Welcome to the Tax Blog

News, information, and opinions about:

  • Federal, State, and Virginia Beach Taxes
  • The Tax Preparation Business
  • Tax Planning

If you have a question or comment, please drop me a line. Paul @ PIM Tax.

23 September 2015

Surface Transportation and Veterans Health Care Choice Improvement Act of 2015

Virginia beach tax preparation new Tax LawThat's a mouthful, eh? That's the name of a law President Obama signed on 31 July 2015. Even if you heard about it, I am willing to bet you didn't know there are some changes to the tax law in there, did you? There were quite a few changes, actually, but since they don't impact every American it didn't get a lot of attention from the media. Strangely, tax law changes are not mentioned anywhere in the title of the new law!

Here's the short version of the changes:

Change of Due Date for Partnership Returns (Form 1065). Beginning in tax year 2016 Partnership Returns will need to be filed by the 15th day of the third month after the tax year. For nearly everyone that means March 15, 2017. If your partnership's tax year is different from the calendar year it's going to be different. Form1065 (Partnership Return) will still be due on April 15, 2016 for tax year 2015.

C Corp Returns Due Date. Just the opposite of the partnership return. The due date was previously March 15, but has been moved to April 15. For corporations that do not use the calendar year as their tax year the due date is the 15th day of the 4th month after the tax year concludes. This change also takes effect for the tax FILING season in 2017.

Additional Information on Mortgage Interest Statements. Also beginning in 2017, mortgage lenders will be required to include the address of the property securing the loan, the loan origination date, and the principal balance at the beginning of the calendar year on Form 1098 Mortgage Interest Statement. I am happy about this change. There has been some confusion in the past.

Consistent Basis Reporting Between Estates and Beneficiaries. Beneficiaries receive a stepped-up basis in inherited property (such as a house). This means if the house is valued at $300,000 on the date of death, the beneficiary's basis in the property (for sale purposes) will be $300,000. For a while there has been a conflict between the estate administrator trying to keep property valuations low in order to keep estate taxes low, and the beneficiary trying to keep the valuation high so that his basis is high. The new law requires the estate administrator to include the valuation of each individual property with the estate tax return - with copies to the beneficiaries.

Note: Due to the (currently) large estate tax exclusion ($5.43 million) estate returns are only required to be filed on the relatively small number of estates exceeding that value. There are, however, some reasons to file an estate return even if it isn't required. Consistent reporting of basis between estate and beneficiary is now another reason to consider filing an estate return even if the estate value is below the requirement threshold.

Foreign Bank Account Reporting (FBAR) Dates. If you have more than $10,000 total in overseas banks you have to report it on FinCen Form114. The due date was formerly June 30, but has been moved back to April 15. While that seems like it raises the burden on the taxpayer to get the Form 114 filed, the new law adds (for the first time) the possibility of getting a 6-month extension to file. Like the other laws, it takes effect in 2016 for the 2017 tax filing.

There were a few other tax items in this new law, but those are the main points. What any of the new tax provisions have to do with surface transportation or veteran's health care is beyond me. I strongly suspect I would not enjoy a front row seat to see how the legislative sausage gets made in Washington. I prefer things simpler - like putting new tax laws in a bill called The New Tax Laws for 2015 Act. Direct and to the point!

16 August 2015

The Child and Dependent Care Credit (CDCC) provides a tax credit to taxpayers who purchase daycare for a young child or a family member/dependent with a disability. You can claim up to $3,000 of expenses for the daycare for one qualifying person who needs care, and up to $6,000 of the expenses if you are paying for the daycare of more than one qualifying person.  Unfortunately, the actual tax credit is not the same as the expenses you can claim. The credit is somewhere between 20% and 35% of your qualifying expenses, depending on your EARNED income.

There are quite a few rules and stipulations regarding the CDCC.

