How Long Should You Keep Your Tax Returns For?

Posted on May 9, 2013 by Russ

A question I’m asked every year is how long should I keep my tax returns? And how long should I keep the backup documentation for the returns? The first question is easy to answer; the second one isn’t. (James Maule’s post on this subject reminded me of this issue.)

To start on this determination, we need to look at the statute of limitations. That is generally three years from the due date of the return or date of filing (whichever is later) for federal returns. However, it doubles to six years if there’s a gross understatement of income. For your 2012 taxes timely filed, that would be either April 15, 2016 or April 15, 2019. Most states give their tax agencies an extra year for the statute of limitations, so if you live in a state with state income tax that means four or eight years from the due date of the return or date of filing (whichever is later). So you can ditch the returns after eight years, right?

Wrong. I strongly recommend you keep your tax returns–and proof of filing–forever. There is no statute of limitations if you don’t file your return. A few years ago, one of my clients was accused by a state tax agency of not filing his 1977 state tax return. Yes, 30 years after that return was likely filed the state came to him and said he didn’t file the return. They accused him of owing a couple thousand dollars of tax, and a lot more in interest and penalties. My client did have his federal tax return, and we were able to find enough records to show that he was owed a refund by the state for 1977. (Most likely, the 1977 state return was filed and the state tax agency’s records got messed up.) Had my client kept his state tax return he would have been able to send a copy to the state and saved himself a lot of aggravation and fees.

Well, at least I can shred all my backup documentation after six or eight years, right?

Perhaps. If you don’t have any investments, any items with basis calculations, or any similar items, yes, those items can be disposed of after six or eight years. For example, a sole proprietor’s travel receipts can be shredded at that time. However, there are many receipts and records that need to be kept for far lengthier periods. Let’s look at some examples:

1. You bought a stock in 1992. You sell it in 2014. You claim a capital loss on your shares of the stock. The IRS examines your return and alleges that you didn’t have a loss; rather, you made a large profit. Wouldn’t you like to have proof of your purchase price?

2. You purchase a rental property in 1998. In 2007, you use a Section 1031 exchange to defer the gain on sale of that property (by purchasing another property through a qualified intermediary). In 2013, you use another 1031 exchange. In 2020, you sell the property that you ended up with. You need proof of your basis in the property. That means you will need the HUD Settlement Statement on the purchase and sale of all the properties. If you made improvements to the properties, you need those receipts. Depreciation records will be needed. If in 2002 or 2006 you disposed of the records of the original rental purchase, you may have a problem.

3. You purchase a boat in 2002 for $50,000. You retire in 2013; your taxable income is now quite low (you have nontaxable income from municipal bonds). In 2014, a drunken boater rams and destroys your boat. Unfortunately, you only receive $25,000 from your insurance company. You claim a casualty loss on the damage to your boat for $25,000. The IRS denies the loss in an audit. If you don’t have records showing the purchase price of the boat (your “basis”), the IRS will likely win in Tax Court.

I can go on with similar examples–these three were ones I quickly thought of. If you are certain that a situation like any of these won’t apply to you, shred away! Unfortunately, I suspect most of us have items like these (especially clients of tax professionals). If so, keep those records.

Posted in IRS | Tagged | 1 Comment

California Leads the Way (as Worst State for Business)

Posted on May 7, 2013 by Russ

If anyone wonders why I left the Bronze Golden State, yet another survey has come out regarding places to do business. Chief Executive Magazine rated all 50 states from top to bottom. Before focusing on the dismal state of California’s business climate, let’s highlight the top ten states:

1. Texas
2. Florida
3. North Carolina
4. Tennessee
5. Indiana
6. Arizona
7. Virginia
8. South Carolina
9. Nevada
10. Georgia

At the bottom was California:

41. Maryland
42. Pennsylvania
43. Hawaii
44. Michigan
45. Connecticut
46. New Jersey
47. Massachusetts
48. Illinois
49. New York
50. California

Looking at why California ranks where it does, one can see the problems are taxation and regulations. The comments note that the regulations and taxation is unreasonably and “…getting worse, if that is even possible.” Compare these to the comments regarding Texas: “Texas is the clear leader because of taxes and pro-business attitudes.”

