Taxation – FAQs
1. I DID NOT FILE TAX RETURNS FOR THE PAST SEVERAL YEARS, WHEN I WAS REQUIRED TO DO SO. WHAT SHOULD I DO?
Failure to file required tax returns can be a crime. Also, you may be responsible for tax due. Don’t wait to be contacted by the IRS. You may lose strategic advantage if you do. In many cases, the best advice is to file outstanding returns and try to work out payment problems with the IRS. To protect yourself, particularly from criminal exposure, seek the advice of a knowledgeable tax professional.
2. I INHERITED SOME MONEY FROM MY MOTHER, WHO RECENTLY PASSED AWAY. DO I HAVE TO PAY INCOME TAX ON THIS?
As a general rule, inheritances are not subject to federal or Connecticut income tax. Exceptions do exist, however. For example, if you received money from your mother’s Individual Retirement Account (“IRA”), there most likely will be income tax due on the proceeds.
3. MY MOTHER GAVE ME HER HOUSE. DO I HAVE TO PAY INCOME TAX ON THE GIFT?
Generally, gifts are tax free to the recipient. However, the donor (your mother) may owe a tax, which if not paid, you, the recipient, must pay. Also, if and when the gifted property is sold, there may be income tax due. This is known as a capital gains tax. Pre-gift tax planning can result in substantial future tax savings to the recipient.
4. I WANT TO GIVE $50,000.00 TO MY SON TO BUY A HOUSE. AM I SUBJECT TO GIFT TAX?
Both the federal government and the State of Connecticut have a $13,000 gift tax, which is imposed on the person who makes the gift. There are exceptions. For example, tax-free gifts of up to $12,000.00 per person may be made each year under the annual exclusion amount. Gifts to your spouse are exempt. There are also exceptions for certain medical and education expense-related gifts. If the gift is over the annual exclusion amount, returns are required to be filed on or before April 15th following the year in which the gift was made, even if a gift tax is not due at that time.
5. WHAT IS AN OFFER IN COMPROMISE?
An Offer in Compromise is an agreement between a taxpayer and a taxing authority (e.g., IRS, Department of Revenue Services, etc.) that resolved the taxpayer’s liability. Taxing authorities have the ability to settle, or “compromise,” federal and state tax liabilities by accepting less then full payment under certain circumstances. A tax debt can be legally compromised by way of an Offer in Compromise for one of the following reasons:
- Doubt as to Liability – Doubt exists that the assessed tax is correct.
- Doubt as to Collectibility – Doubt exists that you could ever pay the full amount of tax owed.
- Effective Tax Administration – There is no doubt the tax is correct, and no doubt that the amount owed could be collected, but an exceptional circumstance exists that allows the taxing authority to consider a taxpayer’s Offer in Compromise. To be eligible for an Offer in Compromise on this basis, the taxpayer must demonstrate that collection of the tax would create an economic hardship or would be unfair and inequitable.
Offers in Compromise are generally accepted when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects collection potential. It is a reasonable alternative to declaring a case currently not collectible or to a protracted installment agreement. For more information, contact a tax attorney at our firm to further discuss the Offer in Compromise procedure.
6. WHAT IS AN INSTALLMENT AGREEMENT?
Installment Agreements allow taxpayers who cannot pay their back tax liability in full or don’t qualify for an Offer in Compromise the option to pay through monthly payments. There are guidelines that determine the payment amount and time frame for the agreement. Additionally, a taxpayer must be compliant with all past tax filings before entering into an Installment Agreement. Depending on the circumstances and the amount of time that the tax authority has left to collect the tax debt, the Installment Agreement may pay all or part of the back tax liability. Once an Installment Agreement has been established, taxing authorities will suspend their collection efforts and refrains from issuing wage garnishments, bank levies, sending notices and making harassing phone calls. For taxpayers that cannot afford to pay their back taxes in full and do not qualify for an Offer in Compromise or a Currently Not Collectible status, an Installment Agreement may be their best alternative. For more information, please contact a tax attorney at our firm to further discuss the Installment Agreement process.
7. WHAT IS THE DIFFERENCE BETWEEN AN IRS TAX LIEN AND AN IRS TAX LEVY?
An IRS tax lien is the federal government’s right to ensure payment of owed taxes by allowing them to place a secured debt on a negligent taxpayer’s property. Tax liens are generally a result of delinquent taxes and they can be placed on real property or personal property. Typically, they act almost as a mortgage against the property and only come into play when the taxpayer is attempting to sell the real or personal property. At the time of sale, the IRS can claim a right to the proceeds of the sale.
An IRS levy is a technical term used to denote an administrative action by the IRS to actually seize property to satisfy a tax liability. A tax levy gives the government the ability to impose this collection without having to get permission from a court. Typically, the IRS uses a levy to seize two types of property: income and proceeds in a bank account.
By law, the IRS is required to issue a Notice of Intent to Levy at least thirty (30) days before the IRS can actually impose the levy. On the other hand, a Notice of Federal Tax Lien is generally issued after the tax lien arises. Furthermore, while a federal tax lien applies to all of a taxpayer’s property and rights to property, an IRS levy is subject to more specific restrictions.
8. WHAT ARE THE SPECIFICS OF THE FIRST-TIME HOMEBUYER FEDERAL INCOME TAX CREDIT AS PROVIDED IN PRESIDENT OBAMA’S 2009 STIMULUS PACKAGE?
- Amount of Credit: The amount of the tax credit is the lesser of $8,000 or 10% of the cost of the home.
- Eligible Property: Any single-family home (including a condo or townhouse) may be an eligible property under the tax credit, provided it will be used as the homebuyer’s principal residence.
- Refundable: The $8,000 tax credit is a clean refundable credit – unlike the one that was passed in 2008, which required a repayment. If you qualify as a first-time buyer, then you can claim the $8,000 is greater then the tax you owe, then you will get a refund check for the difference.
- Income Limit: In order to be eligible for the full tax credit, the homebuyer must have an annual adjusted gross income of no more then $75,000 ($150,000 on a joint return). A homebuyer with an annual adjusted gross income above that level and up to $95,000 ($170,000 on a joint return) is eligible for a reduced tax credit.
- First-Time Homebuyer Only: The tax credit is designed for first-time homebuyers, which means the homebuyer (and/or the homebuyer’s spouse), must not have owned a principal residence in the three years prior to purchase of the eligible property.
- Repayment: There is no repayment of the tax credit by the homebuyer.
- Recapture: If the eligible property is resold within three years of purchase, the entire amount of the tax credit is recaptured on the sale.
- Effective Date: The First-Time Homebuyer Federal Income Tax Credit is effective for purchases on or after January 1, 2009, and before December 1, 2009.
9. CAN I WITHDRAW FUNDS PENALTY FREE FROM MY 401(k) PLAN TO PURCHASE MY FIRST HOME?
If you are under the age of 59-1/2, you cannot withdraw funds from your 401(k) plan to purchase your first home without being subject to a ten percent additional tax on early distributions from qualified retirement plans. However, depending on the rules for your 401(k) plan, you may be able to borrow money from your 401(k) plan to purchase your first home. Your plan administrator should have written information about your particular plan that explains when you can borrow funds from your 401(k) plan as well as other plan rules.
10. WHAT IS THE PRINCIPAL RESIDENCE EXCLUSION AND HOW DO I KNOW WHETHER I QUALIFY?
Taxpayers who sell or exchange a principal residence after May 6, 1997 can exclude up to $250,000.00 on a single return or up to $500,000.00 on a joint return of unrealized gain. A residence includes houseboats, trailers, condos, and co-ops. Gain is computed by subtracting from the gross sales price the selling expenses, cost of improvements, and adjusted basis or original cost which is reduced by any previously deferred gain.
Taxpayers must meet three tests to qualify:
(i) The taxpayer(s) must have owned the residence for at least two of the last five years ending on the date of sale. In the case of a couple living in the residence, only one taxpayer/owner needs to meet the test.
(ii) The taxpayer(s) must have used the residence for at least two of the last five years ending on the date of sale. Both occupants must meet this test, but the time does not have to be consecutive.
(iii)The taxpayer(s) must not have used the $250,000.00/$500,000.00 exclusion for any residence sold or exchanged during a two year period ending on the date of the current sale or exchange. This test does not apply if the first sale or exchange occurred before May 6, 1997.
11. WHAT ARE THE BENEFITS OF A LIKE-KIND EXCHANGE UNDER INTERNAL REVENUE CODE SECTION 1031?
In a typical transaction, the property owner is taxed on any gain realized from the sale. However, through a like-kind exchange, the tax on the gain is deferred until some future date. Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of “like-kind”, while deferring the payment of federal income taxes and some state taxes on the transaction. The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer’s investment is still the same, only the form has changed (e.g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a “paper” gain. The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.
12. I RECENTLY LEFT MY JOB. WHEN I DID, I RECEIVED A DISTRIBUTION FROM MY EMPLOYER’S RETIREMENT PLAN FOR MY VESTED SHARE. IS THIS TAXABLE?
Yes, but you can defer paying the tax on any portion of the distribution that you had your previous employer roll over directly into your IRA within 60 days. If you do not roll over, but receive the distribution, and if certain other exceptions do not apply, you will have to pay regular income tax, plus a ten percent penalty, on the distribution. The penalty does not apply in all instances. For example, the penalty is not imposed if you are over a certain age or if you use the proceeds to purchase health insurance during an unemployment period. Chances are your employer withheld 20 percent of your distribution for taxes. The withheld amount is only an estimate of tax due. You may owe additional tax. For some taxpayers, the withholding makes it difficult to roll-over the entire distribution, because of lack of funds. The withholding tax can be avoided if you arrange to have the distribution made directly to an IRA.
13. I HAVE INVESTMENTS IN ANOTHER COUNTRY. I DO NOT RECEIVE ANY U. S. TAX REPORTING DOCUMENTS, SUCH AS A FORM 1099, FOR THE INCOME EARNED. DO I HAVE TO PAY U. S. INCOME TAX ON THIS INCOME?
As a general rule, U. S. citizens are taxed by the United States on all income earned, regardless of source. If you pay foreign tax on the income, you may be eligible for a tax credit or deduction on your U. S. return.
14. MY FORMER HUSBAND AND I FILED JOINT TAX RETURNS FOR AS LONG AS WE WERE MARRIED. LAST YEAR WE DIVORCED. HE HAS SINCE DISAPPEARED TO PARTS UNKNOWN. I WAS RECENTLY CONTACTED BY THE INTERNAL REVENUE SERVICE AND INFORMED THAT I OWE A SUBSTANTIAL AMOUNT OF TAX AS A RESULT OF AN AUDIT. APPARENTLY, MY EX-HUSBAND WAS INVOLVED IN A SHADY BUSINESS DEAL. I KNEW NOTHING ABOUT HIS BUSINESS AFFAIRS. I JUST TOOK HIS WORD AT THE TIME THAT THE TAX RETURN WAS OKAY, AND I SIGNED IT. AM I RESPONSIBLE FOR THE TAX?
When spouses file a joint tax return, each spouse is responsible for the entire tax obligation, regardless of who earned the income. However, you may qualify under a relief provision in the tax laws for Innocent Spouse Relief. To the extent that you so qualify, you will not be responsible for the tax.