Tag Archives: income tax

Small discrepancies

Last week I got a message from the Canada Revenue Agency about my own 2015 income tax. I did not read the main part. I went to the bottom line and saw that they wanted me to pay them 14 dollars. I know that I could possibly fight this assessment but it would take a lot of time and energy. In addition to that they might decide to question other items on my return. I sent them the 14 dollars.

For a long time I have told tax clients not to worry about small items like this. If there is a large difference of course I will look into it. If the amount was a couple hundred dollars I would spend a couple of hours going through their assessment notice to see if I could find out exactly what they were objecting to. Then I could decide what to do about it.

Last week Revenue Canada sent a letter to one of my tax clients. They specifically asked him for one information slip. It was for a withdrawal from an RRSP (the Canadian equivalent of an IRA but with a much higher contribution limit.) This was amazing because there were only 2 items on the information slip, the withdrawal and the tax withheld.

They did not ask about the withdrawal, only the tax withheld. The brokerage firm that held the RRSP send in their copies of information slips to the tax authorities electronically.  I had to conclude that there had been a glitch in transmission so that the tax withheld did not appear to be 25% of the withdrawal.

This is not supposed to be possible. The only time I have seen such glitches was when I wrote a C program and discovered that the villains in Redmond had filled their new operating systems with read errors. I could write a file whenever I wanted to and then read it when they wanted to let me read it.

I can’t help mentioning that one of my buddies came to see me the first season that I worked on income tax. He had received a letter asking about 3 specific points on his return from the previous year. He was badly rattled and seemed to be very frightened. I went through it with him and showed him that in each of the 3 cases there were some points in his favor. He seemed relieved. When he came to see me the next time he did not remember anything that I had told him, except that now he knew that there were some points in his favor on each one. We went through it all again and this time he paid more attention.

 

 

Donald Trump’s Income Tax Return

Some of the Democrats have complained that Donald Trump has stated that he will not release his current income tax return until after the audit is finished. I think that this is reasonable.

Someone found a copy of his 1995 return in which he showed a huge Net Operating Loss. The calculation of the NOL is complex and difficult. I have only prepared a couple of them. They often take a couple of hours to fill in. The corresponding Canadian form takes only a few minutes.

The concept of Net Operating Losses is to decrease the effects of varying income levels. A typical one would be for someone like a realtor who made money when real estate was moving in the early 2000s and had huge losses when the real estate market died, because he was still making the same advertising expenses. Companies in mining or oil exploration would have the same problems. The NOL permits taxpayers to decrease the tax on other years to compensate for the losses of the loss year.

People whose income varies from year to year are quite likely to use NOLs. Some examples are a newspaper, a grifter, and an angel investor. I specifically mentioned these because the New York Times, Hillary Clinton, and Mark Cuban all recently condemned Trump for using NOLs recently without realizing that they had done the same. I have no idea why Mark Cuban made such a stupid mistake. Until recently I thought that he was smarter than that.

I would not expect to see anything interesting in Trump’s tax returns in any case. Anyone buying real estate developments in the US has to form a new corporation for each project. If the address is 123 Main Street you would try to set up a corporation with a name like 123 Main Street Ltd.

This is necessary because there are huge numbers of lawyers who are looking for business and nearly all of them would be glad to get a chance to make a claim against a property owner. Many lawyers make a practice of filing trivial actions against companies like real estate owners in the hope of getting a quick out of court settlement. They typically ask for an amount that is significantly less than the cost of going to court.

Trump says that he does not pay off these shysters. He makes them go to court. If there was only one or two it would be cheaper to pay them off than to go to court. He takes the position that if he paid off one of them he would be besieged by trivial lawsuits.

As a sidelight here, Al Sharpton’s daughter filed a claim against New York City stating that she had sprained her ankle because she tripped on something on the sidewalk. She went ahead and posted photos on the internet of her dancing in high heels later the day of her supposed accident, and climbing a large hill or small mountain a couple of days later. How stupid can they get?

To take money from a corporation to an individual owner is not difficult. The company can pay a dividend, a management fee, a director’s fee, or some similar thing. All of these would simply go onto a form 1099 and these would be added up, either directly or on a schedule C.

In Canada it used to be necessary to have the owner of a private company receive a draw during the year. Near the end of the year the accountant had to figure how much was a salary and how much was a dividend. The objective was to select the distribution of income types to minimize the total tax bill. Similar calculations are done in the US. Naturally they are more complex when a large number of corporations are involved.

There is an additional complicating factor in Trump’s case. Because he has interests in a couple hundred corporations, some of these are probably treated as separate businesses and some of them consolidate the accounts of some other corporations, which are officially owned by the mother corporations instead of the shareholder. It requires some pretty fancy calculations to figure out the best distribution.

In summary I expect that when his 2015 return is published it will not contain anything interesting because it will only show the funds that went from his companies to his personal account. This will be quite close to his cost of living plus whatever additional amount he wants to put into his stock trading account.

If the Dems really wanted to know what was in his tax return they would instead look at the 104 pages that he filed a few months ago. One financial writer looked at this and found that Trump owned a large amount of shares in a particular company that did not fit in with his other investments. He looked at it, examined the company’s filings, and recommended that his readers all buy shares in it.

Saving Receipts

Some people will tell you that you do not need to keep receipts  for deductible expenses. This is not correct. The IRS or Revenue Canada may ask to see your receipts any time that they want to ask.
When they ask it is your duty and responsibility to provide receipts. If you do not do so they may completely eliminate the business expense. You could end up with a big tax bill. Most likely, if this happens, you will be audited for the next 2 or 3 years.

This brings us to the question of how to collect and categorize your business or employee expenses. The system that seems to be simplest is to put all of January receipts in one envelope, all of February in another and so on. This is not a very good system.

A much better system is to look at last year’s tax form and make a list of the types of expenses that are listed. Prepare an envelope for each one. Place the receipts in the appropriate envelope.  The reason for doing it this way is that whoever prepares your tax return will need to sort them into these categories. If they are already in the correct categories this is no longer necessary.

On some occasions I have spent a long time sorting office supplies from internet service etc. Once they are sorted I like to handle them in the easiest way, which is to take a batch of receipts for one thing and enter them all into an adding machine that produces a paper tape. As soon as I get to the end I wrap the tape around the receipts and put a few staples through the package. Then I write the name of the category on the tape and go on to the next batch. With a little practice this becomes very fast and easy to do.

I use the same system for adding up prescription receipts.

I am sending this to you now because I hope that you do not wait until the last minute to start preparing for your tax preparation.

A new feature this year is that the sales tax that you pay on large items may be deductible if you itemize deductions. The sales tax on an SUV may be a very large figure that would look really good on your Schedule A.

 

US Income Tax Deadline Approaching

The deadline for US income taxes is April 15 in nearly all states. It is only later in 1 or 2 states that have a statutory holiday on the 15th.

If you want to become my tax client send a message to dave@daves-income-tax-online.com by the afternoon of Thursday April 14 giving your name, address, and Social Security Number. I will fill them out and mail them the morning of the 15th.
Of course, if you change your mind and want to have someone else prepare your taxes later that is okay. The extension is 6 months for the tax form 1040 but you are still expected to pay by the 15th of April. The extension is for time of filing, not for paying.
It is not clear at this time whether the extension of time is also for the FBARs needed when your foreign financial accounts sum up to more than $10,000 but it looks like it does.

When To Incorporate

Many people make a big mistake by incorporating at the wrong time. One of my friends made this mistake and he was a Chartered Accountant. He was involved in a real estate development scheme. He incorporated the whole scheme prematurely. Their plans showed the development as becoming profitable at a particular date and he set up the incorporation a few months ahead. The rental market changed and they lost a lot of money for several months, or possibly two or three years.

Because they were incorporated they could not carry the business losses back to their personal tax returns so they had to pay it and could not take deductions for it. This was in Canada. The equivalent in the US would be changing from an S corporation or an LLC to a C corporation.

Before income tax became such a major drag on businesses it was only necessary to incorporate when many or most of the investors did not take an active part in running the business. Now income tax is a major factor, usually much more important than the operational point mentioned above.

It is always difficult to determine when a business is going to become profitable. Unless most of the investors have experience in the business they are guessing. There are also factors that come out of the blue to bite you in the behind. Once a long time ago I was working in a small steel fabrication business. We were churning out estimates for small metal-clad buildings for potential buyers. All of them expected the Canadian government to remove the sales tax on building materials at the next budget. The budget came and the tax stayed. All of a sudden we were not producing any estimates and I was unemployed.

In conclusion you should not set up a corporation or go from an S corporation to a C corporation until the business is actually making money and there are good reasons to expect it to continue to do so. You can never be completely certain but this will often save you from big disasters.

Educational deductions

There is one cute little trick that works like a charm to rescue a tax client who has taken a course that has something to do with his or her occupation but has not got an official receipt for this educational course.

I saw this done several times and I did it myself several times. It was never questioned by Revenue Canada and I am pretty sure that the IRS would not object to it either. There was a large school in Vancouver, Canada that offered courses in modelling, hairdressing and such things but was not registered with Revenue Canada so they could not issue official educational receipts.

What we did was place the school expenses on a business statement and then show nominal income on the same statement. As an example if the client had taken a hairdressing course we would show a business statement as a hairdresser and show say $25 income as a hairdresser and $800 or whatever had actually been paid as a business expense. The client then had a $775 business loss instead of an $800 educational expense. We might have done this statement for free or charged $5 for it because we had to fill in a bunch of stuff at the top of the page but it was still a really good deal for the client.

This worked first of all because it was very close to what had actually occurred, and secondly because Revenue Canada expected to see income from this business in future.

There are many more little dodges like this that can be used when a taxpayer has an expense that does not quite fit into any particular category but clearly has a business purpose. Using any of these little dodges must be done very carefully because if the paperwork is not clear the tax authorities will deny the deduction and maybe do more than that. It is necessary to balance the chance of trouble with the tax authorities against the loss of a legitimate business expense.

Recently I saw some expense claims that were ridiculous. One woman charged a new fur coat as an expense of advertising her business but her business had nothing to do with fur. I could not see any connection with her advertising and neither did the IRS. I think that they hit her with a penalty for this claim.

All Ready for Tax Year 2015

I am finally ready for Tax Year 2015. All that is left is to connect to the FBARs. For some reason this is slow this year.(but see below)

I do both Canadian and US tax returns, and of course I do returns for taxpayers who have to file in both countries. There is a tax treaty that determines which country gets to tax which income. This is important in cases where a person gets income from both countries in any one year, or when a US citizen is working or living in Canada.

If you want a price quotation give me an idea of the type and number of information slips. If you have financial accounts outside the US and the maximum value of these accounts is more than 10,000 I need to know how many of these accounts you have.

If you want to send me your job to do, do not send originals. Send only copies. Better yet, instead of sending me copies, use your printer-scanner to make images, then send me the images attached to an email. This simplifies the whole process.

I will prepare the returns and send them back to you as PDF files so that you can print them out, sign them and send them in. I can efile Canadian returns now. I hope to be able to efile US returns in late March but it is not possible to determine when the IRS will give me permission. It is to their advantage to have forms efiled because it means that they do not have to input them manually. I should note here that the Canada Revenue Agency charges tax preparation firms $25 per return for handling paper returns unless the firm prepares only a small number of returns.

It is very important to determine if your financial accounts outside the US add up to 10,000 or more. For this purpose take the maximum value that each account had during the year. Often if you take out a loan the loan amount appears in your checking or savings account for only a few minutes but this still counts for determining the limit.

If the total of the maximum value of each account comes over 10,000 then you need to include every financial account that you have signing authority for, even tiny ones like your gardening club, your kid’s Boy Scout troop, or anything like that.

Preparing the statements for these financial accounts is sometimes more work than preparing the income tax statements. They need the complete street address of each financial institution, the account number and the maximum value of the account. I prepare two sets of statements with this information, one to go with your return and another to go to a different branch of the Treasury Department. There must be some logic behind this but I do not see it.

A couple of weeks ago I read that of all the taxpayers who are eligible to receive education credits on their returns only about 2 of every 3 actually make the claims. It is usually necessary to see what has been done in previous years because the American Opportunity Credit is only available for a limited time. The Lifetime Learning Credit has different restrictions.The credit is substantial. I do not know why so many taxpayers miss it. One possible reason is that many tax preparers do not want to take the time to go through the different possibilities so they do not ask about it.

If you are filing a 1040 or 1040NR and have pages and pages of stock transactions I can set up a direct connection between your broker and my software so that the information can be transferred directly. You do not have to tell me your trading password, you only have to tell it to Intuit.

Since writing the above I have found a solution for the FBARs. It took 2 20-minute phone calls to find out what the problem was. Somehow their system had decided that my account was inactive because I had not used it since last tax season. There are several places where they say that FBARs can only be submitted during tax season. I do not see why an account should be declared inactive when it is not used during a time period when it is not supposed to be used, but that is bureaucracy for you.

Please remember that the deadlines are April 15 and probably May 2 in Canada.

Cross-border Taxation

There are many potential problems in cross-border taxation. I will refer mainly to people who have to file in both Canada and the US. Typical examples are US citizens who live and work in Canada and anyone who has moved across the border in either direction during the year.

Canada taxes on worldwide income for residents and Canadian income for non-residents. Taxpayers who enter or leave Canada during the year file a return for the part of the year they were resident.
The US taxes people on the basis of citizenship. This is done by only one other country. Sometimes this other country is stated as being North Korea and sometimes it is stated as Eritrea depending on who you listen to. In either case the US is not in good company.

I prepared US and Canadian taxes together for many US citizens who lived in Canada. In only two cases was there any tax due on the US return. People who have jobs or are self-employed in Canada are allowed to deduct Canadian income tax, unemployment insurance, and Canada Pension Plan from US income tax. The sum of these three is nearly always greater than the US income tax would be so it is only a matter of reporting to the IRS, not paying them as well. Almost The only times when additional tax is due is when someone has sold something relatively large and made a capital gain. There are also differences in limits on charitable deductions, and these are often much more restrictive in the US than in Canada.

Going the other way, Social Security and Medicare taxes are added to US and state (and sometimes local) income taxes when figuring credits on Canadian taxes and the sum of these is usually greater than the Canadian income tax would be. Because of these additional charges usually there is no tax obligation in the second country, even if there is a filing obligation.

Often the most work involved in preparing US taxes for a US person who lives in Canada is the banking statements. These are mandatory and they are getting stickier about them every year. At present you must add up the maximum amount during the year in each account and if it comes over $10,000 you have to list all financial accounts that you have signing authority over, including your child’s boy scout troop, your garden club, your AA group etc. These all go onto two different forms. The reason for having to file what is essentially the same information on two different forms is that different groups within the IRS are interested in different aspects of these financial accounts. If this makes sense to you what are you smoking?

Because of all of these factors if you know that you have a cross-border filing requirement check into all of your financial accounts before you go to have your taxes prepared. If you don’t you will likely be sent home to get more data. This will usually result in an extra charge for the preparation because it is a lot more work to prepare a return if you have to do it in two separate sessions. It takes time to get into a return and remember everything that is in it. Even if there is no extra charge it will cause bad feelings all around.

A few years ago I prepared a form for a US citizen living in Canada who had left a large sum of money with an investment adviser in Washington state. He charged her hefty management fees as you might expect. I had to call him about something related to the account. It soon became clear to me that he had no understanding of the fact that because she was living in Canada and in fact had 10 rental properties in Canada that he should have been thinking about exchange rates. He had not even thought about them. The accounts that she had with him showed a moderate income in US dollars but a huge loss in Canadian dollars. IMHO he should have paid some attention to the way exchange rates move so that he would be able to maximize the gain in Canadian dollars but he seemed to be quite incapable of understanding the concept.

I am currently in Guadalajara, Mexico and expect to go to Vancouver, Canada, sometime in March. If you want me to prepare your taxes the easiest thing is to email them to me. If you do so and you have to file US taxes please make sure that you include all of the information about financial accounts.

FBARs

FBARs are forms prepared for the US Treasury Department showing information on foreign financial accounts for US citizens, US residents, and green card holders. If you are in one of these categories and adding the maximum value of each foreign financial account at the time that it is at a maximum comes to more than US$10000 you have to file FBAR accounts. These consist of form 8938, Statement of Specified Foreign Financial Accounts, and the FINCEN form. Form 8938 goes with the tax return itself, and the FINCEN form must be efiled to the Treasury Department. The FINCEN form replaces the older TD F90 form, which was mailed to the Treasury Department in Detroit. You may ask why it went to Detroit and the most likely explanation is that at the time this was set up Detroit had one of the highest unemployment rates in the US.

There is some delay and red tape involved in getting set up to handle FINCEN accounts. In theory one person in each office becomes the designated FINCEN administrator and efiles all of the forms prepared in that office. I sent off the required forms and it took something like a couple of weeks to get approval as an administrator. The literature clearly states that the forms must be submitted by June 30 of the following year, and that extensions of time to file a tax return do not apply to the FINCEN form. Naturally enough the first or second page of the form asks if the form is being submitted late and if so what is the reason for this late submission.

For taxpayers who have not filed returns for the last few years they ask for financial reporting to be done going back 5 or 6 years. It appears that the intention is that the taxpayer will file forms TD F 90 in Detroit for previous years and FINCEN forms for 2013 and following years.

Beginning July 1, 2014 foreign financial firms are required to file FATCA forms, giving the US Treasury Department details on accounts of all US citizens who have accounts there. Many firms responded by simply closing all of these accounts. This is a special problem in Canada, where estimates are that as many as a million US citizens are living. Except on the fourth of July they look very much like Canadians so this is a big problem for the financial institutions there. I have no idea how they can determine citizenship.

The time and effort required to fill in and submit these forms is often more than is required to prepare and submit tax forms.

Retirement Savings Accounts

There are many different tax-advantaged saving accounts in Canada and in the US. Unfortunately they are radically different in each country. In the US there are Keogh, IRA, traditional and Roth, 401k, and many others. In Canada there are RRSPs, TFSAs, and many others. In addition to these there are plans that are sponsored by employers. In most cases tax-advantaged savings accounts in one country are not recognized in the other.

Let me describe some of the problems related to RRSPs. Their full name is Registered Retirement Savings Plans. In 2005 the US came up with form 8891 to report these plans. For some reason that is not clear to me they required that these plans be reported to the IRS in US dollars. The RRSP records are kept in Canadian dollars. The conversion to US introduces a very large error in these reports, since the two currencies move up and down faster than the securities in the average account gain in value. For 2013 most RRSPs will show a large decrease in value when converted into US dollars, regardless of how well they do in Canadian dollars.

For some reason California believes that it has the right to charge state income tax on the RRSPs owned by California residents, including those caused by changes in the exchange rate. They may change their view when they see the large losses expected in 2013 returns.

Each of these retirement savings plans causes problems for people who live in the other country. When distributions are made before the stated maturity date this introduces another level of uncertainty. I can’t give you any general information about these, but can only go into details on particular cases.