Few people marry or divorce to change their tax status, but the federal income tax code does treat married couples and single people differently. Each group has its own tax brackets, standard deductions, credits, and phaseouts. As a result, two people can face very different tax bills if they are married and file jointly than if they are single and file either as individuals or heads of household. Couples who pay more than singles bear a “marriage penalty.” Those who pay less enjoy a “marriage bonus.”
Bonuses occur because couples pay tax on their combined income, no matter how much each spouse earns. If you’re married, in a progressive tax system like ours, taxing combined incomes rather than separate ones lowers your tax bill if you and your spouse have substantially different earnings. With tax brackets for couples exactly twice as wide as those for single people (and other tax provisions applying equally), a couple’s tax bill can be no greater than what they’d pay as individuals. Either they’d pay the same tax as two individuals or get a marriage bonus.
But tax brackets for couples aren’t all twice as wide as those for singles. Before the 2001 tax act passed, tax brackets were 67 percent wider for joint filers than singles. As a result, couples often paid more tax than if each spouse paid at singles’ rates on half their combined income. Thus, spouses with incomes in the same ballpark still paid marriage penalties.
Debate over the 2001 tax act riveted attention on marriage penalties. It was wrong, some policymakers asserted, to tax married folks more than those who—as people said when I was much younger—“live in sin.” The 2001 law tried to fix this by setting both the standard deduction and the widths of the 10-percent and 15-percent brackets for couples equal to twice those for single taxpayers. But Congress it didn’t fix the problem for the other four tax brackets. In particular, the 35-percent top rate began at the same level of taxable income for joint, single, and head of household filers. And nothing was done about other provisions that affect singles and couples differently.
Two years later, President George W. Bush proclaimed that “My tax relief package eliminated the marriage penalty [in the federal income tax].” The act did spell relief for many couples, but it hardly eliminated the penalty. Still on the books: the enormous penalties that the earned income tax credit (EITC) levies on low-income couples with children and the penalties that occur when tax benefits phase out over income ranges for couples that are less than twice those for single taxpayers. And marriage penalties live on in the basic tax structure because the higher brackets for joint filers are less than twice as wide as for single filers. Couples in which each spouse would have the same taxable income if they filed individual tax returns can pay up to $15,000 more than if they were single.
Most couples won’t feel this pinch from the tax brackets: Only those whose taxable income exceeds $137,300 would face a higher tax bill by getting married. Just one-quarter of couples have income that high, and many of those have earnings divided unequally between spouses. But for those power couples where each spouse earns about the same, the penalty rises quickly. Their taxes can go up by as much as 9 percent when their taxable income approaches $350,000.
Marriage penalties lurk elsewhere in our tax code as well.
But we don’t need much analysis to conclude that marriage penalties remain very much part of our current federal income tax.
Tuesday, March 29, 2011
Saturday, March 26, 2011
Tips for filing your income tax returns
Most find that the federal tax code is too complicated for them to prepare their own taxes. If you decide to hire someone to prepare your federal return, make sure that your preparer has the proper background and experience.
Here are some of the most important considerations follow:
• If you have a complicated return, you should consider using a CPA, enrolled agent or attorney. Such preparers will likely be more expensive than others; however, they are also required to demonstrate continued education in order to maintain their credentials.
• If you have a relatively straightforward return -- even if you itemize -- you should consider using AARP volunteer preparers. This program is available throughout the United States.
The IRS monitors the training of AARP volunteers, and none of them can prepare taxes unless they undergo the proper training and pass a comprehensive test prepared by the IRS. Moreover, AARP uses very sophisticated software that ensures consumers that all proper deductions and credits are taken into consideration.
There is no cost for this service. You do not have to be an AARP member, and there is no age limitation. The only disadvantage is that because the program is so popular, you may have a long wait during the day to have your return prepared. Call your local AARP chapter to find out where and when you can use this service. Ask them what restrictions apply. You don't want to wait all day and find out your return cannot be prepared by AARP.
• You should make sure that there are no complaints made against your preparer. Check with the Better Business Bureau.
• If your preparer is not a CPA, enrolled agent or lawyer, you should ask whether he has any professional designation, and what the requirements are for that designation.
• Avoid any preparer who bases his compensation on the size of your refund. Don't be afraid to ask how he computes his fee. Is it a fixed price based on the type of return? You should not employ a preparer without having a pretty good idea as to what the cost will be. Don't hesitate to ask for references.
• Ask the preparer if he has a Preparer Tax Identification Number (PTIN). This is a new IRS requirement. Do not use a preparer without one.
• Before you meet with the preparer, you should be well organized. Have all your records specifying income, amounts withheld, brokerage statements, deductions, past year return (if applicable), and the Social Security numbers of all your dependents. The less organized you are, the more it will cost to have your return prepared, and the result is much more likely to be inaccurate.
One important tax change for 2010 is related to traditional IRA conversions to Roth IRAs. There are no longer any income limitations for this conversion, starting in 2010.
The entire amount of the conversion you made in 2010 has to be reported as taxable income; however, you can elect to report half the income in 2011 and half in 2012. In order for you to make a conversion for 2010, you would have had to make it by December 31, 2010.
However, you should consider making conversions in the future. Roth IRAs provide significant long-term advantages. Specifically, after a five-year holding period, and after age 59 1/2, all withdrawals, including earnings, are tax-free; moreover, you have no restrictions on when you can make withdrawals.
Roth IRAs have significant advantages for retirement and estate planning. You should discuss these options with your financial planner or attorney.
Here are some of the most important considerations follow:
• If you have a complicated return, you should consider using a CPA, enrolled agent or attorney. Such preparers will likely be more expensive than others; however, they are also required to demonstrate continued education in order to maintain their credentials.
• If you have a relatively straightforward return -- even if you itemize -- you should consider using AARP volunteer preparers. This program is available throughout the United States.
The IRS monitors the training of AARP volunteers, and none of them can prepare taxes unless they undergo the proper training and pass a comprehensive test prepared by the IRS. Moreover, AARP uses very sophisticated software that ensures consumers that all proper deductions and credits are taken into consideration.
There is no cost for this service. You do not have to be an AARP member, and there is no age limitation. The only disadvantage is that because the program is so popular, you may have a long wait during the day to have your return prepared. Call your local AARP chapter to find out where and when you can use this service. Ask them what restrictions apply. You don't want to wait all day and find out your return cannot be prepared by AARP.
• You should make sure that there are no complaints made against your preparer. Check with the Better Business Bureau.
• If your preparer is not a CPA, enrolled agent or lawyer, you should ask whether he has any professional designation, and what the requirements are for that designation.
• Avoid any preparer who bases his compensation on the size of your refund. Don't be afraid to ask how he computes his fee. Is it a fixed price based on the type of return? You should not employ a preparer without having a pretty good idea as to what the cost will be. Don't hesitate to ask for references.
• Ask the preparer if he has a Preparer Tax Identification Number (PTIN). This is a new IRS requirement. Do not use a preparer without one.
• Before you meet with the preparer, you should be well organized. Have all your records specifying income, amounts withheld, brokerage statements, deductions, past year return (if applicable), and the Social Security numbers of all your dependents. The less organized you are, the more it will cost to have your return prepared, and the result is much more likely to be inaccurate.
One important tax change for 2010 is related to traditional IRA conversions to Roth IRAs. There are no longer any income limitations for this conversion, starting in 2010.
The entire amount of the conversion you made in 2010 has to be reported as taxable income; however, you can elect to report half the income in 2011 and half in 2012. In order for you to make a conversion for 2010, you would have had to make it by December 31, 2010.
However, you should consider making conversions in the future. Roth IRAs provide significant long-term advantages. Specifically, after a five-year holding period, and after age 59 1/2, all withdrawals, including earnings, are tax-free; moreover, you have no restrictions on when you can make withdrawals.
Roth IRAs have significant advantages for retirement and estate planning. You should discuss these options with your financial planner or attorney.
Friday, March 25, 2011
Eighteen Ways To Get Tax-Free Income
A two-year tax cut extension? That compromise between Congress and the president was nice, but you can do better. You can get a 0% tax rate on many kinds of income.
It’s pretty hard to avoid paying taxes on your paycheck. But there are all kinds of ways to pick up money that the Internal Revenue Service can’t touch—such as from inheritances, fringe benefits, airline miles and rebates.
Remodel
Sweat equity is tax free, if you know what you’re doing. Buy a fixer-upper and live in it for at least two years. If you’re talented at painting and carpentry, you’ll make a nice profit when you sell, and you can take advantage of the $500,000 exemption on capital gains for your principal home. For singles, the exemption is $250,000.
Moonlight
The first couple of thousand dollars a year you pocket from outside jobs is likely to be tax free. Reason: You probably have all sorts of expenses, such as for continuing education, a home office, professional association dues and a computer, that you can write off against freelance income. Since these are expenses that you usually can’t otherwise deduct, your early freelance dollars are pure gravy.
Get reimbursed
Ask your employer to cover more of your work expenses (like those professional dues) in lieu of giving you a raise. So long as your expenses are documented, the reimbursement is not income to you. Your company will save on payroll taxes, too. But don’t mess with country-club dues; these aren’t deductible.
Earn airline miles
If you pick these up by taking deductible business trips and then use them on a vacation, they should, in principle, be taxable. But they aren’t. This is a political hot potato, and the IRS gives frequent fliers a free ride.
Take the bus
You can pull up to $230 a month out of your paycheck, pretax, to cover mass transit, vanpooling and commuter parking.
Hustle rebates
Those grocery-store coupons may not be worth your time. But the $50 rebates you get on phones and computers definitely are. As a reduction in the cost of an item for personal use, a rebate is not considered taxable income.
Be nice to Uncle Joe
If he leaves you money in his will, you don’t owe a dime of income tax on it.
Pay off credit cards
Where else are you going to earn 18% on your money? To top it off, this 18% dividend is totally tax free.
Rent your house out
If you rent out a house for 14 or fewer days, the income is scot-free. Not only that, you don’t have to prorate or reduce your otherwise deductible mortgage interest and property taxes. Unlike the remodeling gambit, this one works on vacation homes, too.
House sit
You get a rent-free place to stay by keeping watch in a house whose owner is off on an overseas assignment. The $20,000 you save on rent is like getting a $20,000 raise, except that it’s tax free.
Get a cash-back card
Be a good neighbor
You babysit the neighbor’s children, and in return he paints your garage. You’re both earning money, in effect, by providing services. While the IRS can assess taxes on people in barter exchanges that involve account books and transactions with strangers, there’s no way to levy a tax on helping out a friend.
Have a charity tag sale
You were going to send $500 to Doctors Without Borders anyway. Do it this way. Have a tag sale, unloading tchotchkes from your attic, and advertise that 100% of the proceeds will go to the worthy cause. If you haul in $490, that sum becomes, in effect, tax free income for your day of labor.
Own a house
You get a dividend in the form of not having to pay rent. This dividend is tax free. It has nothing to do with mortgage interest. You have a tax free dividend even if you pay cash for the home.
Take up plumbing
…or electricity or carpentry or car repair. When you work overtime at your company in order to have the bucks to pay pros to do various chores, you owe taxes. But when you hire yourself to do chores, there’s no income to tax.
Set up an HSA
In combination with a high-deductible health insurance policy for your family, you set up a health savings account and put $6,150 a year ($7,150 if you’re over 55) of tax-deductible money into it.
You can use the bucks right away to pay uncovered medical costs. But you don’t have to eat into the account in this fashion. Instead, pay your doctor bills out of your checking account. Then let the $6,150 compound tax free until you are retired.
If you use the HSA later in life for medical costs (which will be considerable; Medicare is going bankrupt) then both the principal and the earnings come out tax free.
