Our Taxing Times

Payroll Tax Cut and Refunds

A quick catch up on the biggest tax news.

Both the Senate and House have passed the extension of the 2% payroll tax cuts and the bill is headed to the President’s desk to be signed. The bill also continued unemployment benefits for taxpayers out of work over 6 months and kept Medicare reimbursement for doctors from taking a dive.

And it looks like the IRS is catching up on issuing refunds for returns filed early this month. While funding is still way behind, the refunds are starting to show up correctly on “Where’s My Refund” with a target date. The date is still 2 weeks off but the last time I saw that, the clients actually got their refund much faster. The light at the end of the tunnel is at least lit.

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Wait For It

It’s almost the end of January and across the country taxpayers are haunting their mailboxes and payroll departments in hopes that those pesky W-2s and 1099s will magically appear. The closer to the end of the month, the more frantic they become. Their friends have filed but they are still waiting. So, they make the decision to try to file without everything they should have. Noooooo!

Of course, we’re talking about taxpayers who are sure they are getting a refund. I’ve never seen anyone rush in when they know they will be paying a balance due.

If the taxpayer uses a paid preparer, especially if they use the same preparer each year, they might find themselves making another trip to the office once they really get their form. Most tax software can be set to bring forward W-2 and 1099 info. I use it as a double check against what the client brings in to me. It’s easy to forget an employer where you only received one pay check in January. When that happens, I can estimate the return results, but the client has to come back when they get that form.

What happens when the taxpayer actually files a return without a form that should be reported, whether they forgot or deliberate left it off? They should file an amended return including the missing information. This takes the 1040X form. And no, this is not an alternative to waiting for all the documents they need. While it might result in a refund, there is a very good chance the taxpayer will have a balance due and have to pay back part of the refunds they received. Also, if the taxpayer waits until after the due date for that year to file the amended return, they could be subject to interest and penalties.

If a taxpayer leaves a W-2, 1099 or other income reporting form off their tax return and doesn’t file an amended return, the IRS will catch the omission when they run their matching program. Since the IRS gets copies of all the informational forms, they can create a basic tax return for the taxpayer and check what is on the taxpayer’s return against their return. When the incomes don’t match and results in more tax being due, a letter will be issued asking for the missing tax and penalties and interest.

It’s frustrating to wait for all your W-2s and 1099s when everyone around you is talking about their refund. But it’s less frustrating than coming up with the money to pay Uncle Sam (with interest and penalties) when your rush catches up with you. Employers and payers aren’t required to have those forms mailed until January 31^st. Notice the word mailed. You do have options if you don’t receive a form you should have but they aren’t available until after February 15^th and only if you have contacted the employer/payer.

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More Ways to Use Educational Expenses

In a previous post, I talked about using educational expenses to qualify for the educational credits and deductions. But educational expenses can also be used to offset income or penalties on IRA distributions and savings bond redemptions.

We currently have 2 types of IRAs which can be used to fund education. The Qualified Tuition Programs (OTP) and Educational Savings Programs (ESA) are set up along the lines of the Roth IRA. Contributions aren’t deductible but distributions of earnings can be tax free if the funds are used to pay for education expenses.

The Qualified Tuition Program, also know as 529 plans, are state or college plans that are used to pre-pay college expenses. They have no contribution limits and can be used to pay tuition, fees, books, supplies and room and board for students who are at least half time. They can also be used to cover special needs services for the student. This plan is limited to expenses for undergraduate or graduate programs.

The Education Savings Accounts used to be called the Cloverdell IRA and is limited to a $2000 annual contribution for each beneficiary. The ESA can be used for the same expenses as the QTP plus expenses for students in K-12.

Both these types of plans have different requirements and the taxpayer needs to do a little research to choose the plan that will suit their intentions. But once the money begins to be distributed, the earnings are taxable unless the money has been used to pay qualified education expenses. Since the taxpayer can’t deduct their contributions, that money isn’t taxable just the earnings. As always, once an education expense has been used for a credit, deduction or to offset a distribution, it can’t be used again. If the distribution from an ESA or QTP is greater than the education expenses not used elsewhere, the earnings allotted to the distribution become taxable and may be subject to a 10% penalty. This is a time where good records and a tax pro really can help.

