I am single, and I have always wondered why I could not file my taxes as “head of household.”  After all, I live alone, and I am the “head of my household.” 

“Head of household” is a special filing status that’s given to single taxpayers who are caring for other people.  Congress realizes that it’s often tough for single parents to make ends meet.  So, for many years, single parents have gotten more generous tax brackets and a larger standard deduction.  Head of household status also applies to those who are supporting a parent.  If you are single, and qualify as a head of household, you definitely should file as head of household.

The term “head of household” is probably an unfortunate choice of words.  According to the dictionary definition of the words, yes, a single person living alone is the head of the household.   But the definition in the tax code is what counts.

Tax law, like so many areas of the law, often defines terms very precisely and sometimes those definitions aren’t the same as what the ordinary meaning of the words would lead you to believe.  If the tax code defines a word or phrase (such as head of household), the special definition applies and it overrides the common meaning. 

Section 2(b) of the Internal Revenue Code clearly defines head of household as a single person who lives for at least half the year with a single, dependent child or a dependent parent.  (There are a number of technical provisions to explain special situations.)  There are also elaborate definitions in the tax code as to what is a qualifying dependent child or a qualifying dependent individual.  It’s quite clear though, that you must have a dependent to file as a head of household.

The tax code has been using the term “head of household” for over half a century.  Although the definition has become more technical, the meaning hasn’t changed very much.  So I doubt Congress will replace “head of household” with a more descriptive label anytime soon.

In answering this question, I wondered when Congress started giving breaks to single parents.  

In 1954, the tax code was substantially overhauled, and three separate sets of tax brackets were established for heads of households, single, and married taxpayers.  This was the first time the tax code used the words “head of household.”   Tax brackets for married taxpayers were more generous than those for single taxpayers, with head of household in between.

Before that, the 1939 code had taxpayers paying both income tax and a second income tax called “surtax.”  The rates were strictly based on income, regardless of whether you were married or had a family. 

Times were different.  It was assumed that there was only one breadwinner in each household.  Two-income households were unusual.  The tax code was structured accordingly. 

But even before the separate schedules of tax brackets for single and married taxpayers, Congress realized that a taxpayer who had a family to support needed a tax break. 

The break Congress gave back then was to increase what is now the standard deduction for married taxpayers.  Interestingly, those who were not married, but the “head of a family” got the same standard deduction as a married taxpayer.  (In 2011, the standard deduction for a married couple was $11,600, but a head of household only got $8,500.)          

There was also a primitive version of the earned income credit, which applied to everyone’s wages, regardless of income.  Finally, there was a $400 personal deduction for the taxpayer, spouse, and each dependent.  (That deduction in 2011 was $3,700.)

One of the drawbacks applying the income tax to a family unit is the constant tension between trying to help struggling families and the realization that a married couple can often live more inexpensively than two single people.  Over the years, Congress has recognized the issue and tinkered with the balance repeatedly.  There really is no easy answer, and changing family dynamics have made getting it right even more complicated.

I have my return right here.  I owe, but I can’t afford to pay.  What should I do?

Go ahead, mail in (or e-file) your return.  Pay as much as you can now.  You’ll get credit for the payment and will only owe penalties and interest on the unpaid part.  By filing now, you’ve eliminated the late filing penalty and any amount you pay reduces the interest and penalties charged.

You’ll get a bill from the IRS for the balance due.  If you can pay then, fine.  If you still can’t, you might need to file Form 9465, Installment Agreement Request.  The IRS lets you pay in payments, but on top of all the interest and penalties, they’ll charge you an extra $43 to $105 fee for a payment plan.

So, if I don’t owe, I don’t need to file for an extension, right?

Wrong.  Say that big refund you are expecting turns into owing $500.  Not only will you have to pay interest and penalties for paying late, but you’ll pay a penalty for filing late, too.  Isn’t it worth 15 minutes online to insure against the late filing penalty?

How do I get an extension of time to file?  I waited too long and now I don’t have time to finish my return.   

This one is easy. 

If you use a professional preparer, call and ask the preparer to extend your return.  Because this is a very simple transaction, many will file the extension for you without charge.  The extension request doesn’t need to be signed. 

If you are a do-it-yourselfer, go to www.irs.gov and download Form 4868.  It’s a very simple form that you can complete and mail, use an e-filing program, or use the free file program at the IRS website.  Close to tax time, the IRS website features the extension process and makes it even easier.

Form 4868 asks you to estimate your 2011 liability.  The IRS says that if your estimate is unreasonable, they may void your extension.  However, taxpayers often enter zeros and still have their extensions granted. 

