Friday, November 28, 2014


BUZZ installments have “book-ended” this holiday week.  A “meaty” BUZZ today.

I trust you had a “successful” Thanksgiving.

FYI, I will not be shopping today.

* The December “issue” of THE TAX PROFESSIONAL will be out in a couple of days.  Did you see the November “issue” yet?

* As the title of the post suggests, Manasa Nadig answers the question “What If I Own Real Estate In a Foreign Country? Answers Here! at the well-titled THE BUZZ ABOUT TAXES.

I have one client who owns real estate in a foreign country, and I learned something I did not know from this post.

* Looking for “stocking stuffers”?  How about my $1.00 each tax guides?  Check out my Dollar Store.

* A GETTING YOUR FINANCIAL DUCKS IN A ROW post by Jim Blankenship from 2013, discovered via a “tweet”, deals with the issue of “Per Stirpes/Per Capita–What Does it Mean?”.

The distinction had meaning for me in the will of a recently deceased uncle.

* Another “blast from the past” from GETTING YOUR FINANCIAL DUCKS IN A ROW, this one by Sterling Raskie, discusses the “alphabet soup” of financial planners (as I discuss the “Alphabet Soup” of tax preparation at FINDING A TAX PROFESSIONAL).  The post is titled “A Note About Designations”.

You will note that Sterling correctly says (highlight is mine) “CPAs may be qualified to prepare tax returns” and not that they are qualified to prepare tax returns.  That “may” is very important to note.  Thanks to Sterling for getting it right.   

* Robert W Wood of FORBES.COM reports “Jersey Shore's Mike 'The Situation' Sorrentino Tax Evasion Trial Delayed” again –

Jersey Shore TV star Mike “The Situation” Sorrentino and his brother Marc were supposed to go on trial for tax evasion and fraud on December 2nd. But the judge has granted Marc’s request to delay the trial until March 2015. The case involves voluminous records, and this gives both of the Sorrentino brothers more time. They are free on $250,000 bail.”

If only “The Situation” had spent as much time developing his brain as he did his body.  But then if he had he would have never appeared on a reality tv piece of excrement.

* Joe Kristan took the words out of my mouth when he said in Tuesday’s Tax Roundup “Administration complicates extender negotiations. And: Instant Tax Service has to stay dead” at the ROTH AND COMPANY TAX UPDATE BLOG -   .

Extenders as extortion. The administration yesterday complicated the negotiations on the extension of the perpetually-expiring tax provisions by demanding an extension of the refundable child credit and a permanent expansion of the fraud-ridden earned income tax credit, the New York Times reports.

It’s obnoxious to throw a new welfare program into the extender negotiations at this late date, but a lame-duck administration that will never again face the voters has nothing to lose. While I still think the $500,000 Section 179 deduction will be extended retroactively to January 1, this makes me a lot more nervous.

If anything good comes of this extortion attempt, it’s that it highlights the unwisdom of passing tax provisions temporarily if you don’t really want them to be temporary. Every time you need to re-enact them, you open yourself up to just this sort of shakedown.”

Right on, my brother!

We must also recognize and acknowledge the “unwisdom” of refundable tax credits and distributing welfare benefits through the Tax Code.

* And Joe also provides some excellent advice in another item in the same Roundup (highlight is mine) –

Wait for your W-2 before filing. Don’t try to file off of your pay stub. And if your preparer offers to prepare a return without waiting for your W-2, find another preparer.”

* Interesting information from Michael Cohn at ACCOUNTING TODAY – “Individual Retirement Plan Ownership Trending Down as Assets Climb” –

The share of families with an individual account retirement plan such as an IRA or 401(k) is decreasing, but the assets in those plans are increasing, according to a new study.”

* TIGTA (the Treasury Inspector General for Tax Administration) has issued a report titled “Prisoner Tax Refund Fraud: Delays Continue in Completing Agreements to Share Information With Prisons, and Reports to Congress Are Not Timely or Complete” (now that’s a mouthful).

TIGTA's report is the third in a series of audits it has conducted since 2010 that have documented alarming growth in prisoner tax refund fraud. The number of fraudulent tax returns filed using a prisoner's Social Security Number that were identified by the Internal Revenue Service (IRS) increased from approximately 37,000 tax returns in Calendar Year 2007 to more than 137,000 tax returns in Calendar Year 2012. The refunds claimed on these tax returns increased from $166 million to $1 billion.

Reports issued by TIGTA in December 2010 and December 2012 identified concerns with the IRS's efforts to identify and prevent prisoner tax fraud. The objective of TIGTA's latest audit was to evaluate the effectiveness of corrective actions the IRS has taken to address conditions identified in a prior TIGTA review of prisoner tax fraud.

‘Since TIGTA first began documenting this fraudulent activity four years ago, refund fraud committed by prisoners has grown to become a billion dollar problem,’ said J. Russell George, Treasury Inspector General for Tax Administration. ‘While the IRS has agreed with four of our six recommendations, more needs to be done, as is explained in our report. It is incumbent upon the IRS to act aggressively to prevent tax fraud wherever it occurs, particularly behind bars.’

The highlight above is mine.  Click here to read the full report.

A serious problem that needs to be fixed promptly.  IRS budget cuts do not help.

* Kay Bell speaks about IRS budget cuts in “IRS Taxpayer Service Outlook, Short- and Long-Term, is Bleak" at DON’T MESS WITH TAXES -

Continuing cuts to the Internal Revenue Service budget could have deleterious long-term effects on the agency's knowledge transfer, according to one IRS official.”

On the short-term front –

National Taxpayer Advocate Nina Olson also is worried about a bumpy 2015 filing season. Her main concern, however, is the problem that budget cuts have caused in the customer service area.

Both individual filers calling the IRS for help filling out their forms, as well as tax professionals looking for guidance on their clients' returns could see even longer wait times, warned Olson.”

* Russ Fox has already seen firsthand “tax professionals looking for guidance on their clients' returns could see even longer wait times”, and shares his recent experience with us in “One Ringy Dingy, Two Ringy Dingies…” at TAXABLE TALK (highlight is mine) –

I was on hold for two hours today on the IRS Practitioner Priority Service before my call was picked up.”


A man asks his wife what she wants for Christmas. Her reply = A divorce?

The man responds, “I wasn’t planning on spending that much”.


Thursday, November 27, 2014

Monday, November 24, 2014


I’m a day early - to make up for no BUZZ last week.  

* Tax pros – As I prepare the December issue of THE TAX PROFESSIONAL I am still waiting to “hear” your comments on the issues discussed in the November, and previous, “issues”. 

Email your comments to  

* A belated happy 9th anniversary (11/14) greeting to DON’T MESS WITH TAXES.  This past summer TWTP celebrated 13 years of posting.

* My year-end tax planning articles finally started to show up at MAINSTREET.COM.  First up is “2014 Year-End Tax Planning Strategies to Ensure a Smooth Filing”.

* Just before leaving for Atlantic City I came across "Help Your Children Get Rich With a Roth IRA” at CASH COW COUPLE.

One thing to remember as you read this post - “If your child has no earnings, he or she cannot contribute at all.” 

* BTW – have you visited my Dollar Store yet?  I have added something new – a “Business Expense Guide”.   

* Jason Dinesen agrees taxpayers should “Tell Your Accountant Before You Start Operating in Other States”.

Jason’s post grew out of one of the “things” in the article “Taking on a New Business Client: 18 Things You Need to Know” from the latest issue of NATP’s quarterly Taxpro Journal written by NJ tax pro Marc Standig, a fellow frequent contributing author for the NJ-NATP newsletter.

* Are you looking for a competent and experienced tax professional to help you with year-end tax planning, and prepare your 2014 returns?  Learn “What to Ask A Preparer” at my FIND A TAX PROFESSIONAL website.

* Michael Cohn tells us about the results of a survey of CPAs about the economy conducted by the Franklin and Marshall College Center for Opinion Research University on behalf of the NJSCPA and the PICPA in “N.J. and Pennsylvania CPAs See Economy Stuck in Neutral” at ACCOUNTING TODAY.

Here are some of the results for NJ (no surprises – highlights are mine) -

ü      . . . New Jersey respondents overwhelmingly (71 percent) feel that the business climate in their state hinders economic growth. Other areas where New Jersey respondents expect to see stalled growth include clients’ revenues (44 percent), clients’ workforce (65 percent) and clients’ salaries (51 percent).

ü       In terms of taxes, nearly 87 percent of the survey respondents believe that New Jersey’s tax structure is worse than most states. They cited high taxes as the number one reason (35 percent) for hindering future economic growth in New Jersey and the number two reason (33 percent) for the state’s high unemployment rate.

ü       A whopping 83 percent of New Jersey respondents feel estate and inheritance taxes have prompted clients to leave the state. Not only that, but 71 percent of CPAs in the Garden State have advised their clients to relocate to another state due to New Jersey’s estate and inheritance taxes. A large majority (84 percent) think these taxes affect the state’s middle class just as much as the affluent.

* And Jeff Stimpson includes my post on unfair selective inflation adjustments in his weekly BUZZ-like “In the Blogs” themed “Some Wicked Season”.

* Eva Rosenberg explains “Divorce and 529 plans: What Are the Tax Consequences?” – something that was not discussed at the recent NATP “Beyond the 1040” workshop – at EQUIFAX.COM.

* “Former GOP VP Candidate Paul Ryan to Head House Tax Panel” reports Kay Bell at DON’T MESS WITH TAXES. as she begins her 10th year of blogging (see above).

Is this good?  I believe Ryan is a Tea Party supporter – which is never a good thing.  I do not hold out much hope for substantive tax reform anytime soon. 

* Peter J Reilly asks the question “Should President Obama Offer Amnesty For Legal Residents Behind On Taxes?” at FORBES.COM, and answers yes.

As I say in my comment –

I have been calling for a federal amnesty program since 2008, most recently in a TWTP post this past September.” 

Great minds do think alike.

* Also at FORBES.COM - read about professional opportunist Al Sharpton’s tax troubles in “Lessons From Rev. Al Sharpton's $4.5 Million Tax Bill” by Robert W Woods.

What did this perennial publicity seeker, who Robert misidentifies as a “Civil rights leader”, do?

The New York Times paints a picture of poor planning, with virtually everything paid for and owned by the entities, not by Mr. Sharpton. That may even extend to the clothes on his back, with the entities paying for such personal items as his daughters’ private school tuition.”

It amazes me that “celebrities” and other public personalities, who are otherwise intelligent (he may be a self-important idiot, but he is not necessarily stupid), claim to be totally clueless when it comes to obvious tax fraud or when it comes to hiring tax and accounting “professionals”.

* Let me end with a non-tax item.  Fellow great mind Peter J Reilly “tweeted” a great, and totally true, quote from “Idiot America: How Stupidity Became a Virtue in the Land of the Free” by Charles P. Pierce: 

“. . . there is very little that’s real about a reality show.”

Judging from the title of the book it discusses the steaming pile of excrement that is so-called “reality tv” a lot.


Uncle Frank was a staunch Conservative, and voted straight Republican until the day he died in Chicago.

Since then he has voted Democrat.


Friday, November 21, 2014


Once again I celebrated my natel day in Atlantic City while attending the National Association of Tax Professionals’ year-end tax update workshops.  I travelled to Bally’s Hotel and Casino in Atlantic City, where I had been earlier this year for the NATP Forum, for 2 days of the 3-day “Taxpro Symposium”. 

We were supposed to be at the Showboat, but that hotel and casino had closed its doors.  I paid the same rate at Bally’s that I had booked for the Showboat.  Once again I got a lower rate by booking independently online without using the NATP code.  What good is having a special conference rate if it is not cheaper than the “off the street” internet rate?  I expect this only happens with casino hotels.

One complaint about Bally’s (in addition to the $12.99 per day charge for wifi, which I passed on again) is there was not a chair in sight – not even in the hotel lobby, or on the restaurant/conference room floor (although you could sit in one of the few chairs a small enclosed smoking “closet”).  If you wanted, or needed, to sit down you had to do so at a slot machine in the casino.  I mentioned this in passing to one of the floor guards as I was heading to the elevator of my tower and he gave me directions to the one out of the way lounge area.  By the time I arrived at the lounge I really needed to sit down!

Sitting on the Boardwalk one morning I noticed that the arrogant and annoying Chef Tantrum (aka Gordon Ramsey) is opening a Pub and Grill in Caesar’s.  If I return here in the future that is one place I will avoid – I certainly do not want to put any money in that idiot’s pocket.

For Tuesday, my 61st birthday, the topic was “The Essential 1040”, which covered the “standard features of the inflation-indexed updates for preparing individuals’ 1040 tax returns, new tax laws applicable to 2014 and recent developments”.  And, of course, included the obligatory 2-hours of redundant ethics preaching.

To be honest, for someone like me, who has written frequently over the past year about the 2014 inflation-indexed numbers, and recently about the 2015 numbers, the basic update component is boring.  And, with one exception, there was really nothing of consequence in new developments (IRS rulings and regulations, court cases, etc.).  Any real value was in the discussion of the new capital vs repair regulations, a complicated issue that basically comes down to capitalize just about everything, and, of course, the new Affordable Care Act (aka Obamacare) individual shared responsibility and premium tax credit rules.

During the inflation updates the workshop leader did make a good point about the dreaded Alternative Minimum Tax.  It is not all bad – especially when it comes to year-end tax planning.  It can be looked at like a “bell curve”.  From the point where your situation causes you to enter “AMTland” up till the point that your applicable AMT exemption is fully phased out it is bad.  But from that point on, as long as you are still subject to AMT, it is good – because additional income is taxed at a maximum of 28% and not 33% to 39.6%.

One thing that I did learn on Tuesday is that if a taxpayer does not self-assess the Obamacare penalty where applicable, or if a taxpayer does self-assess the penalty but does not pay it, the only way the IRS can collect the amount of penalty due is by “garnishing” a future income tax refund.   

One item I use to judge the workshop location is the continental breakfast provided by the venue.  Bally’s offering was certainly not the best I have ever seen (there have been two or three hotels over the years that have laid out a true banquet), but it was also certainly not the worst.

I had originally planned an expensive meal at the high-end restaurant in nearby Caesar’s for my birthday dinner - but thought hey, why not celebrate by having what I really enjoy (and at a closer venue).  So I had a greasy cheeseburger, fries, and a banana shake at “Johnny Rocket’s”, home of the singing and dancing waiters.

Wednesday’s “Beyond the 1040” was more beneficial, at least to me, as it covered specific ongoing tax issues.  The topics included divorce, estimated taxes, foreign investment income (the foreign tax credit on Form 1116 and FATCA/FBAR – not to be confused with FUBAR, which is a technical term for the entire Tax Code), and the “Cohan rule” and documentation of travel, home office, and charitable contribution deductions.

Here are some items of interest from Wednesday’s workshop –

* This was not discussed during the workshop – but it is important to point out that there are many potential short-term, long-term, and future tax consequences of actions, payments, and property distributions set forth in a divorce degree about which neither spouse, nor many divorce lawyers, have no clue - so it is important to discuss them with, or have the decree reviewed by, a competent tax professional.  I realize I am showing my age - but while you would certainly want Arnie Becker as your divorce attorney, you should have the divorce agreement reviewed and approved by Stuart Markowitz before signing it.

* Your filing status for the tax year is determined by your marital status on the last day of the year.  If you are legally married on December 31st you are married for the entire year.  If you are legally divorced on December 31st you are unmarried for the entire year.  But under an “annulment” the marriage is treated as never having occurred.  If your marriage is annulled you have never been married – and you can amend any prior years’ returns that you filed as married, either joint or separate, to recalculate each individual “spouse’s” tax as unmarried (Single or Head of Household) and therefore void the marriage tax penalty.

* It is interesting that, when it comes to preparing a 1040, in one situation the divorce degree means absolutely nothing (claiming a dependency deduction) while in another what is stated in the document is very important (deducting/reporting alimony).

* While, for purposes of calculating any penalty for underpayment of estimated tax, income tax withholding is generally considered to have been paid evenly throughout the year, regardless of when actually withheld, you can, using Form 2210, elect to treat withholding as being withheld when actually withheld to avoid or reduce a penalty.

* At one point during the discussion of withholding the question “why is there a marriage tax penalty?” was posed.  The answer (my answer) is that the concept of filing status and the differing tax tables were created at a time in history, many years ago, when the husband worked and the wife stayed home and “kept house”.

Another set of well-done year-end sessions from NATP.  Next fall if they are offered again in Lancaster PA, as they were this year, I will not be returning to Atlantic City.


Thursday, November 20, 2014


I couldn't come up with anything else to write about, so here is a "rerun" of a post from a few years back with an overview of the history of our federal income tax, updated for more recent developments.
1643: The colony of New Plymouth, Massachusetts levies the first recorded income tax in America.

1861: Congress passed the first income tax law as an emergency measure to fund the Civil War.

1872: Congress repeals the income tax law.

1894: As a response to complaints that excessive reliance on tariffs as a source of revenue resulted in an increase in the cost of imported goods, Congress again passed an income tax law.

1895: The US Supreme Court ruled that the income tax law was unconstitutional.

1913: In February the 16th Amendment, which states "Congress shall have the power to lay and collect tax on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration", was ratified by the necessary 3/4 of the states. On October 3rd Congress passed the Revenue Act of 1913, which created the first permanent US income tax.

Under this act, the first $3000 of income for single persons and $4000 for married couples was exempt from taxation. A "normal" tax of 1% was applied to income above $3000 or $4000, and a "super" tax of from 1-6% was applied to income in excess of $20,000. Deductions were allowed for business expenses (including depreciation), interest paid on "personal indebtedness", all national, state, county, school and municipal taxes paid, casualty losses, and worthless debt. In the first year only 1 out of every 271 American citizens were taxed and $28 Million in revenue was raised.

1916: The Federal Estate Tax was enacted to help generate additional revenue to fund America's anticipated entry into the first World War.

1917: Congress raised tax rates in response to the increasing cost of the war and approved credit for dependents and deductions for charitable contributions.

1918: The maximum combined basic and super income tax rate reached 77%.

1922: For the first time preferential tax treatment was provided for capital gains.

1932: The tax law was amended to provide that US presidents were liable for federal income tax on their salaries. Franklin Roosevelt was the first president since Abraham Lincoln to pay federal income tax on his presidential salary.

1935: The Social Security tax, 1% on the first $3000 of wages, was enacted.

1941: Tax tables for low-income taxpayers were introduced, simplifying the calculation of tax liability.

1942-1945: New tax laws, in response to the cost of World War 2, created withholding on wages, more tax brackets for lower income taxpayers, the standard deduction, a personal exemption for dependents, a deduction for medical expenses, and increased tax rates. By the end of the war the maximum tax rate was 94%.

1953: The Bureau of Internal Revenue becomes the Internal Revenue Service. And Robert D Flach, who would eventually become the internet's WANDERING TAX PRO, is born.

1954: Congress completely revised the Tax Code, changing rates, redefining Adjusted Gross Income, and adding credits for retirement income and dividends and new itemized deductions.

1961: Taxpayers were required to provide their Social Security or other taxpayer identification number to banks and other financial institutions so they could report interest and dividend payments to the IRS.

1964: Tax rates were reduced from a range of from 20% to 94% to from 16% to 77%. The Income Averaging method of tax computation was introduced.

1970: Congress created a Minimum Tax so high-income individuals could not completely avoid paying taxes through the use of preferential tax shelters, loopholes and deductions.

1972: Robert D Flach, who would later become the internet's WANDERING TAX PRO, prepares his first Form 1040 as a paid preparer.

1974: Congress created the deductible Individual Retirement Account (IRA) for taxpayers not covered by employer pension plans.

1975: Low-income taxpayers were allowed to claim a refundable Earned Income Credit (EIC).

1979: Unemployment compensation was made partially taxable.

1981: Tax legislation reduced tax rates by 25% over 3 years, indexed tax brackets for inflation, and applied the same tax rates to earned and unearned income.

1984: For the first time recipients of Social Security and Railroad Retirement benefits were subject to tax on up to 50% of the benefits received, depending on the recipient's income.

1986: The largest revision of the Tax Code since 1954, the Tax Reform Act of 1986, was enacted. The law reduced the number of tax brackets from 14 to 2, decreased the maximum tax rate from 50% to 28%, repealed the dividend exclusion, Income Averaging, the itemized deduction for sales tax paid and the preferential treatment of long-term capital gains, introduced the passive activity rules, the Kiddie Tax, the deduction from gross income for health insurance premiums paid by self-employed individuals, and the 2% of AGI limitation on most miscellaneous itemized deductions, phased out the itemized deduction for personal (credit card, auto loan, etc.) interest, limited the deduction for business meals and entertainment to 80%, and replaced the additional personal exemption s for age 65 and blind with an increased standard deduction.

1987: For the first time taxpayers were required to list the Social Security number of dependent children, age 5 and over.

1990: The Revenue Reconciliation Act of 1990 added a third tax bracket (31%) and instituted the reduction of itemized deductions and phase-out of personal exemptions for high-income taxpayers.

1993: The Omnibus Budget Reconciliation Act added the 36% and 39.6% tax brackets, increased the maximum tax on Social Security benefits from 50% to 85%, and reduced the deduction for business meals and entertaining from 80% to 50%.

1998: In response to abusive treatment of taxpayers by the Internal Revenue Service, the IRS Reform and Restructuring Act of 1998 was enacted.

2001: Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, the largest tax cut in over 20 years, with 85 major provisions. All provisions of this act will expire in 2011. And Robert D Flach begins publishing THE WANDERING TAX PRO blog.

2003: To stimulate the economy, Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003, the third major tax bill in as many years, and the third largest tax cut in history.
2010:  Congress passed the "Patient Protection and Affordable Care Act of 2010 and Health Care and Education Reconciliation Act of 2010", aka "Obamacare", which made the US Tax Code even more of a mucking fess and created more unnecessary work for tax preparers.
2013: Congress passed the "American Taxpayer Relief Act of 2012", which made permanent most of the expiring "Bush" tax cuts )from the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003), permanently "fixed" the dreaded Alternative Minimum Tax, and brought back PEP and Pease.

HERE for reports, information, and charts on major tax legislation over the years.  


Wednesday, November 19, 2014


The November issue of NATP’s TAXPRO Monthly includes an article on “Engaging the Nonfiler”.

The article describes a “nonfiler” as “as taxpayer who simply failed to file his or her tax return – either accidentally or intentionally”.

Over the past 40+ years I have come across quite a few clients who did not file on time.  Often I have prepared two or even three consecutive years' 1040s at the same time.

I currently have a client who has not filed her 2011, 2012, or 2013 returns.  Based on our relationship I know that she really has not filed, and not just gone to another preparer.

Why would something like this happen?  I have encountered three reasons:

1. The taxpayer has lost or misplaced much or all of the information (and/or client-prepared worksheets) needed to prepare the first return.  Because the first year’s return has not been filed the second year is delayed.  By the time the third year comes around the taxpayer is already two years behind, and things just begin to snowball.  This is the reason for the current non-filing of the client referenced above.

2. The first and second returns are not filed on time because of ill health – physical or mental (this could include an addiction to alcohol or drugs), and, again, when it approaches the due date of the third year’s return the taxpayer is already two years behind, and things just begin to snowball.

3. The 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!

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 you have income that is reported to the IRS by a third party – such as W-2 wages, gross pension and annuity distributions, interest, dividends, and gross proceeds from the sale of assets.

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

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 reconstructed return will report the gross amount of income that is in the IRS computer system under your Social Security number.

ü 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.

ü 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.

ü 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.

ü 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.

ü 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’s look at a real life example of a reconstructed return from my client files. FYI, in this case returns were file late because of medical reasons –

* 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”, which 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 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.

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 accrual of 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 another real life case from the practice of my mentor, from several decades ago, the taxpayer 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 the tax due on a reconstructed return!

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 detailed example I filed an original Form 1040 for the reconstructed year.

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!


Tuesday, November 18, 2014


You have several options available for investing your current, retirement, college, and health savings.  It is important to understand the tax aspects of each option, and the tax treatment of the various types of investment accounts – currently taxable, tax-deferred, and tax-exempt - to maximize your “after-tax” earnings from your investments.


Investment in shares of stock, both domestic and foreign, can generate qualified dividends while held and, if held for more than a year, long-term capital gains when sold.  Qualified dividends and long-term capital gains are taxed at a special lower rate, from 0% (no federal income tax) to 20%, depending on your level of overall net taxable income.  Short-term capital gains (from the sale of stock held for one year or less) are taxed at ordinary income rates, from 10% to 39.6%.

Qualified dividends and long-term capital gains are also taxed at the special lower rate under the dreaded Alternative Minimum Tax (AMT).  However this type of income increases your Alternative Minimum Taxable Income (AMTI) and may cause you to become a victim of AMT and/or reduce your AMT exemption.

And, depending on your level of Adjusted Gross Income (AGI), all dividends and capital gains may be subject to the 3.8% Net Investment Income Tax.

Distributions from tax-deferred accounts, retirement accounts like a traditional IRA or 401(k) and the various self-employed retirement accounts, are taxed at ordinary income rates regardless of the source of the income within the account - so qualified dividends and long-term capital gains earned within a tax-deferred retirement account are taxed at ordinary income rates when the money is withdrawn from the account.

While taxable distributions from a tax-deferred account will increase AMTI, these distributions are not subject to the Net Investment Income Tax.

Stock investments that will generate qualified dividends and long-term capital gains are taxed less if held in currently taxable accounts.

If you, or your broker, are more of a day trader, and invest in some stocks for quick turn-over short-term gains, these stocks could ultimately generate more net after-tax income if held in tax-deferred accounts. 

Regardless of where held the gains will be taxed at ordinary income rates, but holding these investments in retirement accounts will defer the taxation of gains to the future, in future dollars, when distributions are made after retirement (and when your marginal tax rate, or all tax rates, could be less than they are now).  And holding them in deferred accounts will allow for greater eventual growth as a result of the tax deferral.

I am not telling you not to invest tax-deferred funds in stocks that generate qualified dividends and long-term capital gains.  You obviously want to earn as much as possible within a tax-deferred account.  Even though you may lose the benefit of the lower tax rate, you may make up for this by the increased tax-deferred accumulation of income that will ultimately be taxed in the future in future dollars.

What I am saying is that when considering how to invest funds in currently taxable accounts it is more “tax efficient” to choose investments that will generate income taxed at the lower capital gain rates.


While the same considerations I discussed under domestic stocks apply to international, or foreign, stock (the stock of a company organized and located outside of the United States), the dividends from international stock will often have foreign tax withheld. 

Foreign tax withheld from dividends generated by currently taxed investments can be taken as a credit - often a 100% dollar for dollar credit against current income tax liability.  Unused credits can be carried forward to be used in future years.

While foreign tax withheld from dividends generated by investments held in a tax-deferred retirement account will reduce the income that is eventually taxed, you do not get the benefit of the tax credit.

You should hold investments in international stock in currently taxable accounts.


Bonds pay interest.  Interest is always taxable at ordinary income rates.

Interest on bonds and other direct obligations of the US Government (such as savings bonds and Treasury bonds and notes), while fully taxed at ordinary rates on the 1040, are exempt from state income tax.  

Taxable bonds are a good investment for tax-deferred retirement accounts.


The interest from municipal bonds (issued by the 50 states and the District of Columbia, and the bonds of US possessions like Guam, Puerto Rico and the Virgin Islands) are exempt from the “regular” federal income tax, and the state income tax of a “resident” state (interest from bonds issued by the state of NJ or a NJ municipality, and US possessions, are exempt from NJ state income tax).  Interest from certain “private activity” municipal bonds are taxable under the dreaded AMT.

You should never purchase tax-exempt bonds in a tax-deferred account.

Distributions from a tax-deferred retirement account are subject to federal income tax at ordinary income rates regardless of the source of the income within the account - so interest on tax-exempt municipal bonds earned within a tax-deferred retirement account are taxed at ordinary income rates when the money is withdrawn from the account.


INVESTOPEDIA tells us that a Real Estate Investment Trust, or REIT, is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages.

Generally the dividend payments issued by a REIT are taxed at ordinary income rates.

REITs should be held in tax deferred accounts.


My personal, albeit selfish, advice is never invest in limited partnerships in a currently taxable account.

Long-time readers of TWTP know that I hate K-1s from limited partnership investments.  Properly reporting all the items from the K-1, including those buried in attached statements, on the taxpayer’s Form 1040, and keeping track of suspensions, carry forwards and tax basis, causes considerable pain in various parts of the anatomy of a tax preparer.  And the additional tax preparation costs that result can be more than, or at least take a large bite out of, any eventual tax and financial benefits from the investment.  I truly believe that a carefully researched mutual fund will provide the same potential tax and financial benefit as any limited partnership investment (and welcome the comments of brokers on this statement).

If your broker insists that you must purchase units in a limited partnership, and no mutual fund will provide the same tax and financial benefits, then purchase the partnership in your IRA, traditional or ROTH, or another tax-deferred or tax-exempt account, so you tax professional does not have to deal with it on the 1040.


Mutual funds invest in all types of investments – domestic and international stocks, taxable and tax-exempt bonds, real estate, and limited partnerships.

Some funds invest in a mix of all investments and some funds limit investments to specific categories – small cap stock funds, growth stock funds, dividend paying stock funds, non or low dividend paying stock funds, international stock funds, corporate bond funds, either domestic or international, government bond funds, municipal bond funds, etc. etc. etc.

The taxability of dividends issued by mutual funds is determined by the rules for taxing the individual investments in the fund. Choosing what types of funds you purchase in currently taxed and tax-deferred accounts should be governed by the types of investments held in the fund.

Mutual funds can issue qualified dividends, non-qualified dividends, tax-exempt dividends, return of capital, and capital gain distributions.  Non-qualified dividends are taxed at ordinary income rates.  Return of capital distributions are not currently taxed as income – they reduce your cost basis in the fund.  Capital gain distributions are taxed at the lower capital gain tax rates.

There are “tax-efficient” mutual funds.  These funds can keep it's turnover low, especially if the fund invests in stock, and avoid or limit income-generating assets, such as dividend-paying stocks.  These funds should be held long-term in currently taxable accounts.


It really does not matter how you invest funds held in accounts whose distributions will never be taxed. 

