When you don’t file your tax return or if you don’t pay the tax owed on time, the IRS has specific penalties that are applied to your account.  Recently the IRS issued their Tax Tip 2012-74, which lists eight facts about these penalties.  The actual text of the Tax Tip is listed below:

Failure to File of Pay Penalties: Eight Facts

The number of electronic filing and payment options increases every year, which helps reduce your burden and also improves the timeliness and accuracy of tax returns.  When it comes to filing your tax return, however, the law provides that the IRS can assess a penalty if you fail to file, fail to pay, or both.

Here are eight important points about the two different penalties you may face if you file or pay late.

1. If you do not file by the deadline, you might face a failure-to-file penalty.  If you do not pay by the due date, you could face a failure-to-pay penalty.
2. The failure-to-file penalty is generally more than the failure-to-pay penalty.  So if you cannot pay all the taxes you owe, you should still file your tax return on time and pay as much as you can, then explore other payment options.  The IRS will work with you.
3. The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late.  This penalty will not exceed 25 percent of your unpaid taxes.
4. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
5. If you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid.  This penalty can be as much as 25 percent of your unpaid taxes.
6. If you request an extension of time to file by the tax deadline and you paid at least 90 percent of your actual tax liability by the original due date, you will not face a failure-to-pay penalty if the remaining balance is paid by the extended due date.
7. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.  However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
8. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Every year around this time, the IRS issues its list of the top tax scams they’ve seen, as a reminder to taxpayers to use caution during tax season to protect themselves against schemes from identity theft to return preparer fraud.

Following is the list of the Dirty Dozen Tax Scams for 2012, taken from IRS publication IR-2012-23:

Identity Theft

Topping this year’s Dirty Dozen list is identity theft.  In response to growing identity theft concerns, the IRS has embarked on a comprehensive strategy that is focused on preventing, detecting and resolving identity theft cases as soon as possible.  In addition to the law-enforcement crackdown, the IRS has stepped up its internal reviews to spot false tax returns before tax refunds are issued as well as working to help victims of the identity theft refund schemes.

Identity theft cases are among the most complex ones the IRS handles, but the agency is committed to working with taxpayers who have become victims of identity theft.

The IRS is increasingly seeing identity thieves looking for ways to use a legitimate taxpayer’s identity and personal information to file a tax return and claim a fraudulent refund.

An IRS notice informing a taxpayer that more than one return was filed in the taxpayer’s name or that the taxpayer received wages from an unknown employer may be the first tip off the individual receives that he or she has been victimized.

The IRS has a robust screening process with measures in place to stop fraudulent returns.  While the IRS is continuing to address tax-related identity theft aggressively, the agency is also seeing an increase in identity crimes, including more complex schemes.  In 2011, the IRS protected more than $1.4 billion of taxpayer funds from getting into the wrong hands due to identity theft.

In January, the IRS announced the results of a massive, national sweep cracking down on suspected identity theft perpetrators as a part of a stepped-up effort against refund fraud and identity theft.  Working with the Justice Department’s Tax Division and local US Attorneys’ offices, the nationwide effort targeted 105 people in 23 states.

Anyone who believes his or her personal information has been stolen and used for tax purposes should immediately contact the IRS Identity Protection Specialized Unit.  For more information, visit the special identity theft page at www.IRS.gov/identitytheft.

Phishing

Phishing is a scam typically carried out with the help of unsolicited email or a fake website that poses as a legitimate site to lure in potential victims and prompt them to provide valuable personal and financial information.  Armed with this information, a criminal can commit identity theft or financial theft.

If you receive an unsolicited email that appears to be from either the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System (EFTPS), report it by sending it to phishing@irs.gov.

Return Preparer Fraud

About 60 percent of taxpayers will use tax professionals this year to prepare and file their tax returns.  Most return preparers provide honest service to their clients.  But as in any other business, there are also some who prey on unsuspecting taxpayers.

