Top 10 Tax Mistakes Made by Investors

JOHN BURKE AND STEVEN CRISCUOLO for accounting today write: Investing is a complex undertaking. The supply of investment alternatives is seemingly endless. Evaluating various alternatives can be quite difficult and very time consuming.  And unless held in check, the actual decision-making process is fraught with human emotions that often lead investors to make counterproductive investment choices. Add to this the myriad tax rules and regulations that impact investments and you have enough to overwhelm many investors.

Trusted financial professionals are in a position to help make sense of it all. Certainly, appropriate portfolios should be structured for investors, and suitable investments should be chosen given the current economic environment and the investor’s unique set of circumstances. But tax consequences must also be carefully considered, and the accountant often plays a role in this. Tax treatment, good or bad, can make or break an investment decision.

Here are the top 10 tax mistakes made by investors as gathered in a recent survey we conducted of investment advisors:

1. Short term vs. long term gains: Realized gains on appreciated securities held for one year or more qualify for favorable tax treatment. Long-term capital gain tax rates are significantly lower than short term rates. Holding a security an extra day, week or month can significantly reduce the tax burden.

2. Foreign stock investments held in a tax-qualified account: Most foreign companies are required to withhold foreign taxes on dividends paid. U.S. investors can claim a tax credit on their tax returns, effectively recouping this lost dividend, but only if the foreign stocks are held in a taxable account.

3. Gold and silver held in a taxable account: Gold and silver are treated as collectibles and therefore are not eligible for capital gains treatment. The federal tax for long-term gains on collectibles is 28 percent.

4. Sale of appreciated securities by elderly investors: The cost basis of appreciated securities is “stepped up” to the current market value upon the death of the owner. Prospective capital gains and related taxes disappear. Conversely, all prospective capital losses will be lost. Elderly investors should consider being quick to sell stocks with losses and slow to sell stocks with gains.

5. Generating excess unrelated business income in a tax-qualified account: Certain investments, such as Master Limited Partnerships, generate unrelated business income. These investments belong in a taxable account. If they are held in an IRA or other qualified plan, and if the Unrelated Business Taxable Income, or UBTI, is greater than $1,000, then the investor must complete and file a rather complex Form 990 and pay additional income tax.

6. Ignoring local tax laws: In some states, investors cannot carry capital losses forward to future years. On a federal return, a capital loss in one year can be used to offset gains in a subsequent year. But capital losses without offsetting gains in a current year are lost for state tax purposes.

7. Failing to consider a Roth IRA conversion: When a traditional IRA is converted to a Roth IRA, tax is due on the converted amount in the year of conversion. If, for whatever reason, an investor will have low income in a year, this is an ideal time to convert and settle the tax bill on this money at a significantly lower rate than is otherwise expected in the future.

8. Failing to realize capital gains: Once again, low income in a given year can provide an opportunity to save taxes. Long-term capital gain tax rates are progressive; rates increase as taxable income increases. For taxable incomes up to $72,500, joint taxpayers pay no tax on long term capital gains.

9. Improperly calculating the cost basis for MLPs: Given their unique tax structure, a large portion of a typical Master Limited Partnership distribution is tax-free. This tax-free distribution is considered a return of principal and should therefore serve to reduce the cost basis. In this case, ignorance may be bliss because the reduction in basis would result in a higher capital gain at sale (unless the IRS comes knocking…).

10. Allowing a pension plan to become non-compliant: While not as common as the others, this mistake can be very costly. There are a number of actions or inactions that can put a plan’s qualified status in jeopardy. Oftentimes, an investor will establish a plan with a brokerage firm, and then assume that the brokerage firm is taking care of the ongoing regulatory requirements, including the filing of IRS Form 5500. Brokerage firms rarely do this even though they may have provided the original plan document template. Failure to meet ongoing regulatory requirements can result in disqualification of the plan and a very large tax bill. Investors should consider hiring a third-party administrator to take care of their ongoing compliance obligations.

An effective, long-term investment process must consider and evaluate the overall economic environment, individual investments, tax laws and human emotions. This process is ongoing. Only by constantly balancing all of these elements can after-tax returns be maximized.

How to handle distributions from IRAs

Kathleen Pender for SF  Gate writes:  Today I've got answers to reader questions on individual retirement accounts and how to handle a reclassified dividend.

