Norris Bruce
Feb 28, 2014

Amanda Han and Matt MacFarland of Keystone CPA Join Bruce Norris on the Real Estate Radio Show #371

Amanda Han and Matt MacFarland

Bruce Norris is joined this week by Matt MacFarland and Amanda Han with Keystone CPA. They are owners of Keystone CPA in Orange County, voted one of the top 100 CPA firms. Bruce has had the privilege of speaking with them in front of at least 4 or 5 audiences. Bruce has always learned something from them since they have an expertise in real estate. They have been in their own business now for seven years. Bruce was pleased to speak with them since they saved him money and he has learned something every time he has heard them.

Bruce said one of the words that hits him first is the word “strategy.” Bruce asked since we are almost in March if most of the strategy they will be implemented for 2014 as opposed to 2013. Amanda said this a good question since the answer is yes on some levels. A lot of the significant strategies like entity structuring is something that is only available now in 2014 since we cannot change how we did business and invested in real estate for 2013. It is not a one time a year event; you actually have to give it some thought prior to tax time. It is never too early to start doing tax-planning. The best time to talk to your CPA is before you enter into a transaction, whether this is buying or selling real estate. Before you actually sign on the dotted line, there are other ways to potentially structure things. After the fact it is much harder to rework what you have already done. This includes how you take income or if you try to do some tax-planning strategies like a 1031 exchange or even set up retirement accounts. Most of this has to be thought of before the end of the year.

Amanda said a lot of retirement accounts had to be set up before the end of the year. This is one of those special areas where thankfully for any of the taxpayers out there who have not done planning, there are still a lot of different types of retirement vehicles that could be available today that can help us save taxes for 2013. For example, different types of IRAs such as SEP IRAs or simple IRAs are still available and could really help someone to save a significant amount of taxes upwards of $40-$50,000. This still could be funded into retirement accounts today for last year. This can get very significant when you start doing this and avoiding the taxes. This saves a lot of money up front and starts growing at a much faster rate.

Bruce asked if this is also true with a 401k or a defined benefit plan. The powerful impact these can have is the same or can be more powerful than just a SEP or simple IRA. These are the kinds of accounts Bruce was referring to earlier that need to be set up ahead of time before the end of the year. Part of this can be funded for last year if the account was set up. It really depends on people’s situations, whether they have the account set up or not already they could probably still utilize it. Unfortunately, now they won’t be able to set it up and still be able to contribute. There could be some opportunity here, it just depends on everyone’s situation.

What is neat about the meetings Bruce has with Matt and Amanda along with Kaaren Hall is they have all found they learn from each other. Bruce mentioned this the last time they had their quarterly meeting. It is really important to think of it as a team event; and you really need to orchestrate a team with different expertise to get the complete result you want. It is not one size fits all, and anybody who thinks they can do their own taxes because they can fill in the blanks of turbo tax is probably missing some things that will prove costly. Turbo Tax is kind of a reactive approach. You are basically entering data and telling the software what has happened in the last year. Unfortunately, what it cannot do is be proactive and strategic in helping you plan for the future.
Amanda said she really liked what Bruce said about the collaboration of a team of advisors. Matt and Amanda help people to identify what strategies can help reduce taxes, retirement accounts being one of those strategies. It is important for people to understand this. We do not just want to put money into retirements to get the deduction, but the question is how we correctly deploy the funds once it is in the retirement. Another question is what the best ways are to invest in an asset since you do not just want to put the money into a checking account and let it sit there earning no interest.

Bruce had just been speaking that morning, and right before it was his turn to get introduced there was somebody up there saying he heard the IRS had hired a lot of agents to do audits this year. Bruce asked if this was true, to which Matt said he has heard of this. You hear almost conflicting information because you hear on one spectrum that they are hiring more people, but on the other spectrum you hear they are cutting back as well. The question is who has the right information. Matt thinks it is a mix of things, such as they are hiring more people to do audits but cutting back on other things. Recently they started cutting back on some electronic services people could access online. This is unfortunate because it seems like the way you would want to go is more electronic and less people dependent.

