Saturday, June 4, 2011

3 Ways Your Social Security Payments Are Already Being Cut

At Brummet & Olsen LLP, we are being contacted by an increasing number of clients worried about whether or not they will have enough money in their future retirement years to live comfortably. This concern is appropriate, and certainly timely as Congress is toying with this issue in regards to deficit reduction. The troubling thing we see at our firm, however, is that the only clients that are informing themselves are those approaching retirement. As illustrated in the following article, it is critical that EVERYONE, young and old, become informed as to the current status of Social Security and Medicare, and keep up with the latest developments in pending legislation whose final laws will certainly impact today's workers, their elderly parents, and their children's retirment security. These issues affect everyone, and it is critical to take the time to educate yourself as to what the current law is, what is being proposed, and the long-term effect of any changes. The following Yahoo Finance article summarizes some lesser-known realities of the current Social Security laws.

3 Ways Your Social Security Payments Are Already Being Cut
by Alicia Munnel
Provided by SmartMoney

Policy experts have focused on alternative ways of eliminating Social Security's 75-year financing gap, but lost in the debate is the fact that even under current law Social Security will provide less retirement income relative to previous earnings than it does today. Combine the already legislated reductions with potential cuts to close the financing gap, and Social Security may no longer be the mainstay of the retirement system for many people.

In 2002, the frequently quoted replacement rate for the "medium earner" who earned about $42,000 in today's dollars and retired at age 65 was 41%; that is, Social Security benefits were equal to 41% of the individual's previous earnings. Under current law, three factors will reduce this replacement rate: 1) the extension of the full retirement age; 2) the increase in Medicare premiums; and 3) the taxation of Social Security benefits.

1. The Extension of the Full Retirement Age
Under current law, the full retirement age is scheduled to increase from 65 for those reaching 62 in 2000 to 67 for people reaching age 62 in 2022. This increase is equivalent to an across-the-board benefit cut. For those who continue to retire at age 65, this cut takes the form of lower monthly benefits; for those who extend their work lives, it takes the form of fewer years of benefits. Thus, as reported in the Social Security Trustees Report, the replacement rate for the medium earner will drop from 41% to 36% for people who retire at age 65 in 2030.

2. The Increase in Medicare Premiums
The rising cost of Medicare will also affect future replacement rates. For the medium earner, Medicare premiums, which are automatically deducted from Social Security benefits, are scheduled to increase from 5% of benefits for someone retiring in 2002 to 12% for someone retiring in 2030.

3. The Taxation of Social Security Benefits
The third factor that will reduce Social Security benefits is the extent to which they are taxed under the personal income tax. Under current law, individuals with less than $25,000 and married couples with less than $32,000 of "combined income" do not have to pay taxes on their Social Security benefits. (Combined income is adjusted gross income as reported on tax forms in addition to nontaxable interest income and half of your Social Security benefits.) Above those thresholds, recipients must pay taxes on either 50% or 85% of their benefits. In 2002, only 20% of people receiving Social Security had to pay taxes on their benefits, so median earners typically did not pay any taxes. But the thresholds are not indexed for growth in average wages or even for inflation so, by 2030, as real benefits and other income increases, many medium earners will pay tax on half of their benefits.

The bottom line is that the net Social Security replacement rate for the medium earner will decline from 39% in 2002 to 29% in 2030 under current law. Policymakers need to be aware of this fact when they consider how much of the 75-year financing gap should be closed by benefit cuts and how much by tax increases.

Alicia Munnell is the Director for the Center for Retirement Research at Boston College.

Contact Brummet & Olsen, LLP at (630) 986-0540, we'd be glad to answer any questions you may have.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Saturday, April 9, 2011

What to Do If You Owe Taxes

Many of us already have gotten the bad news -- Uncle Sam is going to hand us a bill. About one in four tax returns have a balance due, according to the Internal Revenue Service. And that could be painful. In 2008, the average bill was a whopping $5,000.

The good news is that there's still time to plan, and you have a number of options before taxes are due on April 18.

Federal taxpayers can choose between swiping and putting the balance on a credit card, starting a payment plan with the IRS, and of course, just paying the bill in full.

If you have the money, your best options include writing a check, making an electronic payment when you e-file your return, or enrolling in the U.S. Treasury's free service for paying federal taxes electronically, the Electronic Federal Tax Payment System.

But even if you can't pay the balance now, make sure to file your tax return by April 18, or request an extension in order to avoid late filing penalties, says Melissa Labant of the American Institute of Certified Public Accountants. Late filing penalties are normally 5% of the tax owed for each month your return is late, for up to five months, according to the IRS. And that's in addition to late payment interest and penalties on taxes owed.

Be sure to let the IRS know you can't afford the bill and then "pay whatever you can," says Labant. "Paying something is better than paying nothing." That cuts down on late payment penalties and interest charges since the IRS generally charges interest on any unpaid tax from the day the tax is due to the date it is paid.The interest rate, currently at 4%, is determined quarterly, and is normally set at 3 percentage points over the federal short term rate. And that doesn't include late payment penalties, which are normally 0.5% of taxes owed a month.

Taxpayers who need less than four months to pay off a balance may be able to set up an informal payment plan with the IRS, says Elaine Smith, an enrolled agent and tax professional with H&R Block. Those who need more time can set up an installment agreement with the IRS, where the late payment penalty is reduced to .25% a month. If the agreement is approved, taxpayers are charged a one-time fee of up to $105, but that fee is slashed to $52 for people who agree to have payments deducted directly from their bank accounts. Certain low-income individuals can qualify for a $43 fee.

You can also buy yourself a 30-day extension by putting the balance on a credit card, but you have to go through an IRS approved service provider that will charge a convenience fee of roughly 2% to 2.4%, plus there is the interest charge you might get from your credit card company. (Crunch the numbers because the interest charges on your card may be less than the late payment penalties charged by the IRS).And a "zero percent credit card could buy you even more time," says Smith.

Your options are different if you owe state taxes because some states offer payment plans or let you pay with a credit card and others do not. Contact your state department of revenue to figure out what your options are.

One other important step is to make sure this doesn't happen again, tax experts warn. Use the withholding calculator on the IRS website to figure out if you need to adjust your income tax with holdings on your W4 form. You might find yourself with a tax bill after a big life change -- getting married or divorced, having a baby, moving out of home for the first time, changing jobs and selling a house, to name a few. So make sure to contact a tax professional or consult the IRS if you have any questions.

Jonnelle Marte
Friday, March 18, 2011

Excerpted from Yahoo!Finance, provided by SmartMoney

Contact our office at (630) 986-0540, we'd be glad to answer any questions you may have.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Monday, April 4, 2011

Ten Things to Know About Tax Refunds

Are you expecting a tax refund this year? Here are 10 things the IRS wants you to know about your refund.

