Chapter 18
What is the penalty to paying taxes late?
.5 of 1 percent each month, up to 2 percent Interest: A monthly rate until the tax is paid in full
Single taxpayers and those who are married filing separately can deduct ______ of any excess loss; those who are married filing jointly can deduct __________.
1. $1500 2. $3000 Losses that exceed these annual limits may be carried over to future years in increments of $1,500 or less (or $3,000 or less). Only investment losses can be deducted from income. Loss of personal property—home, car, expensive jewelry, and so on—cannot be deducted.
Taxpayers who do not pay Medicare taxes and have net investment income may owe the NIIT if their modified adjusted gross income is more than ______1_____ for single taxpayers, ____2____ for married filing separately, and ____3____ for married filing jointly (not indexed for inflation). Obtain expert tax advice for tax management and planning.
1. $200,000 2. $125,000 3. $250,000
An older adult with a family history of dementia wants to ensure his CPA will be able to continue discussing his tax affairs with his health care agent should he lose his ability to make informed decisions. The most important document the older adult should complete is a _______. 1. Consent to Disclose Statement 2. Tax Information Authorization 3. Durable Financial Power of Attorney
1. Consent to Disclose Statement A Consent to Disclose Statement will authorize his CPA to discuss his confidential information with his health care agent and others as needed, for instance, his financial planner and estate attorney. Otherwise, the CPA is prohibited from doing so by IRS rules. The other forms do not give this explicit, legal authorization. However, it would be prudent for the older adult to also complete these two forms.
According to the IRS, older taxpayers most often make these 4 mistakes:
1. Do not take the higher standard deduction for taxpayers age 65 and older. 2. Do not correctly calculate their taxable Social Security benefits (portions of Social Security benefits might be taxable, depending on the person's total annual income and filing status). 3. Pay more than the required amount of tax on qualified dividends income, which is generally taxed lower than the standard rate. 4. Make mistakes in the Social Security numbers of their dependents, delaying the processing of their tax returns and refunds.
What are examples of income that is not taxed?
1. Gifts 2. Inheritances 3. Life Insurance Proceeds 4. Reverse Mortgage Loan Proceeds 5. Certain Veteran's Benefits 6. Inserance reimbursements for medical expenses that were not deducted 7. Worker's compensation NOTE: See IRS Publication 525, Taxable and Nontaxable Income
Tax deferral means avoiding taxes now in exchange for paying the taxes at a later date (or not at all). This approach is effective when a person's taxes are expected to be lower in the future because of:
1. Lower income 2. An increase in deductions to offset taxable income 3. A lower tax rate
Ways to avoid taxes:
1. Make charitable gifts of appreciated property, such as stock, rather than in cash to avoid all taxes on capital gains (if deductions are itemized). 2. Convert short-term capital gains to long-term gains by holding investments for 12 months plus one day. 3. Sell investments that have a higher cost basis. 4. Choose state and municipal government investments, which avoid federal income taxes. 5. Invest in U.S. government securities, which usually avoid state and local income taxes. 6. Accelerate qualified retirement plan distributions in years with larger tax deductions. 7. Shift income taxes to a lower bracket by making gifts of income-producing assets to lower tax bracket family members.
The IRS has ____1_____ years to examine a tax return and ___2___ years or longer, depending on the circumstances, if it suspects fraudulent activities.
1. three 2. six
Taxpayers under age 65 who claim a person living in a nursing home as a dependent must reduce the total medical expenses by _____ percent of their adjusted gross income.
10
Taxpayers age 65 or older may deduct qualifying medical expenses that exceed______ percent of the individual's or couple's adjusted gross income.
10 For example, if 10 percent of adjusted gross income is $4,000 and total unreimbursed medical expenses are $5,000, then only $1,000 is deductible.
