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income tax

Be Careful When Converting

Conversion of St Paul

Conversion of St Paul (Photo credit: Lawrence OP)

When converting from a 401(k), traditional IRA, 403(b), SIMPLE IRA, SEP or 457(b) to a Roth IRA there are some important tax considerations to keep in mind.

First, converting from a tax deferred plan to a tax free plan it’s not always the best idea. Generally, it’s going to make sense to convert if the tax payer believes that he or she will be in a higher income tax bracket in retirement. For example, John, age 28 has a 401(k) and recently left his employer. He’s currently in the 15% bracket but expects to be in the 28% bracket or higher in retirement. It may make sense for John to convert his 401(k) to his Roth IRA.

This makes sense for John because when he converts from a pre-tax, employer sponsored plan like the 401(k) it’s money that has not yet been taxed. If he converts while in the 15% bracket, that money is now subject to tax at the 15% rate, and arguably a lower amount of money being taxed since he’s still young. If he decided to wait until retirement to convert (let’s assume he’s in the 28% bracket) then that money is going to be taxed at 28%, or almost twice the rate if he had converted when he was in the 15% bracket. John has also eliminated future RMDs as Roth IRAs have no such requirement.

Generally, it may make sense to not convert if you expect to be in a lower tax bracket at retirement. The reason is you’d convert at a higher tax bracket today, only to be in a lower bracket in retirement. Thus, you’ve paid a higher than necessary amount of tax on your money.

Second, when converting, pay close attention to you your age and how you choose to “pay” the tax. Let’s look at two examples.

Let’s say John in the example above decides to convert when he leaves his employer at age 28. He’s saved a nice sum of $100,000 in his 401(k). He decides to convert to a Roth IRA at the 15% bracket. He elects to pay the tax himself from outside of the 401(k), that is, he elects to not have any tax withheld from the conversion. He decides he’ll pay the tax from another source when tax time comes around. All is being equal, John owes $15,000 at tax time.

This turns out to be a very wise decision for John. Here’s why.

Let’s assume the same scenario above except that John decides to have the $15,000 withheld from his 401(k) to pay the taxes on the conversion. Remember how old John was? 28. He’s under age 59 1/2 and the $15,000 withheld for taxes is considered an early distribution, and, you guessed it, subject to the 10% early withdrawal penalty. So instead of paying $15,000 in taxes, John pays an additional $1,500 due to the 10% penalty or a total of $16,500.

It pays (either you or the IRS) to consider the tax ramifications of converting to a Roth IRA. Talk to an experienced financial planner and or tax advisor for help.

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Tax Time is Over. Maybe.

Tax

For most folks tomorrow marks the one week anniversary of filing their 2014 tax return. Not much needs to be done after they’ve filed except for deciding to have more withheld in 2014 for those folks who had to write a check to Uncle Sam or deciding what to do with the refund (hint: put it in an IRA) for those folks who got a refund.

What happens when the return may have been submitted with mistakes or perhaps costly errors? Generally, if the error is minor the IRS will correct errors or accept returns without certain forms or schedules attached.

For those returns that have a change in filing status, income, deductions, and credits then filing an amended return will most likely be appropriate. For those folks needing to file an amended return they are allowed to file using form 1040X. Form 1040X will allowing corrections to earlier filed returns that used 1040A, 1040EZ.

If a person needs to file for separate years then a separate 1040X must be filed for each tax year that’s being amended.

According to IRS topic 308 keep the following points in mind:

  • Attach copies of any forms or schedules that are being changed as a result of the amendment, including any Form(s) W-2 received after the original return was filed.
  • Tax forms can beobtained by calling 800-829-3676 or visiting www.irs.gov.
  • An amended tax return cannot be filed electronically under the e-file system.
  • Normal processing time for Forms 1040X is up to 12 weeks from the IRS receipt date.

Generally if a refund is to be claimed the amended return needs to be filed within 3 years after the due date of your original return or 3 years after the date you filed your return if you filed for an extension.

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Obamacare and Your 2013 Tax Return

Taxation - Highlighted in the dictionary

Taxation – Highlighted in the dictionary (Photo credit: efile989)

So – you’re considering your income tax return (or maybe you’ve already filed) and you’re wondering if there are things you need to know with regard to Obamacare.  Fortunately, it’s not much (for most folks), for your 2013 return anyhow.  Next year will be a different story.

The IRS recently produced their Health Care Tax Tip HCTT-2014-10 which lists some tips about how the health care law impacts your 2013 tax return.  The actual text of the Tip is below:

What do I need to know about the Health Care Law for my 2013 Tax Return?

For most people, the Affordable Care Act has no effect on their 2013 federal income tax return.  For example, you will not report health care coverage under the individual shared responsibility provision or claim the premium tax credit until you file your 2014 return in 2015.

However, for some people, a few provisions may affect your 2013 tax return, such as increases in the itemized medical deduction threshold, the additional Medicare tax and the net investment income tax.

Here are some additional tips:

Filing Requirement: If you do not have a tax filing requirement, you do not need to file a 2013 federal tax return to establish eligibility or qualify for financial assistance, including advance payments of the premium tax credit to purchase health insurance coverage through a Health Insurance Marketplace. Learn more at www.Healthcare.gov.

W-2 Reporting of Employer Coverage:  The value of health care coverage reported by your employer in box 12 and identified by Code DD on your Form W-2 is not taxable.

Information available about other tax provisions in the health care law:  More information is available on www.IRS.gov regarding the following tax provisions: Premium Rebate for Medical Loss Ratio, Health Flexible Spending Arrangements, and Health Saving Accounts.

More Information

Find out more tax-related provisions of the health care law at www.IRS.gov/aca.

Find out more about the Health Insurance Marketplace at www.Healthcare.gov.

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Avoiding Mistakes on Your Tax Return

"YOU ARE ONE OF 50,000,000 AMERICANS WHO ...

“YOU ARE ONE OF 50,000,000 AMERICANS WHO MUST FILL OUT AN INCOME TAX RETURN BY MARCH 15. DO IT NOW^ AVOID THE RUSH…. – NARA – 516202 (Photo credit: Wikipedia)

When filing your tax return you want to make sure that you don’t make mistakes.  Mistakes can be costly in terms of additional tax and penalties, as well as the extra time and grief they can cause you.  Most of the time using e-filing software can help you to avoid these mistakes, but you should check over the return anyhow to make certain you haven’t fat-fingered something or if something didn’t go wrong with the software.

The IRS recently issued their Tax Tip 2014-46, which lists out 8 common mistakes that folks make on their tax return, and how to avoid them where possible.  The actual text of the Tip follows below:

Eight Common Tax Mistakes to Avoid

We all make mistakes.  But if you make a mistake on your tax return, the IRS may need to contact you to correct it.  That will delay your refund.

You can avoid most tax return errors by using IRS e-file.  People who do their taxes on paper are about 20 times more likely to make an error than e-filers.  IRS e-file is the most accurate way to file your tax return.

Here are eight common tax-filing errors to avoid:

  1. Wrong or missing Social Security numbers.  Be sure you enter all SSNs on your tax return exactly as they are on the Social Security cards.
  2. Wrong names.  Be sure that you spell the names of everyone on your tax return exactly as they are on the Social Security cards.
  3. Filing status errors.  Some people use the wrong filing status, such as Head of Household instead of Single.  The Interactive Tax Assistant on www.IRS.gov can help you choose the right one.  Tax software helps e-filers choose.
  4. Math mistakes.  Double-check your math.  For example, be careful when you add or subtract or figure items on a form or worksheet.  Tax preparation software does all the math for e-filers.
  5. Errors in figuring credits or deductions.  Many filers make mistakes figuring their Earned Income Credit, Child and Dependent Care Credit, and the standard deduction.  If you’re not e-filing, follow the instructions carefully when figuring credits and deductions.  For example, if you’re age 65 or older or blind, be sure you claim the correct, higher standard deduction.
  6. Wrong bank account numbers.  You should choose to get your refund by direct deposit.  But it’s important that you use the right bank and account numbers on your return.  The fastest and safest way to get a tax refund is to combine e-file with direct deposit.
  7. Forms not signed or dated.  An unsigned tax return is like an unsigned check – it’s not valid.  Remember that both spouses must sign a joint return.
  8. Electronic filing PIN errors.  When you e-file, you sign your return electronically with a Personal Identification Number.  If you know last year’s e-file PIN, you can use that.  If not, you’ll need to enter the Adjusted Gross Income from your originally-filed 2012 federal tax return.  Don’t use the AGI amount from an amended 2012 return or a 2012 return that the IRS corrected.
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Simplified Home-Office Deduction Available

home office

home office (Photo credit: Sean MacEntee)

Beginning with your 2013 tax return you have a new option available for calculating the Home-Office deduction – based solely on the square footage of the dedicated space used for the home office.

Instead of having to maintain records that are directly and indirectly associated with your home office, you can use the simplified method, which applies a flat $5 rate per square foot to the home office space, up to a maximum of $1,500.

The record-keeping and tax preparation simplification is very beneficial: Form 8829 (the usual home-office deduction form) can cause a lot of headaches to prepare, especially if you have more than one home office and you itemize your home mortgage interest and real estate taxes.  For a single home office your tax preparation software will do much of the work for you, but complications like a second home office (not that uncommon in these days of officing-at-home) it can be complex.

Unfortunately, in my experience working with tax returns so far this season, it seems that the simplified method often results in a smaller home-office deduction than the old method.  With the simplified method you get the option to deduct your full real estate taxes and home mortgage interest above and beyond the home office deduction, whereas the old method required you to apportion these expenses between business and personal.  If the new method appeals to you, it is much simpler than gathering all the records and figuring out how to correctly fill out the forms.

The IRS recently issued their a news release, IR-2014-24, which details information about the simplified deduction.

Reminder To Home-Based Businesses: Simplified Option for Claiming Home Office Deduction Now Available; May Deduct up to $1,500; Saves 1.6 Million Hours A Year

Washington – The Internal Revenue Service today reminded people with home-based businesses that this year for the first time they can choose a new simplified option for claiming the deduction for business use of a home.

In tax year 2011, the most recent year for which figures are available, some 3.3 million taxpayers claimed deductions for business use of a home (commonly referred to as the home office deduction) totaling nearly $10 million.

The new optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet, will reduce the paperwork and recordkeeping burden on small businesses by an estimated 1.6 million hours annually.

The new options is available starting with the 2013 return taxpayers are filing now.  Normally, home-based businesses are required to fill out a 43-line form (Form 8829) often with complex calculations of allocated expenses, depreciation and carryovers of unused deductions.  Instead, taxpayers claiming the optional deduction need only complete a short worksheet in the tax instructions and enter the result on their return.  Self-employed individuals claim eht home office deduction on Schedule C Line 30, farmers claim it on Schedule F Line 32, and eligible employees claim it on Schedule A Line 21.

Though some homeowners using the new option cannot depreciate the portion of their home used in a trade or business, they can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A.  These deductions need not be allocated between personal and business use, as is required under the regular method.

Business expenses unrelated to the home, such as advertising, supplies and wages paid to employees, are still fully deductible.

Long-standing restrictions on the home office deduction, such as the requirement that a home office be used regularly and exclusively for business and the limit tied to the income derived from the particular business, still apply under the new option.

Further details on the home office deduction and the new option can be found in Publication 587, posted on www.IRS.gov.

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Your Social Security Benefits: Are They Taxable?

Image courtesy of Salvatore Vuono at FreeDigitalPhotos.net

Image courtesy of Salvatore Vuono at FreeDigitalPhotos.net

If you’re receiving Social Security benefits, either for disability, retirement, or survivor’s benefits, when you file your tax return you will need to figure out if the benefits you’ve received during the prior year are taxable to you.

You’ll receive a Form SSA-1099 from Social Security sometime in the first months of the year, showing what your benefits were in the prior year, as well as any deductions that were made throughout the year – including Medicare premiums (Part B and/or Part D) if applicable, and federal income taxes withheld.

But are the benefits taxable to you?  At most, 85% of your benefit might be taxed – and it’s possible that none of your benefit is taxable, all dependent upon your total income for the year.  See this article for a detailed explanation of How Taxation of Social Security Benefits Works.  The IRS recently published their Tax Tip 2014-23, which details some facts about taxability of Social Security benefits.  The actual text of the Tip is below:

Are Your Social Security Benefits Taxable?

