Scary Tax Creatures to Watch Out For on Halloween
“Halloween is my favorite holiday, bar none. Once a year, we all have license to use our imagination and be someone or something else. And beyond the goblins, pumpkins, ghosts and black cats, there is the absurd amount of candy floating around the stores and office.
The late Vincent Price, an actor who unquestionably had the best horror movie voice in the world, said, “It’s as much fun to scare as to be scared.” Vincent, wherever he is, may be pleased to know something can spook the unwary taxpayer in the same way his voice could invoke fear and trembling: tax creatures like the ones listed below. The good news is that you can avoid or at least minimize these horrors if you start thinking about these things now.
- Count AMT (aka Line 45 on Form 1040) – Dracula could not have devised a better way to suck the money or refund out of your life than the alternative minimum tax. If your income reaches a certain amount, you must recalculate the tax you owe based on a higher income, one that does not have some of the deductions that helped to lower it. Devised as a tool to ensure that wealthy taxpayers could not use loopholes to avoid paying taxes entirely, the AMT now preys on taxpayers who are not so wealthy. The current AMT exemption is $59,900 for single taxpayers and $83,800 for joint filers. Talk to your CPA about ways to soften the impact and be aware that certain deductions act as triggers for the AMT.
- Overstatement Ogre – are you truly a real estate professional? If not, best not to go overboard in claiming your rental income losses. When the head of the IRS Office of Preparer Responsibility is warning tax professionals to ask questions about this, that’s a good sign to be cautious.
To get around the passive-loss rules that prohibit the immediate write-off of rental real estate losses, some taxpayers have been pushing the limits in saying they “materially participate” in the property rental; only those who spend more than 50% of their working hours and 750 or more hours each year can meet that bar. If you can honestly say you “actively participate” in the rental, you can deduct up to $25,000 of loss if your income is under $100,000. (You can still claim the losses when you sell the related property.)
- Taxable Income Troll – The smaller the amount on your W-2 or 1099, the less you will owe in April (generally). Sounds simple, right? Well, some of it is. Bumping up your retirement plan contributions, taking larger deductions out of your pay for a flexible spending account or exercising stock options can all help to lower your income in a way that directly enriches you. Start taking action now, and you can take that troll down!
- The Creatures from Schedule C – The IRS pays close attention to small business returns; in particular, they scrutinize things like vehicle, entertainment and business-meal expenses and home-office deductions. When it comes to justifying these items, proper documentation is critical. In particular, the IRS wants to see contemporaneous documents; i.e., receipts or other records that were produced at the time you incurred the expense. If cash tips play a large role in your profession (hair stylist, cab driver, etc..), that can also trigger an audit.
- Ghosts of Returns Past – Sometimes our mistakes (or others’), no matter how small, can come back to haunt us. I remember the shock of receiving a letter from a state comptroller’s office about a return filed years earlier – they had the wrong address so it took quite a while to arrive. Did I still have the related information? No, that would have made it too easy. Fortunately, my brother put me in touch with a great CPA who helped me resolve it.
While state rules vary, for federal returns, the IRS typically goes back 3 years in auditing returns (6 years for suspected large underpayments); there is no statute of limitations for a return that was never filed. And if you are feeling queasy about a previous return, perhaps you forgot you had a foreign asset that should be reported, be upfront with your CPA. Like your doctor, he or she is not there to judge; and sharing information makes it easier for them to help you.
Tax is not most people’s favorite subject but it is an important one to think about now – waiting until the month before your return is due will be too late to ward off some of those characters! The AICPA’s consumer tax website – 360Degrees of Financial Literacy – has resources such as calculators and FAQs to get you started.”
-Ann Marie Maloney, Communications Manager-Tax, American Institute of CPAs.
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