Archives - Common Tax Questions
As published in the Tacoma News Tribune
Courtesy of Nelson & Company, P.S., CPAs
NOTICE: Tax laws are constantly changing.
The information provided on this page is for reference only.
Contact a tax professional for current details and information.
Question: Why do Income Tax Returns have to be so complicated?
Answer: Congress has enacted fourteen major changes to the tax code since 2000. Many of these changes were designed to equalize the tax burden---obviously that has not happened. In a nutshell, many special interests have influenced Congress to write provisions favorable for them in the tax code.
Question: Will I be able to get my refund in January?
Answer: Maybe. If the President and Congress pass the Alternative Minimum Tax Bill, tax return processing could be delayed until the first of march. If it doesn't pass, processing should begin the middle of January. Without passage of the Alternate Minimum Tax Bill, over six million Americans will pay at least an additional $2,000 in tax. Note: Email us for easy-to-use donation valuation forms. Also note that low value items donated to charity are no longer deductible, therefore we have not included valuations for low quality items in our worksheets.
Question: My employer pays my health insurance directly to an insurance company. They include the amount paid in premiums as income and report it as part of my W-2 wages. Is this correct?
Answer: No! Contributions by an employer to provide accident and health benefits for employees are not taxable to the employee under Code Section 103. It makes no difference whether you're the only one covered by the employer or they cover all the employees. There is no specific rule as to who can or cannot be covered by a health insurance plan. Clearly, under the code, the insurance premiums paid on your behalf are not taxable.
Question: I started an LLC for 2006. My taxes were about the same as 2005. I thought LLCs didn't have to pay taxes. .....continued.
Answer: An LLC should not elect to be a Regular C Corporation. C-Corps pay tax at the corporate level. A C-Corp will cause double taxation. A partnership that owns real estate ideally should be an LLC. Using an LLC for an investment partnership is the best use of an LLC since partnerships don't pay tax on passive income. If you operate a regular business and form an LLC, we recommend if your net income exceeds $60,000, that you elect Sub-Chapter S status. You must pay yourself a reasonable salary and issue a W-2 and pay social security tax.
Question: I started an LLC for 2006. My taxes were about the same as 2005. I thought LLCs didn't have to pay taxes. ....continued.
Answer: Schedules C & E are attached to your individual tax return and can be used by an LLC if you are a sole proprietor or have rental properties. You must be a sole owner; married couples count as a single owner/member. A Schedule C sole proprietor must pay social security tax and income tax on all net business income. A Schedule E for rental properties titled in the LLC name is by far the simplest and most cost-effective way to report rental income as long as you are the sole owner. To be continued...
Question: I started an LLC for 2006. My taxes were about the same as 2005. I thought LLCs didn't have to pay taxes.
Answer: Yes and no. There is a great deal of confusion about how LLCs are taxed by the IRS and what tax form to use. First you must decide what type of tax return to send to the IRS. You can file as a sole proprietor on Form 1040 with a Schedule C attached, a partnership or sub-chapter S (which generally don't pay tax), or a regular C corporation (which pays tax on net income). The IRS does not have a special form for LLC filing. You must decide, based on your circumstance, how you want to report business or investment income and expenses. LLCs were created to protect assets and to limit liability; not for tax purposes. In the coming months, we will explain each of the four ways an LLC can report to the IRS.
Question: I have a stock dividend reinvestment account. I plan to sell the stock this year. How do I figure the gain?
Answer: Hopefully, you kept all of the yearly statements showing the amount of dividends used to purchase shares of stock. If you don't have the records, contact Shareholder Relations or the Trust Company that administers the plan for your company to obtain the purchase records. Once you know the total cost of the purchased shares you want to sell, subtract the sales price to compute your gain.
Question: When I filed my return on April 17th, I attached my payment with my return. When I called the IRS on May 12th, their records didn't show they had received my check. It wasn't until June 1st that I was able to confirm by phone that my payment was received. Why does it take them so long to process payments?
Answer: There are two reasons.
- There is a great deal of security in the IRS system and there are many checks and balances before a transaction is recorded on a taxpayer's account.
- Payments normally go through the Treasury Department and it takes time for the data to transfer from the Treasury to the IRS.
It's good to know that the IRS is extremely security-conscious---it insures that our data is kept safe.
Question: I will be 70 1/2 this year and have five IRA accounts. Do I have to take the required minimum distribution out of each account or can I take it from just one?
Answer: You can take the total minimum required distribution from just one account. As long as the total minimum is withdrawn by December 31st, you will be in compliance with the code. We do not recommend delaying your withdrawal to the following year, which you can do when you turn 70 1/2. Normally, this only doubles your tax on distributions for the following year.
Question: I own a business and just mailed in my tax return, but I could only pay part of the tax due. I owe a lot of tax for back years and every year it gets worse. Is there anything I can do?
Answer: Yes. There are many things you can do, but first you must take a hard look at your business and decide if you want to continue. If you do, you need to change how you operate. Consider forming an S-Corp, downsizing, reorganizing through bankruptcy, or taking other steps to stop increasing your tax debt. Other options include an Offer in Compromise or Partial Pay Installment Agreement. Every month, we see folks who successfully complete one of our action plans. They have put their IRS problems behind them. But, first you must take action and make some changes.