Beside the education IRA, paying for college can provide relief from the 10% penalty on a withdrawal from an IRA. The money actually taken out of the IRA will be included in income and taxed but education expenses not used elsewhere can reduce the amount subject to the early withdrawal penalty.

If savings bonds, especially Series EE purchased after 1989 and Series I bonds, are cashed in to pay qualified tuition and fees the interest may be excluded from income. The key is to set up bond ownership correctly. The bond must be issued after the owner turns 24 and must be in the name of the taxpayer or spouse. No other co-owner is allowed. And the tuition and fees can’t be for classes in sports, hobbies or games unless they are part of the major. Of course, you can’t use expenses used for other educational credits, deduction or reductions. But savings bond interest can be used to invest in QTP and ESAs.

There are a lot of ways to save money on taxes by using education expenses for credits, deductions and to reduce income. But the rules for each program are a little different and you want to check to make sure you are using those expenses as effectively as possible.

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Education Credits and Deductions

As taxpayers continue to wait for all their tax forms to arrive, let’s talk about what to do with one of those forms. Form 1098T is the tuition statement from colleges and universities telling what was paid for a student during the year and what scholarships and grants the college/university know the student received. Besides being one of the last forms to arrive, the 1098T is one that needs to most adjustment to come up with the correct deductions.

When dealing with a 1098T, I really like to see the account statement for that student. Luckily most schools have put student account info online and the student (or parents) can get a print out. It allows me to double check the out of pocket payments the taxpayer made. I’ve seen loans classified as grants, books treated as fees and payments made in December credited to January. What I want to do is to come up with the difference between the amounts paid for tuitions and fees that year and what the student received from grants and scholarships. But not all education expenses will be on 1098T so track them too.

There are currently 2 credits and 2 deductions for education expenses. Each has different requirements and limits. But there three basic rules for all; you can't be filing married filing separate, you can only use an expense once and only one credit/deduction per person (but a return could claim both credits and the Tuition deduction as long as they are the expenses of three dfferent people). And it goes without saying, the student must be the taxpayer, spouse, or dependent on the return unless the taxpayer could claim a dependent but chooses not to (student still can’t claim themselves). And the credits and the Tuition Fee Deduction have income phase outs to consider. A quick aside on the using expenses only once. If a distribution from a Qualified Tuition Program or Education Savings Account (Cloverdell) is taken, the expenses used to keep the distribution from being taxed are not eligible for the credits or deductions.

The American Opportunity Credit (AOC) is the beefed up Hope Credit. It’s available for the first 4 years of post secondary education. The student must attending a qualified school and be in a degree or certification program. The maximum credit per student per year is $2500. Up to 40% of the AOC can be refundable. This is the only education credit/deduction that included the cost of course related books and supplies. All the others are limited to tuition and course fees.

The Lifetime Credit maximum per return is $2000. But it includes non-decree course work and graduate school. But the classes must be at a qualified school and only tuition and fees qualify for the credit.

The Tuition and Fees Deduction is an adjustment to income and not a credit. A taxpayer can deduct up to $4000 in qualified expenses (tuition and fees) from a qualified school. And while not a credit, it may also reduce income on your state return.

Which credit/deduction is best? The one you qualify for - and that depends on the circumstances. I’d start with the AOC since it has the best tax benefit. Lifetime is the next logical step since it’s a credit. Then go to the Tuition and Fee Deduction. But what if you have some education expenses that don’t qualify for the other programs? Specifically, continuing education you have to take to maintain your job. Sometimes these are not offered through a qualified school and so can’t be used with the other credits and deduction. If the course was a job requirement and doesn’t qualify you for a better job, the tuition, fees and books could be a Miscellaneous Deduction on the Schedule A.

Education expenses can help you on your taxes but only if they meet specific qualifications. The key is to maximize the tax savings and that might mean running the numbers a couple of different ways to get the best legal result.

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How Do You Want Your Money?

Electronic filing is up and running and 2011 tax returns are being prepared and transmitted. You have a refund coming back but what are your options?That depends on how you want your refund to come to you and if you want to spend extra for extra services.

This year the IRS will do two things with a refund. They will print a paper check and mail it to the address on the return. The other option is to direct deposit into the taxpayer’s account. Last year, the IRS offered a debit card but that has been put on hold and it’s not available this year.