Question: Linda L. asks, "My husband and I turn 70 1/2 this year and must begin taking required minimum distributions from our retirement accounts. My husband and I both have traditional IRAs (funded with tax-deductible contributions). Along the way, I opened a new account for IRA contributions that were not deductible. We have always comingled our funds and filed joint tax returns.

"We have been informed that my husband's RMD for 2013 is $56,540. Mine is $30,370 from my regular IRA and $2,100 from my after-tax IRA. That adds up to approximately $89,000 RMD for 2013. I understand that it is to our benefit to make our earliest RMDs from after-tax accounts. Would it be smart to withdraw $48,000 from my after-tax account and $41,000 from our two other accounts?"

Answer: Like many people taking their first required distributions, Linda is unclear on two concepts.

The first is that she and her husband must combine their required minimum distributions.

"Even though they file a joint tax return, it is not a joint distribution requirement," saysJeffrey Levine, an IRA expert with Ed Slott & Co. "The 'I' in IRA stands for individual."

Her husband must take $56,540 from one or more of his IRAs and she must take a total of $32,470 from one or more of her IRAs.

Furthermore, it doesn't matter (from a tax standpoint) whether she takes her distributions from her before-tax or after-tax IRAs. "The IRS looks at all of your IRAs as one giant IRA," Levine says.

If you have both pre- and after-tax money in your IRAs, a portion of your distribution will be tax-free no matter which account or accounts you take your required distribution from. The tax-free percentage is the amount of after-tax dollars in all of her IRAs divided by the total value of all her IRAs.

Question: P.D. writes, "In 2010, I rolled over my traditional IRA into my Roth IRA. Due to making too much, I have not been able to contribute to my Roth for the last three years. My brokerage firm advised me that I can make a contribution to the traditional IRA (but not take a deduction for it), and then immediately roll it into my Roth IRA, as long as I file (the appropriate IRS forms).

"My CPA says technically you can, but that the IRS has taken people to court for doing this and won. Essentially, the IRS said the taxpayer was making a Roth contribution he was not entitled to due to his income level. He was then assessed the 6 percent excise tax for every year the disallowed contribution was allowed to remain in the account. Is this a legal practice, since it is not well defined by the IRS codes?"

Answer: No experts I spoke to had heard of the IRS challenging this strategy in court, but one had heard of cases where it was overturned during an audit.

This has been a popular strategy since 2010, when the income limit on Roth conversions was eliminated. Before 2010, people could not convert if their modified adjusted gross income exceeded $100,000.

They still cannot contribute new money to a Roth IRA if their income is too high, but they can make a nondeductible contribution to a traditional IRA regardless of income. To get around the Roth-contribution limit, some high-income people make a nondeductible contribution to a traditional IRA, then convert it to a Roth.

If they have no other traditional IRAs and make the conversion immediately, they won't owe tax on the transaction because there won't be any untaxed earnings in the traditional IRA. If they do have other traditional IRAs, "the rollover to the Roth IRA is taxable to the extent that there are nontaxed contributions or earnings in the traditional IRAs," saysMark Luscombe, a principal analyst with CCH Tax & Accounting.

Intuit CFO Says Company Responding To Challenges

DOUG TSURUOKA, INVESTOR'S BUSINESS DAILY writes: Shares of Intuit (INTU) were up 1% in midday trading in the stock market Wednesday, a day after the maker of TurboTax and Quicken accounting software posted fiscal fourth-quarter adjusted earnings that were in line with Wall Street forecasts.  Sales beat estimates, but the company late Tuesday issued mixed guidance for the current quarter. It also raised its quarterly cash dividend from 17 cents per share to 19 cents, to be paid on Oct. 18.

Excluding options expenses and other one-time charges, Mountain View, Calif.-based Intuit said it broke even for its fiscal Q4 ended July 31, vs. a penny loss in the year-earlier quarter. This matched the consensus view of 20 analysts polled by Thomson Reuters. 

On a GAAP basis, the company said it lost 5 cents a share vs. a penny profit. Analysts had expected a 12-cent loss on a GAAP basis.

Revenue rose 12% to $634 million, beating views of $622 million.

In the current quarter, the company sees sales of $595 million to $605 million, falling short of an analyst forecast for $619 million. Non-GAAP adjusted EPS is expected to fall between a loss of 10 cents and 11 cents, wider than a loss of 3 cents expected by analysts.

"Our revenue and operating income were fine in Q4 and we had a very strong year in our small-business segment, and all of our subscription businesses did very well through the end of the fourth quarter," CFO Neil Williams told IBD in an interview.

He said the downside was Intuit's consumer tax business, which he said reflected a decline in the total number of tax filers.

Williams says the company is responding to its challenges by issuing new small-business products such as an easier-to-use version of QuickBooks Online, set to be released in a few weeks.

He says the company also will be releasing new accounting solutions for small businesses, and starting new global initiatives. "So new version of QuickBooks Online, new accounting solutions and global, we think, are the three big drivers for fiscal 2014," Williams said.

The CFO says more details about its fiscal 2014 strategy will be given at the annual Intuit investor day, set for Sept. 24.

Intuit has been restructuring to focus on its core businesses. Its shares took their worst fall in a decade in late April after CEO Brad Smith said the company was lowering its revenue guidance for fiscal Q3 and fiscal 2014, to reflect weakness in its consumer tax business.

On Aug. 1, Intuit again lowered its current-quarter and full-year outlook based on the divestiture of its Intuit Financial Services and Intuit Health businesses, completed in fiscal Q4.

Williams says some analysts did not update their estimates to show the new guidance and the exclusion of revenue from the company's former financial services and health units.

Intuit's updated guidance for fiscal 2014 ending July 31, 2014, is for revenue of $4.44 billion to $4.525 billion, or growth of 6% to 8%. It expects EPS ex items of $3.52 to $3.60, up 10% to 13%.

Analysts polled by Thomson Reuters are expecting fiscal 2014 revenue of $4.5 billion and adjusted EPS of $3.55 a share.

10 tax tips to save restaurateurs money

Mark E. Battersby for QSRWeb writes:  Year-end tax planning can be quite simple: Simply accelerate payments before the end of the tax year thereby increasing deductions that reduce taxable income. To be really effective not only for the current tax year but for years down the road there is obviously more to it than that. However, now is the best time to think about reducing the restaurant operation's tax bill even lower than the point where the economy may have driven it.

The best guarantee of consistently low tax bills this year, next year and so-on down the road is tax planning. Tax planning is easy: the more tax deductions taken, the lower the restaurant's taxable income will be — at least for the current tax year. Or perhaps, ignoring potential tax deductions this year might mean significant savings in later years when profits — and tax bills — are higher.

But how to make the moves necessary for lower tax bills before the end of the tax year and in the face of all the current uncertainty over tax reform, rates and deductions is a legitimate question.

What every business should know about tax planning

Although tax planning should be a year-round process, the owners and managers of many restaurants often don't check with their accountant or tax professional until tax time and don't consult their attorney unless there is a legal issue. Even worse, many remain in the dark about developments that might impact on their tax bills, such as the following:

1. Health care: Despite the controversy and the confusion over the Affordable Care Act, part of the hotly debated law is already helping employers with 25 or fewer workers who pay their workers average salaries of $50,000 or less, and that pay half of their health insurance premiums by giving them a tax credit, a direct reduction of their tax bills.

2. Faster write-offs: The Section 179, first-year expensing write-off amounts change from year to year. Currently, the amount a small business can expense and immediately deduct for new equipment, machinery, furniture, fixtures and vehicle expenditures is $500,000 -– but only through 2013.

3. Bonus depreciation: Over the years this tax break has allowed restaurants to write-off up to 50 percent of the cost of vehicles, machinery, furniture, fixtures and equipment. Unlike property qualifying for the Section 179 write-off that can be either used or new, the bonus depreciation requirement that the taxpayer be the "first to use." Bonus depreciation is currently available for 50 percent of the cost of newly acquired assets but, once again only through 2013.

4. Faster write-offs for restaurant and retail property: The provision extending the 15-year straight-line recovery period for improvements made to qualified restaurant buildings, leased property, as well as so-called "retail improvements," has been extended for qualified expenditures made before Jan. 1, 2014.

5. Repairs and maintenance: A restaurant operation doing major renovations should schedule repairs and maintenance jobs separately. Despite new guidelines, capital improvements are not deductible as business expenses, like basic repairs are. Instead, improvement costs are added to the "basis" of the property. Lumping all of the work into one project could cheat the operation out of 100 percent deductible expenses.