Matt has heard audits will go on the rise. They have always focused on certain areas that are being abused, but this is always out there. There are also always rumors about if you file an extension for a certain reason, you are at a lower risk for an audit. Bruce wondered if this was true or false. Amanda said this is actually not true, although she has heard this quite a bit. She asked one of their colleagues her and Matt used to work with in the “Big Four” since she is not with the IRS. They are very secretive about things like this, but essentially what they found out was on their end you figure someone who works at the IRS has to work all year long and does not have a quota that says you must finish a certain number of audits between January and April. For them, the workload is essentially the same.

From a tax law perspective, the open period you have is three years from the date your return is actually filed. This is the timeframe when you can be audited. If you filed in April, then three years from this April is when you could be audited. If you extended it and filed in September to October, then you would have three years from this date. There is really no truth to this comment about extensions being a safer bet. Bruce wondered if you increase your chances of an audit if you still do the taxes yourself. Matt jokingly said if you fill out your tax form by pen, they may just send it back to you and tell you to do it electronically.

Bruce asked what the overall odds are of being audited. Matt said he does not know the exact percentage, but it is really low. They come out with these every few years and show stats from 3-4 years ago. It is likely less than 5%, and the truth behind it is that it really depends on what you have going on. The likelihood of somebody with a W2 in a primary residence being audited is probably very slim compared to somebody who has five businesses. Amanda said the profile of each taxpayer also changes the risk levels. For example, if you have a business with average income to expense ratio, the audit risks will be less. A company with 0 income and $50,000 in expenses will be subject to higher audit risk.

Bruce asked if crime pays in the sense that some people have done things where they were never caught, and it was ridiculous that they were never caught for it. These people just shake their heads and think that it is perfectly fine. Bruce forgets to cross one T and somebody from the IRS calls him. In a way, it seems they target the most profitable group to pursue. Amanda said before starting Keystone CPA, she used to work at a bank international company. She knows that a lot of large international companies are on what is known as automatic audit, which means the IRS kindly requests you to sign a waiver allowing them to audit you every year. They always kindly agree because if you don’t, then they will make your life uncomfortable. It is an unspoken understanding with most large multinational companies that their numbers are audited. For smaller business owners or someone with a very simple return, the likelihood of this being audited is small because revenue-wise it is not as lucrative for the IRS to look at it.

Amanda said they have clients who are very conservative and do everything correctly. They want to make sure they are able to sleep at night. Then there are other clients who really want to push the limit and get into the gray zone of what is right and what is wrong. This is really up to each person’s comfort level. Bruce said there are some people in their circle who have not filed a tax return in 8 years. They never really hear from anybody and wonder if they are off the grid. Matt said they had a client whose business return they had been working on, and they were recently in a similar situation. They were contacted by the IRS in the 2006-2007 year because they did not file a return and had a lot of stock sales. Finally, the IRS caught up to them. It is only a matter of time before they see who did not file. If they have a 1099 or W2 that is sent to the IRS, they are going to get a letter sometime in the future. It is really a matter of if you want to take care of it now or later. The three year gap did not apply to a tax return that was not filed. The clock does not start ticking because you haven’t filed a return.

Bruce asked what penalties start to occur for a federal and for California as far as filing for something one year and owing a certain amount. Bruce asked about the progression and if the state is nastier on the penalties in interest. Matt said that generally the IRS has a higher percentage-wise and a couple different penalties. There is one for failure to file, failure to pay on time. One of these maxes out at 25% while the other is at about ½% every month. One of them starts at five and goes up from there. If after a couple years you did not pay after you requested to, you could be looking at penalties of 20-35%. The state is probably 3-4% on top of the IRS. They are obviously adding interest on top of it also, although the interest is only about 2% and accrues every month. This is a variable loan; so if you have interest rates go up it can get bad.

Bruce asked what changes have occurred in 2013 that we will be experiencing as we complete our taxes. Bruce asked what happened to Federal and California tax rates. Matt said this is a good question since not a lot of people are aware of it due to not getting a lot of press. Matt has joked when speaking that the IRS or Congress passed the American Taxpayer Relief Act at the very end of 2012, yet it discussed how rates will go up and he does not see where the relief is. The highest Federal rate went up by 4.6%, and now it is at 39.6%. Matt said for a single person the point of income is $400 and $450 for a married couple. It is a graduated rate getting up there until you hit that mark. You can see from just that one fact alone that since it hits a single person at $400 and a married person at $450, this is a huge marriage penalty. When people talk about it they say they do not have a marriage penalty, but obviously they do.

