The federal Internal Revenue Code (IRC) allows taxpayers to deduct various business expenses from their income for the purposes of computing their total tax bill for a given year, with numerous exceptions. Section 280E of the IRC, for example, prohibits deduction of expenditures involved with “the illegal sale of drugs.” More than half of all U.S. states allow the medical use of marijuana to some extent, but it remains a Schedule I controlled substance under federal law. This is causing problems for businesses that are complying with state cannabis laws. In late 2018, the U.S. Tax Court ruled that a California medical marijuana company could not deduct millions of dollars in business expenditures. The company has announced that it intends to appeal this decision on business tax deductions.

IRC § 162 allows taxpayers to deduct all “ordinary and necessary expenses” that they pay or incur as part of their “trade or business,” subject to various exceptions scattered throughout the statute. The exception for the “illegal sale of drugs” applies to any substance included in Schedules I or II of the federal Controlled Substances Act (CSA), or similarly prohibited by the laws of the state in which the taxpayer does business. The CSA classifies marijuana (or “marihuana”) in Schedule I, which requires a finding that a drug has “no currently accepted medical use in treatment.”

California law takes a substantially different view of marijuana, as do the laws of at least thirty-one other states, the District of Columbia, and several U.S. territories. In 1996, California became the first state in the U.S. to allow the use of marijuana for medical purposes, after voters passed Proposition 215, also known as the Compassionate Use Act of 1996. A 2005 decision by the U.S. Supreme Court, Gonzales v. Raich, held that federal law may continue to criminalize marijuana production, distribution, and possession even when state laws allow those activities. Conflicts between federal and state marijuana laws are an ongoing matter of dispute.

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The Taxpayer First Act (TFA) of 2019, which became law on July 1, makes a variety of changes to the Internal Revenue Code (IRC). Title II, Subtitle A of the TFA, entitled “Cybersecurity and Identity Protection,” addresses taxpayer identity theft. As more and more tax preparation and filing activities move into online spaces, cybersecurity is a growing concern. The TFA directs the IRS to work with the private sector to improve data security, and to standardize and improve its policies and practices regarding taxpayer data. It also increases penalties for misuse of confidential taxpayer information.

What Is Identity Theft?

Identity theft involves the unauthorized use of personally identifying information (PII)—name, address, date of birth, Social Security number, etc.—for financial gain. An identity thief might, for example, purchase items with a credit card in someone else’s name, and leave that person with the debt. In many cases, a person hacks into a private company’s servers steals a large volume of data and tries to sell that data to others. A hacker allegedly gained access to the records of over 100 million people stored on a server owned by Capital One in March 2019. Federal prosecutors allege that the hacker attempted to share this information with others.

Several massive data breaches have occurred in the private sector in recent years. Consumers have incurred losses due to identity theft, and banks, credit card companies, retailers, and other businesses have faced substantial liability. Taxpayer information transmitted online to the IRS, as well as data stored by the IRS, includes numerous forms of PII. Section 6103(a) of the IRC prohibits the disclosure of “returns and return information” by government employees, contractors, and others, except as specifically authorized by law.

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Preparing a tax return can be a time-consuming process. It can also generate a considerable amount of paperwork. Even if you have gone “paperless,” tax records take up space on a computer or external drive that you might rather use for something fun, like family photos or video games. How long should a taxpayer keep tax records? The simple answer is that you should keep records until all applicable statutes of limitations have expired. As is so often the case, though, the simple answer only barely scratches the surface.

What Records Do You Need to Keep?

Almost any document that you used to prepare a tax return could prove to be important down the road. This could include:
– W-2’s, 1099’s, and other forms that show income;
– Receipts, mileage logs, and other documents that show deductions;
– Documents that support any tax credits that you claimed;
– Financial statements for any businesses that you own or operate; and
– Any other documents that support information included in your tax return.