Some people must pay taxes on part of their Social Security benefits.  Others find that their benefits aren’t taxable.  If you get Social Security, the IRS can help you determine if some of your benefits are taxable.

Here are seven tips about how Social Security affects your taxes:

  1. If you received these benefits in 2013, you should have received a Form SSA-1099, Social Security Benefit Statement, showing the amount.
  2. If Social Security was your only sources of income in 2013, your benefits may not be taxable.  You also may not need to file a federal income tax return.
  3. If you get income from other sources, then you may have to pay taxes on some of your benefits.
  4. Your income and filing status affect whether you must pay taxes on your Social Security.
  5. The best, and free, way to find out if your benefits are taxable is to use IRS Free File to prepare and e-file your tax return.  If you made $58,000 or less, you can use Free File tax software.  the software will figure the taxable benefits for you.  If your income was more than $58,000 and you feel comfortable doing your own taxes, use Free File Fillable Forms.  Free File is available only at www.IRS.gov/freefile.
  6. If you file a paper return, visit www.IRS.gov and use the Interactive Tax Assistant tool to see if any of your benefits are taxable.
  7. A quick way to find out if any of your benefits may be taxable is to add one-half of your Social Security benefits to all your other income, including any tax-exempt interest.  Next, compare this total to the base amounts below.  If your total is more than the base amount for your filing status, then some of your benefits may be taxable.  The three base amounts are:
    • $25,000 – for single, head of household, qualifying widow(er) with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year.
    • $32,000 – for married couples filing jointly
    • $0 – for married persons filing separately who lived together at any time during the year.

For more on this topic visit www.IRS.gov.

The Alternative Minimum Tax

Image courtesy of pakorn at FreeDigitalPhotos.net

Image courtesy of pakorn at FreeDigitalPhotos.net

You may not be aware of this, since income taxes are so complicated that not a lot of folks do much digging into the nuances, but there is another income tax rate that could affect you in certain circumstances.

This other income tax is called the Alternative Minimum Tax, or AMT.  This “alternative” tax applies when you have income above certain thresholds. Essentially it ensures that you pay a certain minimum amount of income tax if your deductions reduce your income so much that your ordinary income tax falls below the minimum applied by the AMT.  It gets pretty complicated, but I’ll go over the high points below.

Alternative Minimum Tax (AMT)

AMT has a separate set of rules for definitions of income and expenses, rules for accounting and timing, and exemptions and tax rates.  AMT limits the tax benefit of certain types of income and deductions, otherwise available to some taxpayers under the “normal” rules.

If you have a high income for the year but your taxable income is relatively low due to a large number of dependents, a high amount of your income is long-term capital gains, large Schedule A deductions, or a large amount of tax-free income from private activity bonds, you may be subject to AMT taxation.  Form 6251 is the appropriate form to use when determining if your income is subject to AMT.

Using Form 6251 you add to your taxable income those items that are used to determine the Alternative Minimum Taxable Income (AMTI), as explained below.

Starting with your taxable income (before exemptions) on line 41 of your Form 1040, you must make the several adjustments, adding back in many deductions from Schedule A (some medical expenses, mortgage interest, taxes, and miscellaneous deductions).  In addition to those additions, there are differences in the way that AMT rules define investment interest expense, depletion, stock option exercises, and quite a few specialized items that will only be of interest to business owners.

After these adjustments are made to your income, the AMT tax rates are applied. If the tax calculated is greater than the ordinary income tax, you’ll have to file with the AMT rates applied.

The IRS recently published their Tax Tip 2014-10 which lists out a few facts that may help you to understand the AMT.  Especially helpful is the AMT Assistant Tool, for which a link is provided below.  The complete text of the Tip is listed below:

What You Should Know about AMT

Have you ever wondered if the Alternative Minimum Tax applies to you? You may have to pay this tax if your income is above a certain amount. The AMT attempts to ensure that some individuals who claim certain tax benefits pay a minimum amount of tax.

Here are some things from the IRS that you should know about AMT:

  1. You may have to pay the tax if your taxable income, plus certain adjustments, is more than the AMT exemption amount for your filing status. If your income is below this amount, you usually will not owe AMT.
  2. The 2013 AMT exemption amounts for each filing status are:
    • Single and Head of Household = $51,900
    • Married Filing Joint and Qualifying Widow(er) = $80,800
    • Married Filing Separate = $40,400
  3. The rules for AMT are more complex than the rules for regular income tax. The best way to make it easy on yourself is to use IRS e-file to prepare and file your tax return. E-file tax software will figure AMT for you if you owe it.
  4. If you file a paper return, use the AMT Assistant tool on IRS.gov to find out if you may need to pay the tax.
  5. If you owe AMT, you usually must file Form 6251, Alternative Minimum Tax – Individuals. Some taxpayers who owe AMT can file Form 1040A and use the AMT Worksheet in the instructions.

Visit IRS.gov to find out more about AMT. Also, see the Form 6251 instructions. You can get it at IRS.gov too or by calling 800-TAX-FORM (800-829-3676).

Looking for free tax preparation? IRS provides some tips

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

For lots of people, the option of free tax preparation is an excellent way to go.  There are quite a few providers who will allow you to prepare a simple return for free (more complexity equals more cost, of course).  It’s a good idea to go through the process if you have the aptitude, because it’s helpful to understand the ins and outs of a tax return.  Knowing about how your tax return works can help you to have a better understanding of ways to reduce your taxes in the future.

When using a commercial organization to prepare your return for free, beware of the “add-ons” that make a free process extremely costly.  Among these are – add-on state filing (sometimes more costly than federal preparation!), refund anticipation loans (like a payday loan, only more expensive!), and payment via your refund (another type of refund anticipation loan, with the associated costs).  There’s a reason these organizations offer “free” return filing – by doing so they look like a white knight, and if they can talk you into these add-ons, they’re making a mint off it as well, for very little effort.

On the other hand, maybe you need some assistance with your return.  The IRS provides a couple of programs, VITA (Volunteer Income Tax Assistance) and TCE (Tax Counseling for the Elderly) which provide IRS-trained volunteer help with preparing your return, for no cost to you as long as you qualify.

Recently the IRS issued their Tax Tip 2014-02, which provides their Top 10 Tips for free tax preparation – the actual text of the Tip follows below.

Top 10 Tips about Free Tax Preparation

Each year millions of people have their tax returns prepared for free by volunteers.  These volunteers are part of the IRS Volunteer Income Tax Assistance and Tax Counseling for the Elderly programs.

Here are the top 10 tips the IRS wants you to know about VITA and TCE:

  1. The IRS sponsors both the VITA and TCE programs.  They work with local community groups to both train and certify volunteers.
  2. The VITA program generally offers free tax return preparation and e-filing to people who earn $52,000 or less.
  3. The TCE program offers help mainly to people age 60 or older.  Volunteers specialize in tax issues unique to seniors.  AARP is part of the TCE program and helps taxpayers with low to moderate incomes.
  4. VITA and TCE provide free electronic filing.  An e-filed tax return is the safest and most accurate way to file.  Using e-file combined with direct deposit is the fastest way to get your refund.
  5. Using VITA and TCE may help ensure you get all the tax credits  and deductions you’re able to claim.  For example, credits that you may qualify for include the Earned Income Tax Credit, the Child Tax Credit and the Credit for the Elderly.
  6. Some sites provide bilingual help for people who speak limited English.
  7. VITA provides free tax assistance to military members and their families.  Volunteers help with tax issues related to the military.  These include special rules and tax benefits for those serving in combat zones.
  8. At some VITA sites, you can also prepare your own federal and state tax returns using free web-based software.  This is an option if you don’t need much help or don’t have a home computer.  Volunteers are on site to guide you if you need help.  The self-preparation options generally offer free tax return preparation software and e-filing to people who earn $58,000 or less.
  9. For more than 40 years, the IRS has partnered with nonprofit and community organizations to offer these vital services.  Thousands of VITA and tCE sites around the nation will open in late Jan. and early Feb.
  10. Visit www.IRS.gov to find the nearest VITA site.  Search the word ‘VITA’ and then click on “free Tax Return Preparation for You by Volunteers.”  Site information is also available by calling the IRS at 800-906-9887.  To locate the nearest AARP tax-Aide site, visit www.aarp.org, or call 888-227-7669.
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