One indication that you might be a victim of a tax-time identity thief is an unexpected message from the Internal Revenue Service. This could be a warning sign that your Social Security number is being used by the identity thief. Know that the IRS doesn’t initiate communication with taxpayers via e-mail. OnGuardOnline.gov suggests contacting the IRS if you receive a notice saying more than one tax return was filed in your name or that IRS records indicated that you are on the payroll of an employer that you don’t know. If your Social Security number is stolen, it might be used by a thief to get employment. The thief’s employer would then report their income earned to the IRS using your Social Security number. Consequently, this makes it appear as if you didn’t report all of your income on your tax return.

If you believe that you are the victim of tax-related identity theft, don’t hesitate. Let the IRS know right away. This advice applies even if you don’t have any evidence that the identity theft directly affected your tax return. Specifically, reach out to the IRS Identity Protection Specialized Unit, which assists identity theft victims with filing their tax returns and obtaining any refunds due to them. The unit also serves to protect victims’ IRS accounts from future identity theft. They can be reached at 1-800-908-4490.

For more information, visit the IRS website and look for the article, Identity Theft and Your Tax Records.

Here’s how to handle this unpleasant surprise—along with pointers on avoiding an audit in the future.
Contact your tax preparer.  “Determine if you’ll represent yourself or be represented by a certified public accountant, enrolled agent, or tax attorney. Have your representative contact the examiner to schedule the appointment and acknowledge receipt of the information document request,” says Spiceada A. Davis, CPA and owner of Atlanta-based eXFinancial Inc.

Understand the triggers. Some triggers are earned income credit (a high dollar refund would cause the IRS to question whether children claimed are actually dependents), home offices (in cases of high deductions in comparison to earnings, home depreciation, or withholding), tax shelter losses, unreported income on 1099 forms, and inaccurate W2 forms. “If the IRS thinks you made a minor mistake, they’ll send a paper or correspondence audit. The triggers of a paper audit can be large charitable deductions, large itemized deductions, and mileage logs.  Letters from your church [or other charitable organizations] on letterhead and proof of the itemized deductions and mileage should satisfy their request,” says Terry J. Ellis, president of Alliance Tax & Financial Services Inc. “The triggers of an in-person audit would be investments such as stock loss and repeated late filing of quarterly reports for a business.”

Maintain accurate records. Keep tax returns for three years and receipts for everything you intend to report. Be sure there are no mathematical errors. This will help avoid an audit and prepare for future audits. “Review your tax return. Many don’t and are amazed, when the return is audited, the items that are reported,” says Koreen Jervis, enrolled agent and owner of Korje’ Tax Professionals Inc. in New York.

Beware of costs. Only an enrolled agent, CPA, or tax attorney is qualified to represent you before the IRS. The IRS doesn’t charge for representing you, but your tax professional will. “It’s usually an hourly rate that varies by company based on the complexity of the return,” says Jervis. “Most firms offer audit insurance so there’s no additional costs for audits.”

Know your rights and the rules. The IRS website has a section dedicated to explaining taxpayer rights. Click “individuals” and then “taxpayer rights.” Also read IRS publication Your Rights as a Taxpayer.

Get a handle on large tax bills (Image: Thinkstock)

If you’re one of the unlucky taxpayers who got hit with a large tax bill, you’re probably trying to figure out how to pay. Fortunately, you do have some options. Here are a few tips on what to do if you can’t pay your bill.

Don’t ignore the bill. Whatever you do, don’t ignore your tax bill. The Internal Revenue Service will find ways to get their money. For example, they can garnish your wages. Another important reason not to ignore your bill is the possibility that the amount due is incorrect. If you discover an error, immediately call the number on your bill, send a letter to the IRS office that sent the bill, or visit your nearest IRS office.

Request an installment agreement. An installment agreement allows you to pay a debt over a period of time. If you owe the IRS less than $25,000, you can apply for an installment agreement online via their Online Payment Agreement or call the number printed on your bill. If you owe more than $25,000, you might still qualify, but you’ll most likely have to fill out Collection Information Statement, Form 433F. You’ll also have to fill out the Request for Installment Agreement (Form 9465) and mail it to the address printed on the bill or notice.

