Individual Tax

Interest is taxable but often overlooked

Any interest that the tax payer receives directly, or through a credit in his account and is of the nature that it can be withdrawn at a future date without attracting any penalty or interest, is termed as taxable income. Bank interest rates, money market accounts, certificates of deposit, deposited insurance dividends etc, are few examples of taxable interest income.

The interest on Series EEE and the series IUS bonds saving bonds are usually classified as tax deferred bonds as tax need not be paid on these, unless it matures and starts generating income. Interest from such bonds, which have been issued after the year 1989, are not taxable if it is generated to fund higher education expenses for that particular year. Form 815 explains about the interest that needs to be excluded from redeemed US Savings bond whereas form 1040A, 1040 or Schedule B talks about excludable interest from the Series EEE bonds issued after 1989.

Dividends are actually interests on deposits or accounts with banks, credit union, stocks held in the capital market, domestic building and loan associations, mutual savings banks etc. The interest payer sends the Copy B of Form 1099- NT to the receiver, who in turns all the necessary paperwork to claim deductions for interest received. The Publication 550 or Publication 1212 gives more details about bonds or debt instruments that were originally offered at a discount. This explains that a part of the original discount must be included every year as interest charges.

Some interest incomes qualify for the federal income tax but are exempted from the state and local income taxes. These incomes include interest from Treasury Bills, notes and bonds. Interest income on some bonds that are used for financing government operations, or that are issued by the state government or by the District of Columbia or a US possession does not qualify even for the federal income tax. It is the duty of the tax payer to duly submit all the interest details that are exempted from tax while filing tax returns. This is because details submitted to the IRS should be complete and accurate. This is only for the records of the IRS and they would not charge any tax on this amount.

A nominee who receives the interest on behalf of the actual recipient should inform the IRS of the same and also furnish all these details to the actual recipient or recipients. Interest amount received by the nominee should be shown as a subtotal of the all interest revenues listed under Schedule B of form 1040 or Form 1040A. The nominee must fill up the Form 1099-INT for the interest portion and hand over the copy B to the actual recipient.

If one receives interest income that qualifies for tax payment, then the same should be done by the receiver on time so that no interest charges or penalties are charged on them. The receiver of the interest should furnish accurate details about his social security number to the interest payer.

President Obama's Tax Return Shows Lower Earnings

When the tax filing of the First Family of the US was made public it showed that the President, Barack Obama and his wife, Michelle Obama  had paid $112,2114 as federal taxes and had an adjusted gross income of $608,611. The taxes paid this year by the First Family were around $42K lesser than what they paid last year and their adjusted gross income last year was $789,674.

The main reason for the reduced income in 2012 was attributed to the fact that royalties from the books that the President had written have started falling over the years. “The Audacity of Hope” and “Dreams from my Father” were the two books that sold like hot cakes in the year 2009 and this was the year that Obama earned an all time high royalty of $5.6 million from two publications. These royalties slowly started coming down the years and it has resulted in the lesser earnings and thereby lesser taxes in the year 2012. The royalties were worth only $274,000 in the year 2012.

The First Family’s state income tax contribution to the Illinois state during 2012 was around $29,000 and their contribution to charities and other non-profit institutions were 24.6% of their adjusted gross income. The President and his wife contributed to at least 33 different charitable organizations during 2012. Their most recent contribution was worth around $103,000 to the Fisher House Foundation which helps in setting up free residential areas for the families of injured war veterans.

Their yearly contributions to charitable organizations like the American Cancer Society, Habitat for Humanity and the National Congress for Black Women continued in 2012 as well.  A $5,000 donation was made to Bruce Laurent’s family. Bruce was killed while serving in the motorcade department for the President during September 2012.  During the time of Bruce’s death, the President was attending a campaign on the Palm West Beach. The years 2011 and 2012 saw a $5,000 donation each to Sidwell Friends School, the elite private school where the President’s daughters Malia and Sasha study.

These tax returns of the White House authorities have re-kindled the debate on the amount of taxes that the highly rich people must pay.  The budget that was recently released from Mr. Obama’s office announced high income tax rates as the only solution to restart the deficit reduction talks with the Republicans.  The Budget released from the White House also introduces the Buffet rule, which is nothing but a minimum of 30% of federal income tax to be imposed on individuals earning $1 million or more in a year.

Mr. Obama has personally endorsed this idea to the US citizens emphasizing the simple concept that higher income citizens must pay higher income taxes than the middle class citizens.  This tax rule is named after the capital market baron, Warren Buffet, who was the richest person in the world till some years ago and still continues to figure in the top 10 richest people in the world. He famously said that his tax rates were much lower than his secretary.

Obama Care Explained in Plain English

The US President, Barack Obama and the Congresss, signed an agreement in the year 2010 to bring Obamacare into practice. This is a health insurance scheme initiated by the President, so that all the US citizens are covered. The medical costs are on an uptrend in the recent years and average medical expenses run into thousands of dollars. In a bid to reduce these costs and make the citizens feel covered in case of medical emergencies, the Obamacare plan was launched.

Once a family is covered with the general health insurance, then it need not worry about the shooting medical expenses in case of hospital visits, as a majority of the expenses are covered under this scheme. The patient only needs to pay a very nominal amount during the first visit to the hospital. This is called co-payment. Most of the employees provide this scheme to their employees in return for a reasonable monthly premium payment.

However Obamacare gives additional benefits to families who already have this scheme and it also provides coverage for people who are so poor that they cannot afford even the minimum premium payments. There are lots of daily wage workers in the US, whose employers do not offer any health insurance schemes to cover them. Obamacare is a panacea for all.

Changes that are reflected already

People who have health insurance get additional benefits from Obamacare in various ways. Parents can get additional coverage for their kids, till the kids turn 26 years of age. This plan does not drop patients midway or remove the coverage if somebody in the family falls ill suddenly. Insurance companies, under Obamacare policy, can never refuse to cover for families that have a chronically sick member. The co-payment option is taken off from this system and most of the general check and pregnancy tests can be done free of cost.

Insurance companies cannot act fraudulently and can raise premiums during the term of the policy, only if the increase rates are allowed by the state government. According to this policy, the insurance companies should use 80% of the premiums they receive, for settling claims of the insured people. However, if they fail to do it and instead spend on advertising expenses, they have to send a check to the insured for the excess amount used up. Families that do not have any insurance can use Obamacare to get temporary insurance cover till the year 2014.

Important changes in future

Obamacare will make health insurance compulsory in the year 2013. Failure to take insurance  will attract a fine of 2.5% of the annual income to be paid to the government. Insurance schemes can be easily purchased online. Small business employers will have to mandatorily buy health insurance, failing which, they have to cough up a fine of $2000 per employee, except for the first set of 30 employees who joined the company.

Why you won’t be audited?

Last year, the US saw a huge fall in the tax audit rates by 5.3%. This reduces the probability of individuals being audited.  This research was conducted by the Transactional Records Access Clearing system.  This trend is due to the cuts in the federal spending.  This process is called sequestration and this is a process which cuts down the employees who are eligible for tax audits so that the fraudulent individuals can be tracked down easily. Kevin Brown, leader of Pricewaterhouse Coopers ‘tax controversy and dispute resolution practice, rightly said that if the number of individuals decrease then it correspondingly decreases the number of audits.

The National Treasury Employees Union conducted a survey and it was found out that these cutbacks could impact enforcement actions. The audits usually conduct its audits on days when the works have five to seven unpaid furlough days in the summer. The cuts are also timed in that part of the season, where there is a recruitment freeze which prevents the agency to fill up jobs.  In 2011, the IRS had 7000 full time employees lesser than what it had during the year 2010. The staffing and other enforcement actions were lesser by 6% last year.

The lesser number of individuals to be covered for auditing does not mean that the defaulters can make merry. On the contrary, it is tougher to escape this way because being one among 10,000 people definitely has more visibility than being one among 100,000 people.  The way the audits are being conducted has also changed. Earlier, face to face audits were the fashion. However, this has now been reduced and audits through email correspondence are the order of the day recently.  Audits through emails have increased to almost triple the amount of quantity around 20 years ago.

The IRS has effective software systems to track if the income is not reported rightly. Most of the cases of under reporting of income is tracked through this software by matching the income filed in the form 1099 and other related paperwork, while tax filing. Fewer audits are not necessarily a reason for the defaulters to enjoy. The fewer audits take a longer time to get completed than the frequent speedier audits that was the process some time back.

If a defaulter is found to have misreported income or done fraudulent tax filing in the new long audit process, then the interest and the penalty charges that he needs to pay is exorbitant than what the frequent audits charged. This puts the cheaters in a great fix, as in the current scenario, they not only have to pay taxes due for years together but also have pay very high penalty charges of each year’s missed payments.

Though the audits on individuals have been reduced drastically in the year 2012, the frequency of the audits on the corporate organizations has not changed according to the recent IRS survey. More than 17% of the organizations were qualified for audit in 2012.

The Super Rich’s Offshore Tax Avoidance Strategies

Most of the business tycoons use the trusts or holding companies in a different country to represent a majority of their income, thereby showing very low taxable income in their native countries. This is a strategy that is being employed by quite a few very rich people and the governments of the native and the offshore countries are devising measures to stop this practice completely.

Most of the billionaires are using these offshore holding companies and trusts to manage their assets which are worth hundreds of thousands of dollars, hold these assets till any further notice and obscure them, if needed. A survey was conducted in 2011 by Tax Justice Network, an UK based organization which fights for transparency in the tax rules and payments. The results of this survey were quite alarming. It was found out that the amount which all the rich people had stacked in their offshore companies were running into $32 trillions.

The purpose of these offshore trusts or holding companies is to protect the incomes from the higher tax brackets of the native governments and also to keep a check on the government’s seizure policies.  Bloomberg had analyzed and proved that around 30% of the world’s richest 200 people had assets outside their native countries and these were managed and controlled by the holding companies abroad in an indirect way.

The world saw one of the worst financial crises in the year 2008 and that changed the way the tax system in the US operated. Most of the countries re-visited their tax laws and imposed quick and reasonable changes in them so that the tax payer could not easily manipulate the loopholes of the rule and evade payment of tax.  In the year 2009, Liechtenstein brought out a law which instructed all the financial institutions to release the all the details of their accounts across countries, whenever requested.

Andorra and Switzerland also got influenced by Liechtenstein and hence they also offered concessions to institutions who give a detailed report of all their customer’s accounts held worldwide in all the branches.  With effect from July 1st, Singapore would also join the race to discourage money hoarding in other countries, by making it a criminal offence. Luxembourg is aiming to gradually bring down these kinds of accounts by the year 2015.

Cyprus was the most preferred by most of the Russians to set up offshore holding companies and stack cash in. However, when Cyprus was bogged down in a serious financial crisis in March, the European Union bailed them out upon a condition. The condition was that Cyprus had to introduce a tax on all deposits into its bank that crosses more than 100,000 pounds. This tax component discouraged many wealthy individuals and hence Cyprus saw a huge reduction of deposits to the tune of $2.4 billion in that particular month.

These kinds of changes succeed in reducing offshore money hoarding activities to a small extent, however as more and more countries participate in this drive; this tax evasion process can be completely abolished.

Writing off your summer vacation

Summer vacations can burn a big hole in one’s pocket; however avoiding them is not the long term solution. Working without taking any vacations can kill a person’s work life balance. One has to sneak away to small trips now and then and yet have a check on the travel expenses. Here are a few ways on how to travel yet claim deduction on some of the expenses.

Combine business with pleasure

If a person travels to trips for business meeting he can also combine the trip to do something for his personal interest. There is no hard and fast rule to identify if a trip is for business or personal purposes. If the time spent for official reasons is more on a trip, then it is a business trip. Air fares are deductible expenses. Driving to the venue of meeting gives a whopping deduction of 56.5 cents per mile with the added benefits of parking and toll charges. The key to get travel expenses deducted is excellent documentation.

One must have a very good control of his travel expenses and know all the rules of the IRS thoroughly so that he can answer any query regarding his claim for deductions.  Business trips help to write off the entire transportation and lodging expenses can be claimed for deductions. 50% of the meal expenses spent on working days is also deductible. Hence if one travels with his wife, only the meal expenses have to be taken care of. There should be some reasonable justification to be provided before claiming some expenses as deductions.

Learn something

Enrolling in some courses while travelling is another way to save travel expenses. As long as the course is to improvise on one’s skills at work, the education expenses and the travel expenses can be written off.  One has to regularly attend these classes while travelling and have good records about all the paperwork that might be needed while claiming for deductions. These courses could be a business related seminar or a professional course that would help the person climb his corporate ladder effectively.

Lend a hand

Volunteering to do charity work while travelling can help in claiming tax deductions. This is one way to prove that the aim of travel is not for pleasure or personal purposes. One can choose to do charity work after office hours and get a deduction for all the out-of-pocket expenses one spends. Driving one’s car to the venue of the charity work also helps in deducting car expenses of 14 cents per mile. The parking and other toll expenses are also covered in these deductions.

Get healthy

If a person is suffering from a severe obese condition, then he can get himself treated at a spa for weight reduction and improving his general health. These medical expenses are deductable provided there is a statement from the doctor that the treatment was purely medical and not for pleasure. Driving to the medical center can help to deduct up to 24 cents per mile with the combined benefits of parking and toll expenses.

More states charging taxes for iTunes and eBooks

The highly popular category of iTunes and eBooks has just got more expensive. Millions of people use these applications to download music and books of their choices and the decision of nearly 25 states to levy a sales tax on these downloads, has not gone down well with the phenomenal number of loyal end users of these applications. A recent announcement informed that these states were going to charge sales tax for any kind of digital service like downloading music, e book, selecting ring tone, streaming television shows online etc.

As the digital industry is booming, millions of people have been hooked to the internet for buying their daily needs, books, movies, music, television shows etc. Some state governments felt that the digital industry was eating up a lot of their state revenue that they would have earned otherwise. This thought led to the idea of levying sales tax for the digital market as well, so that the governments would not face any loss in revenue. Minnesota is the latest state to come under the radar for these revised sales tax rules.

Sales through eBooks rose to around 41% as compared to last year, digital music increased to around 9% from last year and the total transactions made online rose to a whopping 37% as compared to last year. Hence some states have introduced sales tax on digital products with immediate effect. The nature of transactions that are taxed differs from state to state. For example, some states tax anything that is bought digitally irrespective of the mode of delivery. However, some states levy tax on music that is downloaded, but not on music that is brought from serviced websites like Netflix or Spotify.

The tax rates differ according to the states. For example, a $12.99 purchase made from the iTunes website, carries a tax of 4% in Wyoming, 6% in Vermont and 7% in Mississippi. EBooks is another major application that took the digital world by storm by attracting huge number of visitors every day. On a $9.99 purchase on eBooks store, the tax levied is 7% in New Jersey and 4.7% in Utah.

There are certain big cities like New York, which levy sales tax on download of mobile applications but do not levy any tax on the digital purchases from iTunes. New York levies a tax of 12 cents on a @2.99 purchase of Angry Birds application, however, music download and purchase from the iTunes is free of tax here. Streaming websites like Netflix are also used widely for downloading music. In most of the cities, these do not carry any tax. However, Washington levies a 6.5% tax for a $7.99 monthly subscription of Netflix streaming, while Florida imposes a slightly higher 6.75% tax for the same amount of subscription. A digital seller can impose sales tax only in those states, where the seller owns a store or a warehouse. A recent change in law, the seller can also impose taxes on those states, where he has a minimum of $1m sales a year

IRS using tracking to understand more about the tax payers than just their tax returns

The Internal Revenue System (IRS) is an organization that is responsible for collecting the taxes of the general public. It holds a highly reputed position and is constantly improving on its techniques to ensure that the taxpayers are loyally paying their taxes every year. However, even if they take immense precaution, cases of tax fraud cannot be avoided. Every year, there always remains a section of people who evade tax and cheat the government in millions.

