March 2017
THIS MONTH: |
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March 12th
Daylight Savings Time Begins |
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March 15th
Due Date for 1065, 1120S Corp. Tax Returns |
Tax season is now well underway. While you’re gathering your materials, or feeling relieved that your tax return is now filed, take a moment to review this month’s articles. Included are tips on common mistakes to avoid in your retirement accounts, a list of common IRS tax scams, and a handy tip to ensure inherited property does not turn into a tax problem.
IRS Announces Annual Tax Scams
Each year the IRS announces a list of the “Dirty Dozen Tax Scams” its agents encounter most frequently. Highlighted here are seven of the most common.
- Creating fake income. It has come to the attention of the IRS that some taxpayers are creating false income for the sole purpose of obtaining tax credits like the Earned Income Tax Credit. This false income can be in the form of a fake 1099-MISC or fictitious self-employment income. The penalties for this type of fraud can be severe.
- Falsely padding deductions. Creating deductions and inflating dollar amounts of legitimate deductions is now on the IRS Dirty Dozen list. While it may seem a little thing to stretch the amounts, the increased reporting received by the IRS makes it easier for them to see these inflated deductions.
- Excessive business credits. This scam focuses on two commonly misused business credits: the fuel credit and the research credit. The fuel credit is usually only available for off-street vehicle use (typically for farming). While the research credit may seem straightforward, there are stringent qualifications and reporting requirements. Prior to using either of these credits, you should ask for a review of your situation.
- Fake charities. After major disasters, many charitable givers are scammed into making donations to fake charities. This makes donations to them nondeductible. To protect against this, prior to donating funds make sure the charity is both legitimate and deemed a qualified charity by the IRS. Here is a link to the IRS tool to confirm charitable organizations. IRS Exempt Organizations List Check
- Identity Theft. Identity theft tops the Dirty Dozen list every year. Thankfully, the IRS takes precautionary measures to curtail this out-of-control problem. In addition to limiting the number of direct deposits it will make to any single account, the IRS is working with states and tax preparation software vendors to put more controls in place. This includes some states requiring drivers license numbers on their tax forms, delays in early processing of tax refunds, internal tracking within software programs, and continual checking for heavy filing activity.
- Phone scams. Phone calls from thieves representing themselves as IRS agents continue to get more sophisticated. The caller ID may show as coming from the IRS and the scam may involve numerous phone calls instead of a single contact. These thieves often have some of your personal information and try to intimidate their victims with threats of jail time, deportation or license revocation. Remember, never give information over the phone to someone claiming to be from the IRS.
- Phishing. This recurring scam involves receiving fake emails and websites that look like the real deal. The IRS will not send you billing information or refund information via email. Do not click on any email link received from the IRS unless you requested it. Remember the IRS does not initiate contact through emails.
If you wish to know more, the IRS has posted information on these scams on their web site, www.irs.gov. Simply click on the “News and Events” tab.
Inherited Property: A Matter of Value
Avoid this potential tax headache
If you are expecting to inherit property when friends or relatives pass away, know that their generosity can come with tax consequences. It’s important to understand how the value of your inheritance is determined in order to avoid a potential tax surprise in the future.
Estate tax basics
When a friend or relative dies and leaves behind a will, someone will be named executor of their estate. The term “estate” means the total amount of the assets and liabilities the deceased person leaves behind, and the “executor” is the person named to handle the the affairs of the estate. It also includes managing the distribution of remaining assets to “beneficiaries,” which is another word for the people who inherit the assets.
The executor has the responsibility to calculate the value of the assets and handle the necessary tax reporting to the IRS and state authorities. If the total value of the estate is worth less than $5.49 million, the estate pays no federal tax. If it’s more than that amount, the IRS’s piece of the pie scales up to a whopping 40 percent. Thirteen states and the District Columbia also collect state estate taxes of as much as 20 percent.
The conflict over value
Generally speaking, executors would rather have the estimated value of an estate’s total property fall below estate-tax thresholds. But as a beneficiary receiving an inheritance, it’s in your interest to have a higher estimate of value. That way you may avoid higher capital gains tax if you sell the property.
A high estate valuation helps you as a beneficiary because you only pay tax on the increase in value from its “basis” when you inherited it. So, if your inherited property was valued at $200,000 and you later sell it for $300,000, you would pay taxes on $100,000. But if the same property was valued at $300,000 when you inherited it, you would potentially owe no tax.
A matter of value
In valuing a piece of property, an executor will compare it to similar properties that have recently sold. Ideally there is a qualified appraisal by an expert to determine the “fair market value”.
If you disagree with the way an executor has valued property you are inheriting, it may be a good idea to have your own appraisal done. With your appraisal in hand, reach out to the executor and make your case for the higher valuation based on your appraisal. Keep in mind that you don’t want an evaluation that is either too low or too high — you want a reasonable fair market value of the assets. If you don’t talk to the executor and you end up using a different valuation in reporting to the IRS, you could be facing a big tax headache.
If you’re able to talk to the executor and agree on a valuation, consider asking for a Form 8971 Schedule A. This form itemizes the valuation of property and is now often required by the IRS for estates worth more than $5.49 million. However it can also be used to provide you with documentation showing that you and an executor have reached an agreement on the value of a specific piece of inherited property.
Seven Common Retirement Account Mistakes
It is all too easy to make a mistake that can cost you plenty if you do not actively manage your retirement assets. Here are some common retirement account mistakes that can easily be avoided.
- Borrowing money, then leaving your job. Those with employer-provided retirement accounts, such as 401(k)s, can often borrow money from their accounts. Unfortunately if you leave your job, this money must be repaid immediately. If it’s not repaid, your loan will be considered a withdrawal of funds, creating a hefty tax bill and early withdrawal penalty.
- Incorrect rollover of funds. If you plan on moving funds from one retirement account to another, do not have the withdrawal check issued to you. If the funds are not correctly redeposited, your transfer could be deemed a taxable event. Better: Create a trustee-to-trustee transfer. By having the funds go directly from one retirement account to another, you eliminate the risk of the IRS assuming you made a withdrawal.
- Waiting until 70½ before taking money out. A key concept in retirement planning is to make your retirement accounts as tax efficient as possible. This often means taking money out of an account before you actually need it. When you reach age 70½ or older most retirement accounts require you to take a minimum distribution based on a formula.Better: Review your tax situation each year. It may make sense to take a withdrawal out of a retirement account now in order to pay a lower tax compared with the tax on a required distribution when you are older.
- Not reviewing beneficiaries. The beneficiaries of most retirement accounts have priority over what is stated in your will. This can have unintended consequences.Better: Review your retirement account beneficiaries each year. Note alternative beneficiaries if allowed within the account.
- Not reviewing your investment mix. Many make their retirement investment decisions when they set up their account and then leave it alone. But as you age, your investment mix should change. Your account can also become out of balance as funds perform at different rates.Better: Review your funds annually, rebalance your funds and replace poorly performing funds as needed. Your employer or trustee appointed advisors can help you make investment decisions that meet your needs.
- Not maximizing your employer contributions. Most employer-provided retirement accounts include an employer-provided contribution. Often this is a matching contribution where your employer will match 50% to 100% of your contribution up to a percent of your pay. Not taking advantage of this free money is one of the worst mistakes you can make.
- Not participating. And the worst retirement account mistake? Not participating. Unless your retirement plan is to win the lottery, you will need income during your retirement years. You are never too young or old to start saving for a retirement free from financial worry.