Beyond EITC, Effective Tax Planning and Assistance

1. Beyond EITC, Effective Tax Planning and Assistance National Disability Institute Mayor’s Leadership Academy Boston, MA – September 27, 2011

2. Selected Issues Affecting Self-Employed Taxpayers • Is free tax preparation assistance available? • Does the taxpayer have net earnings from self-employment? • Must allowable expenses be deducted?

3. Is Free Tax Preparation Assistance Available? • Many self-employed taxpayers can file a Schedule C-EZ; however, a number of issues require a Schedule C. • Schedule C-EZ is in scope for Volunteer Income Tax Assistance (VITA) Programs, but Schedule C historically has not been. • Note: Beginning in the 2011 tax season Schedule C is in scope if the only reason is expenses in excess of $5,000 (but not more than $10,000).

4. Schedule C Pilot • In the past some tax assistance programs decided to train for and prepare Schedule C returns. CFED’s Self-Employment Tax Initiative (SETI) provided funding to support this activity in selected cities. • Recognizing the need to properly serve self-employed taxpayers, IRS - SPEC, the National Community Tax Coalition, and SETI established a pilot to prepare certain Schedule C returns under closely monitored conditions. • A certification test and experience requirements for volunteers were developed. Out of scope issues were identified.

5. Schedule C Pilot – Out of Scope Returns • Total expenses exceeding $25,000 • Businesses with inventory • Businesses with employees • Business use of the home except for day care providers • Accrual basis method of accounting • Net Operating Losses (no resulting carryback or carry- forward)

6. Schedule C Pilot – Second Year • In the first year, partner-developed training and tax preparation by 12 participating programs were reviewed in visits by IRS-SPEC. • Based on the results from the first year, the pilot will be continued for a second year. • A uniform training package is being developed. Testing of volunteers and tracking of results will continue.

7. Does the Taxpayer Have Net Earnings From Self-Employment? • This determination is critical to knowing if self-employment tax will be due and if the Earned Income Tax Credit (EITC) or Additional Child Tax Credit (ACTC) are available. • Net earnings from self-employment of $400 or more are subject to self-employment tax. • Income, even though “earned” by doing something to get it is not earned income for the EITC or ACTC unless it is net earnings from self-employment (assuming it is not employee compensation such as salaries and wages).

8. Was The Income Actually Earned? • Due to the computation of the EITC more income is sometimes better in terms of a refund. • Careful documentation of income received is needed, including payers, amounts, and dates. A separate bank account is best.

9. Is the Activity Self-Employment? • The following items can be helpful in establishing self-employment : • A business plan or other documentation showing an intent to regularly and continuously engage in the activity to make a profit. • Treating it like a business – keeping records of income and expenses. • Documentation that the taxpayer is holding him or herself out as being self-employed and offering services to others.

10. An IRS Position • The IRS has provided two examples of activities that are not considered self-employment even though the taxpayers received Forms 1099-MISC with entries in Box 7, non-employee compensation, and worked for the income. • In both examples the taxpayer does not provide services to others or otherwise appear to be in a trade or business. • Source: http://www.irs.gov/businesses/small/article/0,,id=229048,00.html

11. An IRS Position - Continued • The situations involve: • A taxpayer who is not a trained nurse or therapist paid by an insurance company to care for their disabled or injured spouse. • A taxpayer paid by a state agency to care for his grandchildren so that his daughter can work. • In both situations the taxpayer is advised to report the income on Line 21 of Form 1040.

12. An IRS Position - Continued Consequences of the IRS Position: • The taxpayer is not subject to self- employment tax. • The taxpayer is not entitled to either the EITC or the ACTC.

13. Must Allowable Expenses Be Deducted? • For many taxpayers, more deductions result in less tax liability. • For self-employed taxpayers receiving the EITC for qualifying children, the opposite is sometimes true. • At lower income levels, more deductions can reduce the EITC at a greater rate than a reduction in income tax and self-employment tax because of the percentage differences between the EITC and the taxes.

14. The IRS Position • In 1956, in Revenue Ruling 56-407, 2 C.B. 564, the IRS ruled that “every taxpayer, with the exception of certain farm operators, must claim all of his allowable deductions, including depreciation, in computing his net earnings from self-employment for self-employment tax purposes.” • This Revenue Ruling is still in effect and has been cited in a subsequent Revenue Ruling (57-538, 1957-2 C.B. 55) and a Chief Counsel Advice issued in 2000 (200022051 dated 6/2/2000).

15. Thank you for attending this presentation! Marshall J. Hunt, CPA Director, Tax Assistance Program Accounting Aid Society 7700 Second Avenue, Suite 314 Detroit, MI 48202-2411 313-556-1920 Email: mjhunt@accountingaidsociety.org Website: www.accountingaidsociety.org