income tax

State Income Tax and Retirement Income

On only a few rare occasions does it make sense to defer money to your 401(k) or other employer sponsored plan instead of a Roth IRA. Those occasions include when your gross income excludes you from contributing directly to a Roth IRA (you can still convert), you are currently at a very high tax rate or the case of when you live in a state where retirement income is excluded from state taxation.

Here in Illinois, the current law exempts retirement income from being taxed at the state level. What this means, is that any contributions to a 401(k), 403(b), SEP, SIMPLE and 457 avoid state income taxation. Qualified distributions at retirement are only taxed at the federal level, and then only as income.

If you contribute directly to a Roth IRA that money is after-tax money going in. After-tax in this case meaning it’s been already taxed at the federal and state level. So in this case the money going into the Roth IRA has been “hit twice” with federal and state taxes.

One possible way to avoid this double whammy (going by current Illinois law) is to contribute to your employer’s plan and then at retirement or whenever you leave your job, convert that money to a Roth IRA. In this case the money from your paycheck is already deferred from state taxation and then when it’s converted to a Roth IRA, avoids state income taxation again – since it’s income from a retirement plan and considered retirement income – which Illinois does not tax. This is evidenced by the 1099-R you’ll receive at the time of conversion.

Another way to avoid this is if your employer’s plan allows, convert your 401(k) to a Roth 401(k) while you’re still employed. Again, you’ll pay federal income tax but avoid the state taxation if your state excludes retirement income for tax purposes. If you’re in a higher tax bracket, you may consider staging your conversions up to the point where you maintain low tax costs (converting small amounts over many years). Or you may just want to wait to convert the whole amount when you know you’ll be in a lower tax bracket.

Last-Minute Tax Tips

Apr 15th, 2013

by jblankenship.

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Since today is D-Day for income tax filing, I’ve pulled together a few recent tips that the IRS published. These tips cover a few of the areas that you may find interesting, including how to get a six-month extension for your filing (but not for payment of tax), errors to avoid as you complete your tax return, how to make IRA contributions, and tips for the self-employed at tax time. This is a much longer post than I normally write, but I think it has a lot of very good and very timely information that will be useful today.

The actual text of these tips are listed below, with the reference number of each tip.

IRS Newswire IR-2013-38

Can’t File by April 15? Use Free File to Get a Six-Month Extension; E-Pay and Payment Agreement Options Available to People Who Owe Tax

WASHINGTON – The Internal Revenue Service today reminded taxpayers that quick and easy solutions are available if they can’t file their returns on time, and they can even request relief online.

The IRS says don’t panic. Tax-filing extensions are available to taxpayers who need more time to finish their returns. Remember, this is an extension of time to file; not an extension of time to pay. However, taxpayers who are having trouble paying what they owe may qualify for payment plans and other relief.

Either way, taxpayers will avoid stiff penalties if they file either a regular income tax return or a request for a tax-filing extension by this year’s April 15 deadline. Taxpayers should file, even if they can’t pay the full amount due. Here are further details on the options available.

More Time to File

People who haven’t finished filling out their return can get an automatic six-month extension. The fastest and easiest way to get the extra time is through the Free File link on IRS.gov. In a matter of minutes, anyone, regardless of income, can use this free service to electronically request an automatic tax-filing extension on form 4868.

Filing this form gives taxpayers until Oct. 15 to file a return. To get the extension, taxpayers must estimate their tax liability on this form and should also pay any amount due.

By properly filing this form, a taxpayer will avoid the late-filing penalty, normally five percent per month based on the unpaid balance, that applies to returns filed after the deadline. In addition, any payment made with an extension request will reduce or eliminate interest and late-payment penalties that apply to payments made after April 15. The current interest rate is three percent per year, compounded daily, and the late-payment penalty is normally 0.5 percent per month.

Besides Free File, taxpayers can choose to request an extension through a paid tax preparer, using tax-preparation software or by filing a paper Form 4868, available on IRS.gov. Of the nearly 10.7 million extension forms received by the IRS last year, almost 5.8 million were filed electronically.