Request an Offer in Compromise. If your bill is absolutely beyond what you can afford to pay, the IRS might agree to arrange an Offer In Compromise. This means that the IRS will agree to accept less than the amount due. The only catch is, you cannot have any assets, such as equity or retirement accounts, or any means of obtaining enough income to pay the bill. However, do know that this arrangement could cost you a lot of money (in the thousands) in CPA fees. Negotiating an Offer in Compromise could take more than a year.

For more tax tips, see:

11 Last Minute Tax Tips

(Image: ThinkStock)

It’s tax season again. That means another round of audits will soon be scheduled for those who slipped up (or who the government thinks slipped up) on their returns. If you want to avoid this testy tax-time surprise, be aware of the following audit triggers:

• Earned income credit. A high dollar refund would prompt the Internal Revenue Service to question whether children claimed are really dependents.
• A home office. A red flag would be raised if you have high deductions in comparison to earnings, home depreciation, or withholding.
• Innacurate W2 forms. Make sure to double check your W2 forms. Glaring mistakes might make the IRS do the double checking for you.

Other red flags would be tax shelter losses and unreported income on 1099 forms. In order to avoid a tax audit, make sure to maintain accurate records. Track all of your expenses and get documentation and proof for everything. For example, if you make a large donation to a church, make sure to get a statement on official letterhead, verifying your donation. Be aware that if you make a charitable contribution of more than $250, the IRS requires appropriate documentation.

Know that not all mistakes and red flags will result in an in-person audit. If you make a minor mistake or something you reported needs a little more clarification, the IRS will usually send a paper or correspondence audit. For example, a larger charitable deduction or a large itemized deduction may result in a paper audit.

For more information on your rights as a taxpayer, visit the IRS website and click on “individuals” and “taxpayer rights.” You can also refer to the IRS video series entitled, Your Guide to an IRS Audit.

For more tax advice, see…

10 Ways to Save Money on your Tax Return

Surprise! The IRS Counts Forgiven Debt as Taxable Income

Talk to your accountant about how you can save (Image: Thinkstock)

Call it revenge of the nerds. This is the time of year when former math majors and calculator-toting accountants become our closest friends. It’s tax time–and as of today you have just one month to go before your tax returns are due. If you haven’t filed yet, the National Society of Accountants (NSA) wants you to know that there are still plenty of last-minute strategies you can use to save money on your 2010 tax return.

Here are 10 ways to save this tax season, courtesy of our friends at the NSA:

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• BONUS DEPRECIATION:

Under prior law, a 50% bonus depreciation deduction was allowed for qualifying property. The provision has been extended to include property placed in service before Jan. 1, 2011. Additionally, certain property with long production periods and transportation property, including certain aircraft, qualify if placed in service before January 1, 2012. Bonus depreciation also applies to certain qualified leasehold improvements. The property must not be predominantly used outside the U.S. in order to qualify. The deduction is allowed in full for alternative minimum tax purposes. So if a taxpayer purchases and uses computers (five year property) in 2010 for $2,000,000, the 2010 depreciation deduction would be $400,000 without bonus depreciation. With the bonus, the 2010 deduction would increase to $1,200,000, or 60% of the cost of the property. Over half of the tax relief in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 comes from this single provision.

• SECTION 179 EXPENSE ELECTION:

This section of the IRS code allows a business to deduct the cost of certain property instead of capitalizing and depreciating it. Under prior law, the amount of annual expense was limited to $250,000 and was reduced dollar for dollar for the amount of Code Section 179 property placed in service in excess of $800,000. The allowed expense amount and the investment limitation of $250,000 and $800,000, respectively, were scheduled to revert to prior levels of $25,000 and $200,000 in 2011. The Act, however, increases the allowed expense amount and the investment limitation to $500,000 and $2,000,000, respectively, for years beginning in 2010 and 2011. It also expands to include qualified leasehold improvements, qualified restaurant property, and qualified retail improvements. The expense election is calculated prior to, and in addition to, bonus depreciation. For example, the combined 2010 expense deduction, bonus deduction, and regular depreciation deduction amounts to 80% ($800,000) for a $1,000,000 eligible five-year asset placed in service in 2010.

• ENHANCED START-UP EXPENSE DEDUCTION:

For 2010 only, the deduction limit for qualified trade or business start-up expenses is increased from $5,000 to $10,000. The $10,000 deduction is reduced by the amount of total start-up costs that exceeds $60,000, so if startup expenses totaled $63,000, the deduction would be $7,000. Any costs not deducted are currently capitalized and amortized ratably over 180 months.

• SOCIAL SECURITY (FICA) TAXES:

For 2011 only, Social Security taxes are cutting by two percentage points the employee’s portion of the 6.2% tax to 4.2% up to $106,000.  This benefit also applies to the self-employed as well—reducing the Old-Age, Survivors, and Disability Insurance (OASDI) tax rate under the Self-Employment Contributions Act (SECA) tax by two percentage points to 10.4% for 2011 up to $106,000 plus the additional 2.9% Medicare tax (the 2010 retained rate) on their total self-employment income.

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That’s right. Credit card issuers, banks, and debt collectors who agree to accept at least $600 less than the owed balance are required by law to file 1099-C forms with the IRS. In addition, they send a notice to debtors. In turn, the debtor must report that “income” on his or her federal income tax return.

Here’s an example: Let’s say you owed $10,000 on a credit card and sometime in 2010 you negotiated with a collector to pay off $6,000 to cancel the debt. The credit card issuer will report the forgiven $4,000 you didn’t pay off as taxable income. In the eyes of the IRS, you earned an extra $4,000 in 2010. What can really cause financial pain is when people who’ve experienced a foreclosure receive a 1099-c in the mail. Banks often issue the notices when they sell a foreclosed home for less than the previous owner owed on their mortgage. In some cases, the foreclosed person gets slapped with a 1099-c that adds hundreds of thousands to their earnings for the year.

The 1099-c has been around since 1994, but its use has been growing in recent years. The annual number of 1099-c forms filed with the federal government by creditors and debt collectors nearly doubled between 2003 and 2008, according to the IRS. The IRS received a just under 1 million forms in 2003 and more than 1.99 million in 2008. This year, the number is expected to grow to 2.8 million, and for the 2011 tax year: 3.1 million. Experts believe the spike is partly due to the rise in mortgage foreclosures and settled credit card debt.

“Depending on the amount of debt forgiven, the taxpayer’s income level, deductions and other factors, the consumer could face a sizable tax bill come April 15th,” explains Ben Woolsey, Director of Marketing and Consumer Research for CreditCards.com. “Few consumers are aware of the tax implications of settling to pay a lesser amount than they owe in credit card debt, and never expected their debt settlement would be considered income.”

Since many consumers don’t know what the 1099-c forms are, some may throw out the notices because the forms come from creditors or debt collectors with whom they assumed they had settled. Other taxpayers are not filing the 1099-c with their federal income tax returns, putting them at high risk for IRS audits, penalties and fines.

Woolsey and other experts at CreditCards.com offer five tips for preventing and handling forgiven debt when it resurfaces at tax time.

•Get professional advice: Consumers who receive the 1099-C cancellation of debt forms should immediately take them to a tax preparer or tax adviser.

•Prevention is key: Consult with a tax adviser before finalizing debt settlement agreements to find out the potential tax implications. Ask for a tax preparer who has experience with the 1099-c.  Also clarify with the creditor or debt collector the exact amount that will be declared on the 1099-c form.

•Check your mailbox: Be aware that the 1099-c is coming and don’t throw it away. Take it directly to your tax preparer.

•You may be excluded: Taxpayers may qualify for one of several exclusions that allow them to reduce taxable income from canceled debts.  Look into the details, and if the exclusions apply to you, file an IRS form 982 in addition to the 1099-c.

•Beware of inconsistencies: If there is a dispute about the amount reported on the form, contact the creditor or debt collector immediately to resolve the matter. Then ask for a corrected 1099-c form.

Be sure to also read these related articles…

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