ASK THE TAX PRO - THE ESTIMATED TAX SAFE HARBOR RULE

Now is a good time to review the topic that is raised in this ASK THE TAX PRO question -

Q. We have medical insurance, but in spite of that the costs of my wife's cancer treatments and real estate depreciation deductions resulted in a net loss on our 2006 1040 form. So we ended up not owing any taxes for 2006. We had paid $5000.00 in estimated amounts for 2006, so we applied these 2006 estimated payments to our taxes due in 2007.

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We have submitted an automatic extension for our 2007 taxes.

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During 2007, we received a payment from previously sold property, so we will probably owe something over $10,000. Our 2006 tax liability was under $150,000.00 and we have already paid in over 100% of our 2006 tax liability.

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We conclude that we will not be liable for a penalty for underpayment of estimated tax.

A. Your conclusion is correct.

Because your 2006 federal income tax liability was “0” and you had $5,000 from 2006 applied to 2007 you will not be penalized for “underpayment of estimated tax” for 2007 if you waited until October 15, 2008 to file your 1040 and pay the $5,000 anticipated balance due.

You are covered under what we call the “safe harbor” rule. As long as you had 100% of your prior year tax liability paid in either via withholding or estimated tax you will not be penalized. The alternative is to have 90% of the current year liability paid in.

If your 2007 tax liability was $5,000 and your 2008 tax liability will turn out to be $100,000, as long as you have at least $5,000 withheld during 2008 you can put aside the remaining $95,000 in an interest-bearing account and wait until you file your 2008 return in April of 2009 to send it to “Sam”.

In the case of estimated tax payments the penalty is determined on a quarterly basis. With the above example you would have to pay $1,250 per quarter in estimated tax, for a total of $5,000, to satisfy the safe harbor rule. If you paid the entire $5,000 as your 3rd quarter payment you would be penalized for the first two quarters.

Withholding is automatically treated as being paid evenly throughout the calendar year, regardless of when the money is actually withheld and remitted to “Sam”. You could have no federal tax withheld for the first 11 months of the year and have the entire $5,000 withheld in December and you would avoid the penalty under safe harbor.

Here is a good tip for this time of the year. First pull out your 2007 tax returns. Now get your most recent pay-stub(s) for all your employers and determine the total amount of income tax that has been withheld for the year. Add in any withholding from other sources – pensions, etc. Now compare the total amount withheld-to-date for 2008 to the total tax liability on Line 63 of your 2007 Form 1040 (or Line 37 of a 2007 Form 1040A).

If the 2008 number is already at least as much as the total tax liability for 2007 you are ok. If the 2007 liability is greater, based on your current year pay-stubs estimate the amount of income tax that will be withheld during the rest of 2008. Now see how it compares to the 2007 liability. If you come up short you can have your employer withhold an additional amount from the rest of your 2008 pay checks to cover the shortage. Be aware that it will probably take a week or two for your employer to properly process the additional withholding request – so calculate accordingly.

Make the withholding comparisons for state as well as federal income tax. Most states have a similar “safe harbor” rule.

Of course if you expect your taxable income to be substantially lower for 2008 than it was in 2007 there is no need to meet the “safe harbor” requirement.

If your 2007 Adjusted Gross Income (AGI) is more than $150,000 you must have 110% of the total 2007 tax liability paid in during 2008 to be covered by the safe harbor rule.

TTFN

TO TWIT OR NOT TO TWIT

After reading TAX GIRL Kelly’s post “Twittering Tax Pros, Take Two”, and further email encouragement from Kelly, I decided to become a “twit” (note to Tres Hanley-Millman – I am a “Twit” now, too!) myself and see what all the talk is about.

As I told Kelly, I abhor social networking sites like MY SPACE and FACE BOOK. I am not looking to make new online "friends" and have absolutely no intention of putting my personal information on a public site for all the world, including identity thieves, to see.

Twitter seems to be different – and if it can help to bring more traffic here to TWTP then it is worth a try.

It is way too soon to proclaim, “I’m a tax professional and I love to Twitter!” I will reserve my judgement until I see how it plays out.

FYI - I am twitter.com/rdftaxpro. Check me out.

WHAT HAPPENS IF YOU DO NOT FILE YOUR FEDERAL INCOME TAX RETURN

It is very important that you file your federal income tax return on time – by the original April 15th deadline or by October 15th if extended – whether or not you can afford to pay all or any of any tax due. There are several reasons.

First of all it is the law.

Second, filing a tax return starts the clock running on the statutory three (3) years that the IRS has to audit the return. The IRS has three (3) years from the due date of a return – again April 15 if filed on time or October 15 if extended – or the date the return was actually filed, whichever is later, to audit the tax return. If you file your return after October 15th the clock does not start until the return is filed.

And perhaps most important, the monthly penalty rate for “filing late” with a balance due is ten times as much as that for “paying late”.

I should point out that if “Sam” owes you money there is absolutely no penalty for filing your Form 1040, or 1040A, late. You can file a 2007 tax return in January 2009 and not be penalized if you are getting a refund. However, the three year clock will not begin running until January 2009.

This year there was a special reason to file your 2007 federal income tax return on time. An economic “stimulus” election year bribe check will not be mailed to you this year, if you qualify for one, if your federal income tax return was not filed by October 15, 2008.

Granted if you do not receive a check in 2008, based on 2007 information, and the rebate was not used to offset outstanding federal or state tax liabilities, all is not lost. You can claim the rebate, based on 2008 information, as a refundable credit on the 2008 tax return. However, if your situation changed in 2008 such that the amount of the rebate to which you are entitled is reduced you could be a loser. If you had a dependent child who was under age 17 in 2007 you would be entitled to an additional $300.00. But if that child turned age 17 in 2008, and you did not file your 2007 return on time and therefore did not get a rebate check, you would lose the $300.00.

On the other hand, a taxpayer who would not have received a rebate check in 2008 based on a timely filed 2007 return because the money was withheld to offset outstanding prior year income tax debt can hold off mailing his/her 2007 Form 1040 to “Sam” until January 2009 and it is believed that he/she will be able to claim the rebate amount as a credit on the 2008 return.

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Over the past 35+ years I have come across quite a few clients who did not file on time. Often I have prepared two consecutive years' 1040s at the same time.

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If three or four years pass since the due date of a return and it is still not filed there is an excellent chance that the Internal Revenue Service will reconstruct the return for you, using the information it has available in its computer “matching” system. Of course this will only happen if your have income that is reported to the IRS by a third party – such as W-2 wages, gross pension and annuity distributions, interest, dividends, gross proceeds from the sale of assets, and income “passed-through” on a Form K-1.

Why would this happen? I have encountered two reasons.

One is that the first and second return is not filed on time because of ill health – physical or mental (this could include an addiction to alcohol or drugs). When it comes time to prepare the third year’s return the taxpayer is already two years behind, and things just begin to snowball.

Another reason is that a taxpayer just stops filing tax returns because of the misconception that he/she no longer has to file tax returns. For some unknown reason there are those who think that you do not have to file tax returns any more once you reach age 65 or age 72. This is bull-pucky (technical IRS term). You are required to file a federal income tax return from the day you are born until the day you die, whether you go to your final audit at age 66 or 96, as long as you have sufficient net taxable income!

The problem with the IRS “reconstructing” a tax return is that they prepare the return in the worst possible way.

If you are married they will calculate the tax as Married Filing Separately – reconstructing two returns if there is income reported under both spouse’s Social Security numbers. If you should be filing as Head of Household the IRS will classify you as Single.

You will not be given any exemptions for dependents, even if you had claimed dependents in the past. The only personal exemption that will be included in the calculation is that for yourself, which may be reduced due to a truly “gross” AGI. If there are no dependents there will be no corresponding Child Tax Credit.

The gross amount of income that is in the IRS computer system under your Social Security number will be included in AGI.

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* If you were issued a Form 1099-R for $50,000 for a distribution from an employer pension plan or an IRA that was rolled over within the 60-day “grace” period, and therefore not taxable, the full $50,000 will be included in AGI, and you will be assessed the 10% premature withdrawal penalty.

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* There will be no provision for the cost basis of any asset sales reported on a Form 1099-B – 100% of the gross proceeds will be included in income and taxed as short-term gains.

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* No deductions will be taken against business income reported as “non-employee compensation” on a Form 1099-MISC, and self-employment tax will be calculated on the full amount.

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* There will be no “above the line” deductions (i.e. qualified tuition and fees, IRA contributions, health insurance premiums for self-employed), with the one exception of 1/2 of any self-employment tax assessment.

* The tax liability will be calculated using the Standard Deduction.

It is not unusual to receive a bill from the IRS for assessed tax, penalties and interest on a reconstructed federal income tax return for $50,000 - $100,000!

Let us look at a real life example from my client files. FYI, in this case returns were file late due to medical reasons –

* The taxpayer’s 2002 Form 1040 was reconstructed by the IRS.

* Although the taxpayer had consistently filed his tax returns as Married Filing Joint in the past, his filing status for the reconstruction was Married Filing Separately.

* The calculation showed $260,610 in “total income reported by payers”.

* This included $205,000 in gross proceeds from the sale of investments reported on a Form 1099-B.

* There were no “adjustments to income” , the one personal exemption allowed was totally phased out due to the inflated AGI, and the Standard Deduction allowed for Married Filing Separately was claimed.

* The total tax assessment was $84,459, which after deducting withholding became $71,375 in net tax due. Adding interest of $4,823 and penalties for late filing, late payment and underpayment of estimated tax of $23,392 the total amount due came to $99,590!

The spouse only had W-2 income reported under her Social Security number. Her withholding was enough to cover the tax liability, even filing separately with no deductions, so she did not get a bill from the IRS. She also did not receive a refund for the overpayment on the reconstructed return.

Here are the facts from the 2002 Form 1040 that I eventually prepared –

* The joint total income was $128,751.

* After subtracting the cost basis of the investments sold there was a net capital loss, and the $3,000 maximum loss deduction was claimed.

* There were adjustments to income for the educator expenses and qualified tuition and fees.

* Schedule A was filed to report $40,961 in total itemized deductions.

* The couple had two dependent daughters and personal exemptions of $3000 each were claimed in full for 4 individuals.

* The final tax liability was $15,552, which was more than covered by withholding.
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While we eventually got everything straightened out with the IRS, as a result of the late filing the taxpayer became subject to “back-up withholding” and for several years had 28% in federal income tax withheld from his interest and dividend income, which reduced the potential accrued earnings on this money.

You should note that even if there is an overpayment on the properly constructed return the taxpayer will not receive a refund if that return is not received by the IRS within 3 years of the original due date for the return. While the three-year clock for audit purposes begins on the date the return is actually filed, the clock for refunds begins on the actual due date for the return.

In the case of a taxpayer who was convinced that he no longer had to file once he turned age 65, he became our client only after the IRS attempted to foreclose on his home to pay his reconstructed debt!

If you receive a reconstructed return, which is referred to by the IRS as a “Substitute For Return” (SFR), you should not file an amended Form 1040-X to report the correct information. While an SFR is considered to be a valid tax return it does not constitute an original return filed by the taxpayer. In the above case I filed an original 2002 Form 1040.

So if you want to avoid hassles with the IRS, possible excessive penalties and interest, and a potential lien on your personal residence you should always file your income tax returns on time, even if you do not have the money to actually pay the tax due. It is much “more better” to submit a balance due return with no payment than to submit nothing at all.

And if you have not filed your 1040 for the past year or two or three, get thee to a tax professional!

TTFN

HERE IS A SPECIAL TAX TRICK

Often employee contributions, and employer matches, to a pre-tax employer pension or savings and investment plan will be invested in the stock of the employer-corporation.

When the employee leaves the company he/she can (a) remain in the plan until retirement age (if allowed by the plan), (b) roll-over the balance in the plan to another tax-deferred account and continue to defer taxable income, or (c) “take the money and run” and be currently taxed on the distribution.

If the employee holds appreciated stock in his former employer’s company in the plan, he/she should not roll-over the stock to an IRA. The thing to do is to withdraw the actual shares of company stock and rollover any remaining cash balance.

The employee will receive a 1099-R reporting a taxable distribution equal to his/her “basis” in the company stock, which is generally the total amount of employee contributions used to purchase the stock. The employee will not be taxed on the full market value of the stock on the date of distribution.

The difference between the basis and the market value is referred to as “net unrealized appreciation” (NUA). This NUA is not taxed until you actually sell the stock. When the stock is sold the NUA, plus any additional gain, will be taxed as a long-term capital gain at the special preferential tax rate – which could actually be “0%” depending on the circumstances.

If you roll-over the company stock to an IRA, when you withdraw money from the rollover IRA it will be fully taxed at ordinary income rates. You would lose the tax benefit of capital gain treatment on the net unrealized appreciation.

You can sell the company stock right away. You do not have to wait to actually hold the stock for a year after the date of the withdrawal – the sale will automatically be considered to be long-term.

Of course, as with any other distribution from such a pension plan, if you withdraw the shares of stock before your reach age 59½, (or if you were not age 55 when you left the company) you will be subject to the 10% premature withdrawal penalty on the taxable value of the stock, which is again your basis in the shares withdrawn.

Any questions?

TTFN

CARNIVAL OF FINANCIAL PLANNING

My post on year-end tax planning “That Time of Year Again” is in the “Taxes” section of the November 8, 2008 Edition of the Carnival of Financial Planning at the Skilled Investor’s PERSONAL FINANCIAL PLANNING BLOG.

The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus on efficient and sustainable personal financial planning practices that can lead to lifetime financial security.

Lots of interesting posts in this edition.

The Money Hawk, whose post “Reality Check: The President Can’t Save Us, Nor Should He” is included in the “Economics” section, suggests that “Everyone in the country needs to read this article, period.”

I do recommend that you read it. He makes a good point – “If you want to figure out why you’re in the situation you’re in, find a mirror and stand facing it. There’s nobody left to blame and there’s no other backs to pat. If you’re in it, you did it.” and “A thousand John McCains and a thousand Barack Obamas can’t do for you in a thousand years what you can do for yourself in ten.”

While I mostly agree with the above statement, there are situations when a person did not quite make his own financial bed – someone helped. If you read my post “What’s Wrong With This Picture” you will see that even a family that does everything correct financially can get screwed by the irresponsible behavior of others.

Fire Finance tells us that YUPPIES have been replaced, thankfully, by YAWN in his post “Want To Be A Millionaire? Follow the YAWN Philosophy”.

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’

* Russ Fox of TAXABLE TALK continues to keep us up-to-date on tax fraud in his post “More Tax Fraud”.

His first item reports “the Treasury Inspector General for Tax Administration (TIGTA) issued a report noting that over $1.6 billion in false refunds were estimated to have been issued in the 2006 and 2007 filing seasons”. I wonder if the report identifies how many of the $1.6 Billion in fraudulent refunds involved the Earned Income Credit?

* If you haven’t already done so check out my guest post on “Gift Tax 101” at THE TAX LADY BLOG

* An editorial from MarketWatch via NewsEdge titled “The Solution is Worse Than the Problem”, included in one of the week’s AccountantsWorld.com daily tax headline newsletters, began with some excellent words of wisdom for the “brains” in Congress (the highlights are mine) -

“One of many frustrations for investors during the current economic crisis has been watching a string of knee-jerk reactions and Band-Aid solutions from politicians, aimed at solving the headline-grabbing problem of the day and quelling investor anger.

It's not just that the quick fixes don't necessarily work; it's that they tend to be poorly thought out and good mostly for one special-interest group at the expense of others.

That's why the presidential candidates need to remember that all the king's horses and men could not repair the nation's broken retirement nest eggs overnight . . .”

Right on, brother!

* William Perez of WILLIAM’S TAX PLANNING BLOG at About.com deals in detail with the question “Should You Cash Out Your IRA in a Down Market?”.

As William puts it “The standard reply, of course, is not to over-react to market gyrations”. My response to the question would be the “standard reply”.

* WebCPA reports that “IRS Plans Tax Preparer Survey”. According to the item, “The IRS's Small Business Self-Employed Division will telephone a random selection of tax professionals between early November and January 2009 to gather their opinions on experiences with filing federal tax returns and dealing with the IRS on behalf of their clients”

This is apparently an annual program – although I have never been on “the list”. Perhaps this time – the item points out, “This year's survey has been expanded to capture feedback from unenrolled return preparers, in addition to CPAs, attorneys and enrolled agents”.