1. Refund Options You have three options for receiving your individual federal income tax refund: direct deposit, U.S. Savings Bonds or a paper check. You can now use your refund to buy up to $5,000 in U.S. Series I Savings Bonds in multiples of $50.
2. Separate Accounts You may use Form 8888, Allocation of Refund (Including Savings Bond Purchases), to request that your refund be allocated by direct deposit among up to three separate accounts, such as checking or savings or retirement accounts. You may also use this form to buy U.S Savings Bonds.
3. Tax Return Processing Times If you file a complete and accurate paper tax return, your refund will usually be issued within six to eight weeks from the date it is received. If you filed electronically, your refund will normally be issued within three weeks after the acknowledgment date.
4. Check the Status Online The fastest and easiest way to find out about your current year refund is to go to and click the “Where’s My Refund?” link at the home page. To check the status online you will need your Social Security number, filing status and the exact whole dollar amount of your refund shown on your return.
5. Check the Status By Phone You can check the status of your refund by calling the IRS Refund Hotline at 800–829–1954. When you call, you will need to provide your Social Security number, your filing status and the exact whole dollar amount of the refund shown on your return.
6. Check the Status with IRS2Go IRS2Go is a smartphone application that lets you interact with the IRS using your mobile device. Apple users can download the free IRS2Go application by visiting the Apple App Store. Android users can visit the Android Marketplace to download the free IRS2Go app. Simply enter your Social Security number, which will be masked and encrypted for security purposes, then select your filing status and the exact whole dollar amount of your refund shown on your return.
7. Delayed Refund There are several reasons for delayed refunds. For things that may delay the processing of your return, refer to Tax Topic 303 available on the IRS website at, which includes a Checklist of Common Errors When Preparing Your Tax Return.
8. Larger than Expected Refund If you receive a refund to which you are not entitled, or one for an amount that is more than you expected, do not cash the check until you receive a notice explaining the difference. Follow the instructions on the notice.
9. Smaller than Expected Refund If you receive a refund for a smaller amount than you expected, you may cash the check. If it is determined that you should have received more, you will later receive a check for the difference. If you did not receive a notice and you have questions about the amount of your refund, wait two weeks after receiving the refund, then call 800–829–1040.
10. Missing Refund The IRS will assist you in obtaining a replacement check for a refund check that is verified as lost or stolen. If the IRS was unable to deliver your refund because you moved, you can change your address online. Once your address has been changed, the IRS can reissue the undelivered check.

For more information, visit the IRS website at or call 800-829-1040.
Please feel free to contact our office with any questions you may have.
Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Tuesday, March 22, 2011

Eight Tips for Deducting Charitable Contributions

Charitable contributions made to qualified organizations may help lower your tax bill. The IRS has put together the following eight tips to help ensure your contributions pay off on your tax return.

1. If your goal is a legitimate tax deduction, then you must be giving to a qualified organization. Also, you cannot deduct contributions made to specific individuals, political organizations and candidates. See IRS Publication 526, Charitable Contributions, for rules on what constitutes a qualified organization.

2. To deduct a charitable contribution, you must file Form 1040 and itemize deductions on Schedule A.

3. If you receive a benefit because of your contribution such as merchandise, tickets to a ball game or other goods and services, then you can deduct only the amount that exceeds the fair market value of the benefit received.

4. Donations of stock or other non-cash property are usually valued at the fair market value of the property. Clothing and household items must generally be in good used condition or better to be deductible. Special rules apply to vehicle donations.

5. Fair market value is generally the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts.

6. Regardless of the amount, to deduct a contribution of cash, check, or other monetary gift, you must maintain a bank record, payroll deduction records or a written communication from the organization containing the name of the organization, the date of the contribution and amount of the contribution. For text message donations, a telephone bill will meet the record-keeping requirement if it shows the name of the receiving organization, the date of the contribution, and the amount given.

7. To claim a deduction for contributions of cash or property equaling $250 or more you must have a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift. One document may satisfy both the written communication requirement for monetary gifts and the written acknowledgement requirement for all contributions of $250 or more. If your total deduction for all noncash contributions for the year is over $500, you must complete and attach IRS Form 8283, Noncash Charitable Contributions, to your return.

8. Taxpayers donating an item or a group of similar items valued at more than $5,000 must also complete Section B of Form 8283, which generally requires an appraisal by a qualified appraiser.

For more information on charitable contributions, refer to Form 8283 and its instructions, as well as Publication 526, Charitable Contributions. Please contact our office with any questions you may have.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Thursday, March 17, 2011

FAQ: What are the rules for claiming dependents on my tax return?

A familiar issue to CPAs involves taxpayers who are confused by whether or not they can still claim that college graduate as a dependent on their taxes, or can Grandma be claimed since she lives with them all year. Parents of an adult child with disabilities, or an in-law situation where they live in their own home but require substantial financial assistance are additional examples of dependency questions taxpayers face when preparing their returns.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

Dependency deduction

You are allowed one dependency exemption deduction for each person you claim as a qualifying dependent on your federal income tax return. The deduction amount for the 2010 tax year is $3,650. If someone else may claim you as a dependent on their return, however, then you cannot claim a personal exemption (also $3,650) for yourself on your return. Additionally, your standard deduction will be limited.

Only one taxpayer may claim the dependency exemption per qualifying dependent in a tax year. Therefore, you and your spouse (or former spouse in a divorce situation) cannot both claim an exemption for the same dependent, such as your son or daughter, when you are filing separate returns.

Who qualifies as a dependent?

The term "dependent" includes a qualifying child or a qualifying relative. There are a number of tests to determine who qualifies as a dependent child or relative, and who may claim the deduction. These include age, relationship, residency, return filing status, and financial support tests.

The rules regarding who is a qualifying child (not a qualifying relative, which is discussed below), and for whom you may claim a dependency deduction on your 2010 return, generally are as follows:

-- The child is a U.S. citizen, or national, or a resident of the U.S., Canada, or Mexico;

-- The child is your child (including adopted or step-children), grandchildren, great-grandchildren, brothers, sisters (including step-brothers, and -sisters), half-siblings, nieces, and nephews;

-- The child has lived with you a majority of nights during the year, whether or not he or she is related to you;

-- The child receives less than $3,650 of gross income (unless the dependent is your child and either (1) is under age 19, (2) is a full-time student under age 24 before the end of the year), or (3) any age if permanently and totally disabled;

-- The child receives more than one-half of his or her support from you; and

-- The child does not file a joint tax return (unless solely to obtain a tax refund).

Qualifying relatives

The rules for claiming a qualifying relative as a dependent on your income tax return are slightly different from the rules for claiming a dependent child. Certain tests must also be met, including a gross income and support test, and a relationship test, among others. Generally, to claim a "qualifying relative" as your dependent:

-- The individual cannot be your qualifying child or the qualifying child of any other taxpayer; -- The individual's gross income for the year is less than $3,650; -- You provide more than one-half of the individual's total support for the year; -- The individual either (1) lives with you all year as a member of your household or (2) does not live with you but is your brother or sister (include step and half-siblings), mother or father, grandparent or other direct ancestor, stepparent, niece, nephew, aunt, or uncle, or inlaws. Foster parents are excluded.

Although age is a factor when claiming a qualifying child, a qualifying relative can be any age.

Special rules for divorced and separated parents

Certain rules apply when parents are divorced or separated and want to claim the dependency exemption. Under these rules, generally the "custodial" parent may claim the dependency deduction. The custodial parent is generally the parent with whom the child resides for the greater number of nights during the year.