Question: I just completed my 17-year-old son's tax return so he could apply for financial aid for college in the fall. He owes a bunch of money. I had to figure his taxes based on my rate. What gives? A. Congress changed the law. The Tax Increase and Reconciliation Act signed in May of 2006 increased the kiddies tax from age 14 to age 18. What this means is if a child under 18 has unearned income, i.e., from interest dividends, and/or capital gains, exceeding $1,700, the tax must be figured at the parents' rate. It is a little late for you to do anything for your son, but folks with younger children should consider changing to growth stocks or mutual funds that pay little or no dividends which would save on the tax. Use of a 529 Plan can also eliminate the kiddies tax.
Question: Can Better Records Save Money? I am in sales, travel a great deal, and am extremely busy. My accountant keeps telling me to keep better records and that I am overpaying my taxes because I don't have records for all of my expenses. Anything I can do?
- Get a business credit card and pay the extra fee for a year-end summary of expenses by category. Use your business credit card for only business expenses.
- Diligently run a test for at least 6 weeks for your auto mileage, keeping a detailed log of your business miles. A little extra time on your records can save you a significant amount of tax.
Question: What is Tax Planning? Folks keep telling me I need to do tax planning; what steps do I have to take?
Answer: Tax planning is done before a transaction is begun or at year end to minimize a year's tax. The first step is to project what tax would be due if no changes are made. Then any changes can be added to see if any savings result. The key issue is: real tax planning occurs during the year, before the deal is signed and well before year end in December.
Question: Are there any last-minute things I can do to save money on my 2006 taxes?
Answer: Yes. Clean out your closets of household items and clothing. Donate them to your favorite charity. Don't forget glasses and hearing aids to the Lions' Clubs. For 2006, you can claim up to $500 for the residential energy credit if you bought and installed qualified equipment, i.e. circulating fans, water heaters or a new furnace. See the IRS web site at IRS.gov for details. You should also consider donating appreciated stock to your favorite charity with the recent rise in the stock market.
Question: I have about a million dollars in my rollover IRA account. I want to convert it to a Roth IRA. How much can I convert and will I owe any tax on the conversion?
Answer: Yes, you will have to pay tax on whatever amount you convert. First, you must make sure that your adjusted gross income does not exceed $100,000, not including the amount you want to convert. The amount you convert will depend on your tax bracket. Therefore, before you convert any IRA accounts, you must run the numbers to make sure that it will save you money in the long run.
Question: When I filed my income tax, I had a small balance due which I paid with my return. A few days later, the IRS sent me a notice showing the balance as unpaid tax, plus they added penalties and interest. What can I do?
Answer: While returns are processed by the IRS, checks are actually processed by the U.S. Treasury Department. There is often a time lag between the time your check is posted to your IRS account and the time your return is processed. All you can do is wait a few days and the IRS will send you another notice showing the unpaid tax as paid. This is a continuing problem between the IRS and Treasury, particularly where people file electronically. The Treasury Department cannot post the checks manually as fast as the IRS's computer system can process your return.
Question: Is it true that I can donate $100,000 from my Individual Retirement Account (IRA) to my favorite charity this year?
Answer: Yes, if you are at least 70 1/2 and donate to a public charity. However, you will not get a tax deduction on your income tax return. Your favorite charity can explain the procedure to follow to make the rollover. This change was effective August 17, 2006.Since 2001, Congress has enacted eight major tax law changes that have added hundreds of new pages to the tax code and has just set a record for passing the most tax bills in the shortest period of time. Ever wonder why folks are so confused about tax rules?
Question: I got an extension in April. Should I have filed another extension on August 15th?
Answer: No, not this year. Since you filed your extension in April, it is good for six months. The final date to file your tax return with an extension is October 16th. This is a new procedure this year. You only need to file the one extension to get an automatic six-month extension. Extensions only extend the time to file your return; it does not extend the time to pay. If you owe money, you should file your return as soon as possible to avoid additional penalties and interest.
Question: What items qualify for the new energy tax credit?
Answer: A few items that make your home more energy efficient and also qualify for the new energy tax credit are:Insulation that reduces heat loss/gain, exterior windows, exterior doors, metal roofs, air circulation fans, hot water heaters, solar panels and fuel cells. The amount of credit varies by item. There should be information included with a qualifying item as to the amount of the credit. The tax credits range from $50 up to $2,000.
Question: I had to file an extension because I didn't get a Partnership K-1 until April 15, 2006. Everyone tells me that I will get audited. Is this true?
Answer: Absolutely not! Filing an extension will not cause an IRS audit. This is one of the great urban legends. About 8,000,000 extensions were filed this year. In 2005, IRS Examiners audited about 1,000,000 returns face-to-face. What is most important is the ratio of income to expenses. This determines whether you will have a score high enough to warrant an audit. If you have the records to back up your figures, don't fear an audit. It's what is on the return that counts, not when it is filed!
Question: I just formed an LLC. Does it have to pay tax?
