Limits On Tax-Free Lifetime Gifts Projected To Rise For 2015

It keeps getting less taxing to die rich. Based on inflation data released today by the Department of Labor, Wolters Kluwer , CCH has projected inflation-adjustments to various tax figures that affect financial planning for the well-off: the federal and gift tax exemption amount, the annual gift tax exclusion amount and the kiddie tax threshold.

The federal estate tax exemption—that’s the amount an individual can leave to heirs without having to pay federal estate tax—is projected to be $5.43 million, up from $5.34 million for 2014. That’s another $90,000 that can be passed on tax-free. The top federal estate tax rate is 40%. Talk about tax savings.

The gift tax is tied to the estate tax, so the inflation indexing helps the wealthy make the most of tax-free lifetime giving too. You can make the gifts during your lifetime; just you have to keep track of them as they count against the eventual estate tax exemption amount. In other words, you can’t double dip. So a woman who set up a trust for her kids with $5 million a few years ago could make new gifts to add to the trust and bring it up to the $5.43 million amount. A husband and wife each get their own exemption. So a couple would be able to give away $10.86 million tax-free in 2015 (assuming they haven’t made prior lifetime gifts).


Totally separate from the lifetime gift exemption amount is the annual gift tax exclusion amount. Wolters Kluwer, CCH projects it won’t budge at $14,000 a year for 2015, the same as 2014, up from $13,000 a year in 2013. But it can be leveraged to add up. You can give away $14,000 to as many individuals as you’d like. A husband and wife can each make $14,000 gifts. So a couple could make $14,000 gifts to each of their four grandchildren, for a total of $112,000. The annual exclusion gifts don’t count towards the lifetime gift exemption.

If you want to make gifts and not have to bother to keep track for gift tax purposes, you can make gifts for medical, dental, and tuition expenses for as many relatives (or friends) as you’d like if you pay the provider directly. These gifts don’t count towards any of the limits.

With the federal estate tax exemption rising, most people won’t need to use the annual gift exclusion to whittle down their estates. But it’s a tool you can use if you live in one of 19 states plus the District of Columbia that impose separate state death tax levies. Forbes has an interactive map showing the states with death taxes (estate and inheritance taxes) in 2014 and in 2015.


One thing to watch out for if you’re making gifts to younger members of the family is the federal kiddie tax. The kiddie tax, which covers students through the age of 23, puts investment income, above small amounts, into the parents’ tax bracket. For 2014, the kid pays no tax on the first $1,000 of unearned income and then a 15% rate on the next $1,000. Wolters Kluwer, CCH projects the $1,000 base will go up to $1,050 for 2015–a little help.

The Internal Revenue Service will release the official figures in the fall.

5 Questions to Ask Before Making Gifts for Medicaid or Tax Planning

Many seniors consider transferring assets for estate and long-term care planning purposes, or just to help out children and grandchildren. Gifts and transfers to a trust often make a lot of sense. They can save money in taxes and long-term care expenditures, and they can help out family members in need and serve as expressions of love and caring.

But some gifts can cause problems, for both the generous donor and the recipient. Following are a few questions to ask yourself before writing the check:

1. Why are you making the gift? Is it simply an expression of love on a birthday or big event, such as a graduation or wedding? Or is it for tax planning or long-term care planning purposes? If the latter, make sure that there's really a benefit to the transfer. If the value of your assets totals less than the estate tax threshold in your state, your estate will pay no tax in any case. For federal purposes the threshold is $5.34 million (in 2014). Gifts can also cause up to five years of ineligibility for Medicaid, which you may need to help pay long-term care costs.
2. Are you keeping enough money? If you're making small gifts, you might not need to worry about this question. But before making any large gifts, it makes sense to do some budgeting to make sure that you will not run short of funds for your basic needs, activities you enjoy -- whether that's traveling, taking courses or going out to eat -- and emergencies such as the need for care for yourself or to assist someone in financial trouble.
3. Is it really a gift (part one)? Are you expecting the money to be paid back or for the recipient to perform some task for you? In either case, make sure that the beneficiary of your generosity is on the same page as you. The best way to do this is in writing, with a promissory note in the case of a loan or an agreement if you have an expectation that certain tasks will be performed.
4. Is it really a gift (part two)? Another way a gift may not really be a gift is if you expect the recipient to hold the funds for you (or for someone else, such as a disabled child) or to let you live in or use a house that you have transferred. These are gifts with strings attached, at least in theory. But if you don't use a trust or, in the case of real estate, a life estate, legally there are no strings attached. Your expectations may not pan out if the recipient doesn't do what you want or runs into circumstances -- bankruptcy, a lawsuit, divorce, illness -- that no one anticipated. If the idea is to make the gifts with strings attached, it's best to attach those strings legally through a trust or life estate.
5. Is the gift good for the recipient? If the recipient has special needs, the funds could make her ineligible for various public benefits, such as Medicaid, Supplemental Security Income or subsidized housing. If you make many gifts to the same person, you may help create a dependency that interferes with the recipient learning to stand on his own two feet. If the recipient has issues with drugs or alcohol, he may use the gifted funds to further the habit. You may need to permit the individual to hit bottom in order to learn to live on his own (i.e., don't be an "enabler").

If after you've answered all of these questions, you still want to make a gift, please go ahead. But unless the gift is for a nominal amount, it is advisable to check with your attorney to make sure you are aware of the Medicaid, tax and other possible implications of your generosity.

Biggest urban legend in taxation - the Gift Tax

What is the biggest urban legend in the area of taxation?

If you answered “the gift tax,” score one for the home team.

The most common phone call received by tax professionals involve inquiries from parents or grandparents about whether or not they will have to pay gift tax on their monetary gifts. Adult children and grandchildren call to ask about whether they will have to pay a tax on gifts received. [Lots of hand-wringing going on]

Like the urban legends that struck fear in many of us as youngsters, the dark, scary world of gift taxes does the same to adults. One person whispers a rumor of a gift tax nightmare that some other person experienced and the urban legend grows and grows.

People fear the gift tax simply because they don’t understand how it works.

Knowledge conquers fear: Demystifying the gift tax

The gift tax is a real tax. You don’t necessarily need to pay it, but there are a number of rules surrounding this inconvenient tax.

First, any person can gift any individual up to $14,000 in 2014 and have no obligation to report it to the IRS. So mom and dad can give a combined $28,000 to their favorite child without creating any new filing requirements for themselves. But, if mom and dad gift little Johnny anything above that amount – even $28,001 -- they will need to file a gift tax return with their annual tax return.

Filing a gift tax return does not mean that these generous parents will automatically have to pay a gift tax (yes, the IRS assesses the gift tax based on the giver’s financial circumstances), but they will have to file the return. In fact, an individual owes no gift tax until he or she gives away the lifetime exclusion amount.

So what’s the lifetime exclusion amount?

For 2014, the lifetime exclusion amount is quite generous at $5,340,000! If you give away more than that, then you will owe gift tax – assessed at the whopping rate of 40 percent. This means that for the average taxpayer, fear of having to pay a gift tax represents an unfounded worry. You don’t need to add unnecessary sources of stress to your life.

Every rule has its exception (or two)

In some situations, you may not have to file a gift tax return even if you give over the annual limit.

Let’s suppose your favorite Aunt Martha is very sick and out of the goodness of your heart, you decide to pay her medical bills. No gift tax return is required, even if the amount exceeds $14,000. However this exception comes with an important caveat – you must pay the medical provider directly. If you give Aunt Martha the money and she then chooses to use it to pay her medical bills, you’ll need to file a gift tax return if the amount exceeds $14,000.

Another exception involves gifting money for higher education costs (i.e. college tuition). So, let’s say you decide to pay little Scarlet’s university tuition. You won’t need to file a gift tax return, even if the amount exceeds $14,000. But just like the example with Aunt Martha above, you’ll need to pay the money directly to the university. If you write young Scarlett a check for her tuition and the amount exceeds $14,000, you’ll need to file a gift tax return. By making payment directly to the educational institution, you can gift an unlimited amount of money with no obligation to file a gift tax return, or pay gift tax on it in the future.

Now you know the facts, so stop living in fear and embrace your desire to gift money to your loved ones. Unless you are giving away more than $5,340,000 you will not owe any gift tax.

Even so, any time you plan to give away large amounts of money, it’s wise to consider sitting down with a qualified tax professional. He or she may know of some legal ways to avoid the 40 percent rate on taxable gifts.

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. 

ESTATE PLANNING
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.

GIFT TAX
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).

WHAT THE CHANGES MEAN FOR YOUR ESTATE PLAN
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.

INCOME TAXES
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.

10 Ways to Maximize Your Tax Deductions Without Itemizing

With all the emphasis on itemized deductions at tax time, taxpayers tend to believe that claiming the standard deduction limits the potential to reduce the amount of tax due.

While it's true that many taxpayers rely on popular itemized deductions, those aren't the only deductions available. Taxpayers who file a form 1040 may also opt to claim a number of what the IRS calls "adjustments to income" -- that's another way of saying non-itemized deductions. Since deductions reduce your taxable income, they're a relatively painless way to chip away at your tax bill. Following are 10 ways to maximize your tax deductions -- without going through the trouble of itemizing:

1. Educator Expenses. Teachers (for grades K-12), instructors, counselors, principals or aides who worked in a school for at least 900 hours during the school year in 2010 can take a deduction of up to $250 for qualified expenses (if you and your spouse are filing jointly and both of you were eligible educators, you can claim up to $500). Expenses over the $250 can be taken as an itemized deduction on a Schedule A at line 21. Qualified expenses include those paid in connection with books, supplies, equipment (including computer equipment, software and services) and other materials used in the classroom. Qualified expenses don't include expenses for home schooling or for nonathletic supplies for courses in health or physical education.

2. Alimony. Payments that qualify as alimony can be deducted on your federal income tax return. To qualify, the payments must be "to or for a spouse or former spouse under a divorce or separation instrument." In other words, you must have an official agreement requiring the payment of support in cash or cash equivalent; noncash property settlements or voluntary payments don't qualify. Additionally, payments that can be characterized as child support don't count as alimony payments -- child support payments are tax neutral.

3. Student Loan Interest Deduction. For those of us still paying off those college and graduate school loans, it comes as a bit of a relief to be able to claim interest on a qualified student loan as a deduction. To qualify, you must have paid interest during the year for a student loan used solely to pay qualified higher education expenses; your filing status must not be married filing separately; your modified AGI must be less than $75,000 ($150,000 if married filing jointly); and you and your spouse, if filing jointly, cannot be claimed as dependents on someone else's return. If times were tough and you couldn't make payments during the year so your parents made a payment on your behalf, the IRS may still allow you to deduct up to $2,500 of student loan interest.

4. Student Loan Interest Deduction -- For Someone Else. While it makes sense that you can take a deduction for your own student loan interest, you might not realize you may qualify for a deduction for student loan interest that you paid for someone else. For purposes of the deduction, a qualified student loan is any loan you took out to pay the qualified higher education expenses for not only you and your spouse but for any person who was your dependent when the loan was taken out -- as well as for any person you could have claimed as a dependent for the year the loan was taken out except that the person filed a joint return, the person had gross income equal to or more than the exemption amount for that year ($3,650 for 2010), or you (or your spouse if filing jointly) could be claimed as a dependent on someone else's return. If you qualify, you can deduct the interest even though someone else received the education.

5. Career-Related Moving Expenses. If you moved in 2010 for reasons related to your job or business or to start a new job, you may be able to deduct your moving expenses. Your new workplace must be at least 50 miles farther from your old home than your old workplace was from your old home; if you had no old workplace, your new workplace must be at least 50 miles from your old home. To claim the deduction, you'll need to complete federal form 3903, Moving Expenses.
6. Tuition and Fees Deduction. If you, your spouse or your dependent was a student in 2010, you may be able to deduct tuition and fees paid to an eligible school. An eligible school would include any college, university, vocational school or other post-secondary educational institution that participates in a student aid program administered by the Department of Education. The deduction is based on the amount of qualified education expenses you paid in 2010 for academic periods beginning in 2010 and the first three months of 2011. You cannot take the deduction if your filing status is married filing separately, you were a nonresident at any time during the year, you could be claimed as an exemption by any other person (even if they didn't actually claim you), if your modified AGI is more than $80,000 ($160,000 if filing a joint return) or if you were a nonresident alien for any part of the year. You may be able to take the American Opportunity credit or Lifetime Learning credit for your education expenses instead of the tuition and fees deduction but you may not take both in the same year. To figure your deduction, use federal form 8917, Tuition and Fees Deduction.
7. Health Savings Account Deduction. Health Savings Accounts (HSAs) are tax-favored accounts that allow taxpayers to save for medical expenses. You may be able to take a deduction for those contributions that you make to a HSA during the year; employer contributions, rollovers and qualified HSA funding distributions from an IRA don't count for purposes of a deduction. To be eligible, you must be covered under a high deductible health plan (HDHP) and have no other health coverage except permitted coverage. If you are eligible, anyone can contribute to your HSA. However, you cannot be enrolled in Medicare or be claimed as a dependent on another person's tax return. The maximum amount that can be contributed to your Health Savings Account depends on the type of High Deductible Health Plan (HDHP) coverage you have. For 2010, the maximum contribution for individual plans is $3,050 and the maximum contribution for family plans is $6,150. You'll report contributions and figure your deduction using a federal form 8889, Health Savings Accounts (HSAs).
8. IRA Contributions. Contributions to a traditional IRA may be deductible so long as they meet certain criteria; keep in mind that contributions to a Roth IRA will not be deductible but may still count toward the saver's credit. To qualify, you or your spouse (if filing a joint return) must have earned income during the year. For purposes of determining the IRA deduction, earned income would, in addition to wages and self-employment income, include alimony and nontaxable combat pay; earned income does not include rental income, interest and dividend income, or any amount received as pension or annuity income or as deferred compensation. Additionally, to qualify, you must be under the age of 70 1/2 by the end of 2010. The maximum contribution you can contribute to a traditional IRA is the smaller of $5,000 ($6,000 if age 50 or older) or the amount of your taxable income for 2010, though limits and phaseouts may apply. And unlike many deductions which require you to pay up before the end of the year, you can make an IRA contribution through April 18, 2011, and it will still qualify as a deduction on your 2010 return.

9. Self-Employment Tax Deduction. When you're self-employed, the bad news is that, in addition to federal income tax, you are subject to self-employment (SE) tax. SE tax is a self-employed person's version of payroll taxes: You pay the equivalent of the employee and the employer's contributions to Social Security and Medicare. The good news is that you can deduct one-half of your SE tax paid as a non-itemized deduction.

10. Self-Employed Health Insurance Deduction. Generally, paying out of pocket for health insurance would be considered an itemized deduction that you would claim on a Schedule A. However, self-employed persons who pay for their own plans (as well as for spouses and dependents) may be able to deduct the amounts paid without itemizing. In addition, under provisions in the new small business jobs legislation signed last fall, you can save on payroll taxes due to a move that makes calculating the deduction more advantageous.

These popular non-itemized deductions can dramatically reduce your taxable income, which means you'll pay less in taxes. If you don't itemize, don't automatically reach for the form 1040-EZ; to claim these non-itemized deductions, you'll need to file a form 1040 or, in some cases, a form 1040-A. If you're not sure whether these deductions apply to you, use the "interview style" format found in your tax software or ask your tax professional.

Are churches automatically tax exempt?

Churches that meet the requirements of section 501(c)(3) of the federal tax code are automatically considered tax-exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS. Section 501(c)(3) imposes the following five requirements: (1) a church must be organized exclusively for exempt purposes; (2) a church must be operated exclusively for exempt purposes; (3) none of a church's resources can "inure" to the benefit of a private individual, other than reasonable compensation for services performed; (4) the church may not engage in substantial efforts to influence legislation; and (5) the church may not intervene or participate in any political campaign on behalf of or in opposition to a candidate for public office.

Churches that satisfy these five requirements are automatically exempt from federal income taxes. They are not required to obtain official recognition of exemption from the IRS by submitting an exemption application form (Form 1023) like most other public charities.

Although there is no requirement to do so, many churches seek recognition of tax-exempt status from the IRS because such recognition assures church leaders, members, and donors that the church is recognized as exempt and qualifies for related tax benefits. For example, members who make charitable contributions to a church that has been recognized as tax exempt would know that their contributions generally are tax-deductible.

A church with a parent organization may wish to contact the parent to see if it has a group ruling. If the parent holds a group ruling, then the IRS may already recognize the church as tax exempt. Under the group exemption process, the parent organization becomes the holder of a group ruling that identifies other affiliated churches or other affiliated organizations. A church is recognized as tax exempt if it is included in a list provided by the parent organization. The parent is then required to submit an annual group exemption update to the IRS in which it provides additions, deletions, and changes within the group. If the church or other affiliated organization is included on such a list, it does not need to take further action to obtain recognition of tax-exempt status.

10 Small Business Tax Mistakes That Will Cost You

There’s not an entrepreneur on the planet who likes thinking about taxes. I know, it’s only February, so you’re likely still in deep denial about March 15. But it’s time to get organized! Almost every aspect of your business has tax ramifications and if you don’t know what they are, you’re inviting trouble down the road (can you say “audit?”).
I will share 10 common tax misconceptions that both fledgling and experienced small business owners are guilty of. How many of these phrases have you uttered?
1. “I can do it myself.” “Most small business owners do not have the tax knowledge they need to stay out of trouble, but they won’t pay for planning,” says Rice. “They’re cheap so they use TurboTax.  But TurboTax won’t represent them if they get into trouble.” . Maybe you really are capable of doing your own tax planning. Maybe you can also rewire your office, build your own website, and represent yourself in court. That doesn’t mean you should. Just sayin’.
2. “I keep my receipts so I don’t need a tax diary.“ Every small business owner must keep an accurate tax organizer,  and it’s not the same thing as an expense log. “A tax organizer has all the questions that the IRS requires you to answer about travel, entertainment, and other expenses. It will bulletproof your records and eliminate procrastination, and if you’re audited, it shifts the burden of proof to the IRS,” Rice says. Anything that allows you to feel smug in the presence of an auditor has got to be worth its price, which is not cheap in this case. You’ll spend over $100 for a decent tax organizer/diary.
3. “Yay! A big fat refund.“ Many people are thrilled when they get a big check from the IRS. Wrong reaction.  “A refund means you’ve given the government interest-free money for a long time,” Rice says. “If you have withholding, you want to adjust it to the point where you get very little refund.”
4. “I’ll just borrow a little from employee withholding.“ When they’re short on cash, it’s often tempting for small business owners to dip into the trust fund that’s used for employee withholding and Social Security. “Many employers think ‘ this is my money,’” says Rice. “It isn’t. If they borrow from withholding or Social Security, they are personally liable, with huge potential penalties.”
5. “Let’s make everyone an independent contractor.“ Employees are expensive. Independent contractors, not so much. So why not make everyone independent contractor? It’s not that easy, says Rice.  “If you’re going to designate a worker as independent you have to treat him as independent,” says Rice.  Typically, independent contractors can make their own hours and have control over where, when, and how work is completed. If the IRS determines that you incorrectly designated an employee as independent, you may be subject to penalties for not collecting Social Security taxes, and for more than 40% of workers compensation for the specified time period.
6. “I can pay myself whatever I please.“ If you’re incorporated, not really. Say you typically pay yourself $100,000 a year. After a good year, you decide to increase that to $300,000. “You have to substantiate a reason for the increase, or part of the money can be disallowed by the IRS as unreasonable compensation,” says Rice. “Then it can be taxed at the corporate level, and distributed as a dividend. And then you’ll pay tax on the dividend.” Ouch!
7. “My bookkeeper would never steal from me.” “It’s vital for every small business person to have one person who writes the checks and another person doing the accounting, and never the two shall meet,” says Rice.  So unless you have a trusted family member handling all your finances, make sure that you have different people handling accounting and accounts payable. Nope, this isn’t a tax tip per se, but drop the ball on this one and you won’t have to worry about paying taxes because you may not have a business.
8. “That can’t possibly be deductible.“ Not so fast! The dry cleaning for the suits you wore at that business conference in Duluth?  If you were away overnight, it’s deductible, says Rice. A movie and dinner with friends, with whom you also talked business? Also deductible he says, even if your business discussion didn’t occur at dinner, but within the same 24-hour period as the social engagement.  Just make sure it’s all documented in your tax diary (see #2). Educate yourself on all the juicy deductions you may be missing out on.
9. “This isn’t a hobby, it’s a business.“ Say the “business” you started, selling seashell picture frames online, consistently loses money (those trips to Cape Cod are expensive, after all). The IRS may decide that you don’t have a business at all, but merely a hobby. In that case, you’ll no longer be entitled to the same deductions. “They’ll also disallow your losses,” says Rice. “The government is the biggest bookie — they’ll subsidize your losses, but they want part of your profits.”
10. “I can’t afford to hire my kids.“ Well, sure you can. Especially your kids who are in college. Pay them a reasonable wage for the work they perform, and you’ll be able to deduct their wages as a business expense. Then, have them use the wages to pay for college. Voila! You’ve just made college tuition deductible. Also, remember that up to $5,800 in income is tax-free for your children.

4 questions to ask before hiring a tax preparer

To take advantage of all the tax breaks available, preparers must keep up with changes in the tax code. Late last year, for example, Congress extended several deductions that had expired in 2009.

In most states, anyone can prepare taxes for a fee. There are no training or licensing requirements. Some individuals use the promise of low-cost tax preparation to sell dubious products, such as high-cost refund-anticipation loans.

That's changing, though. Last year, the IRS announced that tax preparers will be required to register with the government, pass a competency test and take continuing-education courses. The IRS plans to phase in the program over several years.

Starting this year, all paid preparers must obtain a Preparer Tax Identification Number from the IRS and include it on all returns they file. At this point, all a PTIN signifies is that the individual has registered with the IRS. Still, you should make sure a preparer has a PTIN. Someone who hasn't gone to the trouble to comply with this requirement may be slipshod in other areas.

Before hiring a preparer, check with your local Better Business Bureau to find out if there have been any complaints against the individual or company. Once you've done that, be prepared to ask some questions, including:

•Do you have any professional designations?CPAs, enrolled agents and attorneys must fulfill continuing-education and licensing requirements and are bound by ethical standards. They're also authorized to represent taxpayers before the IRS in all matters, including audits, collections and appeals. If the preparer doesn't have one of those designations, ask him if he belongs to any professional organizations that have continuing-education requirements.

•How much experience do you have with my type of return? Everyone has to learn the ropes somehow, but you probably don't want someone learning them on your tax return. Ask the preparer how long they have been preparing tax returns and whether they are familiar with your type of return.

•How do you determine your fees? Many reputable preparers charge a flat fee based on the complexity of your tax return. For example, someone with a 1040EZ will usually pay less than someone who has income from rental property and investments, she says. Ask the preparer to put the billing and payment terms in writing.

Steer clear of any preparer who bases fees on a percentage of your refund. Likewise, avoid preparers who claim they can get you a bigger refund than the guy down the street. No one can estimate your refund without first reviewing your financial information.

•Have you represented many clients in IRS audits? A preparer who has experience with IRS audits could provide valuable assistance if your return is scrutinized. But be wary of someone who has been through the process numerous times. That may be a sign he claims a lot of questionable deductions.

Keep in mind that you're responsible for the information on your tax return. Ideally, your tax preparer should e-mail or call with questions before completing your return. And you should always review and sign your return before it's filed with the IRS.

Top 10 Dumbest Things You Can Do With Your Tax Refund

1. Pay for a refund anticipation loan – Pay hundreds of dollars to get your refund faster? Hmmm. You may as well pay the Government to cash out your retirement fund while you’re at it?
2. Buy lottery tickets – Instead just give it to me. I’ll give you 30% back, while making you believe there is a chance you could win big.
3. Waste it on a new car – New cars lose value as soon as you drive them off the lot…duh!
4. NOT use it to pay down/off your debt – Continuing to pay interest on your debt while you waste it away on something meaningless is quite frankly immature.
5. Have it prepared by H&R Block –
6. Loan it to your broke relative – Just give it to them because chances are you will never see it again.
7. Ignore the fact that you have ZERO dollars in your emergency fund – Hint: unemployment, medical emergencies, a bad economy, and that little thing called life will happen. It’s just a matter of when.
8. Buy something that you think will impress your friends – The Joneses are not going to help you when your life comes crashing down. They will probably laugh at you though.
9. Blow it all by throwing a party – Perhaps the most fun way, but definitely the dumbest if you have not prepared for your future.
10. Drive down the interstate throwing it out the window $100 at a time – Believe it or not, a lot of people do this — I certainly used to!

Property Taxes on Vacation Homes & Timeshares

Depending on how often you use your vacation home yourself, how often you rent it out and how long it sits empty, you will fall into one of three different tax categories.
Use a Lot, Rent a Lot
The first category includes homes that are rented often but that are still used a fair amount by the owner. Specifically, this applies to homes that are rented more than 14 days a year and have personal use of more than 14 days or 10% of the rental days, whichever is greater. Personal use includes use by family members and anyone else who pays less than market rental rates.
Vacation homes fitting this description are considered personal residences. This helps you, because Uncle Sam lets you deduct interest on up to $1 million of mortgage debt (and up to an additional $100,000 for home equity loans). Property taxes are generally deductible, no matter how many homes you own. Those fortunate enough to own more than two homes can pick the two with the most mortgage interest each year — usually the main residence and the vacation home with the biggest loan.
Now for the hard part: accounting for rental income and expenses for your dacha. Basically, there is one way to deduct the expenses incurred while you use the house, and another way to deduct expenses incurred while you rent it. But if done correctly, there is generally no tax liability in these cases.
The first step is to allocate interest and property taxes between rental and personal use. For example, say the home is rented for three months, used by you and your family for two months, and vacant for seven months. Since vacant time is considered personal use, you allocate three months' worth, or 25%, of the interest and taxes to the rental period and nine months' worth, or 75%, to personal use. Write off the personal part of the interest and taxes as itemized deductions on Schedule A. In the past, the IRS has disputed this method of allocating the interest and taxes, but the tax court has ruled it's okay.
So far, so good. Now buckle up your chin strap, because there's white water ahead. The goal here is to reduce the rental income to zero to eliminate any tax liability. First, you reduce the income by 25% of the interest and tax expenses you incurred while renting. If there's any rental income left, you can deduct a percentage of operating expenses — maintenance, utilities, association fees, insurance and depreciation — but only to the point where you "zero out" that remaining income.
There is one difference, though: When you calculate operating expenses, you don't count the days the house stood empty. In our example, the house was occupied for only five months, so three months' worth, or 60%, of the maintenance, utilities etc. goes to the rental period and two months' worth, or 40%, to personal use. That 40% evaporates as a totally nondeductible item. On your tax return, you will use Schedule E (Supplemental Income and Loss) to report 100% of the rental income, 25% of the interest and taxes and 60% of the expenses. In many cases, the bottom line on Schedule E will be zero because the rental income and expenses will be a wash.
When all is said and done, this procedure should allow you to fully deduct interest and taxes (part on Schedule A and the rest on Schedule E) and usually enough operating expenses to wipe out your rental income. Any operating expenses that you cannot deduct are carried over to future years, when they can be deducted if you have rental profits. (In real life, this rarely occurs.) Overall, this is not a bad deal once you master the paperwork.
Rent a Lot, Use a Little
The second vacation-home tax category typically applies to houses that are used very little by the owner. Your home will fall under the tax rules for rental properties rather than for personal residences if you rent more than 14 days a year and if your personal use doesn't exceed 14 days or 10% of the rental days, whichever is greater. For example, assume you rent 210 days and vacation 21 days — you have a rental property on your hands. (Vacation 22 days, and you're back under the personal-residence rules explained earlier.) Interest, property taxes and operating expenses should all be allocated based on the total number of days the house was used. The total number of days used in this example is 231, so the split would be 21/231 for personal use and 210/231 for rental.
Here, if the money you get from renting the house does not cover the cost of renting it, you can post a taxable loss on Schedule E. But don't start tallying up your deductions just yet. First you must successfully clear the hurdles set up by the Internal Revenue Service in the form of passive-loss rules. In general you can deduct passive losses in a given tax year only to the extent of passive income from other sources (such as rental properties that produce gains).
There is an exception, though. The IRS will let you write off up to $25,000 of passive-rental real estate losses if you "actively participate" and have adjusted gross income under certain income thresholds. Making the day-to-day property management decisions will get you over the active participation hurdle. Unfortunately, the exception is phased out once you reach a certain income level, and the IRS says the exception doesn't apply anyway when the average rental period is seven days or less. But it's not a total loss: The IRS will let you carry over the passive losses you can't take this year into future years. The reality is that many owners find their hoped-for tax losses deferred by the passive rules.
Another problem: The interest incurred during your personal use (21/231 in our example) is nondeductible, because your home doesn't qualify as a personal residence. (The personal-use portion of property taxes is still deductible on Schedule A.) This means you may actually benefit from slipping in some extra vacation days this year. Then you drop back into the personal residence category — which means you can deduct the interest and taxes and usually offset all of your rental income with deductible operating expenses.
Use a Lot, Rent a Little
The final category is a rarity in the tax laws: It is simple and benefits the taxpayer. This one applies to homes that are rented for fewer than 15 days a year and used by the owner for more than 14 days. These homes are considered personal residences, so you simply deduct the interest and property taxes on your Schedule A, the same as you would for your primary residence. (There's no allocation nonsense to worry about.)
Here's the free lunch: You need not declare a penny of the income. You don't get any write-offs for operating expenses (maintenance etc.) attributable to the rental period, but who's complaining?
If your vacation home is fortuitously located near a major event — like any golf tournament featuring Tiger Woods — you may be able to rent for a few days at an outrageous rate. Under the tax rules, you can stiff Uncle Sam with a clear conscience.
What About Timeshares?
For many people, owning a timeshare is as close as they can come to having a vacation home. These days, a timeshare week can easily cost over $15,000. In fact, two winter weeks in Beaver Creek, Colorado can run you $60,000 and up, so we're not talking about trivial sums here. Many folks borrow all or part of the purchase price, often through the developer. Unfortunately, the tax rules are not particularly favorable if you rent out your unit.
But first let's assume you use your timeshare rather than rent it out. Your share of property taxes (usually buried in the annual maintenance fee number) is deductible on Schedule A. If you have mortgage interest, you can generally deduct it on Schedule A as interest on a second home. Simple enough.
Now let's say you do rent — as long as it's for less than 15 days, the income is automatically tax-free. Right? Wrong. According to the IRS, the tax-free rent deal is available only when the combined rental days for all the owners of your unit total less than 15 and you personally use the unit for more than 14 days. Not likely.
If you rent your unit at all, the Feds say you should follow the personal residence rules (use a lot, rent a lot) explained earlier by allocating expenses (interest, property taxes, maintenance, utilities, etc.) between personal and rental based on total usage by all the owners of your unit. This approach makes little sense and it's usually impossible to gather the necessary information from other owners anyway. So I advocate making the allocation based on either your own usage pattern or your best guess about total rental usage and personal usage by all the owners.
For example, if it appears that 50/50 is the appropriate split between rental and personal use, allocate 50% of the expenses to the rental period and take deductions up to the amount of your income on Schedule E. Then deduct the personal portion (50% in this example) of property taxes on Schedule A.
Unfortunately, you can't deduct the personal portion (50% again) of your interest expense unless you hang out in the unit more than 14 days during the year. That's impossible unless you own at least three weeks, and few people do. Arguably, you can write off the personal portion of the interest on Schedule A as investment interest expense if you acquired your timeshare with the expectation it would appreciate in value. (In some areas, timeshares have indeed gone up.)
Playing the Gain Exclusion Game With Multiple Residences
As you know, there is now a generous gain exclusion for sales of primary residences ($250,000 for singles, $500,000 for married couples). If you are lucky enough to have one or more vacation residences, there are some tax-saving games to be played here, if you are so inclined. The basic gain exclusion qualification rule is simple. You must have owned and used the home as your main residence for at least two years out of the five-year period ending on the date of sale. If you are married, the full $500,000 break is available as long one or both of you satisfies the ownership test and you both satisfy the use test.
So here's the deal. Say you are married and own three homes. First there's your current main home, which qualifies for the $500,000 exclusion and could be sold for a $400,000 gain. You sell it tax-free and move into your vacation home in Destin, Florida. Live there for two years, and you can unload the property and exclude up to $500,000 of gain from this sale as well – but here’s a caveat: You have to run a calculation to prorate the gain accrued during the period you used the property vs. the period it was rented. The gain built up during your use of the property is subject to the gain exclusion. Then, move into your remaining vacation home in Santa Fe, New Mexico, and live there for two years. You get the idea.

And if you are determined to own three homes, you can simply replace each one after it's sold with another property in the same or different location. Then you could start the "use and sell" rotation all over again, while happily excluding gains all along the way. Obviously relatively few people are affluent enough to be able to stiff Uncle Sam to this extent, but if you are one of them, enjoy. One more thing: Be sure to check on the state income tax implications before actually implementing this maneuver.

Is it time to give your CPA the boot?

It’s that time of year again to assemble all of your financial information and bring it to your Certified Public Accountant. However, some of you may be dissatisfied with your current Certified Public Accountant and are contemplating a change.

 

The following list of the Top 10 Questions to ask in order to determine if it is time to change certified public accountants:

1. Do you grab your chest when you open your CPA's bills?
2. Do you feel shunned by your CPA whenever you call his office?
3. Are you tired of seeing a new face handling your account each year?
4. Are extensions your CPA's MO?
5. Are you no longer shocked when you receive an IRS notice?
6. Do you find yourself auditing the work of your CPA?
7. Do you suspect that your CPA never heard of tax planning?
8. Can't remember the last time your CPA discussed his findings with you?
9. When you receive your financials, is it already time for next year's?
10. Do you wake up in the middle of the night in a cold sweat, worrying about an IRS audit? 

In addition to the 10 questions listed above, I decided to compile a list of 10 things to be especially on the lookout for to assist you in deciding whether now is the time to change CPAs.

 

My Top 10 List for Knowing When It’s Time to Give Your Current CPA the Boot! 

1. Your CPA brags about all the money he made on investment referrals to Bernard Madoff’s Investment Securities.
2. The cover letter accompanying your tax return is in Sanskrit, bearing a New Delhi address.
3. You received a wedding invitation of your CPA’s marriage to his prison cellmate, Buster.
4. Your CPA included your dog, Muffy, as a dependent on your 2009 Form 1040.
5. Your CPA billed you for a 2009 Form 1040 tax return filed for Muffy.
6. Your CPA’s tax organizer asks you for all of your credit and debit card numbers, CVV numbers, PIN numbers, expiration dates, names as they appear on the cards, and zip code.
7. Your financial statements and tax returns appear on his website as testimonials.
8. Your CPA off-handedly mentions that he recently hired some big mafooch named Guido to handle collections.
9. Your CPA text messages his attorney always before signing your financial statements and tax returns.
10. Over drinks your CPA lets it slip out that that correspondence course—found on the back of a matchbook cover—sure paid off for him.

8 ways to drive down your 2010 tax bill

The year 2010 is now over. But as you tackle your Form 1040 for the 2010 tax year, you can still find ways to keep that final bill down for your income of last year.
Here are eight tips to keep in mind.
1. Find your records. Locate every single scrap of paper or e-mail that's potentially tax-relevant before you sit down to fill out the IRS forms or take your papers to an accountant.
"Organization doesn't have to be fancy," says CPA Terry Rice. "Just have a place for everything, a place so easy to get to that you'll actually use it for receipts and for all those tax statements that come in after the first of the year."

2. Make a list of every possible deduction and the specific record that backs it up. If you've planned and executed a personal tax plan for 2010, you'll have completed key elements of it by midnight on New Year's Eve. For some people, this included making the maximum allowed contribution to a tax-deferred retirement account and making all planned charitable deductions before year's end. For other taxpayers, it included deferring the collection of certain income until 2011, so as to put off paying taxes on it, or paying deductible expenses in 2010, even though they weren't due until 2011, so as to get a tax break on them.

3. If you're not already itemizing deductions, use the list you've assembled to decide whether you should be. If you're paying mortgage interest and property taxes on your home, or have other tax-deductible expenses, you may well save on taxes by itemizing instead of claiming the standard deduction. But be careful — deduction rules are complicated. Make sure you're claiming only qualified write-offs.

4. Take a partial write-off on investment losses. If you lost money on investments in 2010, you can use the loss to offset capital gains on investments that rose in value. Even if you have no gains, you may still deduct up to $3,000 of your losses each year to offset ordinary income. If you have more than $3,000 in losses, you can carry the excess forward to deduct in future tax years. Although this may not be enough to fully recoup your investment loss, it will help by reducing your tax bill.

5. Make the smart choice between deducting state income tax or state sales tax. Tax law allows you to deduct one or the other. If you live in a state that taxes income, the income tax deduction is probably best for you. But if you bought a big-ticket item like a vehicle, boat or airplane during the year, deducting the state sales tax might be better. Do the math, then decide.

6. Remember those special energy credits. Tax credits are better than tax deductions because they are a direct dollar-for-dollar reduction in your bottom-line tax bill. For 2010, especially generous ones are available: You are allowed a 30 percent credit of what you paid during the year to outfit your primary residence with certain energy-saving skylights, windows, roofs, furnaces, water heaters and central air-conditioning units, up to a maximum credit of $1,500. In 2011, credits for spending on these items are much less generous, but of course you will save energy as well. A taxpayer who owes no federal income tax for 2010 does not qualify for an energy tax credit.

7. Remember those reinvested dividends. Technically, this isn't a deduction, but it can help reduce your tax bill.
If you own mutual funds that automatically invest dividends in extra shares, keep in mind that each reinvestment increases your "cost basis" in that fund. (Cost basis is the original price, plus fees, of an asset such as stocks, bonds and mutual funds.)
Adding the dividends to the cost basis will reduce the taxable capital gain (or increases the loss) when you redeem shares. If you forget to do this, you'll be overpaying your tax.
8. Use direct deposit for any refund. This won't affect the dollar amount of your taxes, but by opting for electronic transfer rather than a check, you'll have a shorter wait for any money that's due to you.

How To Find the Cost Basis of Your Stock

If I had to pick one question I get most often, it's how to figure the cost basis of a stock. Readers ask it mostly around tax time, but it comes up all year. The cost basis is how much you paid for a stock, including commissions and reinvested dividends. We'll talk about stock, since that was your question, but many of the same factors apply to mutual funds and other assets, including your home.

After you buy a stock, your broker will tell you how many shares you bought, at what price, and what you paid in commissions.

Your cost basis will determine how much tax you owe when you sell the stock. If you sell a stock for more than your cost basis, you will owe capital gains tax on the profit. If you don't have the cost basis, you risk paying too much tax, which you don't want to do.

Second, your cost basis is a key ingredient to tracking your investment performance.

Given how vital cost basis is, I'm amazed at how many people don't keep track of it. Every week I hear from an investor trying to find out what they paid for a stock.

You can't rely on your broker to track cost basis for you, either. Some don't track cost basis correctly. Even more likely, if you ever transfer your brokerage account to another firm, your cost basis most likely will be lost.

So. What should you do if you need to find a cost basis? Generally, you have a few options based on how you answer the following questions:

• Does the stock still trade and do you know the date you bought the stock? If so, you're in luck. Using USATODAY.com's free historical price quote lookup, you can pull up a stock's high, low and closing price on that day. If you want to look up prices for another stock, just put the name or ticker in the Get a Quote box on that page, and click on the Historial Quotes tab when the new stock comes up.

• Does the stock no longer trade and you know the date you bought the stock? This scenario gets trickier. Depending on why the stock doesn't trade, you might need to do more calculations, which goes beyond this column. Most online services don't carry historical quotes for defunct stocks. But you can get back copies of USA TODAY newspapers or The Wall Street Journal at your local library and look up historical stock prices that way.

• Do you not know the date you bought the stock? This is the worst-case scenario. Your only hope might be to check your old brokerage statements to try to determine when you bought the stock. You don't want to ever get into this situation. If you read on, I'll show you how to make sure you always have your cost basis.

My top suggestion, while it won't help you retroactively, is to start using Microsoft Money Plus Deluxe.
If you enter all your stock trades into Money Plus, you'll always have the cost basis. All your stock data is stored on your computer's hard drive, so you have access to the information at all times, if you back it up. Money Plus not only tracks your investing performance, but lets you print out detailed reports showing your holdings and your cost basis. The software also lets you figure out, before you sell a stock, what the potential capital gains hit would be, using its built-in Capital Gains Estimator. Money Plus offers other personal finance tools to help manage your checking and savings accounts.

There are other options. But they have serious issues, so I can't wholeheartedly recommend them. Some of the alternatives:

• Intuit's Quicken. Quicken also helps track the cost basis on your investments. I can't recommend the software, though, because some users, including me, have had trouble running it on computers with Microsoft's latest operating system, Vista.

Even some Mac users say Money is the best choice. Quicken hasn't been updated for the Mac in many years, although Intuit says an update is due this summer. Some Mac users run Windows just so they can use Money.

• Online personal finance tools. Several online offerings are interesting, but still not adequate for investors.

One option, Mint.com, looks promising and does a nice job showing you the balances in your accounts, from brokerage to checking and retirement. But some may not like the idea of giving all their account information to a third-party website. To use Mint to track your accounts, you must provide your user name, password and trading password.

Forgetting potential security concerns, which may never be an issue, Mint doesn't yet have the power to handle what most investors need in tracking cost basis. For one thing, at least in my experience, the service doesn't allow you to track different lots. So, let's say you bought 100 shares of GE stock in 2006 and another 100 in 2007. You have two lots of GE stock, each of 100 shares.

Mint groups both purchases into one, providing some sort of average for all 200 shares, which isn't adequate for most users. There are tax benefits to tracking what you paid for the first 100 shares of GE and the second 100 shares.

Mint doesn't track the timing of transactions well enough for serious investors, either. If you bought the stock recently, the date of purchase may be imported into Mint. However, if it's an older position, you might be out of luck. While you can manually enter the price you paid for a stock into Mint, you're not able to enter the date you bought it.

This is inadequate. Gains on stock you own more than a year are taxed at a lower rate than stocks you own a year or less. Mint seems to be improving the service constantly, so it's worth watching.

But for investors who need to track their cost basis, Microsoft Money is still the way to go. Hopefully Microsoft will continue to improve that software, perhaps improving the links to its MSN Money service, as well.

FreeTaxUSA Now Supports All States

Online tax preparation site FreeTaxUSA said it now supports all 42 states with a state income tax.
The site, owned by TaxHawk Inc., has added Vermont, Montana and the District of Columbia, the company said Friday. Taxpayers in states that don’t require a state tax return can still file their federal returns free through the Web site, www.freetaxusa.com. New states have been added to the site each year, with this tax season being the first time all 42 states have been supported on the website.
The state service, for which the site does charge users, includes state form preparation and direct electronic filing to the state’s department of revenue. FreeTaxUSA posts the state preparation costs on its home page and said it does not charge extra fees or for mandatory upgrades in the software.
Information from the federal return is carried forward to the state tax return. Much of the state tax return is completed automatically, helping reduce errors traditionally found when preparing state returns by hand. All applicable state forms are prepared and are ready to e-file once the state portion of the software is completed. Customer support is free for all customers.
Returning users can access prior-year returns saved to their account. There is no fee to access, print, and save prior year tax returns on the Web site. Customers can access their tax return with any computer with an Internet connection as long as they have their username and password. In addition, a PDF of both federal and state tax forms can be saved to their hard drive for future reference.

5 Tax Myths Everyone Should Know

Don't you love a huge refund at income tax time? As it turns out, a big tax refund may make you feel good but it's not actually good for you. It means that way more than necessary was being withheld from your paycheck or, if you're self-employed, that your quarterly tax payments were much too large. 

That's fine for the government because they're essentially getting an interest-free loan in the meantime. But most of us have better uses for our money, like paying off credit cards, making investments or having more cash for routine expenses. So next time you hear someone brag about their big tax refund, you'll know they've bought into one of the oldest tax myths around.

Employees who are getting large refunds should go to IRS Publication 919  for an IRS booklet that shows how to avoid too much withholding; the section you need to read starts on page four. If you're self-employed, have your accountant recalculate your quarterly taxes to prevent overpayment. The notion that large refunds are good is but one of the many enduring tax myths. Here are five others you should be familiar with.

Myth 1: People who file electronically are more likely to be audited.
About 95 million taxpayers e-filed their 2009 income tax returns. In fact, the majority of returns are now filed electronically. Pretty soon, e-filing will probably be mandatory, so people have naturally begun to worry about the new system being more prone to audits. Yet, the IRS audit rate remains steady at less than 2% of all returns. The main audit triggers are the same as always, things like filing late, high self-employment income and math errors.

Myth 2: Paying taxes is voluntary.
Saying that taxes are voluntary or illegal is a favorite argument of tax protesters to justify not filing a return. But to the IRS, "voluntary" simply means you get to do all the tax calculations yourself. We're all required by law to pay taxes. So, if you're thinking of becoming a tax protester, be aware that your chances of avoiding taxes are slim to none - and that you'll probably also be liable for late-payment penalties.

Myth 3: Taxes in America are way too high.
Our income tax system may not always be comprehensible or fair, but Americans don't pay the highest taxes by a long shot. Whereas our highest tax bracket for individuals in the United States is currently 35%, individuals can be taxed at 50% or more in Austria, Belgium, Cuba, Denmark, Japan, The Netherlands and the United Kingdom. The top bracket in Sweden is almost 60%.

Myth 4: Filing for an extension increases your chance of an audit.
Most tax preparers say they haven't seen any link between filing for an extension and getting audited. If anything, filing for an extension reduces your risk of an audit because you buy yourself six extra months to make sure you get your taxes done right. If there aren't any math errors or other red flags, the IRS will be more than likely to pass you over for an audit.

Myth 5: All certified public accountants (CPAs) are income tax experts.
Just because you see "CPA" after someone's name doesn't necessarily mean he or she is an expert tax preparer. Although the CPA curriculum includes extensive income tax courses, not all CPAs go into tax prep or keep up on income tax laws. If you're in the market for a tax preparer and you're looking at CPAs, be sure they've actually got plenty of tax prep experience. 

Tax Myths AboundTo say that the tax laws in America are voluminous and confusing is probably an understatement, so it's no surprise there are so many tax myths. The more aware of these myths you are, the more control you'll have over your own destiny as a taxpayer. 

10 Ways to Avoid a Tax Audit

Worried about extra scrutiny from the Internal Revenue Service?
While you can never completely "audit-proof" your business's income tax return, you can take actions that will greatly reduce your chances of being flagged.
Here are 10 ways to avoid a tax audit:
1. Choose your tax return preparer with care. Today, according to the recent National Taxpayer Advocate report, 60% of individuals and even a greater percentage of businesses use paid preparers to do their income tax returns. Yet, preparers now face more intense IRS review. If the IRS believes a preparer is claiming unwarranted deductions or taking other fraudulent steps on clients' returns, then the preparer's clients are at risk for audit.
The IRS has eight tips for choosing a tax preparer. Key among them is to check the preparer's history to see if there has been any disciplinary action. For example, if you use an enrolled agent, check with the IRS' office of Professional Responsibility at opr@irs.gov (include the preparer's name and address).
2. Report all of your income. The IRS uses information returns, such as W-2s and 1099s, to cross-check income reporting. Under its document-matching program, the IRS' computers compare information on the forms with the income reported by taxpayers on their returns. If the information doesn't match, this leads to an automatic audit. But don't panic; it's merely a correspondence asking about the discrepancy. It can be easily cleared up by submitting an explanation by mail if you think you are correct, or paying the tax owed if the omission was your oversight and the IRS is correct.
Sole proprietors, freelancers and independent contractors who use the cash method of accounting may be vulnerable to year-end payment problems. For instance, a sole proprietor that performed work for a client may have received a payment in early January – but the client might have mailed (and recorded) the payment in December. The client will include the payment on Form 1099-MISC for 2010, but it isn't taxable until 2011. What to do: Include the payment as it is reported on the 2010 return, but then subtract the payment and attach an explanation with the return. Then include the payment on the 2011 return, even though no 1099 will be issued for this year.
3. Provide complete information. All questions should be answered and all required information should be included on the forms and schedules necessary for your return. That means if you're a sole proprietor, include your business code number, accounting method, and, where applicable, inventory valuation method on Schedule C. If information is missing, it could trigger a more extensive look at the return.
Also add information where necessary to explain entries or omissions that are not easily understood—such as in the prior example, when income received in January is reported on a prior year 1099.
4. Avoid claiming deductions that are audit red flags.Advice is easy to give, but unfortunately, the IRS does not say which deductions are likely to provoke a closer look. There are no official audit red flags. While many warn that claiming a home office deduction can prompt an audit, there's no proof of this. If you meet the qualifications for claiming a home-office deduction, there's no good reason not to take the write-off. Check your eligibility in IRS Publication 587, Business Use of Your Home.
A number of years ago, the Government Accountability Office (formerly the General Accounting Office) compiled statistics on deductions claimed by sole proprietors to show the types of deductions relative to the amount of their revenue. Some tax professionals believe that taking more than the "average" can raise an IRS eyebrow, but again, there is no concrete support for this view. A business that is entitled to deductions, even if they are high relative to the amount of their income, should claim them—but be prepared to prove entitlement if the return is questioned.
5. Don't file certain forms or schedules. Some optional forms and schedules virtually guarantee an audit. For example, if you turn a hobby into a sideline and show a business loan, the IRS may question whether some of your deductions are legitimate. If that happens, you might file a Form 5213, which keeps the IRS from auditing you for the first five years of the business. If you can show that you're profitable in at least three of the years, then the business isn't a hobby and the losses in the other years aren't questioned. The problem: Filing the form virtually guarantees an examination at the end of five years.
Better way: If you have loss years, be prepared to prove that you are operating the activity with a profit motive.
6. Pay attention to details. Math errors or incorrect entries of Social Security numbers or tax identification numbers can easily trigger an inquiry into your return. Math errors can be greatly reduced by electronic filing rather than filing paper returns. In the past, the IRS had said that errors are less than 1% on returns that are filed electronically, compared with about 20% on returns submitted via paper. If an e-filed return has a math error, it won't be accepted; instead it is sent back for correction and refiling.
But information on electronically filed returns is only as good as the information you submit. Reporting $2,000 in income when it should have been $20,000 is your mistake and one that likely won't be noticed as a math error by a computer.
7. Mind your personal entries. If there are entries related to the personal side of your return, this can ultimately lead to scrutiny of your return activities. The IRS selects returns for audit in some cases based on a Discriminant Function System or DIF score, which is based on IRS experience with taxpayers claiming certain deductions or credits within set income levels. For example, if you claim charitable contributions that are higher than the average deductions for your income level, this could lead to a personal audit; the personal audit may be expanded to include your business activities.
8. Change your business status. IRS Statistics show that you are 10 times as likely to be audited as a Schedule C filer than if you incorporate your business and elect S corporation status. While it costs a bit of money to incorporate, the move affords you greater personal liability protection and reduces your chances of being audited. In deciding whether to change your business status, include both tax and non-tax factors.
Note: Forming a limited liability company for one owner will not give you any audit protection, because the owner still files a Schedule C.
9. Watch your state tax return. The IRS has information-sharing agreements with the states. If you are audited at the state level and owe additional taxes because of omitting income or for other reasons, this information is shared with the IRS. The information may then prompt the IRS to contact you asking for additional tax payment or to audit your return in more depth.
10. Plan for an audit, just in case. Because the IRS conducts random audits from time to time (such as a three-year random audit program for S corporations in 2007 and a current three-year random audit program for employment tax returns), any return could be selected for review at any time. Be prepared:

• Compile good books and records for your business activities.
• Retain required receipts and other documentation.
• Use separate bank accounts and credit cards for your business and personal activities.

Retain the records and receipts for your tax return for a minimum of three years (the period in which the IRS usually has to audit a return). However, keep in mind that the period becomes six years if 25% or more of income is omitted from the return, and there is no limit when it comes to fraud.

TaxACT Offers Federal Tax Filers Free E-filing

All taxpayers can now e-file a federal return for free with TaxACT, an online service from 2nd Story Software that files returns to the IRS allowing for refunds in as few as eight days with direct deposit.
Users can choose to be notified when the IRS has processed their returns by e-mail or a text message.  They can also check the status of their returns any time at www.taxact.com. The IRS will begin notifying e-filers whether their returns are accepted or rejected on Tuesday, January 18.
“We work closely with the IRS to give all taxpayers the fastest and easiest way to prepare their return, e-file and get their biggest guaranteed refund,” said 2nd Story Software chief executive Lance Dunn. “If your return includes itemized deductions, the Tuition and Fees Deduction, the Educator Expense Deduction or a few other forms the IRS won’t process until February, you can still prepare and e-file with TaxACT before then.”
A Deluxe edition is also available for $9.95 online or $12.95 for download, as well as a state tax edition for $14.95.
More information about all products is available at www.taxact.com.

IRS Scrambling to Update Computers

Because it took a contentious Congress until Dec. 17 to agree to extend the so-called Bush tax cuts another two years, the Internal Revenue Service had to scramble to update its computers.
The result is that about 40 million of the nation's 140 million filers will have to wait until mid- to late March to file their returns if they itemize deductions.
"For everyone else, there is no delay," said IRS spokesman Mark Hanson. "But if you are itemizing on Schedule A, you will have to wait until the IRS gives the green light to file."
Returns filed before itemizers get the go-ahead will be rejected and sent back, Hanson said.
Anticipating that Congresss wouldn't extend the tax cuts beyond 2010, the IRS had adjusted its computer programs to exclude them, Hanson said.
Joseph A. Pancerella, a certified public accountant, financial planner and managing partner of Pancerella & Associates LLC, 301 W. Lancaster Ave., Shillington, tried to simplify the issue.
"As the IRS has stated, most filers will not be affected," Pancerella said. "However, most individuals who use tax preparers will be affected.
"The reason: Because, as preparers, we typically prepare complicated returns. And complicated returns typically contain the items that are causing the delay."
Since the tax-filing season for some has been shortened to six weeks, Hanson said the IRS is encouraging taxpayers to file their returns electronically and, if they want to receive their refunds in as little as 10 days, they should elect to have their refund deposited directly into their checking account. Mailed refund checks take six to eight weeks.

Get Tax Credit for Your Retirement Savings

Tax time is coming soon. The IRS starts accepting e-file Friday January 14th and employers are in the process of getting W-2s out. Many people pay more taxes than they need to because they fail to take all the credits that are available to them. One of the most commonly overlooked credits it the Retirement Savings Contribution Credit.
The Retirement Savings Contribution Credit is a tax credit of up to $1000 ($2000 if married filing jointly) that you may be able to take if you make eligible contributions to an employer sponsored retirement plan or an IRA. This credit could reduce the amount of your federal income tax liability dollar for dollar. It is a non-refundable credit so the amount of your RSCC can not exceed the amount of your tax liability.
In order to be able to claim the RSCC you must meet the following conditions. You must be 18 or older and not a full-time student. No one else (such as parents) can claim an exemption for you on their tax return. Your adjusted gross income must not be more than $55,000 if your filing status is married filing jointly, $41,625 if your filing status is head of household or $27,750 if your filing status is single, married filing separately or qualified widow(er).
The amount of your tax credit is determined by how much you contribute to a qualified retirement plan and your credit rate. The credit rate ranges from as low as 10 percent to as high as 50 percent and is determined by your filing status and income. You can find your credit rate using Form 8880 at IRS.gov.
Most people whose income is low enough to qualify for the 50 percent rate likely will not be able to contribute enough to their retirement savings to qualify for the maximum credit but their tax liability is probably less than that. Even if you only qualify to receive the 10 percent credit rate the credit is worth taking since you should be saving for your retirement anyway. If you contributed to an IRA or your employer’s retirement plan and your income is within the guidelines be sure to determine whether you qualify for this credit when filing your taxes.

Gift Tax Under The 2010 Tax Relief Act (P.L. 111-312): Different Rules For 2010, 2011 & 2012

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312 (2010 Tax Relief Act), which President Obama signed into law on December 17, 2010, makes significant changes to the gift tax.

Different Years, Different Rules

2010

The 2010 Tax Relief Act keeps the gift tax rate and exemption the same as it was under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA): 35% tax rate and $1 million exemption for individuals.

2011 and 2012

The 2010 Tax Relief Act keeps the gift tax rate at 35% for 2011 and 2012, but the gift tax will be significantly different in 2011 and 2012.

(1) Higher exemption. The gift tax exemption for 2011 and 2012 is increased from $1 million to $5 million for individuals. So, individuals who used their entire $1 million gift tax exemption prior to 2011 will be able to gift an additional $4 million in 2011 and 2012 without incurring a gift tax.

(2) Unified exemption. The gift tax exemption will be reunified with the estate tax exemption, starting 2011.

(3) Indexed for inflation. Starting 2012, the gift tax exemption will be indexed for inflation.

(4) Portable. In 2011 and 2012, the gift tax exemption will be portable. Portability allows a surviving spouse to use the amount of estate and gift tax exemption not used by the decedent spouse. For an explanation, see Deborah L. Jacobs, Married Couple’s Guide To The New Estate Tax Law, Forbes, Dec. 23, 2010.

Gift Tax Strategies

The changes that the 2010 Tax Relief Act has a number of implications for estate planning.

(1) Changes year-end planning.

Many older, wealthy people were waiting until the end of the year to make large taxable gifts. Under EGTRRA, there was no estate tax in 2010, but it was scheduled to return in 2011 with an exemption of $1 million and a tax rate of 55% (60% in some cases). Also, under EGTRRA, the gift tax rate was scheduled to jump from 35% in 2010 to 55% in 2011 (with an exemption of $1 million). The idea was to make large taxable gifts and pay a gift tax of 35%. A transfer in 2010 under EGTRRA would have saved at least 20% compared to a transfer (either during life or upon death) under the rules that were scheduled for 2011. A 20% tax savings is significant.

The 2010 Tax Relief Act changes this year-end planning. Taxable gifts for clients in the $5 to $10 million dollar range probably should not be made in 2010. The reason for this is that the exemption under the 2010 Tax Relief Act jumps from $1 million in 2010 to $5 million in 2011. So, by waiting just a few days, money can be transferred by gift without incurring a gift tax.

(2) Limits the 2010 GST tax opportunity.

As I wrote in an earlier post, Congress provided the wealthy a tremendous generation-skipping transfer tax opportunity just for 2010. The 2010 Tax Relief Act reinstated the GST tax in 2010. But Congress is providing a GST tax “holiday” because the GST tax rate in 2010 is 0%.

The $1 million gift tax exemption in 2010 acts as a limit or cap to the 2010 GST tax opportunity. At a minimum, it makes decisions regarding whether to take advantage or pass on Congress’ 2010 GST tax gift more complicated.

Still, distributions in 2010 from non-exempt GST tax trusts can generally be made without incurring a gift tax. (If you have further questions about the GST tax opportunity in 2010 and whether it is right for you, you should consult your estate planning advisor immediately. Time is of the essence as this opportunity is only around for a few more days.)

(3) Creates gifting opportunities in 2011 and 2012.

The gift tax in 2011 and 2012 will be levied at a rate of 35% and with an exemption of $5 million that is portable.

(a) People who were once limited by the $1 million gift tax exemption will be able to gift up to the new limit.

(b) The $5 million exemption can be stretched with proper estate planning. Congress did not change the rules for grantor retained annuity trusts or for valuation discounts. It had been threatening to significantly restrict these estate planning tools. So, they can be used in 2011 and 2012 (so far). (Further, planners who make seed gifts before selling to intentionally defective grantor trusts will use the higher exemption to transfer tremendous amounts of wealth. I am planning to discuss this strategy in a separate post.)