May 22, 2013

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Divorce and the Tax Consequences: Watch Out!

May 9, 2013 By

Divorce can be devastating and a hard blow to accept, as life changes drastically. You can divorce multiple times in a lifetime, but you can never “divorce” Uncle Sam. You have to therefore, pay attention to tax implications to as you split assets with your former spouse. Keeping an eye on financial changes and how they may affect your stakes can guard you from risky confrontations with the IRS.

Are You Single or Married?

The IRS would be interested to know your marital status when filing tax returns; either single, married, or divorced. If the divorce is not settled by the end of the year, you may still be considered as married and you can claim tax deductions by showing your household expenses. Example; if you pay 50% of the household expenses lived separately from spouse for 6 months of the tax year and if you have a dependent child that has stayed with you for over six months, you are eligible for some deductions.

Children-Related Tax Exemptions

Children-related deductions can contribute to huge tax savings, but it depends on the person who has custody. In case a child has stayed with you for a period of more than half a year, you are eligible for tax exemptions, with a current write-off set at 3,700 USD per child. Cash in form of alimony is considered to be valid for tax exemption for the person who is making the payment and treated as income for the recipient. Child support is not liable for deduction or as an income for the recipient.

Retirement accounts:  

IRAs are important settlements during any divorce, the spouse may get the entitlements to part of the other spouse’s IRA plans or employer sponsored IRAs. For the 401(k) or other employer sponsored plan, the benefits may be shared from a spouse’s plan and help save from potential taxes. Alternatively, rolling of 401(k) IRAs into your own IRA may be possible and the best way to evade paying taxes on them. It must be pointed out that making early withdrawals from retirement plans will attract IRS taxes and penalties.

Property Transfers

Any property that changes hands during a divorce settlement is not considered as a capital gain or loss, and therefore, taxes are also not levied on property transfers. However, in the event that the recipient wants to sell the property, then taxes will eventually set in. Such property transfers are valid only if they are completed within a year of legal termination of marriage.

Community Property

The divorcees are liable to tax return on the income of the other spouses (however this is not the rule in community property states such as Arizona, Texas and Wisconsin). In these states, you will be considered to have earned from the income of the former spouse during the year of divorce.

Divorce can complicate your lifestyle and almost all aspects of your life, including taxes. Whichever decision you make during this process, don’t forget to think about the tax consequences. Visit the IRS website or talk to a tax pro if you are unsure on how you will be affected by a divorce. 

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Income Tax Terminologies You Should Understand

May 1, 2013 By

Finding your first job is exciting. As you work on your budget and plan how you to spend your very first paycheck, it is also inevitable that you try to understand some common terms and phrases that revolve around your income, earnings, investments, tax payments, etc. To get you started, some of the common terms, especially for your tax purposes, are:

Gross Income: This is the total income from all the resources before any tax deductions are made. This is very important, even during salary negotiations.

Total Income: This is a rather confusing term to most taxpayers. According to the IRS, total income is the earned and unearned money prior to legislative adjustments, personal deductions or exemptions. This is perfectly explained on line 22 of Form 1040. Total income differs from gross income in that total income is inclusive of net income (from business) after expenses.

Adjusted Gross Income: Abbreviated as AGI, it is the total income excluding certain adjustments that are above the line deductions such as moving expenses, alimony, IRA contributions and student loan interests etc. Adjusted gross income is defined on line 37 of the IRS Form 1040.

Taxable Income: Taxable income is the amount that is obtained by subtracting deductions and personal exemptions from AGI. The taxable income is reported in Form 1040 on line 43.

Tax Rate: This is simply the rate at which tax is applied. In the progressive tax system, the tax rate is constant compared to flat rate. This means that if your income increases, say by 10%, your tax rate will equally increase by same ratio. When a taxpayer is placed in a higher income tax bracket, the tax rate progressively increases.

Effective Tax Rate: Effective tax rate for individual taxpayers is the mean tax rate paid. Dividing the taxable income with sum of self employment tax, FICA taxes paid and income tax gives an average value up on which effective tax rate is calculated.

Total Tax: The amount of tax paid together with house hold tax, employment tax, SE tax and other taxes is called total tax. Total tax is well defined on line 61 of the IRS Form 1040.