Answer: Yes, No, and Maybe. It all depends on what type of business your LLC is doing. LLCs can be taxed as Regular C-Corporation, a Subchapter S-Corporation, a Partnership, and as part of your individual tax return on either Schedule C or E, Sole Proprietorship, or rental properties. C-Corporations pay taxes. Net income from S-Corporations and Partnerships are reported on individual returns. You must use Form 8832 to elect what type of tax return to file. A single member LLC electing to report as a sole proprietor on an individual tax return need not file Form 8832, unless there are employees and an EIN is not needed.
Question: Now that the April 17, 2006 deadline has passed, are there any tax tips for the rest of the year?
Answer: First; extensions are necessary to give your accountant more time to thoroughly review your return and consider tax-planning opportunities. Second, lack of keeping accurate and complete financial records costs more tax dollars than any other single item. Third, owing the IRS money will not get you audited, and finally, the IRS will not zap your bank account if you electronically file.
Question: I have some stock that shows a substantial loss. I understand I can only write off $3,000 a year. Therefore, should I plan to sell only enough shares to generate a $3,000 loss for the year?
Answer: No. If the stock is down and you really want to get rid of it, sell it all. Yes, you are limited to a capital loss of $3,000 a year, however, losses over $3,000 are carried over to the next year. Those losses are then available to offset future gains.
Question: My accountant tells me that I can't claim my kid after my divorce. Is this true?
Answer: For the 2005 tax year, the most significant change is the new simplified definition for dependants. The IRS has five tests. The major test that will cause a change for millions of Americans is the principal place the children live. Children under 19 need only live more than half the year with a parent to qualify as a dependant. The change affects head of household status, exemption for dependants, earned income credit, day care credit, and the child tax credit. the new rules are extremely tricky (not simple) so consult a tax pro if you have any questions.
Question: I sent a check for my estimated taxes for September 15, 2004. IRS said they never got the check. I have the cancelled check. What do I do?
Answer: Call the IRS. Have your cancelled check ready and read the numbers off of the back to the IRS. You should be able to solve your problem with a phone call. Always, when sending payment to the IRS, be sure to write your ID number, social security or EIN, the tax form, i.e. 1040, 941 etc., and the period and year, i.e. first quarter, 2006 on your check.Note: We had several inquiries regarding our November column about owing money to the IRS. Yes, we do offer a free consultation for taxpayers who have serious IRS problems.
Question: What is the new auto mileage rate going to be for 2006?
Answer: The IRS has announced the standard auto mileage rate will be 44.5˘ a mile for 2006. For 2005 tax returns, the rates are 40.5˘ a mile through 8-31-2005 and 48.5˘ thereafter. Effective October 1, 2005, for overnight business travel, the daily per diem rate for food is $45 for any location, and lodging is $96 a day. The 2006 social security wage base goes to $94,200. Medicare Plan B will be $88.50 a month. You can earn $12,480 if you are under 65 and drawing social security without incurring a penalty. Additionally, the 401K contribution limit goes to $15,000, and $20,000 if over 50. IRA deductions for 2005 and 2006 are $4,000 and the +50 catch-up is $4,500.
Question: I owe the IRS about $65,000 from my former business plus personal taxes. My house is almost paid for and I don't want the IRS to seize it. What can I do? Can I settle for "pennies on the dollar" like the national ads say?
Answer: No. But you have several options. With the large equity in your house, an Offer in Compromise would be difficult, if not impossible to get approved. In spite of what the national offer mills say, with your equity and the IRS's new policies, it would be almost impossible to settle for pennies on the dollar. However, you can ask for an Installment Agreement since refinancing is not a viable option for you (because you have IRS liens and your income is so low). The IRS can set you up on a monthly payment. It is based on you ability to pay given your income and living expenses. It's subject to review every two years.
Question: President Bush, on September 23, 2005, signed the Katrina Tax Relief Act.Are there any special tax breaks?
Answer: Yes. For two months in a row now, we have a new Tax Law. Individuals who house victims of Katrina in their home for at least 60 days are entitled to claim a $500 deduction up to a maximum of $2,000. The most significant item is the raising of charitable contributions to 100% of income. This opens up tremendous planning opportunities for folks with large IRAs who are at least 59 1/2 years old. The 3% reduction does not affect gifts to any qualified charity by December 31, 2005. Thus, if you had $5,000,000 in an IRA and wanted to give $1,000,000 to your favorite charity, you could do so with no tax effect.
Question: President Bush just signed a new energy bill. Are there any tax breaks for individuals?
Answer: Yes. Effective for the years 2006 and 2007, there are three major tax breaks. There is (1) a $500 lifetime credit for energy efficient home improvements; (2) a $2000 credit for residential solar or fuel cell heaters; and (3) hybrid cars now become a credit versus a deduction. Some cars will have a credit as high as $3400. The credit ends in 2010. For alternative fuel vehicles or fuel cell vehicles, credits will vary from $4000 to $12,000.
Question: Before my mother's recent death, she wanted to gift her house and some land to my sister and me. She wasn't able to complete the paperwork before she died. My CPA said that was good and that it will save me a lot of money. I don't understand.
Answer: It's called stepped-up basis. Someone dying during 2005 does not have to pay a dime of estate tax if their net assets are valued at less than 1.5 million dollars. However, you are allowed to step up the value of any inherited property to the fair market value (FMV) at date of death. use the FMV to calculate a gain or loss on the subsequent sales. This could save you a tremendous amount of capital gains tax if you sell the property soon after probate closes.
Question: I had to cash in my IRA to pay off some credit cards. A lot of tax was taken out. Now the tax return shows I owe more. Why?
Answer: Withholding is often at ten percent for the early withdrawal penalty and may not cover regular income tax. If you are in the 25 percent tax bracket and take money out of your IRA, you need to have at least 35 percent withheld to cover the regular tax and the ten percent early withdrawal penalty. The ten percent penalty is in addition to the regular tax. The most expensive place to borrow money is from your IRA; any other source is cheaper.
Question: I had to request an extension for my 2004 taxes.All my friends tell me I am going to get audited. Is this true?
Answer: No, No, No. The IRS received approximately 9 million extensions as of April 15, 2005 for tax year 2004. Last year, the IRS audited barely one million individual taxpayers out of 130 million returns filed. The IRS selects individual tax returns for audit based on ratios of deductions to income. Types of returns most often audited are returns with large business losses, large travel deductions, and deductions far in excess of income.
May, 2005 (A follow-up to our March column.)
Here are some additional ideas for success as a self-employed (independent) contractor:
- Being self-employed means you are responsible, i.e. you fired your last boss. You are the boss! Being the boss means you can't blame anyone but yourself if your business fails.
- To own a successful business today takes knowledge, determination, and dedication. Obtain as much education as possible both in your chosen field and how to run a business. Determination means working hard---not just working at your job. Dedication includes setting realistic goals and being focused on achieving them.
- Keep good records. Poor record keeping is the #1 cause of business failure. Don't become an IRS statistic, run your business for a profit. Don't look for write-offs, look for ways to make money.
Question: I just did my taxes and paid a lot more than expected. Are there any steps I can take for 2005 to cut my tax bill?
- Here are six things to reduce your taxes for the coming year:1.Maximize your 401K, SEP, or IRA contributions.
- Keep careful records of all tax-deductible payments, i.e., contributions and business expenses.
- Clean out closets, attics and basements of usable items and donate them to your favorite charity.
- Take out a home equity loan to pay off credit cards and consumer loans. The interest may be deductible.
- Keep track of mileage for charitable work, medical appointments, and non-reimbursed business trips.
- Ask your employer for reimbursement of all business and travel expenses. Remember; write-offs are rip-offs!
Question: We just had our taxes done and we owe over $5,000. We have never owed taxes before. Our accountant says it's because of my husband's new job and receiving a 1099. We don't understand.
Answer: Welcome to the wonderful world of self-employment. Your husband's new job is not a job. He is now self-employed and in business for himself. He has to pay both income and self-employment tax. Self-employment tax is Social Security and Medicare. We see this all the time with employers outsourcing jobs that were once paid via a W-2. We have 25 million businesses in the U.S. vs. 10 million in 1995. This is the primary reason why millions of Americans owe the IRS over $300 billion dollars. Our May column will follow-up with some ideas on how to deal with being self-employed.
Question: I am organizing my tax data for 2004, any tips?
Answer: Make sure all your records are complete. Many people get in a hurry and don't take advantage of the many deductions and/or credits available under the tax code. Well-organized records are a must. If your records are not organized, go through your check registers and credit card statements to identify the amounts paid for various deductions, i.e. charitable contributions, local taxes, business and education expenses, etc. Then, find the back-up material such as invoices and receipts. Every year, approximately 2 million people forego itemizing deductions for the standard deduction. This results in millions of dollars in needless overpayment of taxes.
Question: I am 62 years old and have built up a large credit card debt. I am thinking about cashing in my IRA to pay them off. Do you think this is a good idea?
- Credit card debts generally would not be deductible against your Federal income Tax.
- You are going to need the IRA money later in life to live on. At 62, it will be very difficult for you to contribute enough money and build up your IRA to its present value. You would be better off to go on a strict budget, reduce your debts and keep your money in the IRA.
Question: Are there any year-end moves I can make to save taxes?
Answer: Three items to consider this year are:
- Defer income: We expect rates to decrease in 2005.
- Clean out closets and donate those used household items and clothing to your favorite charity. you can also clean out your pantry and donate to the local food bank. Value the items at fair-market value, i.e. food at your cost.
- Consider donating appreciated stock to your favorite charity, church or university. you can get two benefits: a charitable deduction at fair-market value and avoid paying capital gains tax.
Question: The Feds enacted two new Tax Acts for 2004. Are there any new items?
Answer: Yes. Washington State residents will be able to deduct sales tax on their 2004 returns. Manufacturers and construction contractors will have a new deduction in 2005. The 1st-year deduction for 6,000 lb. SUVs has been capped at $25,000. Cars donated to charity in 2005 can only be written-off for the actual amount of the sale of the car. The IRS has been allowed to use outside collection agencies to pursue outstanding tax debts. The SEC 179 expensing of business equipment, up to $102,000 a year, has been extended through 2007. Beginning in 2005 there will be one definition of a dependant. The Acts contain 721 pages and affects 755 code sections. This is the largest change since 1997.
Question: I have five IRAs at five different banks and will be 70 1/2 next year. Do I have to take the minimum distribution from each account?
