Dirty Dozen Tax Scams for 2022
The “Dirty Dozen” is a list of common tax scams compiled by the IRS for more than 20 years to alert taxpayers and the tax professional community about tax scams and other fraudulent schemes. Designed to raise awareness among taxpayers and others who may not always be aware of developments involving tax administration, it includes potentially abusive arrangements that taxpayers should avoid. Let’s take a look at this year’s “Dirty Dozen” tax scams:
1. Use of Charitable Remainder Annuity Trust (CRAT) to Eliminate Taxable Gain
In this transaction, appreciated property is transferred to a CRAT. Taxpayers improperly claim the transfer of the appreciated assets to the CRAT in and of itself gives those assets a step-up in basis to fair market value as if they had been sold to the trust. The CRAT then sells the property but does not recognize gain due to the claimed step-up in basis. The CRAT then uses the proceeds to purchase a single premium immediate annuity (SPIA). The beneficiary reports, as income, only a small portion of the annuity received from the SPIA. Through a misapplication of the law relating to CRATs, the beneficiary treats the remaining payment as an excluded portion representing a return of investment for which no tax is due.
2. Maltese (or Other Foreign) Pension Arrangements Misusing Treaty
In these transactions, U.S. citizens or U.S. residents attempt to avoid U.S. tax by making contributions to certain foreign individual retirement arrangements in Malta (or possibly other foreign countries). In these transactions, the individual typically lacks a local connection. Local law allows contributions in a form other than cash or does not limit the amount of contributions by reference to income earned from employment or self-employment activities. By improperly asserting the foreign arrangement is a “pension fund” for U.S. tax treaty purposes, the U.S. taxpayer misconstrues the relevant treaty to improperly claim an exemption from U.S. income tax on earnings in and distributions from the foreign arrangement.
3. Puerto Rican and Other Foreign Captive Insurance
In these transactions, U.S owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or other foreign corporation with cell arrangements or segregated asset plans in which the U.S. owner has a financial interest. The U.S.-based individual or entity claims deductions for the cost of “insurance coverage” provided by a fronting carrier, which reinsures the “coverage” with the foreign corporation. The characteristics of the purported insurance arrangements typically include one or more of the following: implausible risks covered, non-arm’s-length pricing, and lack of business purpose for entering into the arrangement.
4. Monetized Installment Sales
These transactions involve the inappropriate use of the installment sale rules under section 453 by a seller who effectively receives the sales proceeds through purported loans in the year of a sale of property. In a typical transaction, the seller enters into a contract to sell appreciated property to a buyer for cash and then purports to sell the same property to an intermediary in return for an installment note. The intermediary then purports to sell the property to the buyer and receives the cash purchase price. Through a series of related steps, the seller receives an amount equivalent to the sales price, less various transactional fees, in the form of a purported loan that is non-recourse and unsecured.
5. Pandemic-related Scams
Economic Impact Payment and tax refund scams. Identity thieves who try to use Economic Impact Payments (EIPs), also known as stimulus payments, are a continuing threat to individuals. The IRS has issued all Economic Impact Payments, and most eligible people have already received their stimulus payments.
Unemployment fraud leading to inaccurate taxpayer 1099-Gs. Many taxpayers lost their jobs and received unemployment compensation from their state during the pandemic. Scammers took advantage of this by filing fraudulent claims for unemployment compensation using the stolen personal information of individuals who had not filed claims. Taxpayers should also be on the lookout for a Form 1099-G reporting unemployment compensation they didn’t receive.
Fake employment offers posted on social media. There have been many reports of fake job postings on social media. These fake posts entice their victims to provide their personal financial information that can be used to file a fraudulent tax return for a fraudulent refund or used in some other criminal endeavor.
Fake charities that steal your money. Bogus charities are always a problem. To check the status of a charity, use the IRS Tax Exempt Organization Search tool. Individuals should never let any caller pressure them. A legitimate charity will be happy to get a donation at any time, so there’s no rush, and donors are encouraged to take the time to do the research.