  • The person you are providing daycare for must be:
    • A Qualifying Child on your tax return under the age of 13. (You can still get the credit for the part of the year your child was under 13 if they turned 13 during the tax year.)
    • OR your disabled spouse
    • OR any disabled person you can claim as a dependent, EVEN IF they made over $4,000 or filed a joint tax return (You cannot normally claim someone who is not your child as a dependent if they earned more than the personal exemption amount ($4,000 in 2015). There is an exception to that rule for the purpose of claiming CDCC.)
  • The taxpayer must:
    • File single, jointly, head of household, or qualifying widower. If you are married filing separately you generally cannot take the credit unless you also meet the conditions of being considered unmarried.
    • AND work, look for work, or attend classes full time. If you file jointly, both spouses must meet this requirement. (You cannot take the CDCC to do volunteer work or to have a 'play day'. You must have a job or be a student.)
    • AND have earned income.
    • AND not claim the credit if the person paid to provide daycare was your spouse or dependent, or the parent of your child.
    • AND provide the required information about the daycare provider.
  • Qualifying Expenses are the lesser of:
    • Actual Expenses
    • $3,000 for one dependent, $6,000 for two or more
    • The amount of earned income of the tax payer (lowest paid spouse if filing jointly).
  • Fees for overnight camps, private schools, or tutoring programs are NOT qualified expenses.

Tax Tip: You can take up to the $6,000 in qualifying expenses for one child in daycare, as long as you have two (or more) qualifying dependents.

Example: Tina works and has two children ages 4 and 12. The 4-year-old goes to Sunshine Valley Daycare Center during the day while Tina works. The cost of Sunshine Valley Daycare Center is $9,000 per year. The 12-year-old goes to school during the day. After school the 12-year-old rides with a friend and the friend's mother to a scouts meeting, which is not a qualifying daycare provider. Tina picks the 12-year-old up from the scouts meeting on her way home from work. Although she is only paying daycare for one child, for the purposes of the CDCC Tina has two qualifying children. Therefore she can use the $6,000 limit on qualifying expenses when she figures her CDCC.

Most people with child or dependent care expenses roll their eyes when they find out the qualifying expenses are limited to $3,000 for a single child. The actual expenses for most daycare are considerably higher. I'd like to see the limit on allowable expenses raised, but that will take an act of Congress. Until we get one we will take what we can get and work to get the largest child and dependent care credit  the law allows.

30 August 2015

virginia beach tax preparerJust spent 2 days at the National Association of Tax Professionals (NATP) annual Forum & Expo at the Rio Hotel in Las Vegas. This was my first time attending this event, but I do not think it will be my last. I had a great time hanging out with my fellow tax nerds, and received my required continuing education credits for both CFP and Tax Pro - delivered by experts in a great environment.  And...well...did I mention it was in Las Vegas? 

My biggest regret is that there were classes I couldn't take because there was not enough time. There were 24 offerings, and only 8 class sessions, so I had to try to be selective. I think I did well, getting some great insights on Schedule C and Schedule E, and a fantastic briefing on how to be the most effective when representing clients before the IRS. I feel very good that I got my money's worth.

I did OK at the poker tables, too. Of course, I left the poker winnings at the craps tables, but that's another story. I might be able to write all of that off my taxes, though, because I met a woman from Virginia who had recently started her own cleaning business and was looking for some tax advice. If I had a substantive discussion with her about her tax situation while betting on dice, wouldn't that conversation mean that the gambling was covered as a necessary business entertainment expense? 

Perhaps I should leave the tax weenie humor for others...

Anyway, my hat is off to the great people at NATP for a fantastic Forum & Expo. I joined NATP so I would have access to high quality research at tax time. I didn't know they were also going to make my continuing education fun and affordable, too.  Really, really happy I attended that event. Now if I could just take a decent selfie...

 

11 August 2015

Unlike the federal and state authorities, Virginia Beach does not have an income tax. This doesn't mean Virginia Beach doesn't collect taxes, of course. Like any government the city of Virginia Beach needs revenue to provide services such as police and fire protection, snow removal, trash collection, etc.

Looking at the chart of revenue streams below you can see Virginia Beach has quite a few sources of income. The two I am going to discuss in this post are the two that can be itemized on Schedule A of the federal individual income tax return; real estate taxes and personal property taxes. Together these two taxes account for nearly 36% of the revenue for the city of Virginia Beach.

tax prep virginia beach revenues

It is not uncommon for people to confuse real estate taxes with personal property taxes. Most of us consider our home to be personal property - and it is - but for tax purposes real estate is taxed differently than other types of personal property. Therefore we have real estate taxes on real estate and personal property taxes on taxable property other than real estate.

Most of the local governments like to describe the tax rates for real estate and personal property in terms of dollars/$100, and Virginia Beach is no exception (i.e. the personal property tax rate on cars is listed as $4/$100). I am going to convert these rates to a percentage because I find that easier to work with. Just realize that makes the rates I am posting unofficial.

