Can't Pay Your Tax Liability?

If you are unable to pay your tax liability, there are some things you need to know. Most importantly, don't let your inability to pay your tax liability in full keep you from filing your tax return properly and on time.  Why?  Because there is a “failure to file” penalty that accrues at the rate of 5% per month or part of a month (to a maximum of 25%) on the amount of tax your return shows that you owe.  The tax ramifications, penalties and possible solutions are included in the article.

Extensions - Although an extension provides you more time to file the actual return and avoid the “failure to file” penalty for six months, it is not an extension to pay.  Not paying the balance of your tax liability will subject you to the “failure to pay” penalty.  The “failure to pay” penalty accrues at the rate of 1/2% per month or part of a month (to a maximum of 25%) on the amount actually shown as due on the return. 

Penalties - If both the “failure to file” and the “failure to pay” penalties apply, the “failure to file” penalty drops to 4.5% per month or part thereof, so the total combined penalty remains at 5%.  The maximum combined penalty for the first five months is 25%.  Thereafter, the “failure to pay” penalty can continue at 1/2% per month for 45 more months (an additional 22.5%).  Thus, the combined penalties can reach a total of 47.5% over time.  Both of these penalties are in addition to the interest that you will be charged for late payment.

Bottom line…if you owe money, file your return on time even if you can’t pay the entire liability. That will minimize your penalties.  Pay as much as you can with the return to further minimizing your penalties.  By the way, the penalties and interest are not tax-deductible.

Loans From Relatives and Friends – Borrow the money from family members or close friends.  Loans from relatives or friends are often the simplest method to pay the bill.  One advantage of such loans is that the interest rate will probably be low, but you must also consider that loans over $10,000 at below market interest rates may trigger tax consequences.  Any interest paid on this type of loan would be non-deductible.

Home Equity Loan – A home equity loan is also a potential source of funds with the advantage that the interest would be deductible as long as you itemize your deductions and your total equity loans on the home don’t exceed $100,000.  However, in today’s financial environment, qualifying for these loans may be too time-consuming in some situations.

Pay By Credit Card – Using your credit card to pay your taxes is another option.  The IRS has approved two firms to provide this service.  The disadvantage is that the interest rates are relatively high, and you must pay the “merchant” fee because the IRS does not.  The fees are deductible as a miscellaneous itemized deduction on your tax return.  For information about the amount of the fees, contact the firms below:

o Official Payments Corporation, 1-800-2PAYTAX, www.officialpayments.com

o Link2Gov Corporation, 1-888-PAY-1040, www.PAY1040.com

Withdraw Money From Retirement Plans – Tapping into one’s pension, IRA or other retirement plan should be the last resort, not only because it degrades your future retirement but because of the potential tax implications.  Generally, except for Roth IRAs, the funds in the retirement accounts are pre-tax and, as a result, when withdrawn become taxable. Even part of a Roth distribution could be taxable, depending on your age and how long you have had the account. If you are under 59½, the taxable part of a retirement plan distribution will also be subject to the 10% early withdrawal penalty.  The federal tax, state tax (if applicable), and the penalty can chew up a hefty amount of the distribution and be too high a price to pay.   

Set-Up an IRS Installment Agreement – You can request an installment arrangement with the IRS to make monthly payments.  However, there are fees associated with setting up an installment agreement, and you must follow some strict payment rules or the agreement can be terminated.  The agreement requires approval and, if your liability is under $50,000, you will not be required to submit financial statements.

The fee for establishing the agreement is $120, but is reduced to $52 when the taxpayer pays by way of a direct debit from the taxpayer's bank account.  For certain low-income taxpayers, the fee is reduced to $43.  You will also be charged interest, but the late payment penalty will be half the usual rate (1/4% instead of 1/2%), if you file your return by the due date (including extensions).

The installment agreement may terminate and all your taxes become due immediately if any of the following occur: the information you provided to the IRS in applying for the agreement proves inaccurate or incomplete; you miss an installment; you fail to pay another tax liability when it is due; the IRS believes collection of the tax involved is in jeopardy; or you fail to provide an update of your financial condition where the IRS makes a reasonable request for you to do so.

The IRS is required to enter into an installment agreement at your request (a guaranteed installment agreement) if the following apply:

• The tax liability is $10,000 or less. 

• Within the prior five years, you have not failed to file returns or pay taxes and have not entered into a previous installment agreement.

• IRS determines the tax liability cannot be paid in full (1).

• The installment agreement provides for full payment within 3 years.

• You agree to comply with the tax laws during the agreement period.

(1) As a matter of policy, the IRS will generally grant installment agreements even if taxpayers are able to fully pay their accounts.

If the full amount owed can be paid within 120 days, a formal installment agreement, and fees, can be avoided. To establish a request to pay in full, the taxpayer must contact the IRS by phone at 1-800-829-1040 or apply online at the IRS web site.

Final Word of Caution – Ignoring your filing obligation only makes matters worse and can become very expensive.  It can lead to the IRS collection process, which includes attachments, liens and even the seizure and sale of your property.  In many cases, these tax nightmares can be avoided by taking advantage of the solutions discussed above.  If you cannot pay your taxes, please call this office to discuss your options.

Understanding AGI Limitations & Phase Outs

AGI is the acronym for Adjusted Gross Income. It is generally the sum of a taxpayer's gross income less adjustments that are permitted by law (but before deductions and exemptions). Those who file Form 1040 can find their AGI at the bottom of page 1 of the tax return. Many tax benefits and allowances, such as credits, deductions, exemptions, etc., are limited by a taxpayer's AGI. There is also the term MAGI which is the acronym for Modified Adjusted Gross Income. Although MAGI may have a different definition for certain limitations and phase-outs, it is generally the taxpayer’s AGI with certain excluded income added back.

Generally, limits are based upon a percentage of AGI. Some deductions are reduced by a percentage of AGI until the deduction reaches zero. The two prime examples of this type of percentage limitation are medical itemized deductions limited by 10% of AGI (7.5% for seniors through 2016) and miscellaneous itemized deductions (limited by 2% of AGI). Others such as charitable contributions limit the deduction to a percentage of the AGI. Charitable contributions have three AGI limitations depending upon the type of contribution: 50%, 30% and 20%.

Many limitations phase in as the AGI increases between two specific AGI values, thereby "phasing out" (reducing) tax benefit to higher income taxpayers. These phase out levels are inflation adjusted and generally change every year. To further complicate matters, there are different phase out levels for different filing statuses. Examples of items subject to phase out provisions are:
  • Personal Exemptions 
  • Itemized Deductions 
  • Education Credits
  • Education Interest Deduction
  • Active Rental Losses
  • Coverdell Education Savings Account Contributions
  • Conventional IRA Deduction
  • Taxability of Social Security
  • Earned Income Credit

Careful tax planning can sometimes avoid or minimize the loss of tax benefits due to AGI limits. If you have advance warning of a large increase in income, it may be appropriate to schedule an appointment to consider alternative approaches to your tax situation.

Get a Big Refund this Year?

Over 100 million Americans annually receive tax refunds averaging around $3,000. If you are among those who received a refund, you are probably celebrating. While some consider a large refund cause for celebration, it's actually a financial mistake that becomes particularly costly for those who get refunds year after year.

What's wrong with a refund you ask? Well, it means you've overpaid your tax all year. That's actually your own money you are getting back and you made an interest-free loan to Uncle Sam. Such unintended generosity costs you more than you might imagine. Consider what would have happened had you instead invested $250 per month into an investment program rather than overpaying the IRS. Instead of waiting for a $3,000 refund in April, you would have had the refund plus investment earnings for the year.

The alternative is to plan your annual prepayments through withholding and quarterly estimate payments so they more closely match your projected tax liability for the year. Your withholding is generally adjusted by changing the number of allowances claimed on the W-4 Form you turn into your employer. The more allowances claimed, the less the withholding. However, be careful that you do not claim too many and end up owing Uncle Sam at the end of the year. You should always double check your payroll deductions once the change has taken effect to ensure the proper adjustment has been achieved.

Let this firm assist you in projecting next year's taxes and adjust your withholding allowances. Please call for assistance.

Years of Inflation and the AMT Pose a Growing Tax Threat

Originally conceived to combat taxpayers in the higher-income brackets who utilized legal tax shelters and tax preferences to avoid paying income tax, the AMT can be tricky and hit you when least expected. The tax was supposed to inflict a “minimum” tax on those who were able to avoid the regular tax. However, years of inflation have pushed many middle-income taxpayers into the reach of the AMT. Although there is a long list of items that can trigger the AMT, for most individuals, the triggers include the following or a combination of the items listed below:
  • Preference income from exercising stock options from an employer’s qualified plan, sometimes referred to as incentive stock options (ISOs);
  • Having a large number of dependents;
  • Having large itemized tax deductions;
  • Having large miscellaneous itemized deductions;
  • Large itemized deductions for state income or sales tax, real property tax and personal property tax;
  • Large medical itemized tax deductions;
  • Home equity debt interest deduction; and
  • Interest income from private activity bonds.
In addition to those items listed above, watch out for transactions involving limited partnerships, depreciation and business tax credits only allowed against the regular tax. All of these can strongly impact your bottom line tax and raise a question of possible AMT.

Tax Tip: If you were subject to the AMT in the prior year and had a state tax refund in that year, part or all of your state income tax refund from that year may not be includable in the regular tax computation. To the extent you received no tax benefit from the state tax deduction because of the AMT, that portion of the refund is not includable in the subsequent year’s income.

As part of the American Taxpayer Relief Act of 2012, Congress has permanently made the amount of income that is exempt from AMT – referred to as the exemption amounts – subject to inflation adjustments in future years. Thus the amount for each subsequent year will be determined automatically and no longer require periodic Congressional action. In addition to the exemption amounts, ATRA also includes a provision for years after 2012 to inflation-adjust the amount of AMT taxable income that is taxed at the higher AMT rate of 28%.



 

The exemption begins to phase out for higher income taxpayers when the AMT gross income exceeds the phase-out threshold and is fully phased out once the AMT gross income reaches the full phase out amount. When income is between the threshold and full phase-out amounts, the amount of the exemption phase-out is 25% of the difference between the AMT gross income and threshold amount.

Example: Jack, a single taxpayer in 2016, has an AMT gross income of $200,000. The phase-out threshold from the table below is $119,700. The phase-out amount is $20,075 ((200,000 – 119,700) x 25%). The exemption for a single individual in 2016 from the table above is $53,900. Thus, our single taxpayer will only be able to deduct $33,825 ($53,900 - $20,075) as his 2016 AMT exemption.


Example: Using Jack in the previous example, his AMT gross income was $200,000, and his allowable AMT exemption was determined to be $33,825. Thus his AMT taxable income is $166,175 ($200,000 -  $33,825). Since the entire taxable income falls into the 26% AMT tax rate his AMT tax is $43,206 ($166,175 x 26%). Jack tax for the year will be the higher of his regular tax or the AMT.

If you have questions about how the AMT might impact your taxes please give this office a call

 

Keep a Low Audit Profile

According to a recent news article in a large metropolitan newspaper, the IRS may be auditing fewer returns but they are getting smarter about choosing those they do audit. Their goal, of course, is to focus scrutiny on the most "audit worthy" returns - those with potential for big adjustments. As taxpayers, all of us would like to avoid an audit. But how does one avoid being "chosen"? While there's no sure way, experts do offer advice on what to look for to help cut audit risk.

Are deductible expenses out of line with income? When a return goes through the IRS computer, it's "graded" with a score that indicates how that return differs from an IRS norm for other returns in the same income level. For example, if your income was $32,000 and you claimed charitable contributions of over $20,000, the IRS system would very likely show more than a slight bleep when your return was processed. The chance of an audit would go up appreciably!

W
here's the hidden income? The IRS questions how savings can go up without a general increase in income from all sources. Thus, returns that show low income but indicate ever-increasing amounts of interest and dividend income can be high audit risk.

Do we have a mismatch? The IRS is expert in matching information on tax returns to what has been reported to them by employers, banks, brokerages, etc. To head off unwanted correspondence with the government, your tax return needs to accurately reflect the 1099s and W-2s you receive. Keep careful records of your accounts to ensure against mismatches.


Does the IRS understand your business better than you think? The IRS now has special audit guides that help their personnel understand the ins and outs of various kinds of businesses. If you're in an occupation targeted by one of the guides, an audit may be more likely. Dozens have already been published zeroing in on a variety of occupations including truckers, innkeepers, lawyers, musicians, taxi drivers, and many others.

Are you a sole proprietor? If so, watch out. Sole proprietors stand out over others when it comes to being audited. Those with incomes over $100,000 "enjoy" a high audit rate. However, business owners with less than $25,000 annual income have one of the highest audit rates. One in twenty are "favored."

If you get an IRS Notice: If you ever receive any communication from the IRS, don't panic. However, your timely response will be one of the main keys to finding a satisfactory solution. To be certain, call us at once. Together, we will determine exactly what course of action needs to be made.

Understanding Your Marginal Tax Rate

Ever wonder what the term “tax bracket” means? It refers to the top marginal tax rate that individuals are being taxed, not the average. Knowing your marginal rate is important, because any increase or decrease in your taxable income will affect your tax at your top marginal rate. Thus, if you are in the 25% marginal bracket and plan on signing up for your employer’s 401(k) plan, you will generally save $250 ($1,000 x .25) in federal taxes for each $1,000 contributed to the 401(k) plan. The reason we say “generally” is because sometimes a tax deduction can actually drop you into a lower marginal tax bracket.

The table below reflects the marginal tax bracket for various taxable incomes. Keep in mind that not all of your income is taxed. The amount equal to the sum of your deductions and exemptions is not taxed at all. If your income is below the sum of your deductions and exemptions, you would not have a taxable income, and your marginal rate would be zero.

However, once your income exceeds the sum of your deductions and exemptions, you will have taxable income and your marginal tax rate can be determined from the table. For example, let’s assume that your income for the year is $50,000. You are married with two dependent children and will take the standard deduction. The standard deduction in 2016 for a married couple is $12,600 ($12,700 in 2017). The exemptions for 2016 and 2017 are $4,050. Thus, your taxable income for 2016 would be $21,200 ($50,000 - $12,600 –$4,050 x 4)). For a taxable income $21,200, the marginal tax rate from the table (table values illustrated are the top of each bracket) is 15%. 



2016 MARGINAL TAX RATES
TAXABLE INCOME BY FILING STATUS
(Values shown are the top of each
marginal tax bracket.)
Marginal
Tax Rate
Single
Head of
Household
Joint*
Married Filing
Separately
10.0%
15.0%
25.0%
28.0%
33.0%
35.0%
9,275
37,650
91,150
190,150
413,350
415,050
13,250
50,400
130,150
210,800
413,350
411,000
18,550
75,300
151,900
231,450
413,350
466,950
9,275
37,650
75,950
115,725
206,670
233,475
39.6%
Over the 35% amounts
* Also used by taxpayers filing as Qualified Widow with dependent child


2017 MARGINAL TAX RATES
TAXABLE INCOME BY FILING STATUS
(Values shown are the top of each 
marginal tax bracket.)
Marginal 
Tax Rate
Single
Head of 
Household
Joint*
Married Filing 
Separately
10.0%
15.0%
25.0%
28.0%
33.0%
35.0%
9,325
37,950
91,900
191,650
416,700
418,400
13,350
50,800
131,200
212,500
416,700
444,550
18,650
75,900
153,100
233,350
416,700
470,700
9,325
37,950
76,550
116,675
208,350
235,355
39.6%
Over the 35% amounts
* Also used by taxpayers filing as Qualified Widow with dependent child

Keeping Old Tax Records

Taxpayers often question how long records must be kept and the amount of time IRS has to audit a return after it is filed.

It all depends on the circumstances! In many cases, the federal statute of limitations can be used to help you determine how long to keep records. With certain exceptions, the statute for assessing additional tax is 3 years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the Federal. The reason for this is that the IRS provides state taxing authorities with Federal audit results. The extra time on the state statute gives states adequate time to assess tax based on any federal tax adjustments.

In addition to lengthened state statutes clouding the recordkeeping issue, the Federal 3-year rule has a number of exceptions:
  • The assessment period is extended to 6 years instead of 3 years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return.

  • The IRS can assess additional tax with no time limit if a taxpayer: (a) doesn't file a return; (b) files a false or fraudulent return in order to evade tax, or (c) deliberately tries to evade tax in any other manner.

  • The IRS gets an unlimited time to assess additional tax when a taxpayer files on an unsigned return.

If no exception applies to you, for Federal purposes, you can probably discard most of your tax records that are more than 3 years old; add a year or so to that if you live in a state with a longer statute.

Examples: Sue filed her 2015 tax return before the due date of April 18, 2016. She will be able to safely dispose of most of her records after April 18, 2019. On the other hand, Don filed his 2015 return on June 1, 2016. He needs to keep his records at least until June 1, 2019. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than 3 years. 

Important note: Even if you discard backup records, never throw away your file copy of any tax return (including W-2s). Often the return itself provides data that can be used in future tax return calculations or to prove amounts related to property transactions, social security benefits, etc. You should keep certain records for longer than 3 years. These records include:

  • Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least 4 years after the year you sell the stock. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.

  • Stock and mutual fund statements where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to basis in the property and reduce gain when it is finally sold. Keep statements at least 4 years after final sale.

  • Tangible property purchase and improvement records. Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least 4 years after the underlying property is sold.

Transform Nondeductible Interest to Deductible Interest

The only interest that is still deductible as an itemized deduction is home mortgage interest and investment interest. If you are like so many others with large consumer debt such as credit cards, car payments etc. you are paying interest that is not deductible. If the amount of consumer interest you pay each year is substantial and you itemize your deductions, you may want to consider converting that non-deductible interest into deductible interest by paying off the consumer debt with a home equity line of credit. Generally, current law allows individual taxpayers to borrow up to $100,000 of home equity and deduct the interest on that loan as home mortgage interest. This would also apply to planned large consumer purchases such as a car or motor home. Using a home equity line to purchase these items will make the interest deductible. 

Before borrowing against the home, you should consider the following:

  • Treat the home equity loan like a consumer loan and pay it off over the same period of time you would have had to pay the consumer loan. Otherwise, you may reach retirement age without having the home paid for.

  • When buying a car, you can sometimes get very favorable interest rates or a rebate. It is good practice to make sure the benefit of making the interest deductible is greater than the benefit of the low interest consumer loan.

  • If there is any chance of defaulting on the loan, the repercussions from defaulting on a home loan are far more serious than on consumer debt.

Avoiding Underpayment Penalties

Congress considers our tax system as a "pay-as-you-go" system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the "pay-as-you-go" requirement. These include: 
  • Payroll withholding for employees; 
  • Pension withholding for retirees; and 
  • Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is 3 percentage points higher than the federal short-term rate and the penalty is computed on a quarter-by-quarter basis. 

Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than a de minimis amount, no penalty is assessed. The de minimis amount is $1,000. This means, if you owe $1,000 or less on your tax return, you will not be subject to the federal underpayment penalty. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:

1. The first safe harbor is based on your total tax in the current year. If your payments equal or exceed 90% of your tax in the current year, you can escape a penalty. 

2. The second safe harbor is based on your total tax in the immediately preceding tax year. If your payments equal or exceed 100% (110% if your prior year’s adjusted gross income was more than $150,000, or $75,000 if married filing separately) of your prior year’s tax, you can escape a penalty.

Example: Suppose your current year tax is $10,000, and your current year prepayments total $5,800. The result is that you owe an additional $4,200 on your current year tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception.

However, the other safe harbor may still apply. Assume your prior year tax was $5,000 and your prior year income was $50,000. Since you prepaid $5,800, which is greater than 100% of the prior year's tax of $5,000, you qualify for this safe harbor and can escape the penalty. If your prior year income exceeded $150,000 (and you didn’t file as married separate), your prepayment target would be $5,500 (110% x $5,000). Having prepaid $5,800, you’d also avoid the penalty.

This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc.

To qualify for this safe harbor, not only must your prepayments equal at least 100% (or 110% if applicable) of your prior year’s tax, they must be paid equally no later than the dates specified by law, which generally are the April 15, June 15, and September 15 of the current year and January 15 of the following year.

Most states follow the same rules as the federal regarding the de minimis exception and safe harbors, but the de minimis amount may be less and the payment dates for the estimated tax installments may vary. Please check with this office for the details.

Is Your Withholding Enough?

Our "pay-as-you-go" tax system requires that you make payments of your tax liability evenly throughout the year. If you don't, it's possible you could owe an underpayment penalty. Some taxpayers meet the "pay-as-you-go" requirements by making quarterly estimated payments. However, when your income is primarily from wages, you meet the requirements through wage withholding and you rely on your employer's payroll department to take out the right amount of tax. Unfortunately, what payroll withholds may not be enough!

For instance, your employer may be using information about your income that is no longer current. Employers compute withholding for their employees using IRS Form W-4, Withholding Allowance Certificate. To make sure W-4 data is accurate, you need to fill it out based on the latest data available about your income and deductions.

Mid-year is a good time to review the withholding situation and forecast your tax liability because there's still time to make adjustments if you're under-withheld. It's especially vital to plan ahead if you've had any of the following:
  • A gain from the sale of property, e.g. stocks, bonds, or real property;
  • Income from a second job;
  • Other income from which there is no withholding (for example, a pension, alimony, IRA, interest or dividends);
  • A change in marital status.

All of the above can cause problems as far as your withholding is concerned and the only way to know for sure is to compute a projection. To be on the safe side, why not give us a call? This office will be happy to assist you in determining safe withholding or estimated tax levels, or help you with long-range tax planning.

Upload Documents


Securely send/receive Quickbooks files and other important documents.

Client Login

Contact Us


Phone
: (305) 445-7956
Fax: (305) 448-5173

Address
7900 N.W. 155 Street
Suite 201
Miami Lakes, Florida 33016

Certifications



Administrator Login