The Ordinary Taxpayer’s Guide To Tax Returns

There are a number of issues raised that can be confusing for ordinary taxpayers. A tax return is not just a bunch of numbers, it is a snapshot of your financial life. Not only do you have a better understanding of where taxable income comes from, but you can also see potential failures in losses and worrisome positions with investments and loans. When it comes to payers who itemize, you can learn about charitable deductions, real estate taxes, real estate holdings, and more.

You can also glean information about the existence of offshore accounts, household employees, rental properties, and more. Tax returns are not dispositive when it comes to wealth. One of the flaws of reviewing tax returns on their own is that they are not a reliable measure of a person’s net worth. By statute, the IRS can not examine tax returns forever.

There are deadlines and the IRS has to resolve exams and other issues within a certain period of time. If the IRS does not resolve the issue by the end of the period, they are done. Sometimes, there is an advantage to extending the time, but it is generally done by agreement in writing. If you do not sign the consent, the IRS can go ahead and issue its findings.

Once that happens, the clock starts running again on your options which typically mean heading to court if you do not agree.

So, if you think that you might be able to reach a settlement, you might want to sign the consent to buy a little more time. You might also do it to keep the matter out of court, which could be what is happening. The benefits of depreciation suggest that the losses on returns do not translate into losses in a portfolio because depreciation is a tax and accounting construct, you do not actually lose value each year on property when you depreciate it.

For federal income tax purposes, depreciation is a deduction that allows you to recover the cost or other basis of certain property. It can be tricky but generally, you begin to depreciate your property when you place it in service for the first time. The IRS considers property placed in service when it is ready and available for use, not when you actually begin using it.

For example, if you buy a car for your business, it is ready and available once it belongs to you, not necessarily the first time you take a ride. You depreciate the cost of the item over its useful life based on the kind of property unless an exception applies, which means that you deduct a little bit every year until its useful life is over. And when you sell or otherwise transfer depreciated property, you may have to recover the depreciation, which can drive up your tax bill.

It can be complicated.

This is why depreciation is not a magic wand, it does not simply create losses out of thin air. Normally, a failure to pay back that kind of debt would result in a taxable event. If you have cancellation of debt for less than the amount you owe, the amount of the canceled debt is considered income and may be taxable unless an exclusion applies. The most common exclusions include bankruptcy, insolvency, and qualified principal residence indebtedness.

If you do not qualify for an exclusion, you typically have to report the income and pay the tax in the year of the forgiveness. That is a tall order. But business losses are sometimes called net operating losses (NOL), and an NOL generally results when your deductions exceed your taxable income. If that number is negative in one year but has been positive in other years resulting in tax payable, that does not quite seem fair.

The NOL exists so that you can balance that inequity. In other words, you can use the loss in one year to lower your taxable income and reduce your burden in another year. Do not confuse capital losses with an NOL, they are not the same thing. Under existing tax laws, if you have an NOL, you first carry back the entire NOL amount for a number of years and if you still have an NOL remaining after you carry those losses back, you can carry the losses forward.

You can also opt not to carry back an NOL and only carry it forward for up to 20 years.

A carry forward means that you can apply the loss towards your income in a future year. NOLs can be tricky, and it is not unusual for the rules to change during an economic crunch. If you pay too much in tax, you may be entitled to a refund. By law, refunds of more than $2 million for individuals, $5 million for corporations, require approval from the IRS, and a report is sent to the Joint Committee on Taxation.

That can result in an audit. Abandonment occurs when a taxpayer deliberately gives up ownership of property including interest in a partnership. The IRS looks at a few factors when considering whether property has been abandoned, including ownership before abandonment, if there is intent to abandon, and actual steps to abandonment. If a loss is considered an abandonment loss, then it is generally deductible as an ordinary loss, that means the full value of the loss can be deductible.

That is huge. But instead, if it is considered a sale or exchange, meaning that you got something back in exchange for walking away, it is treated as a capital loss. Those capital losses are limited to $3,000. Limited deductions include real estate taxes and mortgages, which are capped for homes but not typically for investment properties. To claim a deduction for business expenses, section 162 of the Tax Code requires that the expense is ordinary and necessary.

According to the IRS, an ordinary expense is one that is common and accepted in your trade or business.

The IRS defines a necessary expense as one that is helpful and appropriate for your trade or business. Business expenses remain deductible for the self-employed and businesses. Legal expenses must also be ordinary and necessary in your trade or business to be deductible. Even fees paid to a criminal defense lawyer may be deductible. The rule stands that if the action otherwise meets the criteria for a valid business expense, it is deductible.

There is one notable exception, no deduction is allowed for legal expenses incurred in purely personal litigation. Your records should always support your deductions, rounding or guessing is not enough. And that is especially the case when those numbers indicate a pattern. Numbers that look too good to be true are almost always a red flag. The IRS knows as well as you do that your office phone bill is not always $100, and your office cleaners do not earn 10% of your monthly receipts.

Some taxpayers believe that their returns are private, which is only partially true. No Internal Revenue Service (IRS) employee has the right to simply browse through taxpayer records, it is against the law to inspect returns without being authorized to do so. Congress views any unauthorized inspection of return information as a very serious offense, passed the Taxpayer Browsing Protection Act of 1997 Public Law No. 105-35, which made such an inspection a crime.

And the Internal Revenue Code mandates, in section 6103, that returns and return information shall be confidential except when otherwise specifically authorized.

Under section 7213 of the Tax Code, unauthorized willful disclosure of any return or return information by a federal employee is a felony. And under section 7431 of the Tax Code, civil damages may also be appropriate for willful of negligent violations, depending on the circumstances. In addition, if convicted of such a crime, a federal employee can be suspended or fired.

But those rules apply to federal employees, not private citizens. A private citizen, like a spouse and or an ex-spouse, may legally have access to a taxpayer’s return. And, once your return information is disclosed to a third party, that information is no longer protected under federal tax laws. Simply having someone else’s tax or financial information is not a crime.

Voluntary compliance is the basis of the tax system, and no one is above the law. On September 20th 2020, no matter how much money you make, your goal should be to pay the IRS as little tax as possible. And the smarter you are about taking advantage of tax breaks, the greater your chances of that happening. If you are housing your retirement savings in a Roth individual retirement account (IRA) or 401(k), you will not get an immediate tax break for making contributions.

But if you have your savings in a traditional retirement plan, whether an IRA or a 401(k), the more money you put in 2020, the less tax you will pay the IRS.

For 2020, IRA contributions max out at $6,000 if you are under 50, or $7,000 if you are 50 or older. If you have a 401(k), you can put in up to $19,500 this year if you are under 50, or $26,000 if you are 50 or older. Your savings, meanwhile, will be a function of the tax bracket you fall into. Say you are in the 24% tax bracket, which means you pay that rate on your higher dollars of earnings.

If you put $6,000 into a traditional IRA this year, you will shave $1,440 off your tax bill, just like that. And of course the higher your tax bracket, the more savings you actually stand to reap. Not everyone has access to a health savings account (HSA). But if you are on a high-deductible health insurance plan this year, then it pays to see if you are eligible and put in as much money as possible.

Your contribution limit for 2020 will depend on whether you are funding an HSA just for yourself or on behalf of a family. If it is the former, then you can put in up to $3,550 if you are under 55, or $4,550 if you are 55 or older. If you are funding an HSA on behalf of a family, these limits increase to $7,100 and $8,100, respectively. As is the case with traditional IRAs and 401(k)s, the money you put into an HSA is income the IRS can not tax you on.

You will then have the option to use your HSA contributions to pay for qualified medical expenses, or invest the money you do not need immediately so it grows into a larger sum, just like you can invest an IRA or 401(k).

Your goal in buying stocks is to make money. But if you have specific stocks that have been underperforming, unloading them could actually save you big money on taxes. Specifically, any loss you take in your brokerage account can be used to offset capital gains, which you would normally pay taxes on. If you take a $4,000 loss and have $5,000 in capital gains from selling investments at a profit, you will only end up needing to pay taxes on $1,000 of gains.

Furthermore, if your investment loss for the year exceeds your gains, you can then use it to offset up to $3,000 of ordinary income. And if there is money left over after that, you can carry it into 2021 and use it to lower next year’s taxes, too. The less money you have to pay the IRS, the more you get to keep, invest, and enjoy. It pays to employ these strategies if your goal is to lower your tax burden and reap the major savings that come along with it.

A group of stock exchanges and trading platforms have banded together to create the Coalition to Prevent the Taxing of Retirement Savings in reaction to a proposed financial transactions tax in New Jersey. The coalition, which contends that millions of Americans who invest in financial markets to save for retirement would be hurt by this new tax, is planning tests in the coming weeks to ensure that they have the ability to move out of New Jersey if the tax makes it impossible for them to operate in the state. There is this idea, which was true for a long time before there was full electronic trading, that you needed proximity, you needed to be close.

What this test will be establishing is that these data centers are quite portable.

This is not something that these companies want to do, by any means, but they are concerned about the possibility of rising costs, and they have customers who are concerned about costs as well. A bill introduced into the New Jersey state legislature, which has the support of Governor Phil Murphy, would impose a tax on persons or entities that process 10,000 or more financial transactions through electronic infrastructure located in New Jersey during the year. The tax would work out to a quarter of a cent per transaction.

With billions of financial transactions processed daily, some projections from the legislature estimate New Jersey could collect $10 billion annually from the tax on stocks, options, futures, and swaps trading made in the state’s electronic data centers. Members of the coalition include the New York Stock Exchange, Nasdaq, Members Exchange, Cboe Global Markets, Citadel Securities, Virtu Financial, TD Ameritrade, and Equinix. New Jersey is home to for many Wall Street server farms.

The first test to move beyond New Jersey will take place on Saturday September 26th 2020. Members of the coalition were already planning a test for that weekend, but the plans were recently expanded to test full functionality in light of New Jersey’s proposed financial transaction tax. The scope for this weekend test has been expanded from a connectivity-only test to a full feature test of all exchange functionality in order to ensure data center’s ability to quickly relocate operations from New Jersey to Illinois in the event that it was determined transacting exchange business would result in extra, unnecessary costs to investors.

The test is to ensure that they can leave New Jersey if adverse tax policies are enacted.

Nasdaq will be taking part in the test to ensure that it can move out of New Jersey for financial feasibility if it needs to. Senator Bernie Sanders has introduced a financial transaction tax (FTT) bill at the federal level that claims would generate $2.4 trillion in revenue over a decade. An FTT could be a substantial revenue source for governments, but would have adverse effects on financial markets and the economy.

The burden of an FTT would primarily fall on the wealthy, as the wealthy hold and trade financial assets the most frequently. However, the portfolio values of all investors would be decreased by the reduction in asset prices. An FTT would increase the cost of consumer goods, meaning that all payers would be subject to the tax indirectly.