The Standard Deduction May Be Costing You – This technique could save you plenty
Many taxpayers default to the standard deduction when filing their tax return because of its simplicity. Unfortunately, this often creates a higher tax bill. Here is a tip to ensure it does not happen to you.
Only about a third of Americans file income tax returns using itemized deductions. Unfortunately many of those who don’t itemize are overpaying their taxes. Don’t wait until tax time to figure out if itemizing your deductions yields a lower tax bill. Start now to review your situation and plan for a reduction in your taxes by the end of the year.
The standard deduction for 2017 is $6,350 for individual taxpayers and $12,700 for married couples filing jointly. If you can identify deductions over these amounts, your taxable income will be lower. The first step in this process is to estimate your known itemized deductions. Start by breaking out your potential itemized deductions into these five piles.
Pile #1: State and local taxes. You may deduct state and local taxes on either property or sales, but not both. If you live in a place with high property taxes, or you’ve made big purchases during the year and paid a lot in sales tax, this could be a big source of itemized deductions.
Pile #2: Mortgage interest. You can deduct interest paid to secure a primary or secondary residence. Since interest payments are front-loaded onto the early years of a mortgage, this is a big deduction for new homeowners.
Pile #3: Charitable contributions. Contributions to qualified charities can be used as itemized deductions. This includes cash donations, non-cash donations, and even mileage on behalf of qualified charities.
Pile #4: Medical expenses. Medical expenses greater than 10 percent of your adjusted gross income can be deducted from an itemized tax return.
Pile #5: Miscellaneous itemized deductions. With miscellaneous itemized deductions, you can generally deduct the total that exceeds 2 percent of your adjusted gross income. There are many potential deductions, such as:
- Job-related clothing and equipment
- Unreimbursed job expenses
- Job-hunting expenses
- Tax preparation fees
- Casualty and theft losses
Total up your potential deductions, remembering to only count the deductions for miscellaneous and medical expenses that exceed the adjusted gross income thresholds.
Ideas if you are close
If you are close to your standard deduction threshold, here are some ideas to push you over the line.
Donate stock. If you donate cash to a favorite charity, consider donating profitable stock held more than one year. Not only will the donation be an itemized deduction based on the current value of the stock, the long-term gain will not be taxable.
Make two years of giving in one year. Since you can claim donations when paid, consider prepaying next year’s donation in the current year. This effectively doubles your donations for one year, allowing for a higher itemized deduction total.
Pay taxes prior to year-end. The same technique can be used with property taxes and other tax payments. Make next year’s payments in December of the prior year. This will effectively put two years of taxes into one filing year. While you may not be able to itemize deductions every year using this technique, it can yield a lower tax bill this year.
Defer income. A good option for small businesses is to delay the receipt of income, which lowers the threshold for claiming medical expenses and miscellaneous deductions.
On occasion, shifting deductions may result in using itemized deductions in one year and the standard deduction in the next. However if you plan well, you’ll have a lower total tax burden over the course of both years. Please feel free to ask for help if you wish to review your situation.
Avoid a Debt Settlement Tax Surprise
Reaching a settlement on your debt comes with important tax consequences.
The number of Americans struggling with high debt is increasing, according to the U.S. Federal Reserve. U.S. household debt reached a new record this spring, the central bank said, with the average indebted household owing more than $16,000 on their credit cards.
Seeking debt forgiveness from lenders is one option to try to deal with the burden of high debt. But there is an important tax consequence:
Any amount of cancelled debt is generally taxed as ordinary income.
This can come as a big surprise at tax time, when the relief of having settled a large debt is replaced by the anxiety of owing the IRS money.
Common debt forgiveness surprises
Common examples of when debt forgiveness can create a tax liability include:
- home foreclosures
- car repossessions
- credit card companies forgiving interest owed
- lenders agreeing to reduce or forgive credit card, medical or student loan debt
- lenders decide they can’t collect a debt, or give up trying
Will Payoulater hadn’t been making payments on a $40,000 car loan and woke up one morning to find his driveway empty. The bank had repossessed the car and cancelled the remaining $35,000 balance on his loan. However, due to depreciation and wear-and-tear, the car’s market value was only $20,000 when it was repossessed. Not only is Will down one car, he’ll also have to pay taxes on the $15,000 difference as cancelled debt income.
As you can see in this example, even the calculation of how much debt-forgiveness tax you owe can get complicated. What is the true market value of the car? Was the correct condition of the auto applied to the value? Getting some help from a tax professional can ensure you won’t be overtaxed.
There are several situations where debt forgiveness is not taxable, including when:
- it happens as part of Chapter 11 bankruptcy
- the debtor is insolvent (i.e. total debt exceeds the value of assets)
- student debt is forgiven as part of an agreement to work certain government and education jobs
If anyone you know is considering a debt settlement or has gone through one, please have them get in touch to work out the potential tax consequences
Avoid the 10% Early Withdrawal Penalty – What every Traditional IRA owner should know
While it is not a good idea to tap retirement accounts prior to retirement age, sometimes it cannot be avoided. What can often be avoided, however, is the punitive 10% penalty for early fund distributions. Outlined here are exceptions to the 10% penalty rule for Traditional IRAs.
It is one thing to be taxed on retirement contributions and their related earnings when you withdraw funds from your Traditional IRA, it is quite another when you pay the tax PLUS a 10% penalty for early withdrawal. Need funds prior to retirement and want to avoid the early withdrawal penalty? There are cases when this can be done:
- Medical insurance premiums if unemployed. If you receive federal or state unemployment for 12 or more consecutive weeks, you may pay for medical insurance premiums from your Traditional IRA without paying the 10% early withdrawal penalty. The premiums may cover yourself, your spouse, and your dependents’ medical insurance premium.
- Qualified higher education expenses. You may pay for tuition, books, fees, supplies, and equipment at a qualified post-secondary institution for yourself, your spouse, your child or grandchild from your Traditional IRA without paying the 10% penalty.
- Medical expenses. If you need to withdraw from your IRA to fund medical expenses in excess of 10% of your adjusted gross income you may do so penalty-free.
- First-time home buyer. IRA distributions of up to $10,000 to help pay for the qualified acquisition costs of a first-time home avoid the early withdrawal penalty too. This is a lifetime limit per individual. A first-time homebuyer is defined by the IRS as not having an ownership interest in a principal residence for two years prior to your new home acquisition date. To qualify the home can be for you, your spouse, your child, your grandchild, your parent or even other ancestors.
- Conversions of Traditional IRAs to Roth IRAs. Want to convert your Traditional IRA into a Roth IRA to avoid paying taxes on future account earnings? No problem, this too is considered a qualified event to avoid the 10% penalty.
- You’re the beneficiary. If you are the beneficiary of someone else’s IRA and they die, there is usually an opportunity to withdraw funds without the penalty. Plenty of caution is required in this case, because if treated incorrectly the penalty might apply.
- Qualified reservist. If you were called to active duty after 9/11/2001 for more than 179 days, amounts withdrawn from your IRA during your active duty can also avoid the 10% penalty.
- Annuity distributions. There is also a way to avoid the 10% early withdrawal penalty if the distributions “are part of a series of substantially equal payments over your life expectancy.” This option is complicated and must use an IRS-approved distribution method to qualify.
Some Final Thoughts
- Remember, the above ideas help you avoid an early withdrawal penalty for funds taken out of your Traditional IRA prior to reaching the age of 59 ½. After this age, there is no early-withdrawal penalty. The penalty is also waived if you become permanently or totally disabled or use the funds to pay an IRS tax levy.
- While the above events allow you to avoid the 10% early withdrawal penalty you will still need to pay the income tax due on the withdrawn funds.
- While generally the same, the 10% early withdrawal penalty rules are slightly different for defined contribution plans like 401(k)s and other types of IRAs.
- Before taking any action, call to have your situation reviewed. It is almost always better to keep funding your Traditional IRA until you retire.
Understanding Tax Terms: Basis – Covering the bases on basis
This commonly used tax term is anything but common to most of us. Knowing the basics of basis can serve to lower your tax obligation when you sell property.
Basis is a common IRS term, but probably does not enter into your everyday conversation. This IRS term is important because it impacts the taxes you pay when you sell, exchange or give away property.
What basis is
The IRS describes basis as:
The amount of your capital investment in a property for tax purposes. Use your basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property.
In plain language, basis is the cost of your property as defined by the tax code.
There are a few different types of basis that apply to different situations, including “cost basis,” “adjusted basis,” and “basis other than cost.”
Types of basis
Cost basis. Your basis usually starts with what the item cost. Cost basis also includes sales tax paid, freight, installation, testing, legal fees and other fees to purchase the property. If you acquire a business you must often allocate the purchase price to each of the assets to establish their basis.
Tip: Retain records of any major transaction. Ensure the documentation includes all allowable costs that could be applied to your basis. This will help reduce taxes when you sell or dispose of the property.
Adjusted basis. When you sell, exchange or dispose of property you may have to adjust its basis to account for changes to the property since you acquired it. This is known as its adjusted basis. A common example of adjusted basis is when you add the costs of capital improvements to property that have a useful life for more than one year.
Adjusted basis can decrease the value of property as well. This is the case when property is affected by things such as casualty or theft losses, depreciation and other deductions.
Home tax tip: Adjusted basis applies to many home improvements. These could include a full roof replacement, adding a room to your home, or even special assessments for local improvements. Create a folder and retain all documentation that could add to your home’s basis. It may lower your capital gain when you sell your home.
Basis other than cost. What is the basis when you inherit property, receive property for services or receive property as a gift? In most cases, the basis is the fair market value of the item. This is the price a willing buyer would pay for the item and a willing seller would be willing to receive for that item. But there are also special basis rules for:
- Inherited property
- Like-kind exchange of property
- Involuntary conversions
- Property transferred to a spouse
Should any of these situations apply to you, please ask for a review of your circumstances, as establishing basis can become fairly complex.
Private Agencies Now Collecting for IRS – Your scam alert should be on high
The IRS recently announced its outside collection agencies are now actively collecting past due tax bills. This will impact all of us. Here is what you need to know
In a recent announcement, the IRS notified all taxpayers that outside collection of past-due tax bills is now beginning in mid-April 2017. This is a direct result of Congressional action in late 2015 requiring the IRS to turn over to outside companies billions in uncollected taxes it is no longer pursuing. This will impact all of us. Here is what you need to know.
Turn up your scam alert. Rest assured the tax-related identity theft epidemic is going to hit a new high as scam artists now will try to impersonate collection agencies. Never pay a collection agency directly for any tax owed. If you do not think you owe money to the IRS, ask for help.
Only four agencies have been authorized. Only four collection agencies have been authorized to collect unpaid taxes for the IRS. They are:
- ConServe, of Fairport, New York
- Pioneer, of Horseheads, New York
- Performant, of Pleasanton, California
- CBE Group, of Cedar Falls, Iowa
You will receive written notice…twice. Before an outside agency calls you, the IRS will send two written notices to you and your representative about the transfer of the bill to an outside collection agency. Without these notices, you must assume any contact with a collection agency saying they represent the IRS is a scam.
No payment to the agency. These collection agencies may not receive direct payment. You will be asked to use the IRS online payment system or to send your payment into the IRS. Payment is to be made to the U.S. Treasury and not to the collection agency.
The IRS has announced collection activity will now be starting, so be prepared and ask for help if you are impacted by this change within the IRS.
If you recently got married, plan to get married, or know someone taking the matrimonial plunge, here are some important tax tips every new bride and groom should know.
Notify Social Security. Notify the Social Security Administration (SSA) of any name changes by filling out Form SS-5. The IRS matches names with the SSA and may reject your joint tax return if the names don’t match what the SSA has on file.
Address change notification. If either of you are moving, update your address with your employer as well as the Postal Service. This will ensure your W-2s are correctly stated and delivered to you at the end of the year. You will also need to update the IRS with your new address using Form 8822.
Review your benefits. Getting married allows you to make mid-year changes to employer benefit plans. Take the time to review health, dental, auto, and home insurance plans and update your coverage. If both of you have employer health plans, you need to decide whether it makes sense for each of you to keep your plans or whether it’s better for one to join the other’s plan as a spouse. Pay special attention to the tax implication of changes in health savings accounts, dependent childcare benefits and other employer pre-tax benefits.
Update your withholdings. You will need to recalculate your payroll withholdings and file new W-4s reflecting your new status. If both of you work, your combined income could put you in a higher tax bracket. This can result in reduced and phased-out benefits. This phenomenon is known as the “marriage penalty.”
Update beneficiaries and other legal documents. Review your legal documents to make sure the names and addresses reflect your new marital status. This includes bank accounts, credit cards, property titles, insurance policies and living wills. Even more importantly, review and update beneficiaries on each of your retirement savings accounts and pensions.
Understand the tax impact of your residence. If you are selling one or two residences, review how capital gains tax laws apply to your situation. This is especially important if one of you has been in your home for only a short time or if either home has appreciated in value. This should be done as soon as possible prior to getting married to maximize your tax benefits.
Sit down with an expert. It is natural for newlyweds to focus their attention on the big day. There are so many decisions to be made from selecting a venue to planning the honeymoon. Because of this, reviewing your tax situation often is an afterthought. Do not make this mistake. A simple tax and financial planning session prior to the big day can save on future headaches and avoid potentially expensive tax mistakes.
If you’d like a review of how marriage will affect your tax and financial situation, call at your earliest opportunity.
Five Steps to Take if You’re Audited
Getting audited is no one’s idea of a good time, yet you can get through it if you take the right approach.
Getting audited is no one’s idea of a good time, yet you can minimize the stress if you take the right approach.
Step 1: Understand why and when. While it’s possible you were selected randomly, it’s more likely you were selected for a specific reason. One example might be if your deductions for charitable donations or business expenses were greater than is typical for your income or profession. Before proceeding, make sure you understand what is being challenged and when you must reply.
Comment: Your chance of being audited “randomly” rises along with the size of your income. With $200,000 a year in income your chance of being audited nearly doubles (1.01% in FY2016) compared with a person who has half of that income. People with more than $10 million in income have a nearly 1-in-5 chance of an audit every year.
Step 2: Consider the kind of audit. There are three types of audits, in increasing levels of seriousness: a correspondence audit, (conducted through the mail); an office audit (a visit to nearest IRS office); and a field audit (an IRS agent comes to visit you). How and what you prepare will vary depending on the type of audit.
Comment: About 70 percent of audits are conducted through mail correspondence and they typically involve routine issues like providing information about deductions. With proper documentation and prompt attention, they can be relatively painless to resolve. Office and field audits can be trickier and will involve more work and preparation.
Step 3: Gather documents. Once you’ve understood the reason and the type of audit, gather and organize as much of your relevant records as possible to prepare your response. For example, if the audit is specifically about deducting vehicle costs for business use, gather your mileage logbook, receipts and any other supporting documentation. This will help prove your case and let the IRS know you are a responsible taxpayer.
Comment: If you do not have adequate documentation, you can try to get third-party corroboration. For example, if you took charitable deductions but lost the receipts, you could try reaching out to the charity for their records. While the charity cannot create “new” receipts, they may have copies of confirmations sent out to you at the time of your donation.
Step 4: Know your rights. You have rights to ensure you get a fair chance to state your position. Specifically, you have the right to clear explanations about what the IRS wants and their decision regarding your case. You have the right to appeal the IRS’s decision. You also have the right to have your accountant or lawyer represent you during the audit. In addition, there is a special Taxpayer Advocate Service that is available to help you navigate through problems with your case.
Comment: While you should stand up for your rights, always be polite with the IRS agent assigned to your case. They are just doing their job and you aren’t doing yourself any favors if you show hostility during your audit.
Step 5: Get help. No matter what, reach out immediately if you get a letter from the IRS. It pays to have the right help, because an experienced professional can guide you away from costly mistakes. Too many taxpayers have corresponded with the IRS without this help and have paid the price. Try as you might, you probably do not know the tax law as well as the IRS.
Audits happen. How you handle them can make all the difference. Please call if you need help.
Your next audit may be an “audit lite” – The IRS is handling more reviews with form letters
In-person audits with an IRS agent are becoming more uncommon. The IRS is instead handling their reviews through form letters called correspondence audits. Here is what you need to know.
In-person audits with an IRS agent are becoming more uncommon. The IRS is instead handling many routine reviews through form letters called correspondence audits.
These IRS letters are a kind of “audit lite” the agency uses to ask for clarification and justification of specific deductions on your tax return. Common issues that trigger a correspondence audit are large charitable deductions, withdrawals from retirement accounts and education savings plans, excess miscellaneous deductions, and small business expenses.
Don’t panic if you get one of these “audit lite” form letters. The IRS often uses computer programs to compare individual return deductions with the averages for a person’s income level or profession. If you’ve received a letter, you may have simply fallen outside the averages. As long as you respond promptly, thoroughly and with good documentation, it won’t necessarily become a contentious issue.
The key is to keep proper, well-organized documentation under the assumption you may need it to support your deductions. If you do this right, the correspondence audit will end with a “no change” letter from the IRS, acknowledging you’ve addressed their concerns.
While correspondent audits usually target only a few areas on your tax return, there may be additional complications with this kind of audit. Here are some things to consider:
- It is an audit. Many taxpayers do not realize that this mail correspondence is an audit. When you get the “audit lite” letter, it’s important to ask for help. You need to address the audit promptly, but also professionally and accurately. How you respond is just as important as responding on time.
- No personal touch. Unlike an in-person audit, you won’t have someone there who personally understands your situation. This can be frustrating if you’re told you’re not providing enough information, you’re missing the correct information, or if you disagree with the agency’s findings.
- Back-and-forth hassle. If you want to challenge the IRS’s findings, it often takes multiple back-and-forth letters. Try to be patient. As long as you can defend your position with the correct information, you have a good chance of coming out on top.
Remember to ask for help if you receive one of these letters from the IRS.
Taxpayers to forfeit more than $1 billion in refunds – Are you one of them?
The IRS disclosed there will be more than $1 billion in federal tax refunds forfeited this year if taxpayers don’t claim them by April 18.
The IRS disclosed there will be more than $1 billion in federal tax refunds forfeited this year if taxpayers don’t claim them by April 18.
Refunds have to be claimed within three years or they are forfeited to the government. The unclaimed $1 billion comes from about 1 million taxpayers who still haven’t filed returns for the 2013 tax year. Often the people who leave these refunds behind are young adults, college students, senior citizens and low-income taxpayers.
Why refunds go unclaimed
Forgetting withholdings. Even if you have very little income, your employer may have taken some money from your paycheck for federal tax withholdings. The only way to get it back is to file a tax return.
Not claiming refundable credits. Many tax credits are “refundable credits.” This means you can receive a refund even if you owe no income tax. Common examples available to students and parents are the earned income tax credit and the premium tax credit.
Missing information. Some people don’t file because they’ve lost the information they need. If the reason you can’t file is because you lost your data, you can request an online transcript from the IRS that will give you your wage, income and other tax information. You can also mail the IRS a Form 4506-T to get paper copies mailed to you. However, this will take between five and 10 business days, so don’t delay.
Fear of penalties. Sometimes taxpayers fail to file old returns because they think the IRS may penalize them. There is no penalty for filing a late return if you are owed a refund.
Get your money
The IRS is great at tracking down people who owe them money, but not so great at reaching out to people they owe. This irony should motivate you to get your money back. To be safe, send your 2013 return by certified mail early enough so that the IRS receives it by April 18. Any refunds that aren’t claimed within the three-year due date will be gone forever, swallowed up by the U.S. Treasury Department.
Remember, just because you are not required to file a tax return doesn’t mean you shouldn’t. There are more than a billion dollars in unclaimed refunds – make sure you get yours.
Tax Credits versus Tax Deductions – Which is worth more to you?
Deduct this or take a Tax credits? Which is worth more to you? Often the answer is not as simple as you think.
Every industry and profession has common terms that are used so often those of us in the business often forget that most people do not have the depth of understanding that a person working within the tax code might have. One of these areas is understanding the differences between the tax terms “deductions” and “credits”. Is one better than the other?
If it were simple
Dollar for dollar, a credit is worth more to you than a deduction. Why? A credit is a direct reduction in tax, while a deduction reduces the amount of income that gets taxed. Here is a simple chart showing the difference.
Assuming you have a $2,000 tax credit, how large a deduction would you need to be indifferent?
|Your marginal tax rate||Deduction required to equal $2,000 tax credit|
Note: This example does not account for the possibility that the deduction could move you into a lower tax rate nor does it consider other tax factors, including phaseouts.
So on the surface it appears that a credit is worth more than a deduction to you. But the real answer is….it all depends. Here are some things to consider:
How much is it? A large deduction could be worth more to you than a small credit. In combination with your marginal tax rate, you can calculate the equivalent credit that equals your deduction.
Your marginal tax rate. Remember, a similar deduction is worth more to someone in the 35% income tax range than it is to someone being taxed at 10%.
Are there phase-outs? Most credits and deductions phase out when your income is over certain amounts. Consider this when determining the true tax benefit. When a deduction reduces your income it could make other credits and deductions that were previously phased out now available to you.
Is the credit refundable? Some credits get a “bonus”. While you cannot deduct your income below zero, you can sometimes receive credits that create a refund even if you owe no tax. Credits that have this “bonus” feature are called “refundable” credits.
When it matters
Educational Expenses. If you pay tax-deductible tuition for undergraduate studies you must decide what tax alternative is best for you. Among the many alternatives that need to be evaluated are the American Opportunity Credit, the Lifetime Learning Credit, and the Tuition Deduction.
Understanding the Cost. Remember the value of a deduction to you needs to be filtered with your marginal tax rate to see the true tax benefit. Here is a simple formula.
|Deduction Amount||x||Your Tax Rate||=||Your Tax Benefit|
Thankfully, professional tax software allows for quick analysis of the choices. Please call if you have questions.