A VAT Tax?

A recent Boone County Journal editorial considered replacing the personal income tax with a 17%, flat-rate, Value Added Tax (VAT). According to the editorial, the major advantage would be to spare Americans the need to file a tax return. The editorial suggested that the tax regime would be similar to taxes in place in Canada and Australia.

VAT is essentially a national sales tax. Such a tax would not help most people in Boone County.

1. Starting up a national sales tax by itself will not eliminate tax returns. Canada and Australia both have a Goods and Services Tax (GST) that is a VAT. In Canada, it's extremely unpopular, and often called the "Gouge and Screw Tax." It even applies to postage stamps. Provincial sales taxes are also collected in Canada.

Both countries still have income taxes that are just as high as the US. Canadians "file" and Australians "lodge" tax forms that are every bit as complicated as Form 1040. This in addition to sales tax and GST in the 10-15% range.

How the tax system is structured is what determines whether a complicated tax return must be filed. The United Kingdom has both a VAT and an income tax. But, because of the way the UK system is designed, many Britons do not have to complete a tax return. New Zealand works similarly.

2. Most Americans pay federal income taxes of less than 17%. But they also pay an additional social security tax of just over 15% of their wages.

Social security taxes are cleverly disguised. Unless you are self employed, they don't show up on Form 1040: On your paycheck, you'll see a deduction, sometimes labeled "FICA." Double that amount is paid in social security taxes on your wages.

Most people also pay state income taxes and state sales taxes. Remember, none of those taxes would go away if the federal income tax was replaced with a 17% national sales tax.

For most people, it would be a significant tax increase.

3. In most states and the federal system, it's rightly assumed that the well-off can pay a bigger percentage of their incomes than those with more modest means. Yet a flat tax (whether income or VAT) is often called a "fair" tax, because everybody pays the same rate. This presumes that Fred Factoryworker, with a family to support, can just as easily and should pay the same 17% of his income as Milton Millionaire.

4. To see just how "fair" a flat-tax system is, look no further than Illinois.

Millionaires in Lake Forest, Illinois have one of the lowest tax state income tax rates in the US. Just 3.75%. But a poor, struggling family in Belvidere pays that same rate, too. If you're trying to support a child on $20,000 per year, a 3.75% state income tax rate doesn't help. Nor does a sales tax of 10.25% on diapers in Chicago.

Illinois' flat income tax is embedded in its Constitution. Large Illinois corporations get a break because the Constitution caps the corporate tax rate as a function of the flat, personal income tax rate. Then factor in a "flat-rate" toll for every car on Northern Illinois expressways, and a flat-rate license plate fee (Late-model BMW owners pay the same as a 1999 Chevy).

With our flat, "fair" taxes, despite having one of the highest tax burdens in the US for the poor and middle class, Illinois is flat broke!

5. VAT is ultimately paid by consumers. A VAT in the US would not affect the bottom line of a corporation considering a move overseas. For a VAT to influence that decision, we would have to give a corporate tax break and ask working families to pay more of the burden (either as VAT or income tax). There are better ways to stop basis and income shifting to tax haven countries than giving into the demands of greedy companies that don't want to pay their fair share.

The income tax is too complicated. Lobbyists and others have contributed millions to politicians to keep the current system in place. The tax should be simpler, as well as fairer.

The solution is real reform, not gimmicks like VAT or flat-rate taxes.

Isn't sales tax on Internet services against federal law?

Generally it is, and has been for many years. Recently Congress made the law prohibiting a sales tax on Internet service permanent. A few states had a sales tax (including Wisconsin) on Internet services that were exempt from the ban because these taxes were already in place when the ban took effect. These exemptions will be phased out soon (unless Congress decides to renew them and let those states continue to charge).

Has the deductible IRA and Roth Contribution Limit been increased for 2016?

No, same amount as last year. You can contribute $5,500 to a deductible IRA or a Roth IRA for 2015 and 2016. But if you are at least 50, you can contribute an additional $1,000 per year as a catch-up contribution. So, if you are over 49, you can contribute $6,500 for each year.

Generally, contributions must be made by the tax filing deadline. That means you have until April 18, 2016 to make your 2015 contribution. For example, on March 1st, 2016, you could contribute $10,000: $5,000 for 2015 and $5,000 for 2016.

Your IRA or Roth contribution is also limited by the amount of compensation income you earned. If you only made $2,000 last year, you could only contribute $2,000 for that year. And for higher income filers, if you are covered by your employer's retirement plan, you may not be able to deduct your IRA contribution.

If you are of modest means, don't forget there is an up-to-$1,000 retirement savings credit available. This comes directly off your tax bill and makes it easier to save. It applies if your single adjusted gross income is under $30,000, $45,000 if you are a head of household, or $60,000 if you are married filing jointly.

Retirement accounts represent an excellent planning opportunity to lower your tax bite either currently or over time. But remember, there are a number of important rules dealing with IRAs and Roth IRAs. And you can lose money if you do not invest wisely. This discussion only deals with the contribution limit. Be sure you are well-advised on the rules relating to retirement accounts and have the right plan before taking the plunge.

If death tax no longer applies, can I just write my own will?

Until this year, multiyear estate planning has been a major headache for both lawyers and their clients. Even the best lawyer can’t write someone’s will in November when nobody has any idea what the law will be in January! Congress’ passing the American Taxpayer Relief Act of 2012 at the beginning of the year was just that: Relief.

For at least the last two decades, estate tax laws have been constantly changing and subject to “temporary” tax provisions. Even though estate planning is forward-looking, there has been no way to accurately predict what the tax law would be next year, let alone when the maker of the will actually passed away!

For many people of comfortable means, this has meant an annual (and often expensive) trip to their lawyer’s office to prepare unintelligibly complicated estate documents to try to reduce the potential tax bite.

This law has finally brought some certainty to the estate tax laws: In short, for taxpayers worth less than $5 million (and married couples worth under $10 million), the estate tax is a thing of the past. Gone, too, are most of the complicated gyrations married couples had to go through to take advantage of both spouses’ exemptions. Good riddance.

Even better news. Many states with inheritance taxes are phasing them out or have eliminated them completely. Taxpayers in Indiana no longer have to worry and Tennesseans are about to join them! In Illinois, beginning this year, only estates over $4 million are subject to state death taxes.

The results of these federal and state tax simplifications and phaseouts should be incredibly positive. Estate planning should be a lot simpler for most people. The all-too-frequent, tax-driven professional reviews of these plans will come to an end. Without having to consider estate or inheritance tax, probate proceedings should also be simpler and cheaper.

But does this mean you should treat estate planning as a do-it-yourself project?

You are free to write your own will, and many have done so successfully.

Many lawyers do not make money writing wills. In fact many “lose money” and don’t cover their overhead for the time spent. Often, they provide simple estate planning as a service to their clients.

Before you decide to buy will software and go it alone, there are several things you should consider:

Effective estate planning also includes providing for your minor children. Who should rear them if both parents die? Should their guardian have access to the purse strings? If you become disabled and your spouse can’t act, who should make decisions about your welfare? What if there’s a dispute among the family?

What if your spouse remarries? Do your children get “cut out” in favor of the new person’s kids?

How about your IRA and life insurance? Are the beneficiaries up to date? Should you roll over the IRA now to a Roth IRA and avoid a nasty tax problem? Either way, did you choose a beneficiary that would minimize the income tax consequences? (And you thought the tax problems were gone.)

Many do-it-yourself wills (and trusts) have survived the probate process, but have been delayed or subjected to additional legal procedures because their makers didn’t follow certain formalities or weren’t aware of the consequences of those “helpful” terms and phrases they thought “would be a good idea” to include. Remember, you won’t be around to explain what you meant to say.

Any amount these do-it-yourselfers saved by not consulting an attorney was more than consumed by additional probate costs. The law reporters are full of examples of probate cases that “saved” a few hundred dollars and wasted thousands of dollars. (And those are just the cases that went up to the appellate courts!)

An estate can easily be whittled away to nothing if it comes in dispute.

Estate planning remains important. While the estate tax may be gone, the probate process isn’t. The same important considerations apply. You’ve worked a lifetime to accumulate your possessions and you should invest a few dollars in making sure your legacy isn’t wasted.

Can I still get a tax break for insulating my house?

Yes, provided that you hurry. The applicable tax credit expires on December 31, 2013.

It’s difficult in the summer to visualize three feet of snow on the lawn, a slippery sidewalk and a drafty threshold, but in just a few months, they will all be back. It’s much easier to fix your home now instead of when the cold wind is howling. And the year you make home improvements is the year that you’ll reduce your heating bill.

There are three energy credits of interest to homeowners. The first is known as “Qualified Energy Efficiency Improvements” and covers insulation, roofs and windows in existing homes.

The second is “Residential Energy Property Expenditures.” This program covers furnaces, air conditioners, electric heat pumps, water heaters, biomass (wood) fueled stoves and advanced main air-circulating fans in existing homes. Both of these first two programs expire at the end of 2013.

The third program is for “Residential Energy Efficient Property.” This credit is for solar, fuel cell, small wind, and geothermal systems. It expires at the end of 2016.

Let’s first focus on the first two programs. You can take a credit of up to 10 percent of the purchase price paid for these improvements, up to a total cost of $5000 (for a total credit of $500). That’s a maximum for the lifetime of the program. If you’ve taken any of these credits since 2005, you’ll need to subtract the credit(s) you already took from this year’s maximum credit.

Only $200 of this credit can be used for replacement windows.

Specific standards dictate what materials or systems qualify. They must meet the standards set by the 2009 International Energy Conservation Code or, if applicable, Energy Star requirements. For example, a metal roof must have pigmented coatings and asphalt roofs require cooling granules designed to reduce heat gain.

The manufacturer should provide information on whether their products qualify. When in doubt, demand proof that the materials qualify for the credit before you buy. Check the packaging and the manufacturer’s website.

Finally, the third program is a more generous 30 percent credit of the cost of installing solar, small wind, fuel cells, or geothermal systems. This third credit can be used in new as well as existing homes. If you are considering building a new home or a major upgrade, this credit might be of interest to you.

Even with the credit, it may still be more expensive in today’s energy market to invest in these systems. But as energy prices rise, the cost gap may very well narrow. There is also the satisfaction of having taken a positive step toward a better environment.

To claim any of these credits, attach Form 5695, Residential Energy Credits to your return. You should keep the certification or Energy Star label with your tax records, but don’t attach them to your tax return.

Everyone agrees that conserving energy saves money, reduces pollution and is the right thing to do. Yet Congress has passed tax breaks for saving energy several times only to let them expire, and then reinstated them several times. The latest reinstatement came in the extenders bill (American Taxpayer Relief Act of 2012) passed at the beginning of the year.

It remains to be seen if these energy credits will be extended further. Most of the other “temporary” tax breaks in the tax code were made permanent or extended for longer periods this time. The current crop of tax credits is also not as generous as prior versions. A 10 percent tax credit barely covers the sales tax paid on these items.

Fortunately, there are no income limits on using any of these credits. And even if you don’t itemize your deductions, you can still take advantage of them. These credits apply to your main residence and include mobile homes, cooperatives and condominiums. If you live in a duplex and both families chip in for new insulation, each of you can take up to the maximum credit for your share. But you may not use them to improve a rental property or your vacation home.

I thought the “fiscal cliff” only applied to the tax rates after January 1. But the IRS says that I can’t file my 2012 return until at least January 30 and refunds will come even later? Why is my 2012 refund being delayed?

The majority of taxpayers will be able to file starting on January 30. But taxpayers who must file certain forms or schedules will have to wait until mid-February or early March before the IRS will be able to process these returns. These forms include a lot of the business-oriented tax credits. But several of the tardy forms affect mainly individuals, including energy-efficient home credits and qualified adoption expenses.

There are several reasons why the fiscal cliff delayed the tax filing season. A major reason was that not all of the tax provisions that are affected expired on December 31, 2012. Many of them had already expired at the end of 2011.

As a result, these expired provisions affect 2012 tax liabilities for a lot of people. Many tax experts assumed that Congress would extend these provisions retroactively (as they have done in the past). Still, there was a lot of uncertainty, particularly as the end of the year approached.

The IRS is required by law to collect and program their systems on the basis of the law as it is currently in effect. So it can’t legally begin changing its systems to reflect tax changes until the proposals become law. As a result, the IRS was unable to start reprogramming its computers, revise forms, or make other necessary changes until President Obama signed the new tax law on January 2.

These already-expired breaks included relief from the Alternative Minimum Tax, which would have caused many middle class taxpayers to pay significantly higher taxes in 2012. The new tax law extended the relief that had been given in 2011 and earlier years to 2012. In this latest legislation though, that relief has been made permanent. The amount of the relief is also being indexed in future years to account for inflation.

Other retroactively-extended breaks allow teachers to deduct $250 for classroom expenses, reauthorize deductions for residential energy efficiency improvements, and provide the ability to give away IRA proceeds tax-free to charity. They also allow taxpayers to deduct college tuition and many other provisions, including the popular research tax credit for businesses.

For the last several years, American financial planning has been in a shambles because of the uncertainty of the tax laws. Every year, Congress has waited until the last minute to extend popular tax breaks. In some cases, like this year, they waited until beyond the last minute.

Many economists believe that the economy and financial markets suffer when taxes are uncertain. Not knowing what tax rates are going to be next week or even what the current tax law will end up being is unsettling to anyone trying to prepare a budget.

The new law brings some good news. Some of these tax breaks that have been regularly extended on a year-to-year basis have now been made permanent. In addition, the new tax brackets are permanent.

Of course, even “permanent” tax laws evolve, and are always subject to change. But at least now we have fewer provisions that automatically expire on some future date. This brings more certainty in the short and medium term.

There are many provisions of the new tax law will affect the amount of tax you’ll pay. I will have a lot more to say about the provisions of the American Tax Relief Act of 2012 in future columns.

Does this mean the April 15 (and March 15 corporate) filing deadlines will be extended?

So far, the government has made no moves to change the tax deadline. Of course, taxpayers can always request filing extensions.

My best guess is that the tax filing season will be compressed, but will end on schedule in mid-April.

Remember, even if you file for an extension, you still have to pay your taxes by the deadline or you’ll be charged interest and penalties.

What about dropping off my tax information and let them prepare it while I grocery shop?

Some people dread filing a return. So they’ll drop off a W-2 and maybe last year’s return so they don’t have to sit there and wait.

First of all, if your tax return is really that simple, you should file it yourself and save the filing fee. The IRS and many other agencies will help you file and answer your questions for free.

If your return is very complicated, your preparer may have given you an “organizer” to fill out. These can be helpful if you have a lot of stock transactions or other circumstances. That’s fine, because your preparer has all the information necessary for you to pay the least amount of tax possible.

If you are in between (and almost everybody is), you should allow the preparer to interview you to be sure that you get all of the deductions and credits you have coming. The few minutes you spend with the tax preparer can yield a payoff of thousands of dollars per hour for the time you are sitting there!

But if you drop it off (and nobody asks) you could miss mortgage deductions, property tax deductions and a lot more. Even if you don’t itemize, there are a lot of “above-the-line” deductions or credits that you could be taking! Sit back and take a few minutes to be sure you are getting the refund you deserve.

There’s an ad on TV and several places are advertising that you can do your taxes on your last paystub instead of waiting for a W-2? Can I do this?

Absolutely not. Omitting your W-2 is considered filing an incomplete tax return. The IRS recently issued a warning against submitting incomplete tax returns and has made it clear they intend to punish tax preparers who intentionally do it.

The tax chains know all of this and have no intention of actually filing a tax return for you until they have a copy of your W-2. Instead, for a hefty price, they will estimate how much your refund will be and make a loan to you based on your potential refund.

These loans carry steep interest rates.

Every year, there’s a new scam to bring in tax (and particularly loan) customers. January and February witness a great battle among the tax giants (and the do-it-yourself software makers) to bring in as many customers as possible. Their goal is to do whatever it takes to lock you in before you go to their competitors.

So my question to you is, when a tax service works against you, and has such shady practices, why should you trust them to prepare a return for you? Or even give them your financial information?

Tax planners often use a November or December paystub to help a client forecast tax liability, or to figure out if an end-of-the-year charitable contribution or transaction should be made. But that’s very different than selling you a 30-day loan that carries loan-shark interest rates.

There are a few, rare circumstances when you can omit a W-2 from your return:

If, after trying, you can’t get a W-2 from your employer by February 14, and you’ve contacted the IRS for help, the IRS will allow you to file Form 4852, which is a substitute for Form W-2. It asks you to estimate what your wages and withholdings were.

Also, if your W-2 is incorrect and you’ve been unable to get a corrected W-2, you can use Form 4852 with your tax return. Be warned that the Form 4852 instructions make it very clear that the IRS will severely penalize those who misuse this form.

Besides, what’s the rush? Your employer must furnish you a W-2 by January 31. Because of the late tax legislation, you can’t file a return this year until January 30 anyway. Your refund isn’t coming any sooner than mid-February.

And what if you get another 1099 or other tax statement you weren’t expecting? Then you’ll have to pay to file an amended return.

I’ve been hearing about the “fiscal cliff” and frankly, time is running out. I’m getting worried. What should I do before December 31 to protect myself?

Predicting the future is always a dangerous business and I like my crow roasted medium. All of the drama aside, the “fiscal cliff” is simply this year’s version of the annual, end-of-year showdown between the Democrats and Republicans over tax policy.

Last year, it was over Social Security taxes. You might recall that not only did we have a cliffhanger at the end of the year, but Congress initially extended the two-percent tax break for only two months, creating a second cliffhanger at the end of February.

Fiscal cliffs are not a joke. They hurt ordinary people:

Because of tardy tax legislation, the IRS is once-again likely to delay the start of the filing season. It takes time to reprogram the system. Later-filed tax returns mean even later tax refunds. Which means taxpayers can’t spend those tax refunds and stimulate the economy until later.

What if a small business is on the verge of hiring a worker? If an entrepreneur doesn’t know what the tax rates will be, it’s impossible to make a budget. Should a businessperson hire the worker and risk coming up short when it’s time to meet payroll? What sensible entrepreneur wants to take that chance?

Not knowing what tax rate to expect is called tax turbulence. It can be a major drain on the economy. Many economists believe it also hurts the stock market.

Of course, this, too, shall pass. My advice is to Keep Calm and Carry On. Unless you have a very specific situation or have a fairly high income, relax, and take the long-term view.

Meanwhile, here are some specific end-of-year things you should consider:

Next year, health care expenses are only deductible to the extent they exceed ten percent of your adjusted gross income (rather than 7-1/2 percent this year). The rule will remain 7-1/2 percent for those 65 and over. So, if you have a lot of health expenses, try shifting some expenses into 2012 instead of 2013. Refill prescriptions, visit the dentist, etc.

If this year finds you in a lower tax bracket than usual and you can afford it, consider converting your IRA to a Roth IRA before January 1st. It’s always a bit of a guessing game as to when is the best time to make the conversion and pay the tax. Be sure to speak with a professional before you proceed.

Ordinarily, tax planners suggest that you defer income to the next year and prepay expenses in the current year. This allows you to delay paying some taxes for a year. But if tax rates really do go up, this strategy could backfire. Still, unless your income is over $200,000, it’s probably a safe bet to go with the usual strategy: Delay income and accelerate deductions.

If you are in the process of buying or selling real estate or other assets, by all means, listen to and cooperate with the professionals helping you. If the deal needs to be done in 2012, git‘er done! The same goes for estate planning.

Is there any way we can prevent Congress from creating these fiscal cliffs in the future?

Congress often waits until the 11th hour to pass tax legislation in order to convince constituents that “we-tried-as-hard-as-we-could-but-those-wicked-folks-in-the-other-party….” Maybe this is good politics, but it’s terrible economics.

We need to remind Congress what we learned in high school. Our government is a government of compromises. Our system is specifically designed to resist the changes of would-be tyrants. But with a model like ours, it’s vital for legislators to work together. It’s their job: Conduct the peoples’ business—not damage the economy playing politics.

We need to remove the incentives for Congressmen to be dogmatic and uncivil. Let’s inform our individual legislators that we are watching them, and that like 90 percent of other Americans, we aren’t fond of fiscal cliffs.

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.