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I Forgot To File My Taxes

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Every year I meet a couple people who tell me “I forgot to file my taxes.” How do you forget to file???? Here’s the steps to make it all right with the government.

Did you file your taxes this year? Did you know that nearly 10 million U.S. citizens fail to file by April 15th each year? Some avoid filing on purpose, but many just plain forget. So don’t worry. If it slipped your mind, you’re not alone.

If you still have yet to calculate your refund/payment, do this immediately. Even though you’re late, the process is still the same. Get the appropriate forms and gather all of your tax information and either head to your accountant or calculate your taxes yourself (whatever it is that you typically do). Once you know whether you owe money into the government or if you’re getting a refund, you can take the next steps to file.

 

What Is The Penalty?

 

For most of us, we plan on receiving a refund each year. Some of us even plan on getting as much back at $4,000 or more. This shouldn’t really be your goal since you’re basically allowing the government to use your extra money interest free, but that rant is for another article I suppose. If you have always received some money back each year, then you have absolutely nothing to worry about for filing late. There is no penalty. I was actually surprised to learn this, but it makes complete sense. Why should the government charge you if they just get to keep your money a little longer. In fact, they would probably rather that you never filed your taxes!

If, however, you typically owe money into the government each year, then you will most likely have to pay in a little extra for your late payment. There are three types of penalties that you’ll have to pay: Failure to File Penalty, Failure to Pay Penalty, and Interest.

Failure to File Penalty

This penalty occurs because you did not file your taxes by the deadline and you owe money to the government. The amount of money you owe depends on how late you are to file. If you’re a month late, then you owe and additional 5% on top of what you already owe. For each month that it’s late, you have to add an additional 5%, up to a maximum penalty of 25% (if you’re 5 months late or more).

Failure to Pay Penalty

This penalty occurs when you file, but you just don’t pay the amount you owe. The penalty is 0.5% for each month that you have still not paid in full. There is not maximum penalty, so it’s definitely best to pay the full amount as quickly as you can.

Interest

In addition to the traditional penalties, the government also want’s the money back with interest. While this amount changes all the time, it is currently set at 3% interest per year, but it is calculated based on every day that your return/payment is late. Again, it’s best to pay this sooner rather than later.

Basically, to sum it up, if the government owes you money, you have nothing to worry about. Just file your taxes and you’ll receive your check shortly, with no penalty. If you owe money in, then you’ll have to pay quite a few penalties. So, rather than play the “wait and see” game, you should calculate your taxes and file them as soon as possible.

Photo: 401(k) 2013

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Five Money-Saving Tasks That’ll Help You Cha-Ching! in the 4th Quarter

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I love the sound of the cash register ringing, don’t you?

If you’re going to be successful in your financial life, treat it as if it’s a business and you’re trying to hear that awesome cash register sound. If you don’t, you’ll always prioritize yourself behind more “important” activities like your job (nevermind that the job is there to help your net worth…that’s probably the subject of another post).

Every business has a mandatory list of activities that can’t be ignored. So does your financial life.

Here are five items that MUST be on that list this quarter:

1) Mutual fund capital gains. Even if you don’t have mutual funds outside of an IRA now, you should learn how these rules work. When the manager (or system, for an index fund) trades stocks or bonds inside of the fund a capital gain is generated. Someone has to pay it, and there’s no real fair method, so the mutual fund company declares a date and divides the gain among shareholders of record. Even if you didn’t sell the fund, you’re responsible for your portion of the manager’s buying and selling.

With results so far in 2012 looking up, there’s a good chance you might get hit with a tax bill this year. Avoiding this tax is legal and easy. Find the dates the fund declares capital gains and transfer your money to a different fund in the same family. This avoids fees for switching and the manager’s capital gains tax.

Grab a calculator before you move any money. You’ll still be on the hook for capital gains taxes you generate by selling as well. The cost of switching might outweigh the savings you’ll realize from avoiding any taxes created by the fund manager.

2) The lemon drop. Hoping to skim off some of that skyrocketing Apple stock? Cover a portion of your capital gain by also selling your brother in law’s “can’t lose” loser. There’s no time like now to weed your portfolio of positions that aren’t going anywhere. Although you’re only allowed to show $3k in net capital losses each year, leftovers can be carried over to deduct in future years.

3) Charitable giving. Hopefully you’ve given to your favorite community non-profits throughout the year, but if not (and especially if you itemize), you’ll want to make cash and in-kind donations in before December 31. Keep receipts for your gifts. The IRS has tightened charitable giving laws in recent years.

4) Estimate your taxes and decide when to pay property taxes. If you own a home winter taxes are deductible either in December or January, your choice. Did you receive a big bonus this year? Take the extra deduction now to help lower your tax due. If you make too much, it might be a better idea to wait until next year. High income earners aren’t allowed to claim all of their itemized deductions (ask your accountant about whether you’re subject to phaseouts).

5) Goal evaluation and setting. The 4th quarter is the perfect time to begin thinking about your short and long term goals. Did you hit your benchmark in 2012? If not, what are you going to change in 2013?

While people generally talk a good game about benchmarking, most of my clients were surprised when I pulled the actual number out of their plan to see if they’d hit the mark during a year. By sticking with actual data and avoiding the “Yeah, it feels like I had a good year” you’ll be able to make the necessary course corrections to save the right amount of money in the upcoming year.

I’ll be addressing each of these areas in more detail during the course of the quarter, but do yourself a favor and schedule these tasks now. These are five activities that you don’t want to miss!

What other events are on your 4th quarter financial calendar?

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How to Split an IRA or 401(k) in a Divorce

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Divorce is ugly.  Except under the most limited circumstances, no one wins in the divorce game.  Then, you add the complexity of money into the equation and it gets downright hideous.  In that emotional time, it’s easy to understand why so many people divide IRAs, 401(k)s, and other retirement accounts sub-optimally.

You can’t just “take the money out and give it to my spouse”  That would be a big mistake.  Let me count the ways:

Let’s assume you own a $250,000 401(k) balance.  The judge rules that you’re required to split that 50/50 with your spouse, so you decide it would be easiest to make a phone call and take the money out.  Ouch.  If you do that, you’ll be hit with a 10 percent early withdrawal penalty (yes you, not your spouse, and only if you’re under 59 1/2) and then the amount you removed is added to your taxable income for the year.  Now, for many reading this blog, you’ve just lost 35-45%.

So how do you give $125,000 to someone?  Oh that’s easy – you gift that to them.  But in your haste, you didn’t do this correctly either. To gift it, you either need to reduce your lifetime exemption by filing a form 706 with your income taxes next April, or pay a gift tax of 50%.

Long story short: “taking it out” could be a massive financial mistake.

Instead, consider asking for a QDRO, or Qualified Domestic Relations Order (pronounced quad-row).  A QDRO put together by a competent attorney and signed off on by the judge makes this transfer a ton easier.

First, it directs your retirement plan company to establish another qualified plan in the name of your spouse.  Then, it directs a tax-free transfer to that newly established account.  No taxes, no penalties.  Easy as pie.

Once you’ve begun working on that, you’ll want to make sure the QDRO says that your soon-to-be ex-spouse can’t make any loans or transfers from the account until it’s been split; or you could just pick a date to make the transfer effective on (retroactive) and put a fixed dollar amount based on that date’s plan balance.  This would protect the new beneficiary from being bamboozled by his or her ex.

Finally, don’t forget about pension plans.  A lot of those can be “QDROed” too.  For example, let’s assume your spouse earned a pension at his job of $4,000 during the 30 years he worked.  He was married to you for 20 of those 30 years – making you the owner of 2/3 of his $4,000 per month.  By putting the QDRO in place before he retires, she can have her own pension plan – quite the deal!

At the end of the day, divorce planning with money is just as important as married couple planning.  If you don’t do it, you’ll regret it.  Take the time to review everything – hire a professional and don’t try to cut corners.  The costs are too severe.


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The Roth IRA–Playing Games with Tax Brackets

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Our normal Friday Blog Post of the Week! segment will return next week.

 

The Roth IRA is a Swiss Army knife for financial success.

In our past wildly exciting posts about the Roth IRA here and here, some of the commenters on these stories have discussed the efficacy of the strategies presented by the Other Guy.

In short: is it worth all the trouble jumping through hoops to get as much money into the Roth IRA as possible?

In a word: indubitably (I’ve wanted to use that word since I heard it in Mary Poppins. 10 points!)

While I’ll agree that if the only upside to these strategies are immediate returns on a few exotic Roth IRA gyrations, you’ll only gain a few extra dollars in your pocket for what seems like a lot of work.

…and I get exhausted switching television channels, so let’s not talk about work.

I prefer easy and exciting.

The Roth IRA has one exciting feature beyond those we’ve listed previously—flexibility later in your planning.

 

The problem with financial planning

 

When I read well-meaning blog posts about retirement or education planning (including my own), the writer always discusses assumptions.

You know what happens when you assume…but what choice do we have?

We’ll have to assume that the tax rate will go up/down/stay level.

We have to project inflation rates.

Finally, we have to decide when we’re going to die. (Well, at least you do…I’ve got my cryogenic tank next to Walt Disney ready to go. I’m gonna live forever.)

Back on point: Roth IRA plans, for those of you uncomfortable with this type of tax shelter, give you no tax break today but offers tax free income down the line. Many (yawn) dissenters say that tax treatment of a Roth IRA is irrelevant. You’ll pay the tax today or tomorrow. It’s all the same.

No it isn’t.

We’re working for maximum tax flexibility, not a few random bucks. Because I can’t predict income tax rates, capital gains rates, or estate tax rates, I’m going to create a financial future that is as flexible as possible, as soon as two current criteria are met:

– I’ve done what I can to maximize deductions today. I know what tax rates are right now, so I’ll take my tax break, thank you.

– I’m not locking up money unnecessarily for down the road when I’m experiencing short term needs for cash.

 

Here’s the Roth IRA Game

 

When you reach retirement, let’s pretend you want to live on $60,000. Tax brackets in America are tiered, meaning that you’ll pay 10 percent on the first dollars you make, until you hit the 15 percent bracket, which is what you’ll pay beginning with the first dollar in that bracket, until you reach the 25 percent bracket…..

Because we don’t know what tax brackets will be in the future, let’s pretend the 25 percent line will be at $50,000.

 

You Have Two Pots of Money

 

Most people have a pre-tax retirement plan. As I mentioned, I like my current pretax deductions, so I’ve maximum funded those. Therefore, I have monster amounts of money (otherwise known as oodles) inside of them. These dollars must come out of the plan and get taxed.

I’ll remove $50,000 per year from this plan. Some of it will be taxed at the 15 percent bracket and some at the 10 percent bracket.

 

Here’s Where the Roth IRA Comes In

 

Finally, I remove $10,000 from my Roth IRA. Now I’m living in the 25 percent tax bracket but the government is taxing us at the top of the 15 percent bracket.

 

Lots of Work for Big Payoffs

 

Now, I’ve avoided a 25 percent tax each year (or whatever my top tax rate would be….) on $10,000, or $2,500 in taxes. Of course, I paid those taxes already, but remember, if I’m worried about the HUGE AMOUNT OF WORK this takes, I’m only investing money after I’ve already secured current tax breaks.

(photo credit: Swiss Army Knife: IK’s World Trip, Flickr; License Plate: Gamma Man, Flickr)

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How to Pay an Ugly Overdue Tax Bill

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I just read that Christie Brinkley owes over $500,000 in back taxes. That’s an ugly place to be. Sadly, I’ve been there before (not $500,000, but still a sizeable chunk of money). I’d like to share that story here.

When I began advising people about money, my background was similar to the many professional athletes who become financial advisors: I had no training. I was exactly “that guy” the pros and financial books warn you about when they say “don’t hire the new advisor.” Sure, I’d passed a few tests and took classes sponsored by the company I was going to work for, but I’d been an English major in college with an emphasis in creative writing. Talk about “not in Kansas anymore.” I wasn’t even on the same planet.

Why I’m An Expert In This Area

So, there I was, learning quickly. My paranoia about my lack of knowledge and the ability to “dumb down” difficult financial concepts helped me with early success in my new field—probably because I was coming at those concepts from a similar non-finance point of view. I hauled in a nice income. I had a great relationship with my clients. If I didn’t know something (which was often), I said “I don’t know, but I’ll find out.” That happened a ton.

Here’s the bad part of the story. I was a 1099 independent contractor. (For those of you unfamiliar with “1099”, it means that I didn’t actually work for the company. Because I was technically independent, zero taxes were taken out of my compensation. Without an knowledge of the full impact of not paying taxes, this was a financial meltdown ready to burst.)

Near the end of my first awesome year a friend said, “Who is your accountant?”

Me (thinking): “Dude, I should get one of those!”

So, I did. I found a guy named Tom. He was a great number-cruncher, but a horrible financial coach.

Tax guy Tom: “You owe $26,000.”

Me: “WTF?”

Tax Guy Tom (clueless): “Do you want to attach a check to the return?”

Me: “WTFFF????” I’m pretty sure I yelled. Yeah, I screamed. I should have been screaming at myself. It didn’t matter. He couldn’t believe I was dumb enough to spend every penny of the money I’d made. The funny part now is that I had used all that money to pay down debt.

I’d committed every stupid mistake in the book.

So, what did I do? I made the brilliant decision not to file my taxes, thinking that I’d find a way to catch up.

Note to the world: It doesn’t work that way. You can’t catch up.

So, Christie, I understand an overdue tax bill. I know that today you say that it’ll all be paid quickly. That’s good. If you can’t, or if any other reader is in a similar situation, here’s what to do.  This is what I should have done:

Joe’s Awesome 7 Step “Get Your Overdue Tax Bill Paid” Plan (or “Here’s What I Did”)

1) Find good tax advisors. My advisor helped me file back taxes and face the music. By avoiding the overdue tax bill, it was becoming bigger and more difficult to pay. I thought I was finding a “good” advisor when I met Tom. ….but, had I known how to ask questions, it would have gone smoother. AND I should have known to interview more than one person. I found a guy with lots of pretty letters after his name and hired the first one. I needed someone who could walk a beginner through the process of receipts and “what’s deductible and what ain’t.”

2) Communicate with the IRS. You need to face the music sooner or later. What surprised me is how easy the IRS people were to talk with. I was ashamed of my overdue tax bill, but they deal with people that have late taxes all day, every day.

Here’s a tip: the IRS phone line gets busy, so if you’re going to call, do it right after they open. You should get right through (I now call whenever I have questions or am feeling lonely). In my case, they knew promptly what programs to point me toward. Why did I call the IRS? My tax advisor told me to call them. She said it would help me stay on top of the situation. She also talked to them from time to time. (I had to sign a paper giving her the limited power to discuss my personal tax situation with the IRS first.)

3) Decide which method works best. There are two general directions you can decide between if you can’t pay the entire overdue tax at once. First, you can opt for an offer-in-compromise. This is a settlement with the IRS to pay less than your bill. I couldn’t go this route because (as my tax advisor explained), I had a high income stream and there was a good probability—in the IRS’ eyes—that they’d be able to collect the whole amount sooner or later (it was going to take me 30 years, but they don’t care. They may be nice, but those IRS zombies live forever, apparently.—I HAD to have one IRS joke in this piece….). If you owe less than $25,000, you can apply for an installment agreement, and will usually be accepted as long as you haven’t been a repeat offender. For amounts more than $25,000, the IRS is a little more like a nervous loanshark. You’ll have to fill out some extra paperwork.

4) Fill out the appropriate paperwork. Here’s a link to the IRS page describing all the appropriate tools. Before anything, you need to file the appropriate tax forms, if you haven’t already. Once that’s done, if you owe more than $25,000 on your overdue tax bill (like I did), you’ll need to fill out Form 433F, the Collection Information Statement. If you’re pursuing an installment agreement, complete Form 9465, Request for Installment Agreement. For an Offer in compromise, read IRS Booklet 646. It explains thoroughly the process of applying to reduce the amount you owe the government.

5) Be prepared to pay a fee to set up the agreement. As of this writing, direct debit and online payment plans cost $52, while payroll deduction plans run $105.

6) Wait for an answer from the IRS. They’ll respond in writing. If you called the IRS as I recommend above, you may receive an answer while you’re on the phone with the agent.

7) Realize that speed is your friend. Confronting the pain today is better than waiting. If you’ve managed to accumulate $500k in debt, you’ll owe interest and may owe penalties if you didn’t communicate effectively with the IRS.

Forms Needed:

IRS Collection Information Statement, Form 433F

IRS Installment Agreement Request, Form 9465

IRS Offer in Compromise booklet 646

Have a tax issue you’d like to discuss? While AverageJoe and TheOtherGuy aren’t tax advisors, we can point you toward resources and strategies. Use the comment section below or email me at joe (at) thefreefinancialadvisor (dot) com.

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