Looking Ahead to 2011
By Jim | September 1, 2010
Way back in 2001, and again in 2003, many tax cuts were put into place to help stimulate the US economy. Most of those tax cuts were set to expire in 2011 and for those of you who haven’t noticed 2011 is only about 4 months away.
While the current administration is proposing that many of the 2001 and 2003 tax cuts become permanent, there will nevertheless be certain cuts that expire. From what I have heard and read so far the taxpayers in the top two tax brackets will feel the brunt of the fallout from the tax cuts that may be allowed to lapse.
The senate finance committee recently took up the topic of these expiring tax cuts for discussion and began to weigh the outcome of letting the credits expire, extending all of the credits or picking and choosing which credits to extend. You can read more on the senate finance committee deliberations here. It seems to me that with a deficit that continues to grow and is already at an unprecedented level, it will be hard for all of these tax credits to continue.
From what has come out of Washington the past few months I would think that items such as the Child Tax Credit being increased to $1,000 (from it’s pre-2001 cut amount of $500) and the Qualified Dividends tax rate of 15% for anyone above the 15% tax bracket are a couple of the items that will most likely be extended.
On the other hand the top two tax brackets of 35% and 33% have a decent chance of returning to their pre-tax cut levels of 39.6% and 36% respectively. This is why I mentioned earlier that higher income tax payers may feel most of the effects of any tax cuts that are not extended.
However it isn’t all bad news for some higher income earning tax payers. The current administration has also proposed increasing the threshold amount for the 36% tax bracket (which under current law is 33%). Currently a married couple filing jointly in 2011 would trigger the 36% tax bracket with income of $210,400, but under one proposal this threshold would increase to $232,950. To put this in perspective this means that a couple filing jointly with taxable income of $230,000 in 2010 would be in the 33% tax bracket, while under this proposal would actually end up in a lower tax bracket of 28% in 2011. For taxpayers around that income level that 5% decrease in their tax rate amounts to a significant savings.
No matter what the final decision ends up being my hope is for it to be a permanent one. A temporary extension of these tax cuts, whether it be all of them or only certain ones, would make tax planning for many individuals much more difficult. My wife and I have actually already made the decision to put a rental property of ours on the market now rather than a year or two down the road partially due to the possibility of the long-term capital gains rate increasing from the current tax cut rate of 15% back to it’s pre-tax cut rate of 20%. Issues like the long-term capital gains rate and the estate tax, which via the 2001 tax cuts was phased-out over the course of nine years and completely repealed in 2010, but is set to be reinstated to it’s pre-2001 level if the tax cut is not extended, has made tax planning a sometimes near impossible task in certain situations.
Unfortunately the temporary extension of tax law is actually a common practice. For example the Research & Development tax credit has been renewed on an annual basis for a few years now. For many businesses this means not knowing if what can amount to a rather significant tax credit will be available to them or not in a timely manner, making it increasing difficult to analyze the potential costs of new projects. Hopefully we will not run into the similar issues for individuals by the 2001 and 2003 tax cuts also having to be periodically extended and only on a temporary basis.
After all is said and done, all we can do is sit and wait to see what the final outcome is. It would be nice if these cuts could all be extended, but the reality of the situation is that it will most likely be a pick and choose scenario of which cuts get extended and which cuts are let expire.
No matter what the next four months (and possibly more) will be very interesting to monitor and see which cuts will ultimately be…well….cut.
Topics: Individual Tax, Small Business, Tax Credits, Tax Planning | No Comments »
Possible New 1099 Rules From a Small Business Point of View
By Jim | July 30, 2010
As some of you may have heard the health care reform bill passed a few months back included some changes to the 1099 reporting laws. These changes were put in place for two reasons; (1) Broadening the requirement for when a Form 1099 needs to be filed has been on the IRS wish list for a while, and (2) These new rules will help collect additional revenue that will assist in offsetting the cost of health care reform.
While the bill as a whole can be debated for days on end, my focus here is going to be how these new 1099 rules would affect a small business. There are a large number of small businesses out there who do not file 1099s correctly or at all as it stands right now, so these changes will most likely just add to the confusion.
First off, I would like to point out that these changes are not set to take effect until the beginning of 2012. It is very possible that between now and then these rules are changed or even repealed. On the other hand the IRS has been interested in expanding the 1099 reporting requirement in this manner for some time and therefore may put up a hard fight if some politicians make a big push to curb the changes altogether.
