Our Taxing Times

Dirty Dozen

No not the WWII movie with an all star cast. This Dirty Dozen is a list of scams the IRS releases each year. Heading the list this year are Identity Theft, Phishing and Tax Preparer Fraud.

Information on all the "honorees" can be found in IR-2012-23. The IRS also has YouTube videos on the Dirty Dozen in English, Spanish and ASL. Those links are in the IR-2012-23 page. There are also links to more info on identity theft, phishing and preparer fraud.

 McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

Modernized e-File Works but…

...the systems downstream are having problems.

This is the first year that most tax returns have been filed using the IRS’s new Modernized e-File (MeF). And so far this tax season more returns have been filed MeF than all last year. The MeF system is working just fine. (I’ve been getting acknowledgements less than an hour. They could be coming faster but I don’t check every few minutes.) The problem this year is coming from systems that link to MeF. So until further notice, the IRS is asking those who actually transfer returns to the IRS to use the legacy system so that they can work out the issues. MeF processing and CADE2 systems are working well but services like “Where’s My Refund” are having issues. Once they have resolved the issues, the IRS will open MeF back up.

If you or your preparer has an acknowledgement that your return has been accepted by the IRS, they really do have it and are processing the return. The IRS expects refunds to be issued within the traditional 10 to 21 days.

Oh, and has “Where’s My Refund” been a big mess the last week. Taxpayers are getting messages that the returns filed a week before aren’t in the system. Or, they get a screen asking if they made a mistake in entering their info. Or, they get a refund date 2 weeks after their refund has been released. The system usually works well. In fact, I wrote a post on the 7^th that includes using “Where’s My Refund” to check on your refund. But until the IRS resolved the problem, this is not an accurate widget.

McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

Conflict of Interest

Did you get a divorce or spilt with a significant other this year? Did you end a partnership or S-Corp? If you did either of these or one of several tax changing events, you might have to look for a new tax preparer.
Let's look at a divorce or split. John and Jane have been married for 10 years, have 2 children and they have used George to prepare their taxes for years. But in 2011, they file for divorce which is finalized by the end of the year and each needs to file their taxes. Jane comes in to see George and she wants the best refund she can get. He does the interview and files her return. Then John comes in to have his return prepared. But his answers are different than Jane's and the bottom line is that both are trying to do claim the same children, file as Head of Household, or use the same expenses for deductions. What ever the problem, George has a big problem. He can't tell John what Jane has already done nor can he call her and tell him that he heard a different story from John. And if he files the return as if the only side of the story he knows if John's, he could have a mess to clean up later-on both sides. Also, any tax advice he gives Jane many not be in John's best interest and he is suppose to be working for John too. What should he have done? George should have turned John away once he prepared Jane's return. Or, told Jane he couldn't do her return if he was planning on doing John's return.
If you've just closed a business and both you and your partner/co-shareholder use the same tax preparer, you might want to take conflict of interest into account when you take care of your taxes. This is especially true if there is any contention between business owners.
There are times when one preparer might be able to help both sides of a divorce or business split, but right after the split or if the situation remains hostile is not the time. You're paying them, you want to make sure they are working in your best interests and not putting someone else first.

 

McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

EITC Awareness Day

Who said?

“The Earned Income Tax Credit is the best anti-poverty, the best pro-family, the best job creation measure to come out of Congress.”

Today (1/27/12) is Earned Income Awareness Day. So in honor of the program, here is a little information. The Earned Income Tax Credit (EITC) is a refundable credit targeted at low income families. It was enacted in 1975 to offset the social security taxes taxpayers with children paid through withholding. At that time, the credit was 10% of wages up to $4000. But in 1986, the credit was seriously expanded. There have been several more expansions of the credit. Today, EITC is available to taxpayers with and without children and on 2011 returns the maximum credit is $5700. In 2009, the IRS processed 27.4 million tax returns and paid $60.4 billion in claims. 23 states have their own variations of the credit.

