Bruce Norris is joined this week by Susie Leivas. Susie is the CFO of Leivas Associates. She has been doing taxes since the ripe old age of thirteen, and she just started a new venture in the last year. This new addition to the Leivas family of companies is something she never thought she would do. A man walked into her office who she thought she had a tax appointment with, and he introduced himself as being from H & R Block. He was interested in her becoming a franchise owner. Originally she was not interested, but she decided to give him fifteen minutes of her time. A year later, she is a franchise owner and very happy to be one.
Bruce asked what was different and what assumptions of hers were not correct. Susie said in some regard it is thought of as being for the unsophisticated client and the staff took the basic 60-hour course and became a practitioner. Although this happens on occasion, the additional office they obtained came with a seasoned staff, most of whom had been at H&R Block for over twenty years. Susie took their basic course when she was a junior in high school, where she introduced herself to the new staff. One of the gals in the back raised her hand and said she was her teacher. She was over 80 and had been doing returns for a very long time. Susie really expanded her client base by quite a bit.
That office now does quite a number of those smaller returns, a business Susie never had. Her clients do not come in until the middle to end of February, and they are slammed until the very end. A good number of the clients come in the minute you can file a return, 1200 of which were done by Valentine’s Day by this office. This is half the volume of the returns that they do in a season. This was not a clientele she was used to.
Bruce asked Susie what the length of her day is when she is in full-swing. She tries to get to the gym at least three days a week by 5:30, and then she is in the office after this. She usually does not go home until she is finished since she is booked on the half from nine until about eight. She takes a lunch break but usually not a dinner break, and she does not leave the office until her work is done for the day since she will have a full day the very next day. She is still taking new work assignments at 8:00 and finishing everything else after this. Sleep is usually optional for her during the season, although it is amazing that your body allows you to work this hard and not really require too much.
Bruce asked what was so interesting about this subject. She was a teenager and somehow figuring out that she liked this more than normal junior high and high school things. Her father was in management in the grocery business, and he was building a practice on the side. It got to the point where he needed assistance, and he asked for her help. To have a calculator, typewriter, copy machine, and files at thirteen was something she loved. What was really interesting was back in the day when she was in high school; one of the things that was part of a tax return was income averaging. The old-timers still ask her if they can income average. There was a lot of math involved; and what was really funny about everything was she started doing taxes when they were only using carbon paper before computers. What prompted her to do block was she looked at her thirty-year career, saw she started with carbon paper, and sees how they are now doing electronic filing. The question is what it will look like in the next twenty years considering how far the past thirty years has come.
This makes things a lot easier. Bruce is one of her clients, so when he goes in she can pop up last year’s information or the year before that. She can make different changes, and it is all through the system. Just like in real estate when you do appraising, it is all easier and quicker to do much more. However, if you don’t know what you’re doing, then you are also making mistakes more quickly.
Susie has the title of an enrolled agent, which is a federal designation given by the Internal Revenue Service. A CPA will take a state exam, which lasts two days. In addition to tax, it includes auditing and accounting. The exam that is given by the Internal Revenue Service is two days on tax. It is individual corporate partnership trust and total tax. When you are an enrolled agent, you get to go represent a client if they are being audited. They have the same rights that an attorney or CPA does in front of the Internal Revenue Service.
Bruce wondered what makes an audit more likely, whether it is exaggerating deductions or hiding income. Susie said if you are trying to hide something they know about, then it makes an audit a lot more likely. This is not even an audit, but rather a CP 2000. This is a matching, or the system comparing all the information that it receives on you and compares it to the return you filed. They will give you a chance to dispute it, let you know what was missing from your return and give you the opportunity to let them know whether it is correct or not. Susie had just come from the IRS before the interview, and what really prompted that visit was an economic reality audit. He had a commercial building, so the mortgage interest was posted to the Internal Revenue Service. He also had a home, which had a mortgage, as well as he is a self-employed contractor. It did not look like he made enough money to pay all his bills, so the IRS was very suspicious. The IRS is broke and looking for money, and this would be a good one since they would want to know how he supported himself if he only made $20 grand a year.
