Tuesday, April 15, 2008 12:00 PM
April 15 is here... and once again, you've waited until the last minute to fill out those returns. Have questions about deductions, dependents, or those stimulus payment rebates you've been hearing about?
Edward Lyon of TaxTuneup.com was online Tuesday, April 15, at 12 noon ET to offer advice to those still working on their IRS forms.
A transcript follows.
Edward Lyon: Hi everyone, my name is Ed Lyon. I've worked with tax clients across the country, and created tax-planning systems for individuals and accountants. My website, www.taxtuneup.com, has a Dictionary of several hundred deductions, credits, loopholes, and strategies, with links to IRS forms, publications, and other resources. My goal today is to answer your specific questions -- but also, where possible, to help expand your thinking about taxes to start asking some smart questions you might not already be asking.
Arlington, Va.: I moved from Md. to Va. late last year. I am having trouble figuring it all out. I can probably have my taxes done by tomorrow... How do I figure out the penalty for being a day or two late?
Edward Lyon: In a case like this, you're best off filing an extension and making an estimated payment. Then file the actual return when you're ready. The penalties are based on the amount you owe when you file, so by paying now you can eliminate them entirely.
Bellingham, Wash.: While buying and selling a home last year I fell into a bind and withdrew a large sum of money from my 401k. The home market slump erased an chance of profit taking care of the bill and now I'm facing a HUGE tax bill (25k+). I don't remotely have that kind of money and now I fear everything will come apart as the government comes after what little I have left. Please advice. Thanks, Cash poor in Washington
Edward Lyon: I want to answer this question up front because it's a common sentiment -- "how much trouble am I in?" The reality is, the IRS just wants their money, and they're willing to work with you to set up a payment plan. In fact, www.slate.com just published a first-person story this morning about how easy the IRS is to work with. My advice -- file your return on time, and let the IRS know how much you owe. Then contact them to set up a payment plan. You can even have them automatically debit a bank account for payments.
washingtonpost.com: Why I Love the Taxman (Slate.com)
Washington, D.C.: What should I do if I owe delinquent taxes? How bad are the penalties from the IRS and how willing are they to work out a reasonable payment plan?
Edward Lyon: My answer here is similar to my last answer. if you owe delinquent taxes, the IRS wants to work with you. Interest and penalties run about 9% now -- cheaper than putting them on most credit cards!
Boston, Mass.: Please help me solve an office debate:
Are there income limits or phase-out to the home mortgage interest deduction? We agree that there's a $1M cap on the amount of home purchase that can be counted towards the deduction, but I can't find anything that states that there's a phase-out over xx income. Thanks!
Edward Lyon: Good question. The answer is, you BOTH win. There's no statutory income limit for deducting mortgage interest -- you can deduct interest on up to $1 million in mortgage interest even if you're Bill gates. (Of course, at that level, you'll probably pay cash!) BUT -- there's a $100,000 limit to deduct PMI, or private mortgage insurance. Also, as your income tops $156,400, you start to lose 3 cents in itemized deduction for every dollar in "excess" income. So, while it's not a statutory income limit, it's an effective limit. Oh, and who do we know who has "excess" income, anyway?
Arlington, Va.: State taxes are based on your home address, not your business's address, correct?
Edward Lyon: State income taxes are based on where you live and where you earn your income. But most adjacent states, like VA and MD, or my own home state of OH and KY, have agreements to tax their own residents even if income is earned in a different state.
The answer may be different for business income, as opposed to salary income. If you earn business income in multiple states, you'll probably have to file returns and pay taxes in all of those states.
D.C.: We have season tickets for an area sports team and sell some of our tickets to defray the cost. If we sell these for more than we paid, is that taxable income? How do we account for this on our returns?
Edward Lyon: The law says that if you sell the tickets at a profit, you owe tax on that gain. It's nonbusiness short-term capital gain, but not subject to self-employment tax unless you're regularly engaged in the trade or business of selling tickets -- i.e., you file a business return for "scalper."
Okay, was the term "scalper" invented for "Redskins" fans? And can I tell you how grateful the IRS is that you're interested in how to report this income?