* On Election Day Howard Gleckman did a good job of listing his likes and dislikes of the Presidential campaign in “Campaign 2008: Taking Stock” at the Tax Policy Center’s TAXVOX blog.

Like Howard, I, too, “liked that Obama and McCain nearly engaged each other on the fascinating issue of how the tax code redistributes income. I didn’t like that it never got past McCain’s ridiculous claim that Obama is a socialist.”

I especially liked Howard’s ending comment - “I did not like that many people, including far too many journalists, seemed more interested in Joe the Plumber’s views on fiscal policy and Sarah Palin’s wardrobe than they were on the tough issues that will confront the next president.”

* Another blog list. At the request of a reader, TAXGUY Bruce provides us with 107 “Famous Tax Quotes”.

My all time favorite is from, of all people, Albert Einstein – “The hardest thing in the world to understand is the income tax.”

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I also like this one from Arthur B. Laffer (noted economist and creator of the “Laffer Curve” - “You have to be oblivious to common sense to believe that taxing people who do work and paying people who don’t work results in more people working. That’s just not the way the world works.”

* Paul Caron, the TAX PROF, has compiled the opinions of 15 tax law professors on tax policy in the new Obama-Biden Administration in “Tax Policy in the Obama-Biden Administration”.

The only name on the list of professors that meant anything to me was James Maule of Villanova, who writes the scholarly blog MAULED AGAIN. While I hope he is wrong, I do agree with most of his predictions, especially these (the highlights are mine) -

“Those who thought that the tax law would be simplified will be proven wrong. If anything, the tax law will be even more complicated, as another pile of tax credits are rolled into the tax code.

Those who wished for tax law changes that would contribute to a reduction or elimination of the federal budget deficit will continue to be frustrated. Those who expected a tax cut for "95% of working taxpayers" will wonder how the 95% became a smaller number.

So how will the nation's tax law be different a year from now? It won't be what I want, or what any particular taxpayer or tax expert wants or thinks should happen. It will be some combination of compromise, a more complicated arrangement, and a system that will generate no less griping than what we now have.”

* Jim continues on the topic in his post “What’s Ahead for Tax Law”. Again I certainly agree with much of what he says in the post Here is a sample –

“Trying to predict what changes will take place in the tax law as we approach 2009 and the commencement of the Obama Administration is a fool's errand. No one knows. Barack Obama does not know. Members of Congress do not know."

And, from Jim’s mouth to God’s ears, “Tax return preparation and tax advising will continue to be growth industries”.
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* If you actually believe that Barrack Obama (or for that matter John McCain, if he had been elected) would actually do what he said he would do during the campaign you may want to check out Joe Kristan’s post “Tax Planning Ahead of the Obama Administration” at the ROTH AND COMPANY TAX UPDATE BLOG.

* I love it! The Tax Foundation’s TAX POLICY BLOG dissed, and rightly so, the junior of my state’s Senators (just about every Senator is junior to NJ’s other Senator) for a tax FU in the post “Top Ordinary Income Tax Rate Is Not the Same as Capital Gains Tax Rate, Sen. Menendez". According to the post (the highlights are mine) -

“On Monday, Sen. Bob Menendez was on Neil Cavuto's show discussing Sen. Obama's tax plan. Of course, like most campaign spokespersons, he was only able to recite the 50 words that the campaign staff taught him. It's rather entertaining yet frustrating at the same time to realize that a person this clueless is helping shape fiscal policy in the United States Senate. (He should ask Sen. Wyden to give him a 30-minute tutoring session on the basics of the tax code.)”

Hey Bob, you should read my post “Taxes 101 for Politicians”.

What an idiot!

* Not exactly tax-related, but TAX GIRL Kelly Phillips Erb discusses a “wrinkle” in the Fannie Mae and Freddie Mac bail-out in her post “In Defense of Madness”.

According to the post –

“In response to taxpayer demands, the Justice Department is currently investigating whether there was any wrong doing leading up to the collapse of the mortgage industry. And naturally, executives at companies like Fannie Mae and Freddie Mac are scrambling to hire defense counsel to protect them from potential criminal charges. So that’s their problem, right? Not exactly. Fannie Mae and Freddie Mac had promised to cover legal bills for those executives - and since the feds now 'own' Fannie Mae and Freddie Mac, taxpayers may be on the hook for those defense bills. Only those who are convicted of wrongdoing are required to give the money back, assuming of course, that they have it to give back.”

Be sure to check out the comment from Charles Thomas.

* Kelly also tells us that “As part of President elect Barack Obama’s transition, a new website has been created at www.change.gov.” You can click here for the site’s page on Obama’s tax policies. The site allows you to submit your comments and suggestions.

I have submitted my specific comments and suggestions regarding tax policy, much of which I have posted here at TWTP in the past. I am waiting to see if there will be any response – and will let you know if I hear anything.

* Roni Deutch gives those who want to start a business some good advice in her post “10 Tax Tips for Self-Employed Individuals” at her TAX HELP BLOG.

I especially like #3 – “Remember while you are making your day-to-day purchases to keep any business-related receipts. These expenses are tax deductible, and even the small meetings with colleagues at coffee shops add up! Also, taking the time to add up these receipts once or twice a month will save you a lot of time later on.”

TTFN

WON’T YOU TAKE THIS ADVICE I HAND YOU LIKE A BROTHER. . .

Dear President-Elect Obama:

Congratulations on your historic win in Tuesday’s Presidential election. I wish you the best of luck in dealing with the mucking fess that your predecessor will leave you with.

Some words of advice –

1) I read that you want a second stimulus “package” that would include rebuilding America’s crumbling, roads, schools, and bridges (i.e. the “infrastructure” of the country). This is a good idea - very WPA-like.