Some taxpayers get more time to file without having to ask for it. These include:

Taxpayers abroad. US citizens and resident aliens who live and work abroad, as well as members of the military on duty outside the US, have until June 17 to file. Tax payments are still due April 15.
Members of the military and others serving in Afghanistan or combat zone localities. Typically, taxpayers can wait until at least 180 days after they leave the combat zone to file returns and pay any taxes due. For details, see Extensions of Deadlines in Publication 3, Armed Forces Tax Guide.
People affected by certain tornadoes, severe storms, floods and other recent natural disasters. Currently, parts of Mississippi are covered by a federal disaster declaration, and affected individuals and businesses in these areas have until April 30 to file and pay.

Easy Ways to E-Pay

Taxpayers with a balance due now have several quick and easy ways to electronically pay what they owe. They include:

Electronic Federal Tax Payment System (EFTPS). This free service gives taxpayers a safe and convenient way to pay individual and business taxes by phone or online. To enroll or for more information, call 800-316-6541 or visit www.eftps.gov.
Electronic funds withdrawal. E-file and e-pay in a single step.
Credit or debit card. Both paper and electronic filers can pay their taxes by phone or online through any of several authorized credit and debit card processors. Though the IRS does not charge a fee for this service, the card processors do. For taxpayers who itemize their deductions, these convenience fees can be claimed on Schedule A Line 23.

Taxpayers who choose to pay by check or money order should make the payment out to the “United States Treasury”. Write “2012 Form 1040”, name, address, daytime phone number and Social Security number on the front of the check or money order. To help insure that the payment is credited promptly, also enclose a Form 1040-V payment voucher.

More Time to Pay

Taxpayers who have finished their returns should file by the regular April 15 deadline, even if they can’t pay the full amount due. In many cases, those struggling with unpaid taxes qualify for one of several relief programs, including the following:

Most people can set up a payment agreement with the IRS on line in a matter of minutes. Those who owe $50,000 or less in combined tax, penalties and interest can use the Online Payment Agreement to set up a monthly payment agreement for up to 72 months. Taxpayers can choose this option even if they have not yet received a bill or notice from the IRS. With the Online Payment Agreement, no paperwork is required, there is no need to call, write or visit the IRS and qualified taxpayers can avoid the filing of a Notice of Federal Tax Lien if one was not previously filed. Alternatively, taxpayers can request a payment agreement by filing Form 9465. This form can be downloaded from IRS.gov and mailed along with a tax return, bill or notice.
Some struggling taxpayers may qualify for an offer-in-compromise. This is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed. The IRS looks at the taxpayer’s income and assets to make a determination regarding the taxpayer’s ability to pay. To help determine eligibility, use the Offer In Compromise Pre-Qualifier, a free online tool available on IRS.gov.

IRS Tax Tip 2013-52

Five Things to Know if You Need More Time to File

The April 15 tax-filing deadline is fast approaching. Some taxpayers may find that they need more time to file their tax returns. If you need extra time, you can get an automatic six-month extension from the IRS.

Here are five important things you need to know about filing an extension:

Extra time fo file is not extra time to pay. You may request an extension of time to file your federal tax return to get an extra six months to file, until Oct. 15. Although an extension will give you an extra six months to get your tax return to the IRS, it does not extend the time you have to pay any tax you owe. You will owe interest on any amount not paid by the April 15 deadline. You may also owe a penalty for failing to pay on time.
File on time even if you can’t pay. If you complete your return but you can’t pay the full amount due, do not request an extension. File your return on time and pay as much as you can. You should pay the balance as soon as possible to minimize penalty and interest charges. If you need more time to pay, you can apply for a payment plan using the Online Payment Agreement tool on IRS.gov. You can also send Form 9465,Installment Agreement Request, with your return. If you are unable to make payments because of a financial hardship, the IRS will work with you. Call the IRS at 800-829-1040 to discuss your options.
Use Free File to request an extension. Everyone can use IRS Free File to e-file their extension request. Free File is available exclusively through the IRS.gov website. You must e-file the request by midnight on April 15. If you e-file your extension request, the IRS will acknowledge receipt of your request.
Use Form 4868 if you file a paper form. You can request an extension of time to file by submitting Form 4868, Application for Automatic Extension of Time to File US Individual Income Tax Return. You must submit this form to the IRS by April 15. Form 4868 is available on IRS.gov.
Electronic funds withdrawal. If you e-file an extension request, you can also pay any balance due by authorizing an electronic funds withdrawal from a checking or savings account. To do this you will need your bank routing and account numbers.

IRS Tax Tip 2013-51

Eight Tax-Time Errors to Avoid

If you make a mistake on your tax return, it usually takes the IRS longer to process it. The IRS may have to contact you about that mistake before your return is processed. This will delay the receipt of your tax refund.