A person in assisted living receives medical care. His doctor certified that a stroke permanently affected his ability to bathe, get in and out of bed, and dress by himself. His medical costs are ______. 1. deductible because his impairment requires supervision 2. deductible because he needs hekp with three ADLs 3. not deductible becauses he may recover his ability to funciton by himself
2. deductible because he needs hekp with three ADLs Generally, the cost of direct and substantial medical care received in an assisted living facility qualifies as a medical deduction if a licensed health care professional certifies the care receiver needs ongoing help to perform at least two activities of daily living or requires supervision because of cognitive impairment. This person cannot perform three activities of daily living. His doctor certified it is an ongoing condition. He does not have cognitive impairment.
An older man interviewing a potential tax return preparer by phone asks about her estimated fee, how long she's been doing returns, and what her experience is with reporting different types of income. The MOST important other thing he should ask is whether she ______. 1. belongs to any professional organization, and if so, which ones 2. will be responsible for any errors and pay any associated costs 3. has an advanced degreee in accounting or other financial area
2. will be responsible for any errors and pay any associated costs Professional tax return preparers or agencies accept responsibility for any errors in preparing the tax return and pay any associated penalties and interest. Professional memberships and education are helpful, but they are not as important as being accountable. He should also ask if the professional can represent him before the IRS, how much time it will take to prepare his tax return, and, if he hires her, what he should bring to an in-person meeting.
Like an adjustment to gross income, the value of a tax credit is ______. 1. a tax bracket percentage 2. equal to the person exemption 3. dollar for dollar
3. dollar for dollar A tax credit reduces income tax dollar-for-dollar. An adjustment to gross income is also dollar for dollar.
What is the penalty to filing taxes late without an extension?
5 percent each month, up to 25 percent Interest: A monthly rate until the tax is paid in full
The cost basis of an investment can be increased or decreased. Two common examples for older adults are:
>A dividend reinvestment plan (DRIP)—people automatically purchase more stock with the dividends they earn >Their primary home, traditionally one of older adults' biggest assets
What are the three amounts the Standard Deduction consists of?
>A standard amount set by federal law based on filing status (e.g., single, married filing separately or jointly) >An additional deduction for age 65 and older >An additional deduction for those who are blind
What is another name for adjustments on your taxes and what do you subtract them from?
>Also called above-the-line deductions because, in tax law, adjusted gross income is "the line." >You subtract them from Gross Income to get adjusted gross income.
What are some other ways (besides Section 121 or1031) to avoid Capital Gains Tax?
>Charitable contributions or charitable trusts >A step-up in cost basis (highly appreciated property is transferred at the owner's death to a beneficiary, rather than sold or gifted during the owner's life)
What are examples of home modifications that would qualify as deductible medical expenses?
>Constructing entrance or exit ramps for the home >Widening doorways at entrances or exits to the home, hallways, and interior doorways >Installing handrails or support bars in bathrooms or anywhere in the house >Modifying stairways; hardware on doors >Lowering or modifying kitchen cabinets and equipment >Moving or modifying electrical outlets and fixtures >Installing porch lifts and other forms of lifts (elevators generally add valueto the house)
Many miscellaneous expenses over 2 percent of adjusted gross income can be deducted. These include:
>Fees for tax preparation and investment account management >Legal fees for financial, tax, and estate planning advice >Certain appraisal fees >Safe-deposit box rental fees, if the box is used to store investments such as stock certificates
Qualified 401(k) contributions are an example of ______. A. income that is nontaxable or excluded from all income B. an above-the-line tax adjustment to gross income C. a below-the-line tax deductino to adjusted gross income
A. income that is nontaxable or excluded from all income Any income the IRS deems non-taxable or excluded is subtracted from all income to arrive at gross income. Examples of non-taxable or excluded income include 401(k) contributions (annual limit), qualified Roth IRA distributions, certain veterans' benefits, gifts received, and inheritance.
What is the result when taxable income is multiplied by a person's tax rate? A. total tax due B. tax already paid C. tax refund due
A. total tax due Taxable income is multiplied by the person's tax rate to determine the amount of tax due. Then payments already made or available tax credits are subtracted to arrive at the tax refund or tax due.
What is Gross Income?
All of your income minus any income the IRS deems non-taxable or excluded. (Gross income is generally the same as total income on line 22 of IRS Form 1040).
What is an Enrolled Agent (EA)?
An EA is a federally-authorized tax practitioner, empowered by the U.S. Department of the Treasury to represent taxpayers before all levels of the IRS. EAs include CPAs and attorneys who have earned the EA credential.
What is an Income Trheshold?
An income threshold is a tax bracket. When gross income exceeds a person's income threshold, the person moves up to the next higher bracket and the tax rate goes up.
Hobby income is not reported on a tax return because a hobby is not a business. (T/F)
Any income from a hobby must be reported on a tax return and may be taxed if it is $400 or more a year.
What does the Consent to Disclose Statement authorize?
Authorizes a tax preparer to discuss the taxpayer's confidential matters with others, for example, should the client become incapacitated. Otherwise, the tax-return preparer is prohibited by the IRS from doing so.
Unlike a short-term capital gain, a long-term capital gain applies to property held ______. A. 12 months of less B. 12 months plus one day or longer C. 12 months plus one day up to 10 years
B. 12 months plus one day or longer Long-term capital gains apply to property held 12 months plus one day or longer. Short-term capital gains apply to property held 12 months or less. There is no time limit on long-term capital gains.
Unlike a tax deduction, a tax adjustment's value is _______. A. a tax bracket percentage B. dollar-for-dollar C. based on age and filing status
B. dollar-for-dollar If several family members are contributing to the financial support of a dependent, only one of them may take the dependent exemption in a given year.
How long does the IRS have to examine a normal tax return? A. one year B. three years C. six years or longer
B. three years The IRS has three years to examine a tax return and, if it suspects fraudulent activities, six years or longer.
Which factor determines the amount of capital gains tax on the sale of an asset? A. Type of investmewnt (stocks, real estate, etc) B. Asset owners marginal tax rate C. Original cost of asset
C. Original cost of asset The amount originally paid for an asset is the cost basis. The cost basis is used to calculate the amount of capital gains tax. Cost basis can be increased or decreased.
What is a nonrefuncable tax credit?
Can reduce tax liability to zero but does not create a refund. >>Older or disabled >>Retirement savings contributions >>Child or dependent care >>Residential energy >>Lifetime learning
Older adults who do not need to file an income tax return automatically receive any tax refund or credit they are owed. (T/F)
False Even people who do not need to file a tax return should do so if they are eligible for an income tax refund or any refundable credit paid directly to them; or if they have gross income above their threshold; or if they make $400 or more a year from hobbies or self-employment.
It is easier for people age 65 or over to file income taxes than for people who are pre-retirement. (T/F)
False Filing taxes as an older adult age 65 or over may be as complex as for those many years from retirement.
Social Security benefits are exempt from federal income tax and, therefore, not a tax concern for retirees. (T/F)
False Portions of Social Security benefits may be taxable, depending on the person's total annual income and filing status. The IRS reports that older adults often incorrectly calculate their taxable Social Security benefits.
Single taxpayers can exclude $500,000 of the sales proceeds on a primary home from capital gains tax.
False Section 121 of the IRC provides an exclusion from capital gains tax on a home sale of up to $250,000 for a single taxpayer or up to $500,000 for married taxpayers filing jointly, if certain conditions are met.
Short-term and long-term capital gains are taxed at the same rate. (T/F)
False Short-term capital gains are taxed at ordinary income tax rates; long-term capital gains are taxed at lower rates.
Only income earned in the United States is taxable. (T/F)
False The US tax code applies to all income earned anywhere in the world.
An older adult who hires a home health care aide from an agency list does not have to pay taxes. (T/F)
False The older adult is an independent employer and must pay the employer's portion of FICA, Social Security, and Medicare taxes and withhold the employee's portion of these taxes from the aide's payments.
The cost basis of a primary home is the original purchase amount. (T/F)
False When selling a primary residence, the cost basis is the original purchase amount plus the cost of permanent, major improvements and certain selling expenses.
What are adjustments that most often apply to people age 65 or older?
IRA contributions >for those who are self-employed, self-employment taxes, health insurance premiums and qualified plan contributions (e.g., SEP, SIMPLE).
What is the broad definition of income?
Income is broadly defined as all income in the form of money, goods, property, or services, from all sources. Typical income sources for older adults include tax-deferred retirement plans such as annuities, IRAs, 401(k) plans, and pensions; Social Security benefits; insurance proceeds and reverse mortgage loans. Those in the high net worth or middle-income groups could also receive income from capital gains on investments. Other sources of income include: >Compensation (earned income) >Interest, dividends, and capital gains >Unemployment compensation >Hobbies and self-employment >State tax refunds >Proceeds from the sale of property >Rental property, estates, or trusts >Fees received as an estate executor >Alimony
What is the Taxpayer Advocate Service?
Independent program within the IRS that serves taxpayers and their advisors. Each state and service center has at least one local, independent taxpayer advocate, who reports directly to the national taxpayer advocate. The Taxpayer Advocate Service ensures prompt and fair management of tax problems that are not resolved through normal channels, protects individual taxpayer rights, and helps people resolve tax problems.
What are the rules of taking Dependent Exemptions?
Individuals may take an exemption for each dependent. >>Dependents may be a qualifying child or relative—parents, grandparents, siblings, adult children with a disability, or grandchildren being raised by the individual. NOTE: If several family members contribute financially to support a dependent, only one of them may take the exemption in any given year. Expert tax advice is crucial.
What are the rules of taking Personal Exemptions?
Individuals may take one personal exemption, single or married (a married couple filing jointly can take two personal exemptions). The amount of the exemption is reduced by a certain percentage if adjusted gross income exceeds the person's income threshold. This can result in a larger tax bill. When itemizing, there is no additional tax exemption for age 65 and older.
When is the interest on a reverse mortage loan tax deductible?
Interest on a reverse mortgage loan is tax deductible at the time it is paid, which may be when the loan is paid off or before the loan is due. There may be a limit on the amount that can be deducted.
Are spouses considered a dependent on your tax form?
No Spouses are not dependents. A dependent cannot also claim a personal exemption.
If I apply the date in which I pay my taxes, what is the extension date?
October 15
What is IRS Form 2848?
Power of Attorney and Declaration of Representative Authorizes another person such as a CPA, attorney, or EA to represent the taxpayer before the IRS and to discuss tax issues with the IRS and the Taxpayer Advocate Service.
What are the last items you subtract from Gross Income?
Tax Exemptions (personal and dependents)
What is IRS Form 8821?
Tax Information Authorization Allows another person to receive information about a taxpayer's tax records and to authorize the IRS to send correspondence, audit letters, or balance-due notices to both the authorized person and the taxpayer. The authorized person can also give a professional the necessary knowledge to assist the taxpayer.
What is the alternative minimum tax (AMT)?
Taxpayers must pay the higher of the AMT or the regular tax. They may owe penalties if they should have paid the AMT and did not. The alternative minimum tax (AMT) is a separate tax system with its own tax rates and rules that are different from IRS Form 1040, Schedule A, particularly for itemized deductions and exemptions. Created to close legal loopholes for high-income taxpaers to avoid taxes.
What is a refuncable tax credit?
The IRS treats it as a payment and can generate a refund. >>Earned Income People who have lower income or are raising grandchildren may qualify for an earned income credit. This credit is available only to: >>Single taxpayers between the ages of 25 and 65 >>Those with qualifying dependents >>Married couples filing jointly, who may qualify if one spouse meets the requirements The IRS publishes tables each year with the amounts of credit, determined by income and number of dependents.
How can the cost basis of a home change?
The cost basis of a primary residence is the original purchase price, plus the costs of permanent, major improvements. Examples of improvements that increase the cost basis of a house include: >>A new addition, such as a bedroom >>Remodeling an existing room, such as a kitchen or bathroom >>Replacing a major interior system, such as the HVAC >>New landscaping and plantings >>Water and sewer hookups >>Driveway construction >>Addition of a storage shed NOTE: Repairs and maintenance do not count as home improvements. The cost basis of the home, plus selling expenses such as commissions and advertising, can be subtracted from sales proceeds to reduce the amount of capital gains.
What is marginal tax?
The highest rate that a person must pay on taxable income. It's a percentage. If people are in one tax bracket and additional income puts them into the next higher tax bracket, then only that additional income is taxed at the higher rate.
What if a spouse dies? What can the surviving spouse do about deceased spouse's taxes?
The surviving spouse: >May file a joint return with the deceased spouse, unless he or she remarries before the end of the tax year. In this case, the decedent's tax return is filed as married, filing separately. >Signs the tax return as the decedent's spouse or personal representative. NOTE: To claim a tax refund for a deceased taxpayer, attach IRS Form 1310 to the decedent's tax return, which may be filed electronically.
What is an IRC Section 1031 exchange?
This allows taxpayers to exchange commercial property for property of like kind—business, trade, or for investment. (Like kind does not mean that the businesses must be identical.) No capital gains tax is paid on the first property if a replacement property is purchased within 180 days. For example:
Those who paid taxes on significant assets can deduct these taxes from their adjusted gross income. (T/F)
Those who paid taxes on significant assets can deduct these taxes from their adjusted gross income. Examples are: >State income tax on tax-deferred retirement plan distributions >Estimated tax payments made to the state >Real estate tax on the primary residence and a second home (that is not rented on a regular basis) >Personal property tax (e.g., annual tax on a car) >Foreign income tax (taken as either an itemized deduction or a tax credit; consult a tax expert)
Cost basis is the amount originally paid for an asset. Cost basis is used to determine the amount of short- and long-term capital gains. (T/F)
True
Gambling losses are wholly deductible but must be reported separately on IRS Form 1040. (T/F)
True
Home repair costs to age in place are not deductible, unless they are part of extensive remodeling or restoration. (T/F)
True
People age 65 or older have a higher minimum threshold for gross income than younger taxpayers do. This means older taxpayers can usually exempt more of their income from tax than younger people with the same filing status (except for those who are married filing separately). (T/F)
True
People may need to report income even if they do not receive a W-2 or Form 1099. (T/F)
True
The cost of medical care received in continuing care retirement communities, assisted living facilities,, and nursing homes is generally tax deductible. (T/F)
True
When itemizing, there is no additional tax exemption for age 65 and older. (T/F)
True
A CPA is a good choice as a tax preparer for an older couple who own a business and have numerous medical expenses. (T/F)
True A CPA, tax attorney, or Enrolled Agent should be used by people who have complicated tax returns—for example those owning a business, renting properties, or paying numerous health expenses.
The entire cost of nursing home care, including meals and lodging, is a deductible medical expense if the person (or spouse or dependent) is there primarily to receive medical care. (T/F)
True A person who is in a nursing home mainly for personal reasons can deduct expenses for medical care but not meals and lodging.
Short- and long-term losses are first used to offset capital gains of a similar nature. (T/F)
True Capital losses can result from the sale of assets such as stocks, bonds, mutual funds, and real estate. Short- and long-term losses are first used to offset capital gains of a similar nature.
Above-the-line adjustments are preferred to itemized tax deductions because adjustments directly reduce income dollar-for-dollar. (T/F)
True Deductions only reduce income by a percentage.
Even though mistakes may be unintentional, the IRS is legally required to charge penalties for certain errors. (T/F)
True Even though mistakes may be unintentional, the IRS is legally required to charge penalties for certain errors: negligence, substantially understating taxes, incorrect credits, and failure to include transactions that should have been reported on a tax return.
A portion of the cost to install a wheel chair ramp to the family home to accommodate a resident's disability may be tax deductible. (T/F)
True Home improvements made to enable a taxpayer or immediate family member with a disability to continue living in the family home may qualify as deductible medical expenses.
Major tax mistakes can carry criminal penalties. (T/F)
True Major mistakes—failure to file a tax return, tax evasion, or tax fraud—carry criminal penalties.
Tax deductions reduce adjusted gross income and, therefore, taxable income. The amount of taxes saved is directly related to the tax bracket—the higher the tax bracket, the larger the savings from a deduction. (T/F)
True NOTE: However, as noted earlier in this chapter, there is a limit on the total amount of itemized deductions that can be taken each year. Some itemized deductions are reduced (phased out) when adjusted gross income exceeds a certain income threshold.
Many older adults can exempt more of their income from tax than younger people. (T/F)
True People age 65 or older have a higher minimum threshold for gross income than younger people in the same filing status, therefore, older adults can exempt more of their income from tax (except for those who are married filing separately).
Higher income thresholds have fewer deductions and exemptions. (T/F)
True Tax rules apply differently for each income threshold. For example, higher income thresholds have fewer deductions and exemptions.
Older taxpayers often mistakenly pay more tax than required on their qualified dividends income. (T/F)
True The IRS reports that older adults often pay more than the required amount of tax on qualified dividends income, which is generally taxed lower than the standard rate.
A person who moves to a nursing home due to a major illness can deduct all their expenses as medical, even though some are for meals. (T/F)
True The entire cost of nursing home care, including meals and lodging, is a deductible medical expense if a person is there primarily to receive medical care. A person who is in a nursing home mainly for personal reasons can deduct expenses for medical care, but not meals and lodging.
U.S. tax code applies to all income earned anywhere in the world. (T/F)
True U.S. tax code applies to all income earned anywhere in the world. For example, if a U.S. taxpayer earns interest on a bank account in Canada, it is taxable income in the U.S.. Any pensions or social security payments from another country are also taxable.
Unmarried couples who live together have tax incentives to remain single. (T/F)
True Unmarried couples who live together and file as single taxpayers may pay less tax than if they were married. At the same time, legally-married couples (including common law and same-sex) may file jointly or separately and receive certain tax filing breaks, deductions, and credits. Consult with a qualified tax expert.
When a rental property is sold, total depreciation is subtracted from its cost basis, thus reducing the cost basis. (T/F)
True When the rental property is sold, total depreciation is subtracted from its cost basis, thus reducing the cost basis. This increases profit on the sale and the capital gains tax.
What is a DRIP plan?
When people automatically purchase more stock with the dividends they earn, it is called a dividend reinvestment plan (DRIP). A DRIP increases the cost basis of an investment. The cost basis for the stock is the total of the original investment plus the amount of dividends on which taxes were paid. For example: >>Tom bought 100 shares of IBM stock on June 23, 1980, and paid $58.88 a share. Tom's original cost basis is $5,888. >>If Tom had used a DRIP plan ever since his June 23, 1980, purchase date, he might now own 531 shares of IBM stock, currently worth $182.82 per share, for a total current value of $97,079.85. >>Tom's cost basis for his stock is the total of his original investment ($5,888) plus the sum of the reinvested dividends (on which he paid taxes).
Tax credits reduce taxes _______ ____ ______.
dollar for dollar. ax credits are refundable or nonrefundable:
Changes in the Affordable Care Act (ACA) of 2010 increased the Medicare tax, created a new _______ ________ ________ ______, and reduced the following three items:
net investment income tax (NIIT), and reduced: 1. The limit on flexible spending account (FSA) contributions 2. Itemized medical expenses 3. Deductions and exemptions for higher-income taxpayers
A person, vendor, or institution that believes it is owed money can go back _______ years to try to collect it.
seven
Taxpayers should keep year-end W-2s, investment statements, and other records for _______ years.
seven
A_____ _____ ______ formula can be used to compare the net income after taxes between taxable and tax-exempt bonds.
taxable equivalent yield (TEY)
Generally, the cost of direct and substantial medical care (e.g., for dementia or special needs) received in an assisted living facility qualifies as a medical deduction if a licensed health care professional certifies that the care receiver needs ongoing help to perform at least _______ activities of daily living or requires supervision because of cognitive impairment.
two
