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Alternative Minimum Tax Means Required Maximum Effort to File!

Tue, 06 May 2008 20:36:23 GMT

The National Taxpayer Advocate (NTA) of the IRS has labeled the Alternative Minimum Tax (AMT) “the poster child for tax-law complexity.” Congress created the Taxpayer Advocate to make recommendations to Congress, and since 2001 the NTA has advocated for Congress to either completely repeal the AMT or index it with inflation. Congress has yet to act on either recommendation, but instead, does just enough to fix it until the next year.

The AMT was enacted in 1969 to ensure that the top 1% of households paid income taxes because they were eligible for so many deductions their tax liability dropped to nearly nothing. The NTA found that individual tax filers with incomes as low as $150,000 may now have to pay the AMT. Far from targeting only the super rich this legislation has ripened into a permanent root affecting millions of upper-middle income tax payers.

Congress’s annual “just in time” fix of the AMT may cause more problems than the tax itself. In 2006 Congress waited until December to extend several tax deductions. The NTA found that delay caused 1.4 million fewer claims for those deductions than in previous years. Why? Because the IRS prints tax forms in November. Many tax filers did not know about those deductions because they were not included on the original forms printed in November.

Again this year Congress “patched” the AMT in December 2007. This late fix is now causing the IRS to reprint several forms related to the AMT: education credits (Form 8863); residential energy credits (Form 5695); child and dependent care expenses (Schedule 2, Form 1040A); mortgage interest credit (Form 8396), and the D.C. first-time-home-buyer credit (Form 8859). Because of this delay the IRS said that as many as 13.5 million taxpayers who use these forms will have to wait to file their returns until its computers can be reprogrammed, which is scheduled to be completed in early February. Though many taxpayers wait until March or even into April to file, those who choose to file early may be unable to do so.

How can this continual mess be remedied? Congress is a constitutionally created branch of government. Meaning it cannot be abolished or its composition changed. The tax code and the IRS are creatures of Congress which can be changed. Congress acted to create a specialized office, the NTA, to help make changes. As shown though, Congress seems to be incapable of acting on its own good ideas.

The NTA is required by law to annually report on the top twenty problems taxpayers encounter. Maybe the 2008 report should anoint Congress as problem #1. Tax attorneys are benefiting from Congress’s indolence but no one else is.

For more information on alternative minimum tax, contact a tax litigation attorney

Child Tax Credits and Deductions

Mon, 10 Nov 2008 13:53:59 GMT

Federal and state tax laws provide many tax credits and deductions for having children. One of the most common tax benefits for children includes the dependency exemption, or the ability to claim children as dependents on your tax return. Keep in mind, however, that if you have a child with a person to whom you are no longer or never were married, your divorce and/or paternity decree may spell out which parent gets to claim the child as a dependent on his or tax return. If there is no court order in place that deals with this issue, the parent who has custody of the child generally gets to claim the child, unless the parents agree otherwise. Plus, if you are a non-custodial parent, and you are going to claim your child as a dependent on your tax return, the custodial parent must sign IRS Form in order to permit you to legally claim the child.

Other common tax benefits for people with children include the child care credit, and dependent care accounts, both of which are related to childcare costs that you pay for your eligible children, including the costs of daycare, preschool, and nanny services. The child care credit gives you a tax credit of 20% - 35% of the first $3,000.00 in child care costs that you pay per child per year. The exact amount of your tax credit is dependent upon your adjusted gross income (AGI”), and the amount of your eligible child care expenses, and phases out when your AGI reaches a certain level.

If your AGI is relatively high, you are likely to benefit more from dependent care accounts, which are similar to pre-tax 401(k) accounts offered through your employer. Not all employers offer these plans, but it is a great way to reduce your child care expenses if available, although there are certain contribution limits. Usually, you sign up for the account once a year, and decide how much money you want to put into the account, which is then deducted from your paycheck on a pre-tax basis. Once you have a child care expense, you fill out a form in order to get reimbursement for that expense from your account. Be cautious, however, about the amount of money that you put in your dependent care account; if you don’t use the entire amount during that year, you will lose any money that remains in your account.

The only other limitation on these tax benefits for child care expenses is that the total amount of your credit must be less than your earned income, or your spouse’s earned income, for the year. However, there are some exceptions to this rule if your or your spouse is disabled or a full-time student.

In order to be eligible for either the child care tax credit or the dependent care account, you must meet certain criteria. The child for whom child care expenses are incurred must be your biological, adopted, step or foster child, and must live in your home for more than half of the year. Additionally, your child must be younger than 13 or permanently disabled, and you (and your spouse, if married) must work or go to school full-time, plus have earned income for the year.

What if I cannot file my income tax return on time?