However, if certain conditions are met, the noncustodial parent may claim the dependency exemption. The noncustodial parent can generally claim the deduction if:

-- The custodial parent gives up the tax deduction by signing a written release (on Form 8332 or a similar statement) that he or she will not claim the child as a dependent on his or her tax return. The noncustodial parent must attach the statement to his or her tax return; or

-- There is a multiple support agreement (Form 2120, Multiple Support Declaration) in effect signed by the other parent agreeing not to claim the dependency deduction for the year.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Sunday, March 13, 2011

Taxpayers the IRS Is Targeting This Year

Every year clients inquire as to the probability of their returns being selected for audit and what can trigger an examination. The following article explains in general what areas are of special interest to the Internal Revenue Service.

Taxpayers the IRS Is Targeting This Year
Mark P. Cussen

Excerpted from

Out of the millions of tax returns that are filed with the IRS each year, a certain percentage are inevitably flagged and chosen to be audited. In some cases, this is because the taxpayer filing the return is already being investigated for tax fraud or other crimes, while other returns are merely selected at random. The formula that the IRS uses to flag returns for random audit, known as the Discriminant Function, is a highly classified secret known only to a few. However, there are several types of returns that the IRS tends to focus on in general. Filers with returns that fall into one of these categories must accept that there is a higher probability that they will be audited than other taxpayers. Some of the types of returns that the IRS tends to scrutinize more closely include:

Returns that Itemize Deductions
Taxpayers who include a Schedule A with their 1040 likely have a higher chance of being audited than those who don't. This is because the additional calculations invite a greater possibility of fraud or error by the taxpayer.

Self-Employed Taxpayers
Taxpayers who report income on Schedule C or E are prime targets of the IRS, because of the number of expenses that can be claimed as deductions. Those who report net losses for the year that reduce other taxable income, such as salaries or investment income are especially vulnerable to examination by the IRS.

"Cash Cow" Businesses
Many businesses have traditionally operated largely on a cash basis, such as laundry services, restaurants, casinos and gaming establishments and other similar enterprises. A substantial percentage of these businesses have traditionally underreported their income on their tax returns, due to the difficulty of proving revenue that is received in cash from thousands of separate transactions. For this reason, the mafia and other organized crime syndicates have been heavily involved with these industries for the past several decades. Of course, this has not escaped the notice of the IRS, which has collaborated with various law enforcement agencies who pursue these criminals.

Small Businesses
Even businesses such as florists, hobby store owners, construction contractors and other local enterprises are often scrutinized by the IRS. This is because even honest business owners and partners often don't understand the rules for correctly reporting their income and expenses and therefore submit erroneous returns. This is particularly true of those who are filing a business return for the first time, such as the proprietor of a new company.

Private Transactions
Taxpayers who engage in the sale of substantial pieces of real estate or hold interests in oil and gas leases or other such investment property can often realize enormous income and profits from individual buyers or small companies. The IRS knows how easy it can be to underreport the profits from these transactions, in some cases.

The Bottom Line
Remember that if the IRS does flag your return for audit, it does not mean that they suspect you of cheating. As mentioned previously, many returns are selected at random, according to a formula. As long as you have not cheated on your return, then you don't have to worry about what they find. If there is an error, the IRS will notify you in writing of the discrepancy and tell you how much more you owe. Of course, this process can work both ways; it is possible that the IRS could state that you owe less than you reported as well. Just make sure that you have all of the documentation that you need to prove your deductions, such as copies of receipts and bills. As long as you can supply what the IRS requests, your audit should be a relatively quick and painless process.
March 4, 2011

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Tuesday, March 8, 2011

10 Tax Mistakes Parents Often Make

Being a parent is a challenging job. At tax time, parents have an additional challenge of deciphering the tax code to properly handle income, deductions, and credits that relate to their children. Our previous blog dealt in depth with education tax issues. This article deals with some overall areas that parents tend to navigate with difficulty.

10 Tax Mistakes Parents Often Make
Kimberly Palmer

Excerpt from

Between sleep deprivation and hectic schedules, parents don't always have time to decipher the tax code. That means many of them lose out on potential savings in the form of tax credits, deductions, and tax-advantaged savings plans. We interviewed tax experts on the most common mistakes that parents make when they do their taxes. Here are the top 10:

Failing to quickly get a Social Security number for a new child:
Mark Luscombe, principal federal tax analyst for the tax firm CCH, says that even newborns need Social Security numbers right away. Hospitals make it easier by helping new parents with the paperwork, but parents are still responsible for making sure they get the number and use it correctly when filing taxes. Otherwise, Luscombe says, the IRS could disallow some of the tax benefits.

Luscombe adds that parents themselves need to make sure they have their correct Social Security number on their tax forms. This can be especially challenging for people who recently got married, changed their names, and requested a new number. "If the name on the tax return and the Social Security number don't match up, the IRS gets concerned," he says.

Omitting the dependent exemption for babies born at the end of the year:
Even babies born on December 31 provide their parents an entire year's worth of exemption status. "You don't have to apportion it to the time the baby was alive," explains Barbara Weltman, attorney and author of J.K. Lasser's 1001 Deductions and Tax Breaks 2011. She adds that even high-income tax payers get the full value of the exemption this year.

Overlooking the adoption credit:
This credit, which can be worth about $13,000, is designed to alleviate some of the expenses associated with adopting a child. But because adoption often takes more than one year and involves many types of expenses, parents can get overwhelmed with the paperwork. Bob Meighan, vice president of TurboTax, recommends keeping careful track of receipts, then filing for the credit the year of the adoption.

Forgetting to keep careful records of care providers:
Many working parents are eligible for the child and dependent tax credit, which can help ease some of the costs of daycare, babysitters, and after-school programs for children younger than 13. What often trips parents up, says Luscombe, is that they forget to record the tax ID or Social Security numbers of the care providers throughout the year. Without that information, they can't file for the tax credit. "If you've had a succession of babysitters and have no Social Security numbers, then you could lose out on part of the credit for not doing your homework," he says.

Stacey Bradford, author of The Wall Street Journal's Financial Guidebook for New Parents, adds that summer day camp fees also count if both parents are working, looking for work, or studying, as long as the child is under age 13.

Claiming something other than head of household status:
Single parents in particular often forget to claim head of household status, which provides certain tax advantages, including the ability to claim dependents. "There's a lot of confusion about the head of household filing status and a lot of people don't seem to understand what that means," says Luscombe. Single parents could be eligible for this status if they paid more than half the cost of maintaining their household throughout the year and live with their children for more than half the year.

Ignoring the child tax credit:
The child tax credit, which is worth up to $1,000, phases out for higher earners, but most taxpayers qualify for it, says Meighan. It applies to children under age 17 who live with the parent claiming the credit for more than half the year.

Not filing taxes for an older child with a part-time job:
"Parents forget that an older child might have a tax filing requirement," says Meighan, even if that child is still a dependent. And failing to file that older child's taxes could mean losing out on a refund, because teens often don't earn enough to have any tax liability, even though their employers have withheld taxes. "To get that money back, they have to file a return," adds Meighan.

Failing to take advantage of tax-advantaged savings plans:
Most adults have never heard of 529 college savings accounts, which allow parents to invest after-tax money and grow it tax-free as long as they use it to pay for tuition. Coverdell education savings accounts, which come with strict contribution limits ($2,000 a year) as well as income limits, also offer tax advantages. Similarly, many parents forget to put pre-tax money aside (up to $5,000) into flexible spending accounts offered through their employer to pay for childcare expenses.

Skipping education write-offs:
From the American Opportunity Credit to the Lifetime Learning Credit, there are many tax benefits that help alleviate some of the cost of paying for college. Parents often forget that they can claim student loan interest on their own taxes if the college student is still a dependent--even if the college student is the one paying the loan interest, says Meighan.

Bradford adds that many parents don't realize that a number of states allow deductions for contributions to college savings plans. In New York, she says, residents can write off $5,000 for single filers and $10,000 for married joint filers. She suggests checking to see if you qualify.

Repeating classic errors that all taxpayers make:
Eric Smith, IRS spokesman, says the most common errors include forgetting to sign returns, just one spouse signing it, forgetting to attach a W-2 form, failing to use enough postage, and writing the name and address on the mailing envelope illegibly. "Take advantage of computer technology, and most of those mistakes go away," he says.

Kimberly Palmer (@alphaconsumer) is the author of the new book Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Sunday, March 6, 2011

Education tax benefits: A report card

While Congress extended the reduced individual income tax rates with passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) in late 2010, it also extended several educational tax benefits as well through 2012. As families plan their upcoming tax year, it is important to keep these benefits in mind.

American Opportunity Tax Credit

Individuals may continue to claim a credit against their federal tax liability based on tuition payments and certain related expenses. Previously referred to as the Hope Credit, the American Opportunity Tax Credit (AOTC) remains available for taxpayers for the 2011 and 2012 tax years. Qualifying families may claim an annual tax credit of up to $2,500 for undergraduate college expenses, up to $10,000 for a four-year program. According to a recently-issued report, Treasury predicts that 9.4 million families will be able to claim a total of $18.2 billion AOTC credits in 2011, an average of $1,900 per family.

Lifetime learning credit

Taxpayers can claim the lifetime learning credit for post-high school education, as well as courses to acquire or improve job skills. These institutions include colleges, universities, vocational schools, and any other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. The lifetime learning credit is limited to $2,000 per eligible student, based upon payment of tuition and other qualified expenses.

The IRS released Tax Tip 2010-12 reminding taxpayers that they cannot claim both the lifetime learning credit and the AOTC for one child in a single tax year. However, if the family has multiple children in college, the family may apply the credits on a "per-student, per-year basis." This means that the family with two children in college, for example, could claim the AOTC for one child and the lifetime learning credit for the other.

Coverdell Education Savings Accounts

The 2010 Tax Relief Act also extended the increased maximum contribution amount to Coverdell education savings accounts. Taxpayers may contribute a maximum of $2,000 per year to these tax-preferred accounts. Earnings on these contributions grow tax-free, while amounts subsequently withdrawn are excludable from gross income to the extent used for qualified educational expenses.

Educational assistance programs

The 2010 Tax Relief Act also extended taxpayers' annual exclusion of up to $5,250 in employer-provided educational assistance from their gross income. The exclusion applies to both gross income for federal income tax purposes, as well as wages for employment tax purposes.

Federal Scholarships with Service requirements

The 2010 Tax Relief Act continues the gross income exclusion for scholarships with obligatory service requirements received by candidates at certain qualified educational organizations. The exclusion applies to scholarships granted by the National Health Service Corps Scholarship Program or the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program.

Qualified Tuition and Expense Deduction

The 2010 Tax Relief Act also extends the above-the-line deduction for qualified tuition and related expenses through 2011. The deduction applies to tuition and fees paid for the enrollment of the taxpayer, the taxpayer's spouse, or any dependent for which the taxpayer is entitled to a dependency exemption. Taxpayers can not claim both one of the education tax credits and the tuition and expense deduction in a single year. These continue to be either/or tax breaks.

Student loan interest deduction

Finally, after the student graduates, they may still claim an educational tax benefit by repaying their educational loans. Within certain adjusted gross income limits, taxpayers may claim a deduction for interest paid on student loans. The 2010 Tax Relief Act extends favorable limits on this deduction. Through 2012, the law extended the increased modified adjusted gross income phase-out ranges, meaning more taxpayers can claim the deduction. The 2010 Tax Relief Act also extended the repeal of the 60-month limit on deductible payments.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Sunday, February 20, 2011

Can You Trust Your Tax Preparer?

Many taxpayers are shocked when they find out the error rate of tax returns provided by non-CPA paid tax preparers. As in any industry, there are various levels of assurances consumers can have based on their choice of tax preparers. As Certified Public Accountants(CPAs) in the state of Illinois, we are registered and licensed by the Illinois Department of Financial and Professional Regulation. We also are required to complete numerous hours of continuing education to maintain a high level of competency in our services. We are voluntary members of the American Institute of Certified Public Accountants (AICPA) and its Tax Section, as well as members of the Illinois CPA Society. As such, we are subject to additional rigorous ethics and competency requirements, which are all in the best interests of our clients. The following article from Yahoo! Finance discusses the evolving nature of tax preparation.

Carla Fried
Excerpt from article of
Saturday, February 19,

On January 31st, Jackson Hewitt, the second largest tax prep firm in the country, sued No. 1 H&R Block over Block's claims it can find errors in two-thirds of tax returns prepared by "other" tax preparers. Jackson Hewitt obviously resents the insinuation. Whatever the outcome of the case, though, it's safe to say the entire industry isn't exactly a bastion of reliability. The Inspector General of the U.S. Treasury found a 61 percent error rate in prepared tax returns.

But if you're looking to the Internal Revenue Service to provide some supervision and oversight of tax preparers, well, that's not going to happen until at least 2014. Last year, the IRS announced a new program that requires the estimated 1 million U.S. tax preparers to register with the IRS, be tested for competency, and agree to ongoing continuing ed classes. All good news. Yet yesterday the IRS released a report saying it needs a few more years to get its new tax preparer review system up and running.

That leaves the estimated 83 million Americans who hire a tax preparer to vet them on their own. Given the high error rate, that's no small job. And even once the IRS program is in place, it's not going to magically catch every schnook and rube. Keep in mind that any error the IRS finds that raises your tax bill is your legal responsibility. You can negotiate the matter with your tax preparer, but from the IRS's vantage point, you're the one who is on the hook. That's why it's important to do your homework.

A few of these red flags are obvious, but the IRS suggests you be especially wary of tax preparers that do any of the following:

• Guarantee you'll get a refund.
• Get paid by charging you a percentage of the refund.
• Don't ask you for supporting documents, such as your W-2 or 1099s.
• Offer to create documents to support false or exaggerated deductions.
• Ask you to sign a blank form that they will fill in later.
• Refuse to give you a photocopy of your return.
• Refuse to list his or her Social Security number and sign the return, as required by law.
• Aren't available year-round. (Some preparers set up shop during the mad tax rush and then sort of disappear.)

Another red flag is if a tax preparer tries to push his or her bona fides by telling you they're already part of the IRS's new oversight system. The fact is, some preparers have already been assigned their official tax-prep ID number, but that's all that has happened. No tests have been given, no education provided. Any preparer using this as a selling point is being disingenuous.

How to Find a Top-Notch Tax Pro

If you've got a somewhat complicated tax story, hiring a solid Certified Public Accountant can be a smart move.

If you're going to work with a human being, asking friends and colleagues for references is always a good place to start, but a little more legwork wouldn't hurt, either. You can check with your state board of accountancy to see if there are any known problems with a CPA you are considering. And taking a quick spin through the Better Business Bureau website will let you see if there are any complaints registered against him or her. It also can't hurt to run a check on someone you're already working with.

When you're interviewing a tax preparer, ask how many times his or her clients have been audited -- by federal and state -- and how many times the client has wound up owing more upon review. That's a fair question, and no pro should take umbrage. And while you're at it, ask how errors and audits are handled. Are you charged more for the extra time? Will the preparer cover any extra money owed? And again, it's helpful to clarify this even if you're already working with someone.

Finally, cross your fingers that maybe, just maybe, Washington will get serious about overhauling the individual tax code. President Obama gave it a passing mention in his State of the Union address. The reality is that the incredible complexity of the code is a Petri dish for errors and outright fraud.

Sunday, February 13, 2011

Finding Free and Low-Cost Tax Help

As Certified Public Accountants and professional tax preparers, we take our responsibilities as our clients' trusted advisors very seriously. We are constantly pursuing continuing education to stay current on the latest tax laws and strategies. We maintain this high level of professional competence and knowledge in order to provide our clients with unparalleled services. However, not every tax situation calls for this type of expertise and experience. The following Yahoo! Finance article delineates the different alternatives that taxpayers have when comtemplating their tax return preparation. We find that many taxpayers have differing tax preparation needs in different years. For some taxpayers, the issue of data privacy is paramount and CPAs are in a unique position to safeguard your personal information. We are always glad to help taxpayers find the best solution for their situation, and look forward to being the tax professional of choice when the situation warrants.

Finding Free and Low-Cost Tax Help
by Laura Rowley

Mailboxes are filling up with W-2 and 1099 forms, heralding the arrival of another tax season.

Last year's stimulus package unleashed a variety of new and expanded deductions and credits, for everything from car and home purchases to energy-efficient upgrades to college tuition. This may the year that Americans are worried about making mistakes on their taxes. To minimize that, here are some of the best places to find free or cost-effective assistance.

If You Earn $57,000 or Less
Households earning $57,000 or less -- that's 70 percent of the nation's taxpayers -- can use the Free File program online, a partnership of the Internal Revenue Service and 20 tax software companies. Go to, choose a software provider and you'll find step-by-step form that asks simple questions and then fills in the answers on the tax form for you. You can file the return electronically, and if you qualify for a refund, receive it in as little as 10 days. If you owe money, you have until April 15 to send in payment. Paying with a credit card will incur fees.

Many states also allow you to do your state taxes and electronically file them through Free File. (Use the tool called "Help Me Find A Free File Company" to find a firm that may offer Free File for your state.) Finally, people who took advantage of the first-time homebuyer tax credit last year can use Free File, but have to print their returns, attach proof of their home purchase, and mail everything in.

If you earn less than $50,000 and want help from a real person, call the Volunteer Income Tax Assistance Program at 1-800-TAX-1040, which has chapters in many communities. The AARP offers free assistance to the elderly at 7,000 sites nationwide -- you can find one at or 888-227-7669.

Purchasing Tax Software
Using tax software is fast and relatively easy, and it will boost the chances of an accurate return, as well as the odds of getting all the deductions and credits for which you qualify. The biggest names are TurboTax from Intuit and Tax Cut by H&R Block, but others include TaxBrain, Complete Tax and The price will depend on your needs, but most people will pay $50 to $100 for the cost of federal and state preparation, and federal and state e-filing. (Many people don't realize there is a separate charge for the filing.)

Dan Green, a married father of three and a public relations executive in suburban Chicago, has used for the last five years. He says it takes him about an hour to fill out his 1040 form. He pays about $15 for electronic filing for his federal taxes and $12 to file state taxes.

"I was a little skeptical at first because I thought there would be charges for everything," Green says. "But it was so simple for me, and I have no accounting background. It takes you through the process step by step, so it's almost impossible to make a mistake. After you're done you do a review process, and it tells you if there are any red flags so you can go back and check."

Check the software company Web site to see if you qualify for a free version. Some provide freebies to taxpayers with very simple returns. Also look for discounted software through your bank, credit union or brokerage., for example, offers a 25 percent discount on TurboTax to clients. Sites such as also include discounts for software.

Look for guarantees that the software provider will pay penalties and interest if their product doesn't produce an accurate return. Some providers also offer audit support from a professional.

This year Green got a $1,500 credit for installing new energy-efficient windows in his home. "I didn't have to worry about being sure I received the credit, because I knew would have it included in this year's program," he says. Which brings up an obvious, but important point: Make sure the package you purchase is for 2009, not an older version piled up in a store's bargain bin.

Store-Front Preparers
A store-front firm is an option for someone with no computer-savvy who feels utterly helpless in the face of paper tax forms. The biggest players include H&R Block, with about 13,000 U.S. locations, and Jackson Hewitt, with 6,000 offices. In this case, the preparer is basically filling in the software program for you. The cost varies depending on the complexity of the return, but for most people will run from $100 to $500. (The companies offer cost estimators, and sometimes coupons for discounted service, on their Web sites.)

In a tough economy, many people need their refund checks right away. But just say no to offers for "refund anticipation loans" -- where you can get your refund immediately for a fee. The National Consumer Law Center estimates that 8.4 million refund loans were made in 2008, and taxpayers -- mostly moderate and low-income -- lost $800 million from their refunds to these short-term loans.

In December, the IRS said it is scrutinizing refund anticipation loans, and bank regulators are cracking down as well. Recently, the Office of Comptroller of the Currency blocked Pacific Capital Bank from making the loans during this tax season.

Finally, be aware of privacy issues. Tax preparers just need your signature to sell your confidential tax return information to marketers, so read all the forms carefully before signing.

Professional Preparers: Individual Practitioners
People with complicated tax returns often turn to a professional. The IRS recently proposed that all paid preparers be registered and undergo testing and continuing education unless they are lawyers, certified public accountants or licensed enrolled agents, who represent taxpayers before the IRS. But for this tax season, you're on your own.

Get recommendations from people you trust, and check the credentials and references of the professional you plan to engage. How long have they been in business? Do they get additional training each year? Do they specialize in a particular area? Check for complaints filed against the preparer with your state's board of accountancy (for CPAs), state bar (for attorneys) and the Better Business Bureau.

Be prepared to pay from $100 to $1,000 for the service, and get the cost estimate in advance. Since many professionals charge by the hour, have all of your paperwork and receipts organized before you begin. Avoid preparers who claim they can get you a juicier refund than their peers and propose to charge a percentage of your refund.

Finally, find out if the service is guaranteed. According to a Better Business Bureau analysis, the number one complaint against tax preparers in 2008 was mistakes that resulted in penalties and fines.

CPAs are governed by strict codes of conduct and ethics that other preparers may not follow. As always, please contact our office with any questions you may have.
Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Sunday, January 30, 2011

How Do I Report Gambling, Hobby and Other Miscellaneous Taxable Income?

During economic downturns, many people often look for ways to supplement their regular employment compensation. Or, you may be engaging in an activity - such as gambling or selling items on an online auction - that is actually earning you income: taxable income. Many individuals may not understand the tax consequences of, and reporting requirements for, earning these types of miscellaneous income. This article discusses how you report certain types of miscellaneous income.

Reporting your miscellaneous taxable income

For most people, gambling winnings and hobby income are uncommon types of taxable income. Gambling winnings and hobby income, as well as prizes and awards, represent "miscellaneous income" and are reported on Line 21 of your Form 1040 as "other income."

Hobby income

Hobbies are generally considered under the tax law as activities that are not pursued "for profit." However, the tax law provides that if your hobby shows a profit in at least three of the last five tax years, including the current year, you are assumed to be trying to make money. However, you can rebut the assumption -- that you are not out to run a profitable business even if you regularly have losses -- with evidence to the contrary. Just because you love what you are doing in a sideline business does not mean it's a hobby for tax law purposes. In fact, one secret to business success is often enjoying your work. Profits you receive from an activity that is a hobby and not a for-profit business are reported as "other income" on Line 21 of your Form 1040.

Hobby losses and expenses

You cannot deduct your hobby expenses in excess of income you derived from the hobby, and you can only deduct qualifying expenses if you itemize your deductions. Expenses that you incurred in generating hobby income are generally deductible as miscellaneous itemized deductions, subject to the two-percent floor, on Schedule A. If you incurred losses in connection with your hobby activities, you may generally be able to deduct these "hobby losses" but only to the extent of income produced by the activity.

However, some expenses that are deductible whether or not they are incurred in connection with a hobby (such as taxes, interest and casualty losses) are deductible even if they exceed hobby income. These expenses, however, will reduce the amount of your hobby income against which your hobby expenses can be offset. Your hobby expenses then offset the reduced income in the following order:

1. Operating expenses, generally;

2. Depreciation and other basis adjustment items.

As mentioned above, your itemized deduction for hobby expenses is subject to the two-percent floor on miscellaneous itemized deductions.

Gambling winnings

Gambling winnings, whether legal or illegal, are included in your gross income. If you have winnings from a lottery, raffle, or other types of gambling activities, you must report the full amount of your winnings on Line 21 of your Form 1040 as "other income." The taxable gains are the amount by which your winnings exceed the amount you wagered. If any taxes were withheld from your winnings, you should receive a Form W-2G showing the total paid to you in Box 1, and the amount of income taxes withheld in Box 2. You need to include the amount in Box 2 in the amount of taxes paid on Line 59 of your 1040.

Gambling losses

You can deduct your gambling losses as an itemized deduction for the year on Schedule A (Form 1040), line 28. However, you cannot deduct gambling losses that exceed your winnings. Thus, you can deduct losses from gambling up to the amount of your gambling winnings. You cannot reduce your gambling winnings by your gambling losses and report the difference. You must report the full amount of your winnings as income and claim your losses (up to the amount of winnings) as an itemized deduction. Therefore, your records should show your winnings separately from your losses.

You can reduce your gambling winnings by your wagering losses regardless of whether the underlying transactions are legal or illegal. Moreover, gambling losses may be offset against all gains arising out of wagering transactions, and not merely against gambling winnings. However, gambling losses can only be used to offset gambling gains during the same year.

Moreover, you cannot use your gambling losses to reduce taxable income from non-gambling sources, and they cannot be used as a carryover or carryback to reduce gambling income from other years. For example, the value of complimentary goods you might receive from a casino as an inducement to gamble are gains from which gambling losses can be deducted.

Casinos, lotteries and other payers of gambling winnings of $600 or more ($1,200 for bingo or slot machines and $1,500 for keno) report the winnings on Form W-2G, Certain Gambling Winnings.

If you have any questions about tax and reporting requirements in connection with hobby activities and other sources of income, please call our office.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Monday, January 24, 2011

How Do I Convert a Traditional IRA to a Roth IRA?

People are buzzing about Roth Individual Retirement Accounts (IRAs). Unlike traditional IRAs, "qualified" distributions from a Roth IRA are tax-free, provided they are held for five years and are made after age 59 1/2, death or disability. You can establish a Roth IRA just as you would a traditional IRA. You can also convert assets in a traditional IRA to a Roth IRA.

Before 2010, only taxpayers with adjusted gross income of $100,000 or less were eligible to convert their traditional IRA (provided they were not married taxpayers filing separate returns). Beginning in 2010, anyone can convert a traditional IRA to a Roth IRA, regardless of income level or filing status.

Comment: While you can only contribute a maximum of $5,000 to a Roth IRA for 2010 (plus a $1,000 catch-up contribution if you are over age 50), you can convert an unlimited amount from a traditional IRA.

Conversion is treated as a taxable distribution of assets from the traditional IRA to the IRA holder, although it is not subject to the 10 percent tax on early distributions. While paying taxes on conversion is undesirable, the advantages of holding assets in a Roth IRA usually outweigh this disadvantage, especially if you will not be retiring soon. Furthermore, if you converted assets in 2010, you had the option of including them in income in 2011 and 2012 (50 percent each year) instead of 2010.

Comment: Generally, this income-splitting would have been advantageous to any taxpayer who does not expect a sharp increase in income in 2011 or 2012.

There are four ways to convert a traditional IRA to a Roth IRA:

A rollover - you receive a distribution from a traditional IRA and roll it over to a Roth IRA within 60 days;
Trustee-to-trustee transfer - you direct the trustee of the traditional IRA to transfer an amount to the trustee of a Roth IRA;
Same-trustee transfer - the trustee of the traditional IRA transfers assets to a Roth IRA maintained by the same trustee; or
Redesignation - you designate a traditional IRA as a Roth IRA, instead of opening a new Roth account.

Comment: The account holder does not have to convert all of the assets in the traditional IRA.

Another advantage of converting assets from a traditional IRA to a Roth IRA is that you can change your mind and put the assets back into the traditional IRA. This is known as a recharacterization. You have until the due date, with extensions, for the return filed for the year of conversion. Thus, if you converted assets in 2010, you have until mid-October in 2011 to undo the conversion.

This ability to recharacterize the conversion allows you to use hindsight to check whether your assets declined in value after the conversion. Since you are paying taxes on the amount converted, a decline in asset value means that you paid taxes on phantom income that no longer exists. However, if you convert assets into multiple Roth IRAs, you can choose to recharacterize the assets in a Roth IRA that decreased in value, while maintaining the conversion for a Roth IRA's assets that appreciated in value.

The use of a Roth IRA can be a savvy investment, but whether to convert assets is not an easy decision. If you would like to explore your options, please contact this office.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Wednesday, January 19, 2011

Does Filing My Tax Return Early Make Sense?

Although individual income tax returns don't have to be filed until April 15, taxpayers who file early get their refunds a lot sooner. The IRS begins accepting returns in January but does not starting processing returns until February. Determining whether to file early depends on various personal and financial considerations. Filing early to somehow fly under the IRS's audit radar, however, has been ruled out by experts as a viable strategy.

Required documents

Filing a return early may not be practical for many taxpayers because they do not yet have enough information to accurately fill out their return. If you have not received information returns, like Forms 1099 or Schedule K-1, or if you are missing documents or other information you need to complete your return, it may be difficult, if not impossible, to accurately prepare your tax return. For example, employers do not have to provide wage statements to their employees until January 31 (although an employer can provide Form W-2 sooner if an employee terminates employment). The IRS requires this statement to be attached to your return (either in paper form or electronically when filing online).

