income tax

7 Questions to Ask Before Moving Out of State

Kat Tretina — Fri, 23 Feb 2018 09:30:09 +0000

Growing up in Pennsylvania, I learned to dread the winter months. The cold and snow would leave me feeling depressed and miserable. I dreamed of moving somewhere warmer, but I was afraid of the high cost.

After months of waffling back and forth and saving every dime I could, I finally took the plunge and moved to Florida. And while it was expensive and scary, I've never regretted it.

Whether you're contemplating a job offer in another state or simply want a change of scenery, relocating is a big decision. Before deciding one way or another to move hundreds or even thousands of miles away like I did, ask yourself these questions.

1. What is the cost of living?

If you're reviewing a job offer or looking for a new job in another state, make sure you keep in mind the cost of living. Even if you earn a higher salary in your new state, you could still end up in worse financial shape than before if living in the area is too expensive.

Depending on your intended location, you could need thousands more dollars to maintain the lifestyle to which you're accustomed. The cost of everything from housing to groceries can significantly add to your expenses.

Use a cost of living calculator to figure out how much you'd need to earn to afford living in your new city. Say you lived in York County, Pennsylvania and earned $50,000 per year. If you wanted to move to San Diego, where housing costs 160 percent more, you'd need to earn at least $73,673 to keep your same standard of living. (See also: Here's How Much Life in the Big City Will Cost You)

2. Who will care for family members?

If you have elderly or disabled family members, coming up with a plan for their care should be part of your relocation decision. If you cannot be there with them, you'll have to find a way to provide for them otherwise. Depending solely on outside care or nursing home facilities can be cost-prohibitive for your relative; a recent study by Lincoln Financial Group found that a private room in a nursing home costs an average $102,911 per year.

If that cost is beyond your family's budget, and they were depending on you to some extent for help with daily life, moving to a new state may not be practical or financially wise.

3. How will you adjust to the climate?

Although some moves can be beneficial in terms of climate (hello, beaches!), some people struggle adjusting to new weather conditions. If you're from a state with four seasons, moving to a warmer place can be hard. You might find that you miss the snow and changing seasons. If you move from a sunny place to somewhere with long, gloomy winters or regular rain, it can be a strain on your mental health.

If at all possible, spend some time in town during the state's poorest weather season to see how you cope. You might find that you can handle the cold better than you expected, or you might discover you hate it and want to stay put.

4. How much will is cost to move?

You know moving is expensive, but until you see the real numbers, it's hard to get an idea of how much it really will hurt your budget. According to the American Moving and Storage Association, it costs an average $5,360 to move to a new state.

If you have to break a lease or struggle to sell your home, you might need to spend thousands more to make the move possible. (See also: Avoid These 6 Common Mistakes When Moving Across the Country)

5. Is there a state income tax?

If you're in a state like Florida or Texas, which do not have a state income tax, moving to a place that does can come as a big shock. The raise you carefully negotiated at a new job might be negated by the increased taxes taken out of your paycheck.

6. What college savings programs are available?

If you have children, saving for their education is likely a major priority for you. And with current four-year tuition costs reaching an average $9,650 for in-state schools and $33,480 for private schools, that's a smart decision. However, where you live can impact your college savings.

All states offer at least some form of a 529 plan, such as a prepaid tuition or a college savings program. However, some states only offer one type, which can limit your child's educational options.

In addition, some states offer tax benefits for contributing to a 529 plan, while others do not. Switching to a new state could result in losing those benefits, reducing how much you can save each year. (See also: The 9 Best State 529 College Savings Plans)

7. Will you feel isolated?

Beyond financial and logistical issues, moving can be emotionally exhausting and difficult to navigate. If you grew up in one area and became attached to the neighborhood, moving to a place you don't know, without friends or family, can be lonely and isolating. You might find that even the best job is not worth the move without your loved ones.

However, other people thrive on the unknown and the sense of adventure that comes from entering a new place and meeting new people. Only you can know what works for your situation. By asking yourself these questions and preparing for a move ahead of time, you can ensure you make the best decision for you and your family.

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This article is from Kat Tretina of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

7 Last-Minute Ways to Cut Your 2016 Tax Bill

Mikey Rox — Mon, 26 Dec 2016 10:30:23 +0000

Before you know it another tax season will be upon us. Do your wallet a favor and score all the deductions you can with these last-minute ways to reduce your bill in 2016.

1. Investment Account Balancing

Year-end investment account balancing is a no-brainer. If you have a taxable investment account, you should review your transactions for the year to see if you're in a net capital gain situation. If you are — says Jacob Dayan, co-founder of tax-relief service Community Tax — find some losing positions that will offset the gains and liquidate them by the last business day of December.

"If you wish to remain invested in these assets long-term, you can buy them back after 30 days," he adds. "Note that this strategy also works in reverse, with one difference. If you sell a net-gain position, you don't have to wait 30 days to buy it back. In either case, if you have positions involving multiple purchases over time, identify the specific assets you want to liquidate by purchase transaction to give you the greatest tax benefit."

2. Charitable Donations

'Tis the season to give unto others — if only for the tax breaks. You have until the end of the year to make charitable donations that will count toward your 2016 contributions for tax purposes.

"All charitable donations made to qualifying organizations before December 31 will count toward your 2016 deduction, as long as you itemize your deductions," says Pennsylvania-based certified public accountant William Ray. "Deductions are generally limited to 50% of your adjusted gross income, although additional restrictions may apply for those in higher income brackets. You may also deduct the current fair market value — not your original cost — of noncash contributions made to qualifying organizations. Certain noncash contributions may require additional support or an appraisal, so you should review IRS Publication 526 before claiming noncash contributions."

It's also important to track your volunteer time.

Ray adds, "Although you cannot make a deduction for your time, you may claim a deduction for any mileage driven using your personal vehicle ($0.14 per mile) and any out of pocket expenses that are not reimbursed. As is the case with any deduction, documentation and support should always be maintained for all contributions."

Financial planner Andy Yadro details another option for end-of-year giving.

"Consider contributing to a donor-advised fund," he suggests. "You get an immediate tax benefit and your money can be invested with potential to grow. This is a great last minute option for someone who wants to make a donation, but hasn't decided which charity it should go to."

3. Max Out Retirement Contributions

Were you fortunate enough to get a holiday bonus? Use it to top of your tax-deferred retirement accounts such as an IRA. Even better, kick in a few extra dollars from your regular paycheck. You'll boost your savings while reducing your taxable income. However, be aware of the contribution limits for both types of retirement account.

"If you or your spouse are not covered by a retirement plan through your employer, you're both eligible to contribute up to $5,500 each to an IRA ($6,500 if you are over age 50)," Ray says. "You may be eligible to make a contribution, even if you are covered by a retirement plan through your employer, depending on your income."

You also have until April 15, 2017, to make this contribution and still have it count toward your 2016 taxes. However, it's highly recommended that you do not file your tax return until you make the contribution. If you claim the deduction but cannot pay, you'll need to file an amended tax return by April 15, 2017, or pay penalties and interest.

4. Pay Your State or Local Income Tax Bill Early

If you itemize deductions, you can claim a deduction for state income taxes paid during the calendar year. This includes any amounts paid for your 2015 tax liability that were paid in calendar year 2016.

"If you consistently owe taxes on your state or local tax returns, paying them early can result in immediate federal tax savings," Ray explains. "States and localities allow you to make estimated tax payments or prepayments at any time during the year. If you make a payment before December 31, 2016, that payment can be deducted on your 2016 federal tax return. But be careful of overpaying. If you overpay and receive a state or local income tax refund, you will need to claim that as income on your 2017 federal tax return."

5. Make January's Mortgage Payment in December

One of the joys of homeownership is taking advantage of the various tax breaks the government provides. The biggest of these is the mortgage interest deduction. If you can spare the extra cash, consider making your January 2017 mortgage payment before the end of the year. You'll be able to deduct the mortgage interest on your 2016 tax form. Don't get greedy here, though. Tax law generally prohibits taking annual deductions on "prepaid interest," so you won't be able to pay February's mortgage bill and claim that for 2016, too. For more on the tax advantages of homeownership, see the Tax Policy Center's analysis. (See also: 4 Tax Deductions New Home Owners Shouldn't Skip)

6. Review Your Health Coverage

If you're covered by a high-deductible health plan, you may qualify for a Health Savings Account (HSA) and contribute $3,350 ($6,750 for a family) to the plan — all of it tax-deductible.

"Many employers now offer high-deductible health plans, meaning employees often have to pay thousands toward a deductible before their health coverage kicks in," Ray says.

To offset this cost, you may qualify for an HSA.

"An HSA is basically a 'retirement account for health care' and is becoming more common each year," Ray continues. "The HSA allows you to contribute to an investment account that can grow tax free over time, while receiving a deduction on your tax return. You even receive a deduction if you don't itemize. The account can then be used to cover qualifying medical costs. Unlike a Flexible Spending Account (FSA), an HSA is 'your money' and can grow over time, rather than being forfeited at the end of the year."

Check with your employer to see if your plan qualifies for an HSA. (See also: 11 Surprising Things Your HSA Will Cover)

7. Prepay Real Estate Tax

If you foresee a changing income situation, supplement next year's loss with a right-now gain. Yadro suggests prepaying your real estate taxes and taking the deduction now.

This article is from Mikey Rox of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Can't Pay Your Taxes? Here's What to Do

Matt Bell — Tue, 17 Mar 2015 13:00:10 +0000

No one likes unexpected bills — especially big unexpected bills. This time of year, one of these nasty shocks can come in the form of owed income taxes. Common candidates for a hefty income tax bill include the self-employed, especially if you earned a decent income in 2014 but didn't make sufficient quarterly payments.

If it looks like it's going to be difficult to pay all that you owe by April 15, here are your options, along with some key facts you need to know. (See also: Don't Have Enough to Pay Your Taxes?)

Understanding the Rules

There are two distinct aspects involved in paying taxes: filing your return and paying it. Not filing your return on time and not paying what you owe come with different ramifications. It may surprise you to know that if you don't file your return on time, even if you can't pay all that you owe by April 15, you'll face the biggest penalty.

Failing to file on time and not paying all that you owe by the due date will cost you a monthly penalty of 5% of your tax bill plus interest. However, if you do file on time, or request a filing extension by midnight on April 15, the penalty drops to half of 1% plus interest. So, at the very least, file your return or request an extension by April 15.

Paying as much as you can by the filing deadline will lower your costs as well, since the late payment penalty is based on a percentage of what you haven't paid.