EITC is based on earned income. This is moneys from wages and self-employment income. If you charted EITC benefits vs. earned income, it would look like a flat top pyramid. As income increases, the amount of the credit also rises until the top refund amount is reach. Then here is a plateau before the refund begins back down to no credit. Actually, there are 8 charts. Two are for taxpayers without children; one for married and one for unmarried taxpayers. Three more charts are for married taxpayers with one, two or three (or more) children. The final three charts are for unmarried taxpayers with one, two or three (or more) children. Besides having to decide which chart to use, qualified taxpayer also need to look up both their earned income and their Adjusted Gross Income (AGI) on that chart. Their EITC is the lower of the two numbers. One of the disadvantages of EITC is the complexity.

Complexity is a big issue with EITC. Before deciding which chart to use, the taxpayer needs to decide if they qualify to take the credit. That is daunting. As a tax pro, I have to do Due Diligence on potential EITC clients to make sure they qualify. I have to check age, residence, relationship, foreign income, investment income, and potential conflicts with other taxpayers. Because of the complexity, the IRS estimates about 25% of the claims it sees are incorrect or fraudulent.

But is the credit worth the problems with it? According to Alice Lieberman, of The University of Kansas School of Social Welfare as quoted in the Topeka Capital Journal.

"The Earned Income Tax Credit is the most effective anti-poverty program in the United States," Lieberman said. "It both encourages and rewards work by allowing low-income workers to recoup money that otherwise would have gone to taxes. And since low-income people are more likely to spend their income than to save it out of necessity, it is also an economic stimulus."

Also from the Capital Journal, a 2005 National Bureau of Economic Research study found the federal program raises employment by making low-wage jobs more attractive.

“(The EITC) successfully meets its explicit goal of encouraging low-income parents to go to work by, in effect, lowering their tax rate and providing a financial bonus for that work effort,” the study found. “It has been especially effective in encouraging single parents, particularly women, to obtain employment.”

As a tax practitioner, I like the EITC (and I know many preparers who don’t). The due diligence is time consuming and it can be difficult to explain why a taxpayer doesn’t qualify or why their credit is less than a prior year. But I’ve seen the benefits. My client base included many hard working people who have low paying jobs. The EITC they receive is used to pay for unexpected expenses and as a cushion right before payday. It keeps them in their homes. I think it’s one of the better things Congress has done. So I don’t mind the extra work if helps reduce fraud and keep the credit for the good people who need it.

The quote that started this post was from Ronald Reagan.

 McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

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.

McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

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.

McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

Income and Their Forms

As you’re waiting patiently for all your tax forms to arrive, it might be a good idea to review.

Wages – If you worked in 2011, you will get one of 2 forms. The most common is the W-2 that lists your wages and withholding. There is no minimum. Even if you worked a few hours, you should get a W-2. On the other hand, if your employer treated you like a contract labor, you will get a 1099MISC from them. There is a minimum on the 1099MISC. If they paid you under $600, they aren’t required to send you a form. They can send you a 1099MISC if they choose and you are required to include what they paid you whether or not you get the form.

Interest – You will get a 1099INT from the bank or other payer if you earned over $10 of interest for the year. If your interest is under $10, they are not required to send the form but you are required to report it. And it doesn’t matter if you actually received the cash or left it into the account, it’s taxable.

Dividends – These are reported on a 1099DIV and the same rules apply as for interest.

Retirement – Pensions and IRA distributions are reported on 1099R. Don’t rely on a check stub. The 1099R provides more info than just the amount you received.

Social Security – The SSA-1099 shows the total benefits paid to you and for you. This is the amount that is reported on your tax return.

Prior Year State Refund – If you itemized deductions the previous year you should get a 1099G from the state. This may not be the correct amount to report. There is a calculation that might reduce the taxable amount. This is why a new preparer would want a copy of your prior year return.

Unemployment – A 1099G is also used to report any unemployment you received in 2011.