Do I expect anything to change in California? No — I think the state will have to hit bottom (be broke) in order for real change to happen.

Posted in Canada, Texas | 1 Comment

Reversing Two Penalties That Should Never Have Been Charged

Posted on May 6, 2013 by Russ

When are tax returns due? For most individuals, its April 15th. However, if you are outside of the United States on April 15th for purposes of employment or self-employment you get an extra two months (until June 15th) to file your return. There are no penalties but interest is charged. As the IRS states (see the link), you simply attach a statement to the return and no penalties are supposed to be charged. I’ve been preparing returns for expatriates for years and never had any problem with this…until last year (the 2012 tax season for filing calendar year 2011 returns).

For whatever reason, I had several clients who were charged penalties who were outside of the United States on April 17, 2012 (last year’s tax deadline) for employment/self-employment purposes. I checked with my software vendor and they told me that nothing had changed with the software–the notices were attached to the filed returns. I believe them because I had two clients who paper-filed who were charged penalties! In all cases, a statement was attached to the return noting the taxpayer was outside of the US on the tax filing deadline.

In most of these cases, I was able to reverse the penalties with a phone call. However, I have had three clients where I have had to write letters to the IRS. Here’s how one case was resolved.

This client’s return was filed in early June. She took the automatic extension, with a statement attached to her return. She had a small balance due which was paid through electronic debit (with the filing of her return). In mid-July she received a CP14 notice noting that she owed late filing and late payment penalties. I obtained a Power of Attorney and called the IRS. The IRS refused to lift the penalties. I wrote a letter in early August explaining that no penalties should be owed. In mid-September, I received a response from the IRS that they hadn’t resolved the situation. In mid-December, the IRS denied removing the penalties.

We have carefully reviewed your case. However, the information provided did not establish reasonable cause. Thus we are unable to remove your penalties for failure to file and failure to pay.

Did the IRS even read the letter I wrote? I asked for the penalties to be removed based on the out-of-country automatic extension, not for reasonable cause. (And yes, it took the IRS over four months to give an answer to my letter.)

We then appealed the decision. The hearing was held in late March and was the shortest Appeals hearing I’ve ever had. The Appeals Officer stated that we were correct, and that no penalties should be charged. “I can’t remove the interest,” he noted. I told him that was fine–the client does owe the interest. The Appeals Officer told me that he had no idea why this couldn’t have been resolved at the Service Center level or by Service Center Appeals Screening. (All appeals are first screened for obvious cases where the appellant is correct. A few years ago, I filed an appeal on behalf of a client who was charged the late filing penalty when his efile return was rejected on October 15th; he had mailed the return the next day–and mailed it using certified mail, return receipt rejected. The screening staff granted our appeal.)

Well, I may be able to answer the question as to why this couldn’t be resolved at the Service Center. I suspect that staff answering the notices (generally, the automated underreporting unit, or AUR) have problems when it’s not something they’ve encountered before. (I cringe when I have a client who receives a CP2000 notice regarding, say, a W-2G. Most personnel at the IRS rarely see gambling-related tax issues and don’t understand the law.) Most likely, the individuals who reviewed the letters I sent had no idea that there’s an extended deadline when you’re outside of the US on April 15th. Since they didn’t know of it, it couldn’t exist.

Second, the sheer volume of notices being sent out is creating a huge volume of responses. This means the staff handling those responses have been overworked. Given that two-thirds of IRS notices are incorrect (in part or in whole), the IRS is likely getting lots of letters. Overwork leads to errors in responses.

I don’t know if I’ll actually have to go to Appeals on the other two clients whose cases have yet to be resolved. (These are both going through the same IRS Service Center which rejected my first client’s out-of-country extension.) In the end, I’m certain my clients are in the right. But consider the expense to my clients and the expense to the IRS. As Joe Kristan noted last week, the IRS could do a better job in spending the money it has. I would expect that basic training in the deadlines would be given (or at least, knowledge of the rules or a database of where to look).

