You vs. the IRS: 5 Common Reasons for Tax Litigation

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Most tax disputes with the IRS are settled during audits, collection proceedings and appeals — long before the need for litigation.

But sometimes, disagreements with the IRS land taxpayers in federal court. A tax litigation case can result from any form of taxation, from income to local property taxes. And these legal proceedings don’t just impact individual taxpayers, but businesses and estates, as well.

Litigation may result in penalties, fees, jail time or (best-case scenario) dismissal for the accused party. But what triggers litigation in the first place?

Here are 5 common reasons for tax litigation:

  1. Accuracy-related penalties. According to the IRS, this type of penalty applies when underpayment is shown on a return. For example, a deduction or credits may be claimed when the party doesn’t qualify, or total income is not reported. Challenging an accuracy penalty usually starts with an IRS auditor before seeking the last resort — heading to court.
  2. Summons enforcement. These disputes arise when a taxpayer doesn’t comply with an IRS request for information, usually stemming from an audit or investigation. A summons is issued, forcing the taxpayer to procure the necessary paperwork.
  3. Trade or business expense From home office costs to interest deductions, these cases are usually identified during an IRS audit. In most instances, the taxpayer doesn’t have documentation to substantiate an expense, but they can attempt to rectify the penalty by presenting their case to the IRS.
  4. Failure to file/pay penalties. These issues are typically the result of a taxpayer not submitting sufficient information or properly maintaining tax records, rather than willful neglect to file and pay. A taxpayer can wipe the slate clean by demonstrating that the error is due to reasonable cause.
  5. Frivolous issues. The IRS constitutes a frivolous argument as any in which a taxpayer makes a nonsensical dispute about the validity of the tax code. For example, they may challenge a collection issue by citing that the tax code is illegal. The best way for taxpayers to avoid these cases? Stick to the facts.

Evading the courthouse

If you’re involved in a tax dispute, we recommend speaking with a knowledgeable tax professional to guide you through IRS procedures and come to a resolution — outside of court. But sometimes, it’s necessary for the case to be further litigated.

If you have questions on any tax-related issues, don’t hesitate to contact the experts at Magone & Company

The Different Types of Investment Income

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Investing wisely can be a great way to grow your wealth over time. However, much like any money-making venture, there are tax implications to consider.

The IRS taxes each investment income differently, and the tax rate depends on various factors, from your income level to the length of time you’ve held the investment. So before you dive into a new opportunity, find out how taxes work in relation to the income you’ll (hopefully) generate.

Interest income. Interest income is the money you earn from savings accounts, CDs and bonds. This type of investment income is generally taxed at your ordinary income tax rate. (The interest income you earn from municipal bonds is an exception and is typically tax-free.)

It’s important to note that you’ll receive a 1099-INT from your financial institution, reporting the interest income earned during the year. This income must be reported on your tax return and will be taxed accordingly.

Dividend income. Dividend income is the money you earn from owning stocks that pay dividends. It’s taxed at a different rate than interest income.

Qualified dividends — dividends paid by domestic corporations and certain foreign corporations — are taxed at the long-term capital gains tax rate, which is generally lower than the ordinary income tax rate and depends on your income level. Nonqualified dividends, which include dividends paid by real estate investment trusts (REITs) and some foreign corporations, are taxed at your ordinary income tax rate.

Capital gains. Capital gains are the profits earned from selling an asset for a higher price than you paid. The amount you’re taxed depends on whether they’re short-term or long-term gains. Short-term capital gains — gains on assets held for one year or less — are taxed at your ordinary income tax rate.

Long-term capital gains — gains on assets held for more than one year — are taxed at a lower rate than short-term gains, dependent on your income level. If your income is below a certain threshold, you may not have to pay any taxes on long-term capital gains.

Required minimum distributions (RMD). RMDs are the minimum amount you must withdraw from your retirement accounts each year. It’s important to factor in the tax implications of RMDs when planning for retirement.

If you have a traditional IRA or a 401(k), you will be required to take RMDs once you reach age 72. When you withdraw the funds, you’ll be taxed at your ordinary income tax rate.

Estate taxes. If you leave a large estate to your heirs, they may be subject to federal and possibly state estate taxes <Link to new blog post, CPA vs. Estate Attorney> The federal estate tax rate ranges from 18-40% and generally applies to estates valued at more than $12.92 million. However, this threshold is subject to change, so it’s essential to stay informed about any updates to the tax code.

Foreign investment income. If you earn investment income from foreign sources, you may be responsible for additional taxes and reporting requirements. The IRS requires taxpayers to report foreign investment income on their tax returns and may impose penalties for failure to disclose this income.

If you have foreign investments, it’s essential to consult with an experienced international tax professional to ensure compliance with all applicable tax laws.

