Divorce and Taxes-Part 2

When last we met, I left you hanging with a couple of divorce related tax thoughts to keep in mind. Let’s wrap up this discussion with a few more things to think about while planning (or waiting for) the next spiteful spousal action(!)

Transfers of property-“Generally”, property transferred from one spouse to another can be made without tax consequences to either party, as long as the transfers are made “incident to the divorce”. As with anything that IRS uses the word “generally” for, there are exceptions and rules to follow to make sure that the transfers don’t create taxable income for one of the spouses.

Marital home-Similar to the discussion above, if the transfer of one spouse’s interest in the marital home is incident to the divorce, there’s no gain recognized on the transfer. Additional things to consider are who gets the deduction for mortgage interest and real estate tax, and whether there’s excludable gain on the sale of the ‘principal residence’ (and who gets it).

Filing status-I covered this subject briefly last week, but I wanted to add one other ‘curveball’ to this discussion. Under certain circumstances, an individual may be able to file a return as “head of household”, which will result in a lower tax bill than “married filing separately”. There are a number of requirements that must be met, in order to do this.

Alimony and child support-Alimony is deductible to the payer and taxable income to the recipient, while child support is nondeductible and nontaxable.

Attorney fees-As with many other issues, attorney fees generally are not deductible. Fees paid for the actual divorce/separation/custody/etc issues aren’t deductible, but fees paid for tax planning and tax advice are. If that’s the case, be sure the invoice splits out the portion of the fees paid for tax related services.

As you can probably tell, since it’s taken two articles to barely scratch the surface of the topic “divorce and taxes”, this is a very complex and treacherous area to deal with. To repeat what I said at the beginning of part 1, I strongly recommend that you engage the services of an attorney and a CPA to help you through both the legal and tax aspects of the divorce.

I hope this two-part article has been of help to you, or people you know who are going through one of the most stressful of life events. Please feel free to pass a link to this article to someone who may benefit from it, and leave any comments you may have. If you have any subjects that you’d like to see addressed in future articles, please let me know.

Divorce and Taxes-Part 1

Did the title of this article grab your attention? Divorce and taxes are two subjects that can be pretty painful and gut wrenching on their own, but put the two together, and one may well want to run away and bury their head in the sand. To quote John Lennon, “living is easy with eyes closed”, but that won’t help get either a divorce or taxes behind you. Two words come to my mind in this situation; attorney and CPA.

I’m not an attorney, but being married to an attorney who spent a number of years practicing matrimonial law, I can tell you that you don’t want to go through the divorce process alone, and you need representation to make sure you’re not signing your rights away. Enough said on that; let’s talk about taxes.

When a couple is divorcing, there are all sorts of tax implications to think about, and this is why it’s imperative to engage a CPA for help. This is for your benefit, not for my job security! Similar to the paragraph above, you don’t want to make any tax mistakes, or give anything away, because you weren’t properly advised. Let’s look briefly at some tax things to think about, when going through the divorce process.

Filing Status-I’ve told clients for years that 99.9% of the time, ‘married filing jointly’ will produce a lower tax than the combined tax from two ‘married filing separately’ returns. A divorcing couple may not want to file jointly, since they’re probably already at the point of separating their finances, and don’t want the other to see what’s on a tax return. If one spouse is opposed to filing jointly, the other may have no choice but file separately. Another twist on this is the fact that a joint return means that both spouses are jointly and severally liable for any tax. What this means is that if a couple files jointly, divorces, and then a year later it’s determined that there’s more tax due, IRS can look to either spouse for payment of that tax. This is a major reason why many divorcing couples choose to file separately, i.e. to not be potentially responsible for the other’s tax.

Dependents/exemptions-How many people know divorced couples who have kids (I have two hands raised). Besides legal arguments over custody and child support, there’s the question of which spouse gets to claim the kids as dependents on their tax return. This is a question/issue not just for the year of divorce, but also for subsequent years. There are all sorts of rules and tests to determine who claims the dependents. This article would be way too long if I got into a detailed explanation, but let’s just say that generally the custodial parent would be entitled to claim the dependent/exemption, but there’s a lot behind the word “generally”.

Next week I’ll wrap up this discussion with a few other tax issues to keep in mind when going through a divorce. If you know somebody who’s going through a divorce (one of the most stressful life events), please pass this article along, and if you’ve heard of any divorce/tax “war stories”, please share them.

