Where does one start?

[rtsietsema]

Friend ask me to review step-daughters returns. She does day care and has used five preparers in five years, including two EA's.

Here are my most pressing errors. Ideas on how to proceed are greatly appreciated.

1. 2008 preparer started depreciating items like furniture, TV etc. in a home she shared, but had no ownership. She owned none of the items valued in excess of $8,000.

2. Subsequent preparer's carry forward the depreciation, at times using incorrect amounts.

3. Client purchases home in June 2011, with her friends as co-signers. She alone occupies the home and pays all expenses, but has the friends names as co-signers. She will run the daycare here.

4. 2011 tax preparer tells client to start using the home for office in the home expenses against the business income, even though the day care isn't moved to the new home until 2012. Improvements were being made to the home and don't show up on the 2011 or 2012 returns.

5. 2012 and 2013 returns have errors on the amount of space and hours used for daycare, the basis of the home as well as other omissions competent preparers should catch.

Of course the client is clueless, naive, and has poor records. She means well, but needs help getting the business records and tax returns straightened out. Correcting the area calculations and hours used for daycare will be in her favor.

The 2008 - 2010 are beyond amending, but the erroroneously depreciated items should be fixed somehow shouldn't they? And what to do with the OIH when the business wasn't even there?

[Koss]

Correcting Errors

The 2008 - 2010 are beyond amending

The 2010 return can still be amended. The due date for that return was April 15, 2011, so an amended return can be filed until April 15, 2014.

the erroroneously depreciated items should be fixed somehow shouldn't they?

I don't think I would mess around trying to correct anything earlier than 2010. Yes, there is a process for correcting errors in depreciation, and it is not limited by the three-year statute of limitations. It may or may not be applicable to your client's situation. It involves Form 3115, Application for a Change in Accounting Method. If you really want to go there, you'll need to read Revenue Procedure 2011-14.

I would certainly advise the client to file amended returns for 2010 through 2013.

And what to do with the OIH when the business wasn't even there?

Ummm... that's not allowed. You can't take a home office deduction if there is no office in the home. So it would have to be removed on an amended return.

BMK

[DonB]

1. 2008 preparer started depreciating items like furniture, TV etc. in a home she shared, but had no ownership. She owned none of the items valued in excess of $8,000.

How about stopping the depreciation like you would if the item were converted to personal use?

[rtsietsema]

Stopping the depreciation is obvious at this point. My concern was that it never should have been taken continues to follow her for all years in which it was.

Is is possible to recapture the accumulated depreciation in an amendable year and stop the bleeding? Or does that draw too much attention to the fact that errors were made in the first place?

[JohnH]

Part of the answer is relevance.
How much depreciation was taken, and what was the net tax effect?

You also mentioned some adjustments that might be in her favor.
What's the bottom line once everything washes through, both pro and con?

[rtsietsema]

I'm still trying to work through the numbers, but depreciation on items that never would be allowed is around $6000. With SE, her tax bracket and State we are looking in excess of $2100 just to correct that.

Removing the OIH from 2011 will will have about the same impact. So she is down at least $4200 before we can begin to try and recoup from amending 2012 and 2013. I'll run the numbers, but she might break even. Unfortunately she would be laying out the payments, before receiving the refunds, if everything is accepted.

Then, of course, will be the cost of straightening this out. My fee will need to be substantial for the time it will take.

[Roberts]

They depreciated assets they didn't own?
Dang, why didn't I think of that?????

There is a Malaysian airplane I could start depreciating.

[rtsietsema]

Better yet was the EA who started taking OIH prior to the day care being operated in the home. She bought home in 2011, spent time to fix it up and moved the business there in 2012, but took OIH in 2011!

Whoops....

[Nashville]

What is our Liability?

It's not my nature to run away from problems, but just how much of this mishandling is our liability to correct? I think at a minimum we should advise taxpayer to amend prior returns, but if she is not engaging us to do the work, then is it our responsibility to put Humpty Dumpty back together again?

Before you think I am too complicitous to the errors in prior years, think of it this way... New client comes in and has a daycare. Does not have copy of prior year return and for all we know, this is first year in the daycare business. Client admits to keeping childerns for 5 years but tells you she doesn't have any records at all. If this is the case, is your liability any different?

My point (if there is one) is "ignorance is bliss". Sometimes it really is. Maybe we should look at the definition of "scienter" from a legal perspective.

[JohnH]

I agree.
Wholeheartedly.

(And I've forgotten what "scienter" means, even though you taught it to us long ago, Ron.)

[rtsietsema]

That's part of my problem. I looked too closely and found out things I wished I hadn't and now I know too much. Can I in good conscience ignore the past, correct the space usage and hours for the OIH, and other errors that are easy and obvious without dealing with it?

Amending any return that has MACRS being carried forward erroneously would require me to at least take it off, and offer what explanation for making the adjustment? Do I tell the IRS it should have never been? Saying it went to personal use is a lie. They stopped using it is a lie. And saying they sold it is a lie. If I try to fix anything, I almost have to try it make it as right as possible.

[Nashville]

Ignore MACRS

If you subscribe to the "see-no-evil, know-no-evil" discussion above, you would go forward with no treatment or even acknowledgement of prior MACRS property. That would leave the responsibility of explaining the depreciation of non-existent furniture to the preparer who perpetrated the hoax. Focus on 2013 and leave 2008-2012 alone unless you are engaged to clean up the mess.

[rtsietsema]

I have made the client aware of the mess, and the possible outcome if the IRs questions those returns. She is tempted to put her head in the sand and is asking me to correct things more recent.

My fear is making corrections to the OIH for proper usage of space imight raise a flag. Her space usage, since she is single and has areas of the home 100% dedicated to daycare, is close to 55%. The returns for 2011, 2012 and 2013 have it as 34%, 27% and 29%. Would a correction of that much error cause the IRS to question more things?

Of course 2011 OIH should never have happened, and maybe the best way to start there. Throw that out, then start it correctly in 2012 and move forward. Correcting 2012 and forward makes no sense, since I know the house wasn't even used for all of 2012, much less 2011.

And......kind of ignore the depreciation errors in the past?

[Koss]

Airplane

They depreciated assets they didn't own?
Dang, why didn't I think of that?????

There is a Malaysian airplane I could start depreciating.

I think that particular asset has been withdrawn from service...



BMK

[rtsietsema]

I'm still in a quandary as to just drop it off the amended return and list "No longer in service" as the explanation, or try to drop it off and recapture several thousand dollars on Form 4797.

My drive for correctness leans toward the latter, but the first might be the neatest option. How can I list an asset sold on the 4797 she never did have? I might have answered my own question. I can't.

Final solution, fix the OIH, drop the assets off the return and don't look back?

Thanks for all the opinions. It has helped.