Finding the tax planning approach that’s best for you

There are various strategies to legally reduce your tax liability on investment income, such as tax lost harvesting. This approach involves selling losing investments to offset gains in other investments to reduce your taxable income.

If your losses exceed your gains, you can offset up to $3,000 of your ordinary income each year. Any remaining losses can be carried forward to future years.

The above general information is provided for education only and should not be considered tax or legal advice.  There’s never a one-size-fits-all approach to treating investment income, so understanding how it’s taxed can help you make more informed decisions on minimizing your tax liability.

The knowledgeable CPAs at Magone & Co can answer your questions and help you make the most tax-efficient decisions. Give us a call today at (973) 301-2300.

Saving for College 101

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Saving for college could be an investment that pays for itself. But for many families, it can also be a huge strain on your budget.

If you’re looking into ways to help fund your child’s educational future, read on for our handy guide.

Building a college savings

There’s no single “best” way to manage higher education costs. It all comes down to your family, your goals and your finances.

529 plan. A 529 plan allows money to grow in a tax-deferred account. It can be withdrawn tax-free for qualified, education-related expenses at colleges, vocational programs and apprenticeships. The funds from a 529 plan may even be applied toward up to $10,000 in student loan debt.

Education Savings Account (ESA) or Education IRA. An ESA allows investments of up to $2,000 (after tax) per child, per year for tax-free growth. The rate at which it grows varies based on the investments you choose, but it generally offers a higher rate of return compared to a regular savings account.

Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA). While savers can use a UTMA and a UGMA to put away money for college with reduced taxes, they can also be used for non-educational costs. Similar to mutual funds, they give parents control of the funds until the child reaches age 18 or 21 (varies by state), at which point they may choose how to allocate the funds.

Remember, the sooner a plan is opened, the more time investments will have to grow.

Tax savings for current students

Once your child is enrolled in higher education, he or she may also want to take advantage of these tax-savings opportunities. Remember, it’s always best to speak with a tax professional regarding your family’s personal situation.

  • American Opportunity Credit. For qualifying students, this credit pays for up to the first $2,000 spent on tuition, fees, books and more. Plus, it’s applicable for all four years of undergraduate studies.
  • Lifetime Learning Credit. The Lifetime Learning Credit gives students a tax credit equal to 20% of their tuition and related expenses up to $10,000. The credit maximum is $2,000.
  • Tuition and fees deduction. Independent students may qualify for a tax deduction of as much as $4,000.

A plan to save

Let’s face it. Higher education costs are just that — high. The average student attending an in-state, public four-year institution spends about $25,707 in a single academic year. The average student attending a private, nonprofit university spends a whopping $54,501 per academic year. While there are student loans, scholarships and financial aid opportunities, any amount saved will help chip away at the steep costs.

Just like retirement and tax planning, figuring out how to pay for college is an important discussion to have with your trusted financial advisor. Need assistance? Count on Magone & Company as a knowledgeable financial resource. Reach out today at (973) 301-2300.

Estate Planning: CPA or Attorney? How About Both?

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If you’re thinking about the future, specifically how to build long-term financial stability for your family, estate planning gives you control of how your assets are dispersed when you’re gone.

As the saying goes, you can’t take anything with you, so making a plan in advance is a vital step in ensuring that your wishes are carried out, no matter how much your assets are worth. Protecting your legacy is one of the most thoughtful things you can do for your loved ones.

Many certified public accountants (CPAs) and attorneys offer estate planning services. But choosing one (or both) comes down to your needs and goals:

CPAs. With a wealth of tax law knowledge, a CPA can offer financial expertise, especially in the areas of estate laws and gift tax laws. They can also advise on how each estate planning tool will impact taxes and fees and can strategize to help families and individuals minimize their tax liabilities. (For example, it may be possible to eliminate estate tax by simply leaving all property to a charity.)

And because a CPA also prepares their clients’ tax returns, they’re aware of personal tax information that can require changes to estate plans and can watch for administrative estate planning issues.

Estate planning attorneys. Like a CPA, attorneys can lend their vast knowledge on wills, trusts and business succession matters, while addressing other legal implications of an estate plan. They specialize in more precise areas of concentration, such as evaluating estate planning options to benefit future generations, drafting a last will and testament, appointing guardians for minors, granting living relatives a power of attorney and preparing a living will to outline end of life decisions.

Working in tandem

When considering estate planning goals, clients may leverage the insight and experience of both professionals. A CPA who works with an attorney on their clients’ behalf can save them time, money and headaches — maximizing tax breaks while efficiently managing the distribution of their assets.

And when sharing a client, a lawyer and CPA are in regular contact, communicating any changes in their planning, adding value in their areas of specialty and improving outcomes for the client and their loved ones.