Next, you'll have to come to an agreement on how to pay the rest of what you owe. Don't let this slide. Uncle Sam may look friendly, but he has some collection tactics available to him that most other creditors don't. This could be garnishing your wages, taking money from your bank accounts, or slapping a lien on your property.

Don't let things get to that point. Instead, explore the following options.

Short-Term Extension

If you think you can pay all of what you owe within 120 days of April 15, apply for an online payment agreement. You can also call the IRS at 1-800-829-1040 for more information. There is no up-front fee for a short-term payment extension. However, a late-pay penalty (half of 1% of the balance owed per month) and interest will be charged. Still, that should amount to less than what you'd be charged with a longer-term payment agreement.

Long-Term Extension

If you can't pay what you owe within 120 days, you may be eligible to pay your tax bill in monthly installments over the course of up to 72 months. There is a fee of $120 to establish an installment agreement, or $52 if you agree to have your payments automatically deducted from your bank account. While you'll still have to pay interest, if you filed your return on time, the monthly late-pay penalty will be half of 1% of what you owe.

If you owe the IRS $50,000 or less (including penalties and interest), you should be able to set up the online payment agreement. If you owe more than $50,000, you'll need to complete Form 9465 and supply the IRS with a Collection Information Statement (Form 433-F).

Temporary Delay

If your circumstances are such that you can't pay any of what you owe, and you're not sure when you'll be able to, the IRS may temporarily delay collection until your financial condition improves. However, your debt will grow because penalties and interest will accrue until you come up with the full amount. During the temporary delay, the IRS will continue to review your ability to pay. The government may also place a lien on real estate or other property you own. Contact the IRS at 1-800-829-1040 for more information about requesting a temporary delay.

Offer in Compromise

If you can't afford an installment agreement, you could offer to settle your tax debt in one lump sum totaling less than what you owe. Whether you'll qualify depends, in part, on your income, expenses, assets, and the IRS' assessment of your ability to pay. However, be forewarned: Relatively few offers in compromise are accepted. There is also a non-refundable $186 application fee, and most applicants have to make an up-front, non-refundable partial payment when they apply. So, make sure you feel confident about meeting the requirements. You'll need to demonstrate that situation is such that you will never be able to pay back everything you owe. Details are in the IRS' Offer in Compromise booklet.

Consider Inside Assistance

If you are having a difficult time resolving an IRS tax dispute, contact the IRS Taxpayer Advocate Service. This is an independent organization within the IRS designed to provide free help to people whose tax issues are causing financial difficulty. Here's how to contact the Taxpayer Advocate Service office nearest you.

Avoid Outside "Assistance"

You may be tempted to turn to a private company for help in settling your tax debt for less than you owe through an offer in compromise, but beware. Such companies often charge steep up-front fees, and there are some unscrupulous players in this field.

Take Action

If you have a big tax bill you can't pay, you may be tempted to just ignore it. But that will make the problem worse as interest and penalties pile up. As just described, there are several options for paying what you owe over time.

For more guidance on what to do if you can't pay your tax bill, read, The "What-Ifs for Struggling Taxpayers" on the IRS web site.

Whether you owe money this year or are due for a refund, right now might also be a good time to think ahead and start planning for next year's tax season.

Have you ever been walloped by an unexpected tax bill? How did you cope?

This article is from Matt Bell of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Tax Brackets Explained

Julie Rains — Fri, 22 Jun 2012 10:24:13 +0000

Being in a high tax bracket seems to be something that people envy (in others) but avoid (for themselves). But what does that mean, and what does it matter? (See also: 15 Surprising Facts About Income Tax)

Here’s what to know about tax brackets:

Your tax bracket is based on taxable income (not your annual salary) and filing status with the IRS (such as Single or Married Filing Jointly)
The percentage associated with your tax bracket is your marginal tax rate
The percentage associated with your tax bracket is not the same as your average or effective tax rate
You may be able to move to a lower tax bracket by making contributions to a tax-deferred investment account such as an IRA and 401(k); making charity contributions; or selling stock held in regular accounts at a loss
Selling stock at a gain may move you to a higher tax bracket, even if your earned income stays the same

IRS Tax Brackets

Generally, when people talk about tax brackets, they are referencing income levels associated with IRS (federal) tax rates for ordinary income tax and not other types of taxes or withholdings for state and local taxes. Federal income rates and tax brackets change periodically. To give you an idea of current tax brackets, consider these income levels and percentages using information from IRS Publication 505, Tax Withholding and Estimated Tax.

2012 Tax Brackets by Taxable Income

Single Filing Status

10% – less than $8,700
15% – between $8,700 and $35,350
25% – between $35,350 and $86,650
28% – between $86,650 and $178,650
33% – between $178,650 and $388,350
35% – over $388,350

Married Filing Jointly

10% – less than $17,400
15% – between $17,400 and $70,700
25% – between $70,700 and $142,700
28% – between $142,700 and $217,450
33% – between $217,450 and $388,350
35% – over $388,350

What Difference Your Tax Bracket Makes

Your tax bracket determines your marginal tax rate. This percentage can be important when considering financial decisions. Specifically, knowing the marginal tax rate helps you to determine the impact of certain actions (such as making a charitable contribution or making an IRA contribution) on your cash flow.