Hire the kids
If you own your own business, make your teenage children into employees. If the pay is reasonable for what they do, you can deduct the payroll, lowering your high-bracket net income. On the receiving end a child laborer owes no federal income tax on earned income below the $5,700 standard deduction.
If the kid also has investment income, the exact value of the freebie gets more complicated. But, in round numbers, $5,000 of summer job income is going to be free of income tax.
You will, however, have to cough up for Social Security and Medicare taxes.
Get paid in lodging
If part of your compensation is a free apartment, and if your presence on the premises has a business purpose, then you don’t owe tax on the benefit. This works for hotel managers, apartment supes and roustabouts on offshore rigs.
Clergy members get a better deal: Their housing allowance is tax-free even if paid in cash.
It’s pretty hard to avoid paying taxes on your paycheck. But there are all kinds of ways to pick up money that the Internal Revenue Service can’t touch—such as from inheritances, fringe benefits, airline miles and rebates.
Remodel
Sweat equity is tax free, if you know what you’re doing. Buy a fixer-upper and live in it for at least two years. If you’re talented at painting and carpentry, you’ll make a nice profit when you sell, and you can take advantage of the $500,000 exemption on capital gains for your principal home. For singles, the exemption is $250,000.
Moonlight
The first couple of thousand dollars a year you pocket from outside jobs is likely to be tax free. Reason: You probably have all sorts of expenses, such as for continuing education, a home office, professional association dues and a computer, that you can write off against freelance income. Since these are expenses that you usually can’t otherwise deduct, your early freelance dollars are pure gravy.
Get reimbursed
Ask your employer to cover more of your work expenses (like those professional dues) in lieu of giving you a raise. So long as your expenses are documented, the reimbursement is not income to you. Your company will save on payroll taxes, too. But don’t mess with country-club dues; these aren’t deductible.
Earn airline miles
If you pick these up by taking deductible business trips and then use them on a vacation, they should, in principle, be taxable. But they aren’t. This is a political hot potato, and the IRS gives frequent fliers a free ride.
Take the bus
You can pull up to $230 a month out of your paycheck, pretax, to cover mass transit, vanpooling and commuter parking.
Hustle rebates
Those grocery-store coupons may not be worth your time. But the $50 rebates you get on phones and computers definitely are. As a reduction in the cost of an item for personal use, a rebate is not considered taxable income.
Be nice to Uncle Joe
If he leaves you money in his will, you don’t owe a dime of income tax on it.
Pay off credit cards
Where else are you going to earn 18% on your money? To top it off, this 18% dividend is totally tax free.
Rent your house out
If you rent out a house for 14 or fewer days, the income is scot-free. Not only that, you don’t have to prorate or reduce your otherwise deductible mortgage interest and property taxes. Unlike the remodeling gambit, this one works on vacation homes, too.
House sit
You get a rent-free place to stay by keeping watch in a house whose owner is off on an overseas assignment. The $20,000 you save on rent is like getting a $20,000 raise, except that it’s tax free.
Get a cash-back card
The best of the breed give you 2% back, and the rebate is tax free if the charge was for a personal purchase. For more, read this.
Be a good neighbor
You babysit the neighbor’s children, and in return he paints your garage. You’re both earning money, in effect, by providing services. While the IRS can assess taxes on people in barter exchanges that involve account books and transactions with strangers, there’s no way to levy a tax on helping out a friend.
Have a charity tag sale
You were going to send $500 to Doctors Without Borders anyway. Do it this way. Have a tag sale, unloading tchotchkes from your attic, and advertise that 100% of the proceeds will go to the worthy cause. If you haul in $490, that sum becomes, in effect, tax free income for your day of labor.
Own a house
You get a dividend in the form of not having to pay rent. This dividend is tax free. It has nothing to do with mortgage interest. You have a tax free dividend even if you pay cash for the home.
Take up plumbing
…or electricity or carpentry or car repair. When you work overtime at your company in order to have the bucks to pay pros to do various chores, you owe taxes. But when you hire yourself to do chores, there’s no income to tax.
Set up an HSA
In combination with a high-deductible health insurance policy for your family, you set up a health savings account and put $6,150 a year ($7,150 if you’re over 55) of tax-deductible money into it.
You can use the bucks right away to pay uncovered medical costs. But you don’t have to eat into the account in this fashion. Instead, pay your doctor bills out of your checking account. Then let the $6,150 compound tax free until you are retired.
If you use the HSA later in life for medical costs (which will be considerable; Medicare is going bankrupt) then both the principal and the earnings come out tax free.
Hire the kids
If you own your own business, make your teenage children into employees. If the pay is reasonable for what they do, you can deduct the payroll, lowering your high-bracket net income. On the receiving end a child laborer owes no federal income tax on earned income below the $5,700 standard deduction.
If the kid also has investment income, the exact value of the freebie gets more complicated. But, in round numbers, $5,000 of summer job income is going to be free of income tax.
You will, however, have to cough up for Social Security and Medicare taxes.
Get paid in lodging
If part of your compensation is a free apartment, and if your presence on the premises has a business purpose, then you don’t owe tax on the benefit. This works for hotel managers, apartment supes and roustabouts on offshore rigs.
Clergy members get a better deal: Their housing allowance is tax-free even if paid in cash.
Thursday, March 24, 2011
What to Do if You Can’t Afford to Pay Your Taxes
With tax season winding down, millions of taxpayers may be looking at tax bills they can’t afford to pay but can’t afford to ignore either.
“If you can’t pay what you owe, still file a tax return and make payment arrangements with the IRS,” said Terrence Rice, CPA. “Otherwise, you’re immediately facing a failure-to-file penalty as well as interest, additional costs and potentially a tax lien or levy down the road.”
In February, the IRS issued new rules to help soften the blow for taxpayers who can’t afford to pay their taxes when owed. These new rules include increasing the threshold at which the IRS files a tax lien and expanding the installment and offers in compromise programs to allow more taxpayers to qualify.