Unfortunately, I don’t expect things to get better. The problem is that the AUR program is a huge moneymaker for the IRS. Far too many individuals see an IRS notice and blindly pay it. Most of my clients have been reading my newsletter (or this blog) and know the reality of IRS notices and don’t blindly pay IRS notices. Make sure you don’t either.

Posted in International, IRS | Tagged , | 2 Comments

How Not to Deduct 85,491 Miles

Posted on April 30, 2013 by Russ

Having resided in Southern California, I know you can put a lot of miles on your car in that area. One engineering teacher learned the hard way from Tax Court that a written mileage log is essential if you want to deduct your business miles.

The petitioner taught at several schools in Southern California. He was not reimbursed by the schools for his mileage. He claimed 85,491 business miles driven–a deduction of $46,593. The IRS allowed only 4,970 miles. That’s a difference of 80,000 miles and a difference that large led to the case going to trial.

Unfortunately, the petitioner did not keep a contemporaneous written mileage log. The Cohan rule (allowing the Court to estimate an expense) does not apply to automobile expenses.

To meet the heightened substantiation requirements, a taxpayer must substantiate the amount, time of use, and business purpose of the expense. Sec. 274(d); see also sec. 1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). To substantiate by adequate records, the taxpayer must provide both an account book, a log, or a similar record, as well as documentary evidence, which are together sufficient to establish each element of an expenditure…Documentary evidence includes receipts, paid bills, or similar evidence…To substantiate by sufficient evidence corroborating the taxpayer’s own statement, the taxpayer must establish each element by the taxpayer’s statement and by direct evidence, such as documentary evidence.

Unfortunately, the petitioner didn’t maintain a contemporaneous log.

During his testimony petitioner submitted into evidence a mileage log which was created after the 2008 tax year. Petitioner claimed he drove 88,820 miles related to business travel in 2008. Corroborative evidence used to support a taxpayer’s reconstruction of expenditures “‘must have a high degree of probative value to elevate such [a] statement’ to the level of credibility of a contemporaneous record.”

The question for the Court was whether the testimony of the petitioner was enough to prove the 80,000 miles were for business but not commuting (commuting mileage is never deductible).

We find the mileage summary to be insufficient under section 274(d) because the mileage amounts were not entered at the time the vehicle was used. Petitioner testified that the mileage log he presented at trial was prepared “after [he] was approached by the IRS”. Outside of the syllabi petitioner presented, we are unable to determine for what purpose petitioner was traveling to and from the various schools outside of class time. Petitioner provided no evidence to corroborate entries in the mileage log for random trips to the schools other than testimony that he made various trips to prepare for the semester. We are unable to verify whether these trips were for business or were personal.

The petitioner also attempted to argue that even if the mileage were commuting mileage, these were temporary positions. The problem is that commuting to temporary positions outside of the metropolitan area where you reside can be deducted (this would be a travel expense). Unfortunately, all of the positions were within the Los Angeles metropolitan area.

Petitioner worked and lived in the same metropolitan area, and therefore we find that petitioner’s commuting expenses do not qualify for the exception to the general rule of nondeductibility. We hold that petitioner’s commuting expenses were nondeductible.

If you’re going to deduct mileage, keep a contemporaneous written mileage log. It takes just a few seconds to note your starting and ending mileage, the date, where you went, and the business purpose. It could be the difference in deducting 80,000 business miles.

Case: Daniel-Berhe v. Commissioner, T.C. Summary Opinion 2013-33

Posted in IRS, Tax Court | Tagged | 1 Comment

1700 Miles and a 7% Difference

Posted on April 28, 2013 by Russ

One of the most difficult things to explain to a non-tax practitioner is the tax concept of domicile. For most individuals, your domicile is your residence. I reside in Las Vegas, Nevada. It’s my only home. In my case, my domicile and residence are identical (as is the case for most people).