If you think you owe taxes, estimate how much you owe and make a payment along with the extension request.  If you pay too much, you’ll get the excess back with you file your return, generally with interest.  If you pay too little, you’ll pay interest and penalties. 

If you are filing electronically and want to send a payment, you can have payment deducted from your checking or savings account.  Or, if you are mailing in your request, enclose your check with the extension request.

You now have until October 15 to file your return.

Most states (including Illinois and Wisconsin) extend your return automatically if you file a federal extension.  If you are extending only your state return or want to make a payment toward your state taxes, you’ll need to file a state extension though.  Each state has a form on their website.

The IRS doesn’t charge to file for an extension, but there are several costs to filing late: 

If you don’t pay by April 15 (April 17 this year), you’ll pay interest from April 15 until the date you pay the tax. 

Second, there’s a late payment penalty.  This penalty is one-half percent of the tax due.  It is charged for every month or partial month until you pay the tax.  That’s 6 percent a year, in addition to the interest.  This penalty caps out at 25 percent after about 4 years.  You can sometimes avoid this penalty if you had reasonable cause to pay late.  If you’ve paid 90 percent of your liability by April 15, you are considered to have reasonable cause. 

Third, there’s a late filing penalty.  This penalty is much steeper and is 5 percent of the amount due for each month (or part) that your return is late.  If your return is more than 60 days late, this penalty is a minimum of $135 or the amount you owe.  Again, you can sometimes avoid this if you had a good reason for filing late.  Be warned, that, even if you extend, but don’t file by October 15, this penalty sets in.

I just discovered I made a stupid mistake.  What do I have to do to fix it?  I mailed my tax return yesterday.

We are human and, no matter how much we double check, mistakes do happen.

As I don’t know what kind of a mistake you made, let me answer the question in general terms.

Typically, when you make a mistake or want to change your return (unless the IRS contacts you first), you file an amended return.  If you caught the mistake and make the correction before the return was due, you won’t be charged interest or any penalties.  You may have to pay interest or penalties though, if you file the amended return after April 15 (April 17 this year).   But if you get a refund because of the change, the IRS generally pays you interest.

Before you begin, decide if you should file an amended return.  If you accidentally omitted income, transposed a child’s social security number, checked the wrong filing status, or some other serious error, you definitely want to amend.  It’s better to get to the IRS before they get to you.  You’ll reduce interest and penalties that way.

Sometimes it’s really not worth it to amend.  Perhaps you forgot to deduct the $100 contribution you made to the local volunteer fire department.  If your marginal tax rate is 15 percent, ask yourself if filing an amended return is worth an extra $15 refund.

Taxpayers often decide not to amend a return because amending the return will extend the time the IRS gets to audit their returns.  This is known as extending the statute of limitations. 

Generally speaking, the IRS has until April 15, 2012 to audit 2008 returns.  Say that in March 2012, you discover a deduction from 2008.  If you decide to amend, the IRS now has until March 2015 (3 years after you file the amended return) to look at that 2008 return a little more closely.   

Sometimes tax laws change retroactively, and it’s in the taxpayer’s best interest to go back and amend a prior year’s return.  For example, taxpayers whose homes were built with corrosive drywall can go back, amend their returns, and claim a casualty loss.  Or, in a few cases, taxpayers are able to back and claim first-time homebuyer credits on prior-year returns.

Regardless of whether you originally filed Form 1040, 1040A, or 1040EZ, start by downloading Form 1040-X and the instructions from the IRS website, www.irs.gov.  

Form 1040-X is designed to handle a variety of different mistakes.  It’s very important to consult the instructions as to which parts of the form you’ll need to complete.  Depending on what changes you are making, there are instructions and detailed charts telling you what should be reported on each line of Form 1040-X.   Where you should send the completed return depends on the type of changes and where you live.  There’s a chart for that, too.

The IRS sets a goal of 12 weeks to process an amended return.  Because of different filing circumstances, that varies greatly and is often longer.

Often, when you amend your federal return, you must also amend your state return.  You should amend your federal return before your state return.  If the mistake was solely on the state return, you can file just an amended state return. (IL-1040-X in Illinois and Form 1X in Wisconsin)  Both of these forms and instructions are available on the state websites.

Amending a tax return can be a little tricky.  Regardless of the change you are making, the key is to follow the instructions carefully.  If it’s a simple change, you may be able to do it yourself.  If it’s more involved, consider getting professional help.

How much of a gain can I take on the sale of my house before I have to pay a capital gains tax? 

If you have lived in the house for 2 of the last 5 years, there is a special exclusion.  You can exclude $250,000 of gain if you are single and $500,000 if you are married.  You calculate the gain by first taking the amount you sold the house for, and the subtracting the price you paid, the cost of major improvements, and the costs of selling the house, such as real estate commissions.

Remember, this special rule only applies to your personal residence.  Vacation homes don’t qualify.  And if you were running a home business and took depreciation deductions, you’ll have to pay tax on those amounts.  Be sure to keep receipts for what you paid for the house and major improvements.  You’ll need these numbers so that you can exclude those amounts when calculating the exemption or any taxable gain.

I heard we have until April 17 to file federal returns this year.  Is that true, and what about state returns?

Yes.  April 15 is on Sunday, and April 16 is a holiday in Washington, DC.  States typically extend the filing deadline to match the federal deadline.  Both Illinois and Wisconsin have extended the deadline until April 17.

 

When is the best time to file a tax return?  I hear if you wait until April 15, you stand less of a chance of being audited.

Like so many other things you hear on the street, this one is an urban legend, too. 

The IRS has a minimum of three years to audit your return.  If they decide to examine your return, they have plenty of time.  If they find your return “interesting,” the “last minute rush” isn’t going to diminish the chance of an audit. 

Frankly, if you wait until the last minute to prepare (or have someone else prepare) a tax return, you are more likely to make a silly mistake, which will increase the chance of an audit.

This brings up another question, when should you prepare a tax return.  Generally speaking, February is the best time.  It generally takes several weeks into the new year before you receive all of the W-2s, 1099s and other important tax information. 

Employers are required to send you your W-2 by January 31.  Similar deadlines apply to other filings.  Shareholders in S corporations, partners in a partnership, and trust beneficiaries are used to waiting even longer for their K-1 forms.  Sometimes those forms come so late that partners and beneficiaries have to file for an extension.

Never file your return until you receive all of the tax information you are expecting from others.  If you file too early, you might get another tax statement that you had forgotten about.  At the very least, that means you’ll have to recompute your taxes.  If you have already filed, it means you’ll have to file an amended return. 

If your return doesn’t match the information reported to the IRS by others, the IRS will probably contact you.  When information doesn’t match, the IRS generally assumes that your numbers are wrong and the burden is on you to explain any differences. 

Once you have all the information, you should prepare your return as soon as possible.  If you owe tax, it gives you a little time to make arrangements to pay without paying further penalties. 

One of the classic situations I’ve seen is where a taxpayer had taxes withheld in the wrong state.  If the return is filed early, you can get a refund from the “wrong” state and use that refund to pay the “right” state.  The same thing happens when you have a refund coming from federal taxes but owe the state (or vice versa).  If you procrastinate until April 15, you’ll have to dig into your pocket to pay now, and wait for a refund! 

If you have a refund coming, by all means, file right after you prepare your return.  The sooner you file, the sooner you’ll have your money.  The quickest way to get your refund is to e-file and use direct deposit to your bank account.

If you owe, you have several different options: 

You can e-file your return now and mail your payment later with Form 1040V, which is a payment voucher.  As long as you mail the payment by April 15 (April 17 this year), there is no penalty. 

Another option if you e-file is to mark your return for automatic withdrawal from your checking or savings account.  You specify the date of withdrawal.  You can either pay now or put off paying until the payment is due. 

If you mail the return, the same options apply.  You do not need to enclose payment with the return.  You can send it later with the voucher or you can specify an automatic withdrawal.

If you use an automatic withdrawal, I recommend you set the date for early April, sometime between April 5 and April 10.  This allows you to go back and check that the withdrawal was actually made.  Occasionally, the withdrawal isn’t made, and if you wait until the last day, you end up paying interest and possibly a penalty.

If you make estimated tax payments, you can include your estimated tax payment for this year with any tax due for last year.  Or you can have a tax refund credited to this year’s estimated tax.

I bought gold bullion in 2008 and sold it in 2011.  I had a gain of $10,000.  Will I have to pay any tax on that?  I am in the 15 percent tax bracket.

Congratulations on your good fortune.

Long-term capital gains are gains from selling property that you held for at least one year.  In 2011 or 2012, if you are in the 10 or 15% tax brackets, any long-term capital gains are tax-free because they are taxed at a rate of 0%.  So had your gain come in the stock market, you wouldn’t have to pay any tax on your profit. 

Unfortunately, there are special tax rates for gain on “collectibles.”  Collectibles include stamps, coins, artwork, Scotch whiskey and any type of gems or metal.  Even though gains from this category are considered “capital,” any long-term gains are still taxed at ordinary tax rates.  In your situation, at the 15 percent rate, the gain would be subject to $1,500 in federal income tax.  If you were in the 28 percent bracket, you would have had to pay tax at a 28% rate, or $2,800. 

There is one bit of relief for the very affluent:  If you were fortunate enough to have made $171,851 last year ($209,251 if you are married), the tax rate on your collectibles gain would be limited to 28 percent rather than your higher marginal ordinary rate of 33 or 35%. 

While it’s hard to think of copper ingots and tin as collectibles, the rules apply to all types of metal that you either take physical custody of or have warehouse receipts for.  There was a bill in Congress in 2003 to treat gold, silver, and platinum the same as stocks, but the bill went nowhere, and there are no plans to make a change.

It hardly seems fair that a trader in copper pays more than someone speculating in grains, foreign currency, or oil.  But that has been the law since 1981.

It gets worse.  Let’s say that instead of a $10,000 long-term gain, you had a $10,000 long-term loss on your gold investment.  Like any other capital loss, unless you had other offsetting capital gains, you would only be able to deduct $3,000 of the loss this year, and $3,000 every year until the loss was used up.  So it would take 4 years for you to be able to fully deduct your losses.

Like other investments, if you had held the gold for less than a year, the loss would have been deductible or any income would be taxed at ordinary income tax rates.

Different rules apply to financial contracts traded on an established exchange.  And, while trading metals in your retirement account may not be specifically prohibited, but it will result in a tax disaster.  In both cases, the rules are extremely complicated.  Seek specific tax advice before you get into a situation like that.

Before you decide to buy metal or other collectibles, be sure to take into account these less favorable tax rates on collectibles.  If you need help, ask before you invest.

 

My Tax Preparer retired this year.  Now what?

Some people actually enjoy preparing their tax return.  If your return is fairly simple, that’s certainly an option.  If you do it yourself, you can still obtain the paper tax forms and instructions and file by mail.

Or maybe you’d like to try using a computer instead.  At this time of year you can’t avoid tax software commercials.  Millions of people spend quite a bit of money for these programs.  But it seems to me that very few people really benefit from them:

If you earned less than less than $57,000 last year, you can use the tax software at the IRS website for free.  And many states, including Illinois and Wisconsin, allow you to file state tax returns at their websites for free.  If you’re single, taking a standard deduction, and your only income is from your paycheck, you can do it yourself without buying any software.

If you don’t qualify for free filing, you might consider buying tax software.  Although they’ve improved, these programs are still written for “ordinary situations” and your situation might be a special case.  Despite the checklists built into the software, you still need to know how the deductions, credits and other terms apply to you. 

Remember, the tax law can get complicated in a hurry.  Taking the wrong deduction or passing one up can be costly.  But if you know what you are entitled to, and you want automatic calculations, think about buying a program.  Professionals rely on tax software to save them time.  But just remember, you’re preparing one return, not hundreds.  You can do the same thing using a paper form and a calculator for free.

If you need a professional preparer, you have a lot of options.  Obviously, it’s more expensive to use a preparer than doing it yourself, so you’ll want to be sure you’re getting your money’s worth.

Sometimes it’s hard to tell a really good provider from a mediocre one.  First and foremost, a professional preparer should care about you and be trying to help you save money this year and offer suggestions for lowering next year’s tax bite.  It’s perfectly acceptable to ask someone how long they have been preparing returns and where they learned their trade. 

You can ask respected friends, neighbors, and relatives who they use.  Many of the best preparers don’t advertise, but rely on referrals from satisfied clients.  It’s ok to ask a preparer about fees, but remember that tax returns vary greatly and complex ones cost more than simple returns.  You may be quoted a range or a minimum fee.

While it can be hard to find a good preparer, it’s easy to spot a few that you should avoid:  Some commercial preparers focus on having “fun” while filing your return.  While a preparer should put you at ease and be pleasant, your tax return is not a joke.  You worked hard for your money last year.  Paying the least amount of tax is not a laughing matter. 

If a professional preparer offers to prepare your return “for free,” ask yourself how the preparer earns a living.  Rest assured, there is a catch.

If the tax preparer offers you an “instant” refund, keep walking.  Many preparers, especially the large chains, make their money on refund anticipation loans.  They charge as much as sixty percent interest.  Does a preparer who offers you that “service” truly have your best interests at heart?  .  Do you really want their advice?

E-filed federal and state tax refunds ordinarily take about 2-3 weeks.  If you must have the money quicker, take a cash advance on your credit card. 

When you do find a good preparer, stay put!  Playing musical chairs to save a few dollars on fees is an excellent way to introduce an error on your return.  It’s much easier for a preparer who knows you and is familiar with your circumstances to be sure you got all the deductions you deserve.  Good preparers save their clients many times over the amount of their fee.