Sales – Sales of stock and mutual funds will be reported on a 1099B. This will be adjusted to create a gain or lost that eventually makes it way to the 1040. If you sale property, that will be reported on a 1099S. The exception is if you sold your personal residence and the reporting agent knows you qualify for the exclusion for sale of personal residence. It’s also possible to sell something and not receive a form for it. Check with your preparer about you specific situation.

Business Income – This also includes farming. While you might get a 1099MISC for some of your business income, it’s up to you to keep track of your income and report it.

Rental Income -  If a business is paying you rents for property or equipment, you should get a 1099MISC if the amount is over $600. Individuals are not required to provide the forms and you are required to report all the income whether you get a 1099MISC or not.

Alimony – Since they are payments from an individual, they aren’t reported on a form. But, they are taxable and need to make it on your return.

Gambling - If your gambling income is from winning, you may be given a W-2G. This form has several minimums depending on how the money is won. A 1099MISC might be used if you won a tournament or prize. And yes, even if you don’t get a W-2G or 1099MISC, you report any gambling income.

Share of another entity – If you are a partner in a partnership, shareholder in a S-Corp, or beneficiary of an estate or trust, you should receive a K-1 breaking down your part of taxable income.

There you are- the most common sources of income and their forms (if they have one.) If you have income from a source I haven’t mentions, ask your preparer. Remember, just because you didn’t receive a form reporting the income, you are still responsible for including it on your return. The minimums are for the convenience of the payer not the recipient.

 McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

Debt Offset

You were supposed to get a refund, Federal or state, and instead you receive a letter saying that your refund was being taken to pay a debt you owe. What’s going on and what can you do about it.

The IRS will offset (take) your federal refund for back child support and a federal debt. Generally those debts are back federal taxes and being in default on a student, VA or HUD loan. The operative work is default. The letter you receive telling you about the lost refund will tell you where the money is going. The first question is if you really do owe the money. It could be payments haven’t been credited to your account yet. If you disagree with the IRS about a tax debt, call them. Other debts are handled by Financial Management and you’ll have to talk to them. (800-304-3107)  

If you do owe the money, the next question is how you are filing? If you are using any filing status but Married Filing Joint, congratulations you just paid down your debt. If you file Married Filing Joint, whose debt is it? If the debt belongs to both, like prior year taxes not being paid, you paid down your debt. But if the debt just belongs to one spouse, there might be a little relief using Form 8379, Injured Spouse Claim. The injured spouse, the one without the debt, might be able to get their part of the refund by filing this form. It asks that the taxpayers allocate income and deductions to each spouse and submit the form. The form can be sent with the return if you know you will have a problem or as a response to the letter you receive. The form only allocates it doesn’t calculate any refund. The IRS will do that based on the info on the form and if the state is community property or not.

The states will also take state tax refunds for debts. Taxes and child support are the most common but each state has their own list of debts. Kansas will collect for municipal debts like hospital, ambulance, and utilities. Also states are beginning to collect back taxes for each other. As with a federal offset, it may be possible to do an equivalent of injured spouse on a state debt once you are notified about the lost refund. BTW,  states are starting to collect for each other.

It’s disappointing to lose money you were counting on for other things. On the other hand, you are paying down your debt. And once the debt is satisfied, you’ll get a refund again.

McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

Tax Interview Checklist

You’ve made your appointment to get your tax return prepared but are you ready for that appointment? Here’s a quick list of what I would love that you bring with you. Every preparer is different so check with them. And none of these will apply to everyone. My idea is to get you thinking.