Information returns also do not have to be furnished until January 31. These include, among others, the forms for dividends, interest income, royalty income (Form 1099-MISC), stock sales (Form 1099-B), real estate sales (Form 1099-S), state tax refunds (Form 1099-G), mortgage interest paid (Form 1098), and distributions from pension plans (Form 1099-R). Waiting until you receive all the information needed to complete your return accurately also lessens your chances of making mistakes, which can call attention to your return by the IRS. The IRS will not process your return electronically until it is accurate.

Last year's return

You'll also want to take a look at your 2009 tax return. Did your circumstances change in 2010? Changes such as starting a new job, retiring, getting married, having a child, and so on, have important tax consequences. Congress extended, enhanced and created new tax incentives in 2010 under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) that could generate a larger refund. Another important consideration is the current economic downturn, which may have generated significant tax losses in many investment portfolios.


If you have all the information you need to completely and accurately fill out your tax return, and you are owed a refund, filing early is attractive. The sooner you file, the sooner you'll see your refund check from the IRS. If you file your return electronically and choose to have your refund directly deposited into your bank account, the IRS typically will issue your refund in as few as 10 days.

If you owe money, however, you may want to wait until April 15 to file. Alternatively, you can file early online and date your tax payment to be released on April 15. If you have the funds to pay what you owe and you pay early, you could lose out on keeping the money invested and earning interest until April 15.

Also remember, no matter how early you file your return, the three-year statute of limitations during which the IRS can question your return and assess more tax doesn't start to run until April 15. Please contact our office if you have any questions about filing early.

Circular 230 notification - Any U.S. federal tax advice that is contained in this document was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

Tuesday, January 18, 2011

2010 Tax Relief Act extends lucrative tax breaks for families through 2012.

Congress not only extended the current, lower individual income tax rates through 2012 in the recently enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act); it also extended a number of beneficial tax breaks for families and individuals. Through 2012, the law extended significant tax incentives for education, children, and energy-saving home improvements.

Individual Tax Rates. The 2010 Tax Relief Act extends all of the current lower individual tax rates across the board, for all taxpayers, at 10, 15, 25, 28, 33, and 35 percent for two years, through 2012. In addition, under the new law the size of the 15 percent tax bracket for married couples filing jointly and surviving spouses remains double that of the 15 percent tax bracket for individual filers, thus continuing to provide "marriage penalty" relief.

State and local sales tax deduction. Congress also extended the deduction for state and local sales taxes in lieu of the state and local income tax deduction through 2011.

More marriage penalty relief. In addition to expanding the 15 percent income tax rate bracket, the 2010 Tax Relief Act also maintains the increased basic standard deduction for joint filers. Through 2012, the standard deduction for married taxpayers filing a joint return (and surviving spouses) is twice the basic standard deduction amount for single individuals. For example, the standard deduction for individuals for 2011 is $5,800; for married taxpayers filing jointly, the standard deduction for 2011 will be $11,600.

No personal exemption phaseout. Higher-income individuals and families will also benefit from the ability to claim an unreduced personal exemption. Before 2010, taxpayers with income over certain amounts were subject to phaseout of their personal exemption. However, under the 2010 Tax Relief Act, personal exemptions are not reduced, for an additional two years through 2012.

Expanded child tax credit. The 2010 Tax Relief Act extends the $1,000 child tax credit for two years, through December 31, 2012. The child tax credit can be claimed for each qualifying child under age 17 (at the close of the year) that the taxpayer can claim as a dependent. However, the amount of the credit is reduced as a taxpayer's income increases. The credit is reduced (but not below zero) by $50 for each $1,000 of modified adjusted gross income (AGI) above $110,000 for joint filers and above $75,000 for others. The new law also extends other enhancements to the credit, including the ability to offset both the regular tax and alternative minimum tax.

Expanded earned income tax credit. The 2010 Tax Relief Act extends the enhanced earned income tax credit (EITC) for two years, through 2012. The new law also simplifies computation of the EITC.

Adoption credit. Through 2012, the new law expands the adoption credit and the exclusion from income for employer-provided adoption assistance. However, the new law does not extend certain changes made by the Patient Protection and Affordable Care Act of 2010 (PPACA) for 2010 and 2011. Therefore, the credit is not refundable after 2011 and the additional $1,000 under the PPACA is not available after 2011. For 2012, the maximum credit therefore is $12,170 (indexed for inflation after 2010) and is phased out ratably for taxpayers with modified AGI over $182,520.

Dependent care credit. The 2010 Tax Relief Act extends the enhanced dependent care credit for two years, through 2012. A taxpayer who incurs expenses to care for a child under age 13 or for an incapacitated dependent or spouse, in order to enable the taxpayer to work or look for work, is eligible to claim the dependent care credit. The maximum expenses that can be claimed through 2012 are $3,000 for one qualifying individual and $6,000 for more than one qualifying individual. Additionally, the maximum credit rate is 35 percent. Thus, for 2010, the maximum dependent care credit is $1,050 (35 percent of up to $3,000 of eligible expenses) for one qualifying individual and $2,100 for more than one qualifying individual (35 percent of up to $6,000 of qualified eligible expenses).

Tax breaks for education. The 2010 Tax Relief Act extends a number of tax incentives to help defray the costs of education. The new law extends the American Opportunity Tax Credit (AOTC), the student loan interest deduction, the exclusion from income for employer-provided assistance, and more. The AOTC, which is 40 percent refundable, can be claimed for expenses incurred for the first four years of a student's post-secondary education. The credit equals 100 percent of the first $2,000 of qualified higher education tuition and related expenses (including course materials), and 25 percent of the next $2,000 of expenses. In effect, a maximum credit of $2,500 a year can be claimed for each eligible student.

Through 2012, employees who receive educational assistance from their employer can continue to exclude up to $5,250 in employer-provided educational assistance from their income and employment taxes. Graduate school tuition also qualifies for the exclusion.

Taxpayers will also continue to benefit from the $2,500 above-the-line student loan interest deduction through 2012. The new law also expanded the modified AGI range for the phaseout of the deduction. For 2010, for instance, the deduction phases out ratably for taxpayers with modified AGI between $60,000 and $75,000 ($120,000 and $150,000 for joint filers).

Coverdell education savings accounts (ESAs) provide taxpayers with another mechanism to save for education. The 2010 Tax Relief Act enables taxpayers to continue to contribute up to $2,000 a year to a Coverdell ESA for beneficiaries under age 18 (as well as special needs beneficiaries of any age). In addition to higher education expenses, Coverdell ESAs can be used to pay for elementary and secondary education expenses through 2012. However, the amount that can be contributed is subject to income phaseouts.

Incentives for energy-efficient improvements. The 2010 Tax Relief Act also rewards individuals and families who make energy-saving improvements to their home. For example, the new law extends through 2011 (only one year) the popular Code Sec. 25C tax credit, which provides a credit for expenses for qualified energy efficiency improvements and property, such as furnaces, water heaters, insulation materials, exterior windows, skylights, doors, and other items.

Sunday, January 16, 2011

IRS Audit Red Flags: The Dirty Dozen

As the 2011 tax season begins, we want to address one of the most frequent concerns our clients have as they begin to gather their tax information: what could trigger an audit? The following Yahoo Finance article addresses this area of concern for many taxpayers.

IRS Audit Red Flags: The Dirty Dozen
by Joy Taylor

Here are 12 hot spots on your return that can raise the chances of scrutiny by the IRS.

