Tax Scam 1: Hiding Income Offshore

Many dishonest promoters may try to convince you to hide your money in offshore banks or brokerage accounts, through offshore banks, or trusts, in order to avoid paying taxes on it.  Unfortunately, that’s illegal, and if you’re caught, you’ll be on the hook.  If you’re being pitched one of these deals, be wary.  And if you have used one of these schemes in the past, the IRS has a voluntary disclosure initiative that allows you to come clean through August 31, 2011.

Tax Scam 2: Go Phishing

Smart scammers can design official-looking emails designed to get you to reveal personal information, such as a Social Security number or credit card number.  Beware any email that purports to come from the IRS.  The IRS will not send you an email seeking this sort of information.  If they plan to audit you, they will send you a letter or show up in person.  So, beware an email that purports to come from the agency.

Tax Scam 3: Bad Preparers

While most tax preparers are honest, some unscrupulous preparers may skim a portion of your refund, charge inflated fees, or promise a huge refund.  No preparer should promise a big refund, or try to pressure you to take deductions or credits you didn’t earn.  The IRS has recently stepped up its enforcement of paid preparers, but you still need to do your homework to ensure you’ve hired an honest one.

Tax Scam 4: False Refunds

Scammers will frequently file fake information returns, then try to claim a refund based on the bogus information.  Sometimes scammers will fabricate a Form 4852 (replacement W-2) or Form 1099 as a way to reduce tax liability or claim an undeserved refund.  If someone tries to get you to go along with such a scheme, don’t let it happen.  If you’re caught, you could be on the hook for a $5,000 penalty.  Similarly, a scam artist might try to use your information to file a false return and claim a refund.  This happens often with family or friends of taxpayers, so if someone asks to use your information in order to file a false return, don’t give in to temptation.

Tax Scam 5: Bogus Charitable Deductions

Be careful when claiming noncash contributions to a charity – there are strict rules for claiming the value of noncash contributions, and the IRS specifically looks for donations reported at an inflated value.

Tax Scam 6: Bad IRAs

Beware any financial advisor who suggests that you transfer appreciated assets into an IRA, or proposes any other scheme to get around the IRA contribution limits that apply to you.

Tax Scam 7: Hidden Corporations

The IRS is also working with states to find corporations that have been formed specifically to hide income and prevent the owners of the corporation from reporting it, or allow them to report fictitious deductions.  If a financial advisor is suggesting that you establish “shell” companies to shield income, take a second look.

While you may not think of some of these as true tax scams, the IRS looks at them that way, and really, that’s all that matters.

Have you skipped filing a tax return because you didn’t owe anything? You may be passing up a sizable refund. The Internal Revenue Service recently announced that $1.1 billion in previously unclaimed tax refunds are waiting for nearly 1.1 million people who did not file a Federal income tax return for 2007. Half of these potential refunds could be $640 or more, says the IRS.

Free Tax Money

Even if you think you didn’t earn enough money to merit filing a return, there may be credits that could snag you a refund. For example, you may be entitled to the Earned Income Tax Credit which is available for individuals and families with income below certain thresholds. You may also be eligible for a $400 credit ($800 if you’re married filing jointly) under the Making Work Pay Credit. These credits are refundable to the taxpayer, which means that you don’t have to have taxable income to offset them – if the credits exceed your tax liability, the balance is paid to you.

Also, if you had a job that withheld Federal taxes, file a return; if you don’t owe any taxes, all of that withholding comes back to you.

Don’t worry about being late if you are due a refund – the IRS won’t penalize you. However, if you have a tax liability from prior years, or if you owe unpaid child support, a refund could be applied to those unpaid debts, and you would not receive any cash.

Unclaimed Property

In addition to owed money from the IRS, you may have unclaimed property from any state where you have lived or worked. This might be a deposit that never got refunded; pay that you didn’t collect; or a check mailed to you that you never cashed, either because you moved or just never got around to cashing it. The State of Florida’s official website says it has $1 billion in unclaimed property; California has over $5 billion; and New York has an eye-popping $10 billion.

To find unclaimed property in your name, do an internet search for states in which you have lived and worked, looking for the official state agency that handles unclaimed property. These agencies will have a website with a search engine that allows you to enter your name and personal information, then file a claim for the property if it is, in fact, yours.