Despite the changes, taxpayers still face a host of consequences for not paying taxes when owed and need to understand the options available to address their tax debt.
Ramifications of Ignoring Tax Deadlines
If a taxpayer does not file a tax return and pay the taxes owed when due, the IRS can take several steps, including:
• Failure-to-file penalty. The taxpayer faces a penalty of 5 percent of the tax due for every month or any fraction of a month that the return is overdue, capped at 25 percent. Additionally, failing to file a federal tax return is a misdemeanor and carries a maximum fine of $25,000 for individuals or a one-year prison term.
• Substitute tax return. The IRS can file a substitute tax return for the taxpayer based on information it has from other sources. The substitute tax return will not include exemptions or expenses to which the taxpayer may be entitled. So, it may overstate the actual tax liability.
• Levies and liens. Next, the IRS will start a collection process. This can include a tax levy or tax lien. With a tax levy, the IRS can seize your property – for example, your house, car, bank account or wages – to pay your taxes if you failed to make arrangements to settle your debt. A tax lien is a claim used as security for a tax debt and can have a direct impact on a taxpayer’s credit rating. If a tax liability remains unpaid after the IRS issues a notice and demand for payment, a tax lien is automatically filed to record a claim by the IRS to all property owned by the taxpayer.
Under the new IRS procedures, liens will not be filed until a taxpayer owes more than $10,000 in taxes (up from $5,000). Additionally, the new rules make it easier for a taxpayer to have a tax lien withdrawn from their record after paying their tax debt. However, they need to make a formal request to the IRS for the withdrawal. Also, if the taxpayer enters into a direct debit installment agreement with the IRS, they can have the tax lien withdrawn while they are paying off the debt.
“You want to avoid having a tax lien,” Rice said. “It’s a costly and disruptive experience. Your credit rating will be affected, you can have difficulty buying or selling a home and it could even affect your ability to get a job.”
Three Main Tax Debt Payment Options
Steps taxpayers can take to help avoid a tax lien include either finding a way to pay the taxes owed outright or working with the IRS to arrange a payment schedule and possibly agree to reduce the amount owed.
1. Borrow, liquidate assets or charge to pay the debt. Taxpayers who owe and can’t pay their entire tax bill when it’s due, but can pay the full amount within 120 days, can ask the IRS for a short-term administrative extension.
Taxpayers who need more time have just a few options: They can try to secure a bank loan, such as a home equity loan, cash out a retirement account or use their credit card.
While going into debt to pay off a debt may not seem the best option, the interest rate and fees assessed by a bank or credit card issuer may be lower than the interest and penalties assessed by the IRS. Credit card payments must be made electronically, through personal tax software, a paid tax preparer or through credit card service payment providers.
Penalties for withdrawing from a retirement account may be more substantial. However, taxpayers may also want to explore this option with their tax advisor if other resources are unavailable.
2. Enter into an installment agreement with the IRS. The IRS is required to accept installment payments if a taxpayer has a good filing and payment record over the past five years, the amount owed is not more than $10,000 and it can be paid off in full within three years.
Under the new rules, the agency also is allowing small businesses to enter into “streamlined” installment agreements if their debt is below $25,000 (up from $10,000) and they agree to pay it off in 24 months. The new streamlined installment agreement is available to small businesses that file as an individual or as a business. To participate, the small business must enroll in a direct debit installment agreement.
3. Reach an offer in compromise with the IRS. In some instances, the IRS may accept less than the full amount due. This typically occurs if the taxpayer can show that the full tax debt could never be collected or they have a dispute with the IRS as to how much is owed, but neither party wants to enter into a legal battle to resolve the issue.
Under the new rules issued in February, more people may be eligible to participate in offers in compromise. Taxpayers with incomes of up to $100,000 (up from $50,000) and who have a tax debt below $50,000 (up from $25,000) can now request an offer in compromise from the IRS.
There’s a $150 fee charged for offers in compromise. Certain low-income individuals can ask for a waiver. Additionally, an initial non-refundable payment must be made with an offer in compromise.
“If you can’t pay what you owe, still file a tax return and make payment arrangements with the IRS,” said Terrence Rice, CPA. “Otherwise, you’re immediately facing a failure-to-file penalty as well as interest, additional costs and potentially a tax lien or levy down the road.”
In February, the IRS issued new rules to help soften the blow for taxpayers who can’t afford to pay their taxes when owed. These new rules include increasing the threshold at which the IRS files a tax lien and expanding the installment and offers in compromise programs to allow more taxpayers to qualify.
Despite the changes, taxpayers still face a host of consequences for not paying taxes when owed and need to understand the options available to address their tax debt.
Ramifications of Ignoring Tax Deadlines
If a taxpayer does not file a tax return and pay the taxes owed when due, the IRS can take several steps, including:
• Failure-to-file penalty. The taxpayer faces a penalty of 5 percent of the tax due for every month or any fraction of a month that the return is overdue, capped at 25 percent. Additionally, failing to file a federal tax return is a misdemeanor and carries a maximum fine of $25,000 for individuals or a one-year prison term.
• Substitute tax return. The IRS can file a substitute tax return for the taxpayer based on information it has from other sources. The substitute tax return will not include exemptions or expenses to which the taxpayer may be entitled. So, it may overstate the actual tax liability.
• Levies and liens. Next, the IRS will start a collection process. This can include a tax levy or tax lien. With a tax levy, the IRS can seize your property – for example, your house, car, bank account or wages – to pay your taxes if you failed to make arrangements to settle your debt. A tax lien is a claim used as security for a tax debt and can have a direct impact on a taxpayer’s credit rating. If a tax liability remains unpaid after the IRS issues a notice and demand for payment, a tax lien is automatically filed to record a claim by the IRS to all property owned by the taxpayer.
Under the new IRS procedures, liens will not be filed until a taxpayer owes more than $10,000 in taxes (up from $5,000). Additionally, the new rules make it easier for a taxpayer to have a tax lien withdrawn from their record after paying their tax debt. However, they need to make a formal request to the IRS for the withdrawal. Also, if the taxpayer enters into a direct debit installment agreement with the IRS, they can have the tax lien withdrawn while they are paying off the debt.
“You want to avoid having a tax lien,” Rice said. “It’s a costly and disruptive experience. Your credit rating will be affected, you can have difficulty buying or selling a home and it could even affect your ability to get a job.”
Three Main Tax Debt Payment Options
Steps taxpayers can take to help avoid a tax lien include either finding a way to pay the taxes owed outright or working with the IRS to arrange a payment schedule and possibly agree to reduce the amount owed.
1. Borrow, liquidate assets or charge to pay the debt. Taxpayers who owe and can’t pay their entire tax bill when it’s due, but can pay the full amount within 120 days, can ask the IRS for a short-term administrative extension.
Taxpayers who need more time have just a few options: They can try to secure a bank loan, such as a home equity loan, cash out a retirement account or use their credit card.
While going into debt to pay off a debt may not seem the best option, the interest rate and fees assessed by a bank or credit card issuer may be lower than the interest and penalties assessed by the IRS. Credit card payments must be made electronically, through personal tax software, a paid tax preparer or through credit card service payment providers.
Penalties for withdrawing from a retirement account may be more substantial. However, taxpayers may also want to explore this option with their tax advisor if other resources are unavailable.
2. Enter into an installment agreement with the IRS. The IRS is required to accept installment payments if a taxpayer has a good filing and payment record over the past five years, the amount owed is not more than $10,000 and it can be paid off in full within three years.
Under the new rules, the agency also is allowing small businesses to enter into “streamlined” installment agreements if their debt is below $25,000 (up from $10,000) and they agree to pay it off in 24 months. The new streamlined installment agreement is available to small businesses that file as an individual or as a business. To participate, the small business must enroll in a direct debit installment agreement.
3. Reach an offer in compromise with the IRS. In some instances, the IRS may accept less than the full amount due. This typically occurs if the taxpayer can show that the full tax debt could never be collected or they have a dispute with the IRS as to how much is owed, but neither party wants to enter into a legal battle to resolve the issue.
Under the new rules issued in February, more people may be eligible to participate in offers in compromise. Taxpayers with incomes of up to $100,000 (up from $50,000) and who have a tax debt below $50,000 (up from $25,000) can now request an offer in compromise from the IRS.
There’s a $150 fee charged for offers in compromise. Certain low-income individuals can ask for a waiver. Additionally, an initial non-refundable payment must be made with an offer in compromise.
Wednesday, March 23, 2011
Minimizing Capital Gains Taxes
March is one of my favorite months of the year. Winter’s just about over, NCAA March Madness is around the corner, the NBA the playoffs are coming up, flowers are getting ready to bloom and topping the list is the fact that most of us get to spend time preparing to pay taxes.
How great is that?
Although I’m certain the government is going to put our tax payments to good use, I prefer to minimize the amount I pay and that’s why I pay attention to how I might lower them, especially on things such as capital gains.
Capital gains are certainly nothing new to CPAs but to many, capital-gains distributions remain one of the great mysteries of accounting. For this reason I thought a quick column on what they are and how to potentially reduce them could be of some help.
Capital Gains 101
As an investor, sometimes you sell shares of an investment, such as a stock or a mutual fund. When you make money on that sale, you realize a capital gain.
But that’s not the only type of capital gain that exists. Each year, a mutual fund must distribute to its shareholders a portion of any net capital gains it earned when it sold securities in its portfolio. (Net capital gains are what remain after capital losses are subtracted from capital gains.) As a shareholder, you must pay taxes on those gains. So, even if you didn’t actually sell any of their fund shares,you could end up paying capital-gains taxes.
As unfair as it sounds, this is what I often refer to as the Mutual Fund Twilight Zone Paradox: sometimes funds pay out capital gains distributions in years that they’ve actually lost money. In 2002, for example, the performance of many funds was down. But at the same time, to meet redemption requests, many fund managers were forced to sell profitable growth stocks they’d held during the run-up of the 1990s. As a result, many shareholders were stuck with funds that lost money, yet still owed taxes on capital-gains distributions from the funds.
In addition and unbeknownst to some, “tax free” municipal-bond funds may realize capital-gains tax from selling bonds at a profit, even though the funds are managed for tax-exempt income.
Minimizing Capital Gains — and Taxes
Here are some tips that could help:
As you can likely tell by now, minimizing capital-gains taxes is not the easiest endeavor but hopefully some of the thoughts above can be of help.
How great is that?
Although I’m certain the government is going to put our tax payments to good use, I prefer to minimize the amount I pay and that’s why I pay attention to how I might lower them, especially on things such as capital gains.
Capital gains are certainly nothing new to CPAs but to many, capital-gains distributions remain one of the great mysteries of accounting. For this reason I thought a quick column on what they are and how to potentially reduce them could be of some help.
Capital Gains 101
As an investor, sometimes you sell shares of an investment, such as a stock or a mutual fund. When you make money on that sale, you realize a capital gain.
But that’s not the only type of capital gain that exists. Each year, a mutual fund must distribute to its shareholders a portion of any net capital gains it earned when it sold securities in its portfolio. (Net capital gains are what remain after capital losses are subtracted from capital gains.) As a shareholder, you must pay taxes on those gains. So, even if you didn’t actually sell any of their fund shares,you could end up paying capital-gains taxes.
As unfair as it sounds, this is what I often refer to as the Mutual Fund Twilight Zone Paradox: sometimes funds pay out capital gains distributions in years that they’ve actually lost money. In 2002, for example, the performance of many funds was down. But at the same time, to meet redemption requests, many fund managers were forced to sell profitable growth stocks they’d held during the run-up of the 1990s. As a result, many shareholders were stuck with funds that lost money, yet still owed taxes on capital-gains distributions from the funds.
In addition and unbeknownst to some, “tax free” municipal-bond funds may realize capital-gains tax from selling bonds at a profit, even though the funds are managed for tax-exempt income.
Minimizing Capital Gains — and Taxes
Here are some tips that could help:
- Minimize your capital gains: This one is simple, my favorite and the one I’d have to say is most often missed. Those planning on selling shares of stock or a mutual fund can potentially reduce their taxable gains by selling shares they bought at the lowest or highest price (which to sell depends on a number of factors too lengthy to explain here).
- Make all gains long-term gains: Short-term capital gains are gains from sales of property held one year or less; long-term capital gains are gains from sales of property held for more than one year. In tax year 2010, short-term capital gains are taxed at an investor’s ordinary income rate, which may be as high as 35 percent, depending on your client’s income level. Long-term capital gains, on the other hand, are taxed at a maximum rate of 15 percent: In tax-year 2010, investors in the two lowest tax brackets (10% or 15%) pay zero percent in long-term capital gains tax while everyone else pays 15 percent. So unless you are in the lowest income tax bracket, you will pay lower taxes on capital gains if they hold securities for more than one year.
- Use capital losses to offset capital gains: Both long-term and short-term capital losses can be used to offset capital gains on a dollar-for-dollar basis. A taxpayer can carry forward “unused” losses into future years until the losses are deducted, but no more than $3,000 can be deducted in any given year. For example, if an investor has a capital loss of $30,000 and no capital gains, it would take 10 years to deduct that loss ($30,000 ÷ $3,000 = 10 years).
- Replacing the losers: If you take a taxable loss on a depressed stock or mutual fund and feels it has the potential to rebound, you will want to wait more than 30 days after the date of sale before buying it back. That’s because if you buy identical securities within a period of 30 days before or after the date of sale, the so-called “wash-sale” rule comes into effect. Essentially, the wash-sale rule prevents an investor from claiming a loss on a sale of stock if they buy replacement stock within the 30 days before or after the sale.
- Replacing the winners: The wash-sale rule doesn’t apply when an investor realizes a profit on the sale of a stock or mutual fund: Investors can sell a winner to balance a loss and then buy it back immediately. An added benefit: you will also have the added tax bonus of a higher cost basis for your new shares. It might help to explain that cost basis is the original cost of an investment: investors may want their cost basis to be as high as possible because their investment will have appreciated less, and you will then likely pay fewer taxes when you sell it.
- Not all funds are created equal: Finally, when buying a mutual fund, it could help to encourage you to check its tax-efficiency ratio, which is the fund’s tax-adjusted return divided by its pretax return. This is the percentage of total return an investor actually keeps after taxes. The higher the tax-efficiency ratio, the more tax-efficient the fund has been. Tax-efficiency ratios for mutual funds are available on some financial web sites, such as Morningtar.com.
As you can likely tell by now, minimizing capital-gains taxes is not the easiest endeavor but hopefully some of the thoughts above can be of help.
Tuesday, March 22, 2011
How to Collect Social Security and Keep Working
When it comes to retirement, the average American age 65 and older generates nearly two-thirds of their total income from a combination of earned income and Social Security, with the rest coming from pensions and personal assets.
But despite the fact that millions are earning income and collecting at the same time, there's still plenty of confusion over how Uncle Sam goes about taxing and reducing Social Security benefits for workers. Consider, for instance, some of the reasons why it can be confusing:
First, if you retire before the normal retirement age and start collecting Social Security benefits early, your benefits are reduced not only for starting early, but also as your earnings rise. In fact, if you work and collect before the so-called full retirement age, you'll lose $1 of Social Security benefit for every $2 earned over $14,160 in 2011.
Second, in the year that you reach full retirement age, your benefits are reduced $1 for every $3 earned over $37,680 in 2011, or least that's the case until the month you reach full retirement age.
Finally, once you're at full retirement age, your benefits are not reduced, but as much as 85% of the benefits could be taxed if your income is above a certain amount.
According to the Social Security website, if you file a federal tax return as an individual and your combined income is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. And if your combined income is more than $34,000, up to 85% of your benefits may be taxable. If you file a joint return, and you and your spouse have a combined income that is between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. And if your combined income is more than $44,000, up to 85% of your benefits may be taxable. If you are married and file a separate tax return, you probably will pay taxes on your benefits.
Even though all this might be confusing, there are some ways to increase your after-tax income from all your sources of income — be it earned income, Social Security, dividends, interest income, capital gains, pension income and the like. What's more, there are some ways to think differently about the interaction between earned income and Social Security benefits.
Never a net negative to work and to collect
"I find there are a lot of myths and misconceptions out there about what it means to have earned income still in retirement, and what the tax implications are," said Terrence Rice, CPA. "And frankly, I've never seen a situation where there was actually a net loss for working. There are a lot of folks who have this idea of 'I can't work in retirement because it may make my taxes go up and I may have more of my Social Security taxed or I may have to impact IRAs or do something else, so maybe I won't work.'"
And so the first thing that you have to realize, according to Rice, is that you never get a net negative for working and collecting Social Security. "If you work and you bring additional earned income into the household, there is more money there," he said. "You don't get to keep all of it, Uncle Sam will take a piece, and you may impact a couple other parts of the retirement pie as well, but it's never a net negative."
"It always pays to work," said Rice. "People are under the impression that if they earn more than $14,160 a year that they're going to be penalized. Well, it's really important, when you get into your 60s, to understand what the earnings test really is."
For starters, if you're over full retirement age, there is no earnings test, Rice said. The earnings test comes into play only if you apply for Social Security before you turn full retirement age. And for those who have to deal with the earnings test, where for every two dollars you make over $14,160, one dollar of your Social Security will be withheld, it's important to understand what happens to that amount that's withheld, she said.
"Some people have heard that you get it back," she said. "You don't really get it back. You do, however, get a credit, and it's important to understand that credit for the actuarial reduction."
Rice used this example during the roundtable discussion: If you start Social Security at 62, she said, you'll get 75% of your primary insurance amount and get a 25% reduction. "So let's say you get a job and you receive one Social Security check and then you make enough after that to have all of your benefits withheld," she said. "What happens when you turn 66 is that your benefit will be recalculated, and it will be nearly the full $2,000, so you're getting that 25% actuarial reduction that they took away, you're getting that back, basically. So that's really important for people to understand — that if you apply early, if you end up having an opportunity to work, take that opportunity and work and not worry about the Social Security."
Never earn delayed credits
Rice said another point to consider when taking Social Security before full retirement age, or what is also called normal retirement age, is this: "The fact that you applied before full retirement age means that you can never earn delayed credits, so you will, at full retirement age, get your full benefit amount, but no delayed credits. So this is why it's really, really important for people to think hard about applying for Social Security before full retirement age, because it really limits your options."
For his part, Rice said you should think about paying taxes and reduced benefits this way:
"The taxation of Social Security essentially creates a rule," he said. "If your income is high enough, a portion of your Social Security benefits will be taxed, and in essence, the higher your income is, the greater the percentage is."
"So once we reach an initial threshold, which varies depending on whether you're single or married, you start increasing the taxation of your benefits 50 cents on the dollar. When we get to an upper threshold, we start increasing the taxation of our benefits at 85 cents on the dollar.
And what does that means in practice? "If we earn an extra thousand dollars and we're at the upper threshold, not only do we have another thousand dollars of income we have to report on, but now we have to take $850 of Social Security benefits, and put that on our tax return, and we're going to have to pay taxes on a portion of the Social Security benefits as well," said Rice.
At some point, "We're taxing 85% of the entire amount of Social Security benefits, which is the cap, and that's as high as we can go," Rice said. "And from that point forward, there's, in essence, no further impact for higher earnings on causing more of your Social Security benefits to be taxed."
And that, he said, is where some of the confusion exists about earning income and Social Security benefits. "The worst-case scenario is I'm paying taxes on the dollars I earn and I'm paying some taxes on the Social Security benefits that are now also being taxed because my income is higher," he said. "And for most folks at that level, your tax bracket is probably going to be 15% and maybe 25%, and so your worst-case scenario is still I'm going to pay 25% on my income, I'm going to pay another 25% on the Social Security benefits that I just phased in, which was only 85% of them, so I only pay a portion of that 25, and the net point that we get to is still nothing close to taking home less income than you would have had, had you not worked. It simply means you get a little bit of a higher tax burden for a chunk of income as you're causing some Social Security benefits to become taxed."
To be sure, you don't want to pay more than your fair share of taxes if you are working while collecting. So there are tactics to consider. For instance, you consider adjusting your IRA withdrawals. Or you might consider investing in municipal bonds, since the interest income from taxable bond could cause more of your Social Security benefits to be taxed than otherwise.
You shouldn't let the tax tail wag the earning income dog while collecting Social Security benefits. "We might do other things around the margins to help not make that tax situation impact it even further, but we're still at the point where a dollar you earn puts a bunch of money in your pocket that you didn't have before," said Rice. "Whether you end up paying tax rates of 15% or 20% or 25% or 30% or 35% or 40%, if we add everything in, and there's estate tax liability and all of it is coming on your income and 85% of your Social Security, you still never get close to the point of 'I just wish I hadn't earned the dollar.'"
But despite the fact that millions are earning income and collecting at the same time, there's still plenty of confusion over how Uncle Sam goes about taxing and reducing Social Security benefits for workers. Consider, for instance, some of the reasons why it can be confusing:
First, if you retire before the normal retirement age and start collecting Social Security benefits early, your benefits are reduced not only for starting early, but also as your earnings rise. In fact, if you work and collect before the so-called full retirement age, you'll lose $1 of Social Security benefit for every $2 earned over $14,160 in 2011.
Second, in the year that you reach full retirement age, your benefits are reduced $1 for every $3 earned over $37,680 in 2011, or least that's the case until the month you reach full retirement age.
Finally, once you're at full retirement age, your benefits are not reduced, but as much as 85% of the benefits could be taxed if your income is above a certain amount.
According to the Social Security website, if you file a federal tax return as an individual and your combined income is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. And if your combined income is more than $34,000, up to 85% of your benefits may be taxable. If you file a joint return, and you and your spouse have a combined income that is between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. And if your combined income is more than $44,000, up to 85% of your benefits may be taxable. If you are married and file a separate tax return, you probably will pay taxes on your benefits.
Even though all this might be confusing, there are some ways to increase your after-tax income from all your sources of income — be it earned income, Social Security, dividends, interest income, capital gains, pension income and the like. What's more, there are some ways to think differently about the interaction between earned income and Social Security benefits.
Never a net negative to work and to collect
"I find there are a lot of myths and misconceptions out there about what it means to have earned income still in retirement, and what the tax implications are," said Terrence Rice, CPA. "And frankly, I've never seen a situation where there was actually a net loss for working. There are a lot of folks who have this idea of 'I can't work in retirement because it may make my taxes go up and I may have more of my Social Security taxed or I may have to impact IRAs or do something else, so maybe I won't work.'"
And so the first thing that you have to realize, according to Rice, is that you never get a net negative for working and collecting Social Security. "If you work and you bring additional earned income into the household, there is more money there," he said. "You don't get to keep all of it, Uncle Sam will take a piece, and you may impact a couple other parts of the retirement pie as well, but it's never a net negative."
"It always pays to work," said Rice. "People are under the impression that if they earn more than $14,160 a year that they're going to be penalized. Well, it's really important, when you get into your 60s, to understand what the earnings test really is."
For starters, if you're over full retirement age, there is no earnings test, Rice said. The earnings test comes into play only if you apply for Social Security before you turn full retirement age. And for those who have to deal with the earnings test, where for every two dollars you make over $14,160, one dollar of your Social Security will be withheld, it's important to understand what happens to that amount that's withheld, she said.
"Some people have heard that you get it back," she said. "You don't really get it back. You do, however, get a credit, and it's important to understand that credit for the actuarial reduction."
Rice used this example during the roundtable discussion: If you start Social Security at 62, she said, you'll get 75% of your primary insurance amount and get a 25% reduction. "So let's say you get a job and you receive one Social Security check and then you make enough after that to have all of your benefits withheld," she said. "What happens when you turn 66 is that your benefit will be recalculated, and it will be nearly the full $2,000, so you're getting that 25% actuarial reduction that they took away, you're getting that back, basically. So that's really important for people to understand — that if you apply early, if you end up having an opportunity to work, take that opportunity and work and not worry about the Social Security."
Never earn delayed credits
Rice said another point to consider when taking Social Security before full retirement age, or what is also called normal retirement age, is this: "The fact that you applied before full retirement age means that you can never earn delayed credits, so you will, at full retirement age, get your full benefit amount, but no delayed credits. So this is why it's really, really important for people to think hard about applying for Social Security before full retirement age, because it really limits your options."
For his part, Rice said you should think about paying taxes and reduced benefits this way:
"The taxation of Social Security essentially creates a rule," he said. "If your income is high enough, a portion of your Social Security benefits will be taxed, and in essence, the higher your income is, the greater the percentage is."
"So once we reach an initial threshold, which varies depending on whether you're single or married, you start increasing the taxation of your benefits 50 cents on the dollar. When we get to an upper threshold, we start increasing the taxation of our benefits at 85 cents on the dollar.
And what does that means in practice? "If we earn an extra thousand dollars and we're at the upper threshold, not only do we have another thousand dollars of income we have to report on, but now we have to take $850 of Social Security benefits, and put that on our tax return, and we're going to have to pay taxes on a portion of the Social Security benefits as well," said Rice.
At some point, "We're taxing 85% of the entire amount of Social Security benefits, which is the cap, and that's as high as we can go," Rice said. "And from that point forward, there's, in essence, no further impact for higher earnings on causing more of your Social Security benefits to be taxed."
And that, he said, is where some of the confusion exists about earning income and Social Security benefits. "The worst-case scenario is I'm paying taxes on the dollars I earn and I'm paying some taxes on the Social Security benefits that are now also being taxed because my income is higher," he said. "And for most folks at that level, your tax bracket is probably going to be 15% and maybe 25%, and so your worst-case scenario is still I'm going to pay 25% on my income, I'm going to pay another 25% on the Social Security benefits that I just phased in, which was only 85% of them, so I only pay a portion of that 25, and the net point that we get to is still nothing close to taking home less income than you would have had, had you not worked. It simply means you get a little bit of a higher tax burden for a chunk of income as you're causing some Social Security benefits to become taxed."
To be sure, you don't want to pay more than your fair share of taxes if you are working while collecting. So there are tactics to consider. For instance, you consider adjusting your IRA withdrawals. Or you might consider investing in municipal bonds, since the interest income from taxable bond could cause more of your Social Security benefits to be taxed than otherwise.
You shouldn't let the tax tail wag the earning income dog while collecting Social Security benefits. "We might do other things around the margins to help not make that tax situation impact it even further, but we're still at the point where a dollar you earn puts a bunch of money in your pocket that you didn't have before," said Rice. "Whether you end up paying tax rates of 15% or 20% or 25% or 30% or 35% or 40%, if we add everything in, and there's estate tax liability and all of it is coming on your income and 85% of your Social Security, you still never get close to the point of 'I just wish I hadn't earned the dollar.'"
Friday, March 18, 2011
There is an App for Your Tax Refund
Okay smart phone users; they say that there is an App for almost everything. Whether that is true or not, who knows, but there is a brand new App from the IRS that can allow you to check on your tax refund status and obtain other useful information. The all new IRS2GO App is a free download that can be found by visiting your phone’s local App store or marketplace. All this comes from the IRS’s commitment to modernize and help taxpayers to become more engaged in up-to-date tax information. So what are the benefits of having this new App? Well, here are a few good reasons to perhaps try it out.
• Refund Status: Taxpayers can now check on their refund status using the new App with just a few simple pieces of information. For e-filers information could be available as early as 72 hours after the IRS acknowledges receiving your return. Paper filers will require some additional processing time, possibly three or four weeks. Overall it is a great added convenience that can assist you in knowing where your refund is.
• Tax Updates: The IRS2Go App allows users to enter their email address and automatically receive tax tips and updates on all the latest information that can help with the planning and preparing of taxes. Some of these topics might include information on free tax planning or help, tax credits, and even changes in the laws as they happen.
• Follow the IRS: Some may ask who would want to follow the IRS. But in reality there are many who rely on up to the minute information regarding the tax laws and changes. The new App allows you to sign up and follow the IRS on Twitter and YouTube, so you can stay in tune with all of these changes that take place.
Of course this is only the first release of this App and the IRS is hinting that more features are likely to come. But whether you are just looking for your refund information, or trying to keep up on changes in the tax laws. The IRS2GO App looks to be a useful tool in assisting many.
• Refund Status: Taxpayers can now check on their refund status using the new App with just a few simple pieces of information. For e-filers information could be available as early as 72 hours after the IRS acknowledges receiving your return. Paper filers will require some additional processing time, possibly three or four weeks. Overall it is a great added convenience that can assist you in knowing where your refund is.
• Tax Updates: The IRS2Go App allows users to enter their email address and automatically receive tax tips and updates on all the latest information that can help with the planning and preparing of taxes. Some of these topics might include information on free tax planning or help, tax credits, and even changes in the laws as they happen.
• Follow the IRS: Some may ask who would want to follow the IRS. But in reality there are many who rely on up to the minute information regarding the tax laws and changes. The new App allows you to sign up and follow the IRS on Twitter and YouTube, so you can stay in tune with all of these changes that take place.
Of course this is only the first release of this App and the IRS is hinting that more features are likely to come. But whether you are just looking for your refund information, or trying to keep up on changes in the tax laws. The IRS2GO App looks to be a useful tool in assisting many.
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