Questionable return preparers have been known to skim off their clients’ refunds, charge inflated fees for return preparation services and attract new clients by promising guaranteed or inflated refunds.  Taxpayers should choose carefully when hiring a tax preparer.  Federal courts have issued hundreds of injunctions ordering individuals to cease preparing returns, and the Department of Justice has pending complaints against many others.

In 2012, every paid preparer needs to have a Preparer Tax Identification Number (PTIN) and enter it on the returns he or she prepares.

Signals to watch for when you are dealing with an unscrupulous return preparer would include that they:

• Do not sign the return or place a Preparer Tax Identification Number on it.
• Do not give you a copy of your tax return.
• Promise larger than normal tax refunds.
• Charge a percentage of the refund amount as preparation fee.
• Require you to split the refund to pay the preparation fee.
• Add forms to the return you have never filed before.
• Encourage you to place false information on your return, such as false income, expenses and/or credits.
• Ask you to sign a blank return (added by jb)

For advice on how to find a competent tax professional, see www.irs.gov.

Hiding Income Offshore

Over the years, numerous individuals have been identified as evading US taxes by hiding income in offshore banks, brokerage accounts or nominee entities, using debits cards, credit cards or wire transfers to access the funds.  Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.

The IRS uses information gained from its investigations to pursue taxpayers with undeclared accounts, as well as the banks and bankers suspected of helping clients hide their assets overseas.  The IRS works closely with the Department of Justice to prosecute tax evasion cases.

While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirement that need to be fulfilled.  US taxpayers who maintain such accounts and who do not comply with reporting and disclosure requirements are breaking the law and risk significant penalties and fines, as well as the possibility of criminal prosecution.

Since 2009, 30,000 individuals have come forward voluntarily to disclose their foreign financial accounts, taking advantage of special opportunities to bring their money back into the US tax system and resolve their tax obligations.  And, with new foreign account reporting requirements being phased in over the next few years, hiding income offshore will become increasingly more difficult.

At the beginning of this year, the IRS reopened the Offshore Voluntary Disclosure Program (OVDP) following continued strong interest from taxpayers and tax practitioners after the closure of the 2011 and 2009 programs.  The IRS continues working on a wide range of international tax issues and follows ongoing efforts with the Justice Department to pursue criminal prosecution of international tax evasion.  This program will be open for an indefinite period until otherwise announced.

The IRS has collected $3.4 billion so far from people who participated in the 2009 offshore program, reflecting closures of about 95% of the cases from the 2009 program.  On top of that, the IRS has collected an additional $1 billion from up front payments required under the 2011 program.  That number will grow as the IRS processes the 2011 cases.

“Free Money” from the IRS & Tax Scams Involving Social Security

Flyers and advertisements for free money from the IRS, suggesting that the taxpayer can file a tax return with little or no documentation, have been appearing in community churches around the country.  These schemes are also often spread by word of mouth as unsuspecting and well-intentioned people tell their friends and relatives.

Scammers prey on low income individuals and the elderly.  They build false hopes and charge people good money for bad advice.  In the end, the victims discover their claims are rejected.  Meanwhile, the promoters are long gone.  The IRS warns all taxpayers to remain vigilant.

There are a number of tax scams involving Social Security.  For example, scammers have been known to lure the unsuspecting with promises of non-existent Social Security refunds or rebates.  In another situation, a taxpayer may really be due a credit or refund but uses inflated information to complete the return.

Beware.  Intentional mistakes of this kind can result in a $5,000 penalty.

False/Inflated Income and Expenses

Including income that was never earned, either as wages or as self-employment income in order to maximize refundable credits, is another popular scam.  Claiming income you did not earn or expenses you did not pay in order to secure larger refundable credits such as the Earned Income Tax Credit could have serious repercussions.  This could result in repaying the erroneous refunds, including interest and penalties, and in some cases, even prosecution.

Additionally, some taxpayers are filing excessive claims for the fuel tax credit.  Farmers and other taxpayers who use fuel for off-highway business purposes may be eligible for the fuel tax credit.  But other individuals have claimed the tax credit when their occupations or income levels make the claims unreasonable.  Fraud involving the fuel tax credit is considered a frivolous tax claim and can result in a penalty of $5,000.

False Form 1099 Refund Claims

In this ongoing scam, the perpetrator files a fake information return, such as a a Form 1099 Original Issue Discount (OID), to justify a false refund claim on a corresponding tax return.  In some cases, individuals have made refund claims based on the bogus theory that the federal government maintains secret accounts for US citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS.

Don’t fall prey to people who encourage you to claim deductions or credits to which you are not entitled or willingly allow others to use your information to file false returns.  If you are a party to such schemes, you could be liable for financial penalties or even face criminal prosecution.

Frivolous Arguments

Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe.  The IRS has a list of frivolous tax arguments that taxpayers should avoid.  These arguments are false and have been thrown out of court.  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, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a way to improperly reduce taxable income to zero.  The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS.

Sometimes, fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation.  Taxpayers should resist any temptation to participate in any variations of this scheme.  Filing this type of return may result in a $5,000 penalty.

Abuse of Charitable Organizations and Deductions

IRS examiners continue to uncover the intentional abuse of 501(c)(3) organizations, including arrangements that improperly shield income or assets from taxation and attempts by donors to maintain control over donated assets or the income from donated property.  The IRS is investigating schemes that involve the donation of non-cash assets – including situations in which several organizations claim the full value of the same non-cash contribution.  Often these donations are highly overvalued or the organization receiving the donation promises that the donor can repurchase the items later at the price set by the donor.  The Pension Protection Act of 2006 imposed increased penalties for inaccurate appraisals and set new standards for qualified appraisals.

Disguised Corporate Ownership

Third parties are improperly used to request employer identification numbers and form corporations that obscure the true ownership of the business.

These entities can be used to underreport income, claim fictitious deductions, avoid filing tax returns, participate in listed transactions and facilitate money laundering, and financial crimes.  The IRS is working with state authorities to identify these entities and bring the owners into compliance with the law.

Misuse of Trusts

For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts.  While there are legitimate uses of trusts in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes.  Such trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS.

IRS personnel have seen an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses.  As with other arrangements, taxpayers should seek the advice of a trusted professional before entering a trust arrangement.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

If you have an IRA you probably know about the concept of a Roth IRA conversion – where you take distribution of a portion of your IRA and directly transfer that money into your a Roth IRA, paying tax as you go.  Then the Roth IRA can continue to grow tax-free (as Roth IRAs do) and you’ll never owe tax on your qualified distributions from the Roth IRA.

In addition, if the investments you’ve made in the Roth IRA have lost money, before October 15 of the following year you have the opportunity to recharacterize your Roth conversion.  If you didn’t recharacterize, you’d be paying tax on a conversion amount that is much lower now if there was a downturn in the investments, so your average tax rate is much higher than you’d hoped.  By recharacterizing, you can undo the conversion or a part of it.

I had a question raised to me recently about using the recharacterization option to your advantage.  Here’s the gist of the strategy:  If you have an IRA worth, say $100,000, you could convert it into two Roth IRAs, one half invested in a 2x leveraged bull-oriented investment, and the other half invested in a 2x leveraged bear-oriented investment.

If the two investments go flat for the year, your conversion could be recharacterized with no tax consequence.  However, if the market went up by 10%, your bear holding would be down 20% (being leveraged 2x) and the bull holding would be up 20% (vice versa had the market dropped).  This would give you the opportunity to recharacterize only the bear holding, leaving you with a traditional IRA worth $40,000.  Your Roth IRA would be worth $60,000, although you would only have to pay tax on the original $50,000 converted.  At a 25% tax rate that works out to $12,500 in tax, which would only be 20.83% on the Roth IRA.