Watch Out for Sneaky Tax Companies

You may have received a letter or email from a company who promises to retrieve this unclaimed property for you. While this is legal, there is no reason for you to pay that company a cut of your unclaimed property if you can claim it yourself at no charge. Also, avoid any company that promises to tell you how to find unclaimed property in exchange for a fee – they’ll just direct you to the official state website.

Given the billions of unclaimed property out there, there’s a good chance that some of it is yours. It’s not hard to claim this money, so if you think you have something coming, go and get it!

While the tax laws don’t ever seem to get simpler, you can take away some of the pain of tax prep if you get your files in order first.  Find these documents and get them all together, to prevent hours of hunting and stressing out.

Income – W2 vs 1099

By now, you’ve got a form W-2 for the job (or jobs) you had in 2010.  But you may have several Forms 1099.  Form 1099 comes in lots of flavors.  If you did some contracted work you might have a 1099-MISC.  Forms 1099-DIV and 1099-INT will recap your interest earnings for the year, whereas 1099-R will run down your distributions from pension accounts and the like.  And these are just a few.  Get all of these together.

Expenses – Itemized and Other Deductions

If you plan to itemize, get the documents that will support those deductions.  Here are some of the more likely suspects:

• Home Ownership Deduction – you should have received a Form 1098 for your mortgage interest, taxes, and any points you paid on your mortgage.  If you paid any property taxes yourself, you’ll need your property tax bill.
• Medical Expenses Deductions – any payments to doctors, dentists, hospitals, or clinics for medical care, as well as payments for prescription drugs.
• Charitable Deductions – this includes payments by cash or check to any legitimate charity (sorry, your broke buddy doesn’t count).  You can also claim a deduction for noncash contributions if you have a receipt from the charity and you can legitimately substantiate the fair market value of what you donated.  the items were in good condition.  Also, if you drove your own vehicle to perform charitable services, you can deduct 14 cents per mile.
• Investment-Related Expense Deductions – payments to professionals for investment advice, subscriptions to financial publications, and fees for software or online services used to manage your investments are all deductible.
• Tax-preparation Fees Deductions – payments to a tax preparer or the cost of tax-preparation software are deductible.
• Employee Business Expenses Deduction – If you used your own money to make purchases related to your job or business, or if you drove your own vehicle as part of your job (not counting commuting to and from work), this is deductible.

In addition to expenses paid by cash or check, don’t forget credit card charges – even if you’re carrying a balance on your plastic, you can deduct expenses in the year they were charged.

Tax Accountants Can Help…So Can the Internet

Tax laws are complicated enough, and if you’re dreading tax time, you probably don’t want to spend hours doing research to find more deductions to take.  At a minimum, an Internet search will yield numerous tax preparation checklists that can direct you to deductions you may not have known about.  Even better are the commercial tax-preparation software packages that will direct you to potential tax deductions based on your answers to questions.

If your return is very complicated – you did a sizeable amount of contracted work, own a rental property, or have lots of complex investments, for example – consider hiring a professional.  The prep fee might be well worth the time and stress you avoid doing it yourself.

No matter how you choose to do your taxes, however, organizing your records will make everything easier.  Get everything together for 2010…and while you’re at it, start a file for 2011.

What’s a Home?

Mortgage Interest Tax Deduction

Am I Eligible for the Deduction?

Yes, if you’re the primary borrower or you cosigned for the loan.  If you just paid interest on someone else’s behalf to help them out, it’s not deductible.

How Much Can I Deduct?

Any mortgage loan secured by your home counts for the deduction, including first and second mortgages, home equity loans, and even lines of credit.  You can deduct the interest on a combined total of up to $1,000,000 of debt ($500,000 if you are married filing separately).  If you have a home equity loan secured by your residence, you can deduct the interest on up to $100,000 ($50,000 if you are married filing separately) worth of home equity debt – no matter how you used the proceeds.

What About Points?

A point is 1 percent of the loan amount, and lenders will often give you a lower interest rate if you pay some points – so, essentially, the points are prepaid interest.  Assuming that the points you paid were not service charges or for something other than interest, they are deductible – but the “how” of this deduction depends on the type of the loan.