In trying to understand precisely what “marginal” in marginal tax rate means, I came upon several definitions. The one that made the most sense to me described “marginal” as being the one on the top margin of your income. (Definition from the Dictionary of Financial Terms from Lightbulb Press)

For example, if you itemize deductions and you are in the 25% tax bracket, then a charitable donation of $1,000 will “cost” you $750; that is, you give away $1,000 but get a tax break of $250. Similarly, if you are in the 35% tax bracket, then you could reduce your tax bill by $350 for the same contribution.

Likewise, putting money away in an IRA or 401(k) can have tax benefits. These benefits can be measured by your marginal tax rate. A $2,000 contribution might help you to reduce your tax liability by $200 if you are in the 10% tax bracket or $500 in the 25% tax bracket. When you reduce your taxable income, you may move to a lower tax bracket if you happen to be on the edge of a bracket.

Marginal Tax Rate vs. Average Tax Rate

You pay taxes based on a combination of tax rates (unless you are in the lowest tax bracket, and then you pay based on the lowest rate only). That is, taxpayers don’t pay federal income tax that is equal to their taxable income multiplied by their marginal tax rate. Just a portion of your income is taxed at this higher rate.

To determine your average tax rate, you need to calculate how much your taxable income is taxed at each level.

For example, if you are single and your taxable income is $50,000, then your tax calculation (using Publication 505 to estimate your tax liability) is $4,867.50 + 25% x ($50,000-$35,350) = $8,530.00. Or, you can calculate this dollar amount by applying various tax rates to portions of your income, like this:

Portion 1: $8,700 x 10% = $870
Portion 2: ($35,350-$8,700) x 15% = $3,997.50
Portion 3: ($50,000-$35,350) x 25% = $3,662.50
Total of All Portions = $8,530.00

Then take the total tax amount and divide by taxable income to calculate the average rate. In this case, the average tax rate is 17.06% ($8,530 / $50,000).

Average Tax Rate vs. Effective (or Actual) Tax Rate

Now that you see how the marginal rate differs from the average rate, consider how the average rate varies from your effective or actual rate. The actual rate (federal income tax liability divided by annual income) is less than marginal and average tax rates when you consider that your taxable income is much less than your actual income.

Here are some of the factors in determining taxable income.

Income

For many people, annual income is simply your annual salary or total of yearly wages. But income can also include earnings from a side business or freelance gigs, unearned income from interest and dividends, capital gains from the sale of stock, sweepstakes' winnings, unemployment compensation, and payments from pensions. (For a complete list, review IRS Form 1040 (PDF) and instructions (PDF), call the IRS, or talk to your tax professional.)

Qualifying Expenses and Contributions

Certain expenses and contributions are deducted from income. These may include Health Savings Account (HSA) deposits, student loan interest deductions, contributions to IRAs, and self-employment retirement plans. Certain credits are also available, further reducing tax liability.

Exemptions and Deductions

Your income is reduced by exemptions (personal and dependent) and the standard deduction (PDF) or itemized deductions.

So, your taxable income may be $50,000, but your actual income could be $50,000 + $3,700 (personal exemption for 2011) + $5,800 (standard deduction for 2011) or $59,500 (more if you made contributions to your IRA, 401(k), or HSA). In this case, your actual federal income tax rate is 14.34%. You will probably pay other taxes, like state and local taxes, so if you want to get a complete picture of your tax rate, then add up all taxes and divide by your income.

Capital Gains and Tax Brackets

Long-term capital gains from the sale of investments like stocks and mutual funds not held in tax-advantaged accounts are taxed at special rates. Through 2012, these long-term gains have a tax rate of 0% for those in 10% and 15% tax brackets and 15% for those in tax brackets of 25% and above. Qualified dividends are also taxed at these favorable rates.

Income from long-term capital gains is included in taxable income, so you can’t sell lots of stocks for a profit and expect to pay nothing in taxes. However, if you have relatively low income and sell some mutual funds at a gain, then you may be able to benefit from this tax arrangement.

Short-term capital gains (held for one year or less) and ordinary dividends are treated as ordinary income and taxed at regular rates.

When retirees take money out of their Roth accounts, they pay no taxes on qualified distributions (under current tax laws). Compare that to ordinary tax rates for distributions from traditional IRAs and 401(k) accounts.

So both the amount and the type of income that you have can impact your actual tax rate. That’s why some people can have high incomes but lower than usual tax rates.

Have you ever made a financial decision based on your tax bracket? Share in the comments.

This article is from Julie Rains of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Is It Time to Starve Your 401(k)?

Kentin Waits — Mon, 04 Jun 2012 09:48:08 +0000

In the early 1990s, I worked for a benefits consulting firm that managed retirement plans for employees of various companies. Though barred from providing direct investment or tax advice, my coworkers and I gave the standard 401(k) spiel that outlined the benefits of pre-tax contributions. It was a song-and-dance that was pretty much true at the time — “contribute funds pre-tax during your working years; the investments grow tax-free (based upon market performance, of course), and when you withdraw upon retirement, your tax rate is likely to be lower.”

While the logic still makes sense, I’m not so sure the root of that statement applies any longer, or that I could parrot it without some serious reservations now. Newly enrolled 401(k) participants probably still hear it, and I know it echoes in the minds of long-term investors who haven’t looked up from their 9-5 (or 9-9) jobs long enough to consider the game may be changing. But as the U.S. faces staggering debt with two parties that seem intent only upon one-upping the other, and as the ripples of economic instability continue to wash over Europe, the only sure bet seems to be that taxes will go up eventually. (See also: Deciding What You Want Out of Retirement)

The 401(k) Problem

Focusing solely on 401(k) plans may create a trifecta of financial trouble for future retirees:

A generation or two of savers who may not be considering the possibility that their tax bracket in retirement may be equal to (or potentially higher) than during their working years.
Investors who have bought hook, line, and sinker the idea that 401(k) plans are a sure bet for retirement security.
Employees who have maxed out their 401(k) contributions to the point that other potentially more valuable savings vehicles can’t be properly funded.

What’s more, the convenience and hands-off approach that make 401(k) plans so popular tend to lull investors into auto-pilot mode where critical thinking and active investment strategies are replaced by automatic paycheck deductions and only reevaluating investment funds once every blue moon. Are we setting ourselves up for a hard-fall later in life when the bill on all that pre-tax money finally comes due and our tax rate is less-than-optimal?

Another Retirement Savings Option

Though it may sound blasphemous, I think it’s time to put our 401(k) plans on a diet — if not begin to starve them outright. But I make this assertion with two critical caveats. First, if your 401(k) plan offers a company match, don’t walk away from free money. Contribute just enough to get those matching dollars. Second, don’t starve one investment plan without fattening up another. Depending on your current tax situation and age, strongly consider a Roth IRA. The money you put in a Roth goes in after-tax, but your investments grow tax-free and any withdrawals after age 59.5 are not taxed. You can learn more specifics about Roth IRAs by visiting RothIRA.com.

Regardless of what side of the political fence you’re on, the reality is that taxes must (and will) go up. The only real questions are how soon will it happen and how hard will it hit? If you want to be a defensive investor, it’s time to shake off the old notion that a fat 401(k) balance alone will keep you in dancing in Florsheims and dining on steak in your golden years. More likely, a healthy 401(k) plan will become a smaller and smaller part of a broader strategy that’s centered on one important truth — the tax man is coming.

Do you have a plan B (or C) in place for retirement savings? What do you think will happen with income tax rates over the next 10 or 15 years?

This article is from Kentin Waits of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Top 10 Red Flags That Trigger IRS Audits

Marla Walters — Thu, 10 Mar 2011 17:00:19 +0000

Brought to you by TurboTax Federal Free Edition — Free to prepare, Free to print, Free to efile.

The good news is that, on the average, very few people get audited by the IRS. Better still for some of us, the less money you make, the less likely you are to be audited. According to the IRS, for Tax Year 2009, if you made less than $200,000, you had a slightly lower than 1% chance of being audited. If you made more than $200,000, your odds jumped to almost 3%. If you earned over $1 million, bump that frequency up to over 6%.

The bad news is that the chance still exists for all of us, and despite the general professionalism of the IRS, an audit is rarely a pleasant experience. To avoid audits, stay clear of these top 10 things that raise red flags with the IRS.

1. Math Problems

Your income tax return gets entered into an IRS computer, one way or another. If you have made a math error, you will automatically get the computer’s attention. This is why, if you do your own return, it may be a good idea to run it through a tax program to check your math.

2. Match Game

Another simple way to get the IRS computer’s attention is to report income differently on your return than the people who pay it to you report it, via W-2s and 1099s. The IRS computer will try to match all of your payers’ numbers with your numbers, and when they can’t, you get a letter. So gather all of those envelopes stamped “IMPORTANT - TAX RETURN DOCUMENTS,” and tick off all of those numbers.

3. Not Just How Much, But Also How

As I noted above, your income level can affect your odds of being audited, but how you earn that income is also relevant. People who work in jobs where a significant amount of unreported cash changes hands, such as restaurant wait staff or salon workers, garner more interest.

4. The Boss of Me

People who own their own (unincorporated) businesses are responsible for reporting their own income and expenses on Schedule C. While some of their income can be cross-checked with 1099s, they are on the honor system for the rest of their income and all of their deductions. Until such time as the IRS decides to check up on them, that is. Because there is room for abuse, the IRS checks these returns more frequently. (See also: When and How to Incorporate: A Guide For Sole Proprietors)

5. In the Hole

People who own their own businesses and report a net loss, rather than net income, merit even more attention. That is especially true if they are also a full-time W-2 wage earner. This is because you are allowed to deduct a loss from your legitimate business, but you are NOT allowed to deduct a loss from your hobby. If you are a W-2 wage earner who also reports a business loss, it looks like you might just be deducting your hobby expenses. (Keep in mind, though, if you have net hobby income, you must report that.)

6. Let’s All Be Reasonable

While reasonableness seems like a subjective, innately human issue, the IRS computers are capable of making at least a preliminary judgment of it. In fact, they make a practice of doing just that. With complex statistical formulas, they look at the reasonableness of your deductions as they relate to your income. If they seem out of line, your return gets a second look by a human being. So, if some or many of your deductions seem unusually large for someone with your income, prepare for an inquiry.

7. Isn’t That an Oxymoron?

The IRS seems to think so, about the “home-office” deduction. It was once an area of considerable abuse, which always leads to a crackdown. The IRS Code stipulates such strict rules for the home-office deduction that few people qualify for it. When it shows up on a return, the odds that the return will be examined are substantially increased. (See also: The Home Office Deduction Guide)

8. In Round Numbers

Tax returns rife with round numbers smack of estimations. When people estimate, they usually err in their own favor—you do the math. No, really, do the math, and put specific numbers on your return; not estimates.

9. Driving All Out

Numbers can sound good attached to cars—The Beach Boys sang 409 about a souped-up Chevrolet; The Brian Setzer Orchestra had their ’49 Mercury Blues; Sammy Hagar sang, I Can’t Drive 55—but one number that hits a real clinker for the IRS is 100%, particularly when it represents the business use percentage you claim for your automobile. That means you must never drive it to commute back and forth to work, or out to lunch, or to the grocery store. Maintaining 100% business usage of a vehicle is virtually impossible. It’s another round number that just doesn’t harmonize very well with your tax return. (See also: Tax Guide for Business Use of Vehicles)

10. That’s Entertainment!

Yet another area of common abuse is that of meals and entertainment. So much so, apparently, that Congress saw fit to arbitrarily limit your deduction by half back in the 80s. So for every dollar you spend on legitimate business meals and entertainment, you derive a 50 cent deduction. Nonetheless, the deduction is still overused, and therefore an area of heightened interest to the IRS.

Reporting information on your tax return that results in your being audited doesn’t necessarily mean you have done anything wrong. Many CPAs will tell you that you should not allow the fear of an audit prevent you from taking legitimate deductions. However, knowing the kinds of things that are likely to increase your odds for an audit allows you to make decisions about the potential costs and benefits of certain deductions.

This article is from Marla Walters of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 Things Everyone Should Know About This Year's Tax Changes

Darwins Money — Thu, 03 Feb 2011 14:36:12 +0000

Brought to you by TurboTax Federal Free Edition — Free to prepare, Free to print, Free to efile

We saw 2010 close with last-minute wheeling and dealing to satisfy various objectives on both sides of the aisle. Politics aside, the bottom line is that many special tax breaks, credits, and pieces of legislation that were set to expire in 2010 ended up being extended into 2011 and beyond. Additionally, some parts of the tax code are distinctly different in 2011 compared to last year. With a focus on what's different (as opposed to unchanged extensions), here are some key tax changes you'll see in 2011:

1. Temporary Payroll Tax Cut

The payroll tax that most employees face on their first $106,800 of earnings will be reduced by 2% this year only, from 6.4% to 4.2%. The intent of this tax break is to stimulate the economy by having a little extra money show up in each paycheck, which is believed to be more stimulative than a simple one-time "rebate" check like we've seen in the past.

Whatever the ultimate outcome for the economy at large, what this means to you is a virtual 2% raise (tax-free!) up to that $106,800 cap, at which point the payroll tax phases out anyway. This break is currently slated for 2011 only, and it would be highly unlikely to see this extended again since the payroll tax funds Social Security. (See also: What is the Social Security Tax?)

2. FSA Deductions Changed

Part of the health care reform legislation recently enacted is a key change to Flex Savings Accounts (FSAs): You can no longer deduct over-the-counter (OTC) medicines without a prescription. While this may not have a sizable impact on many people, a common year-end activity for people who had unused FSA contributions was to run down the pharmacy and stock up on aspirin and other medications, since you have to "use it or lose it."

The net impact is that you'll have to be a little more careful in how you plan your contributions in future years. And if you used to spend heavily on OTC meds, note that the deduction is gone and is not coming back. (See also: How Healthcare Reform Change the Way You Pay Taxes.)

3. Energy Efficient Tax Credits Diminished

Where in 2009 and 2010 you could deduct 30% of up to $5,000 spent for various energy-efficient upgrades to your home for a total of $1,500 in credits, in 2011, this credit is now capped at $500. The credit is also more restrictive, with a maximum of $200 for windows and $300 for heating systems, and if you took credits in the 2009-2010 session, you cannot participate in this year's $500 credit program (i.e. no double-dipping).

In effect, given the sizable investments new windows and heating units often require and the comparatively small credit, you may not be enticed to jump on a home upgrade just because of the credit. However, if any of these upgrades are required anyway, you'll want to confirm that the upgrade adheres to the government specifications (see Energy Star Requirements), save the documentation, and realize the credit on your tax return.

4. New Estate Tax Criteria Established

With the estate tax moratorium set to expire at the end of 2010, legislation was enacted to set new criteria for the estate tax in 2011 and 2012. Now individuals will see the first $5 million exempt, and couples will see $10 million exempt from federal estate taxes. If that amount is exceeded, a 35% tax will be levied.

5. Business Investment Incentive

A program was established for businesses meant to spur near-term capital investment instead of extending such decisions into the future. Companies will now be able to fully depreciate capital investments in the year of purchase. Specifically, the IRS code Section 179 limits were increased over last year, thus allowing a business to deduct up to $500,000 of qualified capital expenditures subject to a dollar-for-dollar phase-out once these expenditures surpass $2 million.

While this piece may not seem relevant to most individual taxpayers, many small business owners may consider this enough to push them over the threshold and pull the trigger on new equipment upgrades now as opposed to waiting for the economy to fully recover.

These were five significant tax law changes for 2011, but there are some more out there, as well as plans for future tax changes already in the works. For advance planning, check out this nifty tax change summary showing changes anticipated all the way out to 2017.

This article is from Darwins Money of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 Things Tax Preparers Should Tell You

Darwins Money — Tue, 25 Jan 2011 16:02:00 +0000

Brought to you by TurboTax Federal Free Edition — Free to prepare, Free to print, Free to efile.

With tax season upon us soon, it's helpful to go into the tax preparation process with reasonable expectations and knowledge of how the process will work, what the roles and responsibilities are, and what you should anticipate as an output from your interactions with your preparer.

1. What You Need to Bring

It's not always obvious which documents are even required to complete a tax return. It seems as though we’re receiving a tax document per day in the mail, sometimes in a redundant and confusing fashion. Conversely, with the heavy reliance on electronic record-keeping, people are rightfully confused over whether they should always be getting a paper statement for tax purposes or whether they need to print out electronic copies.

You should plan to have in your possession all documents related to income, investments, interest, deductions, credits, and anything else that might reasonably result in an entry on your tax return. If you do any sort of investing outside a tax-deferred retirement account, chances are that any transactions will have to be reported. Just holding on to a dividend-paying stock requires reporting of dividend income. Interest from CDs, money market accounts, and savings accounts is fair game as well.

On the credit side, if you sought to take advantage of any of the various government stimulus programs like the home energy tax credits, cash for clunkers, the new homebuyer tax credit, or others, documentation related to those transactions should be shared with your preparer. Several such topics are outlined in much more detail in this nifty tax preparation checklist. If in doubt, bring it!

2. How to Optimize Your Deductions and Credits

Some like to think of tax preparation and advice as an art more than a science. There are various ways to approach how you set up your income and expenses in your personal life, as well as in any businesses you run, in order to optimize your returns by minimizing your tax liability. Your preparer may recommend anything from optimizing your small-business expenses to pulling forward contributions and expenses into the current tax year to beat the clock and realize the larger deduction come spring.

The preparer may point out credits and deductions you didn't even know existed. Likewise, he may also warn against being too aggressive with certain tax deduction claims to decrease the risk of generating an audit. An oft-cited red flag is the home office deduction, but there are others as well that seasoned tax preparers may recommend you avoid. (See also: 10 most overlooked tax deductions.)

3. How Your Tax Liability or Refund Was Calculated

Rather than just spitting out a number at the end of a session, your tax preparer should walk you through a methodical explanation of both the income side and deduction side, share any notable impacts of various tax rules, and then highlight how and why your ultimate liability or deduction came out the way it did. There should be a full double-check of the information you provided and a chance to point out any omissions or mistakes. While there are ways to amend tax returns later, it may come at additional expense and delay. It's ideal to get it right the first time – and get that refund on time!

4. When Will Your Refund Arrive

With most tax returns resulting in a refund of some sort, it's helpful to know when your refund will arrive. Many people know they're getting a sizable refund each year and plan to use those funds to do anything from pay the annual tax bill to fund the summer family vacation. Be it days, weeks, or longer, the preparer should be able to give an indication of when to expect a refund based on her own internal timeline for submission and the typical turnaround time from the federal government. It may not be evident at the time, but the initial preparer you meet with may or may not be conducting the actual calculations and generating the return herself. Outsourcing is a common business practice now in the field, so that may add to the cycle time considerably.

5. Ideas to Better Manage Your Taxes

Aside from simply completing your return based on historical information, an adept preparer should be able to make suggestions to better manage your taxable liabilities. Suggestions may include highlighting any legislative changes that may affect you, new stimulus and tax-credit programs, how to best incorporate a small business, common deductions worth considering that you may not have tracked and documented in the prior year, and some basic investment concepts related to taxable versus tax-deferred accounts.

These are just a few of the topics an adept tax preparer should be sharing with you. Otherwise, you may be leaving thousands of dollars in tax-saving opportunities on the table each year.

This article is from Darwins Money of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Can You Settle Your Old IRS Debts?

Tisha Tolar — Thu, 25 Mar 2010 13:00:10 +0000

Tax time is never a fun time. It requires a lot of organization and numbers, and if the numbers don't jive you could find yourself owing a nice chunk of change to the state, local, and federal governments. In some cases, people fall behind in filing their annual returns. If you owe back taxes for previous years because you didn’t file an income tax return, it can feel like a huge burden on top of existing debts. But it can also be a scarier situation because owing money to the federal government is a debt that will only continue to grow in penalties and potential legal action.

Many people do not properly file taxes likely because they can not afford to satisfy the debt in full. They fear there are no alternatives and simply choose to try and ignore the situation. Debts with the IRS will only get worse if ignored, but there are options to help get you out of this financial situation. One method involves settling the debt with the IRS.

What Is an IRS Settlement?

In many cases where a debt is outstanding for previous tax years, the IRS will allow a taxpayer to negotiate a settlement agreement where the taxpayer can settle the total debt for less than the amount owed. There are also other processes the IRS will allow where back tax debts in full can be collected over a period of time.

Each program, including the settlement of the debt, includes criteria which the taxpayer must meet in order to qualify for the program. The IRS and the taxpayer will work to find which settlement program is necessary. Documents will need to be completed and submitted by the taxpayer for IRS approval before a final decision is reached. Once the agreement is reached, the taxpayer will no longer be considered in bad standing with the government for the tax years involved in the negotiation or settlement.

Who Can Settle?

Depending on the type of settlement program you qualify for through the IRS, anyone with a past due tax debt can apply. Eligibility will be dependent up individual taxpayer’s financial situation and the size of the outstanding debt.