Tax Due: This is the total amount of money that is yet to be paid to the IRS after all the deductions have been made. It is best explained on line 76 of the 1040.

There is a lot of confusion, contradictions, and controversy about these terminologies that very few people are confident enough in their understanding of them without checking the glossary on IRS website. You can also save yourself the headache by familiarizing yourself with these terms. If you are unsure of their complete meanings, talk to a tax professional for assistance.

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Should You or Should You Not Amend Tax Returns?

March 18, 2013 By

The IRS allows taxpayers who discover errors on their tax returns after filing to amend such returns. But before making the amendments, there are some important considerations the IRS would like you to keep in mind.

The main reasons you may have to revise your tax return include incorrect or omitted filing status, number of dependents, total income, tax credits, and tax deductions.  Other reasons are contained in the instructions.

Amending tax returns may perhaps not be compulsory, as there are times when you really may not have to. Simple math errors are automatically corrected by the IRS; you therefore, don’t have to make amendments. Other instances include when requesting for missing forms like the W-2 or schedules during tax processing.

Use the IRS Form 1040X-Amended U.S. Individual Income Tax Return to revise the IRS Forms 1040A, 1040, 1040NR, 1040EZ, or 1040NR-EZ. Make certain that the tax year return you are revising is accordingly marked on the 1040X. Note: You cannot file an amended tax return electronically, it has to be done manually and mailed.

In case you are amending returns for more than one year, use separate Form 1040Xs for each return. Put every one of the amended returns in a separate envelope and mail them separately to the proper IRS tax return processing center. Refer to the instructions on the 1040X to find out where to mail them.

The IRS Form 1040X has three columns; column A indicates the figures as they appeared in the original tax return, column B is used to show the changes you make and column C shows the corrected figures. Behind the form is a section that explains the particular changes and why they should be changed.

If any of the changes affect other forms or schedules, make certain that the affected forms are attached to the 1040X. Failure to do this may possibly holdup the processing of your tax return. If the amendment you are making is for additional tax refund, just wait for the original refund before going ahead with the amendments; cash the check and wait for the extra refund. Remember that you have to make amendments within three years from the date the original tax return was filed or two years from the date the tax was paid, either that is later to claim any refund.

Finally, amended taxes are normally processed in between 8 to 12 weeks. Before amending the tax return, you may want consult with your tax professional on the best thing to do.

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Tax Consequences of Getting Married

March 11, 2013 By

It feels amazing to finally tie the knot with the love of your life. Marriage changes important statuses in your life, including your tax filing status, that changes to either married filing separately or jointly. Most weddings take place in summer and late spring but as you say “I DO” and speed off to your honeymoon, think about the following tax consequences.

Change of Name: You must promptly inform the Social Security Administration of any name changes, especially if you are dropping your last name and acquiring your spouse’s or adding your spouse’s name to your current name. To do this, file Form SS-5, Application for a Social Security Card that is available for download from the SSA’s website. You can also call or visit the nearest SSA office for help.

Relocation and Address Change: Since you must stay as husband and wife under one roof, one or both of you may move to a new residence. As you move, don’t forget to alert the IRS about the change of address; use the IRS Form 8822-Change of Address. You risk missing out on future IRS correspondence, some that might have some serious tax consequences, if you fail to notify them. You must subsequently inform the U.S. Postal Service and provide a forwarding address. This can be done online or by visiting the nearest post office.

Alert Your Employer: Inform your employer of any name and/or address changes. This will guarantee that you get the IRS Form Form W-2, Wage and Tax Statement at the end of the year with appropriate details.

Withholding: If both you and spouse receive taxable income, combining your income might push you to a different and higher tax bracket. To establish the right withholding amount based on your new marital status, use the IRS Publication 505-Tax Withholding and Estimated Tax. This will also go a long way in enabling you to fill Form W-4-Employee’s Withholding Allowance Certificate. This form can be filled online, printed, and given to the employer(s) indicating the right amount to be withheld monthly from your paycheck.

Form Selection: You must carefully choose the IRS tax forms as they may help you save some extra bucks. You possibly will find it appropriate to claim itemized deductions than standard deductions because of the combined incomes. Use Forms 1040, 1040A, and 1040EZ to claim itemized deduction.