Arlington, Va.: Filed my return electronically last night and was going to mail my checks today. Then I remembered about $200 I earned in interest in an account I forgot about. Ugh! Should I increase the amount on my checks to estimate impact and have them be out of sync with what I filed last night and then file addendums, or do nothing, or what?
Edward Lyon: The IRS will eventually catch up with the missing $200 in interest income and send you a bill for it. Some of the IRS systems are antiquated. (They keep your master tax file on computers bought when JFK was president!) But this is an area where they can match the income to the recipient pretty easily -- and it will be easier for you to wait to be billed than file an amended return.
Edward Lyon: I just saw that our host posted a link to the Slate story I mentioned in the first question. Make sure you take a look at it after the discussion, it will give you a perspective on the IRS that you may not see elsewhere.
Falls Church, Va.: Is the IRS doing anything to improve its civil rights record? Back in the 2004 tax year, the IRS's computers did some fast ratio analysis on my honest tax return, marked it as questionable, and held my return without notifying me or anyone else. It took 18 months of bureaucratic rope-a-dope to finally get my tax refund.
When you file an amended return, does the IRS still claim that you forfeit your presumption of innocence? Back in 2004, innocent until proven guilty didn't apply.
Edward Lyon: I'm not sure I'd characterize this as a "civil rights" issue. But, you're correct that some of the same presumptions of "innocence" you'd find in a criminal court don't apply to the IRS.
As for filing an amended return and forfeiting a presumption of innocence -- unfortunately, the way the tax law works is that the IRS presumes ALL income is taxable, then, by grant of legislative grace, lets you deduct various expenses from that income.
Your best bet is to find ways to file your return that lessen your odds of scrutiny. I would guess, just from the question, that your situation involved a Schedule C sole proprietorship. if you were to organize the business as a partnership or S-corporation, you could cut your odds of being audited by up to 90%.
Arlington, Va.: So I probably already know the answer to this, but ... I left a job in early January of last year -- worked something like two to four days before leaving for my new job, and there was no vacation rollover. I don't have a W-2 from this place of employment. I really have to track it down, don't I? I couldn't just guesstimate it based on the previous year's return or whatever deposit my bank has listed?
Edward Lyon: This is a tough situation. Are you sure your short-term employer even issued you a W2? if so, work hard to track it down, because the IRS CAN match the W2 to your return, and those sorts of mismatches kick your return out of the computer for a real person to see.
Reston, Va.: My wife is an artist, and has started selling some of her paintings and winning prizes (with cash!!) in some local showings. Question - expenses last year far exceeded revenue, so we are claiming a several thousand dollar loss. How many years can we do this? Also, I believe after "x" years, her painting is officially a hobby, so no more deductions, but, do we still have to declare any money she takes in, if the expenses still exceed the income?
Edward Lyon: This is a GREAT question, and a very common one. I wish I could answer in more detail. The key is, are you operating your business with an INTENT to make a profit. if so, you can deduct all losses. if not, you can only deduct up to income from the activity.
If you show a profit 3 out of 5 years, you're presumed to be operating with the intent to profit. Many people misunderstand this to mean they can only show losses 2 years in a row. But, if you keep good books and records, get ongoing training and education in the field, and devote regular hours to the business, you can lose money year after year and still deduct the losses.
there was a tax Court case earlier this year where an interior designer lost half a million dollars on her horses over a 3-year period -- but got to deduct the losses because she showed $1.5 million in income from clients she generated as a result of her horse activities.
Rockville, Maryland: I had a complicated house sale in 04 that I do not want to explain or even find receipts for. Am I "out of the woods" today? All is very legal, just a lot of details and we have moved since then with papers scattered everywhere.
Edward Lyon: If you owned the house and lived in it as your primary residence for at least 2 of the last 5 years, you don't even have to report the sale if the gain is less than $250,000 (filing singly) or $500,000 (filing jointly). I hope that's the answer you're looking for!
Clifton, Va.: If you don't file your Federal income tax returns after 36 months from the filing date, you lose your refund. Many filers don't realize this. I have seen taxpayers lose more than $20k in refunds because they failed to file in a timely manner.
Edward Lyon: This is a great comment, and worth posting. Too many people miss out on legal refunds because they just don't file.