Each year, the IRS publishes a refund chart with the target dates for deposits and checks based when the return is e-filed. This chart is meant to be a guideline. The IRS reserves the right to take longer to process a return. But, generally, refunds have followed this chart for most taxpayers. This year a refund accepted by the IRS by January 25^th should be direct deposited by February 1^st (a week later) and the paper checks will be mailed by February 3^rd. This is a little faster than in previous years. With checks the key is mailed, expect to see the actual check a few days later.

In my practice, direct deposit is very popular. Clients like how fast they can get their refund and that they don’t have to worry about a lost check. If you want to have your refund direct deposited, you want to have the routing number and the account number for an account in your name. A check or bank statement are good sources for the account number and a check will have the routing number also. Be careful of deposit slips I’ve heard of tax pros having problems with the routing number on a deposit slip being different than on the check. If you have a question, call the bank/credit union to get the correct routing number. It’s also possible to have the IRS deposit your refund into a debit card you have your paycheck loaded onto. Check with the debit card company for the routing and account numbers.

There are some other options available to taxpayers who are willing to pay more. The Refund Anticipation Loans (RAL) haven’t died yet. There is one national bank, Republic, offering the program. And there are smaller finance companies creating a variation on the program. These loans will be harder to find and the cost will vary depending on who is funding the loan.

The Refund Anticipation Check (RAC) (this program has lots of names) is not a loan. The taxpayer pays to have a temporary bank account created and their refund deposited into that account. Once the bank has the money, they allocate the fees and release to the taxpayer the remaining money. The only advantage of the RAC is that they allow the taxpayer to have their tax preparation fee come out of their refund. This way they don’t have to worry about an up front payment. Both the RAL and RAC can be distributed by check, direct deposit into the taxpayer’s account or debit card. If you are interested in any of these types of products, check the fees carefully. The fee on the signs is usually just the bank’s charge. Find out what fees the tax preparer and transmitter are adding to that charge.

As for the states, how you get your refund depends on the state and how you are filing. Of course, direct deposit is their preferred choice. But you may want to check if your state is sending paper checks or if they offer debit card. Also, some options are not available if you don’t e-file the return.

Getting a tax refund can be fun even if it’s not the best use of your money. And we now have a wide variety of choices of how to get that money returned to us

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First Things First

The big tax talk today is the prognostications that the Debit Reduction Super Committee won’t make their report deadline. This isn’t a big surprise. I wrote a post last month where Secretary Geithner was quoted saying that the committee wouldn’t have a report on time. They can continue to work on a proposal but automatic budget cuts will start being put into place.

Why can’t they come to agreement? Much has to do with partisanship and different views of what will be best for the economy and the country. But Congress has always been made up of individuals with different views of the best action and still managed to function. What’s different now?

Last night I happened to catch part of an interview with Harvard Law Professor Lawrence Lessig on C-SPAN. They were discussing his book Republic Lost: How Money Corrupts Congress and a Plan to Stop It. His thesis is that costs of running for Congress have changed the priorities for most of our elected officials. Public service has taken a second place to raising funds for re-election. Allotment of Congressional benefits such as committee seats are based on fundraising ability rather than knowledge and experience.

I haven’t read Professor Lessig’s book yet but the theory makes sense. It takes a strong Congressperson to vote to cut the Mortgage Interest Deduction when he/she knows they will need a contribution from the Realtor’s Association to stay in office. Let’s face it, Congress is no sooner sworn in than they start campaigning for re-election. It’s amazing that anything gets done but campaigning.

We need tax reform. We need to decide what we want our tax system to look like and build a Tax Code that reflects that ideal. Since it’s very clear that under the current dependence on contributions that can’t happen, maybe we need to take a step back and fix that problem first. Take care of campaign reform first. Then, with their dependence on re-election money ended, Congress can concentrate on building a tax system that’s fair for all.

States Collecting for Other States

Remember all the discussion last year about the debt indicator? That was when the IRS announced that it would not be sharing with anyone if the taxpayer’s refund would be taken for back Federal taxes, child support or default on a Federal obligation. Well, the states too will take state tax refunds. Besides back state taxes and child support, Kansas will take for hospital bills and even utility bills. The debt has to come from a city, state or county owned entity. And Kansas has a variation of the Federal Injured Spouse they send out when want to take a refund.

