I was asked to take a look at the financial statements and tax returns of a client's relative. He had recently re-located to Northern Nevada and wanted to source his accounting work locally.
My practice is to give anyone who asks an hour of my time to see how I could help them. An interesting fact percolated to the surface during our conversation. He had found an “out of the box” tax preparer who filed his 2018 tax return and amended his 2016 and 2017 tax returns. I thought it would be good fodder for my column to describe what I found, as a way to inform the public about various scams and cons that routinely plague our profession.
Mistake #1: Know that it's OK to ask for authority on a deduction: In the tax preparer's book, the introduction states that if a CPA or Enrolled Agent wouldn't take the deductions that she discusses, then find a new accountant. It is rare that two rational people cannot agree if an item is deductible or not. When you sign a return, it is your responsibility to understand if the positions taken in the return are defensible. A good preparer will be able to show you from some authoritative source why their proposed deduction works.
Mistake #2: File an S Corporation tax return to save on self-employment taxes. While technically true, the preparer forgot to mention that they were required to pay themselves a “reasonable wage” reported on Form W-2 for the value of the services they provided to the S corporation. The returns in questions had significant income, and now wages on line 7. This is a HUGE audit flag currently with the IRS.
Mistake #3: Wages don't qualify for the 199A additional 20% deduction for business income. Let's say for the sake of argument that the business made $50,000 of profits and no wages were paid to the owner. Also assume that the return is filed with no wages, and it gets audited. Since the business “sells” the owner's time to customers, and the owner had all of the $50,000 distributed to him during the year to pay for his living expenses, the IRS argues that the entire $50,000 should have been reported on Form W-2. The IRS will assert that the business owes 15.3% in taxes ($7,650) plus interest and penalties, blah blah blah. The insult to the injury is that now the $10,000 IRC section 199A deduction evaporates. Poof! Had the owner stayed the course as an LLC, the 20% 199A deduction exceeded the 15.3% combined FICA & Medicare taxes.
Mistake #4: The business had sales across many western states, but mostly in Oregon. The S corporation return showed all of the sales in Oregon. They should have “apportioned” the income across that states that they sold to. The real bummer was that the preparer concluded that the taxpayer resided in Nevada! The embarrassing part of this mistake is that it was so obvious. If you have earned income from a state, you have to report that state's source income on a tax return, even if you don't reside there. In fact, it's why “non-resident returns” were created! The preparer was amending tax returns, showing zero source Oregon income, even though the company issued a K-1 showing income. The state's computer system will issue a notice stating that the return was filed incorrectly. In this case, they are not even playing the audit lottery. Even bigger bummer is that once the taxpayer receives the refund of the taxes that were originally paid to the state, they will owe an underpayment penalty once the state matches the issues K-1 with the tax return.
Mistake #5: This was the mistake made by the taxpayer, rather than the preparer. This preparer was not licensed to practice before the IRS. Recently, I spoke at the Nevada Farms Conference and an inquisitive gentleman in the audience approached me afterward, asking questions about how to prepare a tax return for a farmer. I encouraged him to hire a CPA, Enrolled Agent or Attorney. He said that he wanted to file it himself and get into “business.” My words are equally applicable to all who have tax returns prepared for them. Only use a CPA, Enrolled Agent or Attorney to prepare tax returns. As I explained to the gentleman at the Farms Conference, only these three can “practice” before the IRS. If the IRS has a question about our return, they only talk to these three categories. Failure to use them will generally put the taxpayer in a tough spot. The reason being is that Circular 230 lays out the rules for people licensed to practice before the IRS. It requires a standard of care to prepare tax returns, and has penalties if you mess up. The reason this was the taxpayer's fault — they should have known the IRS has no recourse against who prepared the return, since they were not licensed to practice before the IRS. Never put yourself in this painful position!
In conclusion, I believe the people have a good “gut” feel for things that are right or wrong. Feel free to discuss the “why” about a deduction. You don't have to be an expert, but any tax professional worth their salt can explain in lay terms how the law works and applies to their situation. If they can't, they have not invested the time to become an expert in that portion of the tax code. And that's OK, just appreciate that experts can help you navigate to get better outcomes. Non-experts can answer questions, but really don't have the depth of understanding to plan.
Please note that this discussion is general in nature, and not intended to be tax advice. Please consult with a CPA to get answers to your specific fact pattern.
Michael Bosma, CPA, is Principal-in-Charge of the Reno office of CliftonLarsonAllen LLP. His NNBW column, “Covering Your Assets,” focuses on effective planning strategies for every business owner. Reach him for comment at mike.bosma@claconnect.com.