Fortunately, the particular client she represented that morning was amazingly detailed. Often when she writes for Bruce’s newsletter, she stresses on bookkeeping. It may sound ridiculous since most people want to talk to her about how to save money on their taxes. However, it really does boil down to being an amazing record-keeper and doing your bookkeeping. In this case, this particular client did do all this. The reason he was able to get through the year with not a lot of profit was he had a windfall from earlier. The money was in his savings, and he was living off of his savings. They were able to prove it; but until you are in audit they don’t know this. Their assumption is if you are self-employed, they are thinking that you are doing stuff under the table.
With audits, you sometimes you go in; but other times they come to the field. Bruce wondered when either one happens. Whether they are in the field or the office, these are often lengthy and often more entities. It is either the partnership or corporation, although occasionally it will be the sole proprietor. Often it is the entities that will come to them, while the individuals and smaller proprietors will ask them to go into the office. What is becoming even more popular is not doing either one of these things; picking out an item or two on the return, and making it a correspondent’s audit. There were a couple in the last year who were specialty contractors, such as a plumber or electrician, and they wanted to see their mileage log or backup for their tools. You are then preparing all the information and mailing it in.
Bruce wondered if the IRS changes gears and target specific categories certain years as opposed to other categories. They do check to see where they think their focus should be. Often it is on the areas where they are expecting fraud. If you see somebody walking through the door with a smaller return, but they have many children they are looking for different credits. The earned income credit has been a big target. On the sole proprietor side, if they are seeing losses, then often they are double checking to make sure it is really a viable business and not a hobby. Bruce wondered how this differentiates from the former, to which Susie said it does not involve time spent but rather doing everything you would do to be a business owner. Do you have a business plan, can you show that in time you will have a profit, or are you conducting yourself in business-like manner? This includes having a separate bank account, doing advertising, having a business license, or doing all the things where you can really show that you are really out to make a profit and not just doing it for fun.
One of the things Bruce talked to her about over the years is that she sees a lot of people and gets the general mood of the participant taxpayer. In 2005 and 2006 everybody was very happy, but 2012 is pretty grim. She is noticing even in the last couple months folks coming back in from falling out of the system. Life was so horrible that they did not file. Being as the state and Feds are broke, they are sending those notices out saying they have not received a return and therefore we are seeing an upswing of people who are doing multi-year.
When you get behind like this, there are no penalties unless you owe taxes. The one thing to keep in mind if you are looking for a refund is you only have three years on the Federal side to get it and four years on the state. If you have something older than this and need to do a refund, you will no longer receive it.
Bruce asked Susie if her year is affected by the people she is sitting in front of. He wondered if it wears her out if everybody else is down and out. She said it is her job to pick them up. The reason she has a successful practice and why people are drawn to her is because she does have a knack for picking people back up and showing the brighter side as well as giving them ideas and pointers on how to fix things.
Bruce asked her what she thinks 2013 will feel like. She said we are all listening to the news, hearing about the fiscal cliff, and we all know in our hearts that taxes will increase. Three things are a given: we will have increased taxes, inflation, and interest rates will increase. These are all a given; it is just a matter of when. Whether people really have a handle on it is debatable. As long as they pass the laws and fix the withholding tables right away to where everybody is paying a little at a time on their paychecks, it is not quite so bad. California just passed Proposition 30, which is a retroactive increase for those in a higher income level. If your income is over $250, that is when you are seeing this. Those folks might be short this year since there was not a withholding to compensate this. This goes all the way back to January 1 of 2012 when taxes were raised and they did not let them know until 11 months later.
Susie goes to school every year to receive the tax update. Bruce thinks this should have been an interesting year since there were some things they don’t know yet. There is a page and a half of things that are likely to sunset by December 31. Everybody has their opinion of what they think will be extended, but really no one knows. This is kind of a big deal because if you are withholding tax, it could be a big mess if you have a large company. You’re one month into the year and realize it is not what you just practiced for a month, and this gets expensive. It is like playing the game of monopoly where you are told the rules as you play. This makes it a little harder for tax planning or even tax advantages at the end of the year. There are a lot of times people make decisions that are better to make now as opposed to next year. However, you are kind of sitting in the dark wondering if this is true or not.
Susie said the basic rule of thumb through almost her entire career was to push off income to next year and accelerate deductions. This is the very first year she is telling her clients to do the opposite. Susie was included in this. When you use a credit card, it is deductible the day you charge it, not the day you pay the credit card company back. Normally on December 31 she is filling up her gas tank and stocking all the supplies on her shelves. However, she is not doing this at this time this year, but rather waiting.