Currently any business that makes payments to or purchases from an individual or a partnership totaling more than $600 needs to report the total amount paid on form 1099-MISC. A separate 1099-MISC is filed for each individual or partnership that payments in excess of the $600 threshold were made to.
If and when these new changes take effect the 1099 reporting requirement will be opened up to corporations as well as individuals and partnerships. The $600 threshold will remain the same.
So what does this mean to the average small business? In short these new requirements will either (a) take up more of your time, (b) cost you more in accounting fees, or (c) all of the above. You will be spending more time asking each and every vendor you deal with for all of the information you need in order to file a 1099 for them if you exceed the $600 threshold during the year (mainly their Employer Identification Number), whereas before you were only concerned with any individuals or partnerships you were dealing with. If you use a payroll service or and accountant to file your 1099s for you after year-end you will most likely see an increase in that cost since more forms will need to be filed.
To put this in perspective, I like many other small business owners, do a fair amount of business each year at Staples. While in the past I would never have issued a 1099 to Staples for all of my purchases at their stores and website, these new reporting rules would make it a requirement. The same goes for my cell phone company, land line phone company, internet service provider, and every other large corporation I deal with on a regular basis. Actually I never have very many 1099s to file each year, but these new rules will change that, by more than doubling the amount I am currently filing each year.
This is not too big of a hassle for me as I am in the business of completing and filing these forms for others, so it is not much of a resource drain. Other business owners may not feel the same however. Between spending more time collecting tax identification numbers and spending more money to have 1099s prepared these new changes add up to be more of a hassle to small business owners than anything else.
It should also be noted that a portion of these expanding 1099 reporting requirements also affect businesses that accept credit and debit cards as a form of payment. Also beginning in 2012 payment processors will be required to send file a 1099-K which will report the amount credit/debit card sales they processed for businesses that exceed a certain number of transactions or a threshold amount. To read more about this specific rule change, please see this article from CNNMoney.com.
One thing is for sure, a small business owner has no shortage on the amount of paperwork they are responsible for and these new requirements will only add to the pile.
Topics: Business Tax, Record Keeping, Small Business | No Comments »
IRA Conversions – Tax Rates are a Determining Factor
By Jim | June 16, 2010
Prior to 2010 only taxpayers who had an Adjusted Gross Income (AGI) of less than $100,000 were allowed to convert a Traditional IRA to a Roth IRA. Thanks to the Tax Increase and Prevention Act of 2005 those high income taxpayers who were previously not allowed to convert are now permitted to do so in 2010. Because of this change many taxpayers have been rushing to convert their Traditional IRAs to Roth IRAs.
So why the big rush to switch from a Traditional to a Roth IRA? The biggest factor is the difference in how contributions to and withdrawals from each type of IRA are taxed.
With the Traditional IRA your contributions each year are tax deductible (up to a certain limit). However, when you take withdrawals from a traditional IRA, they are then subject to income tax.
With a Roth IRA contributions are made with “after tax” dollars, meaning you do not get a deduction for contributions as you would with a Traditional IRA. However, since you are making contributions with money that has already been taxed, you do not pay tax on the withdrawal of these contributions down the road when you reach retirement age.
There are other advantages of having a Roth rather than a Traditional IRA, such as taxpayers being allowed to contribute to Roth IRAs beyond the age of 70 ½ unlike Traditional IRAs which do not allow for contributions past that age, but the ability to have tax free growth is the biggest factor for most taxpayers.
So as I mentioned before the new tax rules that allow higher income taxpayers to convert Traditional IRAs to Roth IRAs have created a surge of conversions. However is this always the best choice? What about the taxpayers earning less than $100,000 that may not have known this was an option, should they look into converting their IRAs as well? The answers to these questions involve many different factors, but no factor weighs bigger on this issue than tax rates. After all, paying less tax on your retirement savings means more savings available for your retirement, and if having more savings available at retirement isn’t everyone’s’ main goal than I don’t know what is.
In 2010 when a Traditional IRA is converted to a Roth IRA the contributions you have made to the Traditional IRA, and have been received a deduction for, are taken into taxable income. You have the opportunity of paying the entire tax on that amount in 2010, or spreading it evenly over 2011 and 2012. Many taxpayers may not like the idea of writing such a large check out to Uncle Sam in 2010 and opt for spreading the tax out over the next couple of years, but that is one of the areas that tax rates come into play.