• W-2s and 1099s (and 1098s)- this sounds like a no brainer but I have had clients forget them. And don’t get in a hurry and think you can guess unemployment or Social Security benefits.
• IDs and Social Security cards for yourself and spouse (if you are a new client).
• Social Security cards for dependents unless I have them on file already.
• Past year tax return if you are a new client or I didn’t do your return last year.
• If you have a business, farm or rental, I will need income and expenses for that. I don’t need to see the receipts but keep them handy in case I have questions. Also don’t lump expenses into one number. Totals for supplies, repairs, mileage, etc. are great.
• And while we’re talking businesses, please list any equipment or major repairs separately with when you bought/paid for it. Those may be treated differently.
• If you sold any investment or property in 2011, I will need to have the info on when you bought it and any increases in basis. For investments, that could be dividends that were re-invested. (This might be on the broker statement.) Property improvements should also be noted.
• Do you have any K-1s from a partnership, S-Corp or fiduciary? Bring them in.
• Gambling winning and any losses you can support with documentation.
• Did you make an IRA contribution? What about a Sep/Simple? (Withdrawals should have a 1099R)
• State and local taxes might be deductable. This would include taxes on your properties and sales tax.
• Charitable Contributions could be deductible if you have receipts or checks for them. If you made non-cash donations, bring your list of what you gave and any documentation and, if necessary, the appraisals you had made.
• If you paid a lot of medical expenses or insurance out of pocket, you may qualify for a deduction, so bring them in just in case.
• Your mortgage interest should be on a 1098 but if not, bring in that info too.
• Was there an adoption in 2011? Bring in your documents for that.
• Did you have education expense for yourself or dependent? Bring those records in with the 1098T and any statement the school provides.
• Is there a possibility for child care credit? Then I’ll need the amount of the day care expenses and name, SSN/EIN and address for the provider?
• Did you make any estimated payments during 2011 (or January 2012)? Please bring dates and amounts for those.
• And for Kansas full year residents, if you qualify for Homestead (or thing you might) please bring in your landlord and rent info or the tax bill you received in Nov/Dec 2011.

A quick checklist. If you have a question about something I might have missed or you need more info, ask  your preparer. I always tell clients, when in doubt, bring it in.

McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

It's Not a Race

Filing your taxes is not a race. Getting your return in first doesn't mean you in a prize. And it doesn't mean that you get something your shouldn't because your return is filed first.

This early in the season I see clients who pick up their W-2 and make a bee-line for my door. Sometimes all they need is the W-2 but sometimes they forget a something in their haste. Something like unemployment or interest income. I give them an estimate and send them away until they get all their paperwork. A slight delay but they will get their money. So far this year, I haven't heard of any tax departments holding refunds because of cash shortages.

But the other group of taxpayers who are in a hurry this year are those who racing to claim a dependent before someone else does. Some are legitamently entitled to the exemption but they're afraid an ex-spouse, parent or child will beat them to filing and cost them the exemption and any credits that go with it. And there are those taxpayers who try to claim an exemption they know they shouldn't. They are under the impression that taxes are a race and the first to file gets the money. Maybe temporarily but paybacks, as they say, are hell

Let's say the kids lived with Mom all year and she qualifies to claim them as dependents and for several credits tied to the dependent exemption (earned income credit, child tax credit, day care credit). Before she can file her return, Dad files his return and claims the kids. (By the way this doesn't mean the preparer was at fault. Too many taxpayers know how to answer the questions to maximise their refund. Yeah, they lie!) When Mom e-files her return, it's rejected because the children have already claimed on another return.  Since we're sure that she does qualify and could supply the IRS with all the documentations they need, the return is paper filed.  In a few months, both Mom and Dad will get letters asking them to check their returns because they claimed a dependent claimed by someone else. If they made a mistake, they need to amend the original return.  If Dad doesn't amend his return, both will get "prove it letter" requesting documentation to show they are entitled to the exemptions and credits.  Since Mom can prove everything, Dad must now payback any refund from claiming the kids. And that will include interest and penalty. Also if earned income credit was involved, Dad could lose the ability to claim the credit, even if actually entitled to it, for a long time.

So, I know you want your refund but waiting to get everything you need might be faster than charging in with pieces at a time. And no matter what your barber, guy at work or buddy says, filing with dependents you shouldn't use will come back on you.