Mon, 10 Nov 2008 13:59:07 GMT

If you can’t file your federal income tax return by April 15^th, or you can’t pay taxes that you owe, there are some simple measures that you can take in order to avoid some really bad consequences. First, you can get an automatic 4-month extension until August 15^th by filing IRS Form 4868 – Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, so long as you file it with the IRS by April 15^th. Next, if August 15^th is coming up and you still need more time, you can request an additional 4-month extension, which the IRS will grant if you have a good reason. A second extension of time, if granted, will give you until October 15^th to file your return.

Keep in mind, however, that getting an extension of time in order to file your taxes does not get you an extension of time to pay taxes that you owe. If you know that you owe taxes, you should send in as much of the taxes that you owe as you can, along with your extension request, to the IRS by April 15^th. Otherwise, if you don’t pay at least 90% of the taxes that you owe, the IRS will charge you interest and penalties on the owed taxes, which range from 1/2 % per month to 1% per month of the amount that you owe.

Additionally, if you don’t pay the bulk of the taxes that you owe, and don’t request a filing extension by April 15^th, the penalties and interest are even higher, ranging from 5% per month to 25% per month of the amount of tax that you owe, plus interest. As you can see, it is much worse to simply not file your tax return on time or request an extension than to file your return and perhaps be unable to pay all of the taxes that you owe.

Federal taxes are one of those bills that you should make a priority in paying. If you don’t file an income tax return, the government has six years to file criminal charges against you for failing to file. Once you file your tax return, however, there is no time limit for the IRS to collect back taxes, penalties, and interest from you. Plus, you can’t get rid of back taxes through bankruptcy proceedings, so that won’t solve your problems, either. However, if you owe a large amount of back taxes, it would be wise for you to contact an attorney who specializes in tax matters for assistance in dealing with the IRS, and perhaps negotiating some sort of plan with the IRS in order to pay your back taxes.

The Mortgage Forgiveness Debt Relief Act of 2007

Thu, 20 Nov 2008 01:41:25 GMT

In December 2007, the federal government enacted the Mortgage Forgiveness Debt Relief Act. The Act was meant to provide tax relief to taxpayers who had debt forgiven on their primary residence and to help struggling homeowners.

The Purpose of the Mortgage Forgiveness Debt Relief Act

The idea behind the law was to help homeowners avoid foreclosures by not taxing them when they refinanced their mortgages. The law was designed to be an incentive for homeowners and lenders to work together to renegotiate adjustable rate mortgages that were rapidly rising at a time when home values were decreasing and to allow more homeowners to remain in their homes while lenders were paid on the outstanding debt.

The Details of the Mortgage Forgiveness Debt Relief Act

The law applies to debt that is forgiven on primary residences in 2007, 2008 or 2009. The general rule is that income that is realized as a result of a mortgage relief measure is considered income for federal income tax purposes. However, the Mortgage Forgiveness Debt Relief Act changes that rule if the mortgage relief, such as a restructuring or foreclosure sale, is done for a primary residence and happens in 2007-2009. In order to qualify, the debt must have been used to buy, build or substantially improve that primary residence and must have been secured by the residence. It does not apply to second homes, credit card debt, car loans or any other type of debt. The provision applies in full as long as the dollar amount of the loan was less than 2 million dollars.

While the majority of people who take advantage of this provision are doing so as a result of a mortgage restructuring or foreclosure sale there is no requirement that the mortgage forgiveness be provided in those ways. Other forms of mortgage forgiveness such as short sales and deeds in lieu of foreclosure also qualify.

One of the biggest criticisms of the Act is that it is providing too little relief too late for the many homeowners who have been suffering. President Bush made clear when he signed the legislation that it was only one step in the necessary process of helping homeowners who have been hurt by the decline in the housing market.

How to Take Advantage of the Mortgage Forgiveness Debt Relief Act

It is important to note that while income earned in the manner described above will not be taxed for 2007-2009, it still must be reported to the IRS on Form 982. Your mortgage lender will send you a form 1099-C Cancellation of Debt that should be used when completing Form 982 and your tax returns. Like all other tax forms, Form 982 is available from the IRS or from your accountant.

The Mortgage Forgiveness Debt Relief Act of 2007 is one action by the federal government to try to help struggling homeowners achieve mortgage debt relief without incurring the penalty of higher income taxes and it is important to understand the details of the Act if you find yourself in a situation requiring debt relief.

What You Need to Know about 401k Withdrawals

Tue, 21 Apr 2009 12:43:35 GMT

401k plans are common retirement investment tools for United States workers. The plans, named for the section of the IRS code that defines them, allow workers to save for retirement and to defer income taxes until the time the money is withdrawn. However, with these tax benefits come restrictions on when money can be withdrawn from the plan without financial penalties.

401k withdrawals

Typically, specific criteria must be met before a person can withdraw funds from a 401k retirement plan. Usually no financial penalties will be incurred if an employee withdraws from a 401k plan and is 59 ½ years old or older, the plan holder dies or becomes permanently disabled, the plan terminates and no successor plan is identified by the employer or the plan holder has a financial hardship that qualifies for an exception to the general rule. 401k plan holders must take care to make sure that what they consider to be a financial hardship will be defined as a financial hardship by the IRS. Otherwise, if a 401k plan holder fails to meet any of the withdrawal criteria described above, then he or she is likely subject to a 10 percent penalty tax for an unqualified 401k withdrawal in addition to the ordinary income tax that is always assessed on 401k distributions.

Required 401k distributions

While many people are concerned about how soon they can take money out of a 401k plan, it is also important to be aware that there are certain circumstances which mandate a 401k distribution. Most plans require that a retired person or a working person who owns more than 5% of the employer maintaining the plan begin to make withdrawals by April 1 of the calendar year in which they turn age 71 ½. If neither of those criteria is met then this required distribution age is put off until April 1 of the calendar year in which the employee retires from the service of that employer.

A 401k distribution may also be required when an employee stops working for an employer. Unlike previous generations of workers, today’s employees often change employers several times during their careers. Employees should make sure that they do not forego any retirement savings in the process of changing jobs and should request that any 401k money be rolled over into an eligible retirement account. Funds that are properly rolled over into eligible retirement accounts will not be subject to either the 10 percent penalty tax for early withdrawals or income tax at the time of the rollover.

401k Loans

Some 401k plans have specific provisions that allow plan holders to take loans out against their 401k investments. If your 401k plan permits loans then the IRS will allow plan holders to borrow up to 50% of the vested account balance up to a maximum of $50,000. Borrowers should be aware that the loan must be repaid within 5 years, unless it is used to buy a primary residence and that substantially level repayments must be made over the life of the loan. Failure to adhere to these rules could result in a tax assessment against the borrowed amount.

401k plans are designed to be retirement savings plans. While the IRS allows for early withdrawals in certain circumstances, plan holders must be aware of the potential penalties for unauthorized early withdrawals in order to protect themselves from unwarranted tax penalties.

Should You Borrow Money From Your 401k?

Tue, 21 Apr 2009 12:44:32 GMT

It can be frustrating and often frightening when due to unemployment, a recession, or other factors, a person’s available cash is not enough to meet his or her obligations. Sometimes when this happens, a person does have money in his or her 401k plan that could help the person pay his or her bills. However, it is important to understand the potential penalties for borrowing or withdrawing funds from a 401k plan before it is done.

Borrowing from Your 401k Plan

In order to borrow money from your 401k plan, the plan must explicitly allow it. If the plan allows a plan holder to borrow money from the plan then the plan holder may qualify to take a loan of up to 50% of the plan’s assets with a maximum of $50,000. If the borrower makes substantially level payments over the life of the loan and the loan does not exceed 5 years then the IRS will not impose the traditional 10% tax for early withdrawals on the borrowed money.

However, just because the loan can be repaid without penalty does not necessarily make it a smart financial move even in difficult financial times. Plan holders need to think very carefully about all of the risks and all of the costs associated with a loan. For example, some employers are now offering 401k debit cards that allow plan holders to easily access the money in their 401k accounts. Plan holders should be aware, however, that using a 401k debit card is not the same as using a debit card that is linked to your checking account.

A 401k debit card requires you to pay fees and interest on the money that you borrow. That means that you will need to repay more money then you actually borrow in order to replenish your 401k account. If you fail to replenish your 401k account within the 5 year time limit then you will owe income tax on the money borrowed plus incur a 10% penalty if you are not at least age 59 ½.

Early Withdrawals from a 401k Plan

401k holders should also consider whether they qualify for an early withdrawal from their 401k plan. While unqualified early withdrawals are subject to a 10% tax, a 401k holder who meets one of the criteria described below may be able to withdraw the money without paying the 10% tax and without having to repay the money as is required when the 401k holder borrowers money from his or her 401k plan.

An investor may be able to avoid the typical 10 percent tax for early withdrawals if:

The employee dies and his or her beneficiary seeks to withdraw the money;
The employee becomes completely and permanently disabled;
The employee is at least age 55 and no longer works for the employer associated with the 401k plan;
A qualified domestic relations order (QDRO) is issued by a court that requires that the assets in a 401k plan be split between two divorcing spouses;
The employee has medical expenses that are greater than 7.5% of his or her income and needs the money in his or her 401k plan to pay the medical bills.

The purpose of a 401k plan is to save for retirement. If funds are borrowed or withdrawn prior to that time then your loan or withdrawal must meet the standards set forth by the IRS and by your individual 401k plan in order to avoid expensive penalties. Therefore, each loan or withdrawal should be very carefully considered.