Virginia Beach taxes personal property at the following rates:

 Type of Personal Property Annual Tax Based on Assessed Value 
Cars, trucks, trailers (work), motorcycles, and aircraft  4%
Privately owned recreational watercraft (boats)  0.000001%
All other boats  1.5%
RVs, campers, horse trailers 1.5%
Vehicles for elderly or disabled 3%
Vehicles for disabled veterans 1.5%
Mobile Homes 0.93%

To qualify for the reduced rate on vehicles for the elderly and disabled the Virginia Beach resident must be age 65 or over by December 31 of the previous year OR permanently and totally disabled AND combined gross annual income (including social security) may not exceed $29,500. The reduced rate is only applicable to one vehicle. Additional details here.

Veterans who are permanently and totally disabled due to a service-connected event can qualify for a reduced personal property tax rate on one vehicle. Additional details here.

Elderly and/or disabled residents of Virginia Beach can get an exemption from the mobile home tax if over 65 by December 31 of the previous year OR permanently disabled AND gross household income is $64,675 or less. More details here.

The 0.000001% tax on recreational boats is a placeholder. There is essentially no tax charged on recreational boats at this time, but if the city decides to collect such a tax in the future they don't have to change the law - they just have to change the rate.

Military personnel stationed in Virginia Beach can obtain an exemption from personal property taxes by mailing a copy of a current LES to the Virginia Beach Tax Assessor's office.

You can appeal the assessed value of your personal property if you believe the tax assessor's valuation is too high. Details can be found here.

Virginia Beach Real Estate Taxes

Location in Virginia Beach  Tax Rate on 100% of Assessed Value 
General  0.99%
Sandbridge  1.05%
Central Business District South  1.44%
Old Donation Creek 1.174%
Bayville Creek 1.353%
Shadowlawn 1.1494%
Chesopeian Colony 1.2813%
Harbour Point 1.069%
Gills Cove 1.053%
Hurds Cove 1.428%

The named areas are known as Special Service Districts (SSDs). The city is charging the waterfront homeowners in the SSDs a higher real estate tax rate to pay for dredging operations to maintain beaches and navigable water channels.

Elderly and/or disabled residents may qualify for an exemption for some or all of their real estate tax if they are over 65 OR permanently and totally disabled AND their household income is not more than $50,668 (disabled residents get a $10,000 income exclusion allowance). Additionally, you can't have more than $350,000 in assets. You must reside in the Virginia Beach home to get the exemption for the real estate taxes (second/vacation homes do not qualify). Additional details here.

There are also real estate tax breaks for energy efficient buildings as well as buildings listed in the Virginia Landmarks Register. Find additional details here.

If you itemize deductions on your federal income tax return you can deduct your real estate and personal property taxes (unless you are paying AMT).  This effectively removes them from your Virginia state income tax return as well. It turns out to be a substantial deduction for most people. For example, a Virginia Beach home valued at $300,000 would generate real estate taxes of $2,970. A taxpayer in the 25% top marginal rate for federal taxes (and 5.75% for Virginia) would knock $913 off his/her combined federal and state income tax bill for the year by itemizing that $2,970 as a deduction on Schedule A. Paying $913 less (or getting $913 more refunded) is pretty good money for filing your taxes properly. See me if you have questions.

02 September 2015

The Net Investment Income Tax (NIIT) has been in effect since 2013. It provides for an additional surtax on investment income for taxpayers with MAGI over a threshold specific to their tax filing status. I have found that most people do not understand the NIIT. Probably because it is new and because the IRS description is written like this:

For the Net Investment Income Tax, modified adjusted gross income is adjusted gross income (Form 1040, Line 37) increased by the difference between amounts excluded from gross income under section 911(a)(1) and the amount of any deductions (taken into account in computing adjusted gross income) or exclusions disallowed under section 911(d)(6) for amounts described in section 911(a)(1). In the case of taxpayers with income from controlled foreign corporations (CFCs) and passive foreign investment companies (PFICs), they may have additional adjustments to their AGI. See section 1.1411-10(e) of the final regulations.

Clear as mud.

Let me try to break this down to make it understandable. There are 4 elements to the NIIT:

  • Statutory MAGI Thresholds
  • Calculating your MAGI
  • Definition of Net Investment Income
  • Determining the lesser amount to be taxed

First let's look at the statutory MAGI thresholds:

Federal Filing Status  MAGI Threshold Amount
 MFJ and QW  $250,000
 Single and HoH  $200,000
 MFS  $125,000

If your MAGI is above the applicable threshold amount for your filing status, you will owe the Net Investment Income Tax on Net Investment Income. Note: these threshold amounts are not indexed for inflation, so each year more and more taxpayers will find themselves paying NIIT.

Calculating MAGI. MAGI for the NIIT is your AGI plus any amounts excluded as foreign earned income, income from controlled foreign corporations, or income from passive foreign investment companies. Most taxpayers do not have income from foreign sources, so in most cases the NIIT MAGI will just be the same as AGI.

Definition of Net Investment Income. Net Investment Income includes interest, dividends, capital gains, rental income, non-qualified annuities, trust income, and passive business income (i.e. limited partnerships). There are a few others listed on form 8960, but the sources of income listed above will cover 98% of taxpayers. If you have other forms of investment income you are probably sophisticated enough to know what they are and their impact on your NIIT.

Last, but not least, you have to determine which is the lesser amount - your Net Investment Income, or the amount by which you exceed your MAGI threshold. Let's look at a few scenarios.

Don is single and his only source of income is the rents he collects on the dozen houses he owns. He collected $93,000 in rental income in 2014. He had no adjustments to income. His MAGI for NIIT purposes is $93,000. This is below Don's statutory MAGI threshold. He does not owe NIIT.

Janice is single and earned $190,000 in salary in 2014. She also had interest income, capital gains, and dividends totaling $36,000. She had no adjustments to income. Her MAGI for NIIT purposes is $226,000. The threshold for her filing status is $200,000, which she exceeds by $26,000. We need to compare that amount ($26,000) to her Net Investment Income, which is $36,000. Janice will have to pay NIIT on the lesser of those two amounts - $26,000.

Thomas and Traci are married and file jointly. Thomas earned $140,000 in salary in 2014. Traci earned $155,000 in salary. They also has $1,600 in CD interest. They took a $2,500 adjustment for student loan interest paid. Their MAGI for NIIT purposes is $294,100 [$140,000 + $155,000 + $1,600 - $2,500]. They exceed the NIIT threshold for their filing status by $44,100. Their Net Investment Income was $1,600. They will owe NIIT on the lesser amount of $1,600.

Jeff is single. When his father passed he left Jeff a trust that generated $310,000 of income to Jeff in 2014. Jeff had no other sources of income and no adjustments to income. His MAGI exceeds the threshold for his filing status by $110,000. He has $310,000 of Net Investment Income. He will pay NIIT on the lesser amount of $110,000.

The Net Investment Income Tax is another reason to get as much of your investment portfolio as possible into tax-qualified accounts where it does not count as income. If you would like some advice on how to do that, come see me.

 

22 August 2015

Taxpayers can deduct up to $2,500 of student loan interest from their federal taxes each year by taking an above the line adjustment. Essentially, that means you can take the student loan interest deduction even if you use the standard deduction when you file. Lenders are required to report student loan interest to taxpayers on form 1098-E. If you have mulitple student loans you will receive multiple forms 1098-E. If your total interest payments for the year exceed $2,500 you are out of luck. $2,500 is the cap, and there is no carryover to subsequent tax years.

1098E virginia beach tax prep

While form 1098-E is quite handy, it may also be misleading. It may not include everything you can deduct as student loan interest. The law allows some expenses to be deducted as student loan interest by the taxpayer, but does not require the lender to report them on the 1098-E.

Deductible Student Loan Interest NOT Reported On Form 1098-E:

Loan Origination Fees were not required to be reported as interest on 1098-E for loans taken out prior to Sept 1, 2004.  Loan origination fees are typically withheld from the loan when it is secured by the borrower. For example, Tammy takes a $10,000 student loan with a 3% origination fee. The lender only delivers $9,700 to Tammy, and keeps the $300 (3%) loan origination fee. That fee is interest, and can be deducted from your taxes using (according to the IRS) any reasonable method that allocates the loan origination fee over the term of the loan. If the term on Tammy's loan is 10 years, she can deduct $30/year from her taxes as student loan interest due to the loan origination fees. If you are still paying on student loans originating in 2003 or earlier find out if there were origination fees you could be deducting.

Capitalized Interest is unpaid interest that is added to the principal of the loan by the lender. This typically happens when loans are consolidated or refinanced - any accrued, but unpaid interest is added to the principal of the new loan. In the bank's eyes that money is now principal, but in the eyes of the IRS it still qualifies as interest and can be deducted in the year it is paid. Figuring the part of your payments that are due to capitalized interest can be tricky. It's a complex math problem I'm not going to try to explain here. Come see me if you have questions about it.

Credit Card Interest can count as student loan interest. (Wait!, What!?!) You read that right, credit card interest can count as student loan interest. To qualify the credit card must be used for qualifying higher education expenses (QHEE), and QHEEs must be the only thing on the credit card. If you're using your credit card to fill gaps in your education funding, it's probably worth it to have a specific credit card set aside to use exclusively for education spending.

Interest on Home Equity Loans/Lines of Credit can also be written off as student loan interest under the same rules as credit card interest. The expenses must be QHEE, and the only expenses on the loan must be QHEE. If you take out the home equity loan for education, you're good. If you take out the loan for education and a boat, you can't deduct the interest.

QHEE for the student loan interest deduction include tuition, fees, room and board, books, equipment, supplies, transportation, and other necessary expenses to attend higher education classes.

There are some limitations on who can deduct student loan interest. If your filing status is single, head of household, or qualifying widow(er), then the deduction begins to phase out at MAGI of $65,000; completely gone at $80,000. If your filing status is married filing jointly the deduction begins to phase out at MAGI of $130,000; completely gone at $160,000. If your filing status is married filing separately you do not qualify for the student loan interest deduction.

If you qualify for the student loan interest deduction be sure you are deducting ALL of the allowable interest - not just what is on your form 1098-E. If you are still planning your college financing, it is worth it to consider all available tax benefits.

08 July 2015

For Virginia residents, Virginia 529 plans are a great way to save for college. Your contributions get you a break on your Virginia state income taxes. Earnings and growth within the account escape both state and federal income taxes, as do qualified distributions from the account when it is time to pay for college. That's a whole lot of good things stacked up in one account - what could go wrong?  In a word: plenty.

The federal government offers some very valuable tax credits to help make college more affordable. The American Opportunity Credit (AOC) pays you back dollar-for-dollar on the first $2,000 you spend on tuition and required fees, plus 25% on the next $2,000. Spend $2,000 on tuition, get $2,000 back in tax credits. Spend $4,000 on tuition, get $2,500 back in tax credits. AOC can only be used for undergrad education, and can only be used 4 times per student.

If you run out of AOC eligibility the Lifetime Learning Credit (LLC) kicks in. You can get 20% back on the first $10,000 you spend on tuition and required fees. Spend $10,000 on tuition, get $2,000 back in tax credits. The LLC can be used for any accredited post-secondary education, and as many times as you want. You just can't use AOC and LLC for the same expenses.

The AOC and LLC are very valuable - more valuable than having a 529 plan. Fortunately, you can have your federal tax credits and a 529 plan, too. You just have to be careful. If executed poorly the 529 plan could cancel your eligibility for the federal tax credits, potentially costing you thousands of dollars annually. Tax break fratricide - one tax break killing another.

The way the 529 can interfere with eligibility for the federal tax credits is a little complex, which is probably why the mistake is easy to make. Essentially, you cannot claim the tax benefits of the 529 and a federal tax credit for the same education expenses. It makes sense, but the sequence of events can trip you up on this. Tuition is due in the year before you file for the federal tax credits. You would naturally think to use your available 529 money when the tuition comes due. This would be a mistake. Since the federal tax credits can only be used for tuition, if you pay the tuition with 529 money you cannot claim either of the (more valuable) federal tax credits when you file your tax return the following year.

In my opinion this makes the prePAID 529 plan especially risky. The prePAID plan is designed specifically to pay for tuition at some point in the future. This virtually guarantees you can't get the federal tax credits because you are using 529 money to pay the tuition. (You can take the money out of a Virginia 529 prePAID plan in cash and use it for other 529 qualifying expenses such as room and board, but you only get the original contributions back plus money market interest - not a great investment.)

Higher income families won't qualify for the federal tax credits. In 2014 AOC was completely phased out at $180K modified AGI for joint filers, half that for everyone else. LLC was completely phased out at $128K modified AGI for joint filers, half that for everyone else. Additionally, if you're married filing separately you are not eligible for the AOC or LLC. If you're not going to be eligible for the federal tax credits, then use the heck out of the 529 plans, even the prePAID plan. They can't interfere with the federal credits if you don't qualify for them. Just don't forget that your child will be filing separately from you at some point. Don't wreck his/her eligibility for AOC or LLC with a 529 plan.

The Virginia 529 Plans are fantastic. No one should think I am telling you to avoid them. (I have several Virginia 529 accounts!) It's the only way to get a tax break for room and board - which can be a significant portion of the college expenses. The 529 Plans just need to be part of an overall integrated college financing strategy so that you don't end up with one tax break cancelling another. You can get both if you prepare properly.

If you have any questions, please contact me: Paul @ PIM.

 

8 August 2015

It sounds promising, doesn't it? Alternative Minimum Tax. Two of those words convey a sense of hope. Alternative - like you have options. Minimum - like you could pay a smaller amount of tax.

I hate to burst your bubble, but neither is true. Alternative Minimum Tax (AMT) is misleadingly named. There is no option - if you owe it, you pay it. Likewise, it does not minimize anything - if you owe AMT your tax bill will be larger as a result. Perhaps it should have been named the Required Higher Tax.

There are many conditions (26 or 27) that may trigger AMT, but the most common are large Schedule A deductions for other taxes (state, real estate, personal property) and/or a mortgage interest deduction for a loan used for something other than buying or improving your home. (You took a home equity loan to buy a sailboat or fund your child's education.)

The Alternative Minimum Tax (AMT) is treated like an 'additional tax' by the IRS, but in reality it is a parallel tax system to the 'regular' federal tax system. Everyone's federal income tax is figured under both systems and whichever way the tax bill is higher, that's the one you pay.

AMT is calculated on form 6251, and I made the graphic below to show how it works (relative to the 'regular' tax system). The AMT system follows the 'regular' system right up until you have taken your Schedule A deductions, then it goes in a different direction. At the end it throws the results back into the 'regular' system on form 1040 line 45. However, if you look at how the math works you can see that it is really a separate tax system known as the Tentative Tax System.

Virginia Beach Tax AMT vs regular2

With AMT, after taking your deductions you must add back any of the 26 things listed on form 6251 you had previously taken off your taxes, starting with the taxes, mortgage interest (not used for acquisition or improvement of the home), and miscellaneous deductions you took on Schedule A. There are 23 more add-backs on form 6251. (Notably: accelerated depreciation of business assets. AMT uses a different (slower) depreciation schedule.) Adding those 26 items back produces your Alternative Minimum Tax Income (AMTI). The Tentative Tax System equivalent of AGI.

After calculating the AMTI you are allowed an AMT Exemption (if you qualify). For 2014, the AMT exemption starts at $52,800 for single and HoH, $82,100 for MFJ, but each of those exemption amounts decreases above certain AMTI thresholds. If you're MFJ your AMT exemption drops to $0 when your AMTI reaches $484,900.  It zeroes out at $328,500 for single and HoH. If you qualify for an AMT exemption you can subtract it from AMTI. That gives you the amount of income exposed to the AMT tax rates.

Figuring your tax is as convoluted as the rest of it. You pay 26% on the amount up to $182,500, and 28% on the rest. UNLESS you had capital gains and/or qualifying dividends. Then there is a worksheet for figuring your tax with the lower capital gains rates worked in. Either way you have now arrived at the Tentative Minimum Tax. You subtract your 'regular' base tax from Tentative Minimum Tax to get your AMT. The AMT is then added to your form 1040 on line 45, where the 'regular' base tax is immediately re-added to it. This subtracting and then re-adding the 'regular' base tax is why the AMT is really a parallel tax system. You're either paying the 'regular' tax or you're paying the Tentative Minimum Tax - whichever is higher.

If you're paying AMT and you have children in college you may want to look at not claiming their exemption(s) on your tax return. If you're paying AMT you're not getting anything for the exemption (note how it is missing from the calculation of Tentative Minimum Tax. It is actually possible to have so many exemptions that you trigger AMT!). Your child may not be able to claim their own exemption, but they may be able to claim some education credits on their tax return(s) if you don't claim their exemption.

