May 25th, 2011 Amanda Han CPA (Taxloopholes.com Tax Strategist)
Mistake #1: Deducting Expenses in the Wrong Place
Heard of the phrase all men are created equal? Well, unfortunately, not all tax deductions are created equal. For example, did you know that your travel expenses can save you as much as 50% in taxes or save you ZERO taxes?
You may be surprised to hear this but there is actually a RIGHT way and a WRONG way to take your tax deductions. One of the most common mistakes we see is tax deductions being taken in the wrong place.
Take the example of a client Tony who is a pilot. Tony also has a business where he sells nutritional products. For all of Tony’s travel costs, his tax preparer took those deductions on his Schedule A as unreimbursed employee business expenses. Based on his income level and the limitations on Schedule A, he was unable to benefit from any of his $20,000 of travel costs. Had he correctly reported these travel costs to be part of his business expenses (ie: on his business tax return or Schedule C), he would have been able to increase his tax refund by close to $10,000.
Now you can see what we mean when we say not all tax deductions are created equal: Make sure you are taking your tax deductions on the right forms and schedules!
Mistake #2: Limited by Passive Loss Rules
Here is common situation that I see time and time again. Carol is a retired teacher and she operates a home-based health food business with her friend Joyce. Based on the advice of her advisor, Carol and Joyce correctly formed a partnership to jointly run the business. As with many businesses, 2010 was a not a good year and the business suffered losses of around $30,000.
After meeting with their tax preparer, Carol was shocked to learn that she still owed taxes to the IRS. We reviewed her tax return to find out that her CPA incorrectly prepared Carol’s individual tax return showing her to be a passive investor in the partnership rather than as an active business owner.
This error left $30,000 of tax write-offs on the table! Fortunately for Carol, it was easy for us to simply check a box in the tax return for her to claim that $30,000 tax write-off. So if you are a business owner or someone who receives a K-1 from any of your businesses or investments, make sure you speak to your tax preparer to ensure you are not erroneously being limited on your tax write-offs by the passive loss limitation rules.
Mistake #3: Real Estate Professional Status
If you are a real estate investor, you MUST read and understand this. The reason is because this is by far the biggest mistake that I see time and time again made by real estate investors and this is a mistake that cannot be undone.
What I am taking about is the real estate professional status. Lynne has been working with a CPA for many many years and was always told she has been benefiting from the tax deductions as a real estate professional. When I reviewed her tax return 2 months ago, I had to be the bearer of bad new and let her know that her CPA prepared her taxes wrong and she lost out on $20,000 of a tax refund. The worst part of this was that there was nothing I could do after the fact to get that money back for her.
So what exactly is the real estate professional status? Well, it actually has nothing to do with your education, professional licenses that you hold, or what type of business you are in. Rather, the IRS looks to what you do for real estate and how much time you spend in your real estate activities. The reason that you want to qualify for the real estate professional status is because without the real estate professional status, your ability to actually benefit from your real estate tax deductions may be limited.
As a real estate professional, however, you get to take advantage of an unlimited amount of real estate deductions each year on your tax return.
Contrary to popular belief, the real estate professional status is not taken by simply indicating that as your occupation on your tax return. It is not a specific form to fill out or even a particular box to check. Rather, it is an election that must be attached to your tax return at the time you file it.
If you invest in real estate, make sure you speak to your tax preparer to ensure that election is in place before you send off that tax return. The average tax savings between a real estate professional and someone who is not a real estate professional is anywhere between $15,000 to $35,000 each and every year!
Mistake #4: Missing Carryforward Tax Benefits
There are a lot of things on our tax returns that move with us from year to year and these are commonly referred to as “carryforwards”. For example, if you had certain types of tax deductions, losses, or tax credits that you were not able to use in the past for any reason, these generally get “carried forward” on your tax returns from one year to the next.
One of the most common mistakes we see is carryforward tax benefits being lost between the years. For example, a new client Brandon made some bad investments in 2008 and had close to $40,000 of a loss carryforward on his tax return. However, his over-worked CPA somehow “lost” that carryforward when he prepared Brandon’s 2009 tax return. It was a mistake that could have cost Brandon close to $18,000 of tax refunds over the next few years! A small but potentially costly mistake.
Mistake #5: Lack of Proactive Planning and Analysis
There is no doubt that the best way to minimize your tax liability is with proactive tax planning and analysis.
Proactive and frequent planning sessions with your tax advisor allows you to take advantage of opportunities that can significantly diminish your tax liability. Here is an example of an opportunity that I just went through with a new client. Sherri has 2 sons who are currently in college.
After a review of her previous year’s tax returns, I noticed her tax preparer did not claim an education tax credit of $2,500 each for her college sons. Sherri’s tax preparer told her that due to her high income level, she is not able to claim any education credits for her sons.
Now although this is a correct statement (there is an income limitation for claiming the education tax credits), there was a loophole that was overlooked. With some analysis, I determine an easy loophole: Sherri’s sons could have filed their own tax returns and they could have benefited from the $2,500 each on education tax credits! With a little strategy and analysis, Sherri and her sons were able to increase their overall tax refund by $5,000 per year just by taking advantage of the education credit!
As you can see, not all tax deductions are created equal and not all tax preparers are created equal. If you want to finally be confident this year and file your taxes knowing you have taken advantage of all the tax loopholes available to you, give us a call at (877) 975-0975 Ext. 7 and we would be happy to get you started!