Hence the IRS has come up with the technologically sophisticated tracking tools that help them understand more about the tax payers than just their tax returns. These tracking tools, keep a check on the digital transactions of the defaulting tax payer like his eBay transactions, Facebook settings and one of the most recently developed technique to track the tax payer’s online payment details, his credit card number and other personal data. This data is essential for the IRS personnel to track down the defaulting customer and make him pay the dues that he is rightfully liable to pay.

Big cities like Washington are reeling under losses to the extent of $300 billion dollars caused to the state’s exchequer because of fraudulent people. Hence the IRS has brought in new models like the robot audit and third party audit to bring these faulty people to justice and make them cough up their shares.  There has been a little apprehension among the people, for these techniques, because the personal details like bank, card details etc of the loyal tax payers are also scrutinized while analyzing the details of the tax evaders. This has not gone down well with the general public, however other than implementing this method; tax evasion cannot be controlled properly.

The IRS big data tracking system is an efficient tool for tracking the digital background of the tax evaders. Here the social networking transactions are tracked, electronic payments are monitored and auditing is conducted for those individuals who are regular defaulters. The internet browsing pattern is also tracked here. This tool is used to study the digital and the economic behavior of the individual and around 1 million unique attributes are attached with these individuals. Relationship analysis, statistical and agent based modeling are employed in this method to know about the defaulter better.

The computing power of the IRS is increased in huge proportions. Of the entire storage capacity of the IRS, only 1.5% is used to store tax returns of an entire year. This gives huge amounts of empty storage space which can be used for more productive purposes like tracking the individual and forming a pattern around his transactions.

During last year, the behavior and the profiling test study conducted by the tracking mechanism of the IRS, helped to identify around 1500 people with past records of tax evasion. These people were tracked down to where they live, were constantly chased upon and around $200 million was recovered from them. This is enough proof to explain the efficiency of the auditing and tracking tools of the IRS.

Four commonly missed tax breaks

 

Once the tax returns are filed, people generally want to forget income taxes for a while. This is not the right approach. The time just after filing the returns, is the apt time to think over and reflect on the process, what could have saved tax and what to do better next year to reduce tax payments in a big way. This is the time, when the rules and policies are fresh in the minds so as to proceed with the tax saving benefits analysis. Here are some of the benefits, which people usually miss to consider while filing returns.

Roth IRA – The retirement benefits of IRA can be considered as a good option to invest money in, thereby reducing the taxable income portion for the current year. However one tends to forget that future withdrawals from the 401K plan attracts at least minimum tax rates. This is the reason why most of the younger generation today opts for the Roth IRA schemes.

The youth, at the start of their careers are eligible for a lower tax bracket and they contribute to the Roth IRA schemes from after tax money. The best benefit of this scheme is that in future, when these people become old and tend to withdraw money, both the contribution and the earnings of this scheme that can be withdrawn is totally tax free.

Flexible Spending accounts – These accounts are the only way out to save taxes on expenses related to medical, child care and other personal reasons.  Most of the companies offer their employees, a part of their salary in the form of these FSAs. The traditional IRS rule does not allow any deductions for medical expenses, if these expenses do not exceed 7.5% of the adjusted gross income. Hence this scheme is taken by people who do not have huge medical expenses and yet need deductions that can be offset by other deductions that are not allowed like property tax and state income tax.

Proper Asset Location – Classifying assets is more important than holding the assets themselves. It is important to classify the assets correctly into the taxable, tax –deferred and tax free pockets of one’s portfolio. It is a smart move to place the bonds in the tax deferred category as even if one gets to sell these instruments, the tax need not be paid immediately. It is also wise to keep stocks in the taxable category, because this is sold rarely and tax needs to be paid only upon sales.

Performing a Roth conversion in a Low income year – When income levels drop, there is an option to convert the benefits from the IRA model to the Roth model for a nominal charge. This converts the income from taxable category to tax free category. Partial conversion of benefits into the Roth model is also possible.

These are the schemes that are part of the daily lifestyle of the tax payers. However one needs just to twitch in here and there to maximize these for one’s benefits.