Frequently Asked Questions

Are my Social Security benefits subject to income tax?
Do I have to pay U.S. taxes when I work abroad?
I don’t have the cash to pay my taxes. What can I do?
My spouse passed away this year. When I file my taxes, what filing status should I claim?
What is my tax bracket?
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What penalties and interest will I be charged for paying and filing my federal income taxes late?
Now that my child is in college, am I entitled to any education tax credits?
Can I deduct home office expenses?
Can I deduct the cost of improvements or repairs I have made to my home?
I paid my mother’s real estate taxes last year. Can I deduct this on my tax return?
We just bought our first home. What can we deduct from the settlement statement?
Are alimony payments considered taxable income?
What are the tax implications of child support payments?
Are life insurance proceeds income taxable?

Am I having enough tax withheld from my paycheck?

It is important that you properly estimate your tax withholding. If an insufficient amount of taxes is withheld, you may end up owing a substantial sum, including penalties and interest, when you file your tax return. Choosing the correct withholding amount for your salary or wages is a matter of completing Form W-4 worksheets, providing an updated Form W-4 when your circumstances change, and perhaps becoming familiar with IRS Publication 919, which deals with withholding. Two factors determine the amount of income tax your employer withholds from your regular pay: the amount you earn, and the information regarding filing status and withholding allowances that you provide your employer on Form W-4. If you accurately complete all Form W-4 worksheets and you do not have significant nonwage income (e.g., interest and dividends), it is likely that your employer will withhold an amount close to the tax you owe on your return. In the following cases, however, accurate completion of the Form W-4 worksheets alone will not guarantee that you will have the correct amount of tax withheld: When you are married and both spouses work When you are working more than one job When you have nonwage income, such as interest, dividends, alimony, unemployment compensation, or self-employment income When you will owe other taxes on your return, such as self-employment tax or household employment tax When your withholding is based on obsolete W-4 information for a substantial part of the year (e.g., you’ve gotten married, gotten divorced, gained a dependent, experienced income fluctuations) To ensure that you have the correct amount of tax withheld, obtain a copy of IRS Publication 919. It should help you compare the total tax to be withheld for the year to the tax you anticipate owing on your return. It can also help you determine any additional amount you may need to withhold from each paycheck to avoid owing taxes when you file your return. Alternatively, it may help you identify if you are having too much tax withheld.


Are my Social Security benefits subject to income tax?

A portion of your benefits may be subject to income tax if your modified adjusted gross income (MAGI), plus one-half your Social Security benefits, exceeds specific limits. Your MAGI equals: Adjusted gross income (or the adjusted gross income of you and your spouse if married and filing jointly), including wages, interest, dividends, taxable pensions, and other sources, Tax-exempt interest income (e.g., interest from municipal bonds and qualified U.S. savings bonds), and Amounts earned in a foreign country, U.S. possession, or Puerto Rico that are exempt from tax Up to 50 percent of your Social Security benefits may be subject to income tax if your combined income (MAGI plus one-half your Social Security benefits) exceeds $25,000 for an individual filing single, unmarried head of household, or qualified widow(er) with dependent ($32,000 if married and filing jointly). If your combined income exceeds $34,000 ($44,000 if married and filing jointly), up to 85 percent of your benefits is taxable. If you are married and filing separately, up to 85 percent of your benefits will be taxed unless you and your spouse live apart for the entire year. Consult an accountant or other tax professional for more information. Or, contact the Internal Revenue Service at (800) 829-1040 or www.irs.gov. Ask for Publication 554, Tax Guide for Seniors, and Publication 915, Social Security and Equivalent Railroad Retirement Benefits.


Do I have to pay U.S. taxes when I work abroad?