Qualified distributions from a ROTH IRA or 401(k) account, a Section 529 qualified tuition program, a Coverdell Education IRA, a Health Savings Account, or a Medical Savings Account are totally tax free.  So taxes are not a consideration in determining where to invest the money.  Obviously you want to make sure that all distributions from these types of accounts are qualified distributions.

Before you invest you should consult a tax professional.  Do not rely on a broker for tax advice.


Monday, November 17, 2014


I do believe that indexing of tax items for inflation began with the Economic Recovery Tax Act of 1981, the first major tax act of the Reagan Administration.  ERTA called for the indexing of personal exemptions and rate brackets, effective in 1985, based on changes in the Consumer Price Index (CPI) for years ending in September of the calendar year preceding the tax year.  The landmark Tax Reform Act of 1986 indexed the Standard Deduction for inflation beginning in 1989.

As subsequent tax acts continued the concept of reducing deductions and credits based on AGI that began with TRA 86 most of the phase-out thresholds were indexed for inflation.  The American Taxpayer Relief Act of 2012 finally permanently indexed the dreaded Alternative Minimum Tax (AMT) for inflation

Today many items on the 1040 are indexed for inflation – but not all. 

“Retirement Distributions: Finding the Sweet Spot” by Michael McGilligan in the Fall 2014 issue of NATP’s Taxpro Journal discusses the taxation of Social Security and Railroad Retirement benefits.  Michael provides background on this issue and tells us that when the taxation of up to 50% of these benefits was first enacted, effective with tax year 1984 –

“. . . it was estimated that only 10% of Social Security recipients would be affected by the tax.  By the time the law was first amended in 1993 {to make up to 85% of benefits taxable – rdf}, about 18% of beneficiaries were affected.”

This change apparently “did not increase the number of beneficiaries subject to the tax, but did increase the amount of taxes for over half of the 18%”.

Michael goes on to say –

The Congressional Budget Office estimated that by 2005, 39% of beneficiaries had a portion of their benefits subject to tax.”

What changed?

The answer lies in what didn’t change – the thresholds used to calculate the taxable portion were not indexed for inflation and remain at the levels in effect in 1984 and 1994, respectively.  Therefore, without indexing, we can expect the percentage of beneficiaries subject to tax to continue increasing.”

“Social Security: Calculation and History of Taxing Benefits” Noah P. Meyerson, published by the Congressional Research Service on August 4, 2014, provides the following update -

According to the Congressional Budget Office (CBO), 49% of Social Security beneficiaries (25.5 million people) will be affected by the income taxation of Social Security benefits this year.”

An article from the March-June 2003 issue of Enrolled Agent Doug Thorburn’s “Wealth Creation Strategies” newsletter suggested that had the threshold numbers ($25,000 for single taxpayers and $32,000 for married couples for the 50% level. and $34,000 and $44,000 for the 85% level) been indexed for inflation since day one the adjusted numbers for tax year 2002 would have been $44,422 and $56,861 and $60,415 and $78,183.    .
Another item that has not been indexed for inflation is the $3,000 maximum current capital gains deduction.  If capital losses exceed capital gains on Schedule D you are only allowed to deduct up to $3,000 against other income.  Net losses in excess of this $3,000 limit can be carried forward to apply against net gains in future years.

When I first started preparing 1040s back in 1972 the maximum capital loss deduction was $1,000.  In went to $3,000 in 1978.  According to Doug Thorburn, the inflation adjusted amount for tax year 2002 would have been $8.759.

The maximum amount of rental loss that can be currently deducted on Schedule E under the passive activity rules created by TRA 86 has been $25,000, and the phase-out range for this deduction $100,000-$150,000, since 1987.  According to Doug indexing would have brought these numbers to $40,344 and $161,378-242,067 for tax year 2002.

Doug’s index-inflation estimates are for 2002.  Imagine what they would have been for 2014!

One final example.  The maximum deduction for a business gift has been $25.00 per person for the 40+ years I have been preparing 1040s.  The $25.00 limit was actually set by Congress in 1962!  That was 52 years ago.  In 1962 the median annual family income was $6,000, a new house cost $15,000, a gallon of gas was 25 cents, and a 1st class postage stamp was 4 cents.

The result of the lack of indexing for many important numbers on the 1040 is annual “back-door” tax increases for many taxpayers.

If it is appropriate to index some tax items for inflation why shouldn’t ALL deductions, credits, thresholds, etc. be indexed for inflation?