Finally, carefully choose your filing status, either jointly or separately. In most cases, joint filing is preferred, but vary from one case to another-choose one that saves you money.

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Why You Need to File Your 2012 Tax Return

March 4, 2013 By

The IRS expects all individuals who earned any form of income in 2012 to file tax returns in 2013. This will however, depend on various factors like your age, the amount of income earned in 2012, the received income type, as well as the filing status. Even though you may not be required to file, you still might find it beneficial to go ahead and file. Filing a tax return makes it possible for you to claim some tax credits you are eligible for or even refunds if too much federal income tax was withheld from your pay by your employer.

Discussed below are five main reasons you might still find it necessary to file the annual return even if you are not obliged to.

1. Claim Refunds: Did you make any estimated tax payments? Was your federal income tax withheld by your employer? Did you have a tax overpayment the previous year that applied to the current year’s tax? If you answered yes to any or all of the above questions, then you sure will want to file your return to claim a refund from the IRS.

2. The EITC: You might be eligible for Earned Income Tax Credit if you earned less than $50,270 in 2012. This is reimbursed tax credit given to eligible taxpayers as a tax refund. Furthermore, you can be entitled to up to $5,891 if you have qualifying children. To claim this credit, you must file a tax return; find out if you qualify by using the EITC Assistant.

3. Health Coverage Tax Credit: To meet the requirements for this credit, you should be receiving payment benefits from the pension benefit guarantee corporation, alternative trade adjustment assistance or the reemployment trade adjustment assistance. Eligible taxpayers can get a 72.5% tax credit of the amount paid for your qualified health insurance premiums. Dependents and spouses can also qualify.

4. American Opportunity Credit: Are you, or do you support someone who is a student? The American Opportunity Credit is a partially refundable credit that benefits students in their first four years of post secondary education. You can get up to $2,500 via this credit, and even if you don’t owe any taxes, you may be eligible for as much as $1,000 for every qualified student. To claim, file the IRS Form 8863, Education Credits which should be submitted alongside the tax return.

5. The Extra Child Tax Credit: Parents with not less than one eligible child but don’t receive the complete value of the Child Tax Credit can be eligible for the extra refundable credit. To claim, file the new Schedule 8812.

For a comprehensive list of all income tax filing requirements, visit the IRS website. At the site, you will find filing requirements and guides on how to file crucial IRS tax Forms 1040, 1040A or 1040EZ.

 

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Top Five Tax Day Mistakes You Have to Avoid

January 15, 2013 By

Tax Day can be stressing, especially to the procrastinators who only remember to file their taxes on the due date. The intense last-minute pressure is a recipe to commit some avoidable mistakes, some that could trigger trouble with the IRS.
1. Failure to Meet the Deadline: Capital One’s 2012 Taxes and Savings Survey indicates that 11% of taxpayers wait until the last minute to begin filing taxes. As a result, most of them totally miss the deadline. In the event that you cannot meet the deadline, submit an IRS Form 4868, which automatically grants you a six month extension to file. Use the extension to evade penalties as well as avoid the last-minute errors on your returns.
2. Ignoring Electronic Filing: In 2012, close to 100 million taxpayers filed their returns electronically using e-file in 2012 according to the IRS. Paper filing and manual calculation are tedious and contribute to a huge chunk of tax return flaws. E-file is designed for taxpayers with an AGI of $57,000 or less. E-filers are also eligible to receive their refunds through direct deposits and the refunds can be received in less than 10 days and not weeks, as it is the case with paper filing.
3. Math Blunders: Math errors are among the most common flaws the IRS reports annually. These mistakes can best be spotted and corrected when using tax software. Electronically filed returns have less than 1% error rate as opposed to a whopping 20% mistake-rate contained on paper returns.
4. The Audit Stress: No one wants to be audited by the IRS, but there is no reason to fret at the idea. It must however, be pointed out that the IRS only audits a small number of taxpayers. With 70% of taxpayers with an AGI of $57,000 or even less, the chances of an audit are really slim. In 2011, only 1% of taxpayers earning less than $200,000 were audited, with 3% for those who earn more than $200,000, and 12% for taxpayers with income exceeding $1 million.
5. Failure to File: An estimated 7 million Americans (which translates to 5% of taxpayers) do not file their tax returns. Reasons for not filing vary, ranging from lower income that doesn’t meet the set threshold or even laziness. Some find the process tedious or complicated. The fact is, the moment you fail to file your returns, you attract serious IRS penalties. You may also be losing a lot of possible refunds. In 2008, more than $1 billion of unclaimed refunds was held by the IRS.