6. Offer in Compromise (OIC) “mills”
An “offer,” or OIC, is an agreement between a taxpayer and the IRS that resolves the taxpayer’s tax debt. The IRS has the authority to settle or “compromise” federal tax liabilities by accepting less than full payment under certain circumstances. OIC mills are a problem all year long but tend to be more visible right after the filing season ends, and taxpayers are trying to resolve their tax issues perhaps after receiving a balance due notice in the mail. These “mills” contort the IRS program into something it’s not – misleading people with no chance of meeting the requirements while charging excessive fees, often thousands of dollars. They make outlandish claims, usually in local advertising, regarding how they can settle a person’s tax debt for pennies on the dollar. The reality usually is that taxpayers pay the OIC mill a fee to get the same deal they could have gotten on their own by working directly with the IRS.
OIC mills are just one example of unscrupulous tax preparers. Taxpayers should be also wary of unscrupulous “ghost” preparers and aggressive promises of a bigger refund.
Ghost preparers. Although most tax preparers are ethical and trustworthy, taxpayers should be wary of preparers who won’t sign the tax returns they prepare, often referred to as ghost preparers. For e-filed returns, the “ghost” will prepare the return but refuse to digitally sign as the paid preparer. By law, anyone who is paid to prepare, or assists in preparing federal tax returns, must have a valid Preparer Tax Identification Number (PTIN). Paid preparers must sign and include their PTIN on the return.
Inflated refunds. Not signing a return is a red flag that the paid preparer may be looking to make a quick profit by promising a big refund or charging fees based on the size of the refund. Unscrupulous tax return preparers may require payment in cash only and will not provide a receipt, invent income to qualify their clients for tax credits, claim fake deductions to boost the size of the refund, or direct refunds into their bank account, not the taxpayer’s account.
7. Scams To Steal Your Identity, Personal Financial Information, and Money
Criminals have used bogus calls, texts, emails, and posts online for years. Victims are tricked into providing sensitive personal financial information, money, or other information that can be used to file false tax returns and tap into financial accounts, among other schemes. The IRS continues to see common scams such as text messages, email phishing, and phone messages. Generally, the IRS will first mail a bill to any taxpayer who owes taxes. All tax payments should only be made payable to the U.S. Treasury and never be made payable to third parties. Anyone who doesn’t owe taxes and has no reason to think they do should never give out any information. Hang up immediately and do NOT click links or open attachments in unsolicited, suspicious or unexpected text messages, whether from the IRS, state tax agencies, or others in the tax community.
8. Spear Phishing
Spear phishing is an email scam that attempts to steal a tax professional’s software preparation credentials. These thieves try to steal client data and tax preparers’ identities to file fraudulent tax returns for refunds. Spear phishing can be tailored to attack any type of business or organization. It is a serious problem because it can be tailored to attack and steal the computer system credentials of any small business with a client database, such as tax professionals’ firms. The latest phishing email uses the IRS logo and a variety of subject lines such as “Action Required: Your account has now been put on hold.” These emails are scams that send users to a website that shows the logos of several popular tax software preparation providers. Clicking on one of these logos will prompt a request for tax preparer account credentials.
9. Concealing Assets in Offshore Accounts and Improper Reporting of Digital Assets
Offshore accounts. As international tax and money laundering crimes have increased, numerous individuals have been identified as evading U.S. taxes by attempting to hide income in offshore banks, brokerage accounts, or nominee entities. They then access the funds using debit cards, credit cards, wire transfers, or other arrangements. Some individuals have used foreign trusts, employee leasing schemes, private annuities, and structured transactions, attempting to conceal the true owner of accounts or insurance plans.
U.S. persons are taxed on worldwide income. The mere fact that money is placed in an offshore account does not put it out of reach of the U.S. tax system. U.S. persons are required to report income from offshore funds and other foreign holdings under penalty of perjury. The IRS uses a variety of sources to identify promoters who encourage others to hide their assets overseas.