Statute of Limitations for Audits

As a general rule, the IRS has three years from the due date of a particular tax return to audit it. Many exceptions apply, of course. Some are based on the taxpayer’s own alleged conduct, while others are based on the type of information involved.
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In 2003, Congress allowed eligible taxpayers to deduct contributions up to a certain amount to a health savings account (HSA). In order to qualify for the HSA deduction, a taxpayer must be covered by a high-deductible health plan (HDHP). This means that the plan must require the covered individual to pay a rather large amount out-of-pocket before the insurer must contribute. The HDHP is not, however, required to have a high deductible for services deemed “preventive care.” In July 2019, the IRS issued Notice 2019-45, which describes an expanded list of medical services and medications that will be considered preventive care for the purposes of HSA deductions. This is hopefully good news for people who need various preventive medical services.

What Is a Health Savings Account?

Congress created HSA’s in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. Title XII of the bill, entitled “Tax Incentives for Health and Retirement Security,” adds a new § 223 to the Internal Revenue Code (IRC), codified at 26 U.S.C. § 223. It allows “eligible individuals” to deduct contributions to an HSA, with an annual limit of $2,250 for a health insurance plan with single coverage, or $4,500 for a family plan. Additional contributions are allowed for people who are 55 years old or older. In order to be an “eligible individual,” they must be covered by an HDHP.

What Is a High-Deductible Health Plan?

Section 223(c)(2) of the IRC defines an HDHP as a health insurance plan with an annual deductible of at least $1,000 for a single individual, or $2,000 for a family; and an annual sum of the deductible and out-of-pocket expenses of no more than $5,000 for an individual or $10,000 for a family.
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Creating a business entity for your business, such as a corporation or limited liability company, offers a wide variety of benefits. State law governs the formation and governance of these organizations, while federal law governs the aspects that relate to federal income taxes. The Internal Revenue Code (IRC) recognizes two types of corporations:  “C” corporations and “S” corporations. Choosing the form that is right for your business depends on multiple factors, including the existing structure of your business and your goals with regard to matters like financing and growth.

What Is a Corporation?

The primary purposes of a corporation are to allow the owners of a business to operate it as a single legal entity, while also protecting those owners from various forms of liability. A corporation has the authority to enter into contracts and conduct other activities in the same way that real human beings can.

The owners of a corporation are known as shareholders. Their ownership is represented by shares in the corporation, also known as stock. Shareholders are nominally in charge of running a corporation, but they usually delegate this duty by electing a board of directors. The directors further delegate operations to officers, such as a CEO or president, a treasurer, and others. Shareholders may receive a portion of a corporation’s profits in the form of dividends. Continue reading

The overall percentage of federal income tax returns audited by the IRS has been decreasing over the past several years. This is at least partly due to budget cuts, which leave the IRS with fewer resources to conduct audits. People with particularly high incomes have reportedly seen a steeper decline in audit rates than other people, but they still get audited at a higher rate than the general U.S. population.

The apparent decline in IRS audits is definitely not cause to be less careful with one’s taxes, especially for high-income individuals. The Tax Cuts and Jobs Act (TCJA) of 2017 led to significant tax cuts for many people with high incomes, but it also created opportunities for tax write-offs that are likely to catch the IRS’s attention. It may take the IRS a few years to catch up to some of these new opportunities, but they almost certainly will.

Decline in Audit Rates

In 2017, the IRS audited one out of every 160 tax returns that were filed. This was the sixth year of decline in the total number of audits, and the lowest number in fifteen years. The audit rate for individuals with annual earnings of $1 million or more was higher than the rate for the general population, at more than four percent in 2017. That same group, however, was audited at a rate of almost ten percent in 2015. This is also the lowest rate since the early ‘00s.
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Nearly every adult in the U.S. must file an annual federal income tax return with the IRS that discloses their income, identifies tax deductions and credits, and states the amount of tax that is owed. What happens if a taxpayer fails to file on time? The consequences could include penalties and interest, as well as limits on the ability to obtain relief if they cannot afford to pay their tax bill.

What Are the Tax Deadlines?

Federal income tax returns are due on April 15 of each year. If the 15th falls on a Saturday, Sunday, or federal holiday, the due date is the next business day. California has the same deadline for state income tax returns.

