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Watch Out For These 5 Tax Traps

Thursday, February 2, 2017

Watch Out For These 5 Tax Traps

Many folks are already working to file their taxes… especially if they have refunds due. But nearly 60% of taxpayers worry quite a bit about their taxes.

  • Worry about what they might owe the IRS.
  • Worry about completing the paperwork properly.
  • Worry about a potential IRS audit.

So, we’ve put together these 5 tips to help calm fears and make certain your taxes are as stress-free as possible.
Mistake #1 – Skip Filing Taxes

Many individuals mistakenly think they don’t need to file if they don’t have a paycheck. This is especially true for seniors. Small business owners may make this mistake too – particularly if they haven’t been making estimated tax payments. Regardless, it is never a good idea to skip filing. Failure to file penalties can be excessive – 5% of overdue taxes for each month the return is late.
If you have a reason why you can’t file on time, simply file for an automatic six-month extension for the IRS by filing Form 4868. In many cases, this will protect you from getting hit with late-filing fees.

And it is important to note that filing for an extension doesn’t give you more time to pay your taxes. If you owe, estimate that amount and be sure it is paid by the filing due date.
Mistake #2 – Social Security
Many seniors assume their Social Security benefits aren’t taxable. That isn’t always true. In certain situations Social Security earnings can be taxed if you are married and your income is above $44,000. They can also be taxed if you are single and your earnings are greater than $34,000.
As much as 85% of your Social Security income can be taxed depending on how far above the thresholds your actual income is.
This is where talking with a professional is important. For example, some believe if income is from tax-exempt interest like from municipal bonds, they don’t have to worry about how it influences the taxation of Social Security benefits. This would be a mistake.
Mistake #3 – Required Minimum Distributions
If you have money in an IRA or 401(k), you need to begin taking required minimum distributions (RMDs) after you turn age 70 1/2. If you fail to do so, you risk a 50% penalty on what you should have withdrawn.
Financial organizations that administrate these plans have a requirement to advise you on your RMD. However, the responsibility to take the distribution resides with you.
If you’ve discovered you’ve made a mistake in taking your distribution, you need to correct that right away. Showing that you recognize the error and have taken action to correct it will help with the potential of having the IRS waive fees.
Also, if you don’t plan your required minimum distributions carefully, you could end up bumping yourself into a higher tax bracket. Again, this is where talking with a qualified financial advisor is critical to find the most tax-advantaged ways of dealing with RMDs.

  1. Some Bonds Get Taxed

Bonds are a popular option for folks in or nearing retirement. But it’s a mistake to believe that all bonds are tax-free. Some local bonds carry tax risk.
For example, some municipalities issue bonds for constructing things like sports arenas. These are called “private activity bonds”. If you face the alternative minimum tax or AMT, the interest from these types of bonds must be included in AMT calculations.
As a result, you could face a 28% federal income tax on that bond income.

The AMT was created years ago to prevent abuse from wealthy individuals claiming too many deductions. However, the tax itself hasn’t been indexed to inflation. That means that many middle-income taxpayers are now trapped paying AMT… so be very careful about this.

  1. Gifts

It’s popular for folks in retirement to distribute assets as gifts to their children and grandchildren. The thinking is this helps to minimize the size of the estate and potential probate taxes. Given that folks with assets of more than $5.45 million face Federal estate taxes a high as 40% it’s understandable why people want to avoid this.
You can give gifts up to certain thresholds after which if you give away more than the threshold you have to report the gift to the IRS.
Many people fail to make these filings because they misunderstand federal rules governing estates and gifts. It’s wise to talk with someone that knows about taxation to make sure you have a clear strategy for wealth distribution from your estate while you are still alive.


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