Points paid for a mortgage used to buy or build your primary home, and secured by that home, are generally deductible in full in the year you paid them, as long as the term of the mortgage is 30 years or less.  You may also choose to prorate the points deduction over the life of the loan if you meet all of these requirements.  Points paid for a loan to buy or build a second home must also be prorated over the life of the loan.

What About Refinancing?

Interest on a refinancing is deductible, as long as your refinanced amount is no more than $100,000 over the amount of the original mortgage (the excess $100,000 is considered a home equity loan).  Points paid for refinancing a mortgage for the acquisition of your home must be prorated over the life of the loan.  If the refinancing was, at least in part, to improve your primary residence, however, the points applicable to the proceeds used for improvement are deductible in the year paid.

What About a Rental Home?

If you have a second home that you rent out, you must live in it for 14 days during the year, or more than 10% of the number of days you rented it out, in order to be considered a qualified residence.  If you don’t meet this test, your home is considered a rental property, and is not eligible for a home mortgage deduction.

How Do I Take the Mortgage Interest Tax Deduction?

Your lender will send you Form 1098, “Mortgage Interest Statement” (not to be confused with 1098-T or 1098-E) that will show the mortgage interest and points for the year.  If you paid points and they are not displayed on the form, such as points paid at closing, you can still deduct them – just make sure you have the closing statement for proof in case you’re asked.

Conclusion

Buying a home tends to be the event that finally makes itemizing your tax deductions worthwhile.  The mortgage interest tax deduction results in tax savings that can be huge and are one of the biggest tax writeoffs most Americans have. It’s definitely worth the extra work to file for the deduction.

Well, now there’s a way to get even.

The IRS has beefed up its rewards program for ratting out tax cheats.  Now, you can rat out your neighbor, lawn guy, or even your boss and get up to 30% of his under-reported tax liability!

But before you get too excited, know that there are rules for this, just like everything else with the IRS.  Under the IRS’ guidelines, if the under-reported tax liability you report turns out to be $2 million or more, and the questionable taxpayer is an individual with income of $200,000 or more, you can get a payment of up to 30% of what the IRS collects.  What’s more, if the IRS collects, and you think you were stiffed on your reward, you can actually go to Tax Court. 

The program in its current incarnation came into being in 2006.  Prior to that, plenty of would-be whistleblowers complained that there was little enforcement to ensure they got the cut of tax cheating to which they were entitled. 

Clearly, the $2 million limit means that ratting out the typical hairdresser or handyman probably won’t get you very far.  Not only does the IRS want to pursue only those cases that are truly worth their time, they don’t want to bother getting into disputes between family members or between disgruntled employees and small-time employers.

But the tax man is also interested in closing the so-called tax gap – that is, the amount of taxes that people should be paying, but aren’t.  In 2009, the IRS estimated this gap at about $300 billion. 

There’s no limit on the amount a whistleblower can get from the government if the shortfall in the taxpayer’s liability is large enough.  It also doesn’t matter if the taxpayer simply made an honest mistake, or under-reported his tax liability on purpose.  If the IRS collects, so do you.

There is a less lucrative program where you can report errant taxpayers with income of less than $200,000, and an under-reported liability of less than $2 million.  However, you can’t sue in Tax Court if you don’t collect.

Of course, there’s a whole process involved in collecting under this program.  First, you’ll have to fill out a Form 211, “Application for Award for Original Information.”  That “original” information in the form’s title suggests that if the violator is already in the IRS’ crosshairs, you probably won’t collect unless you have some totally new and valuable piece of information to supply.

Form 211 also requires you to give up your name and SSN – no anonymous awards.  You’ll also have to provide details of the alleged tax violation, and give detailed information of how you came across the information.  So, overhearing a cocktail party conversation likely won’t be enough – you’ll need to have hard evidence that the taxpayer is a tax cheat.

Also, be prepared to wait, and to spend lots of awkward Christmases with the taxpayer you’re ratting out.  On average, collecting under a whistleblower claim can take some seven years. 