I Thought I Was Getting A Refund!

I had a real life experience recently, which I’d like to share with you, as it’s a perfect example of why you should file your income tax returns timely, and NOT ignore notices from the IRS.

A new client was referred to me last year, who hadn’t filed any tax returns since 2003, so she needed my help with 2004 through 2009. It’s been almost a year since I wrapped up all those returns, but the problems that were lurking a year ago have not gone away, and in fact, have gotten worse.

As I was in the process of getting the information from the client that I needed to prepare all those returns, I found out that the client had received numerous notices from IRS for the 2004 through 2006 tax years, in particular. The notices requested tax returns for each of the years, but my client didn’t reply to the notices. IRS then sent notices saying that since she didn’t reply to the original notices or submit returns, they were computing the returns themselves, based on information received from payors (i.e. W-2s, 1099s etc), and gave her a deadline to reply and/or submit returns. She didn’t do either. IRS then assessed and billed her for the balances on the ‘returns’ that they computed, and she didn’t pay them. The next step was liens that showed up on her credit report, and then collections. The problem now (and why this has gotten more complicated) is that as far as IRS is concerned, 2004-2006 are closed cases/years, meaning, they computed the returns, the client’s lack of reply was taken to mean that she agreed with their computations, and they just want their money. As of today, IRS is saying that the client owes them about $142,000!

I spent about three hours on the phone with four different IRS representatives, trying to get a handle on what was going on, and what needs to be done, to straighten this all out. What we have to do now is re-submit 2004-2006 and ask IRS to re-open those cases/years and reconsider the returns, which show a total balance due of only about $4,000 for the three years, not $142,000! I was told it could take months to hear back about the reconsideration of these returns, and there’s no guarantee that IRS will agree, and adjust the balances down to what they’re supposed to be.

After the call with IRS, I called my client, and in the course of the conversation, I asked her why she never filed all those returns, and her answer was that she was expecting refunds for those years, and had never previously owed tax to IRS. I told her that if she was expecting a refund, then that’s even more incentive to file on time, so she could get her money back, and not give an interest free loan to IRS (see my Apr 25 article).

It’s taken hours of my time to date, and will take a lot more time to get to the end of this. All of it could’ve been avoided if the client had just filed her tax returns on time. So the moral of the story is, even if you’re expecting a refund, get your taxes done timely, so you can get your refund back. You might even get an unpleasant surprise, and find out that you have a balance due, when you thought you were getting a refund. Either way, it’s way better to find out before IRS gets involved!

Is That Charitable Contribution Deductible?

Like many Americans, you make contributions to charitable organizations out of the goodness of your hearts…and the tax deduction. But is that contribution actually deductible?

This article is an alert to individual taxpayers, but is also a wakeup call to responsible parties of tax exempt organizations. Continuation of your tax exempt status is no longer a given, if you have not fulfilled your reporting requirements.

A few days ago, IRS announced that approximately 275,000 organizations had automatically lost their tax exempt status, because they did not file legally required annual reports for three consecutive years. At the same time, the Service also announced special steps to help organizations apply for reinstatement of their tax exempt status.

In 2007, a filing requirement was imposed on small organizations, where there had been no requirement previously. At the same time, the law allowed IRS to automatically revoke the tax exempt status of any organization that didn’t file the required returns for three consecutive years. Since that time, IRS has made many efforts to inform exempt organizations of these changes, and also gave smaller organizations additional time to file required returns.

All exempt organizations are required to file one type of Form 990 or another. There is the ‘long form’ 990 (Return of Organization Exempt from Income Tax), the ‘short form’ 990-EZ, and the 990-N ‘e-postcard’. For organizations with annual gross receipts of $50,000 or less for 2010, the filing requirement is satisfied by submitting the e-postcard. Not filing at least one of these three returns for the last three years subjects an exempt organization to the automatic revocation of its exempt status. For organizations that have had their exempt status revoked, IRS has procedures for reinstatement that include reduced application fees.

Now back to you, the one making the charitable contribution. Before you take that deduction, check the IRS website, as they have lists of organizations that qualify as public charities, as well as lists of organizations that have had their exempt status revoked. You may only take a deduction for contributions made to qualifying charitable organizations.

If you have any questions about this, please contact me, and please post a comment. And if you have any friends who are involved in small exempt organizations, have them read this article.

The 2011 Dirty Dozen Tax Scams (Abridged)

It’s a sad fact that there are people out there who look to take advantage of innocent taxpayers, in ways you may not have thought of. Unfortunately, they’re not the only ones who are scamming the ‘tax system’. IRS recently published its annual list of “dirty dozen” tax scams, and this article briefly discusses a handful of them.

Hiding Income Offshore-Taxpayers have tried to avoid or evade income tax by hiding income in offshore bank or brokerage accounts, among other ways. IRS currently has a voluntary disclosure initiative, which is designed to bring offshore money back into the U.S. tax system.

Identity Theft and Phishing-With an individual’s personal information, a criminal can file a fraudulent tax return and collect a refund. IRS reminds people that they never contact taxpayers by email, and that IRS impersonation schemes are out there. Never give out personal information to anybody claiming to be from IRS.

Return Preparer Fraud-Most tax return preparers (including yours truly) are professionals who provide honest and excellent service to their clients. As with other businesses/professions, there are rotten apples. Dishonest return preparers can skim or divert a portion of a client’s refund, charge inflated fees, or attract clients by making false promises.

Filing False or Misleading Forms-IRS is seeing instances in which scammers file false or misleading returns to obtain improper tax refunds. One way is by claiming incorrect amounts of tax withholding, based on fabricated information returns (1099s, for example).

Frivolous Arguments-You’ve probably heard this one before; filing a tax return is voluntary, or the income tax system is unconstitutional, or it’s against somebody’s religion. Don’t believe any of these.

Abuse of Charitable Organizations and Deductions-This isn’t a matter of deducting the $5 you put in the Salvation Army kettle last Christmas, but can be overvaluing the broken down car that was donated to charity. Penalties have increased for inaccurate appraisals, and IRS has cracked down on deductions for donated cars.

The title of this article includes the word “Abridged”, and you don’t need a calculator to see that I’ve only included a half dozen out of the Dirty Dozen Tax Scams. Drop me a line if you’re interested in hearing about the other six, and please, feel free to leave a comment.

Tax Refunds

Everybody who wants an interest free loan, raise your hand. While that hand is raised, those of you who got a big tax refund, use that hand to smack yourself over the head! Why, you ask? It’s because you just gave the government an interest free loan. Let me ask you this; would you give a complete stranger a loan, and not expect to get at least some sort of market rate interest on that money? I didn’t think so, but why are you so quick to give the government your money for free? Even having that money in a savings account earning .25% (you know how low rates are these days) is better than earning zero.

For years I’ve heard clients tell me that they look forward to that big check at tax time, and how they have too much tax withheld on purpose, and it’s ‘forced savings’, blah blah blah. My reply has always been “if you want to force yourself into saving money, why not just cut a check (or set up an automatic debit) every month to invest in a mutual fund, or fund an IRA”? It’s such a no brainer that can only help people, which is why it’s confounded me for years. Obviously my job is to advise my clients, and of course they’ll do whatever the heck they want anyway (much the same way as I ignore advice!).

With proper tax planning/projecting, it’s possible to get to the end of the tax year at close to a breakeven (i.e. either very small refund or very small balance due), without incurring penalties, and having more money saved (and no interest free loans to Uncle Sam or Uncle Governor-of-your-state). By changing your withholding exemptions, you’ll have more money in your pocket each paycheck, and won’t have to wait until tax time to get your loan money back from the government.

I have a challenge; allow me to bug you on a monthly basis, to send me a check, payable to the mutual fund/investment of your choice, and I’ll make sure that check gets deposited to your account, so you can earn something on your money…more than the zero percent the government’s giving you. Better yet, you can loan me the money interest free, I’ll invest it, keep the income, and then pay back your loan at the end of the year! Just kidding, but you understand my point.

With that raised hand, give yourself one more smack over head. O.K., you can put your hand down now! Now that your hand is down, please leave a comment. I’m interested in hearing your thoughts on this.

Can You Review My Tax Return?

I’ve recently been contacted by a couple of people, asking me to review the tax returns they prepared themselves with TurboTax. They’re just part of a long list of people over the years to contact me about this, which is what prompted me to write this article.

