Money Blue Book

Back when I was in college, I knew absolutely nothing about filing my taxes. Yes, I was a college finance major at the time, but I don’t recall learning anything practical about taxes, deductions, or income withholding in any of my classes - at least not anything involving the actual process of filing one’s tax return. At the time I had a part time job working at a school computer lab making some extra money. Every week I received a pay check but I never paid it much attention. I barely knew what the numbers meant - wages and FICA, they were all the same to me - all I knew was that the government was taking a large chunk of my meager pay check every week, leaving me with only peanuts. Since I made so little at the time, only a few thousand dollars for two semesters of work, when it came time to file my taxes, I decided to try doing it myself. My parents weren’t much help since they were living overseas and had expressed their wish for me to become more financially independent and self reliant.

Sometimes You Make Mistakes in Life - And Taxes Are More Prone To Errors Than Anything Else

Despite knowing next to nothing about taxes, I still somehow managed to file my income tax by following the Internal Revenue Service (IRS) instructions, albeit in bumbling fashion. This was before I started using electronic do-it-yourself tax preparation programs like TurboTax or H&R Block’s Tax Cut. Even though my income was low enough to file a simple 1040EZ with only one set of W-2’s, as a tax newbie, the first year’s filing experience still took hours and hours. The following year I had significant capital losses due to the dot-com stock market crash of 2001 so I had to file the regular Form 1040 return. The process took forever but somehow after many hours of filling in stock data, I successfully completed my tax filing (or so I thought at the time). Unbeknownst to me at the time, but I had forgotten to fill in my federal income tax withholding numbers for two straight years.

It wasn’t until I started law school during the third year that I decided to review my old tax forms. During that time I was enrolled in my school’s low income taxpayer clinic where I was assigned to help low income clients fill out their tax returns and represent their interests before the IRS. In the process I became more educated about taxes. One day on a hunch, I decided to take a look at my old tax returns and was stunned at what I discovered. Apparently I had been filing my taxes incorrectly for the past two out of three years. The reason none of my returns had triggered an IRS audit or unpaid tax liability investigation was because I never owed any taxes in each of those years due to my low $3,200 annual income. However, I had completely neglected to include any information about federal income tax withholding on my submissions. After crunching a few numbers, I realized I was entitled to tax refunds of approximately $340 for each of those two past years, for a total of almost $700. Almost three years had past at that point, but there was still time to correct the tax overpayment mistakes and claim my tax refund - I could file a Form 1040X Amended Federal Income Tax Return.

Tax Mistakes And Erroneous Filings Should Be Amended Upon Discovery

The IRS has a complex system of computers that will detect most simple mathematical calculation mistakes that result only in a few dollars here and there. However, more significant mistakes like the underreporting of certain Form 1099 income sources or failing to report self employment income may come back to bite you in the butt if you don’t report them eventually. The IRS will impose stiff penalties and interest on taxpayers for such tax shortfall violations. I don’t recommend trying to duck the obligation or hoping the danger will pass. If you catch the tax mistake before the IRS does, you may be able to avoid and avert a substantial amount of IRS tax penalties. Yes you may need to pay some interest for making the mistake in the first place and not paying on time, but the consequences for not catching it until much later can be disastrous. IRS unpaid tax penalties are ridiculously harsh.

Keep in mind that not all tax filing mistakes have negative consequences. Oftentimes they are detrimental only because they deprive the taxpayer of legitimate refunds due to overpayment of tax, like in the situation I described above. Sometimes for example, the taxpayer overlooked a more beneficial tax filing status such as head of household but did not realize that until later. Remember, so long as you are not engaging in illegal tax evasion, there is nothing wrong with finding legal methods of reducing your tax liability to boost your take home refund.

The Process Of Filing A 1040X Amended Return To Correct A Past Tax Return Mistake

The current time limit for filing an amendment to correct a past tax return is generally 3 years. So long as you are within 3 years of the filing date of the erroneous tax return, you may file a Form 1040X to fix it and reap whatever tax benefits offered. Of course, if that means you have to pay more in taxes, that’s part of the trade off for getting it right. You may draw some unwanted attention and scrutiny of your past tax returns, but keep in mind, the IRS is likely to catch the mistake eventually so it’s usually best to keep your returns currently and historically accurate. You never want to live your life in perpetual and continuous fear of a full blown IRS audit.

However, for those who failed to pay all of the taxes owed during the past original years filed, your time limit to amend the mistake is shortened to 2 years. From the date that you finally paid the tax, you will have only 2 years to correct the mistake, instead of the usual 3. But if your 2 year deadline arrives later than the standard 3 year deadline, you are permitted to file your 1040X at the later date.

The instructions for filing 1040X are fairly straight forward. Currently, taxpayers who want to file their 1040X Amended Returns online are out of luck since the IRS is not presently accepting 1040X Forms electronically. I’m sure they will bumble their way around to setting that option up eventually but for right now, amended 1040X filers must mail and submit them in paper form. The form itself is rather self explanatory. It does require that you locate archived copies of your past tax returns so you can transfer the original information onto the claim form. You have to list the information you originally reported, and include what your corrected numbers are. Finally you have to state brief reasons why you are now making the corrections. In my case, the reasons were simply that I made a few tax preparation errors by not including tax withholding information.

When filing your 1040X, remember to submit and file a separate 1040X Form for each year you are amending, and don’t forget to sign each one. Also, be sure to write down the year of the tax return that you wish to amend at the top of the 1040X Form. This is such a common mistake to make. After all, you don’t want to end up having to submit yet another 1040X to amend your incorrectly filed 1040X do you?

It’s that time of the year again and it’s looming large. April 15, tax day - the day we take our hard earned money and pay our annual emperor’s tribute to Uncle Sam and the United States government. For most working people, April 15 day is the deadline for filing our tax returns to claim the tax refunds that were withheld by the Internal Revenue Service (IRS) in excess for most of the year. This year is extra special since there’s an extra bonus and incentive twist waiting for us. This year we have the 2008 economic stimulus stimulus rebate qualification to contend with.

The IRS has already stated that taxpayers who wish to receive their tax rebate payment in timely accordance with the official tax rebate payment schedule must file by April 15, 2008. Currently, the economic stimulus rebate will be issued according to the last two digits of the primary tax filer’s Social Security Number. People who chose to receive their tax refunds via direct deposit will enjoy speedy priority and will be among the first to receive the payments starting May 2 and lasting until May 16. For those of you who chose the slower paper check option, your stimulus payment check won’t get to you until the direct deposit crowd have gotten theirs. Paper checks won’t be sent out until May 16, and lasting all the way into July 11.

How Do I Request An Extension To File My Federal Income Tax Return?

If for whatever reason you cannot file your 2007 return by the due date, you may be able to get an automatic 6 month extension of time to file. The official directions to filing for a tax return extension and information about related late filing penalties are located on the IRS website. Essentially, you must file Form 4868 Application For Automatic Extension Of Time To File U.S. Income Tax Return by the tax filing due date, usually April 15. A granted extension will allow you to file your income tax return by the later date of October 15, 2008. Note that special rules may apply if you are living outside the United States, or out of the country when the filing extension expires, or if you are serving in a combat zone such as Iraq or Afghanistan. Be sure to file on time or request a proper time extension. If you don’t, the IRS will slap interest and penalties on your unpaid tax liability.

However, you must be aware that any grant of extension of time to file your return does not grant you any extension of time to pay your tax liability. This means even if you are permitted to file past April 15, 2008, you must still pay your estimated tax liability by that date. Those who owe taxes must make reasonable payment when they file the extension either by mailing a check or by making an electronic money transfer. If you don’t make payment by April 15, beware the mighty wrath of the IRS. If you do not submit payment for at least 90% of your total tax bill, factoring all prior tax withholdings, estimated payments, and additional payments, the IRS will hit you with an interest and penalty stick - and it’s a big one. You will be charged late payment interest and late payment penalties for each month the unpaid tax liability remains outstanding, up to a whopping 25% penalty of the total unpaid tax liability!

For those of you who reasonably anticipate a tax refund, you don’t have to worry about penalties, although by dragging it out you are essentially giving the IRS an interest free loan.

When Will Those Who Request An Income Tax Filing Extension Receive Their Tax Rebate Checks?

Unlike most of the usual governmental knuckle and foot dragging we usually see, the IRS is actually under substantial pressure and governmental poking to get these tax rebate direct deposits and payment checks out as soon as possible. The whole point of the rebate is to get them into the hands of Americans so we can start pumping some fast cash into our battered economy that’s already showing sickly signs of a recession (yes I think we are already in one). As such, even if you were to request a filing extension, I don’t anticipate the IRS waiting too long to send you your economic stimulus payment.

However, as tax rebate checks will only be sent beginning in May to taxpayers who timely filed their income tax returns, filing for an extension will inevitably delay your rebate payment as the IRS will not issue rebate checks for a taxpayer unless and until a 2007 federal income tax return has been filed. The IRS has indicated that people who file income tax returns after April 15 and receive a refund can expect to receive their economic stimulus payments in about two weeks after receiving their tax refunds, but not before the date they would have received their payment if the return had been processed by April 15, 2008. Despite the IRS’ somewhat ambiguity on the timetable of tax rebates for extension filers, I think taking into consideration the urgency of these rebates, those who file their tax returns as post-April 15 extensions should expect to receive their tax rebates within a month after their returns have been filed.

Remember, if you want to receive your economic stimulus rebate payment before the end of the year, you must file your tax return by the 6 month extension deadline of Oct. 15, 2008 at the very latest. If you delay and file your tax return after the extension deadline, you may need to rely on the tax rebate amendment option when you file your 2008 income tax form on April 15, 2009.

In the world of taxes and financial planning, the terms adjusted gross income (AGI) and modified adjusted gross income (modified AGI or MAGI) are particularly significant. They are frequently used to calculate and determine the extent of certain benefits and deductions. AGI in particular is used to determine qualification to take certain itemized deductions and used to calculate taxable income. It is also the key determinative factor to rebate payment under the 2008 economic stimulus tax package. Qualification for the stimulus payment is not based on salary or after-tax take home income, but rather on the taxpayer’s total adjusted gross income, which is a terminology encompassing a broader range of income sources.

The term modified adjusted gross income is particularly important as well. It is used to determine qualification to take certain tax adjustments like the child tax credit and eligibility for certain education expense credits. Overwhelmingly though, the MAGI’s significance is most commonly associated with tax deferred investment retirement accounts (IRA’s). It is a key income factor in determining Roth IRA contribution limits and phaseouts, as well as qualification for IRA to Roth conversions. The higher the MAGI, the more the Roth IRA contribution limit is reduced and ultimately phased out. The MAGI term is often overlooked because the amount calculated in MAGI is often similar or even the same as the adjusted gross income for most ordinary tax situations.

For clarification, here are the income and deductions that comprise both the AGI and the MAGI:

1) Adjusted Gross Income (AGI) - is comprised of all gross income sources reduced by adjustment deductions. This total income amount represents the amount before you take your personal exemption, or choice of standard or itemized deductions into account. Thus standard and itemized deductions are not factored into the AGI. The adjusted gross income is also the delineating and final number on the first page of the 1040 federal tax form that separates above-the-line adjustments such as business deductions, from below-the-line itemizations such as the charitable deduction.

The following income sources added together comprise a taxpayer’s initial gross income figure:

• Salary and wage income,
• Interest income,
• Dividend income,
• Income from certain retirement accounts,
• Capital gains,
• Alimony received,
• Rental income,
• Royalty income,
• Farm income,
• Unemployment compensation.

To reach the adjusted gross income, the above total gross income amount must subtract the following deductions below:

• Deduction for contribution to an IRA,
• Health savings account deductions,
• Student loan interest deduction,
• Certain business expenses of reservists, performing artists, and fee basis government officials,
• Certain moving expenses,
• One half of self employment tax,
• Penalties on early withdrawal of savings,
• Alimony paid,
• Health insurance premiums due to self employment.

2) Modified Adjusted Gross Income (MAGI) - is basically the AGI figure, modified for various tax adjustments by excluding the items listed below. When the original AGI was calculated, certain deductions were subtracted from it. To arrive at the MAGI amount, take the AGI and add the following items back to it:

• Any deduction you claimed for a normal contribution to a Traditional IRA.
• Any deduction you claim for student loan interest or qualified tuition and related expenses.
• Any income you excluded because of the foreign earned income exclusion.
• Any exclusion or deduction you claimed for foreign housing.
• Any interest income from series EE bonds that you were able to exclude because you paid qualified higher education expenses.
• Any employer-paid adoption expense you excluded.
• Any amount claimed as domestic production activities deduction.

Tax Planning Tip For Lowering Your Modified Adjusted Gross Income (Useful for avoiding the Roth contribution limit and phaseout).

While many deductions are added back to the AGI to reach the MAGI amount, you should note that contributions made to an employer sponsored retirement plan such as a 401K is not one of them. If you anticipate reaching the annual income limit for Roth contribution phase out, you may want to seriously consider increasing your contributions to your employer’s sponsored plan. For example, in 2008 you may only make contributions to a Roth IRA if your MAGI is below $169,000 if you’re married filing jointly or below $116,000 if you’re a single filer. The amount you may contribute to a Roth starts to phase down once your MAGI reaches $159,000 as a joint filer or $101,000 as a single filer. If you anticipate reaching the phase out period and you’re on the fence, contributing some extra money into your job’s 401K plan will help reduce your overall AGI as well as your MAGI, since the contribution’s not one of the many items added back to calculate the MAGI.

Updated Tables For 2007 and 2008 Tax Years.

Because of the power of compound interest, it is never too early to start saving for your future and planning your retirement nest egg. The earlier you start taking advantage of tax deferred investments, the more money you’ll have to live on when retirement rolls around. Don’t count on dying young to relieve you of the need to save either. Statistics show that improvements in medical technology and lifestyle changes, coupled with increased health awareness are extending our lives longer than before.

For the younger, single people out there, I know it can be strange discussing retirement so early on, but you must remember that your actions now have a huge impact on your future welfare. The cash you invest today in a tax deferred retirement account has a disproportionately more significant impact on your wealth level than money invested later. Don’t delay or keep putting it off - even catch up contributions won’t be much help if you wait too long to save for retirement.

When it comes to saving for retirement, there are a variety of tax deferred options such as the common employer sponsored 401K plan. But there is also the Traditional Investment Retirement Account (IRA) and the Roth IRA. Both are excellent ways to save for the future but you must be mindful of IRS rules when funding them - by being aware of the annual contribution limits, the contribution deadlines, and the applicable income phaseout ranges. I’ve created a list of helpful tables that cover the most important funding rules below. The income phaseouts listed on the charts are based on modified adjusted gross income (modified AGI or MAGI), which is derived by adding certain income back to the adjusted gross income (AGI). If you want clarification, check out the IRS explanation for modified AGI. For many taxpayers however, the MAGI will oftentimes be the same as their AGI.

1) Traditional IRA and Roth IRA Contribution Deadlines

With certain exceptions made for weekends, the April 15 deadline for filing your federal income tax is also the deadline for investors to make their final Traditional IRA and Roth IRA contributions for the closing tax year. For example, April 15, 2008 is the contribution deadline to make a IRA or Roth contribution towards the 2007 limit. After that date, all contribution money will go towards the 2008 tax year limit. This differs from a 401K, which has a contribution deadline that ends on December 31 of the tax year. Thus you should never miss the final deadline to contribute for the prior year. Contribution limits for the IRA and the Roth are considered by the IRS to be “used it or lose it” benefits. Those who fail to contribute the maximum allowed contribution to their IRA or Roth by the deadline, forfeit the limit for that year.

Note that even if you’ve already filed your tax return before April 15, you can still contribute to your IRA or Roth by the filing deadline, so long as you file an amended 1040X return thereafter to declare it.

2) Traditional IRA and Roth IRA Annual Contribution Limits

Qualification to contribute to an IRA or Roth account requires the contributing taxpayer to have earned income or taxable compensation, comprised of wages, salaries, fees, tips, commissions, bonuses, and taxable alimony. While the traditional IRA is available to all with no income restrictions or contribution phaseouts, only the Roth reduces and limits your contribution if your income goes above certain levels. However for both the IRA and Roth, you are permitted to contribute the lesser of the normal contribution limit noted below or the entire amount of your total taxable income. You are not required to contribute the full amount but you cannot exceed the contribution limit. Those who are 50 years old or older are entitled to higher contribution limits called “catch ups” to help them expedite the pace of their investment.

Another thing to keep in mind is that for married couples, both the husband and wife may make separate contributions to their own individual retirement accounts, even if one of them is not working. This has the potential to effectively double the combined total they may contribute as a married couple.

3) Roth IRA Contribution Phase Out Due To Higher Income

Unlike the IRA which has no contribution phaseouts due to income, the amount of money that may be contributed to a Roth IRA per year is dependent on tax filing status, modified adjusted gross income, as well as age. Once the contributor reaches a certain modified AGI level, his or her maximum Roth contribution limit may be phased out or gradually eliminated in linear fashion. The phaseouts in the chart above show income ranges that span between a floor and a ceiling. Those with income below the lower floor amount may contribute the maximum amount. Those that exceed the higher ceiling are completely phased out and will not be permitted to contribute to a Roth IRA for that year. Of course, they can always still contribute to a traditional IRA.

Because the phaseout range is liner, if your income fell precisely in the middle of the income range, you would only be able to contribute 50% of the maximum Roth contribution limit shown above. Keep in mind that IRA and Roth’s share the same combined contribution limit. You may open multiple accounts, but the total contribution amount cannot exceed the limit.

4) Income Phase Out For The Traditional IRA Contribution Deduction

Traditional IRA’s, unlike the Roth, offer a unique tax benefit - contributers may be qualified to take a tax deduction on the amount they contribute. However, whether the entire amount can be deducted or only partially deducted from income depends on factors including tax filing status and income range.

An important factor that affects the phase out range is whether the contributer is already an active participant in an employer sponsored retirement plan, such as a 401K from work. For those who already participate in such a plan, their IRA contribution deductions are phased out quicker and at lower income levels than those who don’t participate in such a plan.

For married couples, if neither you nor your spouse participate in such a plan, the entire amount you are qualified to contribute towards your IRA may be deducted from income. If either of you participates in such a plan however, then deductibility depends on your tax filing status. There are two tables below - one for those covered under an employer plan, and the second one for those who are not. For those who are not personally covered by an employer plan, different rules apply if their spouses are covered (Spouse Covered) and for those whose spouses are not (Spouse Not).

For Those Who Are Covered By An Employer Sponsored Retirement Plan:

For Those Who NOT Covered by An Employer Sponsored Retirement Plan:

So what are you waiting for? Go open a Roth IRA right now! If you don’t qualify due to income phaseout, then at the very least you should go open a Traditional IRA.