The IRS reminds filers that e-filing their tax return greatly lowers the chance of errors. In fact, taxpayers are about twenty times more likely to make a mistake on their return if they file a paper return instead of e-filing their return.

Here are eight common errors to avoid.

Wrong or missing Social Security numbers. Be sure you enter SSNs for yourself and others on your tax return exactly as they are on the Social Security cards.
Names wrong or misspelled. Be sure you enter names of all individuals on your tax return exactly as they are on their Social Security cards.
Filing status errors. Choose the right filing status. There are five filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household and Qualifying Widow(er) With Dependent Child. See Publication 501, Exemptions, Standard Deduction and Filing Information, to help you choose the right one. E-filing your tax return will also help you choose the right filing status.
Math mistakes. If you file a paper tax return, double check the math. If you e-file, the software does the math for you. For example, if your Social Security benefits are taxable, check to ensure you figured the taxable portion correctly.
Errors in figuring credits, deductions. Take your time and read the instructions in your tax booklet carefully. Many filers make mistakes figuring their Earned Income Tax Credit, Child and Dependent Care Credit and the standard deduction. For example, if you are age 65 or older or blind check to make sure you claim the correct, larger standard deduction amount.
Wrong bank account numbers. Direct deposit is the fast, easy and safe way to receive your tax refund. Make sure you enter your bank routing and account numbers correctly.
Forms not signed, dated. An unsigned tax return is like an unsigned check – it’s invalid. Remember both spouses must sign a joint return.
Electronic signature errors. If you e-file your tax return, you will sign the return electronically using a Personal Identification Number. For Security purposes, the software will ask you to enter the Adjusted Gross Income from your originally-filed 2011 federal tax return. Do not use the AGI amount from an amended 2011 return or an AGI provided to you if the IRS corrected your return. You may also use last year’s PIN if you e-filed last year and remember your PIN.

IRS Tax Tip 2013-50

Top Ten Tips on Making IRA Contributions

The IRS has 10 important tips for you about setting aside money for your retirement in an Individual Retirement Arrangement.

You must be under age 70½ at the end of the tax year in order to contribute to a traditional IRA.
You must have taxable compensation to contribute to an IRA. This includes income from wages, salaries, tips, commissions and bonuses. It also includes net income from self-employment. If you file a joint return, generally only one spouse needs to have taxable compensation.
You can contribute to your traditional IRA at any time during the year. You must make all contributions by the de date for filing your tax return. This due date does not include extensions. For most people this means you must contribute for 2012 by April 15, 2013. If you contribute between Jan. 1 and April 15, you should contact your IRA plan sponsor to make sure they apply it to the right year.
For 2012, the most you can contribute to your IRA is the smaller of either your taxable compensation for the year or $5,000. If you were 50 or older at the end of 2012 the maximum amount increases to $6,000.
Generally, you will not pay income tax on the funds in your traditional IRA until you begin taking distributions from it.
You may be able to deduct some or all of your contributions to your traditional IRA.
Use the worksheets in the instructions for either Form 1040A or Form 1040 to figure the amount of your contributions that you can deduct.
You may also qualify for the Savers Credit, formally known as the Retirement Savings Contributions Credit. The credit can reduce your taxes up to $1,000 (up to $2,000 if filing jointly). Use Form 8880, Credit for Qualified Retirement Savings Contributions, to claim the Saver’s Credit.
You must file either Form 1040A or Form 1040 to deduct your IRA contribution or to claim the Saver’s Credit.
See Publication 590, Individual Retirement Arrangements, for more about IRA contributions.

IRS Tax Tip 2013-46

Top Six Tax Tips for the Self-Employed

When your are self-employed, it typically means you work for yourself, as an independent contractor, or own your own business. Here are six key points the IRS would like you to know about self-employment and self-employment taxes:

Self-employment income can include pay that you receive for part-time work you do out of your home. This could include income you earn in addition to your regular job.
Self-employed individuals file a Schedule C, Profit or Loss from Business, or Schedule C-EZ, Net Profit from Business, with their Form 1040.
If you are self-employed, you generally have to pay self-employment tax as well as income tax. Self-employment ax includes Social Security and Medicare taxes. You figure this tax using Schedule SE, Self-Employment tax.
If you are self-employed you may have to make estimated tax payments. People typically make estimated tax payments to pay taxes on income that is not subject to withholding. If you do not make estimated tax payments, you may have to pay a penalty when you file your income tax return. The underpayment of estimated tax penalty applies if you do not pay enough taxes during the year.
When you file your tax return, you can deduct some business expenses for the costs you paid to run your trade or business. You can deduct most business expenses in full, but some costs must be ‘capitalized’. This means you can deduct a portion of the expense each year over a period of years.
You may deduct only the costs that are both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business.