Kansas also has a reciprocal agreement with Missouri to help collect each other’s debts. The states are working out these agreements to help collect revenue. A Taxpayer who owes Kansas for back taxes moves to Missouri. On their Missouri state return, they have a refund coming but due to the reciprocal agreement, Missouri can take that refund and send it to Kansas.

This is a growing trend as states are working together to collect for each other. So, if you owe back state taxes, child support or certain other debts, don’t expect moving will help you avoid paying your debts.

Deductions for Workshops

I'm at school in KC, sort of. I actually came up a day early to visit family. I always try to go to one of Drake's update schools to learn about changes to the tax software. But this year, the Wichita school is the same week as the 2 day Kansas Tax Institute and it's a payroll week so missing 3+ days is not a good idea. But the point of this post is what expenses can you deduct when you go off to school like this? There are some caveats, but I'll get to them a little later in the post. What can be deducted? Travel to the site and back. I'm driving so I am using my new mileage app to track the miles round trip. A mileage log will work too. If I flew or took the train, I could take the cost of the ticket and car rental or taxi to get around. Of course, I have a hotel room. (Make sure you keep the receipt for the hotel, it's an IRS must have.) And I'll eat so I have the option of keeping my food receipts or using the IRS per diem. The per diem includes things like tips and other incidentals. I'll also be able to use the tolls I'll pay. And let's not forget the actual cost of the workshop. Now for the caveats. You can't deduct the personal part of the trip. When I get home, I'll separate one night in the hotel as personal expense and I won't take the per diem for the extra day. I will use all the miles and tolls since I would have had those expenses no matter how many days I was here. Along the same lines, if you take your spouse with you, you can't deduct their costs. You do need to apportion the hotel to each of you and only deduct your hotel and meals. And keep the actual receipts for meals and incidentals. There have been reports of these being disallowed in audit when the only proof is the credit card bill. So, be careful with those little pieces of paper. Are you an employee or self employed? I have it easy, my expenses will come directly off against my income on my Schedule C. If you're an employee, the reporting on your tax return is more complicated. First, you start with the Form 2106-Employee Business Expenses and enter your expenses on the appropriate lines. If you have more than one trip or other employee expenses, they are all combined on this form. Your spouse, if they have expenses, will have their own 2106. If your employer reimburses you for any expenses, you will have to deduct that reimbursement off the actual expenses. The bottom line from Form 2106 is carried to the Schedule A miscellaneous deduction section. There it has a couple of other hurdles. First, it must get through the 2% floor on that section and the whole itemized deductions from the Schedule A must be more than your standard deduction. That's how you deduct a workshop if you are an employees. Enjoy the workshop and keep your receipts and records so that you can deduct the expenses.

Tax Treatments for Military Taxpayers

I’m an Army Brat. My dad was career Army and served until he had no option but to retire or become an officer. Mom was in the Navy during WWII. One brother was career Navy who became an attorney when he retired. (The military service makes up for the attorney thing.) Another brother served in the Army for a tour and I almost made it to the Air Force. I also live in an area which always sees a high percentage of the young people enlist in the military. And while I’m happy that these kids are coming home, I have been very worried about the chances of finding a job in the current economy.

So, I’m happy that the Senate has addressed the issue with the VOW to Hire Heroes Act. As outlined by Kelly Phillips Erb in her Taxgirl Blog. The legislation would provide tax credits to employers who hire vets that  meet the unemployment requirements. The bill will also beef up the education opportunities available to the vets.

There are, however, other special tax treatments available to the military; active duty, reserve or retired. All treatments have their own qualifications and “buts”. This is intended as an overview.

• Veteran’s Benefits are not taxed. The only time I know they come into play is for the Kansas Homestead/Safe Senior rebate.
• Combat Pay is not taxable although it comes into play in some calculations.
• The First Time Homebuyer Credit allowed active duty personal extra time to qualify for the credit and provided an exemption to the recapture rule for a duty related move.
• A duty move also allows an active duty military taxpayer to qualify for the Sale of Personal Residence exclusion even if they don’t meet either of the time rules.
• For purposes of the Earned Income Credit, the taxpayer can chose to include combat pay into the calculation for a larger credit.
• Combat pay, along with pay differential, is also used to determine if a taxpayer has enough compensation to for an IRA contribution.
• Combat pay also gives the taxpayer longer to file their taxes, claim a refund and defer collections.
• Reservists can deduct the cost of their uniforms, insignias and their mileage, lodging and other training expenses. Active duty military can only deduct the insignias and related stuff. (Of course, they have to meet the miscellaneous deduction floor and other Schedule A qualifications.)
• Many states do not tax military pensions or partially exclude the income. Kansas and Oklahoma are among them.
• A military spouse can get special state tax treatment thanks to MSRRA.

I am sure that there are other special tax treatments for active, reserve or retired military personnel. These were the ones I could think of off the top of my head. And I think the proposed tax credit for employment would be a well deserved addition to these.

My thanks to all who served or are serving in any branch of the military.

Can You Give Away an Exemption?

Maybe. But first an explanation.

A divorce or separation can have a major impact on the taxes of the taxpayers involved. And no issue can be harder for a tax pro to deal with than which parent can claim the dependent exemption. While the rules can be a little convoluted, the big problem is the emotion of the issue and the fact that too many attorneys writing the divorce decrees have not keep up with tax law changes and documentation requirements.

The basic rules to claim your child as a dependent (all subject to qualifications and exceptions):

1. You can’t be claimed as a dependent on someone else’s return. Not that you are being claimed but that you can’t be claimed. There is a difference.
2. A dependent can’t file a Married Filing Joint return with their spouse (of course there is an exception.)
3. The dependent must be a US citizen or US national or a resident of the US, Canada or Mexico.
4. The dependent must be the taxpayer’s son, daughter, stepchild, fosterchild, brother, sister (steps count too) or a descendent of one of these individuals. (There is a 2nd set of requirements if the child not one of these.)
5. The dependent must live with the taxpayer over 6 months of the year.
6. They have to be under age 19 or disabled or under 24 and meet student requirements.
7. The dependent can’t have had enough income to provide over half of their support for the year.

For parents who are no longer together the big issue is number 5 since they generally both meet all of the others. Between the 2 parents, they must have had custody of the child for over half the year. But, only one parent can claim the dependent exemption for the child on the tax return. The IRS has decided  (based on Congress's laws), and it has stuck in court, that the parent who actually (physically) had the child more nights during the year gets the exemption. If the court documents give both parents “joint custody” with the child’s physical residence switching every 2 weeks, then the parents will need to sit down with a calendar and count who had the child more nights during the year. That parent has the right to the claim the exemption for that child. If it gets to the point that the IRS is involved, they don’t care what the divorce decree or other court documents say. They want to know who had the child more during the year. And that parent will get the exemption for that child even if the difference is just one night. They become the tax custodial parent.

BUT

The custodial parent has the right to give the non-custodial parent the exemption for that child. They can only “release” the exemption the other parent (no friends, grandparents, brother…) and they are only giving the exemption, and if the child meets the requirements, the child tax credit. There is some documentation required. The custodial parent will need to sign a Form 8332-Release of Claim to Exemption. There are three parts on the form. The first section releases the exemption for that child just for one specific year. The second part allows the release for more than one year. The final section cancels a prior Form 8332 for multiple years. The Form 8332 will be sent to the IRS when the non-custodial parent claims the child on the return. A substitute to Form 8332 can be used but it must include all the same info as the actual form. If the return is paper filed, the Form 8332 goes in with the return. There are special rules to mailing if the return is e-filed. And this will have to be done each year the child is claimed even if the release is for multiple years.

Now for the big issue, a divorce decree or support document generally won’t work to claim an exemption for a child. For it to be acceptable to the IRS, the document must first have no conditions to the release of the exemption. Say Dad has custody but must release the child’s exemption to the Mom in even tax years. So far that will work. However if the exemption release is contingent on Mom being up-to-date on child support, Mom will need a Form 8332. If there is no contingency restricting the exemption, then the court document must be signed by the parents. By the parents, not signed by the attorneys for the parents. If both rules are met, the court document can be used like a Form 8332 as long as a copy is sent to the IRS. I’m sorry, but if the custodial parent won’t sign the Form 8332, it doesn’t matter what the divorce decree says. The only way to force it is to get the attorneys involved.

Dependency issues are confusing and this is just a quick overview of one issue. Please check with a tax pro about your specific situation. Oh, and make sure you keep a copy of the signed Form 8332 or court documents for your records.