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Sponsored by Taxsoftware.com   http://www.taxsoftware.com        October 12, 2009        Issue 23

Special Interest Articles

First-Time Homebuyer Credit Provides Tax Benefits to 1.4 Million Families to Date, More Claims Expected 

Ten Facts about the First-Time Homebuyer Credit

Nine Facts about the New Vehicle Sales and Excise Tax Deduction

Six Facts About the American Opportunity Tax Credit

Featured Article: What you need to know about federal taxes and your new business

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First-Time Homebuyer Credit Provides Tax Benefits to 1.4 Million Families to Date, More Claims Expected 

With the deadline quickly approaching, the Internal Revenue Service reminded potential homebuyers they must complete their first-time home purchases before Dec. 1 to qualify for the special first-time homebuyer credit. The American Recovery and Reinvestment Act extended the tax credit, which has provided a tax benefit to more than 1.4 million taxpayers so far.

The credit of up to $8,000 is generally available to homebuyers with qualifying income levels who have never owned a home or have not owned one in the past three years. The IRS has a new YouTube video and other resources that explain the credit in detail.

The IRS encouraged all eligible homebuyers to take advantage of the first-time homebuyer credit but at the same time cautioned taxpayers to avoid schemes that help ineligible people file false claims for the credit. Currently, the agency is investigating a number of cases of potential fraud and is using computer screening tools to identify questionable claims for the credit.

Because the credit is only in effect for a limited time, those considering buying a home must act soon to qualify for the credit. Under the Recovery Act, an eligible home purchase must be completed before Dec. 1, 2009. This means that the last day to close on a home is November 30.

The credit cannot be claimed until after the purchase is completed. For purchases made this year before Dec. 1, taxpayers have the option of claiming the credit on their 2008 returns or waiting until next year and claiming it on their 2009 returns.

For those considering a home purchase this fall, here are some other details about the first-time homebuyer credit:

bullet The credit is 10 percent of the purchase price of the home, with a maximum available credit of $8,000 for either a single taxpayer or a married couple filing jointly. The limit is $4,000 for a married person filing a separate return. In most cases, the full credit will be available for homes costing $80,000 or more.
bullet The credit reduces the taxpayer’s tax bill or increases his or her refund, dollar for dollar. Unlike most tax credits, the first-time homebuyer credit is fully refundable. This means that the credit will be paid to eligible taxpayers, even if they owe no tax or the credit is more than the tax owed.
bullet Only the purchase of a main home located in the United States qualifies. Vacation homes and rental properties are not eligible.
bullet A home constructed by the taxpayer only qualifies for the credit if the taxpayer occupies it before Dec. 1, 2009.
bullet The credit is reduced or eliminated for higher-income taxpayers. The credit is phased out based on the taxpayer’s modified adjusted gross income (MAGI). MAGI is adjusted gross income plus various amounts excluded from income—for example, certain foreign income. For a married couple filing a joint return, the phase-out range is $150,000 to $170,000. For other taxpayers, the range is $75,000 to $95,000. This means the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.
bullet The credit must be repaid if, within three years of purchase, the home ceases to be the taxpayer’s main home. For example, a taxpayer who claims the credit based on a qualifying purchase on Sept. 1, 2009, must repay the full credit if he or she sells the home or converts it to business or rental use at any time before Sept. 1, 2012.

Taxpayers cannot take the credit even if they buy a main home before Dec. 1 if:

bullet The taxpayer’s income is too large. This means joint filers with MAGI of $170,000 and above and other taxpayers with MAGI of $95,000 and above.
bullet The taxpayer buys a home from a close relative. This includes a home purchased from the taxpayer’s spouse, parent, grandparent, child or grandchild.
bullet The taxpayer owned another main home at any time during the three years prior to the date of purchase. For a married couple filing a joint return, this requirement applies to both spouses. For example, if the taxpayer bought a home on Sept. 1, 2009, the taxpayer cannot take the credit for that home if he or she owned, or had an ownership interest in, another main home at any time from Sept. 2, 2006, through Sept. 1, 2009.
bullet The taxpayer is a nonresident alien.

