1099-B. On the form, your broker reports details of transactions, such as sale proceeds, relevant dates, your tax basis for the sale, and the gain or loss.

The 2021 legislation expanded the definition of “brokers” who must furnish Forms 1099-B to include businesses that regularly provide services accomplishing transfers of digital assets on behalf of another person. Thus, once the IRS issues final regulations, any platform where you buy and sell cryptocurrency will have to report digital asset transactions to you and the IRS.

These exchanges/platforms will have to gather information from customers, so they can issue Forms 1099-B. Specifically, they will have to get customers’ names, addresses, and phone numbers, the gross proceeds from sales, capital gains or losses, and whether they were short-term or long-term.

Note: It’s not yet known whether exchanges/platforms will have to file Form 1099-B (modified to include digital assets) or a new IRS form.

Cash transaction reporting

Under a set of rules separate from the broker reporting rules, when a business receives $10,000 or more in cash, it must report the transaction to the IRS, including the identity of the person from whom the cash was received. This is done on Form 8300. For this reporting requirement, businesses will have to treat digital assets like cash.

Form 8300 requires reporting information, including address, occupation, and taxpayer identification number. The current rules that apply to cash usually apply to in-person payments in actual cash. It may be difficult for businesses seeking to comply with the reporting rules to collect the information needed for crypto transactions.

 

What you should know

If you use a cryptocurrency exchange or platform, and it hasn’t already collected a Form W-9 from you, expect it to do so. In addition to collecting information from customers, these businesses will need to begin tracking the holding periods and the buy-and-sell prices of digital assets in customers’ accounts. Contact us for more information on your situation.

© 2023

A common question for people planning their estates or inheriting property is: For tax purposes, what’s the “cost” (or “basis”) an individual gets in property that he or she inherits from another? This is an important area and is too often overlooked when families start to put their affairs in order.

Under the fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property that’s equal to its date-of-death value. So, for example, if your grandfather bought shares in an oil stock in 1940 for $500 and it was worth $5 million at his death, the basis would be stepped up to $5 million for your grandfather’s heirs. That means all of that gain escapes income taxation forever!

The fair market value basis rules apply to inherited property that’s includible in the deceased individual’s gross estate, whether or not a federal estate tax return was filed, and those rules also apply to property inherited from foreign persons, who aren’t subject to U.S. estate tax. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of the jointly-held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.

Lifetime gifting

It’s crucial for you to understand the fair market value basis rules so that you don’t pay more tax than you’re legally required to.

For example, in the above scenario, if your grandfather instead decided to make a gift of the stock during his lifetime (rather than passing it on when he died), the “step-up” in basis (from $500 to $5 million) would be lost. Property acquired by gift that has gone up in value is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift.

A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his or her basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.

These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. And gifts made just before a person dies (sometimes called “death bed gifts”) may be included in the gross estate for tax purposes. Contact us for tax assistance when estate planning or after receiving an inheritance.

© 2023

Once you file your 2022 tax return, you may wonder what personal tax papers you can throw away and how long you should retain certain records. You may have to produce those records if the IRS audits your return or seeks to assess tax.

It’s a good idea to keep the actual returns indefinitely. But what about supporting records such as receipts and canceled checks? In general, except in cases of fraud or substantial understatement of income, the IRS can only assess tax within three years after the return for that year was filed (or three years after the return was due). For example, if you filed your 2019 tax return by its original due date of April 15, 2020, the IRS has until April 15, 2023, to assess a tax deficiency against you. If you file late, the IRS generally has three years from the date you filed.

However, the assessment period is extended to six years if more than 25% of gross income is omitted from a return. In addition, if no return is filed, the IRS can assess tax any time. If the IRS claims you never filed a return for a particular year, a copy of the return will help prove you did.

Property-related records

The tax consequences of a transaction that occurs this year may depend on events that happened years ago. For example, suppose you bought your home in 2007, made capital improvements in 2014 and sold it this year. To determine the tax consequences of the sale, you must know your basis in the home — your original cost, plus later capital improvements. If you’re audited, you may have to produce records related to the purchase in 2007 and the capital improvements in 2014 to prove what your basis is. Therefore, those records should be kept until at least six years after filing your return for the year of sale.

Retain all records related to home purchases and improvements even if you expect your gain to be covered by the home-sale exclusion, which can be up to $500,000 for joint return filers. You’ll still need to prove the amount of your basis if the IRS inquires. Plus, there’s no telling what the home will be worth when it’s sold, and there’s no guarantee the home-sale exclusion will still be available in the future.

Other considerations apply to property that’s likely to be bought and sold — for example, stock or shares in a mutual fund. Remember that if you reinvest dividends to buy additional shares, each reinvestment is a separate purchase.

Marital breakup

If you separate or divorce, be sure you have access to tax records affecting you that are kept by your spouse. Or better yet, make copies of the records since access to them may be difficult. Copies of all joint returns filed and supporting records are important, since both spouses are liable for tax on a joint return and a deficiency may be asserted against either spouse. Other important records include agreements or decrees over custody of children and any agreement about who is entitled to claim them as dependents.

Loss or destruction of records

To safeguard records against theft, fire, or other disaster, consider keeping important papers in a safe deposit box or other safe place outside your home. In addition, consider keeping copies in a single, easily accessible location so that you can grab them if you must leave your home in an emergency.

Contact us if you have any questions about record retention.

© 2023