If you are in one of the two highest income brackets of 33% or 35%, you should be aware that those tax rates were put into effect as a result of the Economic Growth and Tax Relief Reconciliation Act back in 2001 and that they may revert to their previous rates of 36% and 39.6% in 2011 and 2010. Unfortunately there is no way to tell at this time whether the tax rates will revert to their higher percentages or if the government will vote to extend the current, lower tax rates. However the current administration has discussed only letting the top two brackets revert to their higher rates, which is why I have focused on the those rates in this article. Therefore by spreading out the tax on your conversion over 2011 and 2012, you may risk paying more in taxes than if you had paid the entire amount in 2010. That is a circumstance that those higher income taxpayers considering going through with a conversion must take into consideration during their decision process.
How about those taxpayers not in the top two tax brackets? What should they consider in regards to tax rates when they are looking into converting a Traditional IRA to a Roth IRA?
One simple consideration is that the taxable income the conversion creates may push you into a higher tax bracket. Let’s say you are a married taxpayer filing jointly with your spouse and that your combined taxable income is $110,000 in 2010 and that you decide to convert your Traditional IRA to a Roth IRA which results in additional taxable income of $30,000. You will now be paying an additional 3% on all of your taxable income as a result of this conversion. At $110,000 you and your spouse would have been in the 25% tax bracket, but once you converted your IRA the additional $30,000, for a total of $140,000, pushed you into the 28% tax bracket. This is a rather simplistic example, but it is only meant as an illustration to get the point across that a conversion may actually subject your regular earnings to additional tax in certain situations.
It should also be noted that the general idea that a Roth IRA is superior because of the tax free growth is not always applicable to every taxpayer. Many taxpayers earn more today than they will after their retirement which means that they are in a higher tax bracket today than they will be during retirement. In these instances it may be better to have a Traditional IRA now and take a deduction against your current, higher income. This would mean that when you take distributions from your Traditional IRA in retirement, you will be paying tax on your withdrawals at your lower, retirement income tax rate. With a Roth IRA in this scenario you are paying taxes on your contributions at your current, higher tax rate.
The concept on income being lower at retirement is not a simple one to know for sure since there are so many variables that enter into the picture. Add to that the fact that the further you are away from retirement age the harder this scenario becomes to predict and that future income tax rates are impossible to predict, it becomes an even tough decision as to whether or not to convert a Traditional IRA to a Roth IRA.
IRA conversions are a complicated subject. My discussion here is merely focusing on one or two factors that should be considered when determining if converting a Traditional IRA to a Roth IRA is right for you. This is definitely one of those subjects that you will want to speak to a CPA or a retirement specialist about.
Topics: Individual Tax, Retirement Plans, Tax Planning | 2 Comments »
Window Closing on Potential “LLC Tax” Refund for NH Taxpayers
By Jim | May 14, 2010
For those who either are a member of an LLC in NH or deal with NH taxes, the new “LLC Tax” is still a hot button issue. From the manner in which the tax was slipped into a budget bill under everyone’s radar, to the questions about what the state will use as criteria to determine reasonable compensation, this new tax law change has ruffled a few feathers to say the least.
For those who are less familiar with the subject here is a quick (make that a crash-course) summary:
In June of 2009, NH changed the definition of what is considered a dividend for LLC taxation purposes. With this change in the tax law, all LLC distributions deemed to be paid out of current year or accumulated earnings would now be deemed dividends and therefore be subject to the NH Interest and Dividends Tax (NH I&D). To make matters worse for business owners and tax preparers, the change was made retroactive to the beginning of 2009.
This change also brings the concept of “reasonable compensation”, something that was already a source of debate and NH Department of Revenue Administration Audits, into the spotlight once again. NH allows LLC owners to reduce their profits by what is called a personal compensation deduction. This compensation deduction in theory represents an amount of reasonable compensation that an LLC member or members would have taken as wages, but were not able to since tax law precludes LLC members from taking wages in the same manner that owner/shareholders of corporations would. In affect this deduction allows LLCs a wage deduction to reduce the amount of profit that would be subject to NH Business Profits Tax (NH BPT) in order to make their taxation fall in line with the manner in which NH corporations are taxed.
The problem with reasonable compensation, is that the process of how to determine what amount of compensation for a member is reasonable has never been clearly defined. If NH decides to create more standardized amounts for what can be deemed reasonable for compensation deduction purposes, it could lead to NH LLCs having increased amounts of profit subject to the 8.5% NH BPT. In addition to the NH BPT that would be paid on profits, any amount taken by members of an LLC beyond the compensation deduction amount that came from current or prior year accumulated earnings would be subject to the 5% NH I&D tax.
To put things in perspective: amounts taken as a compensation deduction in NH were previously only subject to the NH Business Enterprise Tax (NH BET), at a rate of only .75%. With that fact in hand it is not hard to see why LLC owners are up in arms about the implications of this new tax law. After all, there is a big difference between paying a tax of .75% and paying a tax of 13.5% on the money being taken out of an LLC by an owner.
So now that you have had a quick look into what the new LLC tax is all about and how it affects NH LLCs, I can get to the real subject of this post. As discussed in this e-newsletter from the NH law firm Devine Millimet, a lawsuit has been brought against the NH Department of Revenue claiming that this new tax change is unconstitutional. Please follow the link to the newsletter I provided above if you are interested in reading about some of the details of the lawsuit.
The most important thing at the moment that LLC owners who paid NH I&D tax because of the tax change for the 2009 tax year should be aware of, is that if this lawsuit is successful and the LLC tax is deemed unconstitutional, they must have already filed a claim for a refund within 120 days of the due date of their return in order to receive a refund. Whereas normally a taxpayer has at least three years from the due date of a return to file for a refund, NH places a separate time limitation of 120 days from the due date of a return for refund claims filed upon the basis that a tax is unconstitutional. Again, please see the newsletter linked above for more information regarding NH statute of limitations for refunds.
Taking this 120 day limitation into account, any taxpayer hoping to ever get a refund for the NH I&D tax they paid in 2009 that was a direct effect of the recent tax law change should file a refund claim now. As of the time I am writing this entry, we are already down to almost 90 days from the due date of a return for a filer who had an April 15 deadline, so the window of opportunity is closing.
Regardless of how likely or unlikely it is that the new LLC tax is deemed unconstitutional, filing for a refund is something that does not take a lot of time or effort, so don’t wait until it is too late.
Topics: Business Tax, Individual Tax, Small Business, State Taxes | 2 Comments »
It is Now “The Last Minute”: Time to Think About Extending
By Jim | April 12, 2010
It’s the week of April 15th and with only a day or two until the personal income tax filing deadline, it is time to think about extending your return if you haven’t filed yet. Maybe you are waiting for a K-1 from a partnership that hasn’t filed yet or maybe you are just a procrastinator, but whatever the case now is the time to work on estimating what your tax may be and file that extension.
Believe it or not it is still a very common misconception that an extension gives you more time to file your return AND pay. However, those who believe this are mistaken, as an extension only gives you an extension of time to file your return until October 15. Even with an extension you are required to pay-in any tax due by April 15th.
Since you have to pay in your tax due by the 15th even after filing for an extension, you will need to estimate any income from sources you haven’t received tax documents from as of yet and do your best to ball-park any amount due you may owe. The key is basically making estimates of income and expenses you may have that get you as close as possible to what your actual numbers will be. This will help minimize the possibility of any penalties and interest you may receive after actually filing your return and finding out that you underestimated what your tax liability would be on your extension.
That’s right, if you don’t pay in what you owe by the 15th you can be hit with penalties and interest on the amount you underpaid. It would be bad enough to find out you owe more than you thought you originally would when you were filing your extension without penalties and interest being involved, so do your best to use the most accurate information you can for your estimates and always try to be conservative.
So we’ve established that you need to pay any tax due by April 15th even with an extension, but what about those taxpayers who expect a refund? They have it much easier. All they need to do is file the extension form (Form 4868) with a “0” on line 6 for balance due (and make their estimated tax liability on line 4 equal to their total tax payments, such as W-2 withholding and estimated tax payments, on line 5).
Don’t bother trying to figure out an estimated amount you will receive back via a refund, it isn’t worth the time since you won’t actually receive your refund until after you file your return. Unfortunately an extension is not a two-way street when it comes to owing additional tax with the extension and refunds. While you need to pay-in tax due by the 15th, the IRS will not send you a refund based upon the information you file on your extension.
Given the fact that you still need to pay in your tax due by the 15th with an extension, I suggest to anyone who can file before April 15th to do so. Those who extend should only be doing so for reasons out of their control or extreme circumstances. Mainly I see taxpayers waiting for K-1s (from S-Corps, LLCs or Partnerships that haven’t filed yet or are own extension themselves) or waiting for 1099s that have been delayed or need to be corrected as the people who really need extensions. Of course I have clients who merely don’t have all of their information together by April 15th and request an extension and that is fine with me as well. After all, it gives me more to do after April 15th (and less to do before it) and that is fine with me!
Please see this link to Form 4868 and the related instructions on the IRS website for more information on filing for an extension.
Topics: Individual Tax, Tax Planning | 2 Comments »
The Child and Dependent Care Credit
By Jim | April 5, 2010
Speaking as a parent I have to say that the amount my wife and I have had to pay for daycare was one of many surprises we were not prepared for after having a child. We only have one child and it is a major expense, so I can’t even imagine the costs when parents have more than one child.
At least there is some relief in the tax code when it comes to the costs of child care. The relief comes in the form of the Child and Dependent Care Tax Credit.
The nonrefundable credit is calculated as a percentage of your total qualifying child or dependent care expenses. The maximum amount of qualifying expenses that may be used when calculated is $3,000 for one qualifying child and $6,000 for two or more qualifying children. Yes, that unfortunately means that if you have more than two children that you incur daycare expenses for, you still can only use a maximum of $6,000 of childcare expenses towards computing your total credit.
The percentage used to determine your tax credit based upon your total qualified expenses ranges from 20% to 35% depending on your adjusted gross income (AGI). Anyone with AGI over $43,000 is limited to 20% of qualified expenses.
That means a family with one qualifying child and an AGI of $45,000, who paid $3,500 for child care would be eligible for a Child and Dependent Care Credit of $600. This is how the $600 is calculated:
(1) Since the family’s AGI is over $43,000 their percentage for computing the credit is 20%.
(2) With one child only a maximum of $3,000 of the child care expenses may be used for calculating the credit.
(3) $3,000 x 20% = $600
For a table showing the applicable percentages for AGIs under $43,000, please see page 11 in Pub. 503 on the IRS website.
So I am sure your are wondering what types of expenses qualify for this credit. Here is a summary listing of various qualified expenses:
- Dependent Care Center (Child Care Center)
- Services Provided in your Household – Such as housekeeping, babysitter, cook, etc. to the extent they are incurred for the well-being of the qualifying dependent.
- School Costs – Any costs for preschool, nursery school or other such programs paid for a child that is below kindergarten level (in most situations) are qualified expenses for the purpose of determining your credit amount. Costs for before and after school programs for children at or above the kindergarten level may qaulify for the credit.
- Camp – Expenses related to a day camp your child attends is a qualified expense, however overnight camps are not considered a work-related expense and are therefore not a qualified expense. Summer school and tutoring costs are also not considered qualified expenses.
For more information on the above qualified expenses and a full listing that includes other qualified expenses please see IRS Publication 503 mentioned and linked to above.
Obviously most people with children qualify for this credit due to their child care center expenses. Those are the expenses I see most of my clients claim towards the credit. Most of the time I see clients being limited to $600 (or $1,200 if they have more than one child) since the vast majority of my clients who have children have an AGI over $43,000.
Those clients are sometimes disappointed about getting only $600 worth of a credit when they paid thousands of dollars in child care expenses. I then have to point out that they are also, in most situations, receiving the benefit of the child tax credit, additional child tax credit and an exemption. When you add all of that up it does usually create a significant tax benefit.
Overall the credit is fairly simple when you have child care expenses, so if you prepare your own taxes you shouldn’t have too much difficulty as long as you review Pub. 503 whenever you have a question. However when you get into some of the other expenses, especially if they involve household employees, it may be a good time to contact a CPA for some guidance. Those situations tend to be a little less cut and dry and also carry some other possible complications along with them (such as household employee payroll taxes).
Topics: Individual Tax, Tax Credits | 4 Comments »
Who Can You Claim as Your Dependent?
By Jim | March 29, 2010
The question of who can be a dependent comes up many times every year from my clients. Most of the time the question can be answered simply, but every once in a while the situation and the answer become a little more complicated. Wow, the tax code can be complicated? I’m sure that comes as a shock to all of us.
Here’s the “easy” part of determining if someone is a dependent:
In order to be claimed as a dependent a person must be (1) unmarried (or not filing a joint return if they are married), (2) a US citizen, resident alien, or a resident of Canada or Mexico and (3) a qualifying child or a qualifying relative.
Other rules to take note of include that a taxpayer cannot claim any dependents if he/she can be claimed as a dependent on another person’s return and that a spouse is never considered a dependent, but they are included in your exemptions.
Next we have to look at who is a “qualifying child” and who is a “qualifying relative”. Let’s start with qualifying children. In order to be considered a qualifying child, a person must:
(1) Be the taxpayer’s (or descendant of the Taxpayer’s) child, stepchild, foster child, brother, stepbrother, sister or stepsister.
(2) Be younger than the taxpayer and either under the age 19 or a full-time student under the age of 24. However if the person is permanently disabled no age restrictions apply.
(3) Live with the taxpayer more than half of the year.
(4) Not provide more than one half of his/her own support.
(5) Not file a joint return.
(6) Not be able to be claimed as a qualifying child of someone else who would receive priority under the tie-breaker rules. More on those tie-breaker rules in a moment…
Please note how dogs, cats or pets of any kind are not mentioned as dependents. Unfortunately there’s no deduction for pets regardless of how much you spend on them.
Next let’s look at a qualifying relative. In order to be considered a qualifying relative a person must:
(1) Have half of their support provided by the taxpayer.
(2) Not be a qualifying child (of the taxpayer or anyone else).
(3) Live with the taxpayer for the entire year, OR be related to the taxpayer.
(4) Have gross income of less than $3,650 (for tax year 2009).
A big point to take out of the qualifying relative rules is that if someone is related to you they do not need to be living with you to be considered a dependent as long as they meet the other criteria listed above. Many people believe that relatives must live with you in order to be considered a dependent, but that is not always the case.
So what about those tie-breaker rules mentioned in number 6 of the qualifying child criteria? Well this is where it can get complicated. To illustrate the tie-breaker rules, let’s say that two taxpayers claim the same child as a dependent on their return. Since the same dependent can’t be claimed twice, who is actually entitled to the deduction?
To answer this question the IRS uses the tie-breaker rules. To determine who takes the child as a dependent these questions are answered in this order:
(1) Is only one of the taxpayer’s the child’s parent? If yes, the parent claims the child. If no, proceed to #2.
(2) Did the child live with one of the taxpayers for a greater portion of the year? If yes, that taxpayer claims the child. If no, proceed to #3.
(3) Which parent had the highest adjusted gross income (AGI)? The parent with the highest AGI claims the dependent.
(4) If neither taxpayers are a parent of the child the same AGI test as in #3 is applied and the taxpayer with the highest AGI claims the child.
I had an interesting case occur this year where two taxpayers came to me after they attempted to do their own taxes and found that if the mother claimed their daughter she received a very large refund due to the earned income credit, but if the father claimed their daughter as his dependent his refund did not increase as much (they were not married). They were worried about possible rules regarding who should claim their daughter, which is why they came to me.
It was a good thing they did come to me too. Since both were a parent of the child and all three of them lived together during the entire year it came down to who had the highest AGI and that was the father. I had to unfortunately break the bad news to them that the proper way to file was not the way that would net them the biggest refund however they did rest easier knowing that they filed correctly and would not have to worry about interest and penalties down the road if the IRS looked into their return and found the wrong person claiming the child.
I was actually very impressed that those clients came to me about their dependent issue. I bet most people would put the dependent on each return to see how their refund is affected and then file in the way that would net them the most money. Luckily these individuals had the where with all to realize that if it sounds too good to be true, it probably is….or when taxes are involved it is more like “there must be a catch”.
Topics: Individual Tax, Tax Planning | 1 Comment »
I Don’t Have the Money! Now What?
By Jim | March 22, 2010
So your return has been prepared and unfortunately you owe. To make matters worse you owe more than you have or can afford to pay.
Perhaps you were laid off from your job in 2009 and had to take a withdrawal from your retirement plan to make ends meet before you found another job and the early withdrawal penalty is causing you to owe more than you thought you would. Or maybe you are a small business owner who couldn’t afford to make all of your estimated payments during the year and now have a larger balance due at the end of the year, including some estimated tax penalties, than you anticipated.
A lot of taxpayers are finding themselves in the position where they owe more tax than they can afford to pay for 2009. That leads to the question; What do I do now?
Well you do have options. None of them may seem like the most appealing choices in the world, but at least you do have a few ways to handle this unfortunate situation. Let’s take a look at them:
(1) File the return with no payment:
Please don’t ever do this! This is the worst possible thing you can do when you can’t cover your tax liability. To me this really isn’t an option, but I know some taxpayers feel it to be.
The IRS will process your return and then begin charging you late payment penalty and interest on the amount due.
You are only making matters worse if you go this route.
(2) Pay some now and the rest later:
You file your return and pay in as much of the tax due as you can afford and pay in the balance as soon as you can. Once the IRS process your return they will send you a notice that lists the remaining balance due and any penalties and interest associated with it.
This option is reasonable if you know you will be able to pay the remaining balance due within a few months of filing. Considering the late payment penalty is .5% of the amount due for each month the balance is outstanding you don’t want to wait too long to pay off your liability. By the way, the maximum for the late payment penalty is 25% of the balance due. Hopefully you don’t let it go that far! Also, don’t forget that the IRS will be charging interest on top of those penalties as well.