Taxpayers may be able to obtain an extension of up to six months to file their federal tax return. This typically requires filing an extension form, and paying their estimated tax owed, prior to the April deadline.
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Congress passed H.R. 3151, a bipartisan bill known as the Taxpayer First Act (TFA), in June 2019. The president signed it into law on July 1. Title I of the new law, entitled “Putting Taxpayers First,” improves procedures for assisting taxpayers and handling appeals. Title II, entitled “21st Century IRS,” improves identity theft protections and directs the agency to make technological upgrades. This bill replaced an earlier version, H.R. 1957, which had been introduced in March. A series of media reports in April led to criticism of several provisions in the first bill. Those provisions were removed in the reintroduced bill.

Office of Appeals

Section 1001 establishes the Internal Revenue Service Independent Office of Appeals (IOA) to “resolve Federal tax controversies without litigation.” The TFA identifies three main goals for the office:
1. Fairness towards both taxpayers and the IRS;
2. Consistent enforcement of tax law, along with “voluntary compliance” by taxpayers; and
3. “[P]ublic confidence in the [IRS’s] integrity and efficiency.”

Taxpayers who receive a notice of deficiency can request a referral to the IOA. If the IRS denies the request, the TFA requires it to provide written notice to the taxpayer explaining the reasons for the decision and explaining the procedure for filing a protest.
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In recent years, taxpayers have been investing in virtual currency to exchange monies in the virtual marketplace or hold on to as investment assets. One of the subgroups of virtual currency is cryptocurrency, or a digital form of currency traded or secured using cryptography. The emergence of this digital asset has yet to provide definitive tax guidelines for taxpayers and tax practitioners, particularly for taxpayers who are concerned about their privacy rights in cryptocurrency. However, one thing is clear when it comes to virtual currency: taxpayers must pay their taxes on the gains made from the profits on virtual currency. If not, taxpayers will reap the consequences of enforcement from the IRS.

The IRS has provided some guidance to the virtual currency debacle in the form of Notice 2014-21. The IRS defines virtual currency as a digital representation of value that functions as a medium exchange, a unit of account, and/or a store of value. Virtual currency can act as a substitute for real currency, also known as “convertible” virtual currency, but does not have legal tender status in any jurisdiction. An example of a convertible virtual currency is Bitcoin, which can be digitally traded between users and exchanged into US dollars, Euros, and other real or virtual currencies.

Based on that comprehensive yet confusing definition of virtual currency, taxpayers may wonder how virtual currency might be treated for federal tax purposes. According to the IRS, virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. That means taxpayers who receive virtual currency as payment for goods or services must include the fair market value of the virtual currency, measured in US dollars, the date that the virtual currency was received. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.

Last month, the House Ways and Means Committee unanimously approved a bill to allow same-sex couples who married before the overturn of the Defense of Marriage Act (DOMA) to amend their filing status and claim their tax refunds as jointly-filed spouses. If enacted, this bill would be a huge step for the government because it would make an exception to the three-year statute of limitation rule for taxpayers to claim their refunds.

The purpose of H.R. 3299, or the Promoting Respect for Individuals’ Dignity and Equality (PRIDE) Act of 2019, is to permit legally married same-sex couples to amend their filing status for income tax returns outside the statute of limitations and to amend the Internal Revenue Code of 1986 to clarify that all provisions shall apply to legally married same-sex couples in the same manner as other married couples. It incorporates language from H.R. 3294, the Refund Equality Act, and H.R. 1244, the Equal Dignity for Married Taxpayers Act. This bill would provide same-sex couples, who married before the Supreme Court’s decision in U.S. v. Windsor, an opportunity to claim their tax refunds and would remove gendered language such as “husband” and “wife” from the Internal Revenue Code to accommodate same-sex married couples.

Prior to the Windsor decision, federal law defined marriage for federal purposes as the union of one man and one woman, and allowed states to refuse to recognize same-sex marriages granted under the laws of other states. DOMA barred same-sex married couples from being recognized as “spouses” for purposes of federal laws, effectively barring them from receiving federal marriage benefits such as the filing of joint tax returns and federal refunds from those joint returns. Although the Supreme Court declared section 3 of DOMA unconstitutional under the Due Process Clause of the Fifth Amendment, the IRS lacks the authority to override the three-year limitation on which a claim for refund can be made.

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