Ever wonder why some tax returns are audited by the IRS while most are ignored? Well, there's a whole host of reasons to this age-old question. The IRS audits only about 1% of all individual tax returns annually. The agency doesn't have enough personnel and resources to examine each and every tax return filed during a year. So the odds are pretty low that your return will be picked for an audit. And of course, the only reason filers should worry about an audit is if they are cheating on their taxes.

However, the chances of you being audited or otherwise hearing from the IRS can increase depending upon various factors, including whether you omitted income, the types of deductions or losses claimed, certain credits taken, foreign asset holdings and math errors, just to name a few. Although there's no sure way to avoid an IRS audit, you should be aware of red flags that could increase your chance of drawing some unwanted attention from the IRS. Here are the 12 most important ones:

1. Failure to report all taxable income. The IRS receives copies of all 1099s and W-2s that you receive during a year, so make sure that you report all required income on your tax return. The IRS computers are pretty good at matching these forms received with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 for income that isn't yours or the income listed is incorrect, get the issuer to file a corrected form with the IRS.

2. Returns claiming the home-buyer credit. First-time homebuyers and longtime homeowners who claimed the homebuyer credit should be prepared for IRS scrutiny. Make sure you submit proper documentation when taking this credit. First-time homebuyers have to attach a copy of their settlement statement to the return, and longtime homeowners should also attach documents showing prior ownership of a home, including records of property tax and insurance coverage. All claims for this credit are being screened. As of May 2010, more than 260,000 returns had been selected for correspondence audits (examinations done by mail rather than face-to-face) because filers did not attach the necessary documents to their tax returns. And those numbers will continue to grow.

Also, the IRS has ways of policing the recapture of the homebuyer credit. Generally, the credit is required to be recaptured if the home is sold within three years for homes bought in 2009 or 2010 and within 15 years for homes bought before 2009. The IRS is checking public real estate databases for sales of homes in which the credit was taken.

3. Claiming large charitable deductions. This comes up again and again because the IRS has found abuse on audit, especially with those taking larger deductions. We all know that charitable contributions are a great write-off and help you to feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared to your income, it raises a red flag. That's because the IRS can tell what the average charitable donation is for a person in your tax bracket. Also, if you don't get an appraisal for donations of valuable property or if you fail to file Form 8283 for donations over $500, the chances of audit increase. Be sure you keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. And attach Form 8283 if required.

4. Home office deduction. The IRS is always very interested in this deduction, primarily because it has a pretty high adjustment rate on audit. This is because history has shown that many people who claim a home office don't meet all the requirements for properly taking the deduction, and others may overstate the benefit. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance, and other costs that are properly allocated to the home office. That's a great deal. However, in order to take this write-off, the space must be used exclusively and on a regular basis as your principal place of business. That makes it difficult to claim a guest bedroom or children's playroom as a home office, even if you also use the space to conduct your work. Exclusive use means a specific area of the home is used only for trade or business, not also where the family watches TV at night. Don't be afraid to take the home-office deduction if you're otherwise entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.

5. Business meals, travel and entertainment. Schedule C is a treasure trove of tax deductions for self-employeds. But it's also a gold mine for IRS agents, who know from past experience that self-employeds tend to claim excessive deductions. Most under-reporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorships as well as smaller ones.

Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too large for the business. Agents know that many filers slip in personal meals here or fail to satisfy the strict substantiation rules for these expenses. To qualify for meals or entertainment deductions, you must keep detailed records generally documenting the following for each expense: amount, place, persons attending, business purpose and nature of discussion or meeting. Also, receipts are required for expenditures over $75 or any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.
[New Tax Deal: What's In It For You?]

6. Claiming 100% business use of vehicle. Another area that is ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use for an automobile on Schedule C is red meat for IRS agents. They know that it's extremely rare that an individual actually uses a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. IRS agents are trained to focus on this issue and will closely scrutinize your records. Make sure you keep very detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the revenue agent to disallow your deduction. As a reminder, even if you use the IRS' standard mileage rate to deduct your business vehicle costs, ensure that you are not also claiming actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has found filer noncompliance in this area as well and will look for this.

7. Claiming a loss for a hobby activity. Your chances of "winning" the audit lottery increase if you have wage income and file a Schedule C with large losses. And, if your Schedule C loss-generating activity sounds like a hobby -- horse breeding, car racing and such -- the IRS pays even more attention. It's issued guidelines to its agents on how to sniff out those who improperly deduct hobby losses. Large Schedule C losses are audit bait, but reporting losses from activities in which it looks like you might be having a good time is just asking for IRS scrutiny.

Tax laws don't allow you to deduct hobby losses on Schedule C. However, you do have to report any income earned from your hobbies. In order to claim a hobby loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes you're in business to make a profit, unless the IRS establishes to the contrary. If audited, the IRS is going to make you prove you have a legitimate business and not a hobby. So, make sure you run your activity in a business-like manner and can provide supporting documents for all expenses.

8. Cash businesses. Small business owners, especially those in cash-intensive businesses -- taxi drivers, car washes, bars, hair salons, restaurants and the like -- are an easy target for IRS auditors. The agency is well aware that those who primarily receive cash in their business are less likely to accurately report all of their taxable income. The IRS wants to narrow the tax gap, and history has shown that cash-based businesses are a good source of audit adjustments. It has a new guide for agents to use when auditing cash intensive businesses, telling how to interview owners and noting various indicators of unreported income.

9. Failure to report a foreign bank account. The IRS is intensely interested in people with offshore accounts, especially those in tax havens. U.S. tax authorities have had some recent success in trying to get foreign banks (such as UBS in Switzerland) to disclose information on U.S. account holders. Also, the IRS had a voluntary compliance program where people came in and reported their foreign bank accounts and foreign assets in exchange for lesser penalties than they would have otherwise been subject to. The IRS has learned a lot from these probes.

Failure to report a foreign bank account can lead to pretty severe penalties, and the IRS has made this issue a top priority. Make sure that if you have any such accounts, you properly report them when you file your return. Keep in mind, though, that if you have never previously reported the foreign bank account on your return, and you decide to do so for the first time in 2010, that might also look suspicious to the IRS.

10. Engaging in currency transactions. The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious activity reports from banks and disclosures of foreign accounts. A recent report by Treasury inspectors concluded that these currency transaction reports are a valuable source of audit leads for sniffing out unreported income. The IRS agreed and it will make greater use of these forms in its audit process. So if you are a person who makes large cash purchases or deposits, be prepared for IRS scrutiny. Also, beware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as persons depositing $9,500 cash one day and an additional $9,500 cash two days later).

11. Math errors. One of the biggest reasons that people receive a letter from the IRS is because of mathematical mistakes they make on their tax returns. If you make an error in your favor, you are going to hear from the tax man, and there is a greater risk of the IRS pulling the whole return for audit. So take time to ensure all your calculations are correct. Even though math errors may not lead to a full-blown audit, it's always best to remain under the radar of IRS computers.

12. Taking higher-than-average deductions. If deductions on your return are disproportionately large compared to your income, the IRS audit formulas take this into account when selecting returns for examination. Screeners then pull the most questionable returns for review. But if you've got the proper documentation for your deduction, don't be scared to claim it. There's no reason to ever pay the IRS more tax than you actually owe.

Tuesday, December 21, 2010