(3) Using a credit card:
This can work when it is used as a very short-term option. If you just need a little more time, say one month, to come up with the rest of the money you need for paying your tax liability you can use a credit card and then pay the balance off on your next statement. This way you avoid the finance charges the credit card company would charge you on the outstanding balance if you waited longer to pay it off.
If you need a longer amount of time to pay, this option isn’t that great. We all know that credit cards carry huge interest rates. Those rates can cause your situation to go from bad to worse very quickly.
(4) Request an Installment Agreement:
You can file Form 9465 and request an installment agreement from the IRS for the balance you owe. In most cases if you owe less than $25,000 and are going to pay the liability off within five years the IRS will accept the agreement.
Please be aware that you cannot receive an installment agreement if you have one still in effect from a prior tax year and you cannot have any other tax debts.
There is a user fee charged by the IRS for an installment agreement that ranges from $43 to $105 depending on your income level and if you choose a traditional payment option or a direct debit from your bank account.
It should also be noted that interest will still be charged over the life of the agreement on the outstanding balance.
Those are the most common options you have when you can’t afford to pay your tax liability. Please notice that I did not mention anything about extending your tax return as an option. Many people believe that an extension also extends the amount of time you have to pay your tax liability, however this is not true. An extension is only an extension of the time you have to file the return, giving you an extra few months to send your return in and avoid any failure to file penalties. You still need to pay in the amount you will owe, or your best estimate of the balance you will owe, by April 15 even if you file an extension.
To me the installment agreement is the best option in most circumstances when you need more then 30-60 days after the due date of the return to come up with the money needed to pay your tax liability. It allows you to avoid the late payment penalties while also setting up a payment plan that hopefully puts you in a better situation and your mind at ease.
Topics: Individual Tax | 1 Comment »
Easily Missed Deductions
By Jim | March 15, 2010
Many people who prepare their own taxes take the same steps each year as they did the year before in gathering and reporting the information on their tax return. While it is always good to be consistent, this leads many to repeatedly missing some credits or deductions every year, especially new deductions the self-preparer may not become aware of.
For that reason I wanted to look at a few miscellaneous deductions that some taxpayers may not be aware of. Hopefully some of these help you reduce your tax bill this year!
(1) Deducting Property Taxes – For Non-Itemizing Taxpayers
If you own a home and pay property taxes, but don’t have enough of other types of deductions to itemize you used to be stuck taking nothing more than the standard deduction. That all changed for the first time in 2008 when non-itemizing taxpayers were allowed to deduct the property taxes they paid during the year, and that option is still available to taxpayers in 2009.
Now before you get too excited, it should be noted that there is a limit as to how much of your property taxes you can deduct when you are not itemizing. Single taxpayers can deduct up to $500 of property taxes paid and married taxpayers can deduct up to $1,000 of property taxes paid.
The amount of property taxes you deduct in this manner basically acts as an addition to your standard deduction and reduces your taxable income. This is a big one that the self-preparer doesn’t want to miss considering it could reduce your taxable income by as much as $1,000!
(2) Points Paid During Refinancing
With interest rates at significant lows during the 2009 tax year, many people refinanced their mortgages. Some of those who refinanced paid points in order to receive an even better rate. Those points paid during refinancing are deductible, but must be spread out over the life of the mortgage.
To determine the amount deductible each year take the total points you paid and divide it by the length in years of your mortgage. So, if you paid $1,000 in points for a 30 year mortgage, you can deduct $33 per year. For the same amount of points paid on a 15 year mortgage you can deduct $67 per year over the life of the mortgage.
Obviously this deduction won’t be the difference between receiving a small refund or a large refund, but in my book all of these little deductions you can find and take tend to add up in the long run.
(3) Tax Preparation Fees
Okay so the person who always prepares their own return most likely won’t have paid tax preparation fees the previous year, but they may have used a CPA for assistance during an IRS audit. So even the self-preparer should be aware that fees paid to a professional to prepare your prior year taxes, to assist with an IRS audit, or even just respond to an IRS notice and other such tax related situations are deductible as an itemized deduction on Schedule A.
(4) State Income Taxes
Don’t forget that any amount you paid during the tax year to a state as income taxes is deductible as an itemized deduction on Schedule A. That not only includes amounts you had withheld from your earnings during the year, but also any amount due you paid in for the previous year.
Of course you also need to be aware that refunds from overpayment of state income taxes should be reported on your Federal return as income in the year they are received if you had previously taken a deduction for paying those taxes on a prior year return.
(5) Sales and Excise Taxes Paid on a New Vehicle
Thanks to the American Recovery and Reinvestment Act of 2009, if you bought a new vehicle (sorry used cars don’t qualify) during 2009 and paid sales taxes related to that sale at the time of purchase you can deduct some or all of those taxes on your return. Even better, you don’t need to itemize in order to take the deduction!
If you live in a state that doesn’t have a sales tax, like my home state of NH, you can deduct any fees or taxes based upon the sales price of the new vehicle assessed by either the state or a municipality.
The deduction is limited to the taxes and fees paid on up to $49,500 of the purchase price of an eligible vehicle. An eligible vehicle being a new car, light truck, motorcycle or motor home purchased between February 17, 2009 and December 31, 2009.
If you itemize, this deduction shows up on schedule A. If you do not itemize, this deduction shows up on schedule L and is added to your allowable standard deduction.
So there are five deductions that may be easily missed by the self-preparer. Of course there are more deductions and credits like these that many may not know about considering how complicated the tax code is, but if you are really worried about getting all of the deductions and credits you qualify for you might want to go to a professional preparer rather than preparing your return on your own.
Topics: Individual Tax, Tax Credits, Tax Planning | No Comments »
Do You Have a Business or a Hobby?
By Jim | March 8, 2010
Remember back in your high school days when a guidance counselor would tell you that you should find a type of work you enjoy when deciding on your career? Well the IRS isn’t your high school guidance counselor and believe it or not, you getting too much enjoyment out of your business might give them ammunition to declare it a hobby.
Okay, so the IRS wouldn’t deem your business to be a hobby solely base upon how much satisfaction you derive from it, but it is part of a “Facts and Circumstances Test” they use in determining whether someone is partaking in a business activity for profit, or a hobby.
Before we get into that fact and circumstances test we should look at why it would be a big deal for a business activity to be declared a hobby by the IRS. When you own a company (for our discussion I am referring mostly to a sole proprietorship since this situation usually affects that type of business owner) you are allowed to deduct expenses that arise in the ordinary course of business associated with your business activity. If those expenses exceed the income you earned from that business activity, the resulting loss is deductible against other income on your personal return (such as w-2 income and capital gains).
On the other hand hobby expenses are only allowable to the extent that you have hobby income. This means that a hobby is not allowed for tax purposes to generate a loss that can be deducted against other forms of income. Of course if your hobby generates a profit, you are still required to report that income on your personal return.
So what exactly differentiates a business from a hobby? Basically the IRS considers a business to be an activity that is operated for the purpose of generating a profit. This doesn’t mean that the business always needs to generate a profit; it simply means that the intent to generate a profit must be present within the daily operations of the business.
The first sign that an activity is considered to be a for profit business is when gross business income exceeds allowable deductions for at least three years out of a five year period. If an activity does not meet the three out of five year qualification, the taxpayer must prove that the activity a for profit business within the factors put forth by the facts and circumstances test mentioned earlier.
The following factors make up the Facts and Circumstances Test used by the IRS to determine if a profit motive is present:
(1) The manner in which a taxpayer carries on the activity.
(2) The expertise of the taxpayer or advisers.
(3) Time and effort spent by the taxpayer in carrying on the activity.
(4) The expectation that assets used may appreciate in value.
(5) Taxpayer’s success in other similar or dissimilar activities.
(6) Taxpayer’s history of income/loss with respect to the activity.
(7) Amount of occasional profits (if any).
(8) Financial status/situation of taxpayer.
(9) Elements of personal pleasure or recreation.
Obviously, you only have so much or just indirect control over some of these factors. However the first factor is the one a taxpayer has the most direct control over and can go a long way to showing that your are motivated by profit and not recreation.
You basically need to run your business like a business. That means keeping thorough records, maintaining separate business checking and credit card accounts, maintain an office (either commercial or home office), writing a business plan that puts forth periodic goals for the company (especially sales and profitability goals), having a business phone line and listing, etc.
If you have a small home business the steps listed above can go a long way to demonstrating that you are running a business and not merely supporting a hobby. I always stress record keeping, organizing and keeping personal and business expenses as separate as possible to my clients, but it becomes even more important if there is any question as to whether an activity could be looked at as a hobby by the IRS.
So, keep good records, strive for profitability and enjoy your job….just not too much according to the IRS and factor #9.
Topics: Business Tax, Individual Tax, Record Keeping, Small Business | 2 Comments »