Prime time to begin tax planning

For most people, the start of the last quarter of the year marks the beginning of the countdown to the holiday season. However, before thinking about vacations and merrymaking, taxpayers from all income brackets must first put some tax-planning strategies in place to reduce their liabilities for the year.

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While the deadline for getting things done is still a few months away, investors and tax payers need ample time to assess their current financial situation, re-evaluate their goals, and plan out what needs to be done to stay on track for the next year. They should also check for any changes in the rates and tax cuts that are applicable to them.

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Many taxpayers make the mistake of assuming that their liability from the previous years will apply to their latest tax bill. However, it is wrong to assume that the tax bill will be the same on a year with significant tax law changes. For instance, it is especially important for high income earners to take into consideration in their tax planning the tax cuts from the Bush-era which expired this year.

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With just a little over two months until the new year, taxpayers seeking to keep more of their money need act soon to ensure that their financial planning duties are properly dealt with so as not to interfere with their holiday celebrations.

Isidor Hefter is a certified public accountant and a senior partner at Rosen Seymour Shapss Martin & Company LLP. Find more tax planning advice on this Facebook page.

REPOST: Ways Professional Traders Can Save Big At Tax Time

Let this Forbes.com article help you learn the mistakes that traders and tax preparers make before planning and filing taxes, and how to avoid them.

Trader tax laws and benefits are complex and nuanced. Far too many traders and tax preparers don’t know the laws or misapply them on tax returns. Why pay tens of thousands of tax dollars more than you should?

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wise to do the same before planning and filing tax returns. To help with the latter, I’ve assembled a list of the most common mistakes made by traders and tax preparers.

Big picture items

1. Not claiming trader tax status, business expense treatment. (Or claiming this status when not entitled to it.) Business traders can save an average of $5,000 or more using business expense treatment. Business expenses are 100% deductible from gross income, whereas investment expenses are considered miscellaneous itemized deductions and are only deductible “below the line” in excess of 2% of adjusted gross income (AGI) and added back for the Alternative Minimum Tax (AMT), also known as the nasty second tax regime. Business expenses allow home-office deductions, education expenses, and startup costs, whereas investment expenses do not. Also, traders may claim trader tax status after the fact, including on amended tax return filings for the past three open tax years.

2. Not filing the Section 475 MTM ordinary loss election on securities and getting stuck with the puny $3,000 capital loss limitation, wash sale loss headaches, and extra tax costs. Many traders and accountants mishandle the Section 475 election statement (due by April 15 of the current tax year for existing individuals and partnerships) or they botch perfecting the election on a Form 3115 filing. One mix up can jeopardize ordinary gain or loss treatment. The biggest pitfall for traders is not deducting trading losses when they otherwise could. Section 475 does not apply to segregated investments or Section 1256 contracts when elected on securities only.

Unfortunately, you can’t fix a missed or botched Section 475 election; you need to focus on climbing out of the capital loss carryover hole you dug. You can form a new entity and use the “new taxpayer” exception allowing an internal Section 475 election within 75 days of inception.

3. Making the wrong decision about the forex Section 988 opt-out election and reporting forex incorrectly. Spot and forward forex receives Section 988 ordinary gain or loss treatment (which generally is better than a capital loss limitation). At any time during the tax year, traders are entitled to file an internal “contemporaneous” opt-out election to have capital gains treatment instead. That’s helpful if you have capital loss carryovers. If you trade in major forex currencies and don’t “take or make delivery” of the underlying currency, the opt-out election subjects forex forwards — and we make a case for spot forex too — to the lower Section 1256(g) 60/40 tax rates. That reduces the highest tax rates by 12%!

Forex reporting depends on whether you file the Section 988 opt-out election and whether you qualify for trader tax status. Section 988 without trader tax status is line 21 of Form 1040, and with that status its Form 4797 Part II. Section 988 losses over $50,000 require “tax shelter” Form 8886. Many IRS agents are confused over tax treatment for spot forex, plus forex brokers aren’t supposed to issue 1099-Bs for spot forex. Make sure to read brokers’ tax reports correctly. For example, rollover interest is part of trading gain or loss. If you opt-out of Section 988 and choose Section 1256(g), use mark-to-market at year-end on Form 6781. Thankfully, summary reporting applies on forex.

4. Business traders not forming a trading entity to unlock AGI deductions for retirement plans and health insurance premiums. These AGI deductions can save $2,000 to $17,000 or more in taxes, but sole proprietor retail traders can’t get them in connection with trading gains. By forming a simple pass-through entity like a partnership, LLC, or S-Corp, business traders can take advantage of these deductions.

Tax reporting errors and compliance headaches

5. Reporting trading gains and losses on Schedule C, almost guaranteeing an IRS notice or exam. Items must be reported in the correct place. While business expenses are reported on Schedule C, trading gains and losses are reported on other tax forms like 8949, 6781, and 4797.

6. Using our transfer-of-income strategy incorrectly, or not using it at all. The transfer is executed differently for sole proprietors vs. entities. You need this transfer to unlock the home-office deduction, Section 179 depreciation, and AGI deductions, and to reduce the IRS red flag factors on Schedule C and entities.

7. Using the wrong solution for securities trade accounting and calculating gains and losses incorrectly, especially wash sales. Many traders and preparers botch IRS cost-basis reporting on Form 8949 and the reconciliation with Form 1099-B. Some traders fail to report non-1099-B items like stock options on Form 8949. We recommend TradeLog software to handle this after downloading actual trades, rather than inputting 1099-B information.

8. Botching tax treatment between securities, Section 1256 contracts, forex, ETFs, options, precious metals, foreign futures, and more.

9. Misreporting Section 1256 contracts such as securities on Form 8949 rather than on Form 6781, thereby losing lower 60/40 treatment. Not all brokers report Section 1256 contracts correctly, especially instruments that aren’t clearly designated as such including some E-mini indexes and options on those indexes.

10. Misreporting ETFs and ETF options and not adding Schedule K-1 pass-through income to cost basis. ETFs and ETF options are generally taxed as securities, and commodity ETFs often pass through Section 1256 income or loss on a K-1. Options on commodity ETFs can be considered Section 1256 contracts. It’s a pain to deal with numerous ETF K-1s at tax time.

11. Not filing a 1099-Misc for fees paid to service providers, including you for administration. Sole proprietors or entities paying service providers $600 or more by check or cash must issue a Form 1099-Misc. It’s better to file a 1099-Misc. late subject to a penalty of $50 rather than encourage the IRS to catch you and assess much higher penalties.

12. Misreporting education expenses. Pre-business education expenses — including seminars, trade shows, and travel — are generally not allowed as investment expenses. Education is allowed as a business expense but only if incurred after qualifying for trader tax status. Try to squeeze a reasonable amount of pre-business education into Section 195 startup costs to expense once you achieve trader tax status. Don’t fall prey to those promising better results using dual entity schemes including a C-Corp.

13. Not filing a tax return due to negative income and trading losses. Expect a “jeopardy” (made up) tax assessment notice from the IRS. If you trade securities, the IRS doesn’t see the full picture, even with new cost-basis reporting. The IRS may think you made a lot of money and will hit you with a huge tax bill. Not filing can cause you to lose capital loss carryovers for previous years. With 1099s filed by brokers, there is no place to hide.

14. Mishandling tax notices and IRS exams. Generally, IRS and state agents don’t understand a trading business. It’s not a passive loss activity or hobby loss activity, and various items are reported in different areas with complex and nuanced tax treatment and elections. State tax rules for entities usually make exceptions for trading businesses, but that is not always apparent. Before a tax exam gets out of control, consult with a trader tax expert to get it on the right path.

15. Being non-compliant on FBAR and other foreign tax reporting such as Form 8938 (foreign financial assets). Congress and the IRS are very concerned about tax cheats using offshore bank accounts, structures, and schemes. Not filing foreign bank account reports (FBAR) on time or correctly can be costly: Back taxes, penalties, interest, and even criminal proceedings could be the result. Consider the IRS’s Offshore Voluntary Disclosure Initiative (OVDI). (Note that this program is NOT amnesty; in some cases, it’s a mistake to enter OVDI when there’s a better way to come clean.) Generally, opening offshore entities doesn’t help reduce taxes as they are treated as disregarded entities or they are subject to passive foreign investment company rules. Avoiding the Commodity Futures Trading Commission’s rules for retail forex trading by using offshore accounts or entities doesn’t work.

Entities and retirement plans

16. Forming the wrong type of entity, and in the wrong state. If you live, work, and trade in your home state and want to form a pass-through entity, it’s best to form it there. Don’t fall prey to promoters in Nevada harping on the benefits of corporations formed in Nevada. If you don’t register that Nevada entity in your home state, you won’t have asset protection in your home state. A Nevada LLC filing as a partnership passes through its income to your home state.

17. Tapping into IRA and other retirement funds incorrectly, causing IRS penalties and trouble. Don’t get busted by the IRS for misusing your retirement funds. See our recent blog “Learn the DOs and DON’Ts of using IRAs and other retirement plans in trading activities and alternative investments” for more on this topic.

18. Triggering wash sale losses in IRAs which are permanently lost. Far too many traders make this tragic mistake. When you buy back a “substantially identical” security position in any of your IRAs 30 days before or after selling it for a loss in any of your taxable accounts, you can kiss that tax loss goodbye forever. It applies across husband and wife individual and joint accounts. Normally, wash sales are only a deferral problem, but in this case it’s a permanent problem. Abstain from trading substantially identical positions in your IRA accounts or house your active trading in an entity, which is a different taxpayer for purposes of the wash sale rules. A Section 475 election also solves this problem.

19. Choosing the wrong type of retirement plan. The Individual 401(k) plan for business traders is best. It combines a 100% deductible 401(k) elective deferral — where the biggest tax savings lies — with a 20% deductible profit sharing plan. Don’t forget to open this plan before year-end, even with no money contributed.

20. Paying self-employment (SE) taxes on trading gains. Only full members of futures exchanges owe SE taxes on futures trading gains. Too many traders pay SE taxes on these gains and the IRS doesn’t challenge it. Watch out for the new Affordable Care Act’s 3.8% Medicare surtax on unearned income starting in 2013.

Bottom line

Common mistakes cost traders tens of thousands of dollars per year on their tax returns. Don’t be penny wise and pound foolish. Spend a few dollars to buy premium trader tax guides to learn how to avoid these mistakes. Consider engaging a trader tax expert to help with your tax return elections, planning, and preparation. Use the right trade accounting software for securities. Some mistakes you can fix on tax returns on extension or on amended tax return filings. Other mistakes can’t be fixed, and you should focus on tax strategies to dig out of that hole.

Carrying out year-end tax planning could be a gamble or even a waste of time. To avoid this, follow Isidor Hefter's Twitter page to help you deal with your tax agonies.

REPOST: IBM stands behind cloud-computing account amid SEC probe

Many companies believe that cloud-computing is the future, and IBM is no exception. This AccountingToday.com article reports that the company is standing behind its cloud-computing accounting methods despite the SEC probe.

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(Bloomberg) International Business Machines Corp., facing a Securities and Exchange Commission investigation into how it reports revenue from offsite cloud services, said it stands by its accounting methods.

IBM is cooperating with the SEC in the probe, which it learned about in May, it said today in a filing. The company books its revenue from cloud services, such as storing customers’ data and software applications remotely, under generally accepted accounting principles, said Ed Barbini, a spokesman for Armonk, New York-based IBM.

“IBM’s reporting of cloud revenue is the result of a rigorous and disciplined process, and we are confident that the information we have provided has been consistently accurate,” Barbini said.

Chief Executive Officer Ginni Rometty has identified cloud computing as one of IBM’s chief sources of growth amid a slowdown in demand for hardware and for consulting services. The investigation at the company, known for consistently meeting analysts’ earnings estimates, underscores confusion about how cloud revenue should be booked, said Michael Cusumano, a management professor at the Massachusetts Institute of Technology’s Sloan School of Management.

“This is a murky area where the rules aren’t really established,” Cusumano said. “Companies treat cloud-computing revenue in different ways.”

About half of publicly traded software companies since 1990 have had to restate revenue because of misclassification of sales and product returns, or because they categorized ongoing payments for tech-support services as a sale of a product license, Cusumano said.

‘Disciplined Process’
While IBM doesn’t disclose its revenue from cloud services, it said the sales rose 70 percent in the first half of 2013 from a year earlier. In its filing today, the company didn’t provide details on what information the SEC was seeking.

“IBM has robust systems and controls to identify and validate what products and services count as cloud revenue,” Barbini said. “IBM accounts for cloud transactions exactly the same way as it would account for those transactions if they were not cloud—in accordance with GAAP.”

Florence Harmon, an SEC spokeswoman, declined to comment.

IBM has beat analysts’ earnings expectations in 32 of the past 33 quarters, according to data compiled by Bloomberg. On the other hand, it has missed sales estimates in seven of the past eight quarters.

More Probes?
The investigation may be the first in a series of probes into companies in the same industry as the SEC tries to clear up confusion and differences in standards, said Jack Ciesielski, owner of investment firm R.G. Associates Inc. in Baltimore and the publisher of the Analyst’s Accounting Observer.

The company has a goal of reaching $7 billion in cloud revenue by 2015, with about $3 billion from new business and the rest from current contracts shifting over to the cloud category.

IBM’s 70 percent growth rate for cloud-computing services in the first six months of 2013 was a slowdown from 80 percent last year. IBM has also said cloud revenue, which is spread across several divisions, tripled in 2011 from 2010.

IBM shares fell 1 percent to $195.04 at the close in New York. The stock has gained 1.8 percent this year.

The disclosure of the probe comes days after IBM won court approval for a $10 million settlement with the SEC for accusations of bribery in China and South Korea. IBM said earlier this year it’s the subject of a U.S. Justice Department bribery investigation related to contracts in Poland, Argentina, Bangladesh and Ukraine.

Autonomy Writedown
Hewlett-Packard Co., IBM’s archrival in the computer-services business, took an $8.8 billion charge last year to write down the value of Autonomy, a software company it acquired, amid allegations of accounting improprieties within the unit. Autonomy, whose products organize corporate customers’ data, had used aggressive tactics to inflate its results, a former executive told Bloomberg News last year.

Earlier this month, IBM acquired SoftLayer Technologies Inc., a cloud-computing storage provider. IBM paid almost $2 billion for Dallas-based SoftLayer, according to a person familiar with the deal.

Market researcher IDC estimates the cloud-computing market may more than double to $105 billion by 2016 from last year. SoftLayer specializes in public clouds—data-center networks that manage computing and software for businesses remotely. IBM is pairing those capabilities with private-cloud operations, building dedicated systems for individual customers.


More news and tidbits about accounting and taxation can be found by following this Isidor Hefter Twitter page.

The social media leverage in the tax prep business

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Social media has revolutionized many facets of society, so much so that almost everything has come to be affected by this global phenomenon. But who would have thought that social media would also touch on the business of tax preparation?

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In fact, many tax prep firms have decided to use different social media platforms in marketing their services. Deciding that the best way to attract business is to go wherever the customers are, these firms have decided to jump in the bandwagon and went on to explore popular avenues, such as Facebook, Twitter, and LinkedIn.

And as more social media platforms arise, more tax preparers are taking advantage of every opportunity to make themselves positively known to the general public.

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A relatively new service which tax prep firms have been using lately is Yelp, a popular review site for consumers who want to learn more about local businesses. A recent Yelp search in Manhattan generated over 200 results of tax prep services reviewed by clients. For these services, their reputation lies on what their customers say—reviews which may range from acclaims to scathing denigrations.

 This is a clear breakaway from traditional marketing strategies. But because the population is slowly but surely migrating to cyberspace, all these efforts might all be worth it in the long run.  

To access more updates on tax preparation, log on to this Facebook page for Isidor Hefter.

Resolving differences: FASB and IASB should agree on credit loss standards

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Intending to encourage both the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) to settle their differences on the issue of credit loss standards for the purpose of converging financial instruments, 15 US banks have written a letter stating their wishes to the chairmen of the FASB and the IASB.

Last year, after initially agreeing on some proposed changes to the standards, the FASB and the IASB ended their meeting without coming to a compromise. Since then, both institutions have released divergent drafts regarding their proposed changes to the standards, especially to loan loss provisioning and expected credit losses for loan impairment.

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Recognizing that all the players and movers in the financial marketplace are going global, the banks, which include Capital One, JP Morgan Chase, and Bank of America, realized that there is a need for a common set of high-quality credit-impairment standards. Although they realize that reconciling different points of view of the two institutions may be difficult, they believe that coming to an agreement on what those standards should be is more important, as loan impairment is a big part of credit risk management.

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Isidor Hefter, CPA, specializes in tax planning and research for both corporations and individuals with high net worth. He is also adept at estate tax planning and providing representation for the Internal Revenue Service and other state and local government organizations. More information about his services can be found at this website.

Anatomizing the financial statement

Whether they are managing a small business or a big corporation, entrepreneurs will always have to deal with financial statements in their line of work. According to BusinessDictionary.com, a financial statement is “used to show a company’s performance over a certain period of time, generally every fiscal quarter.” It shows quarterly gains and losses, and reflects a company’s financial standing.

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Because of their importance, financial statements have become a part of any business venture, thus requiring entrepreneurs to be proficient in reading and interpreting these documents. Reading a financial statement may be daunting at first, but anatomizing it to its three essential components may help neophytes in conquering this challenge.

Components of a financial statement

1. Balance sheet. This contains the assets, liabilities, and net worth or shareholder equity of a corporation. Put in simpler terms, it represents what the company owns (e.g., bank accounts and real estate) and how much the company owes to others (e.g., loans and accounts payable).

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2. Cash flow statement. This is a report of cash inflow and outflow, and provides a clear picture of where all the company’s money goes. It is further subdivided into three parts: financing activities, operating activities and investment activities.

3. Income statement. This shows how much revenue the company was able to take in for a specified time period, alongside the amount used to come up with that revenue.

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Isidor Hefter has been affiliated with Rosen Seymour Shapss Martin & Company, LLP for more than 20 years and is currently a senior partner at the firm. More updates on the accounting industry may be found on this Facebook page.

REPOST: New IRS data: Rich got richer, but paid lower tax rate as stocks gained

The groundbreaking study from the Internal Revenue Service shows that the richest Americans pay lower taxes despite their high income. Find out the reason why in this Forbes.com article.

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The Internal Revenue Service today released a new report showing that in 2010, as the nation’s stock markets recovered, the richest Americans saw their share of all national income rise and their effective federal income tax rate fall.

In 2008 and 2009, the wealthy saw their share of national income decline and their tax rates rise, in large part because their more lightly taxed capital gains fell. But in 2010, the top 1% (the 1.35 million families with adjusted gross income above $369,691), reported 18.87% of all AGI, up from 17.21% in 2009. Meanwhile their average tax bill (as a percentage of AGI) fell to 23.39% in 2010, from 24.05% in 2009. The trends were even more favorable for the top 0.1% (the 135,000 households with income above $1.6 million), who captured the lion’s share of the 1%’s income gains, garnering 9.24% of all AGI, up from 7.94% in 2009. The tax rate paid by the top 0.1% fell to 22.84% in 2010 from 24.28% in 2009, meaning they paid a lower rate than their less rich fellow 1 per-centers. As a result, while the share of all income taxes paid by the top 0.1% also rose—to 17.88%, from 16.91% in 2010—it rose by less than the increase in their share of total national income.

The IRS report also shows that in 2010, 10,666 families reporting AGI of more than $10 million realized 5.5% of the nation’s taxable income, but a stunning 41% of all long term capital gains and corporate dividends taxed at the special low 15% rate; that 41% share equals $152.4 billion in such income, almost double the $77.9 billion in such long term gains and dividends reported by families with AGI above $10 million in 2009. The IRS hasn’t yet released its analysis of how the richest 400 fared in 2010, but it seems likely that their income share rose and their tax rate fell, since they’re even more dependent on lightly taxed capital gains. (In 2009, the richest 400 saw their income fall 25%, while their tax rate rose to 19.9%.)

Even more than a recovering economy, a surging stock market pads the reported incomes of the rich. After falling 38.5% in 2008, the S&P 500 rose 23.5% in 2009 and another 12.8% in 2010—meaning more investors finally had gains to realize. The S&P was flat in 2011 and up 13.4% in 2012, which was likely a huge year for capital gains realizations by the rich, as they took gains in advance of an expected increase in the tax rate for 2013. As part of the fiscal cliff tax deal, the capital gains rate was raised from 15% to 20% on taxable income above $400,000 for a single or $450,000 for a couple. In addition, as part of ObamaCare, a new 3.8% Medicare surtax applies to capital gains and investment income, to the extent a single filer has AGI above $200,000, or a couple has AGI above $250,000.

The IRS’ Statistics of Income division also published today preliminary estimates for 2011, which are less detailed by income level and don’t include tax returns filed after September 30th 2012, even though rich folks with the sort of extensive investments and partnership interests Mitt Romney has (a preliminary version of his 2011 return was 379 pages), often apply for extensions which allow them to delay filing until October 15th. Still, the IRS’ preliminary 2011 numbers—when compared directly with the IRS’ 2010 preliminary release—suggest the better off may have continued to increase their share of the national pie during 2011 too. While capital gains were down a tad, 23.4% of income in the 2011 preliminary numbers was reported by those with AGI above $250,000, up from 22.9% in 2010.

The 2011 preliminary report shows AGI on all tax returns (a total of 145.6 million were filed) increased by 3.1% to $8.3 trillion, with wages and pensions and annuities both rising 4% and corporate dividends rising 9%. But with the Federal Reserve keeping interest rates low, taxable interest fell 17%, a big hit to retirees who rely on interest from bank CDs or taxable bonds. Meanwhile, taxable distributions from IRAs rose 12%. The number of tax returns reporting taxable unemployment compensation declined 12%, while the amount of taxable unemployment benefits reported fell 23%.

Just 31.8% of the nation’s taxpayers claimed itemized deductions in 2011, down from the 32.6% of taxpayers who itemized in 2010. The falling share who itemize could be a factor as Congress considers whether to limit itemized tax deductions as part of a tax reform.

Know and understand your tax planning options by visiting this Isidor Hefter Facebook page.