FAQs

5 Things To Consider If You Win It Big

I’ve been asked many times what you should do if you win the Megabucks or the lottery. So here are a few suggestions (not all need to be taken seriously):

1. Don’t tell anyone you won (except contact your CPA immediately). You should also contact your financial advisor and attorney, too.

2. Don’t spend any of it (except the 10% fee to your CPA which you should pay immediately). Generally, there’s no rush to share your wealth with family and friends.  Think about what you want to do with it first, plan it out with the help of your financial advisor, attorney and CPA.  You can always spend it later.

3. No one escapes paying taxes. The payer reports prizes and awards more than $600.00 to the IRS.  If it is not reported on your personal income tax return, you will receive a notice or inquiry from the IRS.  Remember the first guy who won the Survivor reality TV show?  He won the $1 million prize but failed to report it on his personal income tax return.  He was caught because the $1 million in prize money was already reported to the IRS by the television show but there was no corresponding amount reported on his personal income tax return. Generally, I would assume a 35% Federal tax rate and an 8.25% Hawaii tax rate.  So, for example, if you won $30 million (and opted for the lump-sum option), expect to pay about $13 million in taxes.

4. As a rule of thumb I tell people that on a one time payout, you will get to keep roughly 40% of the jackpot. So with a $1.5 billion jackpot you’d keep about $600 million after taxes. It will vary by the winner(s) state residency and other factors.
5. You can gift up to $13,000/year per person without any gift tax consequences. If you receive a gift – the gift itself is neither reportable nor taxable on your income tax return.  The person who makes the gift, though, may have to file a gift tax return to report it.

The penalty for the uninsured starts at $95, or 1% of taxable income in 2014, whichever is greater. In 2016, it will increase to the greater of $695 or 2.5% of taxable income. Unlike income levels subject to increased Medicare taxes, which are not indexed for inflation, the penalty for failure to insure will be adjusted for inflation. Subsidies will be made available to those who can’t afford insurance.

I recommend reporting it because it helps to look for it next year.  If I see it on last year’s tax return, I’ll ask what happened to it for this year.  If I don’t see it, then I won’t ask for it. In most cases, it will not increase your income tax much if you do report it. As always, it’s up to you whether you want to provide the year-to-date interest amount if it’s less than $10.00.

It depends because there are limits on its tax-deductibility.  For example, if you make $100,000 in income, have $10,000 in out-of-pocket medical expenses and you’re under age 65, it’s not tax-deductible.  The limit is any medical expenses over 10% of your AGI is tax-deductible.  If you have $11,000 of medical expenses, only $1,000 of it would be deductible.  If you’re over age 65, then the limit drops to 7.5% so $10,000 of medical expenses means you could deduct $2,500 of it.

I won’t know until I start preparing your tax returns so I couldn’t tell you until early 2014 whether to track your 2013 medical expenses, which is too late.

SO I tell my clients it’s best to track your medical expenses every year.  It’s a good habit to track them and perhaps there might be a year where it will prove to be helpful.

Wikipedia describes it as, “the collective effort of individuals who network and pool their money, usually via the internet, to support efforts initiated by other people or organizations.”  You can read more about it in greater detail here.

I’m not going to go into too much detail on this but I will state that the tax issues were unusual.  Are the individuals who participate in crowdfunding investors?  Customers?  Donors (as in a gift)?  But in the one situation I looked into, the money would be taxable by the recipient (to the person or business who proposed the project and received the money).  And since the project/business was in the State of Hawaii, the money could also be subject to Hawaii general excise tax!

This was something I heard of, but have no direct experience with. As you’re aware, personal income tax returns must show your social security numbers. It is important that you do not lose your copy of the tax returns and that you keep it in a secured place.

But there are two recent twists I’ve heard recently that you should be aware of:

• The use of children’s social security numbers, which are also disclosed on the parents’ tax returns. Identity thieves use these illegally obtained numbers to obtain credit cards, for example. And what’s worse is that many parents do not think to check their children’s credit or credit reports. Who would when they’re minors?
• Falsely prepared and filed tax returns. Some “tax preparers” would file fraudulent tax returns to obtain huge tax refunds under illegally obtained social security numbers. This would be done as early as possible in the tax season so by the time the real, correct person files their tax return, the IRS would reject the actual tax return. And clearing it up with the IRS would be time-consuming and would delay in processing your tax return.

Generally, the IRS only knows what is reported using your social security number (SSN). Tax forms such as W-2’s, 1099’s, Schedule K-1’s & etc. are all reported to the IRS BEFORE you file your personal tax return. If you fail to report this information on your tax return, it creates a discrepancy which the IRS will mostly likely send you a letter asking you for an explanation.

