Tax Season Takeaways

Life is returning to normal after another successful tax season here at Truepoint. As our season progressed, we noticed a number of themes emerging that set this year apart from past years.  From delayed receipt of tax reporting documents from financial institutions, to an increase in IRS audits, here are some of the highlights we believe will impact our clients in the coming years.

Increased Complexity

Every year, tax preparers hope it will be the year when Congress simplifies the tax code, and every year, this proves to be wishful thinking. In fact, taxes keep getting more complex. This year, Congress “upped the ante” on the complexity by shortening the amount of time for CPAs to educate themselves on the latest changes and minimize any impact on clients. These changes included:

• Laws: Thousands of pages of laws were added to the tax code and regulations on the last day of the year.
• Reporting: The late passing of laws resulted in delayed tax reporting for brokerage accounts and other financial institutions.
• Tax Forms: The late passage also delayed many tax forms. The IRS had a much greater challenge than all of us. They had to quickly interpret and reflect the new law in tax forms and instructions. Unfortunately, many forms were not ready for our use until early to mid-March.
• Filing: The net result of the late Congressional action compressed tax season from its normal 10 week period to about 6 weeks, resulting in a large number of extension requests.

Increased Complexity = More Audits

We have seen three federal income audits in the 12 years that Truepoint has prepared tax returns.  All of them have been in the last two years.  During the 1990s and early 2000s, the IRS had scaled back the number of IRS agents as a means to control portions of federal spending. Therefore, the “come to the federal building” audits were virtually non-existent. Beginning just a handful of years ago, the IRS started hiring and training a significant number of new agents.  These agents are now ready to audit taxpayers to ensure compliance with the increasingly complex income tax law. These agents are trained to seek hidden assets and income. While we recommend that you keep ALL tax documentation, it is critical to maintain documentation in the following areas:

• Foreign-Bank Accounts: Some of our clients hold assets in foreign accounts. The reporting requirements for these foreign-held assets become more complex and onerous every year. Failure to comply with these foreign reporting requirements can result in substantial financial and even criminal penalties!
• Charitable Contributions: To claim a deduction of cash or property of $250 or more, you must maintain supporting documentation. As we participated in a recent audit, the IRS agent indicated that receipts from the charity are no longer sufficient as documentation. The IRS will ask to see cancelled checks as evidence of your donation even for those falling below $250. The federal tax statute of limitations runs for three years after you file your tax return, so remember to hang on to those cancelled checks for at least three years.
• Self-Employed Business Income and Expenses: Self-employed tax payers will likely be a focus for the IRS in the coming years. The area of tax law pertaining to self-employed individuals is overly complex, easily resulting in errors. Expenses that are not supported by receipts will likely be disallowed.

Increased 2013 Rates + Hidden Increases + Surtaxes = More Taxes

Higher income tax rates, Medicare surtaxes, and phaseouts of itemized deductions and personal exemptions are all contributing to higher tax liabilities for a number of our clients. Many clients are finding that the payroll withholding is no longer sufficient to protect them from penalties. In these instances, one must either increase federal tax withholdings and/or remit quarterly estimated payments. If you are retired, this may mean your existing quarterly estimates or IRA withholding amounts become larger than in the past.  All of this means we need to continue re-evaluating income throughout the year and making changes as necessary.

One notable “hidden” increase our clients should be aware of is the depletion of capital loss carry forwards (or the net amount of capital losses that are not deductible in the current tax year, but can be carried over into future tax years). During the economic downturn in 2008 and 2009, we implemented a tax/portfolio management technique called “tax loss harvesting.” This technique resulted in a capital loss carry forward “bank,” which was used to offset gains in subsequent years. In many of our client portfolios, the strong gains recognized since that time have significantly reduced and, in many cases, depleted these losses. Now that these banked losses are depleted, an increased amount of capital gains will be subject to tax in future years.

It is our ultimate goal to keep our clients compliant and free of penalties. With the changing tax landscape, it is crucial for our clients to be aware and actively engaged in the tax portion of their wealth management plan throughout the year. And, remember that the Truepoint team is always available to speak with clients at any time if there are questions or concerns.