Individuals can work with the IRS to settle balances owed or they can contact a tax professional who will handle the negotiation process in the best interest of the client. The IRS is generally willing to work with those who have outstanding tax debts provided the taxpayer cooperate and make payments as agreed. There will be penalties assessed for the late filings and payment which will add to the debt. Those fees can also be negotiated throughout the process as well.

If you owe back taxes or find you have not filed income tax returns during a particular year, you do need to act soon. Contact a tax professional or the IRS directly to discuss what can be done to satisfy the debt before the government has to take action, in which case they will be less flexible in their options to eliminate the tax debt burden.

This article is from Tisha Tolar of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Software review: TurboTax

Philip Brewer — Mon, 24 Mar 2008 14:16:20 +0000

I wasn't looking forward to doing my taxes this year. They were going to be more complicated than in years past, because I left my regular job and started working full-time as a writer. I also had some other new complications. TurboTax handled it all without difficulty.

I should mention that I've used TurboTax (and before that, its predecessor MacInTax) since 1995. This year I got a free review copy. I wrote a bit about the new features in TurboTax back in January.

Me and tax expertise

Back in 1981 there were some major changes to the tax code. Since I was just out of college, working at my first job, I paid some attention--this stuff was going to matter to me. There were lots of parts of the tax code that I didn't understand, but I felt like I had a pretty good handle on the ordinary stuff as it applied to ordinary people earning a salary.

The rules changed a bit every year, which was annoying--I'd put a lot of effort into understanding all this stuff, and here they were still screwing around with it--but I was keeping up okay. Then, in 1986, there was a big rewrite of the tax laws. Practically all the stuff I'd learned in 1981, and then kept up on for the next four years, was changed.

There'd been a brief period there when I was, if not a tax expert, at least a resource for my friends and coworkers. They could ask me stuff about the rules for IRAs or 401(k)s, and I'd often know the answer.

After 1986, though, I gave up. Not only was it impossible to keep up with the changes, it really wasn't worth arranging your finances to take advantage of special rules, unless you got an advantage in that same tax year: several special rules that I'd been counting on were eliminated in the 1986 tax reform--before I'd had a chance to take advantage of them.

Since then, I pretty much don't say anything about taxes without prefacing the statement with, "Well, I'm no tax expert, but...."

This year's taxes

Here's how things went.

The old stuff

TurboTax still has the good stuff that it's had for years. It gets the information from last year's tax files, so you don't have to retype your name, address, social security number, or bank account direct deposit information. It also remembers things like what 1099 forms you had last year, and tells you if one is missing this year--very handy if you're trying to do your taxes early, unaware that there's a form or two yet to come.

Speaking of 1099s, they've improved the process for entering them. For a long time, they've been set up to walk you through them in batches--all the 1099-INTs, all the 1099-DIVs, all the 1099-OIDs, etc. In my case, though, several of my 1099s (the ones from fund families and brokerage accounts) combined two or three or four different kinds of 1099, which meant that I had to go through the same form two or three or four different times. Much better for me to just put the stack of 1099s next to my keyboard, and go through it one time, entering all the information off each form. Once I've gone through my stack, I know I've got all the information. The latest version of TurboTax makes it quite a bit easier to do it that way.

The new stuff

The last time I thought I understood the home-office deduction (which was probably back in the 1980s, although I might have tried to figure it out again during the period when I owned a home in the 1990s), the rules were more strict than they seem to be now. Back then, I think, you could only deduct whole rooms as a home office. If any part of the room was used for non-business purposes, no deduction was allowed.

With that as my recollection, I wasn't too sure if the space I use for my writing qualified for a home office deduction. Happily, TurboTax is set up to help users figure that sort of thing out, asking questions to make sure you meet the rules. (As near as I can tell, I do.) Once it verified that, it gathered the information on deductible expenses and did all the calculations to pro-rate the home expenses by the fraction of the home that my office uses. (It also has a page to gather home office expenses that shouldn't be pro-rated, but I didn't have any of those.)

The other new (for me) thing was that I had a Health Savings Account. That was a bit complicated--the rules about how much I could put in had changed last year, after I'd already arranged (back in October of 2006) to fund it via payroll deduction. Also, while I'd been working, my employer had contributing, but that ended when the site closed. Those contributions were pre-tax (hence not deductible), but I also contributed a chunk of after-tax money to bring my total contribution up to the IRS maximum. TurboTax sorted out the pre-tax and post-tax contributions, deducted the deductible parts, and verified that I hadn't gone over the maximum. All very handy.

Filing

For years, I resisted electronic filing. (I figured I'd go with electronic filing as soon as they'd do it for the cost of a stamp.) About three years ago, I finally came around, and I've been pretty happy with the e-file process. No need to make photocopies of the forms. No need to sort out what goes in the envelope. No need to make a trip to the post office. Get proof that you filed. Get your refund much earlier. It seemed like it was worth the $16.

This year, though, it was more like $18.

So, I compromised. I filed the federal return (where I'm getting a refund) electronically. But I'm sending the state return in via regular mail.

There are a couple of reasons why this makes sense. First, in Illinois, the state taxes are very simple--just a couple of pages--so there's not so much to send in. Second, I'm not getting a refund, so it's easy to send in a check with the return.

Bottom line

Basically, I'm entirely pleased with TurboTax. I got a free copy this year. (It didn't come with free e-filing, though, so Intuit still made a little money off me.) Next year, I expect I'll once again buy my own copy.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: