Manipulating SE Income

[Edsel]

Businessman files joint with wife and two kids. Normally makes middle-to-high income living and tax reporting is commensurate with this.

For the most recent filing year, the fangs of the recession bite into his income, and it is so low that he qualifies for EIC. Which of the following (if any) is proper? (I'm sure we are in universal agreement about the first choice)

a) Taxpayer omits deduction of normal operating expenses that he has consistently deducted in the past. By leaving off these operating expenses, he positions himself at the optimum level for EIC.
b) Taxpayer consistently has taken maximum MACRS-allowed depreciation in the past. For the year in question, he chooses alternative lives for new purchases. The maximum election would create virtually zero profit on his schedule C. By choosing alternative lives and straight-line, he positions himself at the optimum level for EIC.
c) Same as b) above, except for 3yr property he chooses maximum depreciation and for 5yr and 7yr property he chooses minimum lives and methodology. This course of action positions himself at the optimum level for EIC, whereas consistent depreciation among the classes would create very little EIC.

I'll be the first to show my hand. Obviously a) is improper, but I would allow either b) or c). I don't have the same confidence in c) that I have in b).

That's why they have these elections. The election in one year is not binding on the next for new purchases, and the election for one class is not binding on another.

[ChEAr$]

Your three answers are absolutely correct.

[oceanlovin'ea]

I agree with you. Number 1 is not allowed.But 2 or 3 would be fine.

Linda, EA

[DaveO]

I take "B" on a regular basis when it applies. "A" is out of the question and "C" is probably okay as long as the alternate class life is allowed.

[MilTaxEA]

Just to elaborate on your first point. Page 5-23 in TTB:

The Self-Employment Contributions Act of 1954 requires every taxpayer to claim all allowable deductions, including depreciation, in computing net earnings from self-employment for SE tax purposes. (Rev Rul 56-407)

[DaveO]

Just to elaborate on your first point. Page 5-23 in TTB:

The Self-Employment Contributions Act of 1954 requires every taxpayer to claim all allowable deductions, including depreciation, in computing net earnings from self-employment for SE tax purposes. (Rev Rul 56-407)

I fully agree with your point. What about the case were the taxpayers mileage records are a mess or non-existent? You have reason to believe they incurred some mileage expense but not as much as claimed. Reducing the expense to a reasonable level then puts them in the EITC sweet spot. Balancing between expenses based on provable documentation and the dynamics of the EITC can be tricky.

On the flip side I had an audit recently where the auditor requested documentation of items of income. It was without question the money was earned, deposited into the account and reported on the return. He wanted sales receipts and work orders. The client could produce some but not all since he tended to work on a handshake and a promise. When I went back to the auditor I explained that we couldn’t produce the work orders and we would have no choice but to remove the income from the return. He didn’t find that near as funny as I did.

[Burke]

I When I went back to the auditor I explained that we couldn’t produce the work orders and we would have no choice but to remove the income from the return. He didn’t find that near as funny as I did.

But I love it even if he didn't. Great answer!

[Gary2]

I fully agree with your point. What about the case were the taxpayers mileage records are a mess or non-existent? You have reason to believe they incurred some mileage expense but not as much as claimed. Reducing the expense to a reasonable level then puts them in the EITC sweet spot. Balancing between expenses based on provable documentation and the dynamics of the EITC can be tricky.

My guess (and I emphasize guess) is that this is where the "Do you have evidence and is it written" questions come into play.

Claim whatever mileage seems to be closest to the honest answer, say no to one or both of those questions, and let the IRS decide how much to allow or disallow based on the evidence (assuming they do so fairly).

[Gretel]

Just to elaborate on your first point. Page 5-23 in TTB:

The Self-Employment Contributions Act of 1954 requires every taxpayer to claim all allowable deductions, including depreciation, in computing net earnings from self-employment for SE tax purposes. (Rev Rul 56-407)

Sure, agreed. Poster never suggested not to take depreciation. Every year I make depreciation choices based on what makes most sense for my client. I often choose ADS/straight line. If this increases EIC fine but this is not my goal. My goal is to have depreciation left for coming, hopefully more prosperous years.

[JohnH]

Smart practice. Every now and then I see a new client with a return taking section 179 on a self-employed person in the 15% marginal bracket and I ask myself "What was the other preparer thinking?"

[Rae]

Sure, agreed. Poster never suggested not to take depreciation. Every year I make depreciation choices based on what makes most sense for my client. I often choose ADS/straight line. If this increases EIC fine but this is not my goal. My goal is to have depreciation left for coming, hopefully more prosperous years.

Oh yeah.... I had a new client (because former tax preparer dropped dead at the beginning of the season - don't know WHAT she was thinking) where the previous preparer took HUGE sec 179's & bonus dep so they'd get the EIC. Then when I took over the well was dry and they had to pay in $10,000. Lucky she was dead because they would have killed her. She never once explained how it's works to them or asked them. I always explain how it works and go through the pros and cons. What the previous preparer did will hurt them for 7 years!

[Gretel]

. I always explain how it works and go through the pros and cons. What the previous preparer did will hurt them for 7 years!

Amen. This also confirms my believe that most of the posters on this board really care (at least those who stay).

[Burke]

And since I can see retirement coming faster every year, I am making sure that the TP gets every worksheet I can print out of my software to go in their copy of the return. Depreciation, office-in-home calcs, loss carryovers, clergy worksheets, state tax refund calcs, etc. You never know when you are going to drop dead, or get out of this business and the next one is going to need all that stuff. A former preparer once told me, "it's like having a baby. You say that's IT, but a year goes by, and pretty soon you forget and think -- maybe it wasn't so bad after all."

[Gretel]

And since I can see retirement coming faster every year, I am making sure that the TP gets every worksheet I can print out of my software to go in their copy of the return. Depreciation, office-in-home calcs, loss carryovers, clergy worksheets, state tax refund calcs, etc. You never know when you are going to drop dead, or get out of this business and the next one is going to need all that stuff. A former preparer once told me, "it's like having a baby. You say that's IT, but a year goes by, and pretty soon you forget and think -- maybe it wasn't so bad after all."

I like that comparison. Yes, I print out the worksheets with the calculations. I want my clients to be free to do whatever they please in the coming year and not throw obstacles in their way. I am not sure I pay enough attention to printing ALL the worksheets though. Thank for the reminder.

[JG EA]

Oh yeah.... I had a new client (because former tax preparer dropped dead at the beginning of the season - don't know WHAT she was thinking) where the previous preparer took HUGE sec 179's & bonus dep so they'd get the EIC. Then when I took over the well was dry and they had to pay in $10,000. Lucky she was dead because they would have killed her. She never once explained how it's works to them or asked them. I always explain how it works and go through the pros and cons. What the previous preparer did will hurt them for 7 years!

As I have often said before - I shy away from having my clients sign things like they are criminals.... but one thing I do, is make them sign a form I made up if they take 179 for a lot of money just to give themselves a break in current year without regard for the future. I want them to know how important a decision they are making.

However, I don't put it with their the return so the next preparer may say "What was that preparer thinking?"