Having been in public accounting for about thirty years, I’ve always used professional tax preparation software that’s meant for people who know their way around tax returns. The difference between the software I use and TurboTax is sort of like the difference between a Viking and EZ-Bake oven. You’ve heard the line “kids, don’t try this at home”, right? Well, when it comes to taxes, it’s the same thing. You shouldn’t be doing it yourself. I must confess, though, that for a very simple tax return (with one W-2 and one 1099 for bank interest, for example), you probably can get away with using TurboTax.

I have a problem with Intuit, the company that makes TurboTax. They’re trying to convince the world that all you need to do is pay $49 (or whatever the cost is) for ‘The Box’, and ‘The Box’ will guarantee your biggest tax refund, will support you in case of an audit, will guarantee its calculations, and will answer all your questions (wow, maybe I should use TurboTax!). The problem is, taxes are just not that easy, regardless of what Intuit is trying to brainwash the masses into thinking. Neither is bookkeeping, and Intuit has the same tactic with QuickBooks, but that’s a subject for another day.

The question I have for all those people who have contacted me to review their self-prepared TurboTax returns is “if Intuit is giving you all this support, and making these guarantees, and you think you know enough to do the return yourself, then why are you contacting me?” It seems to me that there’s some sort of doubt in the minds of these people; that maybe placing so much faith in ‘The Box’ isn’t enough assurance that the job is being done correctly. I’ve had many people come to me over the years, who have found out the hard way that putting blind faith in ‘The Box’ has led them to notices from IRS, and paying hundreds or thousands of dollars in tax and penalties and interest that could’ve been avoided by spending a little more than $49, to have a real person/tax professional, advise them.

I recommend that you think long and hard about whether you’re really qualified to prepare your own tax returns, or if it’s a better use of your time and hard-earned money to have a knowledgeable tax professional help you instead.

I Started a Nonprofit, and Now I Have to Do What??

You just formed a nonprofit organization. Congratulations on your altruism, and your chutzpah! Most people would’ve just made a donation to the charity of their choice, and considered that to be doing their part to help humanity, or the environment, or the planet, or something else. You’ve taken a step past that; a BIG step. You’re going to personally help further a cause that’s near and dear to you, and that’s beyond commendable, because you’re about to sacrifice yourself in ways that you may not have considered.

This is a brief discussion of some things that you’ve hopefully thought of, when you decided to form your nonprofit. For those of you considering starting your own nonprofit, think about these things before you take the big leap. The following issues have all arisen in discussions with clients, over the years.

I’m in business for myself?

In a word, yes! Starting a nonprofit is the same as starting your own for-profit business, except you’re using the public’s money. Until you’re large enough to have your own staff, you’re going to be the program director, development director/fundraiser, bookkeeper, and other positions, all rolled into one. Taking into consideration other ‘adult’ duties (i.e. spouse, parent, ”real job”, soccer practices, etc), when you add the responsibilities of managing a nonprofit business, you may run out of hours in a day.

I have to file what with IRS?

Just because you filed with the Virginia State Corporation Commission (SCC) to be a non-stock corporation, doesn’t mean that you’re done with the formation. When most people think of forming a ‘nonprofit’, they’re thinking of a 501(c)(3) public charity, as recognized by IRS. That doesn’t come automatically with your SCC filing. To be recognized as a public charity, Form 1023 “Application for Recognition of Exemption…” must be filed with (and approved by) IRS. The application is fairly rigorous, and is not rubber stamped, so make sure all the information is completely and accurately filled out, before submitting.

I need to be a bookkeeper too?

For us CPAs, this part is a breeze, but for the general public, maintaining accounting records can be a real drag. If you’re going to be a public charity using public funds (contributions), you will be accountable to the public as to how you used their money. By some means (yourself, a bookkeeper, etc) you will need to keep books and records of the organization’s finances, for different purposes, one of which follows, next.

I have to file what with IRS?

I know, you’ve heard that already. The issue is, filing that original application for tax exemption with IRS doesn’t fulfill your obligations to them forever. A report of one length or another must be filed with IRS annually. It can be as detailed and complicated as the Form 990 (Return of Organization Exempt From Income Tax), which is the “long form” 990, or can be the 990-EZ “short form”, or even the 990-N “e-postcard”. Which form you file is dependent on how much your gross receipts and total assets were for each tax year.

This article barely scratches the surface of things that you need to consider when you form a nonprofit organization (or think of forming one). Remember, you’ll be using other peoples’ money, and will be held to a higher standard than if you were in business for yourself. Be prepared!

%d bloggers like this: