Photo: Flickr via doc_for_matt
Not to be pessimistic, but it’s safe to assume that not every taxpayer is 100 per cent truthful when it comes time to fill out their tax returns. In a 2011 IRS report, twice as many Americans (8%) said a little fibbing on tax returns is fine compared to the same survey issued in 2010.
And although it’s true that the IRS doesn’t exactly go after “small potatoes” taxpayers for fibs (generally, you’d need at least $1 million in assets to interest their auditors), even a few missing details could put your refund in jeopardy.
Whether you’re going solo or working with a tax professional this year, transparency is the key to getting the maximum return –– and keeping auditors off your tail.
Here are seven “confessions” we recommend making soon if you haven’t already:
“I made a nondeductible contribution to a traditional IRA.”
“While nondeductible contributions have no impact on your tax liability in the year they are made, by not reporting these contributions on your return, it’s more difficult to claim these same amounts are not taxable when they’re later withdrawn from the IRA, usually many years later,” says Tim Steffen, CPA and director of financial planning at Baird.
“I’ve earned income outside of my regular 9-to-5.”
Whether it’s a lawn mowing service you keep on the side, or freelance writing gig at your local newspaper, any additional income will need to be reported on your tax forms.
We know. It’s a pain to gather all your 1099 forms and keep track of every dollar and cent that you’ve earned yourself, but it’s a big red flag to potential auditors if you don’t. At least 4 million people were audited in 2010 for under-reporting their income, according to Minyanville.
The IRS uses document-matching programs that let agents cross-check income reported on tax returns against what is reported on forms like a W-2, 1099-INT, 1099-DIV, and 1099-B.
“I converted my IRA to a Roth IRA in 2012.”
If you’re among the plethora of workers who’ve decided to ditch the traditional IRA model in favour of a Roth IRA, you’ll need to tell your tax preparer for sure –– especially if you switched to a Roth in 2012. Since Roth contributions aren’t taxed when you contribute, half of that the amount you converted to a Roth is considered taxable in 2012 and the other half in 2013. “This is especially important if you’re using a different accountant or tax advisor this year,” Steffen says.
“I rented out my apartment to get through the housing slump.”
Even part-time landlords are required to fill out a Schedule E form at tax time if they’re planning on claiming deductions, and Minyanville’s Stephanie Christenson stresses the importance of knowing all of the nuances behind the process.
“Real estate rentals tend to reflect losses due to depreciation write-offs, and … most of the time, those losses are limited on an individual’s tax return — unless he or she qualifies as a real estate professional,” she writes. “Many taxpayers take the losses on their individual tax returns, and as a result, get audited.”
To qualify for deductions for landlords, “you must devote at least 500 hours toward the rental property in order to take deductions on the property, or invest 750 hours to managing the rental, to be considered a real estate professional.”
“I exercised employer stock options (or received restricted stock) and then sold the shares right away.”
Even if the sale didn’t net any profit for yourself, the IRS will still want to see it reported on your tax return this year, Steffen says. Your broker should issue a 1099-B form with that information included.
“I earned interest from municipal bonds.”
“While that interest is usually not taxable for federal purposes, the interest on some bonds is taxable under the [Alternative Minimum Tax] rules,” Steffen says. “In addition, that interest is usually taxable for state tax purposes.”
“I’ve had credit debt forgiven by debt collectors.”
Negotiating with debt collectors to settle unpaid debts for a lesser amount is a smart way to dig out of debt for people who have no hopes of paying off the full balance. But things get tricky when tax season rolls around.
As far as the IRS is concerned, that debt you got away with is considered income.
“If a debt is canceled, forgiven or discharged, you must include the canceled amount in your gross income, and pay taxes on that ‘income,’ unless you qualify for an exclusion or exception,” writes Credit.com’s Gerri Detweiler. “Creditors who forgive $600 or more are required to file Form 1099-C with the IRS.”
Visit this fact sheet from the IRS to see if you qualify for an exemption for canceled debts.