For more information, visit the Small Business and Self-Employed Tax Center on the IRS website. There are three IRS publications that will also help you. See Publications 334, Tax Guide for Small Business; 535, Business Expenses and 505, Tax Withholding and Estimated Tax. All tax forms and publications are available on IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Estimated Tax Payments

Apr 11th, 2013

by jblankenship.

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When you have income from sources other than traditional employment, it often becomes necessary to make Estimated Tax payments since you don’t have withholding (as you would from traditional wages). This income may be from self-employment, rents or royalties, or from interest and dividends from your investments. Income of this variety may also be from pensions, Social Security, and IRAs or qualified retirement plans.

Sometimes you can set up the payments from various sources to withhold tax payments and the provider will then send the withheld tax to the IRS on your behalf. These tax payments will be reported to you on your 1099R, SSA-1099, and/or other specific tax documents that you receive at the end of the year. If you don’t have another form of withholding, you may need to make estimated tax payments throughout the year.

The IRS recently issued their Tax Tip 2013-49, which details Six Tips on Making Estimated Tax Payments. The actual text of the Tip is listed below.

Six Tips on Making Estimated Tax Payments

Some taxpayers may need to make estimated tax payments during the year. The type of income you receive determines whether you must pay estimated taxes. Here are six tips from the IRS about making estimated tax payments.

If you do not have taxes withheld from your income, you may need to make estimated tax payments. This may apply if you have income such as self-employment, interest, dividends or capital gains. It could also apply if you do not have enough taxes withheld from your wages. If you are required to pay estimated taxes during the year, you should make these payments to avoid a penalty.
Generally, you may need to pay estimated taxes in 2013 if you expect to owe $1,000 or more in taxes when you file your federal tax return. Other rules apply, and special rules apply to farmers and fishermen.
When figuring the amount of your estimated taxes, you should estimate the amount of income you expect to receive for the year. You shold also include any tax deductions and credits that you will be eligible to claim. Be aware that life changes, such as a change in marital status or a child born during the year can affect your taxes. Try to make your estimaes as accurate as possible.
You normally make estimated tax payments four times a year. The dates that apply to most people are April 15, June 17 and Sept. 16 in 2013, and Jan. 15, 2014.
You should use Form 1040-ES, Estimated Tax for individuals, to figure your estimated tax.
You may pay online or by phone. You may also pay by check or money order, or by credit or debit card. You’ll find more information about your payment options in the Form 1040-ES instructions. Also, check out the Electronic Payment Options Home Page at IRS.gov. If you mail your payments to the RIS, you should use the payment vouchers that come with Form 1040-ES.

For more information about estimated taxes, see Publication 505, Tax Withholding and Estimated Tax. Forms and publications are available on IRS.gov or by calling 800-TAX-FORM (800-829-3676).

jb Note: Another way to ensure that you have appropriate withholding for the tax year is by taking a distribution from an IRA and having tax withheld from the distribution. This is a little-known option that you can use to avoid having to make quarterly estimated tax payments throughout the year – see the article “IRA Trick – Eliminate Quarterly Estimated Tax Payments” for more details.

What Income is Taxable?

Apr 10th, 2013

by jblankenship.

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It may be tough to figure out which parts of your income you’ve received over the year are taxable, and what parts are not taxable. This is because certain kinds of income may seem like they should not be taxed (but they are), while other items of income seem like they should be taxed (but they’re not).

The IRS has published a Tax Tip to help understand which income is taxable and which is not. The complete text of IRS Tax Tip 2013-12 is detailed below.

Taxable and Nontaxable Income

Most types of income are taxable, but some are not. Income can include money, property or services that you receive. Here are some examples of income that are usually not taxable:

Child support payments;
Gifts, bequests and inheritances;
Welfare benefits;
Damage awards for physical injury or sickness;
Cash rebates from a dealer or manufacturer for an item you buy; and
Reimbursements for qualified adoption expenses.

Some income is not taxable except under certain conditions. Examples include:

Life insurance proceeds paid to you because of an insured person’s death are usually not taxable. However, if you redeem a life insurance policy for cash, any amount that is more than the cost of the policy is taxable.
Income you get from a qualified scholarship is normally not taxable. Amounts you use for certain costs, such as tuition and required course books, are not taxable. However, amounts used for room and board are taxable.

All income, such as wages and tips, is taxable unless the law specifically excludes it. This includes non-cash income from bartering – the exchange of property or services. Both parties must include the fair market value of goods or services received as income on their tax return.

If you received a refund, credit or offset of state or local income taxes in 2012, you may be required to report this amount. If you did not receive a 2012 Form 1099-G, check with the government agency that made the payments to you. That agency may have made the form available only in an electronic format. You will need to get instructions from the agency to retrieve this document. Report any taxable refund you received even if you did not receive Form 1099-G*.

For more information and examples, see Publication 525, Taxable and Nontaxable Income. The booklet is available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

* jb Note: If you didn’t itemize your deductions on the previous year’s return and/or if you did not deduct state or local income taxes on the previous year’s return, your refund is likely not taxable income. An example would be if you took the state & local sales tax deduction instead of state & local income taxes (you have to choose between the two) – in this case if you received a refund from the state or local taxing authority, this is usually not taxable in the current year.

What You Need to Know About the Alternative Minimum Tax (AMT)

Apr 8th, 2013

by jblankenship.

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When you have high taxable income and certain deductions and exclusions from income, you may be subject to the Alternative Minimum Tax, or AMT. This is a nearly flat-tax, which excludes a higher amount of income from the regular income tax. For 2012 taxes, the exclusion of income is $50,600 for singles, and $78,750 for married couples. The “nearly flat” tax rate starts at 26% and the upper end rate is 28%.

Under the AMT, no deduction is allowed for the standard deduction, or for personal exemptions. State and local taxes are also not allowed to be deducted from your income. Your other itemized deductions are allowed, at least to a certain extent.

Recently the IRS issued their Tax Tip 2013-17, which lists Five Facts to Know About AMT. The actual text of this Tip is below.

Five Facts to Know about AMT

The Alternative Minimum Tax may apply to you if your income is above a certain amount. Here are five facts the IRS wants you to know about the AMT:

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.
The 2012 AMT exemption amounts for each filing status are:
- Single and Head of Household = $50,600;
- Married Filing Joint and Qualifying Widow(er) = $78,750; and
- Married Filing Separate = $39,375.
AMT attempts to ensure that some individuals and corporations who claim certain exclusions, tax deductions and tax credits pay a minimum amount of tax.
You should use IRS e-file to prepare and file your tax return. You figure AMT using different rules than those you use to figure your regular income tax. IRS e-file software will determine if you owe AMT, and if you do, it will figure the tax for your.
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.

Visit IRS.gov for more information about AMT. You should also check Form 6251, Alternative Minimum Tax – Individuals and its instructions. Both are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

The IRS Released Their “Dirty Dozen” Tax Scams for 2013

Apr 1st, 2013

by jblankenship.

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Every year the IRS releases a list of what they refer to as the “Dirty Dozen” tax scams – which are particularly timely to review during tax filing season. Don’t expect this to be as much fun as watching the original 1967 movie – c’mon, this is the IRS, not Lee Marvin! However, it’s important to know about these scams because, as the taxpayer, it is you who is ultimately responsible for the information on your tax return – even if you were duped into believing a particular “scam” was legit.

Recently this list was released for 2013, in the IRS’ Special Edition Tax Tip 2013-08. The actual text of 2013-08 follows:

Protect Yourself from the Dirty Dozen Tax Scams

The IRS’s annual ‘Dirty Dozen’ list includes common tax scams that often peak during the tax filing season. The IRS recommends that taxpayers be aware so they can protect themselves against claims that sound too good to be true. Taxpayers who buy into illegal tax scams can end up facing significant penalties and interest and even criminal prosecution.

Tax scams that made the Dirty Dozen list this filing season are:

Identity Theft. Tax fraud through the use of identity theft tops this year’s Dirty Dozen list. Combating identity theft and refund fraud is a top priority for the IRS. The IRS’s ID theft strategy focuses on prevention, detection and victim assistance. During 2012, the IRS protected $20 billion of fraudulent refunds, including those related to identity theft. This compares to $14 billion in 2011. Taxpayers who believe they are at risk of identity theft due to lost or stolen personal information should immediately contact the IRS so the agency can take action to secure their tax account. You may also call the IRS’s Identity Protection Specialized Unit at 800-908-4490. Find more informaiton on the identity protection page on IRS.gov.

Phishing. Phishing typically involves an unsolicited email or a fake website that seems legitimate but lures victims into providing personal and financial information. Once scammers obtain that information, they can commit identity theft or financial theft. The IRS does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels. If you receive an unsolicited email that appears to be from the RIS, send it to phishing@irs.gov.

Return Preparer Fraud. Although most return preparers are reputable and provide good service, you should choose carefully when hiring someone to prepare your tax return. Only use a preparer who signs the return they prepare for you and enters their IRS Preparer Tax Identification Number (PTIN). For tips about choosing a preparer, visit www.irs.gov/chooseataxpro.

Hiding Income Offshore. One form of tax evasion is hiding income in offshore accounts. This includes using debit cards, credit cards or wire transfers to access those funds. While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirements taxpayers need to fulfill. Failing to comply can lead to penalties or criminal prosecution. Visit IRS.gov for more information on the Voluntary Disclosure Program.

“Free Money” from the IRS & Tax Scams Involving Social Security. Beware of scammers who prey on people with low income, the elderly and church members around the country. Scammers use flyers and ads with bogus promises of refunds that don’t exist. The schemes target people who have little or no income and normally don’t have to file a tax return. In some cases, a victim may be due a legitimate tax credit or refund but scammers fraudulently inflate income or use other false information to file a return to obtain a larger refund. By the time people find out the IRS has rejected their claim, the promoters are long gone.

Impersonation of Charitable Organizations. Following major disasters, it’s common for scam artists to impersonate charities to get money or personal information from well-intentioned people. They may even directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds. Taxpayers need to be sure they donate to recognized charities.

False/Inflated Income and Expenses. Falsely claiming income you did not earn or expenses you did not pay in order to get larger refundable tax credits is tax fraud. This includes false claims for the Earned Income Tax Credit. In many cases the taxpayer ends up repaying the refund, including penalties and interest. In some cases the taxpayer faces criminal prosecution. In one particular scam, taxpayers file excessive claims for the fuel tax credit. Fraud involving the fuel tax credit is a frivolous claim and can result in a penalty of $5,000.

False Form 1099 Refund Claims. In this scam, the perpetrator files a fake information return, such as a Form 1099-OID, to justify a false refund claim.

Frivolous Arguments. Promoters of frivolous schemes advise taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. These are false arguments that the courts have consistently thrown out. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.

Falsely Claiming Zero Wages. Filing a phony information return is an illegal way to lower the amount of taxes an individual owes. Typically, scammers use a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 to improperly reduce taxable income to zero. Filing this type of return can result in a $5,000 penalty.

Disguised Corporate Ownership. Scammers improperly use third parties to form corporations that hide the true ownership of the business. They help dishonest individuals underreport income, claim fake deductions and avoid filing tax returns. They also facilitate money laundering and other financial crimes.

Misuse of Trusts. There are legitimate uses of trusts in tax and estate planning. But some questionable transactions promise to reduce the amount of income that is subject to tax, offer deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the promised tax benefits. They primarily help avoid taxes and hide assets from creditors, including the IRS.

For more on the Dirty Dozen, see IRS news release IR-2013-33.

Capital Gains and Losses on Your Tax Return

Mar 25th, 2013

by jblankenship.

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When you sell things, including stocks, bonds, real estate, collectibles, and other items, you may either gain money or lose money from the original purchase price. This gain or loss is known as a capital gain or capital loss, and (with some exceptions) you will report these capital gains or losses on your income tax return.

Often the gains are afforded special tax rates and treatment, and the losses provide additional benefits as well. This entire area of tax reporting can be confusing and there are special rules that you need to follow in order to make sure that you report these transactions correctly and pay the appropriate taxes.

The IRS recently published their Tax Tip 2013-28, which details Ten Facts about Capital Gains and Losses. The actual text of the Tip is below:

Ten Facts about Capital Gains and Losses

The term “capital asset” for tax purposes applies to almost everything you own and use for personal or investment purposes. A capital gain or loss occurs when you sell a capital asset.

Here are 10 facts from the IRS on capital gains and losses:

Almost everything you own and use for personal purposes, pleasure or investment is a capital asset. Capital assets include your home, household furnishings, and stocks and bonds that you hold as investments.
A capital gain or loss is the difference between your basis of an asset and the amount you receive when you sell it. Your basis is usually what you paid for the asset.
You must include all capital gains in your income.
You may deduct capital losses on the sale of investment property. You cannot deduct losses on the sale of personal-use property.
Capital gains and losses are long-term or short-term, depending on how long you hold on to the property. If you hold the property more than one year, your capital gains or loss is long-term. If you hold it for one year or less, the gain or loss is short-term.
If your long-term gains exceed your long-term losses, the difference between the two is a net long-term capital gain. If your net long-term capital gain is more than your net short-term capital loss, you have a ‘net capital gain’.
The tax rates that apply to net capital gains are generally lower than the tax rates that apply to other types of income. The maximum capital gains rate for most people in 2012 is 15 percent. For lower-income individuals, the rate may be 0 percent on some or all of their net capital gains. Rates of 25 or 28 percent can also apply to special types of net capital gains.
If your capital losses are greater than your capital gains, you can deduct the difference between the two on your tax return. The annual limit on this deduction is $3,000, or $1,500 if you are married filing separately.
If your total net capital loss is more than the limit you can deduct, you can carry over the losses you are not able to deduct to next year’s tax return. You will treat those losses as if they occurred that year.
(jb note: In other words, your carried over loss from a prior year is subtracted from your gains or added to the losses in the current year. If the result is a net capital loss, up to $3,000 is deducted from your ordinary income in that year, and the excess amount carried over to the next year. If the result is a net capital gain, this net gain is reported and taxed as a long-term gain on the current return.)
Form 8949, Sales and Other Dispositions of Capital Assets, will help you calculate capital gains and losses. You will carry over the subtotals from this form to Schedule D, Capital Gains and Losses. If you e-file your tax return, the software will do this for you.

For more information about capital gains and losses, see the Schedule D instructions or Publication 550, Investment Income and Expenses. They are both available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Adoption Credit for Tax Year 2012 and beyond

Mar 18th, 2013

by jblankenship.

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As you probably already know if you’re in the position to seek the adoption credit, this credit has undergone some changes for the 2012 filing season.

In the past, for tax years 2010 and 2011, the adoption credit was a refundable credit – meaning that you could receive the entire credit regardless of the amount of tax you have to pay. For example, if you had $10,000 of adoption credit and your tax return otherwise indicates that your tax is $6,000, you were able to claim the entire credit and $4,000 would be refunded to you. This was in addition to any overpayment you may have made on your withholding.

However, for 2012 (and beyond, unless the rules change again) the adoption credit is back to being non-refundable. Now, in the situation described above, the maximum amount of credit that you could claim is equal to your tax, or $6,000.

The limit for adoption expenses for 2012 is $12,650 per child. A portion of these expenses could have been incurred in a prior year, and the credit claimed for that tax year. The total of all credits for the adoption of that child (including prior years’ credit) cannot exceed $12,650 if the adoption was finalized in 2012. Any excess credit cannot be carried over to future years.

There is also an income limit for the credit: if your Modified Adjusted Gross Income is less than $189,710 for 2012, the credit is not limited. If your income is above that level but less than $229,710, the maximum credit is reduced pro rata from $12,650. Above a MAGI of $229,710, the credit is eliminated.

It’s important to note that there is also an income exclusion limit for employer-provided adoption benefits – which is also equal to $12,650 per child for 2012. This exclusion has the same MAGI limits as the credit. Credit and exclusion can be taken for the same adoption, but not for the same expenses.

For example, if you had a adoption expenses of $18,000 for tax year 2012 and your employer provided you with adoption assistance of $10,000 for the year, you would only be able to take the credit for $8,000 (the remaining expenses).

Lastly, the adoption credit is claimed on Form 8839, Qualified Adoption Expenses. When using this form to claim adoption credit, you are not allowed to efile your return, it must be printed and filed by mail. However, you do not have to send along the supporting documents and adoption decree (as you did in 2010 and 2011), since the credit is no longer refundable.

Social Security Benefits and Taxes

Mar 8th, 2013

by jblankenship.

2 comments

When you’re receiving Social Security benefits, you may be subject to income tax on those benefits. At the end of the year, you’ll receive a form SSA-1099 from the government that details the benefits that you’ve been paid, as well as the amount that has been deducted for Medicare premiums, and any federal income tax that you’ve had withheld from the benefit checks.

When you prepare your tax return for the year, if you’re using a software program (does anyone prepare them by hand any more?), the program will give you a place to enter the figures from your SSA-1099 form. Then after you’ve entered all of your other income information into the system, it will calculate how much of your Social Security benefit is subject to income tax.

But that’s no fun, is it? How do you know how much of your benefit is going to be taxable?

Here’s how it works: there is a figure known as provisional income, which is calculated using all of your other income (including tax-exempt interest) plus half of your Social Security income. Your provisional income is then compared to a base amount, depending upon your filing status.

For filing status of Single, Head of Household, Qualifying Widow(er) with a Dependent Child, or Married Filing Separately (if you did not live with your spouse at any time in the year), the base amount is $25,000
Married Filing Jointly, the base amount is $32,000
Married Filing Separately (if the spouses lived together at any time during the year), the base amount is $0

If your provisional income is above the base amount for your filing status, your Social Security benefit at least a portion of your benefit is going to be taxable. Up to 50% of your benefit may be taxable as ordinary income, until you reach the next base level. If your provisional income is greater than the first base level but less than the next base level, at most 50% of the Social Security benefit will be taxable. The next base levels are:

$34,000 (Single, Head of Household, etc.)
$44,000 (Married Filing Jointly)
$0 (Married Filing Separately)

When your provisional income is greater than the second base level, a portion of your Social Security benefit will become 85% taxable. Upon reaching the second level, a portion of the benefit is 50% taxable and the amounts above the second level are 85% taxable. As your income increases, eventually all of your Social Security benefits become 85% taxable.

If you want more detail on the calculations, you can look at this earlier article which works through the calculations for Social Security benefit taxation. It gets pretty complicated, but it’s useful to know how it all works, in case you can change your income to make a difference in how the benefits are taxed. This is also useful as you plan which types of income to recognize – if you can take Roth-type income versus regular IRA income,it can have a profound effect on the taxation of your Social Security benefits. For more on how this works, see this article on Roth Conversions and Social Security benefits.

Knowing which tax form to file

Mar 4th, 2013

by jblankenship.

2 comments

When filing your own tax returns, it can be confusing to figure our which form you should use. If you are using tax preparation software, most often this choice is made for you, but if you’re doing it the old-fashioned way, you need to know which form to file.

The IRS recently issued Tax Tip 2013-04, which helps you to choose the correct form to file. The actual text of the Tip follows (I’ve cleaned up a few formatting issues):

Choosing Which Form to File

IRS e-file makes it easy for taxpayers to choose which tax form to file. Tax software automatically chooses the best form for your particular situation. Most people e-file these days, but if you prefer taking pen to paper, the IRS has some tips to help you choose the right form.

Taxpayers who choose to file a paper tax return should know that the IRS no longer mails paper tax packages. The quickest way to get forms and instructions is by visiting the IRS website at IRS.gov. You can also order forms and have them mailed to you by calling the RIS forms line at 1-800-TAX-FORM (829-3676). You may also pick up tax forms from a local IRS office, and some libraries and post offices carry tax forms.

Here are some tips that will help paper tax return filers choose the best tax form for their situation:

You can generally use the 1040EZ if:

Your taxable income is below $100,000;
Your filing status is single or married filing jointly; and
You are not claiming any dependents.

If you can’t use Form 1040EZ, you may qualify to use the 1040A if:

Your taxable income is below $100,000;
You have capital gain distributions;
You claim certain tax credits; and

You claim adjustments to income for IRA contributions and student loan interest.

If you cannot use the 1040EZ or the 1040A, you’ll probably need to file using the 1040. The reasons you must use the 1040 include:

Your taxable income is $100,000 or more;
You claim itemized deductions; and
You are reporting self-employment income.

IRS Publication 17, Your Federal Income Tax, provides helpful information about which form is best for you.

Access to IRS forms and instructions or information about e-filing, including IRS Free File, is available 24 hours a day, seven days a week on IRS.gov. Tax products often appear online well before they are available on paper. You’ll find downloadable tax products on IRS.gov by clicking on the “Forms and Pubs” link on the Home Page.

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