6. Contributing food inventory: The charitable deduction for contributions of food inventory now expire Dec. 31, 2013. Thus, both incorporated and un-incorporated restaurants and food service businesses can claim an "enhanced" deduction for some donations of food inventory. For a business other than an incorporated restaurant, the total deduction for food inventory donations is limited to a maximum of 10 percent of the net income from the operation.

7. Losses: There are strict time limits for a restaurant to claim a Net Operating Loss carryback as well as electing to forego the carryback and just carry the loss forward. The typical statute of limitations for filing a NOL tax refund claim is three years from the time the return was filed or two years from the time the tax was paid, whichever period expires later. Lawmakers enacted a special provision that requires the claim for a refund to be filed within three years of the date on which the return was due to be filed (including extensions) -– for the taxable year of the net operating loss which results in such a carryback.

8. Work opportunity tax credit: The WOTC, a tax credit that rewards employers that hire individuals from targeted groups, was extended to Dec. 31, 2013 and applies to individuals who begin work for the employer after Dec. 31, 2011. Under the revised WOTC, restaurants and businesses hiring an individual from within a targeted group are eligible for a credit generally equal to 40 percent of first-year wages up to $6,000.

9. Independence contractors or not: The Affordable Care Act's so-called "Employer Mandate," has been postponed. That means restaurant operations with 50 or more "full-time equivalent workers" won't be required to offer health plans to employees, or pay stiff penalties for each uncovered worker beyond 30 employees until 2015. However, this might be the perfect time to reclassify workers classified as independent contractors whether in anticipation of the Employer Mandate or simply made erroneously and make that change as of Jan.1.

10. Records: Don't forget to hold onto those receipts for smaller expenses. While the IRS only needs receipts for business expenses over $75, every restaurateur and his or her business needs some form of documentation in order to claim those deductions. Of course, it also helps to know what deductions are available and what is needed to prove them.

Year-end strategy, myths and plans

For businesses, it may not be feasible to accelerate expense payments into the current year. If, for example, the restaurant had a pretty bad year with a lower-than- average profit and expects profits to pick back up next year, it might be prudent to defer as many expenses into the following year as possible. A business in the 20 percent tax bracket this year, but expecting to be in the 30 percent tax bracket next year and with $10,000 worth of expenses in question, will save only $2,000 deducting them this year, while deducting them next year will save $3,000.

Paying the owner, principal or partner a bonus, taking a shareholder distribution/dividend/draw, repaying officer loans, paying down credit card balances, paying down credit lines, or paying off other debt will not create deductions that result in tax deferrals. Generally, in order to put this plan in place, the business must actually be paying expenses or purchasing equipment.

Above all, understand whether the operation files its tax return on the accrual basis or the cash basis. Most year-end tax strategies only work for cash-basis taxpayers. Accrual-basis taxpayers report all income in the year that it is earned and all expenses in the year that they are incurred. So, just because 2014 expenses are paid in 2013 doesn't mean they can be deducted in 2013.

One caveat: the financial or operational strengths of a business transaction should always stand on its own, aside from the tax benefits that may be derived from them. In other words, the tax tail should never wag the tax dog.

Don't spend money that wouldn't ordinarily be spent merely to reduce the restaurant operation's tax bill. Remember, $1 spent does not equal $1 worth of tax saved: $1 spent creates a $1 deduction, which (depending on the tax bracket, business structure, and state of operation) will only lead to up to $.60 worth of tax saved.

Tax planning ALL the time

Despite or because of the uncertainty of what tax rates may look like next year, many restaurant operators and managers are sticking with what's worked best for them in the past: Minimizing income and maximizing expenses. For those restaurants sure to face higher taxes next year, an argument could be made to generate as much income as possible this year, as it will pay more in taxes but at a lower rate.

Although tax planning should be a year-round process, a number of year-end strategies can reduce not only this year's tax bill, but future tax bills as well. The operators and managers of every restaurant should also be taking additional steps to ensure the success of the operation in 2014.

While many restaurateurs rely on the advice and help provided by tax professionals, or utilize software programs to ensure a low tax bill, even the most knowledgeable professional doesn't know what will happen down the road to affect the business from achieving a legitimately lower tax bill for not just this tax year but year-after-year.

Congress could kick the can down the road again, but in terms of tax planning, norestaurant operator, owner or manager can wait until lawmakers all go home for the holiday recess. It will be too late to make the moves to reduce tax bills this year and for many years to come.