-->I was asked to take a look at the financial statements and tax returns of a client's relative. He had recently re-located to Northern Nevada and wanted to source his accounting work locally.
My practice is to give anyone who asks an hour of my time to see how I could help them. An interesting fact percolated to the surface during our conversation. He had found an “out of the box” tax preparer who filed his 2018 tax return and amended his 2016 and 2017 tax returns. I thought it would be good fodder for my column to describe what I found, as a way to inform the public about various scams and cons that routinely plague our profession.
Mistake #1: Know that it's OK to ask for authority on a deduction: In the tax preparer's book, the introduction states that if a CPA or Enrolled Agent wouldn't take the deductions that she discusses, then find a new accountant. It is rare that two rational people cannot agree if an item is deductible or not. When you sign a return, it is your responsibility to understand if the positions taken in the return are defensible. A good preparer will be able to show you from some authoritative source why their proposed deduction works.
Mistake #2: File an S Corporation tax return to save on self-employment taxes. While technically true, the preparer forgot to mention that they were required to pay themselves a “reasonable wage” reported on Form W-2 for the value of the services they provided to the S corporation. The returns in questions had significant income, and now wages on line 7. This is a HUGE audit flag currently with the IRS.
Mistake #3: Wages don't qualify for the 199A additional 20% deduction for business income. Let's say for the sake of argument that the business made $50,000 of profits and no wages were paid to the owner. Also assume that the return is filed with no wages, and it gets audited. Since the business “sells” the owner's time to customers, and the owner had all of the $50,000 distributed to him during the year to pay for his living expenses, the IRS argues that the entire $50,000 should have been reported on Form W-2. The IRS will assert that the business owes 15.3% in taxes ($7,650) plus interest and penalties, blah blah blah. The insult to the injury is that now the $10,000 IRC section 199A deduction evaporates. Poof! Had the owner stayed the course as an LLC, the 20% 199A deduction exceeded the 15.3% combined FICA & Medicare taxes.
Mistake #4: The business had sales across many western states, but mostly in Oregon. The S corporation return showed all of the sales in Oregon. They should have “apportioned” the income across that states that they sold to. The real bummer was that the preparer concluded that the taxpayer resided in Nevada! The embarrassing part of this mistake is that it was so obvious. If you have earned income from a state, you have to report that state's source income on a tax return, even if you don't reside there. In fact, it's why “non-resident returns” were created! The preparer was amending tax returns, showing zero source Oregon income, even though the company issued a K-1 showing income. The state's computer system will issue a notice stating that the return was filed incorrectly. In this case, they are not even playing the audit lottery. Even bigger bummer is that once the taxpayer receives the refund of the taxes that were originally paid to the state, they will owe an underpayment penalty once the state matches the issues K-1 with the tax return.
Mistake #5: This was the mistake made by the taxpayer, rather than the preparer. This preparer was not licensed to practice before the IRS. Recently, I spoke at the Nevada Farms Conference and an inquisitive gentleman in the audience approached me afterward, asking questions about how to prepare a tax return for a farmer. I encouraged him to hire a CPA, Enrolled Agent or Attorney. He said that he wanted to file it himself and get into “business.” My words are equally applicable to all who have tax returns prepared for them. Only use a CPA, Enrolled Agent or Attorney to prepare tax returns. As I explained to the gentleman at the Farms Conference, only these three can “practice” before the IRS. If the IRS has a question about our return, they only talk to these three categories. Failure to use them will generally put the taxpayer in a tough spot. The reason being is that Circular 230 lays out the rules for people licensed to practice before the IRS. It requires a standard of care to prepare tax returns, and has penalties if you mess up. The reason this was the taxpayer's fault — they should have known the IRS has no recourse against who prepared the return, since they were not licensed to practice before the IRS. Never put yourself in this painful position!
In conclusion, I believe the people have a good “gut” feel for things that are right or wrong. Feel free to discuss the “why” about a deduction. You don't have to be an expert, but any tax professional worth their salt can explain in lay terms how the law works and applies to their situation. If they can't, they have not invested the time to become an expert in that portion of the tax code. And that's OK, just appreciate that experts can help you navigate to get better outcomes. Non-experts can answer questions, but really don't have the depth of understanding to plan.
Please note that this discussion is general in nature, and not intended to be tax advice. Please consult with a CPA to get answers to your specific fact pattern.
Michael Bosma, CPA, is Principal-in-Charge of the Reno office of CliftonLarsonAllen LLP. His NNBW column, “Covering Your Assets,” focuses on effective planning strategies for every business owner. Reach him for comment at mike.bosma@claconnect.com.