Answer: You have options, but either way, you must take the required minimum amount. It is possible to take the minimum distribution from just one bank, but the other banks must be notified of the distribution. This can be difficult to coordinate and because it is easy to lose track of multiple accounts, many folks get an IRS notice a few months later. To have a complete picture of all your holdings, our recommendation is to consolidate your investments as much as possible.
Question: I just received a substantial sum of money from a relative's estate. Will I have to pay income tax on the money? A. No and maybe. Money inherited from an estate is generally tax-free because the estate pays the tax on the value of the decedent's assets at death. You may owe tax on interest or dividend income earned in the estate's trust. This income would be reported to you on Form K-1 of the IRS Form 1041 Estate Tax Return. If you inherit an IRA, you will pay tax. However, you may be able to lessen the tax by electing to receive the money over time.
Question: I owe the IRS taxes in excess of $100,000 due to financial hardships caused by a failed business. About fifteen months ago, I paid $2,500 to a national company to solve my tax problems. I have not heard anything from them and they have not returned any of my numerous phone calls. What can I do?
Answer: We have heard of many such stories about National Offer Mills. Here are some tips on what to do:
- You should contact the Taxpayers Advocate Office of the Internal Revenue Service. The Seattle number is 206-220-6037. The IRS cannot help you recover your money, but you need to report your problem. The IRS is very frustrated with the Mills and is working hard to solve the problem.
- Report the company to the Consumer Protection Division of the Washington State Attorney General's Office.
- Contact our office for names of local attorneys who may be able to assist you.
Question: Is it my imagination or has preparing my tax return become more complicated the last few years?
Answer: No, you're right. Preparing a tax return has definitely become far more complicated and time consuming. The preparation time for an average tax return, as estimated by the IRS, has increased 19% to 27.5 hours from 1998 to 2003. Congress enacted 7 major tax acts in 1996, 1997, 1998, 1999, 2001, 2002 and 2003. Roughly three hundred thousand words have been added to the Internal Revenue Code, that now totals 2.8 million words. Is it any wonder why over 60% of taxpayers, a record number, sought the advice of paid preparers during the 2004 tax season?
Question: I am retired and hold a real estate contract on land I sold several years ago. The interest rate is 9%. The buyer has told me he plans to refinance at a lower interest rate. Can I do anything? I need the income.
Answer: Yes. Contact the buyer and offer him a lower interest rate. You will receive a much higher interest rate than what the banks are presently paying. The buyer saves appraisal and loan fees. The real estate contract or note can be amended by mutual agreement. An escrow company can handle the transaction. This usually works out to save the buyer money, and the seller doesn't get hit with the full capital gains tax all at once.
Question: If I file an extension, will I get audited or penalized by the IRS?
Answer: The answer is No and No. Tax returns are selected for audit based on the ratio of income to deductions. Filing an extension has nothing to do with a return being selected for audit. The IRS will not penalize you if you are late and due a refund. There is an economic penalty by not having use of your money. Most high-income taxpayers with complex returns file extensions. Currently the IRS estimates that 8.5 million taxpayers have requested extensions for their 2003 return.
Question: I don't have enough money to pay my taxes this year. Someone told me if I file an extension, I could delay sending the IRS any money.
Answer: This is one of the great urban myths. You must pay by April 15th at least 90% of any tax due in order for the IRS to grant you an extension. Extensions (use Form 4868) only extend the time to file your return until August 15th. If you don't pay at least 90% of the tax due the IRS can assess failure to file penalties of 25% on all tax shown on the return. Therefore, you can save money by timely filing a return. If you owe, ask the IRS for an installment agreement. You will avoid substantial penalties.
Question: Why are so many of my 1099s from brokerage houses and mutual funds late this year? Why were several of them corrected after the due date?
Answer: The 2003 Job and Growth Tax Relief Act lowered the tax rate on long-term capital gains and qualified dividends to 15 percent. The new capital gains rate was effective for sales after May 5, 2003. Dividends had to be from stock that had been held 60 days during the 120-day ex-dividend date. This means that the securities industry is having difficulty determining qualified dividends and capital gains. The 15 percent rate has created a tremendous tax savings for many taxpayers. We recommend you be patient and wait until late March before finalizing your tax return, especially if you had a number of stock transactions or own several mutual funds.
Question: I set up an LLC last year for my business. I am a sole proprietor with no employees. The IRS sent me a penalty notice for $300 for failure to file Form 1065 (Partnership Return). Why?
Answer: LLCs for most small businesses are great for protecting your personal assets and operating under limited liability. When you applied for your LLC through the State of Washington, you probably were told to send in the IRS Form SS-4 to request an Employer Identification Number (EIN) and marked the box 1065 for a partnership. However, if you are a sole proprietor with no employees and file a Schedule C or if you have rental properties and report them on a Schedule E that attaches to your individual tax return, you do not need an EIN. In Washington, a community property state, a married couple can file a Schedule C, E or F with their 1040 for jointly owned property. No other return is necessary. If you don't need the EIN, write a short letter of explanation to the address on the penalty notice and ask them to remove your EIN from the 1065 classification.
Question: I am starting my own business this year. Any tips for a newcomer?
Answer: Here are three ways to fund higher education:
- Write a good business plan. If you don't know how, take a class before you invest a nickel.
- Check the competition. This should be the primary part of your basic marketing research.