If you are a U.S. citizen working abroad, you may be able to minimize what you owe in U.S. income tax if you qualify for the foreign income exclusion. If you qualify, you may exclude up to $91,400 in foreign income from U.S. income tax liability in 2009. If you are married, your spouse is allowed an additional $91,400 exclusion. To qualify, you and your spouse must satisfy the following requirements: You must reside in a foreign country for an entire tax year or for at least 330 days during a 12-month period Your salary must be paid by a company or agency in your country of residence or by a U.S. company operating in that country Also, only earned income–salaries, wages, and fringe benefits, plus allowances and expenses for housing–qualifies for the exclusion. Dividends, interest, capital gains, pension or retirement distributions, and alimony do not qualify. If you are a member of the U.S. military or other government service and are living abroad, your income is not considered foreign income. You’ll have to pay taxes as if you were a taxpayer living in the United States. Even if you avoid U.S. income tax, you will likely pay some form of income tax to the country in which you reside and earn a salary. Should you fail to meet its residency requirements, or if you receive income above the allowable exclusion, you’ll probably end up paying both foreign and U.S. income tax. If you do pay foreign income tax, you can apply for a separate U.S. tax credit (using Form 1116) in the amount of foreign income tax you are required to pay. You’ll also owe U.S. Social Security taxes if your country of residence has no treaty to coordinate its social service coverage with the United States. However, if such a treaty is in force, you’ll pay foreign social service taxes to your host nation and will not be required to pay U.S. Social Security taxes. In addition, you may be subject to estate and gift taxes if you transfer property, no matter where that property is located. If you maintain a house in the United States, you may owe state income tax and local property tax. For more information, consult a tax advisor or contact the IRS at (800) 829-3676 or www.irs.gov and request Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.


I don’t have the cash to pay my taxes. What can I do?

If you don’t have the cash to pay your taxes and are unable to borrow the money from a relative or friend, you still have a few options. You can pay by credit card, propose an installment payment agreement or an offer in compromise to the IRS, or declare bankruptcy if you qualify. If you ignore your tax bill entirely, not only will interest and penalties accrue, but the IRS’s tax enforcement and collection powers include the ability to record liens on your property and levy to secure or satisfy such liens. If you’re short on cash, you can pay your taxes with a credit card. This will allow your tax bill to be paid on time. Therefore, you’ll avoid penalties and interest for late payment of taxes. However, the interest rate that the credit card company charges is often higher than what the IRS charges on late payments. You can make credit card payments through certain tax software programs or by calling (888) 272-9829. A fee may apply. An installment agreement is a monthly payment plan with the IRS. You enter into an installment payment agreement by informing the IRS that you are unable to make full payment of taxes. Your tax liability may be spread out over three years, and payments can be made through payroll deduction. You will generally be expected to pay the maximum installment amount that you can afford. You will not avoid interest and penalties with this payment method, but you will avoid more severe collection action. An offer in compromise is a negotiated settlement between you and the IRS, whereby the IRS agrees to accept a lesser figure from you in full satisfaction of your tax debt. You must meet certain criteria to qualify for offer-in-compromise treatment. Along with lowering your tax liability, an offer in compromise can help you avoid severe collection actions. Bankruptcy is a way to resolve your debts when you are unable to pay them. Many taxes cannot be avoided in bankruptcy; however, bankruptcy will suspend most collection activities by the IRS. In addition, reducing your overall debt burden by eliminating unsecured debt (such as credit card balances) through bankruptcy can make more money available to pay your IRS tax bill.


My spouse passed away this year. When I file my taxes, what filing status should I claim?

As the surviving spouse, you have several filing choices that may be appropriate. You may be able to choose married filing jointly, married filing separately, qualifying widow(er), or head of household. Married filing jointly: You can usually file a joint return for the year your spouse died. Generally, you’ll have to file in cooperation with the executor or administrator of your spouse’s estate. If you remarry before year-end, you cannot file a joint return with your deceased spouse for that year. Married filing separately: To determine the most advantageous approach, you should figure taxes according to both the married filing jointly status and the married filing separately status. Qualifying widow(er): If you meet certain requirements (e.g., you support a dependent child for whom you can claim a tax exemption, and you have not remarried), you can file as a qualifying widow(er) in each of the two years following the year of your spouse’s death. This status allows you to use the married filing jointly tax rates. Head of household: If you are ineligible to file jointly or as a qualifying widow(er), the head of household filing status may be possible. To qualify, you must provide support for a relative and meet several conditions. Regardless of whether you file a joint return or a separate return for your spouse, you must write “DECEASED” across the top of the return, along with your spouse’s name and date of death. If you file a joint return and no personal representative has been appointed, write your (and your spouse’s) name, address, and Social Security number in the regular name/address space at the top of the return. To sign the return, write “Filing as Surviving Spouse” in the space for your spouse’s signature, then sign in the space for your own signature. If you are not filing a joint return, write your spouse’s name at the top of the return and the personal representative’s name and address in the remaining space. If a personal representative has been appointed, he or she must sign the return. Again, you must also sign if it is a joint return.