The bottom line is that you want to plan to avoid paying AMT if at all possible. There are some ways to manipulate your deductions that may make AMT avoidance possible. Every situation is different, so we'd have to look at all the variables to know for sure. AMT is extremely complex. If you have questions please contact me.

31 July 2015

The IRS levies two requirements on taxpayers. The first is that we pay our taxes. The second is that we file an accurate income tax return by the specified due date. Failing to file your tax return on time and failing to pay your taxes when due can both result in penalties from the IRS. You might think failing to pay would result in the larger penalty than failing to file, but that generally isn't true. Failing to file your tax return can result in a penalty of 5% of the tax owed per month, up to 25% of the total tax owed. Failing to pay your taxes can result in a penalty of 0.5% of the tax owed per month, up to 25% of the total tax owed. The IRS will also charge interest on overdue taxes owed. Technically interest isn't a penalty, but don't try to tell that to someone who is paying it. It sure feels like a penalty.

Note, though, the penalties are assessed on taxes owed. Therefore if you don't actually owe any taxes, there is no penalty for failing to file your tax return on time. You're still supposed to - you might even be entitled to a refund - but the IRS can't penalize you for not filing unless you also owe tax.

Penalties are sometimes undeserved. It's not uncommon for a taxpayer to believe they are complying with the law, but an error on the tax return triggers penalties. For example, tax forms get mailed to an old address, or an employer does not send the required tax documents and the taxpayer does not realize s/he has a missing form at tax time. They think they have all the forms needed to complete their tax return, but they don't. Fortunately, taxpayers are not always stuck paying a penalty just because the IRS demands one.

Taxpayers can challenge the IRS's decision to impose a penalty for failing to file or failing to pay in a timely manner under a program known as First Time Abatement. The taxpayer must meet two criteria in order to qualify for First Time Abatement. They must not have any overdue tax returns or outstanding taxes owed. This is known as filing and payment compliance. The taxpayer must be up to date on all filings and tax payments. The second condition is the taxpayer must not have been assessed an IRS penalty in the three previous tax years. This is known as having a clean penalty history.

That's it - if you're currently compliant with your tax filings and payments and you have a clean penalty history for the last three years you can have failure to file and failure to pay penalties imposed by the IRS abated. There is no guarantee your penalties will be abated, but the onus is on the IRS to demonstrate a good reason to not abate your penalties if you qualify for this program. 

First Time Abatement can be requested via telephone, through the IRS website, or in writing. You can also authorize your tax preparer to apply on your behalf.

If you've never heard of this program there may be a good reason for it. The IRS does not advertise it. They suspect if taxpayers knew about penalty abatement that more taxpayers would attempt to cheat the system. Fear of penalties keeps many of us on the straight and narrow. They are probably right about that, but there's no reason taxpayers should pay penalties if they qualify for First Time Abatement. Just like deductions and credits, it is a form of tax relief that should be utilized whenever available.

Disclaimer

Information in the Tax Blog is current as of the day it was posted. Tax laws change frequently, and it is likely that as time passes acts of Government will make some of the older blog content out of date.

The information provided is for education purposes only. It is general in nature and may not pertain to the Reader's situation. Every taxpayer's circumstances are unique. Reader's are urged to do some research or talk to a tax professional before acting on any of the information posted in this blog.

Paul D. Allen is a founding member of the Military Financial Advisors Association, as well as a member of the National Association of Enrolled Agents, the National Association of Tax Professionals, the Financial Planning Association of Hampton Roads, the National Association of Personal Financial Advisors (NAPFA), and the XY Planning Network. Paul is the Director of the CFP Board-Registered Program at The Regent University School of Law where he also teaches the Capstone Course in Financial Planning. You can read more about Paul's background here.

 

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Common Acronyms

ACTC - Additional Child Tax Credit

AGI - Adjusted Gross Income

AMT - Alternative Minimum Tax

APTC - Advanced Premium Tax Credit

AOC - American Opportunity Credit

CTC- Child Tax Credit

EIC - Earned Income Credit

HoH - Head of Household

LLC - Lifetime Learning Credit

MFJ - Married Filing Jointly

MFS - Married Filing Separately

MAGI - Modified Adjusted Gross Income

PIM - Plan of Intended Movement

PTC - Premium Tax Credit

QC - Qualifying Child

QHEE - Qualifying Higher Education Expenses

QR - Qualifying Relative

QW - Qualifying Widow(er)

 

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