With all of the kerfuffle over the possibility of a fiscal cliff and increased income and other taxes, it is only natural to feel some unease over what may transpire in the new year. But next year is not here yet, so we must focus on the taxes that we will owe this year. Your preparation for April 15 doesn’t have to be as painful as it may have been in years past, particularly if you remember a few important tips.
First, don’t think that just because you didn’t receive a 1099 from another person or entity you did not have taxable income. Remember Tom Daschle, the former Senator from South Dakota and Senate Majority Leader who had to withdraw his nomination as Obama’s health czar? Daschle “forgot” to include $340,000 in income because he had not received a 1099 form for that income. Self-employed persons often get paid in cash, and the temptation to not report that revenue can be alluring but dangerous. The IRS now has sophisticated tools to enable it to reconstruct a person’s actual income versus reported income, and don’t forget that it may be a crime to under report one’s taxable income, if the IRS can prove fraud.
Believe it or not, the gap between what Americans owe in taxes and what the government actually receives is now estimated to be in excess of $400 billion. So here are some tips to ease your tax angst.
First, keep accurate records and be sure to separate your business expenses from your personal expenses, particularly if you are self-employed. As an example, if you and your spouse are recreational gamblers, it only makes sense to keep accurate track of your wins and losses each day that you are at the casino. Otherwise, if you hit a jackpot and receive a 1099 for your winnings, you won’t be able to offset those winnings by your losses unless you have records.
Another area where it pays to keep accurate records is in charitable contributions. Be sure to make all of your contributions via check, so that you have proof of your donation. If you donate non-cash items to a charity, it is now incumbent upon you to document how you came up with the value of the donation that you claimed. Also, it is not a bad idea to have the charity write on the receipt that your donated goods were in working order or were usable.
It is important to remember that much of what the IRS does is match your reported income and claimed deductions with their records. If there is the slightest mismatch, you could get what is known as a correspondence audit, which would require you to document either your deductions or explain why your income doesn’t match theirs. One common reason why these mismatches sometimes occur is that 1099 forms are either lost by recipients or thrown away. So, a word to the wise, make certain that you file away each and every 1099 that you receive. This is includes 1009-INTs, 1099-MISCs and 1099-Rs. Form 1098 is what your lender will send you each year to report the interest that you paid on your home mortgage.
Payers are required to send out to payees their 1099 forms by Jan. 31, but they don’t have to report to the IRS until the end of February. As a result, if you receive an inaccurate 1099, you still have time to get it corrected. When you contact the sender, be sure to ask them if they have already sent a copy to the IRS. If they haven’t yet reported to the IRS, the correction process is easier, but if they have reported, the correction process is not impossible. Again, keep records of these conversations.
If you are a partner in a partnership, a member of a limited liability company or a Subchapter S shareholder, you should receive a form K-1 each year. This form documents how much income you must report or, happily, how much loss you may deduct. These K-1 forms are supposed to be mailed out by March 15, but many entities miss this deadline, and the upshot is that you may not be able to file your tax return until you receive your K-1. In these situations, you will have to file for an extension, and the IRS will automatically approve it.
Got a financial planning question for Greg? You may email him at firstname.lastname@example.org.
Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience.