Friday, April 25, 2014
Nothing lasts forever, but you wouldn't believe it by looking at some people record-keeping systems. Prolific pack rats insist on keeping every scrap of paper, just in case. And when it comes to tax paperwork, folks are even more adamant. These documents will save me, they argue, if an Internal Revenue Service auditor comes visiting. But that’s not necessarily the case, say tax and organizational experts.
There are limits
When it comes to tax-related documents, you should hang on to records that help you identify sources of income, keep track of expenses, determine the value of property, prepare tax returns or support claims made on those returns. However, common sense--as well as storage space--should be your guide. "We get people looking at boxes of stuff in their basements and ask, ' Can I toss it? '" says Linda Durand, a CPA and senior tax manager with Drolet & Associates PLLC in Washington, D.C. "A lot of it, they can."
The rule of thumb for tax papers is hold onto them until the chance of audit passes. Usually, this is three years after filing. But if the IRS suspects you underreported your income by 25 percent or more, it gets six years to check into your tax life.
That’s why most accountants advise taxpayers, even those who are meticulous fillers, to keep tax documents for six to 10 years.
Use it or lose it
This means 1040 forms and any accompanying tax schedules, along with the documents supporting the return, such as W-2s, 1099 miscellaneous income statements and receipts or cancelled checks verifying tax-deductible expenses.
"Anything that you need to do your taxes, hang onto it," says Saul Rudo, a tax attorney and partner in the Chicago office of Katten Muchin Rosenman LLP. But don't go overboard. If you used something to claim a deduction, keep it. If not, shred it. For example, says Rudo, all those medical bills are useless--and just taking up space--if you didn't accumulate enough to meet the deduction threshold.
Thursday, April 24, 2014
Heartbleed bugs and blood moons. What’s up? You would think it’s Hallowe’en. Well, it is similar to that horror season ... after all it is tax season.
Joking aside, there are several heads-up items to warn you about regarding the recent e-service shut down at Canada Revenue Agency (CRA), even for those who filed their taxes already and think they have escaped the fall out. In fact, for everyone who has or is going to electronically file with CRA, there are a couple of important points to note.
First off, the CRA e-services are up and running as of this past Sunday and have been working well since re-boot. In fact, the e-services might even be operating faster than before the bug. Is that possible? Has everything been house cleaned?
More to the point, CRA has extended the April 30 annual filing date to Monday, May 5 to make up for the lost filing days. However, I advise that if you haven’t filed yet, stay on task as there is no guarantee the CRA electronic system is clean of all bugs.
And on the cyber front, beware of the e-mail scams surrounding the filing of your tax return. I am sure there are other scams but these are the ones I have experienced.
Prior to the heartbleed bug there was, and still is, an e-mail scam arriving in people’s in-boxes that involves a very official looking e-mail from CRA telling the recipient that their tax return has been received by CRA and to click the CRA link within the e-mail to confirm that the return is in fact their return. Or, if they haven’t yet filed their return, they are directed to click on the link to determine if someone is attempting to steal their identity by filing a fraudulent return.
Perhaps compelling reasons to follow the instruction ... but don’t. It’s a scam. And just connecting to that link can be disastrous so don’t be inquisitive. For interest sake, the fake CRA webpage looks quite real.
This scam is followed up by a second scam e-mail telling the recipient that since they did not confirm their tax return by clicking on the link in the prior e-mail, they are now under investigation by CRA and must click on the link provided to communicate with CRA immediately.
“Under investigation by CRA”, now that is compelling reason to follow the instruction. DON’T.
Another derivative of CRA e-mail scams is the requirement via e-mail to change CRA e-service passwords due to the heartbleed bug. Yes you should, but log directly onto the CRA website to do it. Don’t use the link provided in the e-mail.
In light of the heartbleed bug issue these e-mail scams may play into taxpayer fear, or even taxpayer logic given the circumstances. The point is, any supposed e-mail from CRA is just that, supposed. If in doubt about a communication from CRA, go directly to the CRA website or, better yet, get on the old fashion phone and enjoy listening to the music while on hold. When you think about it, it’s a small price to pay to avoid a hacked computer or stolen identity.
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Wednesday, April 23, 2014
This is a good time for a financial spring cleaning.
Most people have filed their income-tax returns, so a lot of financial information is fresh and accessible. It's time to determine which records to keep and which to toss. But taxes aren't the only aspect. Here are 10 general tips for de-cluttering, organizing and protecting:
1. Decide on income-tax records.
When it comes to tax returns, receipts and supporting statements, the general rule is to retain documents for at least three years. The IRS can go back that far on routine audits. But if the IRS suspects you under-reported a sizable chunk of income, it can go back six years. And if fraud is suspected, there's no time limit.
Documents that establish your cost basis in investments should be kept until after you sell. These include papers showing the purchase price or cost of improvements on a home, reinvested dividends in taxable mutual funds and records showing how much you contributed to non-deductible IRAs.
2. Automate what you can.
A big part of cutting down on paper clutter involves doing more business through your home computer or smartphone. This includes setting up automatic bill paying and auto deposits. One benefit of investing in 401(k) plans is that the money automatically comes out of each paycheck and gets transferred into investment accounts, with no need to think about each transaction. You can do the same with non-retirement accounts.
3. Be sensitive to fees.
Survey your financial accounts for the types and levels of fees, from your credit-card interest rate to 401(k) expenses. Make sure they're reasonable. Banks and other financial entities levy fees for bounced checks, out-of-network ATM charges, late payments and more. Most of these charges are avoidable. Many companies allow you to set up alerts so that you don't miss a payment deadline, exceed your balance or otherwise trigger a charge.
Though bank fees can be irritating, investment costs can add up to more money over time. Workplace 401(k) balances can run into the tens of thousands of dollars, so paying even an extra half-percentage point can add up. At a minimum, avoid stock funds charging more than 1 percent annually or bond funds with expenses above 0.5 percent.
4. Take an inventory of belongings.
It's not likely you will be burglarized or suffer fire damage, but if those did occur, you would be thankful to have a list or visual evidence of all the personal items destroyed or taken. That's why it makes sense to take an inventory of belongings. Documentation also will help substantiate insurance claims.
Your inventory can be as simple as walking around the house with a video recorder or camera. If you're more ambitious, jot down model numbers of big-ticket items or compile receipts.
5. Devise an emergency plan.
If you had to evacuate your home, it would be handy to grab a file of essential information, either in paper form or on a flash drive. Your evacuation plan should include details on financial and other accounts, insurer-contact information, a list of bills that need paying, medications and perhaps even veterinarian contacts. It might take some time to distill all the information in your life down to what's really essential, but that's part of the exercise.
6. Close unneeded accounts.
It's possible you rarely use certain credit cards, have low balances in some bank accounts or have two or more mutual funds that hold similar investments. If so, consider removing some of this clutter by closing accounts. You might be able to save money, such as the annual credit-card fees. You also will have less to keep track of.
Some people hang on to old credit cards because they worry about harming their credit scores. Your score could indeed dip if you close a seasoned account, but the impact probably would be minor — certainly less than not paying bills on time.
7. Review your estate plan.
Periodically verify that you have listed the right people to take over your wealth should the time come. Make sure the names are still appropriate, given that some friends or relatives might have died or relationships might have changed. This beneficiary checklist should include retirement and insurance accounts, wills and trusts.
If you have financial or health-care powers of attorney, it's smart to update them if they're more than a year or two old. Financial companies or other parties aren't required to honor these documents if they deem them to be out of date or otherwise deficient.
8. Bolster credit protections.
Check your credit reports every now and then. Given security breaches such as the ones reported by Target and Maricopa Community Colleges, this exercise has become more critical. Monitor bank and credit-card statements for even small transactions, set up account alerts that notify you of transactions and shred unneeded documents containing sensitive information. Order one free report each year from each of the three credit bureaus — Equifax, Experian and TransUnion — at annualcreditreport.com.
9. Keep cyber defenses high.
Install antivirus and malware protection on your computer, stick with secure sites as much as possible and don't click on unfamiliar e-mail attachments. As a kid, you learned not to talk to strangers; now you should avoid answering their e-mail invitations. You also should routinely change passwords and use strong ones — those that include a mix of numbers, letters and special characters.
10. Alter tactics after Heartbleed.
Matters have become more complicated in the wake of the Heartbleed security flaw, which involves possible breaches at websites thought to be secure. Before changing passwords, create an inventory of every website you utilize. Then, without logging on, search each site for a notice indicating that the company has installed the necessary patch or fix. You also can check this by typing Web addresses into www.ssllabs.com/ssltest, which tracks patches as they're made.
"If the Web vendor has validated that it has patched the security hole, change your password," advises accounting-firm CliftonLarsonAllen. But don't do so until the patch is in place. Otherwise, you will need to repeat the exercise and change your passwords again, after fixes have been made.
Tuesday, April 22, 2014
As a business owner, you know that a year-round regimen of good recordkeeping can also make filing accurate tax returns easier. And yet, we often fall short of our best intentions.
If your recordkeeping has fallen short of your expectations, never fear. Below is a list of important documents you should be gathering now to expedite your filing and save you time and money.
The obvious components of good recordkeeping are good organization, and knowing which documents are important to have and how long to keep them. This even applies to small-business owners who leave the preparation of their tax returns to professionals.
The envelopes of some important tax documents will actually have "important tax document" printed on the front. But, also be on the lookout for emails from financial institutions, brokers and others notifying you that tax documents are available via their websites.
This may strike you as common sense. But we live in a noisy world and it’s easy for important documents to get buried or lost in the shuffle.
Small-business owners can use this list to help them begin to compile the documents needed to fill out their tax returns, and to request replacements if any have gone missing:
· Prior year federal and state tax returns. Keep all business tax returns permanently, along with insurance records and legal correspondence
· Business income records. Keep a record of all income in a ledger book or use a software program. If storing your records electronically, make sure the system is compatible with IRS electronic storage system requirements
· Receipts, invoices and bills documenting business expenses. Keep these in addition to credit card statements because they are more detailed accounts of your transactions
· Mileage log documenting car use for business purposes. Keep track of the purpose, date and length of trips
· Utility bills and records of repairs done to home office. Keep track of these expenses because those attributable to the office are business expenses. Utility and other household expenses will be deductible based on the percentage of your home used as an office. A special safe harbor deduction now allows taxpayers to take a home office deduction of up to $1,500, depending on the square footage of the office, without the need to save receipts to calculate relevant home expenses.
· Health insurance payment receipts. Keep these and other documents that substantiate the tax credits and deductions you claim
Many important tax documents also are delivered to the IRS to ensure accurate income reporting and find audit candidates. Among the documents sent as part of this matching system are forms W-2 (wages), 1099-MISC (self-employment income and other miscellaneous types of income), 1099-INT (interest paid) and 1099-B (sale of stock).
If something shows up in the mail and you are not sure if you will need it in April, save it because a tax professional can help you know exactly what you need based on the type of business you operate.
Monday, April 21, 2014
I have a high regard for accountants. They have an extremely difficult job. In order to maximize tax savings for their clients, they need to understand and interpret an incredibly complicated Internal Revenue Code. Former U.S. congressman John Hostettler once said, “The Internal Revenue Code and regulations add up to 1 million words and is nearly seven times the length of the Bible.”
It's not surprising that few accountants look outside the code for tax-saving opportunities. That’s unfortunate. There’s a world of tax-saving possibilities related to investing. If your accountant is not familiar with them, your registered investment advisor should be alerting you to them.
The failure to focus on the tax efficiency of your investments can significantly affect your returns. According to a 2008 Vanguard publication, "Tax-Efficient Equity Investing: Solutions for Maximizing After-Tax Returns," taxes have the potential to take the “biggest bite” out of total returns. How much of a bite? According to research by Joe Dickson and John Shoven, “Taxes and Mutual Funds: An Investor Perspective," taxes can reduce the returns of a mutual fund by as much as a whopping 25 percent.
1. Harvest your tax losses. No one is happy when their investment goes down in value. However, tax-loss harvesting permits you to sell investments at a loss and use those losses to offset gains on other investments. Here’s an example of how it works.
Assume you purchased a fund for $10,000 on January 1 and it declined to $5,000 on March 1 of the same year. If you decide to "harvest" the loss, it will be characterized as a short-term loss since the fund was held for less than one year. Assuming a 35 percent ordinary federal income tax, your tax savings would be $1,750. You will have reduced your economic loss to $3,250.
Tax-loss harvesting is not simple. Initially, it involves determining whether the loss is substantial enough to harvest. You also need to assess the problem of exiting the market and missing out on potentially large gains. You can avoid this problem by complying with the "wash-sale" rule, which permits you to sell a stock or mutual fund and buy a replacement stock or fund, as long as the replacement is not considered "substantially identical" in nature.
2. Invest in retirement accounts. Take advantage of a 401(k) or 403(b) plan offered by your employer. The funds you invest in these plans are pretax. You will defer taxes until you start receiving distributions. Don't forget to contribute on your own to a traditional individual retirement account or (if you qualify) to a Roth IRA. With a Roth, you will be contributing with after-tax funds, but your withdrawals will be tax-free.
3. Allocate your investments. The way you allocate funds between your taxable and nontaxable accounts can have a meaningful impact on your after-tax returns. Funds that pay out meaningful taxable distributions of dividends and capital gains should typically be placed in a tax-deferred account. Taxable bond funds should also be placed in a tax-deferred account. This will permit you to reinvest distributions and avoid recognizing those distributions as ordinary income.
Real estate investment trusts and most alternative investments should generally be held in tax-deferred accounts to defer taxes on distributions.
Active trading of your investments is generally a bad idea because it runs up transaction costs, which reduces returns. However, if you must actively trade, put those investments in a tax-deferred account so you can buy and sell without tax consequences.
Individual stocks that you intend to keep for a long time should be placed in an after-tax account. Index funds and stock index exchange-traded funds are also good candidates for your after-tax account.
When deciding how to allocate investments between your taxable and nontaxable accounts, taxes should not be your sole consideration. Investments in tax-deferred accounts have restrictions on withdrawals. You may incur a penalty if you withdraw these funds earlier than permitted. You want to be sure you have enough funds in your taxable account so you can meet your needs, without accessing your retirement accounts.
4. Buy index funds. As a general rule, index funds (where the fund manager seeks to replicate the returns of the designated index and there are less transaction costs) that track a broad index (like the Standard & Poor's 500 index) and comparable ETFs are very tax-efficient. Most actively managed funds (where the fund manager attempts to beat the returns of the designated benchmark) trade more than index funds, incurring higher taxes. They are less tax-efficient.
The same Vanguard study calculated the tax costs of actively managed funds and index funds. The study measured the tax cost for 15 years ended Dec. 31, 2007. It found the median tax cost of domestic actively managed funds was higher, by 0.83 percent annually, than the tax cost for index funds.
This significant difference in tax costs is a major reason why the same study found that "indexing has historically provided higher after-tax returns than have actively managed mutual funds.”
Here’s the bottom line: If tax efficiency is important to you, consider investing in index funds, ETFs or passively managed fund.