Saturday, April 30, 2011

Tax refunds: Spending tips, payroll withholding effects

IRS data show that most taxpayers get refunds. Yes, even some filers who procrastinate will eventually get money back from the Internal Revenue Service.
As of March 18, the IRS had delivered 64.6 million refunds totalling $193 billion. That's an average refund of $2,985 per tax return.

Controlling your tax refund: Getting a tax refund is, in large part, your choice.
While the IRS is the bad guy for collecting taxes each April and throughout the year via payroll withholding, the tax agency doesn't take excess money or overcharge you. You do it to yourself by not giving your employer the most accurate withholding information.
Conventional wisdom says the tax goal is to have your withholding be as close to your actual eventual tax bill as possible.
Bu as IRS statistics indicate year after year, that's not the typical taxpayer case. Most folks have their workplaces overwithhold their income taxes. That's easy to remedy.
Instead of letting Uncle Sam have year-long, interest-free use of your money, payroll adjustments can help you can get the extra dollars as added income each pay period.
Of course, some folks just aren't good money managers. If they get a bit more each payday, they spend it. So they view overwithholding as a forced savings account.
Then there's the other option. Coming up short when you figure your final annual tax liability.
That's what I prefer. I like owing the IRS a tiny bit each year. That way the Treasury has to wait on my payment each April rather than me waiting for a refund check that might be delayed.
Some taxpayers due IRS refunds had to wait until February this filing season for their money because of late changes to the tax laws and the subsequent IRS computer upgrade catch-up.
One proviso on underwithholding: If you short the IRS too much, you could end up owing extra because of penalties and interest.
Our tax system operates on a pay-as-you-earn basis and the tax collector has the authority to whack filers who try to essentially pay their full annual tax debts in one lump sum each April.
But a little bit of owing is OK, both with the IRS and for your financial bottom line.

State taxes, too: Accurate withholding also works for state refunds.
Again, I'm an advocate of owing a little at the state level each tax year. Residents in refund-delaying states discovered that waiting for a refund from state officials is just as frustrating as waiting for a federal refund.

When to file a new W-4: You definitely should reexamine your withholding when you have a major life change, such as getting married, buying a home of having a child.
Each of those situations could affect your ultimate tax bill. So run the withholding numbers in these cases -- the IRS has an online calculator to help you come up with the most accurate figures -- and turn in a new W-4.
But how much federal (and state) tax you have withheld from your pay is your personal tax and financial choice. Make it wisely.
If you do want to adjust your payroll tax withholding either direction, it's easy.
And you can make the changes as often as you like, or as often as you dare confront your payroll manager!

Friday, April 29, 2011

Attention Online Sellers: How to Avoid Tax Trouble

In February of 2008, just as the recession deepened, Rob Kalin, the founder and CEO of, the Brooklyn-based online market place for handmade goods, showed the audience of the Martha Stewart Show some of the big sellers on this site. Among them: a “sock money soap popsicle” and knitted pussy willows. "Anyone here — if you're in school or out of school, at any age — you can start a business from home," he told the audience. 
Lots of people have done just that. Etsy says more than $314 million dollars in goods were sold on the site last year up from $87.5 million in 2008. In addition to big sites like Etsy, Ebay, and Craigslist, there are plenty of newcomers, such as,, and that allow people to turn a DIY hobby into a business.

Not surprisingly, the Internal Revenue Service is figuring out ways to get its fair share. If you’re using an online auction site to unload old baby clothes or unwanted furniture for less than what you originally paid, relax, the IRS probably isn’t interested. But it’s a different story if you are handling a large number of online transactions,  and selling items for more than your cost. Depending on the details, the IRS may consider your proceeds to be income and come after you for taxes. Just like anyone who is self-employed, if your business earns more than $400 in annual net profits, you’ll need to play self-employment tax. 
But fiscal planning can be a little trickier for online sellers, because they typically have lower expenses and higher profit margins than traditional retailers. That means should your tea cozies made from vintage quilts suddenly be featured on Etsy’s homepage, you could wind up with an unexpected windfall. The self-employment tax can really trip people up. Last year, that was 15.3 percent of your business income. What you’re doing is paying into Social Security and Medicare for yourself. That can be a big bite from a small revenue stream.
And beginning in 2012, taxpayers who annually sell more than $20,000 worth of goods and have more than 200 transactions on sites like Etsy or Ebay will be required to send the IRS a new form, the 1099 K.  Most online sellers, of course, don’t do that kind of volume, but all small businesses must report their income and expenses to the IRS. Many online sellers don’t realize that many of the fees they pay to Ebay and Paypal are deductible, as are their materials costs and shipping expenses.
The biggest mistake [Etsy sellers make] is not becoming knowledgeable about the tax law before starting their business. Every Etsy seller should have a bookkeeping system that they feel comfortable using the moment they start spending or receiving their first revenues.
Even if you have no intention of growing your online sales business into a Fortune 500 company, it’s still a good idea to keep good financial records just in case Uncle Sam comes calling. Options vary from a basic Excel spreadsheet to full-blown accounting software like Quickbooks.

Thursday, April 28, 2011

Wisconsin Taxpayer Alliance Finds Trends In Wisconsin Income Tax Filings

This year’s recent tax season marked only the second in more than two decades that some state income taxpayers faced a major tax increase.
A new analysis of 2009 state income tax returns by the Wisconsin Taxpayers Alliance shows the impact of the increases that were enacted as part of the 2009 Wisconsin budget.
At or above $200,000, the average tax increased four percent to $29,980. This effect was most evident at $1 million and above, where the average tax paid rose 13.5 percent to $168,383; for filers with incomes under $200,000, the average tax declined 3.7 percent to $1,539, the report says.
These high-income groups were the only ones affected by the tax hikes, because raising the top income tax rate from 6.75 percent to 7.75 percent fell only on joint filers with more than $300,000 of income and single filers with incomes of more than $225,000, the document reads.
Similarly, the effect of halving of the state tax break for capital gains—the other major personal tax hike—likely fell on middle- and upper-income filers, those most likely to own stock or other investments.
Overall, the total number of state income tax filers fell 1.9 percent from 2.89 million in 2008 to 2.83 million in 2009. That was the lowest total since 2.76 million filers in 2006. Wisconsin Taxpayers Alliance researchers point to the recession as a main cause for the decline in filing.
However, the researchers also note that the drop in filers was greater at high-income levels: at or above $1 million in income, -15.2 percent to 2,949; between $500,000 and $1 million, -9.4 percent to 6,738; and between $200,000 and $500,000, -7.0 percent to 38,654.
The Wisconsin Taxpayers Alliance suggested several possible reasons for these declines. One theory the alliance has is that the recession probably led to scant profits or losses among small business owners and investors, pushing them out of top tax brackets. Higher income and capital gains taxes may also have had an effect, the alliance says, particularly for those contemplating once-in-a-lifetime sales of family businesses.
In other findings, the Wisconsin Taxpayers Alliance reported that about half of 2009 filers (52.1 percent) had incomes under $30,000. This group accounted for 11.7 percent of income and 4.1 percent of state income taxes paid. At the other end of the spectrum, the $100,000-and-above group accounted for 9.4 percent of all filers, reported 40.3 percent of total income, and paid 51.1 percent of total income taxes.

Wednesday, April 27, 2011

How to Claim the IRS Adoption Tax Credit

If you’ve adopted a child, you may be able to claim an income exclusion of $13170 from your income and a tax credit for the same amount, depending on the expenses you incurred as a result of the adoption. (You cannot, however, claim an exclusion and a credit for the same expenses, as we’ll see below.) To claim the exemption or credit, you’ll need to fill out Form 8839.
First, you should know that Form 8839 comes with certain documentation requirements. You’ll need to include some paperwork along with the form, which means that you cannot file it electronically. You must file paper returns. Along with the form, you’ll need to include the following documentation that varies with the type of adoption.
For domestic adoptions that have not been finalized, include one or more of these:
  • A taxpayer identification number obtained by the taxpayer for the child, included on you return instead of attaching a document
  • A home study conducted by an authorized placement agency
  • A placement agreement with an authorized agency
  • A hospital document authorizing release of a newborn for adoption
  • A court document with official seal approving placement of the child for adoption
Your last option for domestic adoptions is an affidavit or notarized statement by a government official or adoption attorney. Their statement must say that they have placed or are placing the child with you for legal adoption, or that they are facilitating your adoption process in a legal capacity. If they are facilitating your adoption process, the letter must includes steps being taken to do so. (Luckily, if you need to get a letter from you attorney, they should be familiar with the documentation requirements for Form 8839.)
For finalized adoptions, foreign or domestic, you can include any of the following:
  • The adoption order or decree, with official seal
  • If your adoption as governed by the Hague, you can include the Hague adoption certificate, the IH-3 visa, or a foreign adoption decree translated into English
  • For foreign adoptions not governed by the Hague convention, include a foreign adoption decree translated into English, or an IR-2 or IR-3 visa.
Next, let’s go over what sort of expenses Form 8839 is concerned with. Form 8839 refers to the following as “qualified expenses”:
  • Adoption fees
  • Attorney fees
  • Court costs
  • Travel expenses
  • Re-adoption expenses related to the adoption of a foreign child
The form specifically excludes the following:
  • Expenses for which you received funds from any state, local, or federal program
  • Any expenses that violate state or federal law
  • Expenses for carrying out a surrogate parenting arrangement
  • Expenses for adopting a spouse’s child
  • Anything paid or reimbursed by your employer or any person or organization
  • Any expenses that are an allowed exemption under any other provision of federal law
Now, here’s where everything can get tricky quickly. When you take the credit or exclusion depends on the year of the payment and when the adoption was finalized. For example, you should take the credit for any payment in years before the adoption is finalized the year after the payment. For payments made during and after the year the adoption was finalized, the credit is taken for the year of the payment. To make things more complicated, Form 8839 lets you carry over expenses from previous years, which will mean carrying data from last year’s Form 8839.
If your adoption expenses are relatively straightforward, all you need to fill out Form 8839 is identification information, your adoption expenses, and any amounts paid as adoption benefits by your employer. You’ll also want a copy of your tax return handy in order to figure out your modified adjusted gross income. Form 8839 will then lead you through the process of figuring out your credit and exclusion.
On the other hand, if you have adoption expenses from multiple years, you’re carrying over expenses from previous years, or you’re just a little daunted by the process, you may want to consider a tax preparation professional. What seems like a cryptic process for you is a day at the office for a tax professional. They are trained to understand the nuances of these forms, credits and deductions, and they can take a big task off of your plate.

Tuesday, April 26, 2011

5 ways for retirees to save on future taxes

Lowering your tax bill can make all the difference in retirement.
Taking maximum advantage of tax breaks and other strategies will make savings last longer, which is critical for those living on a fixed income.
That means tax planning can't end with the annual filing deadline, however. Just as workers are becoming more self-reliant in financing their retirements, it's increasingly important for retirees to be savvy about the tax consequences of their actions.
Today's seniors have a host of decisions to make regarding managing their tax burdens — from where to live to how to take money from accounts to charitable giving.
Those decisions have the potential to reduce federal and state income taxes while also taking the impact of property, sales and other taxes into consideration.
That doesn't mean taxes should be the sole motivation behind a key move or transaction. But a bit of long-term tax planning can go a long way.
Retirees may be able to lower their annual tax liability by thousands of dollars with some modest effort.

Here are some potential ways to reduce taxes in retirement:
1. Move Consider moving to a more tax-friendly state. Your pension and 401(k) distributions, as well as dividend and interest income, generally are taxable. That could provide the financial incentive to relocate to one of the nine states with no broad-based personal income tax. Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming have no income tax at all, and New Hampshire and Tennessee tax only dividends and interest.
Still, it's important not to overlook other taxes. High property and sales taxes can partially or fully offset the absence of a state income tax, as is the case in Florida.
Perhaps leaving money to your heirs is a priority. Even if your estate isn't large enough to owe money under the federal estate tax, be aware that 14 states and the District of Columbia have their own estate taxes. And eight states impose a separate inheritance tax, paid by the recipient rather than the estate. Details are at the Retirement Living Information Center site, .
You might be able to move just a small distance to make a big difference. In the Washington, D.C., area, Maryland and the District of Columbia each have $1 million estate tax thresholds while neighboring Virginia has no estate tax. It's not uncommon for area retirees to sell their homes and move to Virginia for that reason.

2. Transfer assets Making gifts during your lifetime is one strategy for reducing estate taxes. The tax code allows tax-free annual gifts of up to $13,000, or $26,000 if made jointly with your spouse, in cash, investments or property to an unlimited number of people. This can be a great way to help your children while also reducing estate taxes.
But look before you gift. The Internal Revenue Service warns on its website that the laws on estate and gift taxes are some of the most complicated on the books.
Gifts in excess of the tax-free annual amount not only may incur a gift tax, they will reduce the amount that may be passed free of estate tax. They may also cause your children to pay substantial, and avoidable, capital gains taxes in the future.
Check with an adviser to make sure you fully understand the consequences before using any gifting strategy.

3. Convert to a Roth RMD, short for required minimum distribution, surely rivals IRS as a least favorite acronym among retirees. It refers to the minimum amount that must be withdrawn from a retirement plan account starting with the year the owner reaches age 70 1/2.
Forced distributions raise your taxable income and draw down your 401(k), pension or Individual Retirement Account. You want to take out as little as possible beyond your immediate needs.
One good way to achieve that is to convert a traditional IRA to a Roth IRA. The RMD rules don't apply to Roths while the owner is alive (though they do to beneficiaries). So you can allow your Roth to grow until you need to tap it, and even then distributions will be tax-free.
Roths don't make sense for everyone, especially if you will need the money soon to meet retirement needs. Check with a financial adviser.

4. Donate to charity You can dodge a tax hit on a withdrawal from your IRA or workplace retirement plan by steering it straight from the account to a charity.
This is an excellent tax planning vehicle because you don't have to include the distribution as taxable income. It's also been very popular since it was created in 2006.
The maximum charitable donation allowed from an IRA is $100,000 a year. But you can benefit from a donation of any size — whatever you planned on giving to charity for the year.

5. Diversify Tax diversification can stretch retirement savings. Besides potentially lowering taxable income, parking money in places with various levels of tax exposure provides the flexibility to deal with unknowns such as changing tax rates.
Investors should consider diversifying their savings into three different tax buckets for tax efficiency as they access their assets in retirementl.
Those would include tax-deferred accounts such as 401(k)s and traditional IRAs, tax-free accounts such as Roths and cash value life insurance, and taxable accounts in the form of savings and investments outside of tax-advantaged vehicles.
It's a good idea to constantly be looking at your portfolio. Retirees are not having enough corporate or municipal bonds in their portfolios. If they're in lower tax brackets in retirement, those bonds may well offer better returns after taxes than tax-free bonds.

Saturday, April 23, 2011

Tax records: Save them or shred them?

Tax day is over. Now it's time to find the top of your desk.

If you're like most people, your home office is littered with 1099s, W-2s, letters from charities and other detritus used to prepare a tax return. Most of us are terrified to dispose of these documents, and for good reason: In an IRS audit, "The dog ate my credit card receipt" is not an excuse.
It's not necessary to hang on to everything. In fact, keeping too many documents could make it difficult to find what you really need. Here's a look at what you should save and what you can shred:
Tax returns. Save your tax returns and supporting documents for at least three years. That's how long the IRS has to audit you. There are, however, exceptions. The IRS has up to six years to audit you if you under-report your income by 25% or more. There is no statute of limitations on audits of fraudulent returns.
There's also no statute of limitations on audits of taxpayers who don't file a return. Keep a record that you filed your return indefinitely. That goes for your state return, too.
Taxpayers who e-file should print a copy of the e-mail acknowledging receipt of their return and keep it with their records. Those who file paper returns should send them to the IRS via certified mail and keep a copy of the receipt, she says. (This will also provide proof that you mailed your return before the deadline.)
Keep W-2s, 1099s, acknowledgments from charities and other supporting documents for as long as you keep your tax returns.
If you discuss deductions and other tax strategies with your tax preparer, keep notes of those conversations with your returns, too. They could be helpful in an audit.
Some recommend you keep copies of tax returns forever, because they provide a record of your financial history. You may need previous returns to apply for a mortgage or student loan.
Real estate records. Hold on to your closing statements, purchase and sales invoices, proof of payment and insurance records for at least four years after you sell the property.
You should also keep records of any major improvements made to your home, such as an addition or a new roof. When you sell, you can add the cost of these improvements to the amount you paid for your home, which will reduce taxes on capital gains.
Most homeowners don't have to worry about paying taxes on the sale of their homes. For singles, up to $250,000 in profit on the sale of a primary home is excluded from taxes; married couples can pocket up to $500,000 tax-free.
Still, homeowners who have owned their homes for a long time could exceed those thresholds. And there's no guarantee the tax break will last forever. Right now capital gains (on primary residences) are excluded for up to $500,000, but there was a time when that wasn't the case.
Investments. As is the case with real estate, you should hold on to documents that show the purchase price of your stocks and mutual funds until three years after you sell. You should also keep records of dividends, reinvested dividends, loads and stock splits.
These documents will show the IRS how much you paid for your investments, known as the basis. Without proof of the basis, you could be liable for taxes on the entire proceeds of a sale, even if you sell at a loss. If you claim a loss for worthless securities, hold on to the supporting documents for at least seven years after you file your return.
Financial institutions will be required to track the basis for stocks held by their customers starting this year, mutual funds in 2012, and bonds in 2013. They'll also report this info to the IRS.
However, the law doesn't require financial institutions to provide the basis for securities purchased before the effective dates. So you should keep records of securities bought before Jan. 1 (or in the case of mutual funds and bonds, before 2012 and 2013, respectively).
Bank and credit card statements. Keep credit card receipts and canceled checks that support your tax deductions on your tax return for as long as you keep the return. Statements that aren't related to your tax returns should be saved for a year then discarded, the Federal Deposit Insurance Corp. says. Canceled checks that aren't related to your taxes can be shredded after you've reconciled them with your bank statement.
Many banks don't send canceled checks to customers. But you can order copies of tax-related checks as soon as you get your bank statement, or keep the statement and order tax-related checks in the event of an audit. In general, banks that don't provide canceled checks must keep copies for seven years. You may have to pay a fee for copies more than a year old.
You don't need to kill lots of trees to maintain good records. The IRS allows electronic storage systems as long as they provide an accurate and accessible record of the data. I recommend scanning your documents onto your computer then backing them up on a CD.
For more info about IRS record-keeping rules, see Publication 552, available at

Friday, April 22, 2011

Income tax, Gift tax and Estate tax planning have taken on a new level of importance

Income tax, gift tax and estate tax planning have taken on a new level of importance due to the effects of the Tax Reform Act of 2010 ("the Act").  Because the Act sunsets on December 31, 2012, there is increased urgency to act sooner rather than later.  Further, current planning should be viewed as opportunistic and short-term rather than long-term in nature.  In fact, the 2012 budget proposals recently announced by the Obama Administration raise tax rates and change the lifetime gift tax exclusion amount as of January 1, 2012. Consequently, there is no assurance that the current, highly-favorable income tax and estate tax laws will be available in 2012, much less in 2013.
This significant new tax legislation was enacted on December 17, 2010.  It will materially impact your tax and estate planning over the next twenty months. Under the Act, the estate tax which was phased out in 2010 returns with a lower tax rate of 35 percent (reduced from 45 percent) and a $5 million exclusion per person for years 2011 and 2012 only.  Also, this exclusions amount is portable between spouses with proper planning and an affirmative election. 

The critical message is that all affluent individuals and high-income taxpayers should review their estate plans in 2011.  The planning opportunities presented by these temporary new laws coupled with the current economic environment present, a once-in-a-lifetime opportunity, the so called "perfect storm."
The Act increased the exclusion amount for estate, gift and GST purposes, but the exclusion will drop to $1 million (somewhat higher for GST tax purposes) after 2012.  Varying exclusions can result in a significant shift in wealth depending upon the timing of someone's passing.  Your estate plan should be reviewed to ensure that it reflects your wishes no matter what your estate and GST exclusions are when your wealth passes to your loved ones.
In addition, the top estate, gift and GST tax rates will be capped at 35% for this year and (possibly) next year.  Beginning in 2012, the rates are scheduled to increase to 55% (and 60% for some).  The effective tax rate for estate and GST taxes can result in significant changes in what each of your family members receives.  We think it is appropriate for you to review your plans for the disposition of your property whether the rates of tax are very high or not.  Also, it is highly appropriate for taxpayers to consider using their increased gift and GST tax exclusions as soon as possible.  For some, a lifetime gift of $5 million may be too large; however, a smaller gift using a part of the larger exclusion may be wise to consider in such cases.  By making gifts now, the appreciation of assets will be removed from your estate and you may also avoid estate, gift and GST taxes.
This extraordinary wealth transfer opportunity is amplified by several factors including historically low interest rates, low real estate and business values, and the lowest transfer tax rates since the Great Depression.
A number of articles which have appeared in the popular press and technical journals have extolled the virtues of "portability" and claimed that portability eliminates the need or urgency for formula trust planning or estate planning, in general, for all but the most affluent Americans.  These authors are misinformed and are distributing imprudent advice.  For the first time under U.S. law, portability allows a surviving spouse to utilize the unused lifetime exclusion of their deceased spouse.
Reliance on this provision of the Act, however, is attended by several complexities.  First, portability expires by operation of law; at the end of 2012.  Consequently, we do not recommend relying on portability.  Second, even if portability becomes permanent, it further complicates estate planning for married couples. Third, in the event of divorce, it is uncertain how the exclusion amount will be allocated.  Finally and most importantly, the use of portability requires an affirmative tax election on the part of the executor. This election opens up the applicable statue of limitations which may otherwise avoid IRS examination of the estate of the first spouse to die. Such an examination could call into question tax positions and valuations of an otherwise closed estate. We deem this to be an unreasonable risk for our clients to take.
In addition, significant changes in the estate tax and inheritance tax regimes which exist in 22 states and the District of Columbia, warrant review of estate plans. Many of these laws have changed dramatically in recent years.  The high rates of current state taxation and historically low exclusions further encourage thorough review of existing estate plans.  In sum, now is the time to update, build or modify your estate plan.

One of the most significant provisions of the Act is the increase of the federal gift tax exclusion from $1 million to $5 million.  The increased gift tax exclusion allows married couples to make lifetime gifts of up to $10 million without incurring gift tax.  The law allows individuals who have made prior taxable gifts totaling $1 million to make additional gifts of up to $4 million during 2011 and 2012 without triggering gift tax (or couples who have made taxable gifts totaling $2 million to make additional gifts of up to $8 million).

The Act allows for increased gifting opportunities for individuals who are contemplating significant lifetime gifts to children, grandchildren or more remote descendants.  However, the Act provides only temporary relief and expires on December 31, 2012, unless Congress acts before then.  Beginning on January 1, 2013, the federal estate and gift tax exclusion is scheduled to decrease to $1 million and the estate tax rate will rise to 55%.  Therefore, there is a window of opportunity of less than two years to maximize estate planning strategies utilizing the increased gift and GST tax exclusion of $5 million (or $10 million per couple) and the decreased 35% gift tax rate.

The Tax Reform Act of 2010 extended President Bush's income tax rate reductions for all taxpayers for two years, through December 31, 2012.  The fiscal year 2012 budget proposals, however, call for elimination of these reduced tax rates for all "High-Income Taxpayers," defined as single individuals with incomes above $200,000 and married couples filing joint returns with income over $250,000.  In addition, itemized deductions would be capped at 28% for High-Income Taxpayers no matter how high their income tax rate may be.  Under the proposals, the current 15% maximum rate for capital gains and dividends would be increased to 20% for all High-Income Taxpayers.

A significant tax planning opportunity exists under the current reduced income tax rates.  Given the likelihood of higher federal rates coupled with fewer deductions and more prohibitions and caps, 2011 may be the ideal year in which to voluntarily recognize income.  For example, existing S corporations which are cumbersome for financial and estate planning purposes may be terminated and restructured into LLCs or other entities, thus triggering income tax recognition in 2011.  Similarly, income can be voluntarily accelerated into 2011 by making sales of appreciated assets or securities.  Further, the urgency to consider this kind of income tax planning is increased by recent and expected state income tax rate increases resulting from large state and local government deficits, benefit shortfalls and other budget woes.

Thursday, April 21, 2011

Small Business owners may still have tax work ahead

Small-business owners across the country are getting back to focusing on their companies now that they've filed their income tax returns. But many of those owners may still have some tax work to do.

Make tax process easier
If you had to sweat to get your return completed, think about how to get next year's return done with a minimum of stress. Some owners struggle because they try to do it all themselves. Others have books that are chaotic — if they even exist at all. Then there are the procrastinators.

In many cases, the solution is to get some help. Hiring someone, even a part-time bookkeeper, to help you maintain organized books will simplify compiling next year's return. Hiring an accountant or tax attorney to do the return will also calm your nerves.

If you're one of the many owners who got an extension of the filing deadline because you were disorganized or too busy, you should consider getting the help now, and have your bookkeeper and accountant handle the return before the Sept. 15 deadline for corporations and Oct. 17 deadline for individuals.

If you get a letter from the IRS

Getting a letter from the IRS probably doesn't mean you're about to undergo a full audit. The IRS can question a return anytime up to three years after it is filed. But note that if you decide to amend your return for any reason after it's filed, the three-year period will start fresh from the day the amended return is filed.

Most letters that business owners get are requests for explanations or more information about a return. A common one is when the IRS can't match income on a return with 1099 forms it has received from employers.

If you get a refund, that doesn't mean you're in the clear. The information on tax returns is analyzed by computers that can pick up discrepancies or items that look unusual. In such cases, the IRS may ask to see your receipts and records. If you do get a letter, talk to a CPA or tax attorney before contacting the government, even if you compiled your return yourself.

If you find you made a mistake

You can amend your return using IRS Form 1040X, Amended U.S. Individual Income Tax Return or Form 1120X Amended U.S. Corporation Tax Return. Partnerships should refile Form 1065, U.S. Return of Partnership Income. Amended returns need to be filed on paper, even if the original return was filed electronically. All the forms have instructions.

Wednesday, April 20, 2011

Top Five Tax Resolutions for 2011

How are you doing on that New Year's resolution? Gained, rather than lost, those few extra pounds? Well, it's time to double-down on resolutions now that the IRS tax deadline has passed.

Here's a list of top 5 tax resolutions for 2011 designed to get you in shape for next year's tax return. It may not shrink your waistline, but it's designed to get your wallet and finances in tip-top shape.

1. Set Up a 2011 Tax File
For some people, just getting their materials in one place can help a lot to capture deductions and reduce their tax prep bill if their accountant charges for hourly work.

Taxpayers should save electronic receipts from their online payments by creating PDFs and saving them in a desktop tax folder.

Or, consider using personal financial software like Quicken to track expenses and keep things organized for your taxes throughout the year.

And resolve to keep track of all written acknowledgments from charities regarding your donations to their organizations, since rules around charitable giving have become more rigorous.

2. Review Your Tax Withholding

If you had a big tax bill, or a large refund, consider changing your withholding to avoid another unpleasant surprise next year, or to free up cash flow during the year if you have been in a regular refund situation.

Reducing your withholding can be tough for some folks who are used to the big pop from that yearly refund check. In some cases, it's a good twin-evil twin approach to saving. But remember: A big refund means you've given an interest-free loan to Uncle Sam. Wouldn't you rather have saved the cash yourself?

3. Don't Miss Out on Roth IRAs

Although a Roth IRA does not provide a tax deduction, it does allow contributions to grow tax free. And later in life, that will aid your efforts to maximize your retirement income. I recommend Roth IRAs for people looking for additional places to save money outside of their company retirement plans, or for young folks who don't have a company and aren't interested in committing to a regular IRA..

4. Pay Off Credit Card Debt

Credit card debt, if not paid off monthly, is evil.Over the years, banks have changed the game to where they raise a credit card holder's interest rate if they become delinquent on a card payment.
They are doing nothing for you in terms of tax benefits, only providing a drag on your future.

5. Become a Regular Saver

Like New Year's resolutions to lose weight, after about mid-February, most of the newbies at the gym have returned to their couches. Taking the time now to set up regular automatic savings strategies will help you stay with their program.

Resolve to save regularly, even if it's only $25 a week -- start now, and that small amount would add up to $925, plus interest, by the end of the year.

Tuesday, April 19, 2011

Tips for taxpayers in case the IRS calls

Finding a letter from the IRS in your mailbox is like discovering a baby alligator in your toilet: Your first impulse is to shriek, slam the lid shut and hope it disappears.
But while the alligator might retreat back into the sewer system, the IRS won’t go away. And even though any missive from the IRS looks ominous, the contents could be benign, tax experts say. Here’s what you should do if you receive a letter from the IRS after you’ve filed your tax return:
Don’t panic. Some notices simply inform taxpayers that the IRS has made a correction to their returns, and no further action is required. Occasionally, the IRS sends notices informing taxpayers that they overpaid. More commonly, taxpayers receive a notice from the IRS because information on their tax returns didn’t match information the IRS received from their bank or brokerage firm. For example, you may have failed to report interest on a bank or credit union account because you misplaced a 1099 or never received one, she says. If that led to unreported income, you can usually resolve the problem by mailing the IRS a check.
Respond promptly. If the IRS gives you 60 days to respond, consider that an order, not a suggestion. Ignoring a notice could lead to penalties, liens and seizure of property. The IRS is willing to work with you, But you have to meet them halfway. Some taxpayers stash IRS notices with their other tax records, figuring their tax preparer can deal with it at tax time, Labant says. This is a bad idea. Depending on when you receive the notice, it could be several months before your preparer sees the document.
Don’t assume the IRS is right. The IRS churns out millions of notices every year, and some are incorrect. For example, if the IRS posts an estimated tax payment to the wrong year, you could be assessed underpayment penalties. If you think the IRS is wrong, be prepared to provide records to back up your case.
Keep good records. Make copies of everything you send the IRS in response to a notice. If you contact the IRS by phone, write down the name and ID number of the agent who takes your call.
Get help. If a tax professional prepared your return, send the IRS notice to your preparer immediately. Your tax preparer should be able to figure out whether the notice contains any errors and will provide the IRS with the necessary documents. In addition, even minor changes to your tax return could affect next year’s return, so your tax preparer needs to know about them.
Are you a do-it-yourself taxpayer? You may still want to get professional help, particularly if the IRS says you owe a lot of money or wants to audit your return.
While face-to-face audits are rare, the IRS has increased the number of correspondence audits, which are handled through the mail. Typically, a correspondence audit deals with just one portion of your return, such as a deduction for charitable contributions. A tax preparer can help you find the documents necessary to support your deduction. In some cases, you may need to file an amended return.
Don’t forget your state return. Changes to your federal tax return could affect how much you owe your state. Once you’re done with the IRS, you may need to amend your state tax return. Otherwise, a couple of years down the road, (the state) will be coming after you, and you’ll owe interest and penalties.
Don’t respond to e-mails purportedly from the IRS. Con artists use official-looking e-mails that appear to be from the IRS to steal financial information from taxpayers. Last year, for example, crooks sent bogus e-mails informing taxpayers that they were candidates for an audit. Recipients were instructed to click on a link and fill in personal information.
The IRS doesn’t send e-mails requesting personal information. If you get a suspicious e-mail claiming to be from the IRS, forward it to

Sunday, April 17, 2011

How to correct a mistake on a recently filed income tax return

What do you do when you realize that you made a mistake on a recently filed tax return?
That was the question I got from two recent college graduates who had both filed returns in haste because they were eager to receive refunds.
One had discovered after he filed that he could claim himself as a tax exemption, qualifying him for lucrative deductions and credits available for low-wage earners.
The other had forgotten about a part-time summer job. The W-2 had been sent to his family home, and he got it around the same time that he received a tax refund check and realized that the refund probably should have been smaller.
In both cases, the answer was the same: You can go back and fix tax mistakes that are up to three years old. But it's not necessarily easy.
The key to fixing a tax mistake is a form called the 1040X — the amended U.S. individual income tax return. It looks somewhat like the basic tax return at the top, asking your name, address, Social Security number and filing status. But then it deviates from the regular form by dispensing with all the questions about where your income came from and what specific deductions you might have to reduce the taxable portion.
Instead, the 1040X cuts to the chase with a three-part question: How much adjusted gross income did you report before, what are you reporting now and how much is that number changing?
It then asks the same three questions about your deductions, exemptions and taxable income.
The final portion of the form simply asks for documentation or an explanation of why you're making the correction.
Theoretically, your final step is to simply sign, date and mail.
But filing a corrected tax return is rarely that simple. In reality, any change in your adjusted gross income is likely to alter several other calculations that determine your deductions, taxable income and tax.
That's mainly because many tax breaks are income tested, meaning that they may not be valid at all income levels.
Some examples: Your ability to claim the child tax credit for paying college tuition is predicated on earning less than a set amount. Your ability to deduct medical expenses can depend on whether the bills exceed a certain percentage of your income. You can claim credits for renters and low-wage earners only if your income is under a certain level.
"Any change is going to flow all the way through your tax return," said Terrence Rice, a certified public accountant in Milwaukee.
Therefore, even though the 1040X doesn't technically require it, you'd be wise to redo your entire 1040 tax return, ensuring that you adjust all calculations that could give or take away deductions or credits based on income thresholds. In some cases, a change in your income might allow you to qualify for new deductions, and that could involve filling out additional forms.
Making the correction isn't difficult if you use a tax software program, but it can be time consuming if you do it by hand. Again, although it's not required, it's not a bad idea to include the new version of your entire 1040 with the 1040X form.
If you're expecting a big refund because of your corrections, you'll need to be patient. The IRS says it typically takes eight to 12 weeks to process a corrected 1040.

The Need for Increased Due Diligence in Filing Extensions

The complexities associated with return preparation, tax law, and the April 18 deadline have required taxpayers to devote more time to preparing returns. As a consequence, more extensions of time to file are being filed. The IRS has indicated that taxpayers should file a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. The instructions for filing a Form 4868 require taxpayers to:
  • Properly estimate their tax liability using the information available to them;
  • Enter their total tax liability on line 4 of Form 4868; and
  • File Form 4868 by the regular due date of their return.
Normally, filing this form results in an automatic six-month extension of time to file without any late-filing penalty. However, filing the form does not extend time to pay any income tax liability due. The estimated taxes due should be paid with the extension application. Interest is charged on a material underpayment of tax from the original due date of the return until the tax is paid, and a late payment penalty may also be due. The interest rate varies quarterly with the federal short-term interest rate.
Regulations provide relief from penalties only if the balance due on Form 1040 is less than 10% of the total tax shown on that form and is remitted with the return. If the balance due is more than 10% or is not remitted with the return, the penalty may apply to the total of the balance due from the original due date of Form 1040 to the date of payment, unless the taxpayer establishes reasonable cause.
In addition to these concerns with the federal extension, applicable state extensions and the rules and regulations associated with them require the same careful consideration. The requirement to electronically file some state extensions raises the due diligence required.
First, there is the need to accurately estimate tax liability when an extension is filed. Second,  if an extension is filed, it is an extension of time to file only and not an extension of time to pay. Some taxpayers have the misconception that the filed extension extends not only the time for filing but the time for paying the tax due. Taxpayers should also know that penalty and interest apply to any balances due in excess of 10% of the total tax shown on the tax return. If an extension of time to file is required, any tax due with this return must be paid with the extension. Any amounts not paid by the filing deadline may be subject to interest and penalties.

In Crocker, 92 T.C. 899 (1989), the Tax Court held that the IRS could void the automatic extension because the taxpayers “did not make a bona fide and reasonable estimate of their tax liabilities nor did they make a bona fide and reasonable attempt to secure the information necessary to make such an estimate.”

Friday, April 1, 2011

Why A Roth IRA or 401k Might Not Be a Good Idea if Tax Rates Increase

Earlier this year, there was plenty of stalemate drama between Democrats and Republicans over extending the Bush tax cuts. By not extending these cuts, federal income tax rates would have increased for high-income taxpayers. The stalemate was resolved when Congress decided to extend the Bush tax cuts for two more years; at that point, they’ll expire, unless taxes are changed at that time.
So if tax rates will increase in our future — a strong possibility — should you still contribute to a Roth IRA or, if it’s available through your employer, a Roth 401k? That all depends on what your marginal income tax rates are now and when you plan to retire.
To help clarify the issue, let’s briefly review the main difference between a traditional IRA or 401k, and a Roth IRA or 401k. With a traditional IRA or 401k, your contributions aren’t taxed when you make them; instead, they’re taxed when you withdraw them at retirement. With a Roth IRA or 401k, it’s the other way around: Your contributions are taxed now — when you make them — but not when you withdraw them at retirement.
So the main consideration for whether or not to contribute to a Roth IRA or 401k is a bet on your marginal tax rates now compared to when you retire. If you think your marginal tax rate will decrease in retirement, the traditional IRA or Roth produces more spendable income in retirement after taxes are considered. If you think your marginal tax rate will increase by the time you retire, though, a Roth IRA or 401k would be a better choice because it produces more spendable income in retirement.
But what if your marginal income tax rate will stay the same as it is now after you retire? In this case, the after-tax amount of money you’ll have in retirement is mathematically identical (after taxes are considered). Of course, this assumes you’d invest either type of account the same and would experience identical rates of return.
So now let’s look at the federal income tax rates. The table below compares the final 2011 tax rates for a married couple filing jointly to what they might have been had the Bush tax cuts expired.

Note that the projected tax rates for after the Bush cuts had expired are somewhat speculative; the amounts shown above come from the budget proposal earlier this year, and were developed by the Tax Policy Center
The first thing you’ll notice is that if the Bush tax cuts had not been extended, higher tax rates would have applied only if your taxable income exceeded $212,300. The vast majority of Americans have lower taxable income than this amount now, and that’s not expected to change in retirement. The vast majority will also have lower taxable income in retirement compared to while they’re working. Put these two facts together, and the traditional IRA or 401k would generate more spendable income, after taxes are considered.
If you’re currently in one of the top two tax brackets, however, and you expect to stay in that tax bracket after you retire, and if the Bush tax rates expire, then your tax rates will be higher in retirement. Then it makes sense to use a Roth IRA or 401k.
But if you’re in one of the top two tax brackets now, it’s possible that your taxable income could drop in retirement. If it drops down to the 28% bracket, then your marginal tax rate in retirement will reduce even if tax rates increase. In that case, it makes sense to use a traditional IRA or 401k.
Here’s the same comparison of tax rates for single filers. The considerations discussed above are the same, except that single filers have lower tax brackets compared to married filing jointly.
The above analysis only compares current federal income tax rates to the rates that would exist if the Bush tax cuts had expired. By the time you retire, you could see completely different tax rates and brackets. For example, the U.S. Deficit Commission proposed to reduce income tax rates but also eliminated many tax breaks and deductions. If this happens, there’s a good chance your tax rates will decrease in retirement, again arguing for a traditional IRA or 401k.
From my perspective, your bet on your current marginal tax rates vs. your future tax rates is the primary consideration for deciding between traditional and Roth IRAs and 401ks. Here are a few other considerations to take into account:
  • If you don’t know where tax rates will be when you retire, contributing to a Roth IRA or 401k could be considered a form of tax diversification.
  • A Roth IRA is not subject to required minimum distributions (RMD) at age 70-1/2, while a traditional IRA is. Note that under current law, a Roth 401k is subject to the RMD, but you can get around this by rolling your Roth 401k into a Roth IRA, which is not subject to the RMD.
And that’s just for federal taxes. You’ve also got to consider state income taxes, using similar logic and comparisons as described above for federal income tax rates.
It’s a lot to consider, but it’s well worth your time — you’ll need to make every dollar count in retirement. And don’t let this complexity serve as an excuse not to save. Regardless of whether you use a Roth or traditional IRA or 401k, you’re still better off saving for retirement compared to spending all your money today!

IRS Commissioner Says Government Shutdown Scenarios Under Discussion

Internal Revenue Service Commissioner Douglas Shulman said the Obama administration has not decided whether the IRS would process tax returns and issue refunds if Congress cannot agree to a plan to avert a halt of government spending authority on April 8.
Under previous plans developed for potential government shutdowns near the Oct. 1 start of the fiscal year, the IRS would deposit checks though it would not process tax returns or issue refunds.
“We’ve never had a government shutdown in the middle of the filing season before,” Shulman said in testimony before a House Ways and Means subcommittee today in Washington. “The closer we get to April 15, the more consideration and factors are at play.”
Shulman did not provide further details about discussions he is having with the Office of Management and Budget as to how the IRS would operate during a government shutdown. Individual tax returns this year are due April 18, rather than April 15, because of a weekend and Emancipation Day in the District of Columbia.
Congressional lawmakers are negotiating over spending plans that would cover the remainder of the fiscal year in an attempt to allow federal agencies to continue operating.

Tax Complexity

Also in his testimony today, Shulman said that the complexity of the U.S. tax code hurts the public and makes the tax system tougher to administer.
“The tax code is incredibly complex, and unfortunately it’s been going in the wrong direction over the last decade,” he said. “Anything you can do to simplify the code would help our agency.”
Representative Charles Boustany, who heads the Ways and Means oversight panel, told Shulman that he wanted to work with the IRS in overhauling the tax code to make the system simpler.
“As we go through that process, clearly with a mind on how to simplify things for the taxpayer, we also need to keep in mind the burden it places on your agency as well,” said Boustany, a Louisiana Republican.
The IRS has processed 73.3 million individual income tax returns through mid-March, up 3.4 percent from last year, according to a Government Accountability Office report released today. The percentage of returns that are electronically filed is 89 percent, up from 85.7 percent last year.

Electronic Filing

Electronic filing is important, Shulman told the panel, because it costs the IRS just 17 cents to process an electronic return compared with $3.66 to process a paper return.
Shulman reiterated his opposition to House Republicans’ spending proposals for the remainder of fiscal 2011.
He said a proposed cut of about $600 million to the IRS budget would have “potentially devastating effects to the nation’s tax system” and cost the government $4 billion in forgone revenue.