However, some individuals have multiple residences. Take Ken Mauer. Mr. Mauer has a home in Afton, Minnesota (just east of the Twin Cities). He also has a home in Fort Meyers, Florida. They’re both residences, so which is his domicile? If Mr. Mauer’s had residences in Nevada and Florida, this wouldn’t be a big issue (neither state has a state income tax). However, Minnesota has a state income tax so being considered a Florida resident would save Mr. Mauer thousands of dollars in state income tax.

Shock of shocks, Mr. Mauer declare himself a Florida resident and didn’t file Minnesota tax returns for 2003 or 2004. After the Minnesota Department of Revenue objected, he filed a part-year 2003 return. Mr. Mauer was audited by the Department of Revenue and lost. He appealed the decision to the Minnesota Tax Court and lost. He then appealed to the Minnesota Supreme Court. That court upheld the previous decision.

I’m not going to into Minnesota’s 26-factor test, or the factors that led to Mr. Mauer being considered a resident of the Gopher State rather than the Sunshine State. One factor, though, is key: Mr. Mauer spent more time in Minnesota than Florida. Few tax agencies will consider you a resident of the other state if you continue to spend a lot of time in their state. Suffice to say, it you are in such a situation it’s best to cut all ties to your old state…or at least spend 183 days in your new home. In Mr. Mauer’s case, he’s liable for Minnesota state income tax for 2003 and 2004.

Hat Tip: How Appealing

Posted in Florida, Minnesota | 3 Comments

Use EFTPS If You Use a Payroll Service

Posted on April 28, 2013 by Russ

Most payroll services are reputable. They help companies comply with the myriad of laws and regulations in payroll by preparing payroll checks, paperwork, and even sending the withheld payroll taxes to the IRS and state tax agencies.

Of course, where most won’t go the Bozo wing of payroll services happily head to. From Maryland comes the story of AccuPay. The payroll company is accused of failing to remit payroll taxes to the IRS and Maryland. After local police investigated, the company filed a Chapter 7 bankruptcy case. The owner of the firm refused to testify (citing the Fifth Amendment right against self-incrimination).

The stories read horribly, with some owners having to take out loans, and other firms perhaps going out of business. Yet there’s a way today to make sure your payroll tax company is remitting your taxes: EFTPS. It takes about two weeks to enroll (passwords will be mailed to you). Once you are enrolled, you can see your payroll tax remittances. There’s no reason to be a recurring victim of this kind of theft.

Senator Barbara Mikulski (D-MD) will be proposing a bill that would require payroll firms to register with the IRS and be bonded or certified by the IRS. I oppose this, because it’s not needed. Use EFTPS and you can see for yourself if your payroll taxes are making it to the IRS.

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Kudos to Kenneth Ryskamp

Posted on April 27, 2013 by Russ

Who is Kenneth Ryskamp? He’s a Senior Judge in the United States District Court for the Southern District of Florida. Judge Ryskamp was born in 1932, and has been a US District Court Judge since 1986 (and a Senior Judge since 2000). Why am I noting Judge Ryskamp? Because of a sentence he imposed on Thursday.

Mary Curran of Palm Beach, Florida inherited Swiss bank accounts from her husband. Those accounts had not been reported (and likely the interest not reported on tax returns). Her attorney, Roy Black, tried to get Mrs. Curran into the Offshore Voluntary Disclosure Program (OVDP) but her name had already been given to the IRS. She paid a large fine ($26 million); the Department of Justice brought criminal charges. She pleaded guilty to two false tax return charges. Judge Ryskamp wondered why:

Based on these facts, did it ever occur to the government to dismiss these charges. Instead, the government decided it had to make a felon out of this woman?

Judge Ryskamp gave Mrs. Curran one year of probation. Given Mrs. Curran could have faced six years at ClubFed, that sentence in itself was a huge win. But she got more good news a few moments later: The judge immediately revoked it! Her probation lasted all of five seconds. Judge Ryskamp noted:

This is really a tragic situation…It seems to me the government should have used a little more discretion.

The judge also suggested that Mrs. Curran request a presidential pardon, which he would endorse.

As Joe Kristan noted, the government goes after the accidental offenders with shotguns while slapping the wrists of some big-time offenders. Perhaps the IRS and DOJ will use some discretion in the future…but that’s probably asking too much.

News Coverage: Palm Beach Daily News, ABA Journal

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Bayern Munich Head Reports Self for Tax Evasion

Posted on April 21, 2013 by Russ

Uli Hoeness is the president of Bayern Munich. Who? Well, if you asked a resident of Bavaria this question, you’d get shocked looks–the same as you would get from a New Yorker asking about the Yankees. Bayern Munich is a soccer team in Munich. They’re very successful and already have clinched this year’s bundesliga. This New York Times story notes that the club just won their 13th straight game.

OK, I’m not a soccer fan. However, I am interested in cases of tax evasion and here’s one possible such case. Mr. Hoeness apparently has an issue with a Swiss bank account. Mr. Hoeness filed an amended tax return; the public prosecutor’s office is checking to make sure that the amended return is accurate. If the amended return is accurate, the penalties in Germany for filing the first ‘bad’ return can be lessened.

This is similar to US tax law in that the IRS (and Department of Justice) almost always take a much harder line on individuals that the government finds that have cheated on their taxes than on individuals who have voluntarily come forward.

Posted in International, Tax Evasion | Tagged | 1 Comment

IRS Gives Extra Three Months for Filing and Payments to Boston-Area Taxpayers; Massachussetts Deadline Should be the Same

Posted on April 17, 2013 by Russ

As I’m still not really working, here’s the press release from the IRS:

WASHINGTON — The Internal Revenue Service today announced a three-month tax filing and payment extension to Boston area taxpayers and others affected by Monday’s explosions.

This relief applies to all individual taxpayers who live in Suffolk County, Mass., including the city of Boston. It also includes victims, their families, first responders, others impacted by this tragedy who live outside Suffolk County and taxpayers whose tax preparers were adversely affected.

“Our hearts go out to the people affected by this tragic event,” said IRS Acting Commissioner Steven T. Miller. “We want victims and others affected by this terrible tragedy to have the time they need to finish their individual tax returns.”

Under the relief announced today, the IRS will issue a notice giving eligible taxpayers until July 15, 2013, to file their 2012 returns and pay any taxes normally due April 15. No filing and payment penalties will be due as long as returns are filed and payments are made by July 15, 2013. By law, interest, currently at the annual rate of 3 percent compounded daily, will still apply to any payments made after the April deadline.

The IRS will automatically provide this extension to anyone living in Suffolk County. If you live in Suffolk County, no further action is necessary by taxpayers to obtain this relief. However, eligible taxpayers living outside Suffolk County can claim this relief by calling 1-866-562-5227 starting Tuesday, April 23, and identifying themselves to the IRS before filing a return or making a payment. Eligible taxpayers who receive penalty notices from the IRS can also call this number to have these penalties abated.

Eligible taxpayers who need more time to file their returns may receive an additional extension to Oct. 15, 2013, by filing Form 4868 by July 15, 2013.
Taxpayers with questions unrelated to the Boston tragedy should visit IRS.gov, or contact the regular IRS toll-free number at 1-800-829-1040.

Meanwhile, the Massachusetts Department of Revenue has extended the deadline until at least April 23rd. The press release states, “The IRS is expected to provide details on the federal extension shortly. DOR will match whatever extension the IRS announces.”

Thus, for taxpayers living in and around Boston (and individuals impacted by the bombings, including participants and first responders), they should not owe penalties. Interest, however, is statutory and cannot be waived. The Boston-area tax deadline will be Monday, July 15th.

Posted in Massachusetts | 1 Comment

When a Day Late Isn’t a Dollar Short

Posted on April 16, 2013 by Russ

I’m in zombie mode — it’s midnight and the last of the work is done (for a short time). I’ll be out the rest of today (Tuesday). Tax Day is over.

One place where it’s sort of not over is California. The Franchise Tax Board had major computer issues with their website on Monday. The FTB announced that anyone who pays their tax on April 16th via the FTB’s webpay system (for individuals or for businesses) on April 16th will be considered to have made the payments on April 15th.

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