Considering the amount you pay in taxes is probably much higher than it would be if everyone else were honest, the IRS’ whistleblower program can be one way to relieve the stress of knowing someone else is getting away with paying less than you.  If you’ve got solid documentation of clear wrongdoing, why not report it – and get a refund of some of those unnecessarily high taxes you’ve been paying?

A recent report suggested that many of the millions of disabled Americans may be paying more taxes than necessary because they don’t understand how their benefits are taxed, and may be unaware of credits available to them.  If you or a family member are disabled, consider these steps to ensure you don’t pay too much.

How is Your Income Taxed? Up to 50% of your Social Security Disability Insurance (SSDI) benefits are taxable each year.  But whether they are taxable, and how much, depends on your total income, not just SSDI.  If half of your SSDI plus all other income is less than $25,000 (less than $32,000 for a married couple), you won’t owe taxes.

If you got SSDI benefits in a lump-sum, you can spread the taxes on this amount over several years.  If you choose to do this, however, get a tax professional to help you.

If you got workers’ compensation, or damages from a personal injury lawsuit, these amounts typically aren’t taxable.  If you got payments from a long-term disability insurance plan, the amounts are taxable if your employer paid the premiums, or if you purchased it through a cafeteria plan. If you paid the premiums out of your own pocket, however, the benefits aren’t taxable.

What Can You Deduct? If your medical expenses exceed 7.5% of your adjusted gross income, you can deduct them.  This includes not only doctors’ fees, but also medical equipment and supplies, health insurance premiums you paid, and mileage you drove to get medical care.

Credit Where Credit is Due.  Even if you have no taxable income, or no tax liability, you may still have credits coming your way, and should still file a tax return.

The Credit for the Elderly or the Disabled may be available to you.  To qualify due to disability, you must  1)be under age 65, 2)be retired due to total and permanent disability, 3)be below the mandatory retirement age, 4) have received taxable disability income, 5) have income below certain limits, and 6) are not married filing separately.  Fill out Form 1040, Schedule R, to claim the disability credit.  You can also file Form 2441, Child and Dependent Care Expenses to get a credit for amounts you paid to care for a disabled spouse or a child while you worked.  Neither of these credits are refundable; that means they can reduce your tax liability to zero, but you won’t get any money back.

The Earned Income Credit, however, is refundable and can bring you thousands if you qualify.  If you or your spouse was employed in 2010, had investment income of less than $3,100, and had income below certain limits, you can fill out Schedule EIC to take this credit.  The rules can be a bit complicated, so the IRS website, www.irs.gov, offers the “EITC Assistant” to help you determine if you qualify.

Conclusion. The Internal Revenue Code offers many benefits for disabled persons.  There’s no reason not to claim these benefits if you are entitled to them.  You have enough difficulties to deal with; why not take what’s coming to you?

Job Search Expenses.  If you were laid off and looking for another job in 2010, those costs are deductible.  Mileage driven for job searches, fees paid to employment agencies, and the cost of preparing and sending out resumes are all deductible.   But, sorry, that snazzy “interview suit” is just regular clothing, and not deductible.

Unreimbursed Business Expenses.  If you had a job, but wound up shelling money out of your own pocket for job related expenses, these can be deducted on Form 2106.  These include gifts to business associates (up to $25 per person); entertainment and meals where business was discussed;  membership fees in professional organizations; trade and business publications; and business travel expenses (mileage, lodging, meals) your employer didn’t reimburse.

Energy Savings Home Improvement Credit.  If you installed new windows, a new air conditioning system, new furnace, or other home improvements, you might be able to take a credit of up to $1,500 for those improvements, or up to 30% of the total cost of alternative-energy improvements.

Charitable Contributions.  Cash donations to your favorite charities are easy to figure, but don’t forget all the clothes, books, and other trinkets you took to Goodwill – these are deductible, too.  And did you drive somewhere to volunteer your time for a charity?  Make a lot of last-minute contributions in the grocery store checkout line?  Yep – all deductible. 

State Sales Tax.  If you live in a state that doesn’t charge income tax, you can deduct the sales tax you paid in 2010.  But don’t worry if you didn’t keep every single receipt through the year; the IRS provides tables that you can use to figure your deduction. 