However the same article said you wanted a second round of rebate checks. Please! Please! Please! Learn from the mistakes of the last two failed attempts. Read my lips – NO MORE REBATES!

If your package must include putting money directly into the hands of the people, do some serious investigation of alternative methods, including a “payroll tax holiday”.

2) Whatever you do, do not appoint current New Jersey Governor Jon Corzine as your Secretary of the Treasury. It is not that, as a New Jersey resident, I do not want to lose him as our governor. I certainly do!

Corzine’s alleged “financial expertise” is a fallacy. He certainly hasn’t demonstrated it during his tenure as NJ governor. In reality Jon Corzine was nothing more than a lucky stockbroker.

There are many, many more qualified choices from which to choose – don’t make the mistake of selecting Corzine.

3) When it comes time to put pen to paper on a Tax Reform Act please take a very hard and serious second look at your proposals for multiple ill-conceived refundable tax credits. Refundable tax credits = bad tax policy. They only encourage tax fraud.

That’s about it for now. I am sure I will have more advice for you in the future.

Oh, by the way. The use of the term “brother” in the title of this post has no hidden or sly meaning or connotation. It is simply how the lyrics of the song, from PAJAMA GAME, were written.

TTFN

HEY, IT’S FREE!

Have you downloaded the premiere issue of my new FREE online newsletter “FROM THE DESK OF ROBERT D FLACH” yet?

Click here to download - OCTOBER 2008 ISSUE.

What have you got to lose? It’s free!

WHAT THE IRS WILL BE UP TO NEXT YEAR

I have previously blogged that 2009 will be a year filled with tax law changes. Let us look at what else tax professionals, and their tax clients, have to look forward to next year.

The National Association of Tax Professionals has provided us with some insight as to the upcoming activities of the Internal Revenue Service, based on the association’s recent meetings with various divisions of the Service.

The major news comes from the Small Business/Self-Employed Division of the IRS.

* Auditors from this Division will be concentrating more on payroll taxes in the coming year. A July Government Accountability Office (GAO) report indicated that 1.6 Million business owed $58 Billion in overdue payroll taxes as of September 30, 2007.

* There will be more audits of businesses than individuals. While the number of audits of individual taxpayers will decrease, reviews of corporations and Schedule Cs of high-income individuals will increase (I have always thought that the IRS should look more carefully at the Schedule Cs of low-income individuals). It has long been felt that a large part of the Tax Gap comes from the unreported income of Schedule C businesses.

* The issue of “worker classification” (i.e. employee with W-2 vs independent contractor with 1099) will continue to be a major area of investigation, which ties in with the Division’s emphasis on payroll taxes.

* The “National Research Program” (NPR) will continue. NATP reports, “The recent sampling of 5000 Sub-S returns revealed that IRS thinking about S Corps was not correct. The IRS learned that individuals are using S Corps to filter income. Therefore look for even more attention to be given to S Corps.”

* There will be increased activity in the Service’s efforts to get at sheltered offshore income. For the first time fraud technical agents are being especially trained in international taxation. The IRS will pay special attention to FBARs (not FUBARs – FBAR = Foreign Bank Account Reports) and the Form 5471 (Information Return of U.S. Persons With Respect To Certain Foreign Corporations), imposing automatic penalties on late filed 5471s.

As the NATP does for me, I will keep you informed on future developments in this area as information becomes available.

TTFN

MOVING ON UP!

In the latest Fire Finance list of the “Top 100 Personal Finance Blogs”, based on September traffic, that is.

I am #68 in the rankings (and #54 in the Sitemeter list – the only one I am on). Fire Finance indicates I have moved up 8 spots! Again the only other Tax Blog on the list is DON’T MESS WITH TAXES at #62 overall (and #36 on the Sitemeter list).

As for the JEFFERSONS reference, I once dated a dancer who lived in the building, in the East 80’s of NYC, which was used as the model of the JEFFERSONS’ high rise in the opening credits.

And, oh yes, while I have you let me tell you that the “37th Carnival of Money Hacks: Wonders of the World” is up at LIVING ALMOST LARGE.

My post “Something’s Coming” is among the tons of posts included, in the Financial Planning category.

ASK THE TAX PRO - MARRIAGE AND FORM W-4

Before I begin today’s post I just want to say – THANK GOD IT’S OVER! The historic campaign seemed to go on forever. Congratulations to President-Elect Barack Obama.

And now – today’s question -

Q. My finance and I will be married this fall. Can we change our W-4’s to show Married and have less money taken out now?

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A. Yes you can.

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However you may not want to have less money withheld. On the contrary - you may want to have more withheld as you may be victims of the dreaded (almost as much as the AMT) “marriage penalty”. If you both work you will not pay any less tax – you will pay either the same or more!

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As your status will be “married” on December 31st (the last day of the year) you must file your Form 1040 for the entire year as married – either joint or separate.

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I tell two-income married couples that at least the spouse with the lower income should claim “Married- But Withheld at the Lower Single Rate- 0”.

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If other aspects of your situation will change in the fall, such as the purchase of a home that generates real estate tax and mortgage interest deductions, they may help to wipe out some or all of the additional tax from the marriage penalty. However, if you will be purchasing the home late in the year (i.e. the fall) you may not have enough deductions for the year to be able to itemize.

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My advice to you is to not change your withholding statuses for 2008. Keep your W-4s at Single. This way you will not find yourself in shock next February. You can evaluate your situation after you file your 2008 tax returns and make changes to your W-4s for 2009 if appropriate.

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When preparing your 2008 Form 1040 you may want to consider filing separately. As I advise any clients and readers faced with options – you should calculate the federal and state tax liability filing both joint and separately and compare the results. Check out my posts JOINT OR SEPARATE? THAT IS THE QUESTION! - PART ONE and TWO.

TTFN

THE LAST WORD

One final word on this Presidential Election Day.

Whoever is victorious today has to be at least ten times better than Dubya! George W has certainly been the worst President in my lifetime (yes, that includes Nixon) – and I suspect the last 100 years!

Thank God for America, and the world, he will be gone in January!

KEEP A COPY

{Before I begin just a reminder – don’t forget to vote!}

It is very important to keep a copy of your federal and state tax returns. In the guest post here at TWTP from Trish McIntire (“Best of the Best – Trish McIntire”) Trish said, “The biggest income tax mistake is not keeping a copy of the return and supporting schedules and documents”.

If you prepare your own returns make sure to photocopy every page, Schedule and Form you are sending to “Sam” and your state. If you make the mistake of preparing your own returns using tax preparation software make sure to print out and file away a “hard copy” of the returns.

If you use a tax professional we are required by law to give you a copy of your return.

If you are asked to give a bank, school or other 3rd party a copy of your tax returns give them a copy of your copy. Do not give away your only copy of your tax returns.

While I tell clients that they can toss most back-up documentation for a tax return after four (4) years (the Special Report MY BEST TAX ADVICE gives detailed information on just what records you should keep for how long – see the left margin for how to order the report), I do believe that you should keep the paper copy of your tax returns (Form 1040 or 1040A plus all supporting federal Schedules and Forms) forever. This provides a permanent record of your financial history. You never know when the information on a prior year’s tax return will come in handy for a variety of tax or financial reasons, or just to satisfy personal curiosity.

What can you do if you have lost your copy of your returns? If the return was prepared by a tax professional the first thing to do is contact your preparer and ask for a copy. We tax professionals are required by law to keep on file copies of tax returns we have prepared for at least three (3) years – the “open” years. I keep a copy of every tax return I have ever filed for current clients (I only throw out returns three years after death or three years after a client has gone elsewhere and not returned). Your preparer may charge you a small fee to cover the cost of making the additional copies.

Another source of past year tax returns is the Internal Revenue Service – but this is becoming costly. The fee for an exact copy of a previously-filed and processed tax return and all attachments jumped from $39.00 to $57.00 on November 1st.

To request a copy of a past year’s tax return from the IRS you must submit Form 4506, Request for Copy of Tax Return. Copies are generally available for returns filed in the current and past six years. A “transcript” of a prior year’s return can be obtained by filing Form 4506-T, Request for Transcript of Tax Return. A transcript “shows most line items contained on the return as it was originally filed, including any accompanying forms and schedules. In most cases, a tax return transcript will meet the requirements for lending institutions for mortgage verification purposes.” There is no charge for a transcript.

For more information on getting a copy of past year’s tax information from the IRS check out these links -

How to Get a Copy of Your Tax Return

Frequently Asked Questions on How to Obtain Return Copies

Past/Previous Years Tax Returns

Obviously you should also keep copies of all amended returns and all correspondence with the IRS or a state tax agency.

TTFN

TAX CARNIVAL TIME

Key Bell has done it again – another great Tax Carnival. This one, #42, is the ELECTION 2008 EDITION.

My post “Taxes 101 For Politicians” opens the Carnival as the first entry under “Proposition 1: Taxes and Politics”.

Each edition seems to get bigger, with more and more “non-tax” personal finance blogs making contributions. Lots of new contributors this month.

BTW, I am listening to PlaybillRadio.com as “we speak”. I am reminded that there are many Broadway show tunes that have given us hope and encouragement over the years. “The Sun Will Come Out Tomorrow”, “You’ll Never Walk Alone”, etc.

Perhaps the Broadway song lyric that has given Americans the most hope for the future these past few years is from AVENUE Q – “George Bush is only for now!”. I wonder if they will change the lyric in January?

And John Lithgow told us that anyone can grow up to be President in a song lyric from DIRTY ROTTEN SCOUNDRELS – “The Bushs of Tex were nervous wrecks because their son was dim. And look what happened to him!”

TTFN

GET A GRIP

Tomorrow is Election Day. While every Election Day is important this one is especially so because it is a Presidential Election.

It is also especially important for the residents of my home state of New Jersey.

Grease is not the word for this Election Day in New Jersey. GRIP is the word – as in Get Rid of Incumbent Politicians.

The State of New Jersey will remain in the tops of lists like the most expensive states to live in or highest taxed states or states with the worst business climate as long as we continue to vote in the same greedy hogs that are sucking the state dry each and every election.

We must send a Network-like message of “We’re mad as hell and we’re not going to take it anymore” by voting the bastards out!

Tomorrow New Jersey residents must go to the polls and, after making their choice for President, vote against every single incumbent candidate in every local, county, and statewide race in New Jersey.

This goes for the candidates for Congress as well. After all they all started as part of a local political machine.

It is very important for NJ residents to vote GRIP tomorrow. A very high percentage of NJ voters are either employed by a state, county or local government or a close relative of such an employee. This block will always vote to keep the current crooks in office to maintain the symbiotic relationship between the hogs at the trough in Trenton and elsewhere and state, county and municipal employees and their unions. So every opposition vote counts.

We will never end double and triple-dipping in the state pension and benefit plans by politicians and their spouses with multiple show and no-show jobs, six-figure payments for accrual of bogus unused sick days by retiring school superintendents and other government employees (Superintendents of Schools in NJ are never sick – they just may be “working at home” on certain days), and other expensive abuses by keeping the same pigs in office. Their only goal is to maintain the status quo.

