Nanny Tax

David Cay Johnston recently posted an article on the Nanny Tax. This is a tax that, honestly, most people do not know about. This is the payroll taxes that each of us owe if we hire someone to come work in our home. Such as a house cleaner. Or a regular baby sitter or someone to watch our children. Or the gardener that cares for the lawn.

Yeah, payroll taxes.

The tax does not require the complicated payroll tax forms (e.g., Form 941) but instead is paid with our regular federal income taxes using Schedule H. But it is not exactly trivial to fill out.

The compliance rate? Pretty small numbers. And one of the more difficult items to catch as well.

The downside? There are a lot of people who will not see much, if anything, from Social Security. When Schedule H is not filed, then there is no employment record for the person who did the work. So no unemployment benefits. No disability protection. No retirement benefits. No survivor benefits.

A few years ago the IRS ran a study where they audited 45,000 tax returns for the Household Employee, or nanny. They found $12 million in unpaid taxes. They also found $11 million in over-paid taxes. That generated some nice refunds.

Recent law changes increase the filing requirements related to this. Thank you Health Care. But the best I can offer here is if you do pay someone on any regular basis to do work at your home, discuss this with your tax professional.

"Hello, this is the IRS...."

Nothing like answering the phone and hear the party on the other end identify himself or herself as from the IRS. That could probably give your heart a start!

A phony phone call? It could be. But it could also be real!

Historically the IRS always sent a letter first. No longer. Now a common practice is to call and speak with the taxpayer and to start collecting information.

One problem is that it may not be clear what the real issue is (or issues are) that is/are under audit. Thus it is best to not provide much information without knowing the IRS agenda and what your options are. (Confirming your address is probably fine.) And of course it is difficult to know for sure that it really is the IRS calling.

Fortunately, if you respond stating that you desire representation then the auditor is required by law to immediate cease inquiries on the subject. They will probably ask who your representative is, as they need to send a letter to your representative, so that is fine. If your taxes were prepared professionally by someone capable of representing you then you can give them that person's name. You will also want to contact that person immediately to establish a representation relationship.

If you did not have your taxes prepared by a person qualified to represent you, then explain that you will be obtaining representation and get the contact information for the IRS auditor so that they can be contacted by your representative. Then locate an Enrolled Agent. (That title will likely change in a few months, but no announcement yet.)

Finally, while the IRS will usually send a letter, and sometimes phone, they do NOT send email. If you receive an email message disguised to look like it came from the IRS then you should forward it to phishing@irs.gov.

Refund Anticipation Loans - Bye bye?

If you're reading this blog (Thank you!) then you are probably seeing other news items and have read, over the last 3 days, about a change at the IRS and how this will impact the Refund Anticipation Loan (RAL) business and users. I'll offer my thoughts on this too.

For those unaware, this paragraph will have the short details. The IRS receives from other branches of the government information about what taxpayers owe. This could be related to Social Security, back child support, whatever. They do NOT receive information about what the issue is. When a tax return is e-filed the IRS in the acknowledgment indicates if the refund will be processed normally or if there is an "offset" from a prior tax problem or other government agency that will cause the refund to be held. Banks use this flag to help determine whether or not to write a loan to the taxpayer allowing for the early refund. Without this information if the bank chooses to issue the loan it really does not know if the loan will be repaid by the IRS or not.

The expectation is that RALs may die a quick death. Some speculate that if a taxpayer has had a RAL from the same bank for multiple years then maybe the bank will write the loan anyway. Of course the taxpayer does not choose the bank - that is done by the tax professional in their annual contract. Others speculate that RALs will continue but the fees will escalate significantly to pay for the additional risk that the bank must take.

Many advocates are very please with this happening. Why? The majority of these loans take money out of the pockets of those who need the money the most. One report indicates that in 2008 over $700 million was skimmed away from the low-income portion of our population. One tax preparation chain indicated that their average interest rate on these loans (assuming it expedites the refund by 1 week) was over 80%. I personally have seen these loans at around 180% annual interest rate. The NY state banking department reported loan interest rates approaching 700% in some extreme cases. (Can you spell usury?) One chain even reported in its financial statements that it lost money on tax return preparation but made a profit due to the RAL business. Tax return preparation is just a loss-leader for them.

Others argue that people need these loans. Really? They argue that people are in dire straights - behind on their rent, or with a car in the shop - and these loans are the only way to meet payment commitments. Hmm. For the last 12 months there was no loan coming in. How was the rent paid then? Do these people voluntarily put themselves in this predicament simply because they know they can get that loan money next week? Might they behave differently if it could take one additional week?

Currently almost all refunds are paid within 10 days. A RAL will shorten that to 1-3 days. The IRS has piloted a new e-file system that will provide refunds in 3 days. That's not yet available to everyone, but it was used this past year on many of the simpler returns. Those are the same returns that generally end up with a RAL. Granted this 3-day refund from the IRS is only available to those who choose direct deposit.

Next proponents of RALs point out that many taxpayers do not have bank accounts and there fore are unable to use direct deposit. Isn't a Social Security number and photo ID all that is required to open a bank account? Maybe the slice of our population that will be disadvantages is more narrow that previously acknowledged. Who is unable to have a Social Security number and photo ID???

Interesting that this target slice of our neighbors that get the RAL check, after paying hundreds of dollars to save a few days, must then go to a check cashing business and pay fees again, since they do not have a bank account to deposit the check. No wonder opponents point out that significant money is being siphoned away from the poor and channeled to the rich. This whole process smells of this.

People survived for decades without quick access to their refunds. Proper tax planning will reduce those refunds to a rather minimal amount anyway. People will adjust to the extra delay - where it will really exist. The bottom line will leave a lot more money in the pockets of the lower-income portion of our population. That seems like a good thing.

Oh, the other issue is that some people use this method to pay the tax preparer. That appears to also be in danger. The IRS did state that there is a proposal in process to offer a new capability for that in the 2012 filing season (tax year 2011). So maybe the burden of having to directly pay for services received will only last one year. That too we can survive. To genuinely help our poor, it seems worth it.

The Issues with Income Reporting

If you have been following recent news related to reporting of income, then maybe you can skip this first paragraph. What's the deal? Part of the health bill passed back in March requires business to report to the IRS when they pay another business more than $600 in any year. This is done on Form 1099-MISC. So what changed? First, it now applies to purchase of supplies in addition to services. Second, it now applies to payments to corporations rather than just individuals and partnerships.

The Fort Worth Star Telegram just published an article addressing this. Their point was this is expected to close a $19 billion tax gap. What could possibly be wrong with collecting $19 billion of under-paid taxes each year? And the author rationalizes that business are tracking who they pay and how much anyway. So to require the software to spit out the Form 1099-MISC at the end of the year (something not all bookkeeping software currently does) should be no big deal.

Here is the issue: Many small businesses do not track all expenditures through an accounts payable module that tracks the vendors. We don't - we don't run accounts payable! We actually pay for products and services when we purchase them. The most common example is the purchase of office supplies from stores like Office Depot, Staples, Office Max, etc. (If you think $600 sounds like a lot of office supplies try pricing printer toner and replacement drums.) Can you imagine having to collect tax identification numbers from every store you buy from just in case you have to report it? I can just see me asking the young clerk behind the register what the tax id number for the business is....

One change since the initial bill already made is to exempt payments made by credit cards. That will help if you always pay by credit card. But now not only do businesses need to track which business they purchased from, but how they paid.

I'll agree that $19 billion is a bit more than chump change, but it certainly would help if they also put into place the requirements to make the task manageable.