- Secure adequate capital. Under-capitalization is the major cause of failure.
- Once you start your business, run it by the numbers. Make sure you have a good record keeping system that provides you current and accurate data. This is the only way you will know if you are meeting your goals.
- Be prepared to work at least 60 hours a week and prepare your family of the long hours that are required to be successful in business today.
The number of self-employed individuals is rising at a staggering rate. From 1995 to today, the United States has gone from 11,000,000 businesses to over 24,000,000. This pace will continue because of out-sourcing by major corporations. By 2008, one in every three Americans will be self-employed.
Question: What year-end tax moves should I make?
Answer: For the average taxpayer who owns a home, the best last minute deductions always are to donate to your favorite charity or local food bank. Donations can be either in cash, by credit card or goods. Cleaning out your closet, attic, pantry or garage can yield a substantial tax deduction. Check out www.satruck.com/valueguide.asp for a list of valuations to use for clothing, appliances, household items and furniture. It's best to take a photo and get a receipt for all donations made. Particularly worthwhile are donations of old glasses and hearing aids to the Lions Club. If you donate large amounts of goods, you can purchase either a book or software at www.itsdeductible.com that has a very complete list of values.
Question: I recently refinanced my house for the second time in two years. What items can I deduct?
Answer: You can deduct the points and refinancing fees that you paid at closing. The fees must be amortized over the life of the loan, normally at 15 or 30 years. If you refinanced prior to December 31, 2002 and again in 2003 you can write off the balance of the old loan fees. If you used the money to remodel your house to the extent the money was used for upgrading and remodeling you can write off the fees in full the year the work is done.
Question: With the ever-increasing costs of higher education, what are some tax advantage ways to set aside money to fund my children's education?
Answer: Here are three ways to fund higher education:
- 529 Plans. These plans allow you to set aside the largest amount of money at one time; up to $55,000 per individual or $110,000 for a couple. Grandparents fund the majority of these plans. For complete information regarding the 529 plans access: www.savingforcollege.com
- Coverdell Educational IRAs. Taxpayers can set aside up to $2,000 per year per beneficiary and the money accumulates tax-free. There are income limits and other restrictions. The $2,000 is not a tax-deductible item.
- U. S. Savings Bonds. The accumulated interest income is exempt from taxation if used to pay for higher education. There is a phase out of exemptions if your adjusted gross income is between $87,750 and $117,750. Thereafter, no exemption is allowed. There are many complex rules with all of these items. Do your homework before you invest.
Question: My two older children will soon be heading back to college. Are there any special tax breaks? A. Yes, there certainly are. If you pay your son or daughters tuition and claim them as your dependents you can claim up to $1,500 per student for the first two years of school under the Hope Credit and $1,000 per student for the Junior year and beyond under the Life Time Learning Credit. You can take the Life Time Learning Credit for yourself if you are going back to college and taking postgraduate work. The only limitation is your income. If you are married, filing jointly the credit ends at $103,000. If you make between $103,000 and $130,000 there is a $3,000 special education deduction available which was new in 2002.
Question: With dividends now taxed at 15% by the 2003 Tax Act, are there any special moves that I should make?
You should know that the changes only apply to regular corporation dividends. Items that do not qualify as dividends are: interest from money market accounts, credit union dividends, bond funds, S-Corp distributions, most R E I T distributions, some dividends from foreign corporations, and retirement account distributions. Stock mutual funds can have both regular and non-qualified dividends.
- Radically changing your portfolio to take advantage of the lower 15% tax rate is not recommended. Strong consideration should be given when making a new investment to stocks that pay a good dividend. At this time it would not be a good idea to shift your portfolio to all dividend-paying stocks.
- If you are a shareholder in a small C-Corp that generates substantial profits and you have been taking large bonuses, you should consult with your accountant. You should consider taking some portion of that income in dividends. However, corporations must pay corporate tax before dividends can be paid.
Question: My mother who is over 65 and receives most of her income from Social Security was told she did not have to file a tax return for 2002, how can that be?
Answer: If she is over 65 and her income from other sources: interest, dividends, capital gains and pension (other than Social Security) do not exceed $8,900 she would not need to file. For a married couple both over 65 there is a new a $9,500 standard deduction, income would need to exceed $17,500 before it's necessary to file. This does not count Social Security. Social Security generally is not taxable unless you have substantial other income. Each year the Internal Revenue Service receives millions of tax returns from seniors who do not need to file. What is most confusing is how Social Security is taxed. You must have substantial other income along with half of your Social Security in order for any Social Security benefit to be included as taxable income.
Question: President Bush signed the new tax act on May 28, 2003. Should I change my withholding?
Answer: Do the numbers. There are many changes in the new 2003 Tax Act---not just lower tax rates. Capital gains, dividends, child credit, and marriage tax penalty relief are the major changes. You can go to one of several financial web sites that have projection worksheets. Some charge a small fee. The complexity of the new tax act requires projecting your 2003 tax before making any changes to your withholding. You should project your 2003 tax first using the new tax rates. Then compare it to your 2003 tax withholding. New lower withholding tables take effect in July, so before changing your withholding exemptions, you may want to wait until your first paycheck with the new rates. If your income will be over $200,000 you should have a CPA prepare a 2003 projection.
