Big Tax Changes for Divorce Decrees after 2018

Welcome to 2019 and a delayed provision of the tax reform, also known as the Tax Cuts and Jobs Act (TCJA). For divorce agreements entered into after December 31, 2018, or pre-existing agreements that are modified after that date to expressly provide that alimony received is not included in the recipient’s income, alimony will no longer be deductible by the payer and won’t be income to the recipient.

This is in stark contrast to the treatment of alimony payments under decrees entered into and finalized before the end of 2018, for which alimony will continue to be deductible by the payer and income to the recipient.

Having the alimony treated one way for one segment of the population and the exact opposite for another group of individuals seems unfair and may ultimately make its way into the court system. But in the meantime, parties to a divorce action need to be aware of the change and compensate for it in their divorce negotiations, for a decree entered into after 2018.

This is not the first time Congress has tinkered with alimony. Way back in the mid-1980s, the definition of alimony was altered to prevent property settlements and child support from being deducted as alimony. Under the definition of alimony since then, payments:

(1) Must be in cash, paid to the spouse, the ex-spouse, or a third party on behalf of a spouse or ex-spouse, and the payments must be made after the divorce decree. If made under a separation agreement, the payment must be made after execution of that agreement.

(2) Must be required by a decree or instrument incident to divorce, a written separation agreement, or a support decree that does not designate payments as non-deductible by the payer or excludable by the payee. Voluntary payments to an ex-spouse do not count as alimony payments.

(3) Cannot be designated as child support. Child support is not alimony.

(4) Are valid alimony only if the taxpayers live apart after the decree. Spouses who share the same household can’t qualify for alimony deductions. This is true even if the spouses live separately within a dwelling unit.

(5) Must end on the death of the payee (recipient) spouse. If the divorce decree is silent, courts will generally consider state law, and where state law is vague, judges may make their own decision based on the facts and circumstances of the case.

(6) Cannot be contingent on the status of a child. That is, any amount that is discontinued when a child reaches 18, moves away, etc., is not alimony.

Taxable alimony payments under pre-2019 decrees and agreements are treated as earned income for IRA contribution purposes, allowing the spouse receiving the alimony to make IRA contributions based upon the alimony. The ability to make IRA contributions under pre-2019 decrees and agreements remains unchanged. However, for alimony received as a result of a post-2018 decree or agreement, the alimony can no longer be used as a basis for making an IRA contribution.

To summarize:
Pre-2019 Decrees – For decrees entered into before 2019 and unmodified after 2018:

  • Alimony continues to be deductible by the payer spouse/ex-spouse.
  • Alimony is includable in the income of the recipient spouse/ex-spouse.
  • The recipient spouse/ex-spouse can make IRA contributions based upon the alimony received.

Post-2018 Decrees– For decrees entered into after 2018 (and pre-2019 decrees that are modified and include the TCJA alimony rules): Alimony is not deductible by the payer-spouse/ex-spouse.

  • Alimony is not includable in the income of the recipient spouse/ex-spouse.
  • The recipient spouse/ex-spouse cannot make IRA contributions based upon the alimony received.

One additional complication is if state tax treatment is different than that at the federal level. Some states, such as California, have not conformed to the TCJA; as a result, the state treatment of alimony paid under both pre-2019 and post-2018 decrees in these states will continue to follow pre-2019 law, with alimony payments continuing to be deductible and alimony received being taxable.

If you have questions related to alimony or about how your state will tax alimony beginning in 2019, please give us a call.

Getting the W-4 Right Is Important

As they do at the beginning of every year, employers will request that employees complete the IRS Form W-4. Its purpose is to provide employers with the information they need to determine the amount of federal income taxes to withhold from an employee’s paycheck. So, it is very important that the form is completed correctly.

The problem is that as simple as the form looks, getting those entries on the form to produce the desired withholding amount can be tricky. The passage of the tax reform added additional complications, and the IRS has delayed a major revision of the W-4 until the 2020 tax year. In the meantime, taxpayers must get along as best they can using the old version of the W-4.

