Five Good Reasons to Obtain a Filing Extension

As you’re nearing the tax return finish line, you probably have some clients who are stragglers or haven’t “checked in” yet. Fortunately, you can still rely on the automatic tax filing extension to bail procrastinators out of a jam. Here’s some valuable information to pass along to your clients.

The due date for filing 2011 federal income tax returns is April 17, 2012, but that deadline isn’t etched in stone. You can buy yourself more time by filing Form 4868, Application for Automatic Extension of Time to File US Individual Income Tax Return, by April 17. This provides an automatic extension for filing your return for six months until October 15, 2012 – with absolutely no questions asked by the IRS!

Of course, an extension to file is NOT an extension to pay the tax that’s due. You still have to pay estimated tax in a timely manner to avoid penalties and interest charges.

If you don’t pay the requisite amount of tax by the April 17 deadline, the IRS will impose a penalty of one-half percent each month on the amount of tax owed. And, if you fail to file a return by the October 15 extension date, the IRS will ramp up the penalty to 5 percent per month, up to a maximum of 25 percent.
Why would you need a filing extension? Typically, it’s used by taxpayers who simply couldn’t get their act together in time. But here are few other common reasons for seeking an extension:

1. You don’t have all the information you need for your return or it’s been lost or misplaced. For instance, delays may be caused if you haven’t received a K-1 stating income received in 2011 from a pass-through business entity.

“Frequently, an extension is needed because the business or partnership hasn’t completed its own return,” says Chris Hesse, a partner in CliftonLarsonAllen’s federal tax resource group in Minneapolis, Minnesota. “This has become common because pass-throughs are being used to avoid the double taxation issue. The client must make a payment based on a reasonable estimate.”

2. Circumstances dictate a delay. Even if you fully intended to file your tax return by April 17, sometimes life gets in the way. If there’s been an unexpected illness or death in the family, you might not able to file on time. Similarly, a natural disaster can cause interruptions, although the IRS usually offers relief to those in harm’s way.

3. You don’t have the cash on hand for a retirement plan contribution. If you’re self-employed, you might be using a Keogh plan or SEP to save for retirement. The annual contributions reduce your tax liability, but only if the deposits are made on time, notes Hesse. He says that filing for an extension effectively gives you an extra six months to come up with the money.

4. Obtaining an extension might reduce your tax liability. For example, if you converted a traditional IRA to a Roth in 2011, you must pay tax on the entire account balance at the time of conversion. But the value of the account may have declined since then. By recharacterizing your Roth back into a traditional IRA before you file your tax return, you can avoid an unnecessary tax “overpayment.”

5. You’re concerned about tax audits. There’s a school of thought that filing for an extension reduces your chances of being audited. Here’s why: Normally, IRS auditors examine a certain percentage of returns to randomly check for tax cheats. If you obtain an extension, you might sidestep this auditing procedure entirely, thereby reducing your overall exposure to an audit.

In any event, if you don’t pay the requisite amount of tax by the April 17 deadline, the IRS will impose a penalty of one-half percent each month on the amount of tax owed. And, if you fail to file a return by the October 15 extension date, the IRS will ramp up the penalty to 5 percent per month, up to a maximum of 25 percent.

As with your regular tax return, you can e-file your filing extension request or send it by snail mail. If you’re going to a US Post Office, we recommend using certified mail so you can prove to the IRS that you requested the extension on time.

How do you know how much you have to pay with the filing extension application? It’s not an exact science. Hesse says that his firm refers to figures in prior returns to help arrive at a reasonable amount. Contact your CPA immediately for guidance.

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Tax Tip: How Do You Spell Tax Relief? C-a-s-u-a-l-t-y Loss

Last year was a violent year across the country due of a flurry of hurricanes, floods, earthquakes, and other natural disasters. If insurance proceeds didn’t make your clients whole, they may be entitled to a modicum of tax relief on their 2011 returns. And homeowners who suffered damage in a government-designated disaster area may be in line for a quick tax refund.

The basic premise is that you can deduct unreimbursed casualty and theft losses in excess of 10 percent of adjusted gross income (AGI) after subtracting $100 per event. For simplicity, let’s use the example of a couple with an AGI of $100,000 in 2011. Suppose that a storm caused extensive damage to their house costing them $9,000 after insurance reimbursements. Also, the couple paid $2,000 out-of-pocket for repairs due to a car accident. Due to the limits, they can deduct $800 ? not that much, but better than nothing.

Under a unique tax rule, a loss in a federal disaster area this year can be deducted on the 2011 tax return you’re about to file for the client, instead of waiting to file the 2012 return next year. If you’ve already filed the 2011 return, file an amended return claiming the loss.

Note that damage caused by a taxpayer’s own negligence may be deductible as well as losses that occur, even though they could have been foreseen or prevented. Furthermore, losses aren’t necessarily limited to damages to the home. However, clients aren’t entitled to any tax relief for damage occurring over a long period of time, such as withered landscaping caused by a severe drought.

Theft losses are grouped with casualty losses for this purpose. Again, each event must be reduced by $100 before the 10-percent-of-AGI limit is applied.

Under a unique tax rule, a taxpayer may claim a loss suffered in a federal disaster area on the tax return for the year preceding the year in which the casualty actually occurred. This can provide some much-needed relief in a pinch. For example, suppose a client’s vacation home was destroyed in a wildfire in a federal disaster area earlier this year. The loss can be deducted on the 2011 tax return you’re about to file for the client instead of waiting to file the 2012 return next year. If you’ve already filed the 2011 return, file an amended return claiming the loss.

The tax law limits only apply to personal losses claimed by a taxpayer on Schedule A of an individual return. There is no AGI limit or $100-per-event reduction for losses to business property.

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Money Management Is Possible – Even in Today’s Economy

Most businesses these days are looking to cut spending. Accounting firms are in a unique position to not only help their small business clients trim the fat and manage their money, but to do the same for themselves.

Before any company can delve into strategic ways to save money, it must first set aside time to devote to money management. Even if a company is small, this step is crucial to a company’s success – no other advice is more important.

“You have to be focused enough to dedicate the necessary time weekly, if not more frequently,” said Robin Bell, CPA, member in Brown Smith Wallace (BSM) Tax Services group. “Bill frequently, collect often, and stay on top of billing and receivables. Pay attention to it.”

Set up a budget, then each month, compare the actual to the budget to see where improvements need to be made, suggests Patricia Schreiber, a New Orleans-based CPA.

And if you don’t have the time, delegate.

Look at what you need to have versus what you want to have when determining cash outflow, whether for your clients or your own firm. Once you have what you need, don’t pay more for it than is necessary to effectively operate your business.

“Segregation of duties: Learn it love it. Otherwise, stuff walks out the door,” says Chris Spivey, who has worked as a consultant to the accounting profession for several years.

If you’re an entrepreneur with tons of action items on your plate and collections isn’t your competency, refer it to someone else.

Bell’s longtime retail clients, who are used to bulk-buying seasonal products, have recently experienced difficulties managing their cash flow. Instead of stocking up on the “hot trends” for the season, Bell teaches its retail clients not to purchase more than they need. That way, they don’t have spend money to house products in a warehouse. However, when retail companies do this, they also must pay attention to what their customers might need in the near future. This ensures the retailers’ customers won’t have to wait too long if a product is out of stock.

According to Bell, some retail companies survey their clients to gauge what they’ll want to buy, or they beef up their marketing campaigns. This could put them at an advantage because most companies tend to trim their advertising and marketing dollars when times are tough. It’s not a matter of spending more, it’s just reallocating dollars to draw in more prospects, she said.

Do You Really Need That?

Look at what you need to have versus what you want to have when determining cash outflow, whether for your clients or your own firm, Bell said.

For example, look at telephone costs. If you’ve been using the same telephone provider for years, you might not think about changing vendors. But what about calling your provider to talk about your plan and whether it still makes sense given your current needs. You could also contact other providers to see what they offer.

Ask, “Do I have what I need, and am I paying for what I need versus paying more than what I need to operate my business,” Bell says.

Other potential areas to trim include:

Employee benefits. Can you save money without raising premiums if you have a group of employees who are healthy? “Especially in really small companies, it’s very easy to assess your pool and ask, ‘If I raise my deductible, how much can I save on my premium?’,” Bell said.

Mileage reimbursement. Encourage employees to travel less by visiting several clients on the same day who are based in the same area. Ask employees if they really need to fly nonstop or if they can fly on off hours or off days, Bell added.

While discussing money management is clearly a way to help your clients better manage their money, if they don’t ask you about it, how can you broach the subject?

BSW took a proactive approach by offering its clients a “health checkup,” which included a five-page questionnaire that asked some thought-provoking questions. It also provided BSW financial data that allowed the firm to see client trends and to learn what keeps business owners up at night, Bell said.

“Most clients were interested in seeing what we can do for them,” she said.

Clients want the help, so why not broach the subject?

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Obama Expected to Sign JOBS Act: What’s in it for You

On Tuesday, March 27, the House of Representatives approved the JOBS Act with a vote of 380 to 41. The bill, which amends portions of the Sarbanes-Oxley Act, will now go to President Obama who has indicated he will sign the legislation.

The Jumpstart Our Business Startups (JOBS) Act has been touted as the latest attempt to revive and stimulate the economy, with its key element focused on applying a concept called crowdfunding to small businesses. Crowdfunding is a term used to encourage donations of money to help artists and non-profit ventures. One element of this program has been that often those who donate get some token gift in return for their donation.

Taking crowdfunding to the small business arena, investors will be able to put money into small businesses in exchange for a share of equity without the company needing to jump through all of the hoops normally required by the Securities and Exchange Commission (SEC) of companies that want to issue shares of stock.

This is excellent news for investors who would like to take part in initial public offerings (IPOs) that would normally only be offered to certain qualified institutional investors and for small companies looking to grow capital without having the restrictions that were previously in place.

Here are the key elements of the JOBS Act:

Small privately-held companies with revenue under $1 billion (or $2 billion if the company provides potential investors with audited financial statements) will be able to sell up to $50 million in shares as part of a public offering without having to register with the SEC.

New public company start-ups with revenue up to $1 billion are excused from having an outside audit of internal controls for five years.

Small Companies will be able to have as many as 2,000 shareholders (previous limit was 500) or 500 unaccredited investors without registering with the SEC. According to the SEC, an accredited investor is an individual with a net worth of over $1 million not including primary residence, has earnings of at least $200,000 – or $300,000 for joint earners – for the past two years, or is a general partner, director, or executive officer of the company issuing the security.

A crowdfunding investor is limited to investing in all private companies that are governed by this Act the lessor of $10,000 or 10 percent of his income if the investor earns less than $100,000 a year.

Businesses will be able to use advertisements to solicit new investors.

You should be talking to your clients about these points:

Because SEC registration is no longer required for these small private companies, the standard disclosures to investors will not be required. Companies that want to take advantage of these new rules should consider what types of disclosures they expect to make that will encourage but not mislead potential investors.

Companies considering using crowdfunding techniques need to develop controls to prevent potential fraud and abuse. An accountant is well-suited to help the companies develop these controls.
Remind clients that assurances to potential investors should include descriptions of the controls that will guarantee the safety of investments.

Websites already exist that provide a platform for companies to make themselves available for crowdfunding investments. Sites such as Launcht, Crowdfunder, 40Billion, MicroVentures, and many more help businesses reach a wide audience. Accountants can help their clients choose the right site for their business and also monitor progress and performance.

Clients who are interesting in investing in small companies using crowdfunding techniques should be aware of potential fraud and abuse. Encourage them to learn as much as they can about the companies, their products, their history, and their leaders, before investing. Also work with your clients to explain how they should oversee the investments they make.

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Making Taxes Less Taxing

Gina Noy offers her clients stress-free tax preparation.

It’s not often you find “stress-free” and “tax” in the same sentence, especially during busy season, but for Noy, it’s a philosophy that carries through her Manhattan-based CPA firm.

Noy, who offers tax planning, budget advice, and bookkeeping services, works with a variety of different clients – from individuals and small businesses to start-ups and medium-sized companies. However, she said her sweet spot tends to be start-ups and companies in their second or third year of business – those moving toward a big growth stage.

According to Noy, many new businesses will experience a net loss in their first year – especially in the start-up phase – and she said that’s not necessarily a bad thing.

“If you have other income (such as W2), losses from your business can offset it, reducing your overall tax burden,” she said. “In other words, losses don’t have to be a total loss. However, they can impact your cash flow, your ability to grow your business, and attract investors and financing.”

She said many of her clients – especially those just starting a business – have to deal with correctly identifying whether they’ve hired an employee or a contractor. In the case of an employee, the business owner will be responsible for self-employment tax and keeping and filing additional documentation. Incorrectly identifying an employee’s status may expose the business owner to potential audits and penalties.

“My role in my clients’ business is to educate them,” Noy said. “Spending extra time, especially with new clients . . . educating them, helps them to succeed. I give my clients baby steps in tax, finance, and budgeting.”

It may only be a part, but for Noy, if her clients don’t understand the importance of tax in their business, they’re most likely not going to understand the importance of other financial matters.

“Especially with people who make a transition from working with a company and being self-employed, you feel like you’re floundering in the ocean. The income you earn isn’t always yours to keep, and you have to be responsible enough and realize that with the freedom of being a freelancer, you get a lot of responsibility.”

Noy recommends individuals just starting out to wait on incorporating and operate as a sole proprietor. She suggests saving the money on those start-up fees by purchasing insurance instead, and perhaps incorporating later on.

Many small business owners underestimate the responsibilities of running their business, and simply providing good service isn’t enough, Noy said.

“It’s very important to bill your clients, it’s very important to collect money from those clients and pay your bills on time. One thing leads to another. I find a lot of business owners will work extremely hard but will take a back seat to the financial part.”

And often, entrepreneurs and those just starting out will listen to advice from their friends and family rather than a professional, and they start making decisions, such as forming an LLC, without really having the information they need.

In January, Noy was a presenter at the Reboot Workshop in New York City, a networking event and “unconference” for freelancers and entrepreneurs. She said 90 percent of attendees’ questions were about incorporation and how entrepreneurs should move forward – “Should I incorporate, what type of incorporation should I be, when should I incorporate,” she recalled. “A lot of people incorporated but didn’t know what to do with it.”

Most new business owners are misinformed about write-offs as well. Noy said there are several that aren’t taken advantage of, including setting up a business retirement plan.

“Many clients don’t realize that they can put away as much as $49,000 for 2011 or $50,000 in 2012. Instead of looking for small deductions, business owners should start thinking big. By putting away money for retirement, they can save on taxes and provide for their future.”

Noy also added that many freelancers and entrepreneurs think health insurance is unapproachable and too expensive; therefore, they just put it to the side.

“There’s a way to offset a high deductible – put away pretax money into a Health Savings Account (HSA),” she said. “Tax savings are there. A little planning can go a long way.”

Cash flow management is vital to the successful operation of a small business. Noy says that once she walks her clients through their financial records, figures out how the money is flowing in and out, helps them value their business, and discusses how to price their services, the stress for the client goes away.

For many small business owners, especially freelancers, coming up with rates for services is often a trying and daunting process. Noy said she doesn’t figure out the rates for them, but she does walk them through their expenses and overhead to do some budgeting.

“A lot of people ask me what they should be charging. Of course, it really depends on what the industry expectations are, but it also depends on what their costs are,” she said.

If business owners’ costs are high due to their industry or overhead, then they may need to target corporate clients or more high net worth individuals. On the flip side, if business owners or entrepreneurs have low overhead and work out of a coffee shop on a laptop for the first two years, they can keep their pricing low and target a higher volume of clients – as many as they can service – and grow their business. They can raise their rates later.

The other piece, Noy points out, is knowing your market and pricing competitively. A business or entrepreneur charging too little, say $75 an hour for a service where everybody else is charging $125, could actually deter potential clients.

“I’m going to think something is wrong with your service because it’s too cheap,” she said. “I advise clients that you might want to offer $125, but offer a discount and say ‘I love your business, I really want to do work with you and I can give you a 20 percent discount.'”

Noy stresses that the most important thing for a small business owner or freelancer to remember is to learn how to budget and realize that money management is the key to their success.

“Without managing what’s coming into their business and what expenses have to be paid to come out of their business, it will be harder for them to grow.”

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IRS Ends Tax Rule Unpopular with Small Businesses

The IRS has eliminated an unpopular rule relating to how credit card and debit card payments are accounted for on tax returns, prompting relief from small business owners.

The new process, which was set to go into effect next year, would have mandated that companies explain the differences between numbers on 1099-K forms and their internal records. This rule was termed an “onerous and unnecessary extra step” by the National Federation of Independent Business (NFIB).

The NFIB explained the situation this way: “Section 6050W of the Internal Revenue Code, added by Section 3091 of the Housing and Economic Recovery Act of 2008, requires information returns (Form 1099-K) to be made regarding annual gross receipts reimbursements to settle merchant card transactions. Recently, the IRS added a Line 1a-e on business tax returns requiring business taxpayers to reconcile their actual gross receipts with the aggregate gross receipts amounts from Form 1099-K.”

The IRS announced it would not go forward with Line1a-e on business tax returns. The NFIB had protested the rule, saying that a company’s internal record of gross receipts would “rarely match” the amount payments processors report on 1099-K forms. That figure on the forms could include cash refunds, sales tax, tips, and other fees that merchants would not consider part of gross receipts, CFO magazine reported.

The IRS said in its letter to the NFIB, “There will be no reconciliation required on the 2012 form, nor do we intend to require reconciliation in future years.” The reporting of gross receipts and sales on the 2012 income tax forms will be modeled on the 2010 income tax forms.

“The many complications in our country’s tax code often put the small business owner at a disadvantage with government compliance,” NFIB CEO Dan Danner said in a statement. “For this reason, NFIB fought so hard to have this provision eliminated and we count this as a small, but important, step in the direction of simplifying the tax code overall.” Small businesses spend more than $74 per hour on meeting their tax compliance obligations, the NFIB says.

Lewis Taub, tax director at McGladrey & Pullen LLP, told CFO magazine that business groups might want to change their record keeping. Payment processes must continue to submit 1099-K forms, and a difference between the numbers on the forms and the gross receipts on the merchant’s tax returns could trigger an audit.

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