The Bush tax changed when taxes were lowered. Bruce wondered what the categories were that were affected. For one, the Federal rate went down quite a bit from where it was under Reagan. He was the big one who really changed things. The big song and dance was he is leaving tax rates low. This was the year we lost a lot of deductions, including interest. Susie has the feeling this might be the play we see going forward where they won’t frighten people too badly with the actual rate. However, they are going to start chipping away at some of the things we are used to having. Therefore, our taxable income will be higher and we will essentially pay more even though the marketing might be spent a little differently. It won’t feel so bad since we will think our rents will be the same, but we are paying it on more things.
Bruce wondered what changes are definitely in place for next year. Susie said we know about the 3.8% for single folks who make over $200,000 and $250,000 for married couples. That is 3.8% on investment income. This will be Bruce’s folks following him and the net profit of the rental property. Hopefully all his people have positive cash flows. It is the mental income, interest dividend, stock sales, and all the unearned income.
Most likely they will raise the rate from the maximum rate from $36 to $39 with the 3.8% and increase in capital gain on top of this. If you are lucky enough to have this $250 number, Bruce wondered about the number that is not 39.6 on the whole but that is after a certain number. Bruce wondered what this number is and when we pass the lower ramping up until you get to that number where everything afterwards is the biggest number. Susie said she did not know without seeing the chart, but what is happening is the very small rate, 0-10, is gone. It is now 0-15. All the rates are shifting a little, but Bruce is correct in saying you go from one place to another paying $15, and the method of how they do this is the same. However, they are juggling the numbers.
Bruce said he has seen some charts where 40-50% of people pay no income tax, and he wondered if this was true. He asked if the credits were so amazing that they really don’t pay. Susie said it was the beginning clientele she was talking about that comes in January whose income is lower. If they are receiving earned income credit, child credit, education credit, those people will definitely be down to zero and often are.
Bruce wondered how often major changes get changed again. In the years where the apartment business were booming because they could write a lot of things off of their income, things were suddenly changed that changed the whole industry radically for that industry. You can have major changes, and then they can make changes of the changes, constant and unending. Often you will see a big bill, but then you are left with not really understanding what the intent was really. All the interpretive regs then have to be written, and this is really the whole healthcare issue right now. This will start taking effect in a year, and it is going to be based on your 2012 return. When Susie went to a discussion to learn how to become the expert in that area, there is so much they don’t even know. They will feed you what they do know, then your brain kicks into gear and you start asking questions to which you cannot get answers.
It is just like the mortgage industry. They have the Dodd-Frank Act, so they came up with a bill two years ago and still don’t know what it actually means since it does not say anything. They are still arm wrestling over what it does mean. You can see this happening because this fiscal cliff arm wrestling match about increasing revenue by taxes but only raising it on the rich will not be a permanent solution. We’re going to raise it on everyone else, but maybe not this time. You are in for a round of this going on, which is a little tough for people in Susie’s business since it demands constant education.
One tax that has grown over the years is Medicare. This used to be limited to a certain amount of income, and this is not true anymore. If you make a lot of money, you are going to pay the medical tax on that money. The percentage is 1.45% for the employee and employer. If you are self-employed, it is 2.9%. This is significant. When you bring this up, you look at Social Security and see it has that cap of $110,000. This number changes every year. Susie is thinking this is where we are going to see the change. They will either remove or increase this limit substantially to help fund Social Security. The percentage here is 6.2 x2, which is not little. If you are someone who makes $250,000, you need to start panicking. You take the additional firm of the state and some additional Social Security in addition to the 3.8% and the higher tax rate, it is a little scary. You really start thinking you are going to have less of what you make. The people making way less are complaining that we are not making our share, which Bruce said he is having trouble grasping.
Bruce wondered if the Federal Tax Rate is headed to 39.6%. Susie said she can see this, although in prior years it has been way higher. If you look at history, you see this as well as that there have been more deductions. When you look at the rate prior to Reagan it was 80%, but the question is of what number. You don’t want to get to this one because it is pointless.
Tune in next week as Bruce continues his discussion with Susie Leivas in part 2 of the Norris Group Real Estate Radio Show and podcast.