Tax Tips for Everyone is created to provide updates on current tax topics and increase understanding of terms and issues on income and other taxes.
Deadline or Extension
The deadline for filing 2021 federal income tax returns is April 18, 2022. Of course, if unable to file by the deadline one can request an extension until October 17, 2022 (October 15 falls on a Saturday). If applying for a filing extension, the payment of estimated tax due is NOT postponed. To prevent possible penalties and interest, an individual completes form 4868 to request the filing extension and sends payment of estimated taxes due or pays them through an electronic process. Learn more on the IRS webpage for extension of time to file.
Many taxpayers can file their taxes for free. Individuals and couples with an adjusted gross income of $73,000 or less can either file their return electronically or download fillable forms from the IRIS website.
What is AGI – Adjusted Gross Income
AGI is generally figured as a person’s (or couple’s) total income that is subject to tax minus specific deductions or adjustments. Some of those deductions or adjustments are:
- Half of the self-employment taxes you pay
- Alimony payments to a former spouse (for agreements prior to 2019)
- Contributions to certain retirement accounts (like a traditional IRA)
- Educator expenses
- Student loan interest
- Charitable contributions – Maximum of $300 per person ($600 per couple) for 2021 unless itemizing deductions
Preventing a Refund Delay
The IRS has had a significant backlog of unprocessed tax returns from previous years. That backlog plus the millions for returns being received emphasize the need for careful attention to details to ensure your return is processed timely and any refund paid promptly. Follow this list to help ensure a promptly paid tax refund:
- Make sure the tax return is accurate (double and triple check it)
- Hold onto letters from the IRS (letters this year include the 6419 for child tax credits and 6475 for the third stimulus payment)
- File electronically (paper returns are processed very slowly)
- Use direct deposit
- Use a tax professional (to help ensure you get all credits or deductions)
Inheriting an IRA
The rules changed in 2020 related to how Individual Retirement Accounts (IRAs) are inherited. Generally, a beneficiary who inherits an IRA has ten years to distribute the funds. There are some exceptions for spouses, disabled and underage children, etc. New “proposed” rules from the IRS have added a twist to the ten-year rule. If the deceased owner was already taking required minimum distributions (RMDs), under the proposed rules the beneficiary would have to continue taking an annual RMD during the ten years with any remainder disbursed in the tenth year. While most beneficiaries would spread the distributions from a traditional IRA out to minimize the income tax impact, these proposed rules will require some of the income to be taxed during the ten-year period. Since the distribution from a Roth IRA are not taxable, a beneficiary could take funds out during the 10 years or wait until the end of the period allowing the balance to grow. It is recommended to work with a financial advisor and/or accountant to plan for the impact of a taxable distribution.
Preventing an Audit
The IRS currently audits well less than 1% of all returns (last year around .4%). Taxpayers often make simple mistakes which cause the IRA to send them a notice of needed corrections to their return. Often it is a math error or simply failing to sign the return. Avoiding an audit is always advisable. According to Kiplinger, the following are 23 issues which might increase your chances of being audited:
Failing to report all taxable income; Making a lot of money; Taking higher than average deductions, losses or credits; Taking large charitable deductions; Donating to a conservation easement; Running a business; Claiming a rental loss; Not filing taxes; Writing off a hobby loss; Claiming 100% business use of a vehicle; Claiming the American Opportunity tax credit; Incorrectly reporting the health premium tax credit; Taking an early payout from an IRA or 401K; Taking an alimony deduction; Failing to report gambling winnings or claiming big gambling losses; Operating a marijuana business; Claiming day-trading losses; Taking the research and development credit; Engaging in virtual currency transaction; Engaging in cash transactions (especially if over $10,000 each); Failing to report a foreign bank account; Failing to report professional earnings as self-employment income and Claiming the foreign earned income exclusion.
What Tax Records Should Be Saved
The IRS typically has three years from when a return is filed to audit the return. Similarly, a taxpayer has three years to file an amended return. Most all information such as: W-2s, 1099s, unemployment benefits, investment income, 401K or IRA rollovers, retirement information, receipts for deductible expenses, etc. used to complete a tax return should be saved at least three years. The IRS does have the right to audit six years from the date the return was filed if the income was underreported by more than 25%.
Records of some transactions may need to be saved longer. Homeowners who have made improvements should keep records of the cost of those improvements. Homeowners currently can exclude up to $250,000 (or $500,000 for a married couple) of capital gain on the sale of home where they have lived for 2 of the past 5 years. However, home prices have been increasing rapidly. The gain on the sale could exceed the exclusion and records of any improvements might prevent paying capital gains taxes on the sale. After the sale of a home, it is advisable to hold on to the old records for 4 to 5 years.
Records of the purchase price of investments like stocks and bonds should be kept for four years after selling the investment. If selling a worthless stock, keep the statements for seven years as the loss can be claimed up to seven years in the future. If investing in cryptocurrency, keep records of cost for at least four years (some companies do not provide statements). Most investments held for more than one year are taxed at capital gains tax rates which are often lower than ordinary income tax rates.
Retirement Accounts like your 401K or IRA need to be kept to prove whether tax has already been paid on the income. Income tax has already been paid on funds invested in Roth IRAs and Roth 401ks. Keep records or statements of contributions for at least four years. If contributions were made to a nondeductible IRA it is recommended to keep those records forever. If funds were rolled over from a traditional IRA (which was not taxed) to a Roth IRA and tax was paid, keeping records of the transaction is advised to serve as proof if needed. Similarly, records of funds transferred from a 401K to and IRA should be kept as well for a minimum of four years should the IRS question the transaction.
To save space, scanning or digitizing records is recommended. However, be sure the electronic version is clear and readable before destroying the original. Be sure to protect access to the electronic version with a secure password. If using cloud storage, carefully read the storage agreement to understand any limits to the amount of space allowed and length of time the records will be stored.