Digital assets. The proliferation of digital assets across the world in the last decade has created tax administration challenges regarding digital assets, partly because there is an incorrect perception that digital asset accounts are undetectable by tax authorities. Unscrupulous promoters continue to perpetuate this myth and make assertions that taxpayers can easily conceal their digital asset holdings. Taxpayers should not be misled into believing this, risking the possibility of exposing themselves to civil fraud penalties and criminal charges that could result from failure to report transactions involving digital assets.
10. High-income Individuals Who Don’t File Tax Returns
Most people file on time and pay their fair share of tax; however, those who choose not to file a return represent a compliance problem that continues to be a top priority of the IRS. Taxpayers (especially those earning more than $100,000 per year who have a legal filing requirement) may be wrongly persuaded that not filing their return is a smart move. They should remember, however, that the Failure to File Penalty is initially much higher than the Failure to Pay Penalty. As such, it is more advantageous to file an accurate return on time and set up a payment plan if needed than to not file. If a person’s failure to file is deemed fraudulent, the penalty generally increases from 5 percent per month to 15 percent for each month or part of a month the return is late, with the maximum penalty generally increasing from 25 percent to 75 percent.
11. Abusive Syndicated Conservation Easements
In syndicated conservation easements, promoters take a provision of the tax law allowing for conservation easements and twist it by using inflated appraisals of undeveloped land (or, for a few specialized ones, the facades of historic buildings). They may also use partnership arrangements devoid of a legitimate business purpose. These abusive arrangements do nothing more than game the tax system with grossly inflated tax deductions and generate high fees for promoters. The IRS examines 100 percent of these deals, and hundreds of these deals have gone to court.
12. Abusive Micro-Captive Insurance Arrangements
In abusive “micro-captive” structures, promoters, accountants, or wealth planners persuade owners of closely-held entities to participate in schemes that lack many insurance attributes. For example, coverages may “insure” implausible risks, fail to match genuine business needs, or duplicate the taxpayer’s commercial coverages. The “premiums” paid under these arrangements are often excessive and are used to skirt the tax law. Recently, the IRS has stepped up enforcement against a variation using potentially abusive offshore captive insurance companies. Abusive micro-captive transactions continue to be a high-priority area of focus.
While this list is not an exclusive list of transactions the IRS is scrutinizing, it represents some of the more common trends and transactions that may peak during that tax filing season as returns are prepared and filed. Taxpayers and practitioners should always be wary of participating in transactions that seem “too good to be true.” Please contact the office immediately if you think you’ve been a victim of a tax scam.
Deducting Business-related Car Expenses
If you’re self-employed and use your car for business, you can deduct certain business-related car expenses. Here’s what small business owners need to know:
There are two options for claiming deductions:
Actual Expenses. To use the actual expense method, you need to figure out the actual costs of operating the car for business use. You are allowed to deduct the business-related portion of costs related to gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments).
Standard Mileage Rate. To use the standard mileage deduction, multiply the standard mileage rate set by the IRS each year by the number of business miles traveled during the year. Normally, there is one set rate for the entire calendar year; however, in 2022, there are two rates: 58.5 cents per mile for the first six months (January through June) and 62 cents per mile for the last six months (July through December). For details, see Standard Mileage Rates Increase for Remainder of 2022, below.
Car expenses such as parking fees and tolls attributable to business use are deducted separately no matter which method you choose.
Which Method Is Better?
Using the standard mileage rate produces a larger deduction for some taxpayers. Others fare better tax-wise by deducting actual expenses. Whether you own or lease your car, you may use either of these methods.
To use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. In subsequent years, you can use the standard mileage rate or actual expenses. If you choose the standard mileage rate and lease a car for business use, you must use the standard mileage rate method for the entire lease period – including renewals.
Opting for the standard mileage rate method allows you to bypass certain limits and restrictions and is simpler; however, it’s often less advantageous in dollar terms. Generally, the standard mileage method benefits taxpayers who have less expensive cars or travel many business miles.
The standard mileage rate may understate your costs, especially if you use the car 100 percent (or close to it) for business.
Tax law requires that you keep travel expense records and show business versus personal use on your tax return. Furthermore, if you don’t keep track of the number of miles driven and the total amount you spent on the car, your tax advisor won’t be able to determine which of the two options is more advantageous for you at tax time. It is essential to keep careful records of your travel expenses (if you use the actual expenses method, you must keep receipts) and record your mileage.
You can use a mileage logbook or, if you’re tech-savvy, an app on your phone or tablet. Several phone applications (apps) are available to help you track your business expenses, including mileage and billable time. These apps also allow you to create formatted reports that are easy to share with your CPA, EA, or tax preparer.
To simplify your recordkeeping, consider using a separate credit card for business.
Don’t hesitate to call and find out which deduction method is best for your particular tax situation.
Reverse Mortgages: What To Know
Home equity represents a significant portion of the average retiree’s wealth. If you’re 62 or older and house-rich but cash-poor, a reverse mortgage loan allows you to convert part of the equity in your home into cash – without having to sell your home. You can use this cash to finance a home improvement, pay off your current mortgage, supplement your retirement income, or pay for healthcare expenses. A reverse mortgage is not without risk, however. Here’s what you need to know:
What Is A Reverse Mortgage?
A reverse mortgage is a type of home equity loan that allows you to convert some of the equity in your home into cash while you continue to own the home. Reverse mortgages operate like traditional mortgages, only in reverse. Rather than paying your lender each month, the lender pays you. Three types of reverse mortgage plans are available:
- Single-purpose reverse mortgages that are offered by state and local government agencies and nonprofit organizations,
- Federally-insured reverse mortgages, also known as Home Equity Conversion Mortgages (HECMs), backed by the U. S. Department of Housing and Urban Development (HUD); and
- Proprietary reverse mortgages, which are private loans backed by the companies that develop them.
The primary benefit of a reverse mortgage is that it allows homeowners aged 62 and over to keep living in their homes and use their equity for whatever purpose they choose. A reverse mortgage could be used to cover the cost of home health care, pay off an existing mortgage to stop a foreclosure, or support children or grandchildren. A reverse mortgage can also be into your retirement strategy.
Depending on the lender, borrowers can choose to receive monthly payments, a lump sum, a line of credit, or some combination. Choosing a line of credit offers the most flexibility by allowing homeowners to write checks on their equity when needed up to the limit of the loan.
Reverse mortgages differ from home equity loans in that most reverse mortgages do not require repayment of principal, interest, or servicing fees as long as you live in the home. Instead, the loan is repaid when you die, sell your home, or when your home is no longer your primary residence.
The proceeds of a reverse mortgage generally are tax-free, and interest on reverse mortgages is not deductible until you pay off the debt. When the homeowner dies or moves out, the loan is paid off by selling the property. Any leftover equity belongs to the homeowner or the heirs.
Many reverse mortgages have no income restrictions. If you receive Social Security Supplemental Security Income, reverse mortgage payments do not affect your benefits, as long as you spend them within the month they are received. This rule is also valid for Medicaid benefits in most states.
Who Qualifies for a Reverse Mortgage?
- Applicants must be 62 years of age.
- Potential borrowers must either completely own their home or only have a couple of mortgage payments remaining.
- Reverse mortgage borrowers must live in the home being used as collateral.
- Borrowers must have an excellent credit history to qualify for reverse mortgage loans.
- All homeowners must sign the paperwork to secure the reverse mortgage.
- Primarily, single-family one-unit dwellings are required to qualify for a reverse mortgage.
- During the reverse mortgage process, the homeowners are responsible for property taxes and repairs to the property as they still own their home.
Maximum Loan Amounts
Maximum loan amounts range (depending on the lender) from 50% to 75% of the home’s fair market value. The general rule is that the older the homeowner and the more valuable the home, the more money will be available. All reverse mortgages have non-recourse clauses, meaning the debt cannot be more than the home’s value. That is, you (and your heroes) cannot owe more than the home’s fair market value.
Maximum loan amount limits are based on the value of the home, the borrower’s age and life expectancy, the loan’s interest rate, and whatever the lender’s policies are. For example, a homeowner taking out a reverse mortgage 2022 through the Federal Housing Administration would be subject to a maximum loan amount of $970,800 – even if the appraised value of the home is more.
The Downsides of Reverse Mortgages
If you plan to move a few years down the road or there is a possibility you will have to move due to illness or any other unforeseen event, then a reverse mortgage probably doesn’t make any sense. Additionally, suppose you already have a substantial mortgage on your home. In that case, the reverse mortgage is probably not for you since you will have to pay it off before becoming eligible. Several additional downsides of reverse mortgages include:
- Incurring a Large Amount of Interest Debt. Reverse mortgages (fixed-rate or adjustable-rate) are rising-debt loans in that the interest is added to the loan balance each month. Because it is not paid currently, the total interest you owe increases greatly over time as the interest compounds.
- Fewer Assets for Heirs. If you want to pass your home to your children or heirs, the reverse mortgage is not a good choice since the lender will get most of the equity when the home is sold, leaving fewer assets for your heirs.
- Higher Costs Up-front. The high up-front costs of reverse mortgages may make them less attractive to some people. All three types of plans charge an origination fee, interest rate, closing costs, and servicing fees. Insured plans also charge insurance premiums.
- Adjustable vs. Fixed Interest Rates. With many reverse mortgage plans, interest rates are adjustable annually or monthly and tied to a financial index, sometimes with limits on how far the rate can go up or down. Reverse mortgages with interest rates that adjust monthly have no limit. Remember that the higher the rate, the faster your equity is used up.
Reverse mortgages are a complex financial tool that may be the answer for house-rich and cash-poor retirees planning to age in place – but they are not for everyone. Don’t hesitate to call if you have any questions about how a reverse mortgage might fit into your retirement planning strategy.
Do You Need to File an Amended Return?
If you discover a mistake on your tax return after you’ve already filed it, don’t panic. In most cases, all you have to do is file an amended tax return. Here’s what you need to know:
Taxpayers should use Form 1040X, Amended U.S. Individual Income Tax Return, to file an amended (corrected) tax return. An amended tax return should only be filed to correct errors or make changes to your original tax return. For example, you should amend your return if you need to correct your income, deductions, or credits. Taxpayers can also amend their return electronically if there is a change to their filing status or to add a dependent previously claimed on another return.
You normally do not need to file an amended return to correct math errors because the IRS automatically makes those changes for you. Also, do not file an amended return because you forgot to attach tax forms, such as W-2s or schedules. The IRS normally will mail you a request asking for those.
Generally, you must file Form 1040X within three years from the date you filed your original tax return or within two years of the date you paid the tax, whichever is later. For example, the last day for most people to file a 2019 claim for a refund is April 15, 2023. Special rules may apply to certain claims. Please call for additional information about this.
Amending a Tax Return
If you need to amend your 2019, 2020, and 2021 Forms 1040 or 1040-SR, you can now file the Form 1040-X, Amended U.S. Individual Income Tax Return electronically using available tax software products. If you are amending more than one tax return, prepare a separate 1040X for each return and note the tax year of the return you are amending in the correct location at the top of Form 1040X. In general, taxpayers still have the option to submit a paper version of Form 1040-X and should follow the instructions for preparing and submitting the paper form.
Taxpayers are allowed to file up to three “accepted” Amended Returns electronically. After the third accepted Amended Return, all subsequent attempts will be rejected.
The normal processing time of up to 16 weeks (once received by the IRS) also applies to Amended Returns filed electronically. Calling the IRS will not speed up the processing time of an amended return. Taxpayers should note that direct deposits are not allowed at this time for Amended Returns.
Claiming an additional refund. If you are filing an amended tax return to claim an additional refund, wait until you have received your original tax refund before filing Form 1040X. Amended returns take up to 16 weeks to process. You may cash your original refund check while waiting for the additional refund.
Additional taxes. If you owe additional taxes, file Form 1040X and pay the tax as soon as possible to minimize interest and penalties on unpaid taxes. You can use IRS Direct Pay to pay your tax directly from your checking or savings account.
When to File a Paper Return
For tax years other than 2019, 2020, and 2021 1040 and 1040-SR returns or any other tax types, amended Returns must be filed by paper. Also, if amending a prior year return – and the original return for that year was filed on paper during the current processing year – the amended return must be filed by paper. You will find the appropriate IRS address to mail your return to in the Form 1040X instructions.
If you need to mail more than one amended tax return to the IRS, you must use a separate envelope for each return.
Updates for 2022
Starting in June 2022, more forms can now be amended electronically. These include people filing corrections to the Form 1040-NR, U.S. Nonresident Alien Income Tax Return and Forms 1040-SS, U.S. Self-Employment Tax Return (Including the Additional Child Tax Credit for Bona Fide Residents of Puerto Rico), and Forms 1040-PR, Self-Employment Tax Return – Puerto Rico.
Additionally, a new electronic checkbox has been added for Forms 1040/1040-SR, 1040-NR, and 1040-SS/1040-PR to indicate that a superseding return is being filed electronically. A superseded return is one that is filed after the originally filed return but submitted before the due date, including extensions.
Tracking the Status of a Return
You can track the status of your amended tax return for the current year three weeks after you file. You can also check the status of amended returns for up to three prior years. To use the “Where’s My Amended Return” tool on the IRS website, enter your taxpayer identification number (usually your Social Security number), date of birth, and zip code. If you have filed amended returns for more than one year, you can select each year individually to check the status of each.
Questions About Amended Returns?
Don’t hesitate to call if you need assistance filing an amended return or have questions about Form 1040X.
Standard Mileage Rates Increase for Remainder of 2022
The optional standard mileage rate, which taxpayers may use to calculate the deductible costs of operating an automobile for business and certain other purposes, increases to 62.5 cents per mile, effective July 1, 2022. The new mileage rate is up 4 cents from the rate effective at the start of the year.
The optional business standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage. Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.
The rate for deductible medical or moving expenses (available for active-duty members of the military) increases for the remainder of 2022 as well, to 22 cents per mile. This new rate is up 4 cents from the rate effective at the start of 2022.
Taxpayers should note that the 14 cents per mile rate for charitable organizations remains unchanged as it is set by statute.
Normally, the IRS updates the mileage rates once a year, generally in the fall, for the next calendar year. As a reminder, for travel from January 1 through June 30, 2022, taxpayers should use the current mileage rates (58.5 cents per business mile and 18 cents per medical and moving – military members only).
The rate increases are a special adjustment for the final months of 2022 in response to recent gasoline price increases. While fuel costs are a significant factor in the mileage figure, other items enter into the calculation of mileage rates, such as depreciation and insurance, and other fixed and variable costs. Midyear increases in the optional mileage rates are rare. The last time the IRS made such an increase was in 2011.
What Teen Entrepreneurs Should Know About Taxes
Teens and young adults often go into business for themselves over the summer or after school. This work can include babysitting, lawn mowing, dog walking, or other part-time or temporary work. When a teen or young adult is an employee of a business, their employer withholds taxes from their paycheck. However, when they are classified as an independent contractor or are self-employed, they’re responsible for paying taxes themselves.
Here are six things to keep in mind:
- Everyone, including minors, must file a tax return if they had net earnings from self-employment of at least $400.
- If they owe taxes, teens and young adults should file their own tax returns, even if their parent or guardian claims them as a dependent.
- Teens and young adults can prepare and sign their own tax returns. There is no minimum age to sign a tax return.
- Parents can’t claim a dependent’s earned income on their own tax return.
- In addition to income tax, self-employed people are generally responsible for self-employment tax as well. It’s like the Social Security and Medicare taxes withheld from the pay of most wage earners.
- Teens and young adults can lower the amount of tax they owe by deducting certain expenses.
