What Are The Penalties For Not Filing Your Tax Return?

Everybody knows the old saying about death and taxes, yet a surprising number of people fail to file an income tax return. If you’re one of those people and you think you’ll be able to slide by, you need to reconsider your position. Even if you’re unable to pay your taxes, you need to file a return. Not doing so will eventually lead to a domino effect of negative consequences.

No matter how many people have told you that it’s no big deal, or that the IRS has “bigger fish to fry” than you, the employees of the Internal Revenue Service have a job to do and a process that they follow. Even if no legal action is taken against you, failure to file a return will end up working against you. Let’s take a look at the rules regarding filing your taxes and the various outcomes that you risk:

Most are Required to File Tax Returns
If your income is less than the standard deduction and you don’t owe self-employment taxes, ACA penalties or refunds or qualify for a refundable credit, then you probably don’t have to file a tax return. However, these days with health and family assistance all tied to the tax return the number not required to file a return is shrinking. So just about all individuals, estates and trusts have to file a return and may have to pay taxes. Those are two different things, and there are penalties involved with ignoring or rejecting each of them. Even people who don’t have the money available to pay the tax that they owe are better off sending in a tax return rather than skipping the process. Here’s why:

  • The IRS imposes a fee for not paying your taxes, and they impose a separate fee for not filing. The larger of the two is imposed for not filing – it’s 4.5%, compared to just 0.5% for not paying, and that fee gets charged every single month. You can end up paying up to 22.5% for failure to file and 25% for not paying (plus interest on unpaid taxes accrues from the return’s due date until you pay). The bottom line is that whether you can pay or not, you’ll save yourself big fees by submitting the required paperwork.
  • In addition to incurring fees, consideration must also be given to the actions that the IRS takes when they haven’t received a tax return from a taxpayer. The process involves the preparation of a substitute return which will be completed without consideration of tax advantages, deductions or write-offs, which leads to a higher calculated amount owed than would be the case if you prepared and filed your return for yourself.
  • The IRS is limited by a rule known as the “statute of limitations” that gives them just three years from the date that you file to perform an audit. The three-year clock starts when you file a return, so the sooner you get the paperwork in, the sooner your risk of being audited expires. That statute also applies to any refund you might have coming, after three from the date of filing you forfeit any refund. Beyond audit, if the IRS allows ten years from the date of your filing to go by without pursuing your taxes owed, they lose their ability to collect taxes, penalty or interest. The same is true of your ability to include your tax debt, interest debt or penalty debt in a Chapter 7 Bankruptcy discharge is based upon the date of your tax filing (generally two to four years after your tax return is filed).

What happens if you file your return without submitting the money you owe?
Once the IRS processes a return that is not accompanied by payment or discovers a taxpayer’s failure to file and pay taxes, they issue a Notice of Tax Due and Demand for Payment that will detail how much you owe in taxes, interest, and penalties. You are able to submit payment via cash, money order, credit card, check or electronic funds transfer, and the sooner you submit payment the better, as penalties and interest will continue to accumulate. If you don’t have the funds available, it is better to contact the IRS and discuss your problem with them than to ignore the notification. Options for resolving your payment issue include:

  • Allowing a temporary delay. This is generally offered after a review of your situation, during which time the agency may file a Notice of Federal Tax Lien. This document will allow the government to put a placeholder on the amount that you owe them until such time that you are able to pay.
  • Setting up an installment agreement. This allows you to make smaller monthly payments based on what you can afford.
  • Settling through an Offer in Compromise. This is an agreement that is only possible after all other options have been exhausted, allowing you to pay a lower amount than what is owed. It is issued after a complete review of your financial situation and addresses penalties and interest along with the original tax amount itself. Reaching an Offer in Compromise requires filing an application that costs $150.

It’s important to remember that if you receive a tax bill that you think is incorrect, ignoring it is just as big a mistake as not filing a return. Instead, take positive action by contacting your local IRS office, taking all pertinent documentation along with you to prove your case.

The bottom line
Perhaps more important than all other reasons, you need to be aware that if you fail to file a tax return and you owe income tax, there is a possibility of consequences that go beyond the financial. You could end up vulnerable to criminal prosecution, as well as a whole lot of stress. By following the rules and staying in touch with the IRS, you’ll save yourself a huge headache, and a fair amount of money too. If you have any questions about the penalties for not filing your tax return, please contact us for assistance.

Kiddie Tax No Longer Based on Parents’ Tax Rate

Some years back, it was not uncommon for parents to put their investments in their dependent children’s names to take advantage of their children’s lower tax rates. Although the Uniform Gift to Minors Act legally made a child the owner of money put into his or her name, this didn’t stop parents from routinely putting their child’s name and social security number on the accounts so that the tax would be determined at the child’s lower marginal rate.

The IRS had no easy way to combat parents taking advantage of their children’s lower tax rates, so Congress came up with a unique way of taxing children’s investment income (unearned income) such as interest, dividends and capital gains. When this law was originally passed over 30 years ago, it only applied to children under age 14, but Congress expanded it over time to include children with unearned income under the age of 19 and full-time students under the age of 24 who aren’t self-supporting.

The way it worked prior to the 2017 tax reform, the first $1,050 of a child’s income was tax-free, the next $1,050 was taxed at just 10% and any unearned income above $2,100 was taxed at his or her parents’ higher tax rate. A child’s earned income (generally income from wages) was taxed at the single rate, and the child could use the regular standard deduction for single individuals ($6,350 in 2017) to reduce his or her taxable earned income. The computation got more complicated when the child’s siblings also had unearned income.

With tax reform, for years 2018 through 2025, the first $2,100 of the child’s unearned income is being taxed as before, with the first $1,050 being tax-free and the next $1,050 being taxed at 10%. However, instead of the balance being taxed at the parents’ tax rate, the balance is taxed at the income tax rates for estates and trusts, which for 2018 hits 37% when the balance of the unearned income reaches $12,500. The income tax rates for trusts and estates are illustrated below.

2018 Federal Tax Rate Schedule – Estates & Trusts
If the taxable income is: The tax is:
Over But not over Of the amount over
$0
$2,550
10%
$0
2,550
9,150
$255.00 + 24%
2,550
9,150
12,500
1,839.00 + 35%
9,150
12,500
3,011.50 + 37%
12,500

On the bright side, tax reform increased the standard deduction for singles to $12,000 (2018), meaning that a child can make up to $12,000 of earned income tax-free. The standard deduction is inflation adjusted for future years.

Uncoupling the child’s return from the parents’ return also solved another problem. If a child had taxable unearned income, they previously would have to wait for the parents’ return to be prepared to know what the parents’ top tax rate was before the child’s return could be prepared. It was not uncommon for young adults, in a rush for their tax refund, to jump the gun and file their own return while ignoring the kiddie tax rules, only to have to amend their returns. That is no longer the case.

If you have questions, please give us a call.

Do You Need to Renew Your ITIN?

The IRS has announced that more than 2 million Individual Taxpayer Identification Numbers (ITINs) are set to expire at the end of 2018. An ITIN is a nine-digit number issued by the IRS to individuals who are required for U.S. federal tax purposes to have a U.S. taxpayer identification number but who do not have and are not eligible to get a Social Security number (SSN).

Failure to renew an ITIN in a timely manner can delay one’s ability to file a tax return, and with 2.7 million expected ITIN renewals, acting now to renew ITIN numbers will help taxpayers avoid delays that could affect their tax filing and refunds in 2019.

Under the Protecting Americans from Tax Hikes (PATH) Act, ITINs that have not been used on a federal tax return at least once in the last three consecutive years, as well as ITINs with specified middle digits (see below), will expire on Dec. 31, 2018. These affected taxpayers who expect to file a tax return in 2019 must submit a renewal application as soon as possible.

Who Needs to Renew Their ITIN?

  • Taxpayers whose ITIN is expiring or whose ITIN includes the middle digits listed below and who need to file a tax return in 2019 must submit a Form W-7 renewal application. ITINs with the middle digits 73, 74, 75, 76, 77, 81 or 82 (for example: 9NN-73-NNNN) need to be renewed even if the taxpayer has used it in the last three years. Other ITIN holders do not need to take any action. The IRS has begun sending the CP-48 Notice, “You Must Renew Your Individual Taxpayer Identification Number (ITIN) to File Your U.S. Tax Return,” in early summer to affected taxpayers. The notice explains the steps to take to renew the ITIN if it will be included on a U.S. tax return filed in 2019. Taxpayers who receive this notice after taking action to renew their ITIN do not need to take further action, unless another family member is affected.
  • ITINs with middle digits of 70, 71, 72, 78, 79 or 80 have previously expired. Taxpayers with these ITINs who haven’t previously gone through the renewal process can still renew at any time.
  • Spouses or dependents residing inside the United States should renew their ITINs. However, spouses and dependents residing outside the United States do not need to renew their ITINs unless they anticipate being claimed for a tax benefit (for example, after they move to the United States) or unless they file their own tax return. That’s because the deduction for personal exemptions has been suspended for tax years 2018 through 2025 by the Tax Cuts and Jobs Act. Consequently, spouses or dependents outside the United States who would have been claimed for this personal exemption benefit and no other benefit do not need to renew their ITINs this year.

Family Renewal Option – Taxpayers with an ITIN that has middle digits 73, 74, 75, 76, 77, 81 or 82, as well as all previously expired ITINs, have the option to renew ITINs for their entire family at the same time. Those who have received a renewal letter from the IRS can choose to renew their family’s ITINs together, even if family members have an ITIN with middle digits that have not been identified as expiring. Family members include the tax filer, the filer’s spouse and any dependents claimed on the tax return.

How to Renew an ITIN – To renew an ITIN, a taxpayer must complete a Form W-7 and submit all required documentation. Taxpayers submitting a Form W-7 to renew their ITIN are not required to attach a federal tax return. However, taxpayers must still note a reason for needing an ITIN on the Form W-7. See the Form W-7 instructions for detailed information.

There are three ways to submit the W-7 application package. Taxpayers can:

  • Mail the Form W-7, along with original identification documents or copies certified by the agency that issued them, to the IRS address listed on Form W-7’s instructions. The IRS will review the identification documents and return them within 60 days.
  • Work with Certified Acceptance Agents (CAAs) authorized by the IRS to help taxpayers apply for an ITIN. CAAs can authenticate all identification documents for primary and secondary taxpayers, verify that an ITIN application is correct before submitting it to the IRS for processing and authenticate the passports and birth certificates of dependents. This saves taxpayers from mailing original documents to the IRS.
  • In advance, call and make an appointment at a designated IRS Taxpayer Assistance Center to have each applicant’s identity authenticated in person, instead of mailing original identification documents to the IRS. Applicants should bring a completed Form W-7 along with all required identification documents. See the TAC ITIN authentication page on the IRS website for more details.

Avoid Common Errors and Delays Next Year – Federal tax returns that are submitted in 2019 with an expired ITIN will be processed. However, certain tax credits and any exemptions will be disallowed. Taxpayers will receive a notice in the mail advising them of the change to their tax return and of their need to renew their ITIN. Once the ITIN is renewed, applicable credits and exemptions will be restored, and any refunds will be issued.

Additionally, several common errors can slow down and hold up some ITIN renewal applications. These mistakes generally center on missing information or insufficient supporting documentation, such as for name changes. The IRS urges any applicant to check over their form carefully before sending it to the IRS.

As a reminder, the IRS no longer accepts passports that do not have a date of entry into the U.S. as a standalone identification document for dependents from a country other than Canada or Mexico as well as for dependents of U.S. military personnel overseas. The dependent’s passport must have a date-of-entry stamp; otherwise, at least one the following documents to prove U.S. residency is required:

  • U.S. medical records for dependents under age 6.
  • U.S. school records for dependents aged 6 to 17.
  • U.S. school records (if a student), rental statements, bank statements or utility bills listing the applicant’s name and U.S. address, if age 18 or over.

If you have questions related to a need for an ITIN or the renewal process, please give us a call.

When is a Charitable Contribution Appraisal Required?

A commonly overlooked requirement of taking a tax deduction for donating clothing and household goods to charity is the substantiation requirement, for both what is donated and the value placed on the donation. Because the IRS has encountered so much abuse in this area, it has increased the donation verification requirements over the years, and taxpayers risk losing the deduction if their donations are not correctly documented and reasonably valued.

Fair Market Value – Generally, it is up to you, the donor, to reasonably determine the fair market value (FMV) of the items you donate. If your return is reviewed, the values you claimed can be challenged. A deduction for household goods or clothing is not allowed unless they are in good used condition or better. The FMV of used household goods, furniture, appliances, linens, used clothing and other personal items are usually worth far less than the price they sold for new. Valuing these items as an arbitrary percentage of the original cost or by using another fixed formula is not appropriate – the condition of each item, whether it is still in style and other factors need to be considered. The value of the donated item(s) will determine the type of verification needed. The documentation and verification requirements are broken down into four categories:

  • Deductions of less than $250 – These donations require a receipt from the charity that includes the date and location of the contribution and a reasonably detailed description of the donated property.
    CAUTION – Don’t always rely on door hangers as a valid acknowledgment, since they generally do not include all of the required information (especially the reasonably detailed description of the donated item), and their use as documentation has been denied in tax court.
  • Deductions of $250 to $500 – Such deductions require a written acknowledgement from the charity that includes the date and location of the contribution and a reasonably detailed description of the donated property, whether the qualified organization gave you any goods or services as a result of the contribution, and if goods and/or services were provided to you, a description of the goods/services and an estimate of their value.
  • Deductions of over $500 but not over $5,000 – You must have the same acknowledgement and written records as for contributions of at least $250 but not more than $500, as described above. In determining whether your deduction is worth $500 or more, combine your claimed deductions for all similar property items donated to any charitable organization during the year. In addition, the records must also include:
    • How the property was obtained – for example, by purchase, gift, bequest, inheritance, or exchange.
    • The approximate date when the property was obtained or, if you created, produced, or manufactured it, the approximate date when the property was substantially completed.
    • The cost or other basis, and any adjustments to the basis, of property held for less than 12 months and, if available, the cost or other basis of property held for 12 months or more. However, this requirement does not apply to publicly traded securities. If you are unable to provide either the date the property was obtained or the cost basis of the property and there is reasonable cause for not being able to do so, you need to attach a statement to your return with an explanation.When your total deduction for all noncash contributions for the year is over $500, Form 8283 must be completed and attached to your Form 1040.
  • Deductions over $5,000 – You must have the same acknowledgement and written records as for contributions of at least $250 but not more than $500, as described above. In addition, if the contribution exceeds $5,000 for a single property item or group of similar items, then a qualified appraisal is required, and IRS Form 8283 must be completed, signed by the qualified appraiser and attached to the return. The exception to this rule is publicly traded securities.

Example: Jay and Emily made three donations of used clothing during the year: $2,500 worth to the Salvation Army, $1,500 worth to the Vietnam Veterans of America and $2,000 to Goodwill, for a total of $6,000. Because the items were all similar in nature (clothing) and because the total exceeded $5,000, Jay and Emily will need to obtain a qualified appraisal.

Qualified Appraisal – A qualified appraisal of any property is an appraisal that’s treated as qualified under IRS regulations. This means that the person doing the appraisal is generally someone who earned an appraisal designation from a recognized professional appraiser organization, has met certain education or experience requirements relative to the type of property being appraised, regularly prepares appraisals for a fee and has not been prohibited from practicing before the IRS.

Appraisal Timing– You must obtain the appraisal no earlier than 60 days before the appraisal property’s contribution date and no later than the extended due date of your tax return.

CAUTION – If you don’t bother to obtain an appraisal and the IRS later challenges your deduction, it will be too late to get the appraisal, and the deduction will most likely be denied.

Donations of vehicles, boats and airplanes have a special set of rules not covered in this article if the claimed deduction exceeds $500. Please give us a call about the documentation requirements for vehicle donations and any questions you might have related to any charitable contribution. Click here to download a special non-cash contribution form.

Treasury Department and IRS Proposed Regulations May Cause Family-Controlled Entities to Lose Estate-Planning Discount

The Treasury Department and IRS released proposed regulations, which, if finalized, will reduce the valuation discounts when transferring interests in family-controlled entities among family members.

Valuation discounts are frequently used to lessen the value of interests in closely-held entities for estate, gift and generation-skipping transfer tax purposes. These discounts allow a greater amount of property to be transferred to younger generations, by using less of taxpayer’s estate/gift lifetime exclusion. The proposed regulations affect the value of the interests transferred, but not the entities themselves, by reducing or eliminating the ability to apply valuation discounts in certain circumstances. The proposed regulations were issued on August 4, 2016.

In order to be affected by the proposed regulations, the following three criteria must apply:

  1. Family member owners of entities which are corporations, partnerships, LLCs or other arrangements deemed to be a business entity;
  2. Entities which are controlled by family members before and after a transfer:
    • LLCs or other entities:
      • at least 50 percent of the capital interests in the entity or arrangement; or
      • at least 50 percent of the profit interests in the entity or arrangement; or
      • an equity interest with the ability to cause the liquidation of the entity or arrangement in whole or in part.
    • Corporations:
      • at least 50 percent of the total voting power of the equity interest of the entity; or
      • at least 50 percent of the total fair market value of the equity interests of the entity.
    • Partnerships:
      • at least 50 percent of the capital interest in the partnership; or
      • at least 50 percent of the profits interest in the partnership; or
      • a general partner in a limited partnership regardless of their ownership percentage.
  3. Controlled by the transferor and/or family members. Family includes, for this purpose, the spouse of the transferor, any ancestor or lineal descendant of the transferor or their spouses, and any brother or sister of the transferor and their descendants and spouses. If the owner is an entity, look through the entity to the individual owners. If the owner is a trust, look through the trust to current beneficiaries.

These are complex regulations that determine the impact of changes in voting rights, and restrictions could occur when transferring interests in business entities, either by gift during a taxpayer’s lifetime or by bequest at death. These are generally provsions built into shareholder or partnership agreements that indicate the rights of transferees in the interests they receive. This is compared to the rights, powers and restrictions the transferor might have had prior to the transfer. Changes to these rules will substantially limit the transferor’s ability to reduce the value of the interest transferred.

The new valuation rules will generally apply to transfers occurring after the date the final regulations are published. That date will not occur prior to December 1, 2016.

All individuals who might be affected should identify any potential opportunities for lifetime transfers of property that can still use the discounting benefits before the regulations become final. It is also important to determine the impact of the rules on future estate tax liabilities. Business ownership agreements and your current estate planning documents should be analyzed and reviewed.

Contact Us

Contact a Tarlow partner at 212-697-8540, with any questions regarding this article, or any of your estate planning needs.