What is my tax bracket?

Generally, a tax bracket is the income tax rate at which you are taxed for a certain range of income. The income ranges vary, depending on your filing status: single, married filing jointly (or qualifying widow(er)), married filing separately, or head of household. Brackets are expressed by their marginal tax rate, which refers to the rate at which your next dollar of income will be taxed. There are six marginal tax rates: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent. Year 2009 federal income tax rates for single taxpayers are as follows: If Taxable Income Is: Your Tax Is: Not over $8,350 10% of taxable income Over $8,350, but not over $33,950 $835+ 15% of excess over $8,350 Over $33,950, but not over $82,250 $4,675 + 25% of excess over $33,950 Over $82,250, but not over $171,550 $16,750 + 28% of excess over $82,250 Over $171,550, but not over $372,950 $41,754 + 33% of excess over $171,550 Over $372,950 $108,216 + 35% of excess over $372,950


What penalties and interest will I be charged for paying and filing my federal income taxes late?

If you fail to file your federal income tax return and pay your tax by the due date, you may have to pay one or more penalties, plus interest. Although you are allowed an automatic extension for filing your return if you mail in the appropriate form, you are not allowed an extension for paying your taxes. Interest is charged on any unpaid tax from the due date of your tax return until the date of payment. The interest rate is determined every three months. Filing late: If you do not file your return by the due date (including extensions), you may have to pay a failure-to-file penalty. The penalty is based on the tax not paid by the due date (without regard to extensions). The penalty is usually 5 percent of the tax due for each month or part of a month that a return is late, but not more than 25 percent. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $100 or 100 percent of the unpaid tax. (Exceptions: You will not have to pay the penalty if you show that you failed to file on time because of reasonable cause and not because of willful neglect. Also, you will not be subject to a late filing penalty if you do not owe any tax.) Paying tax late: You may have to pay a failure-to-pay penalty of one-half of 1 percent of your unpaid taxes for each month (or part of a month) the tax remains unpaid. The penalty can increase to 1 percent if you’ve been sent several notices to pay the overdue tax and still have not paid. In general, this penalty cannot be more than 25 percent of your unpaid tax. You may not have to pay the penalty if you can show that your failure to pay was due to reasonable cause and not due to willful neglect. This failure-to-pay penalty is added to interest charges on late payments. Combined penalties: If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is typically reduced by the .5 percent failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $100 or 100 percent of the unpaid tax. You may not reduce the failure-to-file penalty by the failure-to-pay penalty.


Now that my child is in college, am I entitled to any education tax credits?

You may be. There are two education tax credits–the Hope credit and the Lifetime Learning credit. To claim either credit in a given year (you cannot claim both in the same year), you must list your child as a dependent on your tax return. In addition, you must meet income limits. For 2009, a full credit (either Hope or Lifetime Learning) is available to single filers with a modified adjusted gross income (MAGI) below $50,000 and joint filers with an MAGI below $100,000. A partial credit is available to single filers with an MAGI between $50,000 and $60,000 and joint filers with an MAGI between $100,000 and $120,000. Now, what credit might you be eligible for? The Hope credit applies only to your child’s freshman and sophomore years of college. It is worth a maximum of $1,800 per year. It is calculated as 100 percent of the first $1,200 of your child’s annual tuition and related expenses, plus 50 percent of the next $1,200 of such expenses. One final point: To qualify for the Hope credit, your child must be attending college on at least a half-time basis. The Lifetime Learning credit is worth a maximum of $2,000 per year. It is calculated as 20 percent of the first $10,000 of your child’s annual tuition and related expenses. Unlike the Hope credit, the Lifetime Learning credit is available even if your child is enrolled on less than a half-time basis, and it can apply to your child’s junior and senior years of college. If you are eligible to take the credits, remember that you cannot claim both credits in the same year. As a result, you will need to determine which credit offers you the most benefit in a given year. In this analysis, you must consider an important distinction between the two credits. The Hope credit can be taken for more than one child in a given year, provided each child qualifies independently. For example, if you have two children in college, one a freshman and the other a sophomore, you can take a $3,600 credit on your tax return. By contrast, the Lifetime Learning credit is limited to $2,000 per tax return, even if you have multiple children who would qualify independently in the same year.


Can I deduct home office expenses?

If you use part of your home to conduct your trade or business, you might be able to deduct certain related expenses. To qualify for the home office deduction, you must pass certain tests. You must use part of your home regularly and exclusively for your trade or business. Exclusive use means that this space is not used for any nonbusiness purpose, such as watching television, during the tax year of the deduction. If the space is used for business only sporadically or occasionally, you may not meet the regular use test. Also, your home office must be used as either (1) your principal place of business or (2) a place where you meet customers, clients, or patients in the normal course of business. You may also be able to take a deduction if you use part of your home to perform administrative or management duties and you have no other location to do this work. If you are an employee and work from home, the business use of your home must be for the convenience of your employer in order to take the deduction. Certain expenses for a separate structure, such as a garage, may be deductible if the structure is used regularly and exclusively in connection with your business or trade. A separate structure that’s used in this way does not have to be your principal place of business, or a place where you meet customers, to qualify for the deduction. If you qualify under these tests, you can deduct certain expenses related to the business use of your home, but your deduction is limited by the percentage used for business and the deduction limit. You can deduct both direct and indirect expenses that apply to the portion of your home that you use for business purposes. Direct expenses are costs expended solely on the part of your home that you use for business purposes, and these can be deducted in full (subject to the deduction limit). They include such expenses as painting, and installation of separate telephone jacks and wiring. Indirect expenses are costs that benefit your entire home, including the portion you use for business. Indirect expenses include mortgage interest, property taxes, insurance, and so on. You may deduct a percentage of these expenses. You may use a square footage calculation or any other reasonable method to compute the business portion of indirect expenses. If you are self-employed and not a farmer, you must file IRS Form 8829 to take advantage of the home office deduction. IRS Publication 587, titled Business Use of Your Home, offers more information on taking this deduction.


Can I deduct the cost of improvements or repairs I have made to my home?

Generally speaking, you can deduct neither the cost of improvements nor the cost of repairs you’ve made to your principal residence. (However, improvements to your home for necessary medical care may be deducted as a medical expense, if all requirements are met.) Although the improvements cannot be deducted, they do increase the basis of your home. Home improvements add to the value of your home, prolong its useful life, or adapt it to new uses. Examples of improvements include the following: Paving a driveway Paneling a den Putting up a fence Adding a bathroom You should add the cost of improvements to the basis of your property. Your initial basis is usually the cost of your property (what you paid for it originally). Improvements increase your basis. If you sell your home in the future, improvements could lower your tax bite because any gain realized is reduced by additions to the basis of your property. Repairs are different from improvements; repairs keep your home in good operating condition. They do not materially add to its value or substantially prolong its life, and you do not add their cost to the basis of your property. Examples of repairs include the following: Repainting your house (inside or out) Fixing your gutters Replacing broken window panes Note: An entire repair job may be considered an improvement if items that would otherwise be considered repairs are done as part of extensive remodeling or restoration of your home.


I paid my mother’s real estate taxes last year. Can I deduct this on my tax return?

Probably not. A real estate tax can be deducted only by the owner of the property upon which the tax is imposed. Therefore, if the deed to the property lies in your mother’s name, you are not entitled to a deduction for the real estate taxes even if you are the one who actually paid them. Generally speaking, taxes are deductible in the year you pay them. Sometimes real estate taxes are prepaid. If you are the property owner, you can generally deduct prepaid real estate taxes in the year of the prepayment if (1) you are a cash basis taxpayer and (2) you don’t live in a jurisdiction where the taxing authority considers prepayment a “deposit.” Jurisdictions vary regarding how they treat prepaid tax. Be aware that taxes placed in escrow generally aren’t deductible.


We just bought our first home. What can we deduct from the settlement statement?

If you took out a mortgage to purchase your home, you probably paid settlement costs in addition to the contract price. These costs generally include points, attorney’s fees, recording fees, title search fees, appraisal fees, and other loan or document preparation and processing fees. The only settlement costs you can deduct are home mortgage interest and certain real estate taxes. You deduct them in the year you bought the home if you itemize your deductions. Certain settlement costs can be added to the basis of your home. Other settlement or closing costs, however, cannot be deducted or added to the basis. If the loan was for the purchase of your primary residence, the points withheld from the loan proceeds will generally be deductible as up-front interest if you paid a down payment, escrow deposit, or earnest money equal to the charge for points. Generally, you can also deduct any points paid by the seller. Real estate taxes are usually divided so that you and the seller each pay taxes for the part of the property tax year that each owned the home. You can deduct the taxes you actually paid during the year. However, you cannot take a present deduction for taxes paid in escrow for a future tax bill. Other closing costs that you paid are not deductible and must be added to the cost basis of your home. You can include in your basis the settlement fees and closing costs that you paid that are associated with buying your home. You cannot include in your basis the fees and costs associated with getting a mortgage loan.


Are alimony payments considered taxable income?

Alimony is a support payment made to a former (or separated) spouse under a divorce decree or separation instrument in an attempt to maintain the predivorce lifestyle. Alimony is sometimes called maintenance. Simply stated, alimony is taxable income to the one who receives it and tax deductible to the one who pays it. To be considered alimony under present tax rules, however, the payments must meet several requirements. These requirements include (but are not limited to) the following: All payments must be made in cash, check, or money order A written court order or separation agreement must exist regarding the alimony The order or agreement must not designate the payment as not being alimony (i.e., it cannot be designated as child support) The couple generally cannot live in the same household while alimony is being paid (although an exception applies in the case of payments to a separated spouse living in the same household if the payments are made under a written separation agreement, support decree, or other court order) The obligation to pay alimony cannot continue past the death of the payor-spouse The former spouses cannot file a joint tax return You should also be aware of the alimony recapture rules. Because alimony is tax deductible, some spouses are tempted to disguise property settlement payments as alimony. They might accomplish this by front-loading alimony during the first couple of years. That is, one spouse might agree to pay high sums of alimony during the first two years after the divorce, and to continue with normal payments thereafter. According to the alimony recapture rules (which are fairly complex), deductible alimony payments will be recharacterized as nondeductible property settlement payments to the extent that payments made during the first two years are excessively front-loaded.


What are the tax implications of child support payments?

When a separation or divorce occurs and the couple involved has one or more children, the noncustodial parent is usually ordered to pay some child support to the custodial parent. The child’s expenses over and above this sum are generally borne by the custodial parent. Whether you are paying or receiving child support, you should be aware of the federal income tax consequences. You are not taxed on child support that you receive, and you cannot deduct child support that you pay. Payments will be classified as child support for federal income tax purposes if the divorce decree or separation agreement: Fixes a sum that is payable for the support of a child (this can be either a dollar amount or a specific fraction of a payment), or Provides that the amount payable by the payor-spouse to the receiving spouse will be reduced when a contingency relating to a child actually happens, or at a time that can clearly be associated with a contingency relating to a child For example, John agrees to pay his ex-wife, Carol, $2,500 per month until she dies. (Note that the words child support are not specifically mentioned.) Carol has custody of their child, Justin. The divorce agreement states that upon a certain date, John’s required payment to Carol will decrease by $800. Because Justin will turn 18 within six months of the date on which the payment is scheduled to decrease, the payment reduction is assumed to be related to Justin’s reaching 18 years old. Therefore, the $800 per month reduction is treated as child support, regardless of the parties’ intent. From a tax perspective, being a custodial parent can be advantageous in terms of claiming the child dependency exemption and the child-care credit. In addition, the custodial parent can potentially qualify for head of household filing status.

Are life insurance proceeds income taxable?

In general, life insurance proceeds paid to you because of the death of the insured are not subject to federal income tax. To qualify for such favorable tax treatment, the life insurance contract must meet certain IRS requirements. However, proceeds may be taxable in limited cases. For instance, if you receive the insurance proceeds in installments and interest is paid, the interest portion of the payment generated after the insured’s death is treated as taxable income. This is taxed at your ordinary income rate. The part of the installment payment that is classified as investment in the contract is not taxable, however. If a life insurance policy is sold or otherwise transferred for valuable consideration before the insured’s death, the proceeds (except to the extent of that consideration) are generally taxable to the beneficiary, unless an exception applies. This transaction is complicated, so be sure to seek professional assistance before proceeding. Note: Different federal income tax rules may apply to accelerated death benefits (i.e., due to a terminal or chronic illness) and to other types of life insurance benefits paid before the insured’s death (e.g., cash withdrawals, policy loans, dividends).

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