So it’s important to provide your tax preparer all information reported/using your SSN. If, you open a bank account for your newborn or grandchild (i.e., a minor), your SSN or the child’s SSN can be used. Generally, it’s better to use the child’s SSN but it’s an issue you should consult with your tax preparer before you open the account.

I’ve heard many times about these situations, “oh it’s not my money in the account.” It doesn’t matter whose money is in the account. Whatever SSN is used is critical because it was used to report the interest income earned to the IRS. There are ways to adjust and correct this, of course. But the first goal is to avoid needless IRS inquiries simply because the incorrect SSN was used or not properly reported.

I had a client whose father opened a bank account in his son’s name and SSN that earned substantial interest income. My client was unaware this was done so after he filed his tax return, he received an IRS notice with a substantial amount due. Ignoring the gift tax implications of what was done, my client had to pay the additional tax due along with the penalties and interest.

1. “Private School Tuition is tax-deductible.”
No, tuition to Punahou, Iolani & other similar private schools are not tax-deductible. I heard this from a client who had a friend (a physician) who said it was tax-deductible. Yeah, no. If the child is in pre-school or if it’s for after-school care, then such costs can qualify for the child care tax credit. The school does breakout/separately state such costs for the parents on their invoices, but not the tuition proper.

The child’s grandparents can pay the tuition directly. There is no tax deduction but it is also not considered a gift by the grandparents. Generally, gifts of more than $13,000/year per person must be reported to the IRS by the person who made the gift (the grandparents in this example). So, tuition paid by the grandparents would normally require to be reported to the IRS, except for this specific exception.

2. “You can deduct as charitable contributions for services rendered.”
Got this question a couple times. There is no tax deduction for donating your time and services for charity. The only time you can is if you report the same donation amount as income. For example, if I were to prepare a tax return for a non-profit organization for free but it’s worth $1,000 in my billable time, I cannot report a $1,000 donation as a tax deduction unless I report the same $1,000 as income for my business. And since that same $1,000 is subject to Hawaii general excise tax, I’d have to pay 4% (actually 4.5% because of the county surcharge). So a $1,000 donation would actually cost me $45 in GET. It’s the law. Don’t like it, too bad.

3. “Country club dues are tax-deductible.”
Dues paid, for example, to the Waialae Country Club are not tax-deductible. The IRS specifically disallowed this tax deduction. It’s common that the monthly invoice from the club includes things such as green fees and the cost of meals. Those can be deducted as meals & entertainment expenses (only 50% of the cost is tax-deductible), but not the amount of the due itself. If a CPA is deducting it, I can guarantee it is not reported as such on the tax return. More likely, it’s included in “advertising” which is not correct.

4. “The clothes I wear only for work is tax-deductible.”
Yeah, again, no. For many of us in Hawaii, we end up buying clothes for work that we would never otherwise wear – that particular blouse or aloha shirts in general; slacks and those uncomfortable dress shoes. No. The only clothing costs that are deductible are those for protective purposes – such as protective clothing or shoes required to perform your duties such as work boots/shoes for construction workers or the cost of uniforms for military personnel. Generally, hospital scrubs qualify, though, as I understand it, people have started to wear them outside of work. The IRS view is that clothes that can be worn outside of work, regardless that you would or not, means it’s a personal expense. So, even though you bought clothes from Ann Taylor only because of work and you wear it only at work – it’s still a personal and non-deductible expenditure.

5. “Meals for my employees are tax-deductible.”
Yes and no. There are several instances where it is tax-deductible. One, is if it’s for special occasions such as a company picnic or holiday dinner. Generally, it must be available to all employees (no discrimination or only certain employees can go). Whether they go or not is not important, only that they are given the opportunity to do so. And it must be “special”, meaning rare or not often.

I should mention that providing things like donuts for the office does not fall under this discussion. Also, meals while traveling is also not discussed here.

The general term commonly used is, “for the convenience of the employer”. And sadly, not many examples are given so it’s a bit hard to interpret. But it is mostly used to refer to instances where the employee cannot easily obtain food on their own. Construction workers who work at sites where there are no restaurants or even lunchwagons. Or, the job requires the employee to stay on site such as hospitals. In those places, cafeterias are provided and the cost for providing such places are fully tax-deductible by the employer.

I do not think this phrase applies to instances where the employee goes out to McDonald’s and brings it back, regardless of it’s during normal business hours or staying late. It also doesn’t apply to the employee-owner of the business who buy their own lunch everyday. I buy lunch every day (I’m too lazy and not much of a cook) but I don’t/can’t deduct the cost.

The only real instance where paying for an employee’s meal is tax-deductible is if you include in their W-2 pay. So, for example, if you paid for $50 of meals, the $50 is their “net pay” and you have to pay payroll taxes on it so the “gross pay” would be mostly likely around $60 (the $10 is used to pay the payroll taxes). Of course, this is not what employers want to do so it’s not done too often. So yes, paying for your employee meals is not generally tax-deductible.

1. Copies of your tax returns and documents.
Please keep in mind that all tax preparers/CPA’s should provide you with a copy of your completed tax return for your records and return the original tax documents. I am not only talking about annual income tax returns like 1040’s, but business tax returns (1065, 1120 & 1120S), including payroll tax returns (941’s, W-2’s, W-3’s). If they do not, they are not carrying out a crucial part of their duty and responsibility to their clients.

2. CPA’s are not your personal keeper of your records.
What I keep in my files are my own records, not yours. So it’s important that you keep copies of your tax returns and tax documents. If, for whatever reason, you decide to change accountants, it can be awkward, time-consuming, not to mention difficult to obtain the cooperation from the prior accountant for copies of tax returns and documents that the successor requires.

3. Requests for additional copies.
I do not mind providing extra copies if the originals have been lost, but do not ask for them simply because it’s easier to ask me than rummage through your home for it. Please consider keeping all of your tax records in a single, accessible location.

I had a boss who recommended that you keep copies of your tax returns, “forever”. And unfortunately, in at least one instance, it proved crucial. However, that normally is not feasible. I would recommend you do several things, though:

• Depending on the type of tax records, read through IRS Publications 552, Recordkeeping for Individuals and 583, Starting a Business and Keeping Records. You can find them here.
• Generally, though, you keep copies of tax returns for at least 3 years from the date the tax return was filed. So, for example, you would keep your 2010 tax return through the end of 2014 because your 2010 tax return was completed in 2011.
• But I would recommend that you keep it for at least 6 years but not longer than 10 years. If the IRS believes there might be fraud involved in preparing your tax returns, the statute of limitations prohibit the IRS from going back further than 6 years.
• Businesses can request from the IRS and State of Hawaii what’s called a “tax clearance”. A tax clearance means simply that, as far as their records go, the business has filed all necessary past tax returns and there is nothing outstanding.
• You can reduce the paperwork you keep by discarding the superfluous. For example, brokerage statements. You generally receive both monthly statements as well as an annual, year-end summary. You can shred the monthly statements and keep the annual, year-end summary. I would keep, as another example, the last paystub for the year (and not just the W-2) and shred the rest.
• But keep in mind that deciding what records to keep and what can be discarded varies based on the individuals or business needs. There is no hard and fast rule for everyone because we’re not all the same. So, please discuss with your CPA what records should be kept and what can be shred.
• Going paperless. My records are paperless-based, including client’s tax returns and documents. It saves a lot in space, not to mention paper and toner. I am also slowly providing my clients CD copies of their tax returns instead of paper copies. All original, paper tax documents, though, like W-2’s, 1099’s will continue to be returned to the clients.
• You may want to consider doing this for yourself as well. Please keep in mind, though, two things. One, CD’s generally last only 10 years. And two, they are easier to lose, whether it’s an online record or a CD, so having it password-protected and other such protection is needed.

DO NOT PAY IT.  If you are not disputing the penalties and interest and you already sent in a check, do not send another one.  The slight increase in the amount due in the 2^nd notice is for additional interest assessed from the date of the 1^st notice.

DOTAX takes about 6 to 8 weeks to cash checks from the date they received it.  DOTAX also does not record receipt of the check until it is deposited.  However, DOTAX computers will send out a 2^nd notice within 30 days of the 1^st notice if no payment was received.  But, as far as DOTAX is concerned, no payment was received because their computers have no record of the payment – even though you paid it on time.

I understand many taxpayers, afraid to get in further trouble with DOTAX, pay the amount due on the 2^nd notice.  DO NOT DO THIS.  You will not only have paid the same amount twice – you will not get the 2^nd payment returned to you.  DOTAX will not refund any erroneous payment they receive, at least not without requesting for it.

So, when you get the 2^nd notice (and it’s likely you will even if you paid it with the 1^st notice), do not pay it.  You inform DOTAX that you already made a payment and have a copy of the check ready to send to them.  You should also verify with your bank that the check has not yet cleared.