Bruce also asked about the California state tax rate, which Matt said went up back in 2012. They adjusted their highest rate from 9.3% to 12.3%, which just occurred in 2013. They officially made the change in late 2012, but it was retroacted in the beginning of the year. Bruce said we did not know they could do this, so why penalize us for being late? Bruce had asked earlier about the penalties and how California compares to the world in terms of penalties and interests. Amanda said the general idea is that whenever there are laws about California vs. federal taxes, California is always harsher. It is either less deductions or higher tax rates. They don’t really follow federal on a lot of the credit, nor do they follow it on a lot of the exemptions. A lot of times this shocks people. For example, if you are deemed to be active in real estate, you get to use all your losses without limitations off of your income.

What shocks a lot of people is California does not recognize real estate professionals. No matter how much time you spend in real estate, it will always be passive loss to you. There are also limits on how much you can use every single year. This would drive people crazy since these things have legs. Therefore, the next year when you have a Federal tax return, it will have taken into account all the losses on that form. Then, you are saying California will have to use up those losses gradually over the next few years. When someone sells a rental property, the gain for Federal might be large because you took a lot of the write-offs and appreciation. However, in California the gain may be much smaller since California never really allowed you take any of those deductions anyway.

Tax is so complicated now. For every property there is federal depreciation and federal AMT, which they use to calculate to determine the minimum tax. There is also California depreciation and California AMT. On one asset alone there are four different things to be tracking. Bruce asked what they did to the capital gains tax. Matt said they made the top rate for capital gains tax go up by 5%. It used to be 15%, and now the top rate is 20%. This only kicks in for the same income levels, so if your income is below $400 or $450, your long-term capital gains rate is still 15%. If you had a couple big sales in the year that pushes you over this, then you will be paying an extra 5% on the excess over this.

They also drained up another category called unearned income. As part of this relief act, they came out with a couple taxes. One was a tax on unearned income, and now they are taxing you on interest dividends for all the real estate investors and any renal profits you would make on a rental property. They were taxing an extra 3.8% on that income. This is on top of income and state taxes. This can kick in too, although Matt thinks a lot of people are not aware of this one. What is interesting about the unearned contribution packs is that the threshold kicks in for single people with income of over $200 and married for people over $250. Now a larger population will be hit by this unearned income tax. This kicks in before the top rate even kicks in; and if you did not think taxes were complicated enough, there are different ranges for everything.

The statutory rate in California is 2.3%, but if you make over $1 million you have to pay an extra 1%. Effectively, it is 13.3%, although this is not retroactive yet to the first dollar. Bruce said if he made a fair amount of money, he is now approaching 55% tax depending on how he does it. He wondered how much he can set aside as a void tax and what vehicles you can use and the amount you can contribute. Amanda said the largest one that is the most meaningful at this time of the year is retirement contributions. This could still be available for people to fund retroactively. One of the most popular ones is the SEP IRA contribution. Depending on the income earned, it is possible to put away close to $100,000 and take a write-off for that contribution. If you are someone in the 40-50% tax bracket, this could mean $40-$50,000 in terms of tax savings. This could still be possible before the deadline, which happens by the time you file your tax returns. The cool thing is you can still set up your SEP IRA on April 14, file it April 15, and still contribute to it. This is a really nice benefit/loophole the IRS provides for people to take advantage of.

Bruce asked if you can file an extension to get to the other date, which Matt said you can. You can file an extension for your business until September or October. As long as you set it up and fund it before then, you can take advantage of it until you have the cash, even if you do not have it now. This is something to plan for accordingly with your advisor and not something Turbo taxes will tell you. When you end up with that money being set aside, it is not state or federal taxable until you decide to withdraw it. It is like any 401k or traditional IRA. In addition to the current tax savings, what Amanda loves about retirement accounts is it gets to grow tax deferred. This is especially true for their clients who are in high tax brackets in the 30-50% bracket. It is very helpful if you can get a bucket of money to be growing tax deferred every year. This then means that 100% of that money is growing for you at a much faster rate if you do not have to set aside some of it for taxes every year.

Not only do you have the running start of not paying half of it in tax to start with, but now you don’t have to pay taxes as you go. This has been a great invention for people to gain some wealth.

Tune in next week as Bruce continues his discussion with Matt MacFarland and Amanda Han. For more information, you can contact them at 877-975-0975 or visit them on the website at www.keystonecpa.com.

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