Perhaps that rate isn’t low enough for you though – maybe you need to ensure that the tax rate is even lower, say 15% or less.  Following the example, you’d need to see an increase of 66% or more in your holdings, which would equate to a 33% move in the market (for your leveraged holdings, one way or the other).  If the market doesn’t move in the amount you hoped, you can just recharacterize the entire conversion, nothing lost.

You probably want to pull your “winnings” off the table and put the remaining Roth IRA into a safe(r) investment than the leveraged investments chosen before, such as a balanced fund or even straight bonds.

Now you now can pull the same maneuver in the following year with whatever is left in the traditional IRA, splitting it just as before.  Over time you should wind up with a significant Roth IRA with a lower tax cost.

This is not a huge payoff strategy – you’ll be losing money in your traditional IRA holdings each year, guaranteed.  Your net position would be the same (minus the tax).

After the first year of the example, assuming a 20% gain you’d have with $60,000 in the Roth and $40,000 in the traditional IRA, having paid $12,500 in tax.  Second year, same result and you’d have $84,000 in Roth, and $16,000 in traditional IRA, paying $5,000 more in tax.  Third year, again the same 20% gain  resulting in a total of $93,600 in Roth, $6,400 in trad, paying $2,000 in tax.  And so on, until the amount gets too small to work with any more.

The end result is that all of this tallies up to the same $100,000 that you started with, having paid tax of just less than $21,000, versus the original $25,000 you would have paid.  Holding out for a higher return from the strategy would yield a lower tax rate overall.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

For those who are not in the tax preparation business this is probably news to you – but the IRS has taken steps to test and ostensibly improve the competency of professional tax preparers.

Up to this point, there has been literally no requirement of competency for tax preparers.  No testing, education, or oversight was required.  Kinda scary, huh?  Well, it’s true, this has been the situation – literally anyone could hang out a shingle and prepare taxes for the general public.  These folks are referred to as Unenrolled Preparers.  But this is changing, although you may find that the measures being put into place don’t really go far enough.

In the past, there were three groups of professionals who were uniquely qualified by education and certification to prepare income tax returns.  They are: Certified Public Accountants (CPAs), Enrolled Agents (EAs), and licensed attorneys.  Since the IRS was aware there were many more preparers who had no education or certification requirement, they developed the Registered Tax Return Preparer designation (RTRP) in order to improve the quality of the tax return preparation industry.

In order to register these preparers, a certain level of competency is required, naturally.  The problem is that most of these preparers aren’t up to the competency requirements of the professional groups listed earlier, so a lower level of competency was set forth.  These preparers are going to be subjected to annual recertification, via an open book test based upon the Form 1040 tax return.  The open book information they’ll receive includes Publication 17, Form 1040, and the instructions for Form 1040.

Seems like we’re not setting the bar too high.  But then again, there wasn’t a bar before, so this is bound to be an improvement – at least these preparers will have seen a tax form before they start preparing them for the general public, a prerequisite that we don’t know happened before.

Hopefully this will help matters, and we’ll begin to see the level of competency of tax preparers improve across the board.  Time will tell.  Unenrolled preparers will have until the end of 2013 to pass the test for the first time, and will be allowed to continue preparing returns without a test until that time.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

This is, of course, one of the most volatile questions on the political landscape these days.  We have some constituencies claiming that the whole plan is a Ponzi scheme and we should get rid of it altogether – and many others aiming to make radical tax increases in the system to improve solvency, or pushing back the age(s) for receiving benefits to reduce drag on the system.

True, the system is in dire straits – not bankrupt, but needing attention.  Current projections indicate that at current pace, funds allocated to the system will run out sometime around 2036 unless something changes.

Increasing taxes is never popular, and current political winds have shown just how far the dream of no increases in taxes will be pushed.  In addition, extending the age limits during a time when unemployment is at record highs only exacerbates that issue – with older workers hanging on longer, younger workers can’t fill those jobs.

And eliminating the system altogether just isn’t workable.  Roughly 55 million Americans are currently receiving benefits – many with little else to live on in retirement.  A great many more are coming on the rolls every day, as the Baby-Boom generation hits the magic age(s).

Privatization, although once very popular, has lost its luster in recent years due to the market’s fluctuations.  The fact is that the majority of folks are just not very good at managing their own money – and the stakes are too high to give them a shot at what could be their only sustenance in retirement.  401(k) plans are great, but the facts are scary:  the Employee Benefit Research Institute’s (EBRI) March 2011 report showed that nearly half (46%) of all surveyed Americans who have saved anything at all have less than $10,000 saved (not including homes or defined benefit pension plans).  What’s worse is that over a third (36%) of those surveyed figured that if they saved up $250,000, that should be enough to retire comfortably, when in actuality that figure might cover the individual’s healthcare needs only.  And further, EBRI has indicated in countless reports year after year that when a 401(k) plan is in place, the actual returns achieved are dismal compared to the market average, due mostly to reactionary moves by investors operating without proper guidance.

So what can be done?  Means testing, for one thing.  Donald Trump doesn’t need Social Security, and neither do his young children – but they’re eligible (and are likely receiving it).  That’s not to say that eliminating the Donald and his peers from the recipient rolls will balance out the system; many more Americans will likely have to forego at least a part of the benefit that they’ve been expecting.

We’ve had a form of means testing in place since 1983 – via the taxability of Social Security benefits.  And since the limits haven’t been adjusted since that legislation was put into place (actually since the 1993 legislation), this means test is becoming more and more “taxing” to folks with any additional income on top of Social Security every year.  But it probably doesn’t go far enough.

Another item that could be dealt with is the payroll tax ceiling – currently at $106,800 – that could be liberalized a bit without too much ruckus.  Granted, this does mean a new, or rather increased, tax, but when you weigh that against the alternatives, it’s not a bad option to consider.

All in all, the Social Security system has its problems, to be sure. It is, after all, a form of social insurance – meaning that some folks will get far less from the system than they put into it, and others will get far more from it than they put in.  But we’ve got it in place and it’s working (pretty well anyway), so we just need to make some adjustments to make sure that the system can make it through the rough patches.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Image by aloucha via Flickr

A 60-day rollover is where the former plan distributes the funds from your account to you, and in order to make the rollover complete you must deposit the entire distributed amount into the new plan or IRA within 60 days.

Reasons to Use a Direct Rollover

1. You must complete the rollover to the new account or IRA within 60 days.  There is little if any leeway on this 60-day period – and though it seems as if this is a simple task to accomplish, there are many cases where well-intentioned individuals missed the bus on this one.  All it takes is a lost letter in the mail, or the check falling through the cracks, or any of myriad ways to miss the deadline.
2. When funds are distributed from a QRP to an individual, the plan administrator is required to withhold 20% of the distribution for income tax.  This presents a problem if you were planning to rollover the full amount of the QRP into your new plan or IRA, since you’ll now need to come up with the missing 20% from other sources.  Granted, if all things remain the same you should get the withheld 20% back from the IRS when you file your taxes, but that could be a long wait if you don’t have a lot of excess cash lying around.

Using the direct rollover eliminates both of the issues listed above.  When then QRP administrator enacts a direct rollover for you, most often the distribution is directly to the administrator or custodian of the new plan or IRA.  Sometimes the QRP administrator will send a check to you, the plan participant, made out to the new administrator or custodian, so you’ll still need to make sure that the check gets to the new plan within the 60-day window.  You’re in a much better position to get around the 60-day window if the check is made out to the new custodian, since technically the 60-day rollover requires that you have the funds at your disposal (for use or deposit in another account).

In addition, using a direct rollover eliminates the 20% withholding requirement altogether.  There’s no amount to make up later.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

If you have an email address (and let’s face it, who doesn’t?), you’ve likely received this email.  In case you haven’t received it, there’s an email that is being forwarded around the internet about a new tax on selling your home – I get at least one of these a month it seems. I’ve copied the text of one of the emails below. This article is to help you understand why the email is a misguided myth, partly grounded in truth but not applicable for most folks.

The email is usually forwarded at least a half-dozen times by the time you receive it, making it difficult to know where it started from.  In addition, the text of the email is often in large, bold, red font in places, such that you can almost feel the spittle coming off the page at you.

Here’s the email:

Will you ever sell your house?
Did you know that if you sell your house after 2012 you will pay a 3.8% FEDERAL sales tax on it?

That’s $3,800 on a $100,000 home etc.

When did this happen? It’s in the health care bill. Just thought you should know.

SALES TAX TO GO INTO EFFECT 2013 (Part of HC Bill)  Why 2013? Could it be to come to light AFTER the 2012 elections?

REAL ESTATE SALES TAX

So, this is “change you can believe in”?

Under the new health care bill – did you know that all real estate transactions will be subject to a 3.8% Sales Tax? The bulk of these new taxes don’t kick in until 2013 If you sell your $400,000 home, the re will be a $15,200 tax. This bill is set to screw the retiring generation who often downsize their homes. Does this stuff make your November and 2012 vote more important?

Oh, you weren’t aware this was in the obamacare bill? Guess what, you aren’t alone. There are more than a few members of Congress that aren’t aware of it either

<web address deleted>

Why am I sending you this? The same reason I hope you forward this to every single person in your address book. VOTERS NEED TO KNOW. 

Okay, so here are the facts:

It is a fact that under the Patient Protection and Affordable Care Act of 2010 there is a new 3.8% surtax on unearned income for folks above certain income levels.  I wrote about this surtax in relation to Roth conversions last year, but I didn’t go into detail about this email myth – I hadn’t started receiving them with the frequency that I have lately.

So the kernel of truth in the email is that some home sales could be impacted by this new surtax.  The real truth though is that in the case of a home sale, if the taxpayer has lived in the home for 2 out of the previous 5 years, up to $250,000 of gain in the value of the home is exempt from taxation.  The exclusion of gain amount is doubled to $500,000 for a married couple filing jointly who both meet the “2 out of 5” test.

The other test that would have to be met in order for a home sale to be hit with the surtax is that you have Modified AGI in excess of $250,000 for married couples filing jointly, $125,000 for married couples filing separately, or $200,000 for single and head of household filers.  If you don’t have income above that level, the surtax would not apply to you at all.

In other words, the situation described by the email could come about if you had an income greater than the levels outlined above, and one of the two circumstances below is met for the home sale:

• You own a home that you and your spouse have lived in for at least 2 out of the previous 5 years and the home has appreciated more than $500,000 in value (or $250,000 for single filers); or
• You own a home that you have not lived in during the previous 5 years that has appreciated in value in any amount.
• Note: If you lived in your home less than 2 years out of the previous 5, the exemption is pro-rated.  For example, if you lived in the home only 1 year out of the previous 5, half of the exemption would be available.

I doubt if many folks will come anywhere near meeting those circumstances.  It’s not impossible, but I think far less possible than the email leads you to believe, and the surtax certainly does not apply to ALL real estate sales.

Don’t get me wrong, I don’t want extra taxes imposed in these circumstances, either.  I do think people should know about this tax, but I want them to understand the tax in the correct context.  If you’d like more information on this myth, see what Snopes has to say about it.

Feel free to forward this link to anyone and everyone on your email list, so that the corrected word gets out.  Voters do need to know.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

I’ve mentioned before about various types of transactions that are not allowed in your IRA, but we’ve not actually covered the topic of Unrelated Business Taxable Income (UBTI) in your IRA.  UBTI isn’t prohibited within an IRA, but it does pose problems and adds a great deal of complexity to your account.

Unrelated Business Taxable Income

So, what is UBTI anyway?  The concept of UBTI pre-dates IRAs – it was originally developed in relation to charitable organizations, trusts, and other tax-exempt entities.  The IRS developed this concept to ensure that tax-exempt organizations didn’t have a competitive advantage over taxable organizations, such as for-profit corporations.  The way that income is determined to be “unrelated” is by checking these two tests:

• Is the income from a trade or business that is regularly carried on?
• Is the trade or business unrelated to the tax-exempt entity’s exercise of the entity’s tax-exempt purpose?

If these two tests are met, then the income may be UBTI.  Here’s an example that may help you to better understand the concept of UBTI (taken from IRS Publication 598:

An exempt vocational school operates a handicraft shop that sells articles made by students in their regular courses of instruction. The students are paid a percentage of the sales price. In addition, the shop sells products made by local residents who make articles at home according to the shop’s specifications. The shop manager periodically inspects the articles during their manufacture to ensure that they meet desired standards of style and quality. Although many local participants are former students of the school, any qualified person may participate in the program. The sale of articles made by students does not constitute an unrelated trade or business, but the sale of products made by local residents is an unrelated trade or business and is subject to unrelated business income tax.

The concept of UBTI covers many more situations, and you can find out much more about other types of activities that can generate UBTI by going to IRS Publication 598.

IRAs

Since IRAs are, until distribution, exempt from tax, UBTI applies to certain types of income received within an IRA account as well (all of this applies to Roth IRAs as well as traditional IRAs).  The IRS Code defines any active trade or business to unrelated to the IRA’s tax-exempt purpose.

There are exceptions as well (of course there are!).  The exceptions for tax-exempt organizations are numerous and complicated.  The following is a partial list exceptions specifically for IRAs:

• dividends
• interest (includes “points”)
• royalties
• rent from real property (real estate)
• sales proceeds from real property, as long as the property is not held as inventory or held in the normal course of a business (e.g., flipping)

This is nowhere near an exhaustive list – see Publication 598 for more details.

Examples of ways that an IRA investment could generate UBTI include: full ownership of a pass-through business, such as a limited partnership or S-Corporation; use of IRA funds to loan to a business – and the terms of the loan include participation in the profits of the business (as opposed to simple loan payments); and use of IRA funds to flip properties (via a partnership or LLC, for example), since the property is considered inventory and not investments.

Another way that UBTI is generated is through debt-financed income (also known as UDFI).  UDFI occurs in a case like this:  An IRA purchases a piece of real estate to be held for rental property.  In the purchase of the property, the IRA put 50% down in cash and financed the remaining 50% through the seller.  Even though rental income is considered to be exempt (see the list above), since debt was used to acquire the property, half of the rental income (reducing as the debt is paid off) would be considered UDFI, and therefore subject to taxation.  The good news is that the proportional part of the expenses associated with the debt-financed income would offset the income.

Okay, so my IRA has UBTI.  Now what?

If your IRA generates UBTI, it doesn’t disqualify the IRA (like prohibited transactions would).  No, what UBTI does is requires your IRA to file an income tax return.  This is unusual since an IRA is supposed to be tax-exempt, but since the UBTI is generated, income tax will be owed on the income if it reaches certain levels.

If the IRA generates gross income of $1,000 or more during the tax year, the IRA must file Form 990-T by April 15 of the following year, just like individual tax returns.  The issues that arise with this include:

• The IRA must have a federal tax id (EIN).
• The custodian is considered responsible for filing Form 990-T, but most self-directed IRA custodians transfer this responsibility to the account owner.
• The IRA custodian may not have all of the information required to file the return, as much of the information in these privately-held investments is given directly to the account owner.
• The account owner ultimately has the final responsibility to file the Form 990-T, and lack of understanding of the rules can cause major issues for the account owner.
• The account owner also will be required to file quarterly estimated tax payments as long as the investment is in place.  Every three months, a tax payment must be made to the IRS if the total tax for the year is expected to be greater than $500.

Form 990-T is a four-page form, and filling it out can be a fairly complex undertaking – one that you’re not likely to enjoy filling out (as I’m sure you do most tax forms).

Lastly, UBTI is one of those cases where income within an IRA is actually destined to be double-taxed.  Even though you pay tax on the UBTI as it is earned within the IRA (at trust rates, not individual rates, which are more compressed), when you take the money out of the IRA you’ll be taxed again.  Paying tax on UBTI doesn’t create non-taxable basis in the IRA, in other words.

With so many other eligible investment options, why not stick with the simple, non-UBTI investments for your IRA?  If you must invest in one of these investments that could trigger UBTI if it were in an IRA, just go ahead and invest your taxable monies in the endeavor – you’ll save yourself a lot of grief.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

It’s a little known fact that certain costs for caregivers, licensed or unlicensed, may qualify as medical expenses for tax deductions.  Maintenance and personal care service costs can be considered qualified medical expenses in cases where the patient receiving the care has been certified by a health-care professional as unable to perform two or more of the six activities of daily living: Bathing, Eating, Dressing, Toiletting, Continence, and Transferring (moving from bed to chair, for example).

Note: An easy way to remember these six activities is to use the first characters in the order I presented them above – B E D To C – this gives us the first five, and the entire mnemonic provides the sixth, Transferring from BED To Chair.

The health-care professional who certifies the patient as incapable of these activities can be a doctor, a nurse, or a licensed social worker, and the certifying professional is required to approve of the care program for the patient.

Another example of such qualifying expenses would be where an individual has dementia which causes serious health concerns requiring 24-hour supervision, determined by the doctor. Both licensed and unlicensed caregivers are hired to care for the individual.  Payments for these caregivers are deductible as medical expenses.  These expenses are considered qualified long-term care expenses.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

As taxpayers, many of us have faced difficulties in dealing with the IRS – and it can be a daunting position to be in.  One way to deal with these issues is to hire a CPA or Enrolled Agent to help you through the process.  Another way is to deal with it yourself.  The problem is that dealing with the IRS by yourself can be a very difficult thing to do.

The good news is that you have a friend at the IRS:  The Taxpayer Advocate Service (TAS).  The purpose of the TAS is to help

• taxpayers whose problems with the IRS are causing financial difficulties;
• who have tried but have not been able to resolve their problems with the IRS; and
• those who believe an IRS system or procedure is not working as it should.

In the IRS Tax Tip 2011-75, the IRS listed ten things that they believe every taxpayer should know about TAS:

1. The Taxpayer Advocate Service is your voice at the IRS.
2. Our service is free and tailored to meet your needs.
3. You may be eligible for our help if you have tried to resolve your tax problem through normal IRS channels and have gotten nowhere, or you face (or your business is facing) an immediate threat of adverse action.
4. The worst thing you can do is nothing at all!
5. We help taxpayers whose problems are causing financial difficulty or significant cost, including the cost of professional representation.  This includes businesses as well as individuals.
6. If you qualify for our help, we’ll do everything we can to get your problem resolved.  You will be assigned to one advocate who will be with you at every turn.
7. We have at least one local taxpayer advocate office in every state, the District of Columbia, and Puerto Rico.  You can call your local advocate, whose number is in your phone book, in Publication 1546, Taxpayer Advocate Service – Your Voice at the IRS, and on the IRS website. you can also call the IRS at 1-877-777-4778.
8. As a taxpayer, you have rights that the IRS must abide by in its dealings with you.  The IRS Tax Toolkit can help you to understand these rights.
9. TAS also handles large-scale or systemic problems that can affect many taxpayers.  If you know of one of these broad issues, please report it to TAS through the Systemic Advocacy Management System.
10. You can also get updates on hot tax topics by visiting the TAS YouTube channel or Facebook page, or by following the TAS tweets on Twitter.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).