So tomorrow “Get A Grip” and start to take the power out of the hand of the state and local political bosses and put it back where it belongs – in the hands of the voters!

TTFN

PS- Click here for another online posting about GRIP.

PPS- Before I leave the subject of tomorrow’s election – on the Presidential front, Russ Fox has an excellent post on “The President and Taxes” over at TAXABLE TALK that you all should read before going to the polls.

GUEST POST

Two things.

First, and most important - my guest post “Gift Tax 101” appears today over at THE BAG LADY blog. The Bag Lady herself asked me to provide the post to fill in while she travels to China.

So check out my post, which discusses in detail the Federal Gift Tax, and while there check out some of BL’s posts.

And second - FYI, I recently added a very important message for my 1040 clients at my TAXPRO SERVICES CORPORATION website. Click here to read the message.

WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’

* A recent article by Chuck Jaffe at MarketWatch.com titled “Commentary: Consider Selling Mutual-Fund Losers Soon to Avoid Tax Bite” provides something for mutual fund investors to think about.

If anticipated excessive year-end capital gain distributions “are about to make a bad situation worse” then it may be wise to sell your mutual fund shares “before year-end distributions are paid out, thereby avoiding a tax headache and leaving behind a loser fund in one fell swoop.”

As I reported earlier it is expected that the current stock market kerfluffle will result in lots of sales by mutual funds, many resulting in capital gains, and therefore possibly greater capital gain distribution pass-throughs to shareholders this year-end.

* TAXGUY Bruce give us some interesting non-tax facts that may come in handy next time you are playing Trivial Pursuit in his post “Here Are Some Historical Facts”.

* “You've Heard McCain and Obama--What Do the Other Parties Say?” Well Dan Meyer of TICK MARKS (which, I love saying, has nothing to do with Lyme Disease) tells you.

* Kelly the TAX GIRL tells us that “Alabama Imposes ‘Fat Tax’”. No, that isn’t a typo. It’s not a FLAT TAX but indeed a FAT TAX! Gee, I am glad I don’t live in Alabama (although still not totally thrilled to be here in NJ). Check it out.

* Thanks to IRS HITMAN Richard Close for the mention and link in his post “A Ray of Hope...and Tons of Links!”

* Now here is something I didn’t know. According to a recent study, discussed in an AccountantsWorld.com article, “U.S. Capital Gains Tax Rate Uncompetitive With Many Other Major Economies”.

The study finds, “At a 15% long-term capital gains tax rate, the United States ranks higher than countries with lower, more competitive rates including Canada (14.5%), Italy (12.5%) and Japan (7%). Many countries have a capital gains tax rate of zero (0%) including Germany, Mexico, India, Malaysia, Taiwan and Honk Kong.”

* The CCH daily Tax Headlines email newsletter reports “Lawmakers Mull Second Stimulus Package”.

The item says – “Lawmakers on the House Ways and Means Committee heard testimony on October 29 from state officials and industry experts on whether a $150-billion stimulus package loaded with spending on shovel-ready infrastructure projects and higher funding for unemployment insurance claims would help Americans during the current economic slowdown. Lawmakers hinted that the House might return to Congress for a lame-duck session in mid-November, possibly during the week of November 17, to try to pass legislation that would head off an economic recession.”

How many time do I have to say this – PLEASE, NO MORE REBATES!

The White House disagrees that another bill is needed – see “Second Stimulus Bill Not Needed, White House Says, Despite Decrease in GDP”.

* No BUZZ would be complete without something from Joe Kristan of the ROTH AND COMPANY TAX UPDATE BLOG. In his post “Better To Skip Your Mortgage Payments Than Make Your Student Loan Payments” he once again points out the “wisdom” on Congress.

* Joe also reports on what appears to be some good news from the courts in the post “The End of Tax Strategy Patents?”. I have long been against the practice of attempting to patent a tax saving strategy.

* Ben Harris discusses an interesting tax proposal, the Auto IRA, in his post “Something to Agree On” at the Tax Policy Center’s TAXVOX blog.

* Kay Bell of DON’T MESS WITH TAXES tells of “A Tax Attorney’s Take on Dracula”, an appropriate Halloween post. I find it apropos that a lawyer writes about a vampire – both being blood suckers.

My favorite vampire is Barnabas Collins from the DARK SHADOWS “soap” of my high school days. I do believe he was the first “sympathetic” vampire. Every now and then there is talk about bringing DS back either in series or film form (there was even talk for a while about Johnny Depp as Barnabas Collins) – I wish someone would.

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Did you know that the house used as the exterior of the Collins mansion in the original show is one of the mansions of Newport RI?

* Always leave ‘em laughing – check out the Tax Quote of the Week at the Tax Foundation’s TAX POLICY BLOG. Very appropriate for election time.

TTFN

THAT TIME OF YEAR AGAIN

HAPPY ALL HALLOW’S EVE! (No, I am NOT the "model" in the above picture!)

Before I get to taxes I want to let you know about some breaking Presidential election news.

Click here and then click on the Election 2008 News Channel 3 box for this late-breaking news.

Now – on to our topic for the day –

It is that time of the year again – time for year-end tax planning.

Last year at this time I wrote a series of posts on the topic of Year-End Tax Planning, which, for the most part, still apply.

Here are links to the series -

PART I
PART II

PART III

PART IV

PART VI
OOPS!

You will also find a year-end tax planning item in the post STUFF.

Here are some things that you should be aware of when reading these posts and planning your year-end strategies –

(1) It is difficult to predict what the 2009 Form 1040 will look like. I quoted IRS HITMAN Richard Close yesterday in SOMETHING’S COMING as correctly saying, “Regardless of which candidate is elected, 2009 is going to be a year of change. Of course I’m mostly talking about the IRS. From simple things like forms, all the way to policy changes, things are drastically going to change.”

For one thing, while the special “0” capital gains tax rate for those in the 10% and 15% tax brackets is currently in effect through 2010, Congress may change this next year. Depending on who sits in the Oval Office there may be differing changes to the capital gains tax structure. So one should try to maximize the benefits of the “0”% tax rate in 2008.

The bottom line when the next tax year is such an unknown is that one should follow “traditional” tax planning strategies – defer income and accelerate deductions. There is no need to try to “second guess” the new Congress.

(2) Congress has already passed the annual AMT “patch” for 2008. However, the AMT is also an area that may be greatly revised, or even abolished altogether, in 2009.

(3) Congress has also extended the various popular tax breaks that expired on December 31, 2007 for two years. So the following items are in effect for both 2008 and 2009 -

* The option to deduct state and local sales tax instead of state and local income tax.
* The above-the-line “adjustment to income” for qualified tuition and fees.
* The above-the-line “adjustment to Income” for up to $250 in educator expenses.
* The residential energy tax credits.
* The ability to make tax-free transfers directly from an IRA to a qualified charity.

(4) You can click here to download a PRELIMINARY YEAR-END WORKSHEET and here to learn WHAT’S NEW FOR 2008.

So – any questions?

TTFN

SOMETHING'S COMING!

In his post “2009: The Year of Change” IRS HITMAN Richard Close predicts, “Regardless of which candidate is elected, 2009 is going to be a year of change. Of course I’m mostly talking about the IRS. From simple things like forms, all the way to policy changes, things are drastically going to change.”

I certainly agree with Richard.

For one, Congress is “chomping at the bit” to pass another “stimulus” bill, which may well be needed. It will no doubt include new tax cuts and benefits. Let us pray that it does not include any more GD (like extensions) rebates!

Even without the desire to pass a new stimulus bill there will be a major tax Act passed in 2009.

We are fast approaching the “sunset” of all the tax changes passed during the early Bush years. As it now stands, on January 1, 2011 the Tax Code will go back to the way it looked before George W took office. I expect, regardless of who the new Commander-In-Chief is, there will be attempts to make permanent all or parts of what has become known as the Bush tax cuts. Even Obama wants to keep some of the tax cuts.

One specific area of concern is the federal Estate Tax, also called by some the “death tax”. While repeal is probably too much to expect, there will certainly be big changes in store. While I am not a supporter of the concept of the estate tax, I want to make absolutely sure that the concept of “stepped-up” basis remains intact. It would be a true nightmare at tax time if inherited property had a “carry-over” basis. As it is now most taxpayers have no idea what they paid for an investment 5 years ago, let alone what their parents or grandparents paid for something 25 or 50 years ago!

Then there is the issue of the dreaded Alternative Minimum Tax (AMT). Congress has been passing an annual one-year “patch” for the past several years, on occasion waiting until literally the last minute to do so. The House Ways and Means Committee tried to completely abolish the AMT earlier this year, replacing it with a tax “surcharge”, but without success. Let us hope that the newly elected Congress will once and for all address this problem and realize that, as I have been saying all along, like Frankenstein in the old Hammer films, the AMT Must Be Destroyed!

While I will not be holding my breath, I would sincerely hope that when considering tax law changes next year the new Congress seriously looks at making the system simpler and fairer. McCain has proposed giving taxpayers the choice of calculating their liability under the current system or a simpler, flatter one. As I have said time and again, forget the current system – make the simpler one the only one.

Any change to the Tax Code is good for the tax preparation business. The 2010 tax filing season, when 2009 tax returns are prepared, should prove to be a very profitable one for those in my profession.

TTFN

ASK THE TAX PRO – MANY HAPPY STATE RETURNS

Q. In 2004 I was a part-year resident of Michigan (from January thru November) and a part-year resident of New Jersey (December), but received NO income from New Jersey itself (only Michigan, New York and Virginia). Do I have to file a part-year return for New Jersey? If I do, should I allocate 11/12 of the year's income/expenses to Michigan and 1/12 to New Jersey?

I understand I have to file non-resident state returns in New York and Virginia as well.

A. Yes - as a part-year resident of the great State of New Jersey (lucky you) you must file a NJ-1040 for 2004 to report all of your taxable income for period of residence – even though the period of residence is only one month.

As a resident of New Jersey you are taxed on all “taxable” income regardless of the source – not just income from sources within New Jersey.

You would not just allocate 1/12 of all income for the year. What you would report to New Jersey is the money that was actually received in the month of December – your period of residence.

You would only report wages received in the month of December – or for those days in the month of December that you were a NJ resident. You should be able to determine this amount from your pay stubs. You would not report 1/12 of the wages earned in Michigan if, as I expect, you did not work in Michigan while living in New Jersey. Except if, while a New Jersey resident, you received a final paycheck of severance pay or accumulated unused sick or vacation pay. It is possible that some of this information would be on your individual W-2s.

As for interest and dividends, again you would only report the amount received during your period of NJ residence. You would also report any capital gains from investment sales that took place during this period.

You would be allowed a deduction for “excess” medical expenses that you paid during your period of residence. As for your personal exemptions – in this case you would claim only 1/12 of the $1,000 or $1,500 NJ exemption amounts.

And yes, you would also have to file non-resident Virginia and New York state income tax returns. You would be able to claim a credit for the taxes paid to these states on your resident NJ-1040 or, if applicable, Michigan returns.

Any more questions?

TTFN