Arlington, Va.: I work part-time as a contractor for an gov't agency and report it as a business income. I'm doing my taxes right now, but I can't seem to deduct much of the expense except mileage because it's just like any part-time desk job in an office. Do you have any tips on deducting expenses for a 'business' like mine?
Edward Lyon: Let's look at the desk and the office. Can you deduct computer, phone or cell phone expenses, office supplies, and items like that? Can you take a home-office deduction for the space where you perform the work? can you delegate some of the work to a child (in a lower tax bracket) and reduce taxes that way?
if you're married, can you hire your spouse to help with the business? if so, you can establish a medical expense reimbursement plan, and use it to reimburse him/her for all unreimbursed medical expenses for both you, her, and your dependents.
You can even establish a retirement plan for your self-employment income. It doesn't have to be your primary source of income; there are lots of employment bennies you can establish even for startup and sideline businesses.
Washington, D.C.: I use a motorcycle for my business. Can I still take standard mileage rate deduction?
Edward Lyon: Absolutely! In fact, the mileage allowance is usually a poor deal for most business owners because the actual cost of operating most vehicles is more than the allowance. (Have you bough gas lately?) But motorcycles have lower operating costs relative to cars, which makes them better candidates for the mileage allowance (48.5 cents/mile for 2007; 50.5 cents for 2008 -- but don't be surprised if the IRS raises the allowance this summer)
Washington, D.C.: My partner and I filed our DC taxes "separately on the same form." We wanted to file jointly but ran into a strange issue. We both maximized our IRA deductions last year, with no federal penalty. However, were we married, those contributions would exceed the allowable limit based on our joint income, which would then incur a tax-deductible penalty, or so our tax prep software said. Consequently, I didn't feel right filing jointly if it meant reporting a deduction that didn't really exist. Head-scratching I know, but I hope we did the right thing.
Edward Lyon: This is a complicated question, as more and more states allow domestic partners to file jointly, even though the IRS does not. I'm more familiar with the California rules than the DC rules -- but I would suggest contacting the tax-prep software provider to see if they're aware of a problem or have a "fix."
One strategy might be to file your federal return now, but take an extension for the DC return while you work out the issues.
Also, in the last question I suggested hiring a spouse to create some deductible employee benefits. many of those same strategies will work for unmarried partners.
Washington, D.C.: : So, I did my own taxes for the first time this year through a website and then e-filed on Sunday. I did get a confirmation from the website, but haven't gotten a confirmation from the IRS yet. Am I okay? Should I worry about being considered late?
Edward Lyon: If you have a confirmation from the software provider, you should be fine.
Are you getting a refund? If so, you should know that there's no penalty for filing late. That's because penalties are based on the amount of tax you owe -- and if you owe nothing, there's no 'amount owed" to base a penalty on.
Providence, R.I.: My husband and I got married last year, and have filed a joint return for 2007. He has a past-due obligation to the IRS, so even though we're entitled to a refund, we won't get it. I have two questions:
1. Will we still get our economic stimulus rebate and
2. If not, can I get the payment I would be entitled to if we weren't married?
Edward Lyon: it's my understanding that you WILL get the economic stimulus rebate. that's because the rebates are based on 2008 income, even though you have to file a 2007 return to get them. I know, it doesn't make a ton of sense -- but it won't be the first time the government did something that didn't make sense. (Oh and by the way, blame Congress for this one, not the IRS!)
Edward Lyon: While we're waiting for more questions, I want to make a comment on "last minute advice.' The reality is, while I'm happy to offer last minute answers, the real key to minimizing your taxes is up-front planning. I've mentioned strategies like the medical expense reimbursement plan, retirement plans, and hiring kids. These are all things that have to be done ahead of time. otherwise, at midnight on December 31, they're like Cinderella's carriage, and they turn into worthless pumpkins.
it doesn't matter how good I am with a stack of receipts on April 15. if my clients haven't done the right kind of up-front planning, by then it's too late to be as effective as I'd like to be,
Planning is especially important if you own your own business (even a startup or sideline business), you own rental real estate, or you're a securities investor. Planning is the key to beating the IRS -- legally!
Re: gov't contractor: Thanks for answering my previous question on deducting business expense as a contractor. I liked all of your ideas and would love to start trying some of those. A follow-up question is, I commute to the office and sit in one of their desks to perform the work, and I can't work from home. Would the home-office be a place where I do my 'admin' work - filling out monthly invoices? If so, can I hire my wife to fill out invoices for me?
Edward Lyon: You're asking the right questions! In fact, I tell my clients that the real question isn't CAN I deduct something, it's HOW can I deduct it.
IRS Publication 587 says your office at home is your "principal place of business" if you use it "regularly" (8-10 hours/week) and "exclusively" for "administrative or managerial activities" of your trade or business. And yes, even if the home office doesn't qualify, you can hire your wife to administer the business exactly as you propose) and pay her in benefits.
By the way, you can pay her ENTIRELY in benefits. that means no salary -- no employment paperwork -- and no complications. In fact, the Tax Court issued a great opinion on Valentine's day 2006 (the Speltz) decision outlining how a Minnesota daycare operator hired her husband to work for the business (including shoveling snow, which he probably did a LOT despite global warming), paid him in benefits only (specifically, medical reimbursements), and won every dollar of deduction he claimed.
Arlington, Va.: similar question to an earlier poster, I did temporary work in between permanent jobs for two days. But I was never issued a W2 from the temp agency, do I still have to report it? The amount was $141.00. thanks
Edward Lyon: In a case like this, it sounds like you'd be treated as an independent contractor. You can just take the $141 and report it as "Other Income" on Line 21 of Form 1040.
Anytown, USA: I know of friends who itemized 20K+, when the standard deduction should have been used. Does cheating this bad usually result in an audit?
Edward Lyon: Itemized $20K, when the deductions were illegitimate? Tsk, tsk . . . .
For better or for worse, the government doesn't pay nearly as much attention to itemized deductions as they do to business returns. That's just because there's not as much money in it. However, if itemized deductions get TOO far out of whack relative to income, the IRS may notice.
What's happening here is that your friends are playing a game called "audit roulette." Sort of like going to the casino, except if the DO get audited (admittedly, a low-probability event), the consequences can be a real financial hangover!
Arlington, Va.: My income exceeds the limit to make Roth IRA contributions for CY2007. I maxed out contributions to my Roth 401k through work and also maxed out traditional IRA contributions. How do I determine if my traditional IRA contributions are deductible?
Edward Lyon: If you're covered by a retirement plan at work, and your income is too high to qualify for a Roth IRA, you're also earning too much to make regular deductible IRA contributions.
I know, there's no such thing as "too much" income!
It's even worse for filers in high-income areas. If you're in the Washington DC area, and you make more than about $170k or so, you can't make the Roth contribution. That may seem like a lot of money where I am in Ohio ("flyover country"), but it's a solid upper-middle income and no more in DC.
I ask my high-income clients if they consider themselves "rich." To date, I have yet to hear a client say "yes," and I've worked with clients with family net worths over $100 million.
Washington, D.C.: I'm just curious - my wife and I have combined adjusted gross income of about $135K, and have two little kids. Our federal income tax is $20K. I'm not complaining but I thought we'd be paying more. What does the '28% bracket' etc really mean?
Edward Lyon: Great question. You actually pay 10% tax on your first $15K or so of income, 15% on the next $40K or so, then 25% on the amount OVER the threshold for the 25% bracket. Your "tax bracket" refers to the amount you pay on your LAST dollar of income, even though your average tax rate may be far less.
Austin, Tex.: Could you clarify a bit about payment of estimated taxes? I have some Schedule C business income, but it varies wildly. To make payments to cover 100% of my prior year's tax sometimes means I'm paying more estimated taxes than the money I'm making from the business.
What would happen if I paid less and then increased my payment if necessary on the last quarterly installment.
(We're not talking huge amounts of income. Say $10000 or so.)
Edward Lyon: Estimated taxes aren't always easy to calculate -- I had a client last year get a refund of $172,000 because he made estimates based on the previous year's income, even though it went way down in the year.