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The New ITIN Changes Earmarked for the 2012 Tax Filing Season

January 8, 2013 By

The IRS Tax ID number, the Individual Taxpayer Identification Number (ITIN), is usually issued by the IRS to taxpayers who don’t qualify and don’t have a Social Security Number. The ITIN, just like the SSN, is used on the tax returns during filing as well as other related transactions. In a number of cases, this number is used for spouses or dependents of an individual with a Social Security Number. However, it can also be used by foreign nationals or nonresident aliens to enable them file their returns just like other taxpayers.
To apply, a Form W-7 is used and should be submitted alongside a number of very specific original documents or copies that have been certified by the issuing authority. Earlier, the IRS issued interim regulations on the exact documents required as well the copies that have to be certified by the issuing agency to be submitted alongside the application. The use of notarized copies has permanently been scrapped and will no longer be accepted.
Aimed at simplifying the whole application process but at the same time, safeguarding the integrity of the ITINs, the IRS says it consulted relevant stakeholders as well as the taxpayers on the effectiveness of the new rules. Some notable changes include the five year limitation for every ITIN issued. Upon the expiry of the number, taxpayers will be free to reapply or renew their numbers with the IRS.
Most of the document verification is handled by the Certifying Acceptance Agents (CAAs), who will now be expected to authenticate the legitimacy of the documents supporting an ITIN application. They will also be required to meet new standards and face stronger due diligence. There are however, a few exceptions to the new documentation requirements, including military spouses, their dependants, and nonresident aliens who only require the ITIN.

To avoid any confusion and occasions when applications are rejected by the IRS for failing to meet set requirements, those intending to apply for ITINs are therefore, encouraged take a look at the IRS website ahead of time.

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The History and Story Behind the April 15th Tax Date

December 13, 2012 By

The annual tax filing deadline has always been April 15th, at least for as long as most current taxpayers can remember. But whenever this date falls on either a Saturday, Sunday, or a federal holiday, the deadline is pushed to the next business day. This means that if April 15th lands on a Saturday, you have the whole weekend to review your returns and file by the set deadline.

In 2012, April 15th was on a Sunday and taxpayers could have filed their returns by the following day, Monday 16. But luck was still in favor of procrastinators. Monday was also a holiday in the District of Columbia, Emancipation Day. This was good news, as a federal statute enacted many years ago automatically makes holidays observed in the District, nationwide. Since the Tax Day was coinciding with this holiday, as was the case in 2007 and 2011, the deadline for filing was further pushed to the following business day which was Tuesday the 17th April.

This however, doesn’t change the April 15th Tax Day for future years. Have you ever wondered how someone singled out April 15th and made it America’s most loathed day of the year? Initially, tax filing deadline used to be March 1st, which was established on the ratification of the 16th Amendment on Feb 3, 1913. This is the Amendment that authorized the income tax.

To ensure that taxpayers got used to the new and somehow “annoying” income tax idea, Congress chose to grant taxpayers a whole year and a few weeks. On the enactment of the Revenue Act in 1918, the deadline was moved to March 15th through a provision in the law. It was in 1955 when the current April 15th tax filing deadline was enforced through yet, another revision of the tax code. Ever since, the day has been the most stressful and disliked day of the year to many taxpayers.

Coming to think of it, this wasn’t such a bad idea after all. Stashing the Tax Day deep in the calendar year provided the IRS with sufficient time to work on tax returns. Another reason for the April 15th date is attributed to the fact that more middle class Americans were in their mid-50s then, and government was required to issue more refunds. This meant that the government could hold on the money for as long as possible. What a smart move it was, and to date, every taxpayer dislikes the Tax Date like a plague, only that it cannot be evaded.

