Per the Internal Revenue Service, you should keep tax returns and supporting documentation for at least three years from the date you file the return; however, the statute of limitations for the Franchise Tax Board is generally four years from the date you file the return.  So, if you file your 2011 tax return on April 17, 2012, you should keep your records until at least April 17, 2016.    But, the IRS has up to 6 years to audit your return if your income is under-reported by 25%.  If you claim a loss from worthless securities or a bad debt deduction you should keep the records at least 7 years, and there is no statute of limitations if you don’t file a return or file a fraudulent return.  In general, most experts recommend that you keep financial and tax-related records at least 7 years as a conservative estimate.

Per Social Security Administration (SSA), “In light of the current budget situation, we have suspended issuing Social Security Statements.”  You may able to estimate your retirement benefit using the SSA’s Retirement Benefit Estimator.  However, as of the date of this article, it appears that you cannot get an earnings history on paper or online (although your earnings are in the system).  There are plans to resume sending statements in the future, but only to people 60 and older.  Therefore, it appears you should permanently keep your W-2s and tax returns that support your social security earnings.   

You should keep documentation related to property, such as closing statements and support for major improvements, at least four years subsequent to the year in which you dispose of the property and recognize a gain or loss.   Also documentation that may relate to income or a deduction for future tax years, such as installment sales, depreciation and amortization records, and various loss carryforwards, you’ll want to keep at least 7 years after they have been fully utilized or expired.

For further information, refer to IRS Publication 552 or the Franchise Tax Board “Keeping Records” webpage. You don’t need to keep paper copies; the IRS allows electronic documentation, so you can scan (our personal favorite: Fujitsu ScanSnap Scanners) your documentation and save to an accessible CD, flash drive, or on a secure, cloud-based document management system, such as ShareFile or Dropbox.

There are other business-related documents, although not all specifically related to a tax return, that you should keep permanently for your business for legal or insurance purposes.  This suggested permanent file list is not all-inclusive.  You may want to consult with your attorney or insurance agent for documentation specific to your business.

Although these recommended document retention timelines may be longer than you expected, you’ll want to easily and readily be able to substantiate any tax or financial-related issues in an audit, legal or insurance matter, so it’s worth the effort to organize and maintain these files.  If you have any questions about specific documentation, please contact us.

REFERENCES:

Internal Revenue Service:http://www.irs.gov/businesses/small/article/0,,id=98513,00.html

Page Last Reviewed or Updated: September 01, 2011

California Franchise Tax Board: https://www.ftb.ca.gov/businesses/keeping_records.shtml

Keeping Records

What kind of records should I keep?

In the operation of your business, you will come across many types of records related to your income and expense transactions. While it is impossible to list all the records for every possible transaction, following are some examples of records to maintain:

• For gains and losses reported on Schedule D such as sale of real estate or securities, you will need documents to verify the sales price, the cost of the asset you sold plus improvements if any, e.g. sales and purchase agreements, escrow papers, copies of checks, brokerage statements, etc.
• For general expenses, you must be able to document the type of expense, the date and amount of payment, copies of cancelled checks, and that it was incurred in the operation of your trade or business.
• For revenue/income items, you should keep copies of 1099′s, sales invoices, sales agreements or contracts, etc.

There are two methods of filing tax returns: paper and electronic. Both require similar recordkeeping.

• Summary of your business transactions.
• Books and records that support your income, deductions, and credits. This might include journals and ledgers, as well as cash register records, sales records, bank statements, W-2′s, 1099′s, invoices, cancelled checks, sales agreements, etc.
• For more information regarding e-file, please see Individual e-file Frequently Asked Questions and Business e-file for Tax Professionals.

How long should I keep records?

The Franchise Tax Board (FTB) may request information regarding your California income tax return within the California statute of limitations period, which is usually the later of four years from the due date of the return or the date the return is filed. (Exception: an extended statute of limitations period may apply for California or federal tax returns that are related to or subject to a federal audit.)

Keep a copy of your return and the records that verify the income, deductions, adjustments, or credits reported on your return. Some records should be kept longer. For example, keep property records as long as they are needed to figure the basis of the property. In transactions relating to Abusive Tax Avoidance Transactions:

• For notices issued prior to August 1, 2011: FTB has 8 years after a taxpayer files a return to mail a proposed deficiency assessment. Therefore, tax documentation should be kept for at least 8 years.
• For notices issued beginning August 1, 2011: FTB has 12 years after a taxpayer files a return to mail a proposed deficiency assessment. Therefore, tax documentation should be kept for at least 12 years.

Why should I keep records?

Good records will help you do the following:

• Determine whether you are making or losing money and why.
• Prepare your financial statements.
• Identify and categorize sources of revenue.
• Keep track of deductible expenses.
• Prepare your tax returns.
• Document your expenses and transactions in case of an audit.

What is the “Burden of Proof” if I ever need to provide proof of income and deductions claimed on my tax return?

The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove (substantiate) certain elements of expenses to deduct them. Generally, taxpayers meet their burden of proof by having the information and receipts (where needed) for the expenses. You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You generally must have documentary evidence, such as receipts, cancelled checks, or bills, to support your expenses. Additional evidence is required for travel, entertainment, gifts, and auto expenses.

How should I record my business transactions?

Business transactions are ordinarily summarized in journals and ledgers; many of them are in computer software format.

A journal is where you record each business transaction. You may have to keep separate journals for transactions that occur frequently, such as a sales journal, a payroll journal or a check disbursement journal.

A ledger is where you record the totals from all of your journals. It is organized into different accounts.

Whether you keep journals and ledgers depends on the type of business. For example, a recordkeeping system for a small business might include the following items:

• Business checkbook
• Daily summary of cash receipts
• Monthly summary of cash receipts
• Cash & Check disbursements journal
• Depreciation worksheet
• Employee compensation records

FICA limits:  To plan your take-home pay, please note that the employee’s FICA percentage remains at 4.2% for the first two months of 2012.  After that, stay tuned….  In addition, the salary threshold for 2012 has risen to $110,100.  The Medicare rate remains at 1.45%, and there is no salary limit.

CA SDI limits:  The rate on your California SDI withholding has decreased from 1.2% to 1.0% in 2012; however, the salary limit has increased to $95,585.

Check your withholding:  Did you have too much or too little withheld from your paycheck last year?  Now’s the time to make the change.  Figure out how much you should have withheld for the year and change your allowances accordingly.  If you need help figuring your appropriate withholding, go to the IRS Withholding Calculator.  Next, complete a new Form W-4 and give to your employer’s payroll department. 

Maximize your 401(k) contribution:  The maximum you can contribute in 2012 has risen to $17,000 per year ($22,500 if you are over 50).  Remember, the only time you can contribute to your 2012 401(k) plan is in 2012.  Also, this is one of the few tax benefits that doesn’t get phased out due to adjusted gross income limits.  If your employer matches any of your contribution, even better—this is free money!

Health Savings Account (HSA) limits:  If you have an HSA plan at work, the 2012 HSA contribution limits have increased to $3,100 for individuals, and $6,250 for families.  If you are over 55, you can contribute an additional $1000. Even if you don’t think you’ll use all of this contribution in 2012, it carries over indefinitely, and can be withdrawn tax-free for qualified medical expenses. You can take distributions for non-medical purposes without penalty starting at age 65, although they would still be subject to ordinary taxation.  So, it’s almost like another type of retirement savings vehicle.

Flexible Spending Account (FSA) limit:  There is no specific limit on this contribution, as it is currently determined by your employer, and is affected by other benefits such as participation in an HSA and dependent care benefits.  It is slated to be capped at a $2,500 maximum per employee in 2013.  Remember, this is a “use-it-or-lose-it” benefit, so whatever you contribute in 2012, must be used for qualified medical expenses in 2012, and over-the-counter medicines are not eligible unless specifically prescribed by a doctor.

If you will have your 2011 tax return prepared by us or another tax professional, include a copy of your 2012 YTD paystub when send in your 2011 tax return preparation documents.   Ask for recommendations on changes to your 2012 tax withholding and other contributions.  Or, if you want to know how the above suggestions might affect you, please contact us. 

• If you have women’s business suits and other professional attire, there is Dress for Success, a nonprofit organization that provides professional attire to low-income women for job interviews.
• Do you or your daughter have prom or other formal dresses hanging in the closet?  Find a local drop off at DonateMyDress.org.
• Who doesn’t have some old glasses lying around?  Give the Gift of Sight would love to have them!  Drop off old glasses at many eyeglass outlets or the Lions Club, who will clean and repair the glasses for donation to those in need.
• If you have recently built or remodeled your home, and have leftover building materials, take them to the local Habitat for Humanity ReStore.
• Donate your old kid’s DVDs to a local children’s hospital.
• So you just upgraded to the latest iPhone or Droid—give your old cellphone to Cell Phones for Soldiers and support our military!
• An old car or other vehicle can be donated to various local charities, such as St. Vincent de Paul Village or other charitable organizations.  Remember, you can only deduct the amount for which the vehicle is ultimately sold, which will be reported to you on Form 1098-C.
• Books and magazines can be dropped off at many libraries, such as the Carlsbad City Library.
• Old computer equipment can be donated to the National Cristina Foundation.
• If you’re planning a trip to a foreign destination, consider taking supplies for charities at your destination.  For more information go to Pack for a Purpose.

 Once you made a donation, make sure that you get a receipt.  However, it is up to you to determine the fair value of the items that you donated.  A good place to assist you in determining this value is at the TurboTax® ItsDeductiblewebsite.   Also miles driven on behalf of a charitable cause can be deducted at $0.14 per mile, but be sure to log the exact miles and qualified charitable cause.  Following is a chart of how to document and substantiate various noncash charitable contributions:

 Hopefully these ideas will inspire you to clean out and donate your unused stuff.  Remember to document your donation, and enjoy your additional closet space!

A:  A Roth IRA is an individual retirement account (IRA) in which contributions of up to $5000 ($6000 if you’re 50 or better) are NOT deductible as they are with a traditional IRA.  However, earnings can be withdrawn tax-free if you’re at least 59 ½ and had the Roth at least five years.  Also, you don’t have to take required minimum distributions (RMDs) at age 70 ½, as you do with a traditional IRA or 401(k) plan.  In addition, your Roth IRA will not be subject to income tax to your heirs.

Q:  All earnings are tax-free?  Why wouldn’t everyone do a Roth IRA?

A:  Well, if your modified adjusted gross income is between $107,000 and $122,000 if you’re single, or between $169,000 and $179,000 if you’re married, you won’t be able to contribute the full amount.  In addition, you need to make sure it makes sense for you:  If you have many years to go before you’ll need to withdraw the money and you expect your tax bracket to be the same or higher, then the Roth IRA makes sense.  If you think your tax bracket will be lower in retirement, stick with the traditional IRA.

Q:   I want to do it—how do I go about it?

A:  Open a Roth IRA with your financial institution and fund the contribution no later than April 16, 2012.  Even if you extend your return to October 15, you still have to make a Roth contribution by April 16!   

Q:  I had a good year—guess I’m out of luck on the income threshholds.

A:  You could do a Roth conversion (rather than contribution). There’s no income limit on the conversion for this year and beyond.   With a Roth conversion you are converting a traditional IRA to a Roth IRA.  This will result in taxable income in the year of conversion, but future earnings will be tax-free.  There are many things to consider in determining whether a Roth conversion makes sense for you, such as what tax bracket you’re in now vs. retirement, ability to pay the additional tax on conversion, years until you retire, etc.  Since conversions must occur by 12/31, if upon completing your tax return you realize that the Roth conversion doesn’t make sense for you after all, you can convert it back (“recharacterize”) to a traditional IRA by the due date of your return, including extensions.

Q: I had a terrible year—I don’t have the spare cash to make a Roth contribution.

A:  You too should consider a Roth conversion.  If during this difficult economy, your 2011 income has decreased more than usual, it might make sense for you to convert, in order to take advantage of some of the deductions you still have and/or to take advantage of the lower tax bracket you are currently in.  Roth conversions for 2011 MUST be done by 12/31/11, so contact us to see if a Roth conversion might make sense for you.

Consider Roth conversion:   If you have a traditional IRAs, consider a Roth conversion.  Remember, Roth conversions result in taxable income, so there are many things to consider in determining whether a Roth conversion makes sense for you, such as what tax bracket you’re in now vs. retirement, ability to pay the additional tax on conversion, years until you retire, etc.  But if during this difficult economy, your 2011 income has decreased more than usual, it might make sense for you to convert.  Roth conversions MUST be done by 12/31/11.

Maximize your 401(k) contributions:  By maximizing this retirement contribution you reduce your taxes, as well as reducing AGI which may qualify for more deductions and credits that are subject to AGI phase-out.  The maximum contribution for 2011 is $16,500 plus an additional $5,500 if you are 50 or better.  The only time you can contribute to your 2011 401(k) is in 2011!

Make charitable contributions:  Support causes that you believe in.  Clean out your closet and donate to charity.  Make sure you have the documentation, such as a receipt from the charity to support all contributions, even those under $250.

Estimate taxes due for 2011:  If you think you will owe, adjust withholding accordingly, in order to avoid underpayment penalties.  Also, if you pay any state taxes due you may get a Federal deduction.  Also consider prepaying your April property tax installment.  But beware that you are not subject to Alternative Minimum Tax (AMT).

Prepay college tuition:  Think about prepaying college tuition for first term of 2012 in order to qualify for the full $4,000 subject to the American Opportunity Credit.  If your AGI is under $180,000 ($90,000 if single), you may qualify for the credit of up to $2,500.  If you don’t qualify for the credit you may be eligible for the tuition deduction which is scheduled to expire after 2011.

Spend your FSA:  If you still expect to have funds in your Flexible Spending Account (FSA), make arrangements to have doctor checkups, elective procedures, etc. by December 31, so that you can use your FSA funds.  FSA funds for each year are “use it or lose it!”

Install energy-efficient insulation, doors, and/or windows:  If these meet certain energy-efficient qualifications you may be able to claim the nonbusiness energy property credit of up to $500.  This credit is currently scheduled to expire after 2011.

If you want to know how the above suggestions might affect you, please contact us.

A:  Alternative Minimum Tax (AMT) is an alternative tax system started in 1969 due to a few high-income taxpayers who were paying hardly any tax due to various tax deductions and other loopholes.  But because it was never indexed for inflation, even middle-class taxpayers have been subject to AMT.  This tax system disallows certain deductions, the most common of which are property and state tax, has its own exemption, and then applies a tax rate starting at 26%. Your regular tax is then compared to the AMT, and whichever is higher is what you’ll pay. 

Q:  How do I know if I have to pay it?

A:  You may be subject to AMT if you have adjusted gross income of $75,000 or more.  It will also depend on the amounts of your various disallowed deductions and other add-backs, known as adjustments and preference items.  This is all reported and calculated on Form 6251, when you prepare your tax return.   The AMT is a complicated calculation, and the IRS has an AMT calculator to help you estimate whether you’ll have AMT or not. 

Q:  What is the AMT patch that I read about?

A:  Because AMT is not indexed for inflation, every year more and more taxpayers are subject to AMT.  To counteract this, for the past few years, Congress has included in various tax acts, a “patch” which increases the AMT exemption amount for that particular year.  Thus,  more taxpayers will escape some or all of AMT.  The 2010 and 2011 patches were done concurrently; however, Congress has not yet passed a 2012 patch. 

Q:  Is there any way to avoid it?

A:  If you have large differences in either income or the disallowed deductions between years, if you have the flexibility to either pay property or state taxes in one year vs. the other you may be able to reduce or eliminate AMT for a particular year.  Tax planning may help in making this determination. 

Also, be alert to the timing of exercising incentive stock options, as the difference between the exercise price and the fair market value of the stock on the day of the exercise is an add-back for AMT purposes. Basically, you are going to be subject to AMT on the phantom profit on the day of exercise. 

Although it is often recommended that you pay property and state taxes early in order to get the additional deduction, if you are in AMT there is no benefit to doing this, so you might as well hold on to your money for the extra time.

If you have additional questions on how an AMT might affect your personal tax situation, please contact us.

Q:  What is an HSA, and why should I have one?

A:  An HSA is a Health Savings Account.  The premiums under HSA-compatible policies are significantly lower than traditional policies, since they have high deductibles.  The idea is that one funds the HSA plan, resulting in a Federal tax deduction (sorry-California has not complied with this), and then uses HSA funds to pay any qualified medical costs subject to the deductible.  If HSA funds are withdrawn (distributed) for qualified medical costs they are tax-free. (If they are not for qualified medical expenses, they are subject to tax, as well as a 20% penalty.) 

Q:  How does it work?

A:  In order to take advantage of this, you need to

1. First implement a high-deductible, HSA-compatible health insurance policy.  It’s not enough that it is considered high deductible—it must be HSA compatible.  Confirm with your insurance agent that the policy is HSA compatible before you enroll.   This needs to occur by December 31 of the current year.
2. After you are covered by the insurance policy, you should open a health savings account (HSA) with a financial institution.   This is still a relatively new type of account, so not all financial institutions offer it.  Although there are many lesser known institutions that specialize in HSAs, a more recognized institution that has experience with HSAs is Wells Fargo Bank.  Another OptumHeathBank, is focused on financial solutions for health care and provides investment options with leading mutual funds.  For 2011, you can contribute up to $3,050 and $6,150 for single and family policies, respectively, and an additional $1,000 if you are over 55.  Contributions must be made by April 15 of the following year. 

Q:  How do I report this on my tax return?

A:  Contributions and distributions are reported on Form 8889, Health Savings Accounts (HSAs).  The contribution then flows to Form 1040, line 25, as a reduction in adjusted gross income. 

Q: Sounds kind of complicated.  Is it really worth it?

A:  The significantly lower health insurance premiums alone are a major advantage.  If you have chronic or significant health issues, the annual HSA contributions will normally cover most annual deductibles.  Further, because the HSA contributions are fully deductible, but medical expenses are only deductible to the extent that they exceed 7.5% of your adjusted gross income (AGI), (increasing to 10% in 2013), if you even itemize deductions to begin with.  So you can essentially convert a nondeductible medical expense into a deductible expense.     If you are relatively healthy, the advantages are even greater—the contributions can continue to grow in the account (there’s no “use it or lose it”).  Further,  you can take distributions for non-medical purposes without penalty at age 65, although they would still be subject to ordinary taxation.  So, it’s almost like another type of retirement savings vehicle.

If you have additional questions on how an HSA might affect your personal tax situation, please contact us.

For 2011, probably the most dreaded and misunderstood of all the implementations, was the requirement for employers to disclose on the employee’s Form W-2 (2011 to be issued by 1/31/2012), the value of the employee’s health insurance coverage sponsored by the employer.  However, for 2011 this is optional for ALL employers, but in 2012 this is required for businesses that produce 250 or more W2′s.  The delay was due to allowing businesses time to prepare their payroll systems in order to comply with the regulations.   

Related to this rule, there have been numerous emails and other such “urban legends” circulating that claim that employer health coverage will be taxable—it is not true.  Although it will be reported on Form W-2, in Box 12, with the code “DD,”  the draft 2011 Form W-2 instructions specifically state,  “The reporting in Box 12, using Code DD, of the cost employer-sponsored health coverage is for information only. The amount reported with Code DD is not taxable.”   The reporting is a way for employees to see the total value of their health coverage, as well as prepare for government reporting of employee health insurance coverage that will be required of all individuals in 2014 under current provisions of the Act.

Other 2011 tax implications of the Act:

• Excludes the costs for over-the counter drugs not prescribed by a doctor from being reimbursed through a Health Reimbursement Account, Flexible Spending Account or Health Savings Account (HSA). 
• Increases the penalty on distributions from a HSA that are not used for qualified medical expenses from 10% to 20% of the amount used. 

Another reporting nightmare that was to have occurred in 2012, was the 1099 reporting of all payments aggregating $600 or more for services or property to all entities, including corporations.  Fortunately, these increased reporting requirements were rescinded in early 2011; however, businesses will still have to report payments of $600 or more for services to all noncorporate entities, which is unchanged. 

Please contact us if you have any questions regarding how the new tax provisions of the health care form bill affect you.

Q: Why is the tax treatment for these precious metal ETFs different than other securities?

A: The IRS considers gold a “collectible” and taxes your capital gains at a 28%, rather than 15% rate. This designation includes all forms of gold (other than jewelry).

Q: But my financial institution’s Realized Gain/Loss report at yearend already segregates the investments between short and long-term.  Are you saying that those long-term gains are still subject to 28%?

A: Yep.

Q: How do I know which other investments are subject to the 28% tax?

A: As a general guide,  

• All denominations of gold bullion coins and numismatic/rare coins, gold bars, and gold wafers
• ETFs like the aforementioned GLD, iShares Silver, (SLV), iShares Comex Gold Trust (IAU)
• Any electronic form of gold like GoldMoney and Bullion Vault
• Any “paper” or certificate forms of gold, such as Perth Mint Certificates and EverBank accounts

Generally, the ETF’s prospectus will discuss the tax treatment.  To paraphrase the SPDR Gold Shares (GLD) prospectus, GLD is structured as a grantor trust, not a mutual fund.  A grantor trust is ignored for tax purposes so that the investor is treated as owning a pro-rata share of the underlying holdings, not the entity. Therefore, the long-term gain will be taxed at a maximum rate of 28%.  So, this is a classic example of caveat emptor – “buyer beware.”

Q: You didn’t mention PowerShares DB Gold or Silver Funds.  Do they work the same way?

A: The PowerShares DB Gold Fund (DGL) and PowerShares DB Silver Fund are examples of funds the objective of which is to reflect the performance of the underlying precious metal using futures, rather than just owning the gold or silver bullion. But ETFs that use futures to achieve their results, whether they track gold, silver, corn, copper or currencies, come with their own tax headaches.

Unlike the precious metal ETFs, which are organized as grantor trust, these ETFs are structured as limited partnerships, most commonly known to the public as Master Limited Partnerships (MLPs).  Thus, the investor will receive a K-1 at the end of the year, which will have the various tax treatments of the partnership’s underlying investment portfolio detailed in the K-1, rather than on a 1099.

Q: Is there anything I can do to avoid this higher tax rate?

A: If you currently hold these types of precious-metal ETFs and want to sell you may want to consider the tax effects of any capital loss carryforwards or selling other losing securities in your portfolio to offset the gains from these precious-metal ETFs.  Another way to defer and possibly reduce the taxes is to hold precious metals ETFs in a tax-deductible IRA or a Roth IRA, where the ultimate taxation will be at either ordinary rates, or not at all, respectively.

Although you should always consider the tax treatment of these different investments, don’t let the tax tail wag the investment dog.  For more information on how these investments might affect your personal tax situation, please contact us.