2012 CCH Whole Ball of Tax
CCH Says: Steer Clear of Tax Season Headaches by Avoiding Common Blunders
(RIVERWOODS, ILL., January 2012) – There are right ways and wrong ways to make qualified tax credits and deductions work in your favor at tax time. However, taxpayers looking to “game the system” and claim non-applicable tax breaks could face fines, tax evasion charges and possible prison time, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).
“Honest mistakes can happen, because the tax law is complicated and keeping up with changes can be very challenging,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. “As a result, the IRS can be very reasonable when issuing tax oversight penalties. But, intentional attempts to avoid taxes will be dealt with much more severely.”
So, what do taxpayers need to keep in mind this year as they prepare their tax returns? CCH reviews top issues to help taxpayers stay out of hot water with the IRS.
1. Recording basis reporting properly for stock sales
With new basis reporting requirements in 2011 for stock brokers and mutual fund companies, the goal is for investors to more easily obtain financial information for tax reporting and to improve compliance. However, under the expanded reporting requirements for Form 1099-B, the basis reported by the investor must match the basis reported by the broker for the same transaction. Additional reporting is optional for stock purchased prior to 2011.
2. Forgetting to report new Roth IRA conversions
Individual Retirement Account (IRA) investors who chose in 2010 to convert from a traditional IRA to a Roth IRA, where taxes are paid up front, were given the option of splitting the income tax owed on the conversion evenly over 2011 and 2012. Prior to 2010, a taxpayer’s adjusted gross income (AGI) had to be $100,000 or less in order to be eligible to convert a traditional IRA to a Roth IRA. That restriction was lifted as of 2010, allowing any taxpayer regardless of income to convert funds from their traditional IRA to a Roth IRA. However, those who choose the future, split-year tax bill option need to report half the taxable portion of a 2010 Roth conversion on their 2011 return.
“Taking advantage of new rules for deferring tax payments on Roth IRA conversions may have been beneficial in 2010, but you need to remember you owe half the tax bill on your 2011 return,” Luscombe added.
3. Not paying taxes on income earned abroad or from offshore accounts
Taxpayers earning money from sources outside of the U.S. have a new reporting requirement to fulfill. For those falling under this category, Form 8938 must be filed with the IRS to report the value of foreign assets.
“In years past, people thought they could stash money in foreign bank accounts that they thought were out of the IRS’s reach,” said Luscombe. “However, recovering millions of dollars in unpaid taxes owed from offshore tax havens and cracking down on abusive tax schemes continue to be major IRS objectives.”
U.S. citizens and residents must report worldwide income, within and outside of the U.S., on their tax returns. That includes income from foreign customers and applies even if you didn’t received Forms W-2, 1099 or their foreign equivalents. Those who don’t report all taxable income from overseas business transactions or offshore accounts and other assets could face civil and criminal penalties.
4. Not reporting income from gambling or illegal schemes
Form 1040, line 21 and Schedule A, line 28 of the tax return are a bit of a catch-all for reporting various financial gains and losses. Whether you had a lucky night at the casino or financially benefited from an illegal transaction, such as a Ponzi scheme, embezzlement or other types of fraud, line 21 is the taxpayer’s opportunity to tell all. For those who choose not to report gambling winnings or ill-gotten gains, they could be facing income tax evasion charges down the road.
On the flipside, victims of embezzlement can report the amount lost from embezzlement as theft loss and deduct this from their taxes. To qualify as a theft loss there has to be an allegation by someone that there was a criminal theft; however, this generally is the case with Ponzi schemes and other embezzlement situations.
5. Under-withholding of taxes
Generally, income tax follows a pay-as-you-go approach, meaning individual taxpayers must pay taxes on income they earn during the year it’s received. This is done through withholding or by paying estimated taxes on a quarterly basis. Under-withholding results in owing back taxes as well as a possible penalty, which is typically interest on the amount under-withheld. The penalty can be waived under certain circumstances, like failing to make estimated payments due to casualty or disaster. A simple way to avoid under-withholding is making sure you pay at least as much in taxes as you did the previous year (110 percent of prior year if your adjusted gross income exceeds $150,000). Another way is to pay through withholdings or estimated taxes 90 percent of what is owed for the current year.
Self-employed taxpayers are most likely to fall into under-withholding, particularly those who have highly fluctuating incomes that make accurate estimating difficult.
6. Limited qualifications for First-time Homebuyer Credit
For most taxpayers, the First-Time Homebuyer Credit was not available for homes purchased in 2011. However certain members of the military, Foreign Service and certain employees of the intelligence community can claim the credit for homes purchased in 2011. Those who qualify must have purchased their main home located in the United States:
- After December 31, 2010, and before May 1, 2011; or
- After April 30, 2011, and before July 1, 2011, andyou entered into a binding contract before May 1, 2011 and the purchase was completed before July 1, 2011.
Under the first-time homebuyer credit, the filing of the Form 5405 is now optional for some taxpayers – basically those who filed the form last year and did not sell the home or cease using it as their main home in 2011. The First-Time Homebuyer Credit increased to $8,000 under the American Recovery and Reinvestment Act of 2009 (ARRA) and was extended through 2010.
“This credit has been a moving target, so it’s not surprising that some people may inadvertently be claiming the credit when they’re not qualified. However, other people may be up to date on the rules but simply trying to take advantage of them anyway,” said Luscombe. The credit is claimed on Form 5405, First-time Homebuyer Credit.
To avoid problems, taxpayers must meet certain requirements and use the right forms to claim the credit:
- You must use Form 1040 to claim the credit. You cannot use Form 1040-EZ or 1040-A. If you already filed a tax return, it can be amended using Form 1040-X;
- You must attach Form 5405, First-time Homebuyer Credit and Repayment of the Credit;
- You must attach documentation showing the purchase of a home within the applicable dates; and
- You must file a paper, not electronic, return.
Also taxpayers must remember to include regular wage and tax statements, Form W-2, W-2G or 1099-R, or enclose their 1040-V payment voucher, as applicable.
7. Not paying taxes on unemployment, wages, tips or other income
Except for a brief exclusion that expired after 2009, beneficiaries are expected to pay taxes on all unemployment benefits they receive. Likewise, workers are expected to report all their income from work – whether it comes in the form of wages or tips. All investment income, including interest, dividends and capital gains, also is income and has its own tax ramifications.
“Generally, the biggest abuses come from people who earn part of their income from tips or those who are working off-the-books, for example doing side jobs and simply not reporting the income,” said Luscombe.
8. Not paying taxes on household help
Taxpayers who employ a nanny or other household workers are required to withhold and pay FICA taxes if cash wages totaled $1,700 or more ($1,800 in 2012). They also have to report and pay the required employment taxes for domestic employees on Schedule H, Household Employment Taxes, with the tax amount then transferring to the appropriate line on their Form 1040 or 1040A.
Taxpayers with household workers may also want to consider paying the tax on a quarterly basis by having an additional amount withheld from their salary or by making a bigger quarterly estimated payment to ensure they are not underpaying taxes, which would subject them to additional penalties.
9. Not reporting gifts given over $13,000
When someone receives a gift, its value is excludable from their gross income, meaning it’s not taxable to them. However, if they later sell it or receive any other income from the gift, that amount is taxable.
Taxpayers giving gifts in excess of $13,000 as a single filer or $26,000 as a split gift by joint filers have two options to satisfy their tax obligation. They can either pay taxes on the amount above this limit or apply it against their lifetime gift tax exemption ($5 million starting in 2011). The tax on gifts ranges from 18 percent on taxable gifts below $10,000 to 35 percent on taxable gifts of more than $500,000 beginning in 2011. Not reporting the gift is considered tax evasion. Gifts are reported on Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return.
“As a single filer, if you gave your niece a car valued at $20,000 last year, you need to decide if you want to pay taxes on the $7,000 in excess of the allowable gift tax or have that amount applied to your lifetime gift tax exemption,” said Luscombe. “Your niece owes no taxes on receiving the gift. However, if she sells it a few years from now, she owes taxes on any gain on the sale amount.”
10. Inflating the value of charitable donations
The IRS expects people donating items to qualified charitable organizations to use fair market value in determining what each items is worth. For non-cash donations of more than $500, a written description of the donated property must also be furnished and non-cash donations of more than $5,000 must be appraised. Additionally, cash donations of any amount require proof, such as a cancelled check, credit card statement or receipt from the charity. Contributions of $250 or more also require a letter from the organization specifying the name of the donor, the amount given and the date received.
11. Exaggerating business expenses
The IRS pays close attention to fraudulent tax abuses such as inflating business expenses or attempting to write-off personal and family expenses under the guise of a home-based business, where deductions are clearly invalid or where a business doesn’t exist.
For expenses to qualify as business deductions they must be ordinary and necessary expenses paid or incurred in carrying on a trade or business. Taxpayers must have proof to legitimize business deductions such as receipts. If they cannot show proof of expenses, they will be required to pay back taxes and interest on non-substantiated deductions. The IRS may take other measures depending upon the extent of the abuse.
“Some home-business owners are under the misperception that as long as they keep their receipts everything is deductible,” said Luscombe. “However, the costs of heating your entire home just to keep the office warm or payments to your kids for doing household chores are not deductible expenses for your business.”
Sole proprietorships may claim business expenses on Schedule C, Profit or Loss from Business. Partnerships and joint ventures generally report expenses on Form 1065 or 1065-B.
12. Not filing a tax return and common mistakes on returns
Ever since the enactment of the federal income tax in 1913, there have been many legal challenges to the system that have fallen short. Most people are required to file a federal income tax return.
Income thresholds for those who must file range based on age and filing status. For single filers under age 65, 2011 returns must be filed if they earn $9,500; returns must be filed for married couples under age 65 filing jointly if their income is $19,000 or more.
Not filing a tax return when required is considered income tax evasion with penalties including paying back taxes, interest, possible fines and potentially serving a prison sentence in the most serious cases.
And, when filing a return, taxpayers should take care to avoid some common mistakes:
- Failing to include or use correct Social Security numbers;
- Entering incorrect filing status;
- Making spelling errors in names;
- Claiming ineligible dependents; and
- Failing to check liability on whether the alternative minimum tax applies.
2012 Filing Deadline Extended to April 17
For 2012, taxpayers have a couple of extra days to file a return after the usual April 15 deadline date. This tax season’s deadline filing date is Tuesday, April 17. Taxpayers can request an extension until October 15, but they must file that request (using IRS Form 4868) by April 17.
About CCH, a Wolters Kluwer business
CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands (www.wolterskluwer.com).