Question: Both my kids are in college, and have summer jobs. Should they claim exempt on their W-4?
Answer: Yes, if their total earnings from wages and other sources for the year do Not exceed $4,750. Each year the IRS receives millions of tax returns with no tax due and requesting a refund. A student should check the amount of standard deduction for a single person against his income to see if he need to file. Therefore, if you're a student and your total income is less than $4,750 for 2003, mark exempt on your W-4. Your employer will not have to withhold any income tax and you will not need to file a return.
Question: Since this is April 15th, it seems appropriate to list our three favorite tax-saving ideas.
- General: Every taxpayer should use some type of deferred retirement account. This can be a 401K, 403B, Deferred Comp, (Tax Shelter Annuity), a Regular IRA, Roth IRA\SEP\ IRA or Simple IRA. Not only will you save on your current taxes but you also provide for your future retirement.
Businesses: Make sure your accounting records are accurate, complete and timely (only one out of two businesses meet the standard). The work and jobs credits afford the best means to save on income tax. The Employment Security Department at 1-800-669-9271 can provide information.
- Individuals: Donate used serviceable items to your favorite charity. Our particular favorites are glasses and hearing aids to the Lyons Club. We recommend looking at www.itsdeductible.com for contribution values on just about everything from clothing to kitchen items to toys.
Question: I have had the same tax accountant for many years. He is getting old, somewhat forgetful, and doesn't seem to be keeping up with the new tax laws. I really need to change, however, I'm afraid because I know the IRS will audit me.
Answer: This is one of the greatest myths of them all. The IRS, except for the most extreme cases, does not track preparers. The IRS has almost no interest in who prepares your tax returns. Tax returns are chosen generally for audit based on ratios of income to deductions. You should feel free to seek a tax professional who most aptly meets your needs. If you have many complex transactions, you need someone who has experience and is certified through both education and special training such as a CPA. The key to knowing if the person you have selected is right for you is if they ask questions pertinent to your particular situation.
Question: I have asked my employer to change my withholding by signing a new W-4 and each time the amount withheld gets lower and lower. I don't understand. I want to have more withheld not less.
Answer: This is a common problem. Many people don't realize that in order to increase the amount of withholding, they have to claim fewer exemptions. For example, if you are paid every two weeks, make $1,200, are married and claim four (4) exemptions, your employer should withhold $48. However, if you change your exemptions to zero (0), your employer would withhold $118. A lower number of exemptions claimed means a higher amount of tax is withheld. Many people are confused about this issue and it is one of the leading reasons why average taxpayers owe the IRS. You can elect to have more tax withheld at the higher single rate, even if you are married.
Question: Are there any principles or traits that distinguish successful business people?
Answer: I found there are three common traits that all successful business people seem to share:
They run their businesses by the numbers. They have good systems to provide critical numbers to measure progress and set realistic goals.
They focus on what they do best. They don't try to wear multiple hats. They stay focused on tasks that make their business successful. They don't try to become an expert in everyone else's field.
- They never quit learning. They are always reading journals, taking courses, or listening to tapes.
There is always something new no matter what your field. Successful business people stay ahead of their competitors by always reading and learning.
Question: I just received a letter from the IRS. It says that my wages and bank accounts will be levied unless I pay the balance due. It also says that they are going to file a lien. I Don't have the money to pay them; what should I do?
- First, call the IRS and request some additional time.
- If you haven't already done so, file all tax returns. Your tax returns must be current through the year 2001.
- Depending on the balance owing, you can request relief through an Installment Agreement, Offer in Compromise, or other agreement.
You must contact the IRS and request relief. The kinder, gentler IRS is gone, the new computer systems are working hard to collect past-due taxes. However, if you call the IRS and explain your situation, usually you can make a deal to resolve the problem. Remember, if the IRS files a lien, it can affect your credit rating.
Question: I just received a letter from the IRS. It says that my wages and bank accounts will be levied unless I pay the balance due. It also says that they are going to file a lien. I don't have the money to pay them, what should I do!
- First, call the IRS and request some additional time.
- If you haven't already done so, file all tax returns. Your tax returns must be current through the year 2001.
- Depending on the balance owing, you can request relief through an Offer in Compromise, installment or other agreement.
You must contact the IRS and request relief. The kinder, gentler IRS is gone...the new computer systems are working hard to collect past-due taxes. However, if you call the IRS and explain your situation, you can usually make a deal to resolve the problem. Remember; if the IRS files a lien, it can affect your credit rating.
Question: My accountant had me pay a considerable amount of income tax for 2001. I had "0" in my business bank account at year-end so I do not understand why I had to pay any taxes.
Answer: Just because you empty your bank account at the end of the year doesn't mean that everything you wrote checks for is deductible for income tax purposes. You're running your business on what is called "checkbook management". This is the fatal mistake of most small businesses. If you're not a corporation and you took draws out of your business checking account to pay personal living expenses, the draws are not deductible. Further, if you bought equipment it must be depreciated over a period of time, normally 5 years. There is First Year Bonus Depreciation of $24,000, provided you have enough income. You should meet with your CPA before year-end to make sure your accounting records are up to date and accurate, then you and the CPA can prepare a year-end tax plan to avoid any surprises come April 15th.
