Perez's Tax Basics

As anyone who reads my blog knows, I am a huge fan of William Perez, writer for About.com. His blog gives you a simple and easy view of tax basics and always keeps you updated on current tax changes.

In reading some of his blog articles, I came across some of the best links to searches for taxpayers who need a better understanding of how the federal taxing system works in regard to preparing your Form 1040 each year.

Understanding how the tax system works is the first key to lowering your taxes. Take a minute to look through this list, I truly believe that there will be a topic that will catch your eye and ultimately will give you some insight into helping you reduce your liability for the coming tax season.

5 Basic Tax Ideas
3 Basic Ways to Reduce Your Taxes
Understanding Your W-2
How One Couple Eliminated Their Taxes
Tips for Filing Your First Tax Return
Avoid Taxes When Selling Your Home
Capital Gains Can Lower Your Tax Rate
Paying Estimated Taxes
Tips for Freelance Contractors

Filing Status

Choosing the right filing status impacts your tax rates, standard deduction, and various limits on tax deductions. Choosing the best filing status can go a long way to making sure you are paying the right amount of tax.

Choosing Your Filing Status
Single
Head of Household
Qualifying Widow or Widower
Married Filing Jointly
Married Filing Separately

Dependents

Who can you claim as a dependent on your tax return? The answer may surprise you. Congress changed the law regarding dependents in 2005, causing confusion for taxpayers and professionals alike. Being able to claim a dependent will help lower your taxes by increasing your personal exemptions and qualifying you for various child-related tax credits.

New Law for Claiming Dependents
Complications with the New Law for Dependents
Rules for Qualifying Relatives
Residency Requirements for Qualifying Relatives
Pre-2005 Law for Dependents
Child Tax Credit
Child and Dependent Care Credit
Adoption Tax Credit
Personal Exemption Amounts

Investing and Taxes

Taxpayers who invest in stocks, bonds, mutual funds, or real estate can benefit from the lower tax rate on long-term gains. Homeowners in particular can exclude up to half a million dollars in profits when they sell their primary residence. By shifting investment income to long-term gain, you can lower your taxes significantly.

Capital Gains Essentials
Capital Losses and Limitations
Short and Long-Term Holding Periods
Types of Capital Assets
Selling Your Main Home
Capital Gains Tax Rates
Calculating Gains on Mutual Funds
Adjusted Basis

Popular Tax Breaks

Some of life's bigger expenses can help lower your taxes. Here's a list of common expenses can will help qualify you for a deduction or tax credit.

Mortgage Interest
Alimony
Child Care
Credits for Higher Education
Individual Retirement Accounts
Student Loan Interest
Moving and Relocation Expenses
Classroom Expenses for Teachers
Earned Income Credit

Several 2008 Forms Now Available

The IRS has released the 2008 Form 1040 and the instructions, along with several other schedules. All newly released forms and instructions are found on the IRS website.

Form 1040 in Adobe PDF Format
Form 1040 U. S. Individual Income Tax Return

Instructions 1040 in Adobe PDF Format
Instructions 1040 U. S. Individual Income Tax Return

Form 1040EZ in Adobe PDF Format
Form 1040EZ Income Tax Return for Single and Joint Filers With No Dependents

Instructions 1040EZ in Adobe PDF Format
Instructions 1040EZ Income Tax Return for Single and Joint Filers With No Dependents

New Due Date for Furnishing Certain 1099s to Recipients

Recent legislation changed the due date for furnishing Copy B of certain information returns to recipients for returns required to be filed after 2008. The new due date is February 15 of the year following the calendar year for which the return is required to be filed. This change applies to Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, and Form 1099-S, Proceeds From Real Estate Transactions.

This change also applies to Form 1099-MISC, Miscellaneous Income, but only if substitute payments in lieu of dividends and tax-exempt interest or payments to attorneys are reported.

An incorrect due date is printed in the 2008 general instructions for Forms 1099, 1098, 5498, and W-2G, and in the instructions on the reverse side of Copy C of the 2008 Forms 1099-B, 1099-MISC, and 1099-S. The correct due date for furnishing the 2008 Copy B to recipients is as follows:

February 17, 2009, for Forms 1099-B and 1099-S.

February 17, 2009, for Form 1099-MISC if substitute payments are reported in box 8 or gross proceeds paid to an attorney are reported in box 14. If no such payments are reported, February 2, 2009, remains the due date for furnishing Copy B of Forms 1099-MISC to recipients.

2009 Tax Changes

For 2009, personal exemptions and standard deductions will rise and tax brackets will widen because of inflation adjustments announced today by the Internal Revenue Service.

By law, the dollar amounts for a variety of tax provisions must be revised each year to keep pace with inflation. As a result, more than three dozen tax benefits, affecting virtually every taxpayer, are being adjusted for 2009. Key changes affecting 2009 returns, filed by most taxpayers in early 2010, include the following:

The value of each personal and dependency exemption, available to most taxpayers, is $3,650, up $150 from 2008.

The new standard deduction is $11,400 for married couples filing a joint return (up $500), $5,700 for singles and married individuals filing separately (up $250) and $8,350 for heads of household (up $350). Nearly two out of three taxpayers take the standard deduction, rather than itemizing deductions, such as mortgage interest, charitable contributions and state and local taxes.

Tax-bracket thresholds increase for each filing status. For a married couple filing a joint return, for example, the taxable-income threshold separating the 15-percent bracket from the 25-percent bracket is $67,900, up from $65,100 in 2008.

The maximum earned income tax credit for low and moderate income workers and working families with two or more children is $5,028, up from $4,824. The income limit for the credit for joint return filers with two or more children is $43,415, up from $41,646.

The annual gift exclusion rises to $13,000, up from $12,000 in 2008.

Garnishment vs. Levy - What Would You Do?

The IRS, to most people, is a collection agency that can be lethal. If you have an issue with them and think that you can deal with them on your own (without proper expert representation) it is the same as going to court without a lawyer. It's a disaster waiting to happen and there are a tremendous majority of folks who believe that they can handle their case on their own.

An IRS levy is the actual seizure action taken by the IRS to collect taxes. For example, the IRS can issue a bank levy to take your cash in savings and checking accounts.

The IRS can levy your wages or accounts receivable and all other sources of income. The person, company, or institution that is served the levy must comply. If they do not comply, they too may have daunting IRS (legal) problems. The additional paperwork this person, company or institution is faced with to comply with the levy, usually causes the taxpayer's relationship to suffer with the person being levied.

Levies should be avoided at all costs:-Levies usually are the result of poor or no communication between the taxpayer and the IRS.

When the IRS levies a bank account, the levy is only for the particular day the levy is received by the bank. These are generally referred to “one shot” levies.-The bank is required to remove whatever amount is available in your account that day (up to the amount of the IRS levy ) and send it to the IRS in 21 days unless notified otherwise by the IRS. -This type of levy does not effect any future deposits made into your bank account unless the IRS issues another Bank Account Levy.

An IRS Wage Levy is different. Wage levies are filed with your employer and remain in effect until the IRS notifies the employer that the wage levy has been released. These are generally referred to as a continuous levy. Most wage levies take so much money from the taxpayer's paycheck that the taxpayer doesn't have enough money to live on.

Undeliverable Stimulus Checks - 279,000 Were Returned

The Internal Revenue Service is looking for taxpayers who are missing more than 279,000 economic stimulus checks totaling about $163 million and more than 104,000 regular refund checks totaling about $103 million that were returned by the U.S. Postal Service due to mailing address errors.

“People across the country are missing tax refunds and stimulus checks. We want to get this money into the hands of taxpayers where it belongs,” said IRS Commissioner Doug Shulman.

“We are committed to making the process as easy as possible for taxpayers to update their addresses with the IRS and get their checks.”

All a taxpayer has to do is update his or her address once. The IRS will then send out all checks due.

Stimulus Checks

It is crucial that taxpayers who may be due a stimulus check update their addresses with the IRS by Nov. 28, 2008. By law, economic stimulus checks must be sent out by Dec. 31 of this year. The undeliverable economic stimulus checks average $583.

The “Where’s My Stimulus Payment?" tool on this Web site is the quickest and easiest way for a taxpayer to check the status of a stimulus check and receive instructions on how to update his or her address. Taxpayers without internet access should call 1-866-234-2942.

Regular Refunds

The regular refund checks that were returned to the IRS average $988. These checks are resent as soon as taxpayers update their address.

Taxpayers can update their addresses with the “Where’s My Refund?” tool on this Web site. It enables taxpayers to check the status of their refunds. A taxpayer must submit his or her social security number, filing status and amount of refund shown on their 2007 return. The tool will provide the status of their refund and in some cases provide instructions on how to resolve delivery problems.

Taxpayers checking on a refund over the phone will be given instructions on how to update their addresses. Taxpayers can access a telephone version of “Where’s My Refund?” by calling 1-800-829-1954.

Mortgage Forgiveness Debt Relief Act of 2007

People who have lost their homes through foreclosure or who have restructured their mortgage loans may qualify for tax relief under a new tax law, the Mortgage Forgiveness Debt Relief Act of 2007. The tax relief was extended to cover the years 2007 through 2012 under the Emergency Economic Stabilization Act.

You can exclude up to $2 million of debt forgiven or canceled by a mortgage lender on a main home.

Both mortgage restructuring and foreclosures qualify.

Available for the years 2007 through 2012.

Claim the tax relief using IRS Form 982 (PDF)

Anytime a lender cancels, or forgives, your debt, that is considered income to the debtor. The tax laws considers this income, and the debtor is taxed on forgiven debt unless an exception applies.

Anytime a lender cancels or forgives debt, that is usually a taxable event. "Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income." (Source: Publication 525)

Debt forgiveness is reported by the lender using Form 1099-C, Cancellation of Debt. Individuals report the forgiven debt on their Form 1040, Line 21 as other income.

The tax laws provide several exceptions to the tax treatment of forgiven debts. Tax-free treatment of mortgage debt is the most generous and easiest to calculate.

Individuals who lost their homes through foreclosure will not have to pay income tax on the amount of mortgage debt that was forgiven or canceled. Tax-free treatment is also available to people who restructured their mortgages loans for a lower balance.

The tax-free exclusion applies to canceled mortgage debt of up to $2 million (or $1 million is married and filing a separate return). There are additional details to consider to qualify for this tax exclusion. The house must have been used as a main home, which means it was the principal place of residence for the debtor. Also, the debt must have been used to buy, build, or make substantial improvements to the residence.

Some mortgage debt won't qualify for this tax-free exclusion and will be considered taxable income. Mortgage loans that don't qualify include home equity loans where the proceeds were not used to buy, build, or improve the residence. Also, mortgages for second houses and rental properties do not qualify for the exclusion. However, some or all of this debt might qualify for other exclusions.

The IRS explains the tax break this way: "Taxpayers can exclude up to $2 million of debt forgiven on their principal residence. The limit is $1 million for a married person filing a separate return. This provision applies to debt forgiven in 2007, 2008 or 2009. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure qualify for this relief." (Source: IRS.gov)

Individuals who qualify for this tax relief will need to use Form 982 to report the canceled debt.

Besides the provision for mortgages on main homes, the tax code provides other ways that canceled debt can be tax-free. Canceled debts do not need to be included in taxable income if the debt was canceled in a bankruptcy case, if the individual is insolvent, or if the canceled debt was intended as a gift. Certain business or farm property may also qualify for tax-free treatment.

The insolvency exclusion is particularly relevant, as it will likely apply to borrowers with home equity loans or mortgages on second homes and rental properties.

This insolvency provision will prove helpful to individuals who don't otherwise qualify for the mortgage debt relief. To be considered insolvent, the person's liabilities must exceed the fair market value of their assets. This is will be especially true of borrowers who's properties have dropped in value and who now must restructure their loans or surrender their properties through foreclosure.

"You are insolvent when, and to the extent, your liabilities exceed the fair market value of your assets. Determine your liabilities and the fair market value of your assets immediately before the cancellation of your debt to determine whether or not you are insolvent and the amount by which you are insolvent." (Source: Publication 908)

The ABCs of Estates

The taxing of estates is to this writer, one of the most confusing and misunderstood sections of the tax code. You can sit for hours reading the IRS' website on the subject and still be lost. I have searched for some great links that I feel will explain in simple language all of the aspects of estate taxation.

Anyone who has accumulated wealth, no matter what age, should educate themselves on what will happen with their estate should they not plan ahead. I strongly suggest that everyone take some time and read some of these links.

Education and knowledge are powerful tools and the following links contain very valuable information.

Suggested Reading

How to Calculate the Value of Your Gross Estate
What Value of an Asset is Used for Estate Tax Purposes?
How to Calculate Your Net Worth

Definitions

Charitable Lead Trust
Charitable Remainder Trust
Estate Tax

More Defintions

Exemption from Estate Taxes
Gross Estate
Unlimited Marital Deduction

About Estate Taxes

Overview of Taxes That Affect an Estate
Overview of Current Federal Estate Tax Laws
What is the Future of the Federal Estate Tax?
How to Calculate the Value of Your Gross Estate
What Value of an Asset is Used for Estate Tax Purposes?

The above links are courtesy of ABOUT.COM and author William Perez, a highly respected tax professional and one of my daily subscription authors.

What Obama Has In Store For Your Estate!

Now that the presidential election is settled, there's no doubt that president-elect Obama and Congress will be addressing the fate of the federal estate tax very soon. Why? Because next year the federal estate tax exemption will increase from $2,000,000 to $3,500,000 and in 2010 the federal estate tax will completely vanish. Then, in 2011, the federal estate tax will return but the exemption will only be $1,000,000.

During his campaign, then Senator Obama was against full repeal of the federal estate tax in 2010 and instead favored making the $3,500,000 exemption permanent. But couple the fact that then Senator Obama's estate tax plan was put together well before the current economic crisis with the Democrats view that repeal of the federal estate tax would only benefit the super wealthy and take needed funds out of the federal budget, and I have to wonder if we're only a year away from the estate tax exemption reverting back to $1,000,000. And what about portability of the federal estate tax exemption between spouses? Forget about it, at least for now.

With this in mind, while there's been a lot talk about "Obama proofing" your investments and small business, I haven't heard anything about "Obama proofing" your estate plan. What do I mean by this? Here's a few things to consider:

Planning for a $1,000,000 estate tax exemption;

If you're married, taking the steps necessary to maximize the use of both spouses' estate tax exemptions through the use of AB Trusts;

Whether you're married or single, exploring the options for minimizing your estate tax bill through gifting and advanced estate planning;

Whether you're married or single, setting up an Irrevocable Life Insurance Trust to provide readily available cash to pay estate taxes - this needs to be done while you're younger and in good health, and the good news is that if the insurance isn't needed to pay estate taxes, then you'll be leaving a windfall of cash for your loved ones; and

Monitoring your estate plan on a yearly basis to insure that it still meets your needs and addresses your estate tax liability.

Additional reading resources courtesy of ABOUT.COM:

What is the Future of the Federal Estate Tax?
How to Minimize Estate Taxes
What Are the Options for Paying Estate Taxes?
What is an AB Trust?
What is an Irrevocable Life Insurance Trust?

Inherited IRA - Not As Easy As It Seems

Receiving an inheritance can be a nice windfall. But, when it comes to inheriting an IRA, the tax rules can be tricky and your decisions regarding this asset can have far-reaching tax implications. Mistakes can be very costly. So, before you decide what to do with it, find out what your options are so you can maximize the dollars you keep.

One of the greatest benefits of inheriting an IRA is the ability to stretch out the account over long periods of time. Stretching defers the income taxes due on the account, allowing your IRA to grow in a tax favorable environment. If you don't need the current income to survive, this is usually your best option. However, everyone's financial situation is unique.

There are important factors that will determine a beneficiary's choices when inheriting an IRA:

1) Who did you inherit the IRA from?
2) What is the timeframe regarding your transfer options?

Inheriting an IRA from a spouse gives you flexibility not available to other beneficiaries. You can put the IRA in your name or you can roll over the funds into an IRA you have already set up.

The IRS will treat this as if the inherited IRA assets were yours all along.

Assuming that you are younger than 70 ½, as a spouse not only are you not required to take any distributions from the inherited money, but it also means that you can make additional contributions to the IRA (assuming you qualify). Converting the IRA into your name will also allow you determine your own beneficiary.

Your other choice is to leave the IRA in your deceased spouse's name. If you are older that your deceased spouse and your objective is to defer the account as long as possible, this a good option because the RMD's will be based on the younger spouse's age. However, if you are younger than your deceased spouse and do not currently need the IRA income, then this option may be less tax efficient that converting the IRA as your own.

This option forces you to take the RMD (required minimum distribition) as required, with the first minimum withdrawal taken no later than:

• December 31st of the year your spouse would have turned 70 1/2 had he or she continued to live, or
• December 31st of the year following the year your spouse dies (if your spouse was already 70 ½). So if your spouse died in 2003 this year, the earliest possible date for a required minimum withdrawal is Dec. 31st of 2004.

Heirs may base the distribution amount either on their life expectancy or that of the deceased owner.

For surviving spouses who are younger than 59 ½ and depend on the income from the IRA for survival, leaving the IRA in your spouse's name is the best option. It allows you to take distributions without incurring a 10% early withdrawal penalty. But, because the IRA remains in your deceased spouse's name, the future beneficiaries cannot be changed.

As a spousal heir, one of the flexibilities of an inherited IRA is that you can split the account. So, let's say you needed some current income from the account (which you will be forced to take for the rest of your life), but don't want to exhaust the whole account, you can split the inherited account into one that generates income (stays in deceased spouse's name) and the other (converted to your own IRA account) to grow, deferring distributions until your RMD age.

Non spouse heirs do not have the option of treating inherited IRAs as your own. This doesn't mean that the money isn't yours; it simply means that you can't make any contributions to that IRA or roll it over to another IRA. Nevertheless, you have choices.

If the decedent was age 70 ½ or greater (and taking distributions out of the IRA when he/she died), then you may start taking money out using the same distribution method. This option is typically not recommended, unless you desperately need the money. If the decedent was not yet taking distributions out of the IRA, you have two IRA distribution options:

1. All of the interest from the IRA must be distributed to you by December 31st of the fifth year after the year the decedent died, (not the best choice) OR
2. All of the interest must be distributed over your life expectancy

This situation is further complicated when a decedent leaves the IRA to multiple beneficiaries.

Let's assume that a father leaves his IRA to his three adult children. Those children must first establish three new "inherited IRA" accounts.

The transfer from the decedent's IRA must be made directly from the old IRA into the three new IRA's by way of a "trustee to trustee transfer". Releasing the funds directly to the beneficiary will prohibit the future rollover of those assets into the inherited IRA, which forces full taxation on the amount distributed (but does not garner a 10% early withdrawal penalty since it was inherited).

In previous years, RMD's were based on the life expectancy of the oldest child, cheating younger heirs out deferral time. However, if the new inherited IRA accounts are established in the year after the year of the owner's death (so if died 2003, then Dec.31 of 2004), then each child will be able to use his/her own life expectancy going forward on their RMD's.

In all of the above scenarios, income taxes are not due until distributions are actually taken.

However, a 50% tax penalty can be assessed for failing to take the required minimum distribution in a timely fashion. So be mindful of your deadlines, because Uncle Sam will be.

Nobody said inheriting money was easy. The rules are quite complex and ignorance can translate into costly mistakes. Do your homework before your act. Remember, as with any other delicate financial matter, you should probably consult your advisor and/or tax professional first.

Additional resources:

Charles Schwab IRA Brochure

IRS Publication 590

Rollover by Non-Spouse Beneficiary

IRS Publication 575 - Pension and Annuity

Disasters and Crop Insurance - Are They Taxable?

This year has been extremely hard on farmers all over the country. Crop insurance gives farmers a relief from the overwhelming financial burden of these disasters. There are definite taxable events that can take place with the receipt of these insurances.

As with any casualty loss, you must include in income any crop insurance proceeds you receive as the result of crop damage. You generally include them in the year you receive them but if it is a Presidentially declared area, you may have the opportunity to treat the loss in a different year.

You should treat as crop insurance proceeds the crop disaster payments you receive from the federal government as the result of destruction or damage to crops, or the inability to plant crops because of drought, flood, or any other natural disaster.

Please remember that you can request income tax withholding from crop disaster payments you receive from the federal government. Use Form W-4V, Voluntary Withholding Request (PDF).

Refer to How to Get Tax Help in Publication 225 for information about ordering the form.

You May Choose To Postpone Reporting Until The Following Year

If you use the cash method of accounting and receive crop insurance proceeds in the same tax year in which the crops are damaged, you can choose to postpone reporting the proceeds as income until the following tax year. You can make this choice if you can show you would have included income from the damaged crops in any tax year following the year the damage occurred.

How To Postpone Reporting Of Crop Insurance Proceeds

To choose to postpone reporting crop insurance proceeds received in the current year, report the amount you received on line 8a of Schedule F (PDF), but do not include it as a taxable amount on line 8b. Check the box on line 8c and attach a statement to your tax return. It must include your name and address and contain the following information:

A statement that you are making a choice under IRC section 451(d) and Treasury Regulation section 1.451-6

The specific crop or crops destroyed or damaged

A statement that under your normal business practice you would have included income from the destroyed or damaged crops in gross income for a tax year following the year the crops were destroyed or damaged.

The cause of the destruction or damage and the date or dates it occurred

The total payments you received from insurance carriers, itemized for each specific crop and the date you received each payment

The name of each insurance carrier from whom you received payments

Additional resources:

Farm Income Section of Publication 225, Farmer's Tax Guide
Tax Tips - Agriculture

Patronage Dividends

If you buy farm supplies through a cooperative, you may receive income from the cooperative in the form of patronage dividends. If you sell your farm products through a cooperative, you may receive either patronage dividends or a per-unit retain certificate, explained later, from the cooperative.

Form 1099-PATR

The cooperative will report the income to you on Form 1099-PATR (PDF) or a similar form and send a copy to the IRS. Form 1099-PATR may also show an alternative minimum tax adjustment that you must include if you are required to file Form 6251, Alternative Minimum Tax--Individuals (PDF). For information on the Alternative Minimum Tax, Refer to Publication 225.

Per-Unit Retain Certificates

A per-unit retain certificate is any written notice that shows the stated dollar amount of a per-unit retain allocation made to you by the cooperative. A per-unit retain allocation is an amount paid to patrons for products sold for them that is fixed without regard to the net earnings of the cooperative. These allocations can be paid in money, other property, or qualified certificates.
Per-unit Retain Certificates issued by a cooperative generally receive the same tax treatment as Patronage Dividends, discussed earlier.

References/Related Topics

Farm Income section of Publication 225, Farmer's Tax Guide
Form 1099-PATR, Taxable Distributions Received From Cooperatives (PDF)
Tax Tips - Agriculture

Need Some Help With AMT?

One of the biggest concerns that taxpayers with large amounts of deductions face is the Alternative Minimum Tax (AMT). Many of us find it hard to explain and sometimes even harder to understand.

Every year taxpayers need to consider whether they will have to pay the Alternative Minimum Tax (AMT). The AMT Assistant is intended to provide a simple test for taxpayers who fill out their tax returns without using software to determine whether they may be subject to the AMT.

The AMT Assistant is an electronic version of the AMT Worksheet in the 1040 Instructions, called the “Worksheet to See if You Should Fill in Form 6251 - Line 45.”

Using the AMT AssistantThe AMT Assistant is easy to use. You just answer a few simple questions about entries on your draft 1040 and the system does the rest. You will see the results immediately on your computer screen. Based on your entries, the results will tell you that either you do not owe the AMT or that you must go further and complete Form 6251 to find out if you owe the AMT.

Your entries are anonymous and the information will be used only for the purpose of determining your eligibility. All entries are erased when you exit or start over. See the “IRS Privacy Policy” for more information.

The Assistant can be used by individuals, tax practitioners and community or public service organizations.

Tax Year 2007 AMT Assistant

Tax Year 2007 Additional Resources:

Alternative Minimum Tax (AMT) – How It Affects Filing Season 2008
IR-2008-19 - IRS Successfully Processing Tax Forms Affected by AMT Legislation
IR-2007-209 - Filing Season Opens on Time Except for Certain Taxpayers Potentially Affected by AMT Patch
AMT and Filing Season 2008: Q&A
Form 1040 Instructions (PDF)
Form 1116, Foreign Tax Credit (Individual, Estate, or Trust) (PDF)
Form 1116 Instructions
Form 6251, Alternative Minimum Tax – Individuals (PDF)
Form 6251 Instructions