 

Ten Facts about the First-Time Homebuyer Credit

Many taxpayers who purchase a home this year will qualify for an $8,000 federal tax credit. The refundable first-time homebuyer credit is a major tax provision in the American Recovery and Reinvestment Act of 2009. But time is running out to qualify for this credit.

Here are ten things the IRS wants you to know about the first-time homebuyer credit:

  1. To be considered a first-time homebuyer, you – and your spouse if you are married – must not have jointly or separately owned another principal residence during the three years prior to the date of purchase.
  2. You cannot claim the credit before there is a completed sale and purchase of the residence. The sale and purchase are generally completed at the time of closing on the purchase.
  3. To qualify for the credit, the completed purchase must occur before December 1, 2009.
  4. The home must be located in the United States.
  5. The credit is either 10 percent of the purchase price of the home or $8,000, whichever is less.
  6. The amount of the credit begins to phase out for taxpayers whose modified adjusted gross income is more than $75,000 or $150,000 for joint filers.
  7. The credit is fully refundable. A homebuyer with no taxable income, who qualifies for the credit, may file for the sole purpose of claiming the credit and receive a refund. The credit will be paid out to eligible taxpayers, even if they owe no tax or the credit is more than the tax owed.
  8. The credit is claimed on IRS Form 5405, First-Time Homebuyers Credit.
  9. Taxpayers can claim the credit for a qualified 2009 purchase on either their 2008 or 2009 tax return. For those who have filed a 2008 return, a Form 1040X, Amended U.S. Individual Income Tax Return can be filed in order to get a refund in 2009.
  10. The credit for qualified 2009 purchases does not have to be repaid, as long as the home remains your main home for 36 months after the purchase date.

Qualified taxpayers who have been considering a main home purchase may find extra incentive from this tax credit to buy now so they can complete the purchase before the December 1 deadline.

 

Nine Facts about the New Vehicle Sales and Excise Tax Deduction

Taxpayers who buy new motor vehicles this year may be entitled to a special tax deduction for the sales or excise taxes on those purchases when they file their 2009 federal tax returns next year. This tax break is part of the American Recovery and Reinvestment Act of 2009.

Taxpayers in states that do not have state sales taxes may be entitled to deduct other fees or taxes imposed by the state or local government.

Here are nine important facts the IRS wants you to know about the deduction.

1. State and local sales and excise taxes paid on up to $49,500 of the purchase price of each qualifying vehicle are deductible.

2. Qualified motor vehicles generally include new cars, light trucks, motor homes and motorcycles.

3. To qualify for the deduction, the new cars, light trucks and motorcycles must weigh 8,500 pounds or less. Motor homes are not subject to the weight limit.

4. Purchases must occur after Feb. 16, 2009, and before Jan. 1, 2010.

5. Taxpayers who purchase new motor vehicles in states that do not have state sales taxes may be entitled to deduct other fees or taxes assessed on the purchase of those vehicles. Fees or taxes that qualify must be based on the vehicles’ sales price or as a per unit fee. These states include Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon.

6. Taxpayers who purchase qualified motor vehicles may claim the deduction when they file their 2009 tax return in 2010.

7. The deduction may not be taken on 2008 tax returns.

8. This deduction can be taken regardless of whether the buyers itemize their deductions or choose the standard deduction. Taxpayers who do not itemize will add this additional amount to the standard deduction on their 2009 tax return.

9. The amount of the deduction is phased out for taxpayers whose modified adjusted gross income is between $125,000 and $135,000 for individual filers and between $250,000 and $260,000 for joint filers.

Six Facts About the American Opportunity Tax Credit

Many parents and college students will be able to offset the cost of college over the next two years under the new American Opportunity Tax Credit. This tax credit is part of the American Recovery and Reinvestment Act of 2009.

Here are six important facts the IRS wants you to know about the new American Opportunity Tax Credit:

1. This credit, which expands and renames the existing Hope Credit, can be claimed for qualified tuition and related expenses that you pay for higher education in 2009 and 2010. Qualified tuition and related expenses include tuition, related fees, books and other required course Materials.

2. The credit is equal to 100 percent of the first $2,000 spent and 25 percent of the next $2,000 per student each year. Therefore, the full $2,500 credit may be available to a taxpayer who pays $4,000 or more in qualifying expenses for an eligible student.

3. The full credit is generally available to eligible taxpayers who make less than $80,000 or $160,000 for married couples filing a joint return. The credit is gradually reduced, however, for taxpayers with incomes above these levels.

4. Forty percent of the credit is refundable, so even those who owe no tax can get up to $1,000 of the credit for each eligible student as cash back.

5. The credit can be claimed for qualified expenses paid for any of the first four years of post-secondary education.

6. You cannot claim the tuition and fees tax deduction in the same year that you claim the American Opportunity Tax Credit or the Lifetime Learning Credit. You must choose to either take the credit or the deduction, whichever is more beneficial for you.

What you need to know about federal taxes and your new business

As a business owner you may be required to get a Federal Employer Identification Number or EIN.

The EIN identifies tax returns filed with the IRS.

If you don't have an EIN you need to get one if you: pay wages to employees, have a self-employed retirement plan, operate your business as a corporation or partnership, or are required to file any of these tax returns, employment, excise, fiduciary, or alcohol, tobacco, and firearms.

If you're a sole proprietor with no employees and don't meet any of these requirements you don't need an EIN for dealing with the IRS.

But you may need one for dealing with other businesses including banks that require an EIN to set up business accounts.

The IRS will give you an EIN even if you don't need it for IRS purposes.

The easiest and fastest way to get an EIN is online.

Just go to irs.gov, keyword EIN and complete the form, you'll get your EIN within minutes.

While the IRS calls this a provisional EIN, the IEIN is actually the permanent federal employer identification number for your business. This IEIN may be cancelled if, the name and social security number of the principle officer do not match the social security administration records or your business already has an EIN.

Recordkeeping

You must keep receipts, sales slips, invoices, bank deposit slips, cancelled checks, and other documents to substantiate items of income, deductions, and credits. Recording these items will help you pay only the tax you owe. Good records can help you identify sources of receipt; you may receive cash or property from many sources. Unless you have records showing the sources of your receipts you may not be able to prove that some are non-business or non-taxable.

Prevent omission of deductible expenses. You may forget expenses when you prepare your tax return unless you record them when you pay them.

Establish earnings for self-employment tax purposes. Your records should show the amount of earnings reportable for self-employment tax purposes.

Self-employment tax is explained later when we talk about business tax returns, and explain items on your income tax return.

If IRS examines your income tax return you may be asked to support the entries on your return with sales slips, invoices, receipts, bank deposit slips, cancelled checks and other documents.

These items of support are necessary for you to have adequate and complete records. Recordkeeping rules require that you keep adequate documentary records or sufficient evidence to support your own statements.

Make sure you keep receipts and a log or diary for: deductions you take for travel, transportation, entertainment and business gift expenses, and any deduction you take for certain business property. Your records must support the claimed amount, the time and place, the business purpose, and your business relationship to any other persons involved.

If your records are incomplete they may not support your deductions. If you lose your records due to circumstances beyond your control such as by flood or earthquake, you may substantiate a deduction by reasonable reconstruction.

May I get a receipt please?

Let's see, amount $24, time 4:30 p.m., location, International Airport. Business purpose, new product meeting. Business relationship, client. Always keep your business records available for examination by the IRS.

How long do I have to keep all this stuff?

You must keep your records as long as their contents may be material in the administration of any Internal Revenue Service law. Usually the statute of limitations for an income tax return expires three years after the return is due or filed or two years from the date the tax is paid, whichever is later.

To support items of income or deduction on your tax return, you must keep records until the statute of limitations for that return expires. But in many cases you must keep records indefinitely. For example, if you change your method of accounting, records supporting the necessary adjustments may be material for an indefinite time. Another example, you must keep records relating to the basis of property for as long as they are material in determining the basis of the original or replacement property. And if you have employees, then you have to keep employment tax records too. You must keep all employment tax records for at least four years after the date on which the tax return becomes due or the tax is paid, whichever is later.

A copy of your most recent return helps you compute and prepare future tax returns. If you need to correct what is on file the copies help you prepare an amended return and for the benefit of your heirs, previously filed tax forms may be helpful to the executor or administrator of your estate.

Bookkeeping Systems

Many people who operate their own one person business never bother to set up a business bookkeeping system.  Their personal checking account serves as both a personal and a business account. The IRS recommends that you open a separate business bank account.

There are two types of bookkeeping systems, single entry, and double entry. The single entry system is the simplest to keep. With the single entry system you record a daily and a monthly summary of business income and a monthly summary of business expenses.  Single entry is not a complete accounting system but it shows income and expenses in sufficient detail for tax purposes. The system focuses on the businesses profit and loss statement and not on its balance sheet. The more complicated double entry system has built in checks and balances and is more accurate than the single entry system. The double entry system is also self balancing. Since all business transactions consist of an exchange of one thing for another, double entry bookkeeping is used to show this twofold effect. If you want to learn more check with your local library.

Once you select a bookkeeping system you'll also need to select an accounting method. Your accounting method is a set of rules that you use to decide when and how you report your income and expenses. The two most commonly used accounting methods are the cash method and the accrual method. On your tax return you must use the same accounting method you used to keep your records. Under the cash method you report all income in the year you receive it. You usually deduct expenses only in the tax year in which you pay them.

Under the accrual method you report income in the year you earn it regardless of when you receive the payment. You deduct expenses in the tax year you incur them, regardless of when you pay them. Businesses that have inventory for sale to customers must generally use an accrual method for sales and purchases.

My business takes me to rural America. I find and purchase American quilts and sell them to big city art galleries. Some of the quilts are contemporary and some of them are over 100 years old.

In this business you make sales on account. Customers pay 45 days after delivery. I use an accrual method of accounting. I record the sale in the month when I ship the quilt even though I don't receive payment until after the following month.

Robert knows how to apply the accrual method of accounting. He records revenue when he earns it, which is when he ships the quilts. On the other hand if Robert recorded the revenue when he received it, he would be on the cash method.

Software Packages

There are bookkeeping and accounting computer software packages. These packages are very useful, relatively easy to use and require very little knowledge of bookkeeping and accounting. But be careful, if you use software you must be able to produce records from the system to support what is on your tax return. Always keep a backup copy in a safe place.

Here are some useful business terms that help you describe what's going on in your business.

The first one is income statement. An income statement gives an overview of your company's revenues, costs, and profitability.

The next term is cash flow analysis. A cash flow analysis is a detailed monthly account of how money flows into your business as income and flows out of your business as expenses.

Subtracting expenses from receipts gives you a monthly result of how well your business is doing.

It's the end of August, I spent all month pulling together my records and updating the books.  Then I prepared my financial statement just in time. The bank asked to see the income statement and balance sheet. They wanted to make sure that I could pay back my loan. Imagine that, I've had a loan with the same bank for two years and I never missed a payment.

I think it's strange that they insist on reviewing my financial statements. Don't you think they could just trust me? Maria isn't considering the bank's point of view. The bank manager wants to make sure Maria can continue to make her payments in the future. The manager will review the income statement to see if the business made a profit. Then the manager will analyze the assets and liabilities on the balance sheet.

Structure of Ownership

There are five types of business organizations, sole proprietorship, partnership, limited liability company or limited liability partnership, S corporation, and corporation.

A sole proprietorship is an unincorporated business that one person owns. It is the simplest type of business organization; the business does not exist apart from the owner. The owner assumes the risks of the business to the extent of all their assets, even if they don't use their personal assets in the business. Usually the ability to finance the business, known as capital, is limited to whatever the owner can come up with. This may limit the expansion of a business when new capital is required.

A common cause of failure for sole proprietors is lack of capital. Limited capital makes it harder to operate a start up when profits are usually low. During an economic rough spot it's harder to stay in business when your capital is limited. A sole proprietor files their taxes using either Schedule C or Schedule C EZ, Net Profit From Business. They include schedule C with their form 1040 to report their profit or loss from operating their business. The sole proprietor also files Schedule SE Self-Employment Tax to report the social security and Medicare taxes on net profits of the current year's threshold.
The second type of business organization is a partnership. A partnership is a relationship between two or more persons who join together to carry on a trade or business. Each person contributes money, property, labor or skills. Each expects to share in the profits and loss of the business. Any number of persons may join in a partnership.

The advantages to a partnership are: it is easy to organize, it may have greater financial strength than a sole proprietorship, it combines managerial skills and judgments of the partners, it has a definite legal status, and each partner has a personal interest in the business.

The disadvantages to a partnership are: the liability of the partners is usually unlimited, each partner may be held liable for all the debts of the business, therefore if one partner does not exercise good judgment, that partner could cause not only the loss of the partnership's assets, but also the loss of the other partner's personal assets.

And decision authority is divided. Partnerships report profits or losses from operations on Form 1065 US Partnership Return of Income. Form 1065 summarizes the business activity of the partnership. A partnership does not pay tax on income from daily operations. All income, losses, deductions, and credits generated by a partnership pass through to the partners. The partners report the items on their personal income tax returns. Each partner gets a schedule K1, income expenses and credits flow from schedule K1 to form 1040. If you need more information about partnerships check out Publication 541, Partnerships and the instructions to forms 1065 and 1040.
The third type of business entity is a limited liability company, LLC. This is a relatively new business structure allowed by state statute. LLCs are popular because similar to a corporation owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of flow through taxation. For federal income tax purposes, an LLC may be treated as a sole proprietorship, a partnership or a corporation.

If you want to tell the IRS how you want your business to be treated for federal income tax purposes, file a form 8832, entity classification election. If you don't file form 8832, IRS will treat your business as a partnership if it has two or more members and as a sole proprietorship if it has a single owner.

And that means what? In other words if you have a business of two or more people you're automatically classified as a partnership for federal tax purposes. If you are a one person business you're automatically classified as a sole proprietor for federal tax purposes.

So if I don't do anything my business will be classified anyway? Of course there are instructions with the form that explain the classifications and exactly how to fill it out and if you disagree with the default classification you can file a form 8832 to request a change.
The fourth business entity is the S corporation. An S corporation is a small business corporation whose shareholders elect to have corporate income taxed like a partnership. Partnerships are taxed once; corporations are taxed at the corporate level. Then when the income is distributed as dividends it is taxed again at the shareholder level. Organizing shareholders of a corporation who wish to avoid double taxation can file form 2553, election by a small business corporation to be recognized as an S corporation. This election must be submitted by the 15th day of the 3rd month of the 1st S corporation year. For example if your 1st S corporation tax year begins on January 1st, you must submit form 2553 by March 15th otherwise the election is effective for the next tax year.

IRS sends you a CP261 notice, notice of acceptance as an S corporation to let you know we have received and approved your election. You should receive your approval within 60 days. If you do not, contact the IRS campus where you filed your 2553. The instructions for form 2553 have more information.

An S corporation does not pay tax on income from daily operations. All income, losses, deductions and credits generated by an S corporation pass through to the corporate shareholders. The shareholders report the items on their personal income tax returns. However, there are situations where an S corporation is subject to an entity level tax. S corporation officer shareholders who provided services to their corporation are employees. Their compensation is subject to employment taxes.

By law officers of corporations are employees for employment tax purposes and their compensation is wages. An S corporation must pay reasonable compensation to a shareholder employee in return for the services the employee provides the corporation before a non-wage distribution may be made to that shareholder employee. In other words they have to be compensated or paid first. Then they get the distribution. An S corporation has the combined advantages and disadvantages of the partnership and regular corporations. S corporations file form 1120S, return for an S corporation.

The S corporation provides each shareholder a K1, Form 1120S, Shareholders Share of Income, Credits, Deductions, etc. The shareholder uses the schedule K1 to complete part II of schedule E, form 1040 and any other forms and schedules the shareholder must file with their individual return.
Finally, the last type of business organization, the corporation. The law treats a corporation as a legal entity. It has a life separate from its owners and has rights and duties of its own. The owners of a corporation are the stockholders. In case you're wondering, one person can be a corporation.

The managers of a corporation may or may not be stockholders. Forming a corporation involves the transfer of money or property or both by the perspective shareholders in exchange for capital stock in the corporation. For the purpose of federal income tax, corporations include associations, joint stock companies, and trusts, and partnerships that actually operate as associations or corporations.

The advantages of a corporation are: the life of the business is perpetual, the stockholders have limited liability, transfer of ownership is easy, sale of stock, it is easier for corporations to raise capital and to expand than it is for other forms of business. Management may be more efficient and it is adaptable to both small and large businesses.

The disadvantages are: it is subject to tax on its income at the corporate level and when the income is distributed as dividends it is taxed again at the shareholder level. It may be more difficult and expensive to organize.

It is wise to consult an accountant and attorney specializing in corporate law. The corporate charter filed with the secretary of your state restricts the types of business activities and it is subject to many state and federal controls. In forming a corporation a business must organize by applying for a charter through the state government in the state where the principle business activity will occur. To increase its financial ability the charter permits corporations to sell stock to numerous shareholders' owners.

The corporation is empowered to create debts separate from the shareholders. A corporation takes the same deductions for expenses as the sole proprietor. Special deductions are also available to corporations. Profits of the corporation are taxed to the corporation on either Form 1120A U.S. Corporation Short Form Income Tax Return, or Form 1120, U.S. Corporation Income Tax Return, as well as to the shareholders if the profits are distributed. However, shareholders cannot take a loss if the corporation does not operate at a profit.

As a small business owner you have many factors to consider when you choose the form of business organization. For example, depending on the situation, the owners of some daycare centers will choose the sole proprietorship form of business.

Others will decide on the partnership form of business and others will select the corporate form of business. Carpenters and computer programmers may also choose to form sole proprietorships, partnerships or corporations. It's your decision based on your individual circumstances.

Choosing a paid preparer

You may decide to prepare your own taxes, some business owners prefer to do their own. Others are more comfortable with a paid preparer. If you decide you need a paid preparer, the IRS has some information for you to consider. Most return preparers are professional and honest and provide excellent service to their clients, but choose carefully when hiring an individual or firm to prepare your return. You are legally responsible for what's on your own tax returns. Let's review some points you need to be aware of when selecting a tax preparer.

First, avoid preparers who claim they can obtain larger refunds than other preparers. Avoid preparers who base their fee on the amount of your refund. Look for a reputable tax professional who signs the tax return and gives you a copy for your records.

What can you do? Ask questions and get references. Find out the person's credentials. Find out if the preparer is affiliated with a professional organization. Never sign a blank tax return. Never sign a completed form without reviewing it and making sure you understand the entries. Finally, consider whether the preparer will be around to answer questions about the return months, even years after the return is filed.

Tax evasion is both risky and a felony crime punishable by up to five years imprisonment and a $250,000 fine. Remember no matter who prepares the tax return the taxpayer is legally responsible for all the information on that return, so when in doubt, check it out. If you hear unusual claims from return preparers check it out with a trusted tax professional or the IRS before getting involved.