The Q Word

April 5, 2013

Comments and Advice to Help Improve the Tax Returns That We Prepare

Next to being shot at and missed, nothing is really quite as satisfying as an income tax refund. F. J. Raymond

HE OWES, SHE OWES, THEY OWE

Uh oh. Not everybody gets a refund. Last year, the Center for Economic Progress, a VITA preparer in Illinois, prepared 16,008 federal 2011 returns and 15% had a balance due. Thats 2,470 families who ended up owing Uncle Sam. Most balance due returns seem to happen toward the end of the filing season. So its that time of year. Here are some things to remember and some sample conversations that may help when serving clients who owe. Explain the balance due. Go through the 1040 and provide a basic explanation of how the balance due was computed. If the client got a refund last year, look at the prior year return and explain the differences. There are lots of issues that can cause a balance due. Here are some examples. 1. UNEMPLOYMENT COMPENSATION Often there is no withholding. Unemployment is not considered earned income for the EITC or the additional child tax credit. A taxpayer who only had unemployment income will not qualify for EITC. 1. SELF-EMPLOYMENT INCOME Self-employment income is subject to two taxes on the return: income tax and selfemployment tax. There is usually no withholding from self-employment income. 2. EARNED INCOME TAX CREDIT When a taxpayer turns 65 and has no qualifying child, that taxpayer no longer qualifies for EITC. When a child age 19 23 quits school, that child (if not disabled) may no longer be the parents qualifying child for EITC. A client who retires may no longer have earned income. A client who changes filing status to married filing separately no longer qualifies. An increase or decrease to income may mean that the client qualifies for much less or even zero - EITC. 3. CHILD TAX CREDIT A qualifying child may still be the taxpayers dependent, but if the child turned 17 during the tax year the client loses the $1,000 child tax credit. In most cases, someone with earned income under $3,000 will not qualify for the additional child tax credit.

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April 5, 2013

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4. OTHER STUFF A taxpayer who cashed in a 401(k) to pay for general living expenses must pay income tax on that income, as well as the 10% early distribution penalty. Filing married filing separately can have lots of negative effects, such as no education credits, less standard deduction, or increased taxable amount of social security. Sometimes a client gets a new job and claims too many withholding allowances. After graduation from college, the loss of the American opportunity credit can make a big difference in the bottom line on the tax return. Sometimes a family change results in the loss of an exemption; e.g., grandma dies, daughter gets a job and moves out, the grandkids move back in with their parents. Im finished. The next step is to have my manager come over and review my work. But it looks like you have a $1,450 balance due on the federal return. Casey: Well, that cant be right. I always get a refund. Prep: Do you have a copy of your return from last year? Casey: Here it is. You can see I got almost $700 back. Thats how it always is. Prep: I see that your son turned 17 in October. That meant a loss of the $1,000 child tax credit. Also, you had some self-employment income in 2012, which means that you have to pay social security and Medicare tax, as well as income tax. After the manager completes his review, we can go through things line by line and Ill be glad to answer any of your questions. Comment: If both you and the client are gobsmacked by the balance due, check your work. There are lots of ways a preparer can inadvertently cause an incorrect balance due. For example, if there is no EITC, make sure that you know why. One wrong check mark on the EIC worksheet can block the EITC. File it anyway. Often clients who owe want to delay filing the return. Inability to pay a balance due is not a reason to file late. In fact, its a big reason to file on time. A taxpayer who files late with a balance due pays a late filing penalty up to 25% of the amount owed - in addition to any late payment penalty and interest that might be assessed. The payment is due April 15, whether the client files in January or April. The client can and should - still e-file. The clients tax return copy will include a Form 1040-V payment voucher that can be used to make the payment any time on or before April 15. Casey: Well, I understand that I owe, but theres no way that I can pay $1,450 now! Just print it out and give me an envelope. Ill mail it in with a check once my summer job starts in June. Prep: Its really important that you file the tax return before April 15 even if you cant pay a dime. If you file on time and wait to pay in June, theyll add a small penalty and some interest. If you wait to file and pay in June, theyll add a larger penalty for late filing. Casey: OK. How does it work, then? Prep: We can go ahead and electronically file the return now. We will give you a payment voucher and you can send in your payment as soon as you can. If you pay it all before April 15, there will be no penalties or interest. Casey: I told you, I cant pay until summer! Prep: OK. Pay what you can and IRS will charge you some penalty and interest on any amounts paid after April 15. But it will be a lot less penalty if you file on time. Consider the estimated tax penalty. Prep:

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Someone who owes more than $1,000 may owe an estimated tax penalty. The estimated tax penalty appears on Form 1040, line 77. Taxpayers do not owe the penalty if either is true:

 The balance due is less than 10% of the total tax. The taxpayer paid no tax liability for tax year 2011. Taxpayers are not obligated to compute and report their own estimated tax penalty. TaxWise may generate Form 2210, Underpayment of Estimated Tax. If the client paid no tax for 2011 or the client prefers to let IRS compute the penalty and send a bill - go to Form 2210, page 1, Part II, line 9, and override and enter zero. Comment: Estimated tax penalty issues can be complex. For more information, see Publication 505, Tax Withholding and Estimated Tax, http://www.irs.gov/pub/irs-pdf/p505.pdf Explain payment options. Theres a lot of different ways that someone can pay IRS. Mail a paper check, using Form 1040-V, Payment Voucher. The taxpayers SSN and the tax year should be written on the check. Set up electronic funds withdrawal to have the balance due automatically taken out of a checking or savings account. This option is only available to taxpayers who file electronically. See Publication 4012, page 6-3, for detailed instructions. Use electronic payment alternatives: payment with direct transfer, credit card, or debit card. The client can go to www.irs.gov/e-pay to set up the payment. Clients can pay by phone. Find instructions in Publication 17, page 13. Prep: Theres a way to make payment online using the IRS web site. Casey: Nope. I dont want to mess with that. Cant I just mail checks? Prep: Yes. Be sure to write your SSN on the checks. Ill get you some envelopes. Discuss options with clients who cant pay. First, make sure that the client understands the basics: File the tax return by April 15. To reduce penalties and interest, pay as much as possible by April 15 and the remaining balance as soon as possible after that. Taxpayers have two options to get more time. Apply for an installment agreement. An online application is available. There are fees associated with getting an installment agreement. Low-income taxpayers may qualify for lower fees. http://www.irs.gov/Individuals/Online-Payment-Agreement-Application Request a delay of up to six months for situations where paying would cause undue hardship. Apply using Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship, by April 15, 2013. Encourage clients to talk to IRS or seek assistance from a low-income taxpayer clinic (LITC). Ignoring a balance due problem wont make it any better. : IRS customer service: 800-829-1040. Visit an IRS office. Find an office at: http://www.irs.gov/uac/Contact-Your-Local-IRS-Office-1 Clients with the more serious problems or who need representation can find an LITC at: http://www.irs.gov/uac/Contact-a-Low-Income-Taxpayer-Clinic Prep: Remember, if you pay it all by April 15, you wont owe any penalties. Casey: If I pay this by April 15, I wont be able to pay my rent and Ill get evicted. Prep: I suggest you send in this Form 1127. Theres no way to avoid interest, but it will give you six months with no penalties. Casey: Fine. Guess its worth a try. The Q Word Center for Economic Progress April 5, 2013

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Talk about prevention. You want to consider how to prevent a balance due in the future. Self-employed taxpayers sometimes have little or no records of expenses and could reduce the amount of tax with good recordkeeping. Suggest that the client consult Publication 587, Business Use of Your Home, or Publication 583, Starting a Business and Keeping Records. Self-employed taxpayers sometimes have little or no records of expenses and could reduce the amount of tax with good recordkeeping. Suggest that the client consult Publication 587, Business Use of Your Home, or Publication 583, Starting a Business and Keeping Records. Some taxpayers who anticipate a tax liability not covered by withholding may need to make quarterly estimated tax payments. The estimated tax worksheet and payment vouchers are available on TaxWise Form 1040ES. If the issue is too many withholding allowances, employees can give an employer a new W-4 at any time. You can refer the client to the IRS online withholding calculator. (It works, but is a bit intimidating.) Or find the W-4 form on TaxWise and prepare and print it for the client. If the client has an ADP W-2 you can see how many withholding allowances the client has been claiming:

Are you still working at the same job? I will be. I work there every summer. Will your self-employment house cleaning income be about the same? Yes, I expect Ill make about the same amount next winter. I suggest that instead of claiming three withholding allowances at your job, you change your W-4 to claim zero withholding allowances. Casey: Doesnt that mean a smaller pay check? Prep: Yes. It will mean that your employer will take out more taxes. But the extra withholding should cover your taxes, including the social security and Medicare taxes on your house cleaning income. That way you wont owe next year. Casey: OK. Its better than worrying about a debt. Its not your fault! Preparers often feel guilty when a client owes. Your responsibility is to do your best with what the client provides and claim all available benefits. Make sure your work is thoroughly checked and then do your darndest to explain things to the client.

Prep: Casey: Prep: Casey: Prep:

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The Q Word is written to provide commentary, information, opinions and observations from a grass roots perspective to all Preps, managers, and coordinators that are involved in free income tax preparation programs. If you have any suggestions for the Q Word, or would just like to submit comments, questions, praise, or bitter criticism, please e-mail: Barbara DelBene at bdelbene@economicprogress.org

The Q Word Center for Economic Progress

April 5, 2013

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