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Early Tax Return Filing Tips

November 13, 2012 By

Taxpayers can reduce their tax obligations annually through early preparation and understanding of important tax deductions they can claim. Late filing of taxes only results in avoidable interests and penalties. If you couldn’t meet the April deadline and filed for an extension, try to ensure that you successfully file your return before the October 15th deadline. For successful and stress-free filing, find all necessary IRS forms like the W-2(s) and Form 1099 for investment income or contract payments early enough. Get the 1099-G if you receive any unemployment benefits, since they are taxable.

You must report all tips received in the previous month to your employer on Form 4070 if they exceeded $20. The IRS is strict when dealing with tax filing mistakes. You must review the tax return before sending. Keep your eyes open for any tax deductions that you qualify for to cut your overall tax bill. To avoid penalties and interest charges, send the forms before midnight of the deadline (April 15th or October 15th annually) and if you are posting, ensure that the date is post marked on the envelope. Use the Free File program if your AGI was $57,000 or less; it is faster and safer.

If you ended up with a high payroll withholding and as a result, a much bigger refund, or you owed Uncle Sam more because of insufficient withholding, don’t forget to adjust your future withholdings to avoid a similar occurrence. You must then, embark on reducing the following year’s tax bill. Review miscellaneous expenses if they are more than 2% of the AGI if you itemize. For itemized medical expenses, ensure that they exceed 7.5% of your AGI.

Taxpayers are encouraged to prepare for disasters by making necessary storm and financial preparations plus a comprehensive inventory of their belongings. Even though the IRS may postpone the tax filing period as a result of hurricanes and other disasters, you must prepare well and find out any special treatment you may be entitled to if you become a victim. Tax preparation takes time and you can only minimize mistakes on your return if you allocate sufficient time to effectively prepare taxes.

Procrastination affects many taxpayers and its consequences are higher cases of tax return mistakes, overlooked deductions, and even penalties and interests. Taxpayers are encouraged to utilize e-filing, since it is more efficient. If you are eligible, use the Free File option on the IRS website. You can choose to hire a tax preparer to help you preparer the taxes effectively.

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Research Reveals that Late Tax Filers Pay More for Services

November 6, 2012 By

A research survey conducted by a leading online consumer research firm reveals that taxpayers who prepare their tax returns after February pay much more than those who prepare their tax returns in January and February. This research goes a long way in encouraging taxpayers to plan and prepare their taxes early so as to pay less for the preparation services.
Average Costs of Tax Preparation Services

According to the research, the following are the average costs that Americans pay for their tax preparation:
• $54 for taxpayers who opt to use tax preparation software
• $60 for taxpayers who use tax preparer websites to prepare and file their tax returns
• $266 for those who employ the services of an accountant or a licensed tax preparer to file their returns

Costs of Early Filers versus Late Filers

From the research, it was noted that those who prepare their tax returns in March pay on average $163 as compared to those who file in the earlier months who pay on average $87 for their services. This means that on average, taxpayers who file in March pay almost twice as much for the preparation services.

Why Late Filers Pay More

There are various reasons as to why those who file towards the deadline will end up paying much more than those who file early:
• Accountants – Usually, those who file late opt to have their tax returns prepared by an accountant so as to beat the deadline. The pressure of the deadline will have many opting for an accountant as opposed to going for the cheaper options of software or preparer websites. Besides this, most tax preparers will offer discount offers for those who file early while at the same time charging a premium for clients who sign up for an appointment in March. This translates to more costs for those filing late.
• Discounts – Another reason as to why early filers pay less is because there are larger discounts offered by tax software companies in the earlier months than the discounts offered in March. Besides this, statistics shows that about 40% of taxpayers who preparer their taxes in March will not look for discount coupons and thereby paying the full amount due to the tax deadline pressure.

How to Avoid Paying More

From the above research, it is clear that avoiding the rush time will save you money. Besides saving you money, seeking tax services in March or April can be quite hard as most preparers are already fully loaded with work.

If you are not able to make it to file in January and in February, it may be advisable to file for an extension, and this will reduce the deadline pressure. You can also easily get preparers and discounts if you file for an extension. However, you need to ensure that you have paid your taxes by the April deadline.

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