Aging Parents.  If Mom and/or Dad live with you, you’re providing their support and they are earning little or no income, they may very well be your dependents in the IRS’ eyes.  This can net you a valuable extra personal exemption, and could turn your filing status, if single, to the more advantageous head-of-household.

Expenses on your Credit Card.  Deductible expenses, such as charitable contributions and medical expenses, don’t have to be paid in cash to be deducted.  Even if you charged them and haven’t yet paid off the balance, you’re allowed to deduct them on your tax return.

Tax-Prep and Investing Expenses.  Did you pay for a safe deposit box?  Buy magazines on personal finance and investing?  Consult with a lawyer or accountant to do tax planning?  Pay an accountant or buy software to prepare last year’s return?  It’s all deductible on Schedule A. 

Teacher Deduction.  If you’re a classroom teacher, aide, or even a school principal, you can deduct up to $250 spent on classroom materials.

Student Deductions.  If you went to school in 2010, you may deduct as much as $4,000 of your higher-education expenses.  Alternatively, you might qualify for the Lifetime Learning Credit, which covers undergraduate or grad school, or the American Opportunity Credit, which covers undergraduate coursework. 

There’s no reason to ever pay more taxes than you owe.  If you legitimately qualify for a deduction, take it.  Keep good records of your expenses so that – heaven forbid – you can back up your return if an auditor comes calling.

Marginal Tax Rate

Your marginal tax rate is the highest rate that you are taxed. For many people, a portion of their income is taxed at one rate, and the rest is taxed at another rate. For instance, if you make right around $40,000 a year, you may pay 15% on the first $20,000 or so and 28% on anything over $20,000. So, let’s break that down:

15% of $20,000 is $3,000
28% of $20,000 is $5,600
Total tax liability is $8,600

In this case, your marginal tax rate would be 28%, the highest rate at which your income is taxed.

Average Tax Rate

The average tax rate is the actual percentage of income going to pay taxes. In the example above we can calculate average tax rate as follows:

$8,600 / $40,000 = .215 * 100 = 21.5%

So, in this example, your average tax rate is 21.5%, a bit lower than your 28% marginal rate. It’s good to know this because this represents your actual tax liability.

Why the Two Tax Rates?

In the United States, we have something called a progressive tax system, meaning, the more money you make, the higher your tax rate. If the person in the example above only made $20,000, he’d wouldn’t have had to pay the 28%…instead only the 15% would apply. Our progressive tax system taxes you at a lower rate for the first so many dollars you make, everything over that amount gets taxed at a higher rate, and so on until you reach the cap, which, for 2008, was 35%.

So, it all boils down to this, your marginal tax rate is the highest rate at which you’re taxed, but it does not represent the percentage of your income that goes toward paying taxes. That number is the average tax rate.

Incidentally, here are the 2008 tax rates for Individuals, from Edwards Jones Investments:

The home ownership tax deduction is the biggest and one of the few remaining tax deductions for the middle class American, so it’s not something that’s easy to let go of, but there’s an incredibly simple answer to that question.

If I told you that if you give me a dollar, I’ll give you 33 cents back, would you go for that? If so, give me a call, I’m sure we can work something out . All kidding aside, that’s what the home-ownership tax deduction amounts to.

Let’s say you have $85,000 a year in taxable income; if you’re single that puts you in the 28% tax bracket (see chart).

Let’s also say the interest payments on your home are $2,500 a month, $30,000 a year. Since your mortgage interest is tax deductible, you can write off all $30,000, which will give you an $8,400 tax refund.

Now, what if you pay off your home? You don’t get the $8,400 tax deduction, but you also don’t pay the $30,000 in interest in the first place. So, why pay $30,000 to get an $8,400 refund in April?

There Are Benefits to Not Paying Off Your Home

Don’t get me wrong, I’m not always in favor of paying off your home, in most cases it needs to be a personal choice you make after you’ve looked at all the options. The tax break can be used to your advantage with arbitrage, which basically means you’re borrowing money to invest and earning more on the investment than you’re paying on the loan. For example, if you pay $30,000 a year in interest, that’s equivalent to 6% on a $500,000 loan. If you receive an $8,400 tax refund, your effective interest rate on that loan is only 4.3%, not 6%; so if you can find an investment that pays more than 4.3%, you’ll be better off not paying off your home.