Even though the W-4 form itself appears to be simple, the instructions come with an extensive worksheet, which may or may not produce the desired results. In addition, there are other issues to consider, such as:

  • Perhaps you desire to have a substantial refund when your taxes are completed next year. This generally requires custom W-4 adjustments, to produce excessive withholding. Keep in mind: when you have a large refund, you have provided Uncle Sam with an interest-free loan.
  • Your spouse may also work, and your combined incomes may put you in a higher tax bracket. Although the IRS provides a special worksheet for married taxpayers if both spouses work, it may not always provide the desired results.
  • In addition to payroll income, you may also have self-employment income, which is subject to both income tax and self-employment, and so you may require a combination of payroll withholding and estimated tax payments, adding additional complications to the W-4.
  • These are just the tip of the iceberg, as there may be investment income or losses, business losses, tax credits, special deductions and loss carryovers, just to name a few more situations that could impact your tax prepayments and withholding for the year.

If you are concerned about getting your withholding correct, please contact us. We can project your 2019 tax liability and complete your W-4 after taking into account multiple employments, a working spouse, self-employment income and other tax issues unique to your specific tax situation.

IRS Giving a Break to Some Taxpayers Who Under-prepaid Their 2018 Taxes

Taxpayers are required to pre-pay their taxes for any tax year through payroll withholding, estimated tax payments or a combination of the two. Employees and retirees generally accomplish this through withholding, and self-employed individuals and those with investment income by paying quarterly estimated payments.

The late-2017 passage of tax reform that became effective for 2018 and its radical changes added considerable confusion for taxpayers trying to determine how much they should prepay for 2018. This confusion was made worse because the existing W-4 that employees complete and that their employers use to determine the correct withholding was designed for prior law and does not work well with the new tax law. As a result, there has been ongoing concern by the IRS that many taxpayers will end up owing tax this year when they file their 2018 returns, even though they got a tax reduction due to the tax reform changes, simply because their pre-payments through withholding and estimated tax payments were not enough.

For most of 2018, the IRS was issuing alerts that taxpayers may be under-withheld because of tax reform and the fact the W-4 could no longer be relied upon to produce a correct withholding amount.

Taxpayers whose pre-payments are less than certain safe harbor amounts are penalized. Those safe harbors are:

  • 90% of the current year’s tax liability; or
  • 100% of the prior year’s tax liability (110% where the prior year AGI is over $150,000 ($75,000 if married and filing separate returns).

Recently several members of Congress have called upon the IRS to waive underpayment penalties for 2018. On January 16, 2019, although not waiving the penalties entirely, the IRS did change the current year safe harbor from 90% of the 2018 tax liability to 85%, providing a break for some taxpayers.

Even if you don’t meet one of the safe-harbor exceptions, a waiver of the penalty for 2018 may apply if you:

  • Retired (after reaching age 62) or became disabled in 2017 or 2018.
  • You did not make payments because of one of the following situations and it would be inequitable to impose the penalty:
    a. Casualty
    b. Disaster, or
    c. Other unusual circumstance.

There are two other exceptions to the penalty for 2018:

  • If the total tax shown on your 2018 return minus the tax that was withheld is less than $1,000, you will not owe a penalty.
  • If you had no tax liability in 2017, were a U.S. citizen or resident alien for all of 2017, and your 2017 return was for a full 12 months (or would have been had you been required to file), you won’t be charged an under-prepayment penalty.

In addition, where your tax liability and /or tax pre-payments were uneven, the penalty amount may be mitigated by figuring it on a quarterly basis.

If you have questions or would like to make sure your withholding and estimated payments are adequate for 2019, please give us a call.

Tax Time Is Around the Corner! Are You Ready?

Tax time is just around the corner, and if you are like most taxpayers, you are finding yourself with the ominous chore of pulling together the records for your tax appointment. The difficulty of this task depends upon how well you have maintained your tax records throughout the year. No matter how good your record keeping was, arriving at your tax appointment fully prepared will allow more time to:

  • Consider every possible legal deduction;
  • Evaluate which income reporting methods and deductions are best suited to your situation;
  • Explore current law changes that are affecting your tax status; and
  • Talk about tax planning alternatives that could reduce your future tax liability.

New for 2018 – There are a number of new complications this year, including:

  • To combat tax fraud, the IRS is requiring all tax preparers to verify their clients’ identity with a government picture ID, although there is an exception for clients if the preparer has had a multi-year business relationship with a client AND has previously verified the client’s identity with a government picture ID. Since that was not previously required, it will be necessary for all clients this year, so be sure to bring a picture ID (also a requirement for a spouse) to your appointment.
  • Although the federal government changed its tax rules with the tax reform, many states with state income tax, such as California, have not conformed to the federal changes, which means a separate set of rules may apply to your state and federal tax returns.
  • The tax reform added a new 20% deduction for pass-through income from business activities. In some cases, the computation can be very complicated and will take additional time.

Choosing Your Best Alternatives – The tax law allows a variety of methods of handling income and deductions on your return. The choices you make as you prepare your return will often affect not only the current year but also future returns. Topics these choices relate to include:

  • Sales of property – If you’re receiving payments on a sales contract over a period of years, you can sometimes choose between reporting the whole gain in the year you sell or over a period of time as you receive payments from the buyer.
  • Depreciation – You’re able to deduct the cost of your investment into certain business properties. You can either depreciate the costs over a number of years or, in certain cases, deduct them all in one year.

Where to Begin – Preparation for your tax appointment should begin in January. Right after the New Year, set up a safe storage location, such as a file drawer, cupboard, or safe. As you receive pertinent records, file them right away, before you forget or lose them. Make this a habit, and you’ll find your job a lot easier on your appointment date. Other general suggestions to prepare for your appointment include:

  • Segregate your records according to income and expense categories. File medical expense receipts in one envelope or folder, mortgage interest payment records in another, charitable donations in a third, etc. If you receive an organizer or questionnaire to complete before your appointment, fill out every section that applies to you. (Important: Read all explanations, and follow the instructions carefully. By design, organizers remind you of transactions you may otherwise miss.)
  • Call attention to any foreign bank account, foreign financial account, or foreign trust in which you have an ownership interest, signature authority, or controlling stake. We also need to know about foreign inheritances and ownership of foreign assets. In short, bring any foreign financial dealings to our attention so we know if you will have any special reporting requirements. The penalties for not making and submitting required reports can be severe.
  • If you acquired your health insurance through a government marketplace, you will receive Form 1095-A, issued by the marketplace, which will include information needed to complete your return. In addition, you will need to provide proof of insurance to avoid a penalty or qualify for one of the many exemptions from the penalty. If you received a hardship penalty exemption from the marketplace, you will have been issued an exemption certificate number (ECN), which must be included on your tax return. The 1095-A and ECN documentation need to be included with the other material you bring to your appointment. If your insurance coverage was through an employer and the employer issued a Form 1095-B, Form 1095-C, or substitute form detailing your coverage, bring it to the appointment.
  • Keep your annual income statements separate from your other documents (e.g., W-2s from employers; 1099s from banks, stockbrokers, etc.; and K-1s from partnerships). Be sure to take these documents to your appointment, including the instructions for K-1s!
  • Write down your questions so you don’t forget to ask them at the appointment. Review last year’s return. Compare your income on that return to your income for the current year. A dividend from ABC stock on your prior-year return may remind you that you sold ABC this year and need to report the sale, or that you haven’t yet received the current year’s 1099-DIV form.
  • Make sure you have Social Security numbers for all of your dependents. The IRS checks these carefully and can deny deductions and credits for returns filed without them.
  • Compare deductions from last year with your records for this year. Did you forget anything?
  • Collect any other documents and financial papers that you’re puzzled about. Prepare to bring these to your appointment so you can ask about them.

Accuracy Even for Details – Make sure you review personal data to ensure the greatest accuracy possible in all detail on your return. Check names, addresses, Social Security numbers, and occupations on last year’s return. Note any changes for this year. Although your telephone number and e-mail address aren’t required on your return, they are always helpful should questions occur during return preparation.

Marital Status Change – If your marital status changed during the year, you lived apart from your spouse, or your spouse died during the year, list the dates and details. Bring copies of prenuptial, legal separation, divorce, or property settlement agreements, if any, to your appointment. If your spouse passed away during the year, you should have a copy of his or her trust agreement or will available for review.

Dependents – If you have qualifying dependents, you will need to provide the following for each (if you previously provided us with items 1 through 3, you will not need to supply them again):

  1. First and last name
  2. Social security number
  3. Birth date
  4. Number of months living in your home
  5. Their income amounts (both taxable and nontaxable). If your dependent is your child over age 18, note how long the child was a full-time student during the year.

For anyone other than your child to qualify as your dependent, they must pass five strict dependency tests. If you think one or more other individuals qualify as your dependents (but you aren’t sure), tally the amounts you provided toward their support vs. the amounts they provided. This will simplify the final decision.

Some Transactions Deserve Special Treatment – Certain transactions require special treatment on your tax return. It’s a good idea to invest a little extra preparation effort when you have had the following types of transactions:

  • Sales of Stock or Other Property: All sales of stocks, bonds, securities, real estate, and any other property need to be reported on your return, even if you had no profit or loss. List each sale, and have purchase and sale documents available for each transaction.
    The purchase date, sale date, cost, and selling price must all be noted on your return. Make sure this information is contained on the documents you bring to your appointment.
  • Gifted or Inherited Property: If you sell property that was given to you, you need to determine when and for how much the original owner purchased it. If you sell property you inherited, you will need to know the original owner’s death date and the property’s value at that time. You may be able to find this on estate tax returns or in probate documents; otherwise, ask the executor.
  • Reinvested Dividends: You may have sold stock or a mutual fund for which you participated in a dividend reinvestment program. If so, you will need to have records of each stock purchase made with the reinvested dividends.
  • Sale of Home: The tax law provides special breaks for home sale gains, and you may be able to exclude up to $500,000 of the gain from your primary home if you file a married joint return and meet certain ownership, occupancy, and holding period requirements. The maximum exclusion is $250,000 for others. Since the cost of improvements made on your home can also be used to reduce any gains, it is good practice to keep a record of them. The exclusion of gains applies only to a primary residence, so keeping a record of improvements to other property, such as your second home, is important. Be sure to bring a copy of the sale documents (usually the final closing escrow statement).
  • Purchase of a Home: Be sure to bring a copy of the final closing escrow statement if you purchased a home.
  • Vehicle Purchase: If you purchased a new plug-in electric car (or cars) this year, you may qualify for a special credit. Please bring the purchase statement to the appointment with you.
  • Home Energy–Related Expenditures: If you installed a solar, geothermal, or wind power-generation system in your home or second home, please bring the details of the purchase and manufacturer’s credit qualification certification to your appointment. You may qualify for a substantial energy-related tax credit.
  • Identity Theft: Identity theft is rampant and can impact your tax filings. If you have reason to believe that your identity has been stolen, please contact this firm as soon as possible. The IRS provides special procedures for filing if you have had your identity stolen.
  • Car Expenses for Business: If you used one or more automobiles for business, list the expenses of each business vehicle separately. When claiming vehicle-related business expenses, the government requires your total mileage, business miles, and commuting miles for each business vehicle to be reported on your return, so be prepared to have those numbers available. Job-related vehicle expenses are not deductible by employees on their federal returns in years 2018 through 2025. However, some states, including California, still allow them. So if you have unreimbursed employee business expenses, continue to provide the information noted above in case the deduction is allowed for state taxes, and if you were reimbursed for mileage through an employer, know the reimbursement amount and whether it was included in your W-2.
  • Charitable Donations: You must substantiate cash contributions (regardless of amount) with a bank record or written communication from the charity showing the name of the charitable organization, date, and amount.
    Unreceipted cash donations put into a “Christmas kettle,” church collection plate, etc., are not deductible. For clothing and household contributions, donated items must generally be in good or better condition, and items such as undergarments and socks are not deductible. You must keep a record of each item contributed that indicates the name and address of the charity, the date and location of the contribution, and a reasonable description of the property. Contributions valued under $250 and dropped off at an unattended location do not require a receipt. For contributions above $500, the record must also include when and how the property was acquired and your cost basis in the property. For contributions above $5,000 and other types of contributions, please call this office for additional requirements.

If you have questions about assembling your tax data prior to your appointment, please call us.

Do I Qualify for an IRS Offer in Compromise?

If you’re facing outstanding tax debt that you cannot pay, you may want to consider looking into an Offer in Compromise from the IRS. Specifically, an Offer in Compromise is an option offered from the IRS to qualifying individuals that allows them to settle tax debt for less than what they actually owe.

Unfortunately, there seem to be a lot of misunderstandings about Offers in Compromise; many people falsely believe that these are seldom accepted by the IRS. In reality, it is estimated that the current acceptance rate is over 40%, with the average dollar amount of a settlement reaching more than $10,000.

If you’re worried about your inability to pay tax debt, knowing the basic qualifications of an IRS Offer in Compromise and what to expect from the application process can be extremely helpful moving forward.

How to Know if You Qualify

Generally, there are three factors that are considered by the IRS when somebody applies for an Offer in Compromise. Most commonly, the IRS must have a belief that you will not be able to pay your tax debt off at any point in the near future. This means that your financial situation is probably not going to improve anytime soon and that the IRS would not likely be successful in forcing collections on you.

At the end of the day, the IRS needs to believe they are getting a fair deal – so if you have any potential to pay your debt at any point in the near future, you may not qualify.

You might also qualify for an Offer in Compromise if there is doubt as to your actual tax liability; if you have documentation proving that you owe less in taxes than the IRS believes to be true, or if an assessor has made a mistake on your reporting, you may be more likely to have an Offer in Compromise accepted by the IRS.

Finally, if paying your tax bill would create a significant financial hardship, you may also qualify for an Offer in Compromise. Of course, proving financial hardship can sometimes be a challenge.

In addition to all of these considerations, there are several other eligibility requirements that you must meet in order to qualify for an Offer in Compromise:

  • You must pay the application fee 
  • You must have filed all of your required tax returns 
  • You cannot be going through a bankruptcy at the time of filing 
  • You must submit all required documentation 

What to Expect From the Process

One of the most complicated aspects of going through the application process for an IRS Offer in Compromise is filling out and submitting all the required paperwork. There are several documents you may need to complete to even be considered for an Offer in Compromise, including:

  • IRS Form 433-A – this form requires information on your assets, liabilities, expenses, and income to determine your Reasonable Collection Potential
  • IRS Form 433-B – this form needs to be filled out for businesses applying for an Offer in Compromise
  • IRS Form 656 – use this form to apply for an Offer in Compromise so long as there are no doubts as to your tax liability.
  • IRS Form 656-L – use this form to apply if you are disputing your tax liability to the IRS. 

In addition to completing these official forms as part of the application process, you will also need to provide some documentation, such as:

  • health care statements 
  • bank and credit card statements 
  • investment information 
  • proof of living expenses 
  • car loan, mortgage, and similar loan statements 
  • copies of related tax returns 

Working With a Tax Professional Can Help

As you can probably see, the process of determining your eligibility and applying for an Offer in Compromise with the IRS can be quite time consuming and complex. This is where it can be helpful to consult with a tax professional for assistance. A qualified and experienced tax professional will be able to assess your current tax situation and give you a better idea as to whether or not going through the Offer in Compromise application process is worth your time and efforts.

If so, he or she will also be able to assist you with the application process, ensuring that you’re filling out the correct forms and that you submit all required documentation as well. This can increase your chances of reaching a successful offer with the IRS and take a lot of the stress and burden off your chest.

Even if you don’t qualify for an Offer in Compromise, your tax professional may be able to assist you in figuring out other alternatives for making your tax payment more financially manageable for you. This might include options to work out a payment/installment program with the IRS, among other options.

The Bottom Line

Overall, getting an Offer in Compromise accepted by the IRS is nearly a 50/50 shot – but if you meet the eligibility requirements and take the time to correctly submit all paperwork and documentation, your chances of reaching an offer are high. And the best way to get the help you need in gathering this documentation and submitting this paperwork is to consult with an experienced tax professional. Schedule a consultation with us at your earliest convenience to get the ball rolling.

The 1099-MISC Filing Date Is Just Around the Corner – Are You Ready?

If you engage the services of an individual (independent contractor) in your business, other than one who meets the definition of an employee, and you pay him or her $600 or more for the calendar year, then you are required to issue that person a Form 1099-MISC to avoid penalties and the prospect of losing the deduction for his or her labor and expenses in an audit. Payments to independent contractors are referred to as non-employee compensation (NEC).

Because so many fraudulent tax returns were being filed right after e-filing opened up in January and before the old 1099-MISC due date at the end of February, the IRS had no way of verifying NEC. That opened the door for the IRS to be scammed out of millions of dollars in erroneous earned income tax credit (EITC). To plug that hole, the IRS moved the filing date for NEC 1099-MISCs to January 31 and no longer releases refunds for returns that include EITC until the NEC amounts can be verified.

Thus, the due date for filing 2018 1099-MISC forms for NEC is now January 31, 2019. That is also the same due date for mailing the recipient his or her copy of the 1099-MISC.

It is not uncommon to have a repairman out early in the year, pay him less than $600, use his services again later in the year, and have the total for the year be $600 or more. As a result, you may have overlooked getting the needed information from the individual to file the 1099s for the year. Therefore, it is good practice to always have individuals who are not incorporated complete and sign an IRS Form W-9 the first time you engage them and before you pay them. Having a properly completed and signed Form W-9 for all independent contractors and service providers will eliminate any oversights and protect you against IRS penalties and conflicts. If you have been negligent in the past about having the W-9s completed, it would be a good idea to establish a procedure for getting each non-corporate independent contractor and service provider to fill out a W-9 and return it to you going forward.

The government provides IRS Form W-9, Request for Taxpayer Identification Number and Certification, as a means for you to obtain the vendor’s data you’ll need to accurately file the 1099s. It also provides you with verification that you complied with the law, in case the vendor gave you incorrect information. We highly recommend that you have potential vendors complete a Form W-9 prior to engaging in business with them. The W-9 is for your use only and is not submitted to the IRS.

The penalty for failure to file a required information return such as the 1099-MISC is $270 per information return. The penalty is reduced to $50 if a correct but late information return is filed no later than the 30th day after the required filing date of January 31, 2019, and it is reduced to $100 for returns filed after the 30th day but no later than August 1, 2019. If you are required to file 250 or more information returns, you must file them electronically.

In order to avoid a penalty, copies of the 1099-MISCs you’ve issued for 2018 need to be sent to the IRS by January 31, 2019. The forms must be submitted on magnetic media or on optically scannable forms (OCR forms). Note: Form 1099-MISC is also used to report other types of payments, including rent and royalties. The payments to independent contractors are reported in box 7 of the 1099-MISC, and the dates mentioned in this article apply when box 7 has been used. When the 1099-MISC is used to report income other than that in box 7, the due date to the form’s recipient is January 31, 2019, while the copy to the government is due by February 28, 2019.

If you have questions, please call us to schedule an appointment. Tarlow & Co. prepares 1099s for submission to the IRS along with recipient copies and file copies for your records. Use the 1099 worksheet to provide us with the information needed to prepare your 1099s.

Five Reasons to Amend a Previously Filed Tax Return

The most recent data from the IRS on individual tax returns indicates that of 131 million returns filed, about 5 million were expected to be amended. This comes to less than 4 percent, but that projection still affects a significant number of taxpayers. Filing an amended tax return can be a hassle that you definitely want to avoid if possible. But there are some situations where you’ll have to do so, and it’s prudent to seek out the help of a tax advisor who can guide you through the process. Here’s why you may need to file an amended tax return.

1. You made a math or data entry mistake and didn’t realize it until after you submitted your tax return.

For example, you added up your charitable deductions, and after filing your return, you realize you added them up incorrectly, and the difference was sizeable. Filing an amended return can correct that math error and get a refund.

Perhaps you were entering your gross income from your self-employed business into your software while it was late and you were tired, and you inadvertently transposed the numbers and entered the gross income as $78,000 when it was really $87,000. You will need an amended return to correct that error.

However, you would not usually amend a return if you incorrectly entered W-2 income since the IRS receives a copy of the W-2 and will compare it with what you reported and if there was an error, they will automatically make a correction and send you a bill or a refund as the case might be. The IRS website instructs taxpayers not to amend a return in such a situation.

The statute of limitations for refunds is three years for the due date the tax return and if the IRS has not automatically made the correction and you have a refund coming don’t let the statute of limitations expire before filing an amended return. That holds true for any situation were an amended return will result in a refund.

2. You used an incorrect filing status.

Single parents, caregivers of elderly parents, and recently married or divorced people often make the mistake of using “Single” status when it’s the wrong one. “Heads of Household” miss out on crucial tax benefits, while married people will generally need to use “Married Filing Separately” if they don’t wish to file a joint return with their spouse. Because filing status affects so many elements of your tax return, you need to file an amended return to pay additional taxes you owe or receive a refund once the correct one is used.

3. You didn’t realize that there was a tax benefit you qualified for, and you’d like to claim it now.

There are many frequently overlooked tax benefits a tax professional would be aware of that the average DIY person wouldn’t, such as the ability for most individuals and small business owners to make pension and profit-sharing contributions in a new year before the tax-filing deadline and still have it count for the current filing season.

This also works in reverse in that people accidentally claim benefits they weren’t actually entitled to. Often, the best way to know for sure is to consult a tax professional.

4. You had investing activities that affect your tax return.

Typically, you don’t realize a capital gain or loss until you actually sell an asset. But if securities become worthless, this results in a capital loss that needs to be reported the year it was deemed worthless, and not the year you discovered the fact. If this security was deemed worthless a long time ago, you may have to amend prior year returns to account for the capital loss.

This can be significant since you are limited to deducting $3,000 in capital losses from all of your other income and result in capital loss carryovers that last several years. If you have any other investment losses that were forgotten or miscalculated on your original tax return, filing an amended return is the next logical stop to ensure your carryovers are done correctly for future tax returns.

5. You received tax forms after filing your tax return.

If you were due a W-2 or 1099 form, you might not receive it when you’re initially preparing your taxes. It could be a surprise corrected form or the payer was just late sending it to you. But if you already filed your tax return, then got additional forms later on, amending your tax return becomes inevitable.

Amending your tax return can be a cumbersome process, especially if you’re self-employed and/or have a great deal of investing activity. Asking a tax professional to assist you with filing amended returns can eliminate the headaches that come with the process. Many even offer a free review of self-prepared returns and ask the right questions to determine if it’s worth it to amend this year’s return and any prior years’. You may also have to amend your state tax return(s), which can grow more complex if your residency is or was multistate.

States Sue U.S. to Void $10,000 Cap on State and Local Tax Deduction

Four states – New York, Connecticut, Maryland and New Jersey – have sued the federal government to void the tax-reform cap on the federal itemized deduction for state and local taxes, contending that limiting the deduction is unconstitutional. The taxes at issue include state and local income taxes, real property (real estate) taxes and personal property taxes.

These states – all Democratic (blue states), with some of the highest state and local tax rates in the nation – saw this deduction limitation as political retribution from the Republican-controlled Congress and have passed state legislation attempting to circumvent the tax reform provision limiting the federal itemized deduction for state and local taxes (SALT) to $10,000.

Both NY and NJ have created charitable funds that their state constituents can contribute to and allows them to receive a credit against their state and local taxes. NY’s legislation allows 85% of the amount contributed to the fund as a credit against taxes, while NJ allows 90%. The Connecticut law allows municipalities to create charitable organizations that taxpayers can contribute to in support of town services, from which they then receive a corresponding credit on their local property taxes. Each of these measures essentially circumvents the $10,000 limitation on SALT deductions.

However, two big questions are whether a donation for which a donor receives personal benefit is really a deductible charitable contribution and whether the state legislatures really thought this through. These work-arounds overlook one of the long-standing definitions of a deductible charitable contribution: the donor cannot receive any personal benefit from the donation.

Recently, the IRS waded into the issue with Notice 2018-54 and an accompanying news release, informing taxpayers that it intends to propose regulations addressing the federal income tax treatment of certain payments made by taxpayers to state-established “charitable funds,” for which the contributors receive a credit against their state and local taxes – essentially, the work-arounds adopted or proposed by the states noted above and others. In general, the IRS indicated that the characterization of these payments would be determined under the Code, informed by substance-over-form principles and not the label assigned by the state.

The proposed regulations will:

  1. “Make clear” that the requirements of the Code, informed by substance-over-form principles (see below), govern the federal income tax treatment of such transfers; and
  2. Assist taxpayers in “understanding the relationship between the federal charitable contribution deduction and the new statutory limitation” on the SALT deduction.

Substance over form is a judicial doctrine in which a court looks to the objective economic realities of a transaction, rather than to the particular form the parties employed. In essence, the formalisms of a transaction are disregarded, and the substance is examined to determine its true nature.

The implication of the IRS’s reference to the substance-over-form doctrine is likely that the formal mechanisms for implementing the state work-arounds – e.g., charitable contributions to “charitable gifts trust funds” – will not dictate their tax treatment. That is to say, the IRS will not recognize a charitable contribution deduction that is a disguised SALT deduction.

While the notice only mentions work-arounds involving transfers to state-controlled funds, another type of work-around has been enacted, and others have been proposed. In addition to the “charitable gifts trust funds” described above, New York also created a new “employer compensation expense tax” that essentially converts employee income taxes into employer payroll taxes. The IRS stated in Information Release 2018-122 that it is “continuing to monitor other legislative proposals” to “ensure that federal law controls the characterization of deductions for federal income tax filings.”

Allowing these work-arounds to stand would open Pandora’s Box to other schemes to circumvent the charitable contribution rules. For example, a church could take donations and then give the parishioner credit for the parishioner’s children’s tuition at the church’s school – something that is not currently allowed.

Have these states set their citizens up for IRS troubles if they utilize these work-arounds? Are these states now concerned that their work-arounds might not pass muster and will be ruled invalid after several years in the courts, so they are now pre-emptively suing the federal government?

Taxpayers in states with work-arounds should carefully consider all potential ramifications when deciding whether to get involved with something that could drag through the courts for years, with potential interest and penalties on taxes owed if (more likely, when) the IRS prevails. If you have any questions, please do not hesitate to contact us.

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.

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.