Here’s what young entrepreneurs should do to keep on top of their tax responsibilities:
Keep records. It’s good to make and keep financial records and receipts during the year. Recordkeeping can help track income and deductible expenses and provide the information needed for a tax return.Pay estimated tax, if required. If a teen or young adult being claimed as a dependent expect to owe at least $1,000 in tax for 2022, they must make estimated quarterly payments. They should pay enough tax on time to avoid a penalty. They can use one of these forms to calculate their estimated taxes:
- Form 1040-ES, Estimated Taxes for Individuals
- Form 1040-ES NR, U.S. Estimated Tax for Nonresident Alien Individuals
If a taxpayer also has a job where their employer withholds tax, they can request that their withholding be increased to cover their estimated taxes from their self-employed income. That way, they don’t have to pay estimated tax separately. The Tax Withholding Estimator on the IRS website is a great tool to help wage earners figure out how much they should be withholding.
File a tax return. When tax season rolls around, young taxpayers can review the information and forms, gather their records, and e-file their tax returns. When preparing to file a tax return, they should review all their records, including any estimated tax they’ve already paid.
If people owe taxes, they can pay electronically through Online Account and IRS Direct Pay. As always, if you need assistance with these and other tax issues, please call the office.
The Difference Between a Hobby and a Business
A hobby is any activity that a person pursues because they enjoy it and with no intention of making a profit. In contrast, people operate a business with the intention of making a profit. However, many people engage in hobby activities that turn into a source of income, and determining if that hobby has grown into a business can be confusing. For instance, many people may have started making handmade items and selling them for a profit during the pandemic.
As such, taxpayers should know about the nine factors used by the IRS that they must consider when determining whether their activity is a business or hobby:
- Whether the activity is carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records.
- Whether the time and effort the taxpayer puts into the activity shows they intend to make it profitable.
- Whether they depend on income from the activity for their livelihood.
- Whether any losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
- Whether they change methods of operation to improve profitability.
- Whether the taxpayer and their advisors have the knowledge to carry out the activity as a successful business.
- Whether the taxpayer was successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether the taxpayers can expect to make a future profit from the appreciation of the assets used in the activity.
Reporting Hobby Income
All factors, facts, and circumstances with respect to the activity must be considered. And, no one factor is more important than another. If a taxpayer receives income from an activity with no intention of making a profit, they must report any income on their Form 1040.
Please contact the office with any questions about this topic.
Summer Activities That Could Affect Your Tax Situation
Although the tax return filing deadline has come and gone, it’s never too early to start planning for next year’s tax return. With that in mind, let’s take a look at some common summertime situations that could affect your taxes:
Getting married. Getting married this summer? Be sure to report any name changes to the Social Security Administration (SSA). Taxpayers should also report address changes to the United States Postal Service, employers, and the IRS. To report a change of address for federal tax purposes, taxpayers must complete Form 8822, Change of Address and submit it to the IRS. This will help make sure they receive the documents they will need to file their taxes.
Sending kids to summer day camp. The cost of sending your children to a summer day camp may count towards the child and dependent care credit (see above for more details on this credit). Overnight camps do not qualify, however.
Working part-time. While summertime and part-time workers may not earn enough to owe federal income tax, they should remember to file a return. They’ll need to file early next year to get a refund for taxes withheld from their checks this year.
Gig economy work. Summer income earned by providing on-demand work, services, or goods, often through a digital platform like an app or website, is taxable income. Examples of gig work include ride-sharing, delivery services, and other activities. Please call the office to learn more about how participating in the gig economy can affect taxes.
Typically, employees receive a Form W-2, Wage and Tax Statement, from their employer to account for the summer’s work. Taxpayers use this information when filing their tax returns, and they should receive the W-2 by January 31 next year. Employees will get a W-2 even if they no longer work for the summertime employer.
Keep in mind that employers determine whether the people who work for them are employees or independent contractors. Independent contractors aren’t subject to withholding, making them responsible for paying their own income taxes plus Social Security and Medicare taxes.
Adjust Withholding Now To Avoid Tax Surprises Next Year
Life events like marriage, divorce, having a child, or a change in income can affect taxes. Taxpayers should remember that, if needed, they should submit their new W-4 to their employer, not the IRS. Taxpayers can avoid a tax surprise next filing season by using the IRS Tax Withholding Estimator to assess their income tax, credits, adjustments, and deductions. The tool helps taxpayers determine whether they need to change their withholding by submitting a new Form W-4, Employee’s Withholding Allowance Certificate. As always, help is just a phone call away.
Creating Items and Jobs in Quickbooks, Part 1
Before QuickBooks came along, tracking jobs or projects for your business probably involved file folders and paper invoices and bank statements and lots of sticky notes. You hoped that you didn’t forget to bill a customer or record a payment. And calculating the profitability of a job was quite a challenge.
QuickBooks makes these tasks easy. You can attach multiple jobs to customers and assign expenses to them when you enter a purchase. You can also assign estimates and invoices to specific jobs, then do the same when payments come in. QuickBooks allows you to create individual records for each job based on all this data, and run reports that gauge profitability and unbilled costs, for example.
Transaction and reports templates are all ready for you to fill with your own data. If you haven’t yet created records for the products and services you sell to complete your jobs, you should do so before you start building your first one you’ll need to be able to add those sales to your records.
Creating Item Records
It’s always a good idea to make your item records as comprehensive as possible. But it’s especially important when you’re going to be creating and tracking jobs. We’ll create a service that might be used by a landscaping service as an example.
To get started, open the Lists menu and select Item List. Click the down arrow next to Item in the lower left so you can familiarize yourself with the options available there. Click New. In the window that opens, select Service from the drop-down list that opens below Type. Give your service an Item Name/Number and click the box if it will be a Subitem of another account.
Figure 1: Before you can start building job records, you should create records for the products and services that will be used for them.
If you’re using a version of QuickBooks that says Enable under Units of Measure and you want to designate one, click the button and walk through the wizard to define it. If you’re using a version of QuickBooks that doesn’t offer it, don’t worry about it. Enter a brief Description in the appropriate field and then a Rate. Open the list in the Tax Code field and select either Tax or Non.
You may want to meet with someone in the office before you start creating items to go over the Tax Code and Account fields, or the question about assemblies or contractors – especially if you’re new to QuickBooks. They have to be correct, and you may have more questions if you have to create records for inventory parts, as this process is more complicated. If you’re sure of the information you entered here, though, click OK.
To start creating jobs, you need to open the Customers menu and click Customer Center. The Customers & Jobs tab on the left should be highlighted. Click the down arrow next to the field in the upper left and select New Customer & Job if you need to create a customer record first. If you already have a customer record, click once on the customer’s name in the list and then click Add Job. Either way, you’ll see a window like the one displayed below when you click the Job Info tab.
Figure 2: QuickBooks contains templates for each customer that you can use to create individual job records.
At the very top of this screen, above the window, you’ll see a field for Job Name, which you’ll need to enter. If this is a new customer, there won’t be an Opening Balance [dollar amount] As Of [Date]. If the customer owes you money from previous work, you’ll need to supply the balance owed, which you can find by looking in the Balance Total column back in the Customer Center’s customer list.
You’ll enter a Description, of course. If your company offers a variety of summer landscaping packages, you might want to be more specific (like Weekly and Monthly Summer Landscaping) so you can differentiate among them. You need to consider what kinds of Job Types you want to create. Click the down arrow in that field and select . Job Types provide a way for you to categorize different jobs.
Select your Job Status from the drop-down list, and then choose your Start Date and Projected End Date using the calendars provided. You’ll eventually be able to fill in the End Date field. When you’re done, click OK. Your new job will appear in the Customers & Jobs list, under the related customer.
Next month, the focus is will be on learning how jobs are used in QuickBooks. If you have questions before then, please don’t hesitate to contact the office for assistance. The goal, of course, is to learn new features that help you get the most you can out of the software.
Once you’re tracking Jobs in QuickBooks, you can run reports that automatically gauge their profitability. As always, if you have any questions, do not hesitate to ask.
Tax Due Dates for July 2022
Employees Who Work for Tips – If you received $20 or more in tips during June, report them to your employer. You can use Form 4070.
Employers – Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in June.
Employers – Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in June.