Question: I'm earning more than $200,000 at my job. I just received a $10,000 fee for consulting work from another company. Are there any planning techniques I can use to lower my tax bill?
- The $10,000 will go on a Schedule C of your 1040 since you are a self-employed, independent contractor. You can deduct expenses such as computer fees, office supplies and travel costs directly connected with earning the $10,000.
- You should set up a Simple IRA. You can deduct up to $7,000 ($7,500 if you are over 50) plus 3% of your net Schedule C income. A Simple IRA must be established before October 1, 2002 at a financial institution.
Question: How long do I have to replace the rental house that I just sold to avoid paying any tax?
Answer: Once the sale transaction is finalized you must report the sale in the current year and pay any capital gains tax. This applies to single-family dwellings as well as apartment buildings. You may elect to do a 1031 Exchange prior to the closing of the sale. However, you have only forty-five days to identify a replacement property and 180 days to complete the transaction. A 1031 exchange facilitator must handle all funds. See a tax professional to calculate the capital gains and advise if a 1031 Exchange is appropriate.
Question: My teenage daughter took a summer job and will earn $3,000. What should we put on her W-4?
Answer: If your dependent child takes a part-time job and will earn less than $4,700, put "exempt" on line 7 of the W-4. Their employer will not withhold income tax and they will not have to file a tax return. You will still be able to claim them as a dependent and claim the $3,000 deduction.
Question: I just received a bill from the IRS asking me to pay income taxes for 1996. I was married to my former husband then and our divorce decree said that he was responsible for all our back taxes. Can the IRS collect from me?
Answer: Sadly, the answer is yes. If you were married and filed a joint return, the IRS generally looks to both parties to satisfy any unpaid taxes. The IRS is not bound by any divorce decrees issued by a state court. The IRS basically has ten years from the date it assessed to collect the tax. The assessment date is normally a few months after you send in your tax return. If you received a bill from the IRS, it is best to contact them and see if you can work out some kind of payment arrangement. You may be able to qualify as an innocent spouse and under a special rule, you may only have to pay the tax applicable to you.
Question: I lost a large amount of money in my IRA account last year because of the stock market downturn. Can I write the loss off on my taxes?
Answer: No. Unfortunately, many people lost substantial amounts of money since the 2000 stock market downturn. Losses on investments in Individual Retirement Accounts (IRAs), company sponsored 401(k) plans and other retirement accounts are not deductible on neither individual income tax returns or as a business expense.
Question: Will the new 2002 Tax Act affect my 2001 tax return?
Answer: Maybe. On March 9, 2002, President Bush signed the Job Creation Work Assistance Act of 2002. The major item that relates to individuals is the extension of unemployment benefits by an additional 13 weeks.
- For businesses, there is a new 30% first year bonus depreciation provision retroactive to September 10, 2001. If a business bought equipment and has already filed its tax return for 2001, it may want to file an amended return.
- There is a new five-year net operating loss carry-back provision. It is effective for the 2001 tax year. Returns may have to be amended to take advantage of this benefit.
- The bill extended many credits such as: electric cars, alternate forms of energy and work credits.
- Beginning in 2002, classroom teachers can deduct up to $250 above the line for out-of-pocket purchases of classroom materials.
Question: What if I don't have enough money to pay my taxes on April 15th?
Answer: First of all, always file your tax return even if you don't have enough money to pay the IRS There are several options available to taxpayers who can't afford to pay their income taxes on April 15th.
- Request an "Installment Agreement" that enables you to make monthly payments.
- Make your payment with a credit card.
- Borrow the money to avoid paying both penalties and interest to the IRS
- If you are truly destitute, request a "Relief" from the IRS. A no-pay request can be granted for a year.
- File for an "Offer In Compromise". If accepted, it will reduce the amount of tax due.
- Whatever you do, ALWAYS FILE your tax return. By not filing, you'll accrue penalties and interest, making your situation worse.
*Most of the above requires the filing of additional detailed financial information.
Question: We had damage to our home as a result of the February 28, 2001 earthquake. How do we claim the loss on our tax return?
Answer: Under the Internal Revenue Code, earthquake damage is classified as a casualty loss. You need to file an IRS Form 4684. There are two catches to calculating the amount of damage:
- The loss must exceed 10% of our adjusted gross income.
- The loss is calculated based on the difference between the fair market value of the property immediately before and immediately after the earthquake.
This is often very difficult to calculate. If you received money from FIMA, it reduces the amount of your loss.
Question: How do I qualify for the new 8% Capital Gains Rate?
Answer: The 8% Capital Gains Rate became effective January 1, 2001 for taxpayers in the lowest (i.e. 15%) tax bracket. You must have held the stock, security or capital asset for at least five years. For 2001, the 15% rate applies to taxable income of $45,2000 for a married couple and $27,050 for a single person. Taxable income is computed after all deductions and exemptions.
Question: What year-end tax moves should I make? A. For the average taxpayer who owns a home, the best last-minute deductions are to donate to your favorite charity. Donations can be either in cash, by credit card or goods. Cleaning out your closet can often yield as substantial tax deduction. Check out www.satruck.com/valueguide.asp for a list of valuations to use for clothing and household items. It's best to take a photo of and get a receipt for all donations made.