Collaboration is key

At Magone & Company, we believe that open, ongoing dialogue is critical for building wealth now — and planning what to do with it in the future. We have the tools and knowledge to help create lifelong financial stability and success for your family. Contact us for a complimentary assessment at (973) 301-2300.

 

Why Your Business Should Prep for an Employment Tax Audit — Now

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In August 2022, the Inflation Reduction Act was signed into law with a provision earmarking nearly $80 billion in funding to support the IRS enforcement of federal tax laws, notably, employment tax.

The IRS typically performs employment tax audits to ensure that a business is compliant with tax filing requirements and to verify the reported amounts.  With more IRS “boots on the ground,” you may want to prepare for a potential employment tax audit sooner rather than later.

Zeroing in on employer liability

Employers are generally required to withhold federal income, Social Security and Medicare taxes (collectively known as employment taxes) from employees’ earnings and forward these funds to the U.S. Treasury on employees’ behalf.

You’re also liable for taxes imposed by the Federal Unemployment Tax Act (FUTA). The IRS examines some employment tax returns to determine if wages, tips, compensation, credits and taxes are reported accurately.

Companies are obligated to remit payroll taxes on a timely basis. These taxes are called trust fund taxes because employee money is held in a trust until the employer makes a federal tax deposit in that amount. Any unpaid trust fund taxes must be immediately available for collection from the business.

In addition, it’s critical to correctly determine whether workers are employees or independent contractors, as it impacts employment taxes. Employee misclassifications can be an expensive mistake. If an independent contractor is misclassified by a company and pays his/her own self-employment taxes, but offsets it with expenses, the government never receives the entire amount owed.

If you’re concerned you may be falling short on your obligations, now’s your chance to make sure you’re in good standing — and fix what’s broken before an employment tax audit is conducted.

Calling for audit improvements

On February 13, 2023, the Treasury Inspector General for Tax Administration (TIGTA) released a report on the need for improvements to the employment tax examination process to increase taxpayer compliance and collection potential.

Employment tax workstreams are set up to focus on probable areas of non-compliance to show cases with a high potential for audit adjustments. But with increased funding, the employment tax audit process is likely to fine-tune its processes and may involve using more technology in selecting who will be subject to an examination.

Here’s an unexpected way that artificial intelligence (AI) could impact your business. An AI algorithm, for example, could examine thousands of tax returns and isolate certain areas where there are anomalies in a matter of milliseconds.

Getting a step ahead

Businesses may use internal or external resources to prepare for an IRS employment tax audit. Internal audits may be better suited for larger employers with an in-house tax department responsible for filing tax returns and other levels of compliance.

For smaller employers, seeking the help of an independent auditor can provide deeper knowledge into the issues being probed.

Staying ahead of an employment tax audit can be a challenging task. Reach out to the CPAs at Magone & Company to ensure you’re on track for IRS compliance.

This information is provided for educational purposes and should not be construed as financial or legal advice. Please consult your accountant or attorney for advice specific to your situation.

Untying the Knot: The Tax Implications of a Divorce

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From the division of marital property to child custody settlements, ending a marriage often includes complex legal ramifications that can impact your family’s finances. But have you considered the tax implications?

Just as there are financial and legal to-dos for newlyweds, there are also tax-related administrative tasks to tackle once a divorce is finalized.

Most divorcees want to maximize their tax position — and minimize their pay out to Uncle Sam. While every situation is unique, here are some common tax reminders related to a divorce:

Tax filing status. Your marital status controls your filing status. When changing from married to divorced, your standard deduction and income tax payment will likely change as well.

Filing statuses are dependent on when a divorce is finalized. If the new year begins before a divorce is official, you’re still married in the eyes of the IRS and must file a joint return for the previous year or choose married filing separately.

Tax withholding. If you’re working, you need to update the amount withheld from your paycheck. Complete a new Form W-4 to revise your tax withholding amount within 10 days of signing your final divorce papers.

Child support. If you’re receiving child support, the amount is not included as part of your taxable income. If you’re the one paying the support, that expense is not deductible.

Alimony. Alimony is also not deductible by the party on the paying end. And similar to child support, the recipient doesn’t have to include it as taxable income.

Dependents. The custodial parent may claim a child as a dependent for tax purposes. By definition, this is the parent with whom the child spends the majority of nights.

Property settlements. If a marital property is sold as part of your divorce settlement, there can be significant tax ramifications due to unrealized capital gains.

These are general considerations and should not be taken as financial or legal advice.  Consult with your legal or tax professional regarding your personal situation for guidance tailored to your specific needs.

Turning the page on a difficult time of life

Divorce can be the start of an exciting new chapter. But as you settle back into the single life, it’s important to handle financial and administrative chores for a clean a slate. The professionals at Magone & Company have the guidance and expertise in dealing with these tax matters and more. Don’t hesitate to give us a call today at (973) 301-2300.