One solution is to do a "dry run" of your taxes every quarter, and make estimated payments based on the actual amount due from that quarter's net. It's more complicated than just relying on last year's income, but more accurate.
If your business was incorporated, you could pay yourself a salary and "catch up" any amount overdue through withholding. Payments made through withholding are considered to be made equally throughout the year, even if you wait until the end of the year to pay.
Loudoun, Va.: My daughter, age 12, who has no other income, got $45K from an inheritance. Do we need to file anything or pay anything?
Edward Lyon: Don't let her spend it all in one place!
Inheritances are never taxable as income. However, the income she earns on the inheritance will be taxable.
I have a client who used money in her 12-year-old daughter's inheritance to buy a rental house -- and the daughter writes out all the checks for managing the property. that's right, managing rental property in junior high! A great education in fiscal responsibility for a kid that age -- I'd suggest you involve her as much as possible in managing the inheritance. Educate her and give her the confidence that she can manage her affairs as she gets older!
Arlington, Va.: Following up on the non-deductible traditional IRA contributions. What is the advantage of making non-deductible "traditional IRA" contributions? I've read that in 2009/2010, you can convert traditional IRAs to Roth IRAs. Is this true? Outside of this apparent loophole, what is the advantage of making non-deductible IRA contributions vs. a non-retirement investment?
Edward Lyon: I'm not a big fan of nondeductible traditional IRAs. That's because you have to track the nondeductible portion of the contribution as the account grows so that you can avoid paying tax on it when you take the money out. Yes, there's a form (8606) to track it all -- but it's still a major hassle.
And yes, you'll be able to convert regular IRAs to Roth IRAs in a few years -- but you'll have to pay tax on the accumulated growth at that time. (I don't care who's in the White House, we can be sure they'll want a slice of the "surge" in tax receipts THAT produces.
Don't be so quick to stuff ALL your investments in deductible accounts. Everything you take out down the road will be taxed as ordinary income (even from a nondeductible regular IRA). You may find you do better with tax-efficient investments such as stocks OUTSIDE a retirement plan where you can take advantage of lower capital gain rates, tax-loss harvesting, and strategies like that.
Bottom line -- in the long run, you'll probably find it's NOT a tragedy that you can't stuff those particular dollars in a retirement plan.
W.Va.: I work for an international company in our DC office. I live in W.Va. and have requested that they deduct W.Va. taxes. They tell me that they are not "registered" with W.Va. and so cannot deduct W.Va. taxes, and have no intention of "registering" with W.Va. I currently have no state taxes deducted from my check and have doubled the state taxes from my husband's W.Va. taxes. Are there any other options?
Edward Lyon: You can make quarterly estimated taxes to the state of West Virginia yourself. But if you're filing jointly, and your husband's income is such that doubling his state taxes gets the job done, that may work. If it's not enough, you can "double" his state taxes and make extra quarterly payments.
Does an employer that refuses to 'register" with the Mountain State serve decent coffee in the break room? I'd kind of doubt it . . .
D.C.: What are the area post offices with extended hours?
washingtonpost.com: You might find that info here: USPS website tax section
Edward Lyon: That's exactly where to go.
Takoma Park, Md.: Hi,
My wife and I have been subject to heavy AMT payments the last several years. We are thinking of buying a rental property. Does any passive loss associated with getting and keeping a rental property help towards reducing our AMT exposure. I know certain types of deductions don't help.
Thanks very much!
Edward Lyon: The answer depends on your overall income. Passive losses from rental real estate are deductible ONLY if your adjusted gross income is under $150,000. If your income is above that amount, the losses from the property are "suspended" until your income drops or you sell the property. So, buying rental property now might not get you the break you want.
By the way, that's smart of you to ask NOW. I've seen people buy property, and find out AFTER they do their taxes for that first year of ownership that they don't get the tax break that they used as the reason to buy the property in the first place!
Edward Lyon: Thanks for your questions, everyone, especially those of you asking for planning advice. Remember, PLANNING is the key to beating the IRS legally -- and taxes are probably your biggest single expense. So it makes sense to cut your expenses there first. (Sure, you can save 15% on car insurance by switching to GEICO -- but what's that really going to do for you in the long run?)
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