A guide to the U.K.'s flat rate VAT

The U.K. Flat Rate VAT scheme was introduced in the year 2002 and it provides the small businesses in the UK with the chance to simplify VAT accounting. In order for the business to qualify for the scheme, certain requirements must be fulfilled.

• An yearly exclusive VAT taxable turnover of £100,000.

• An yearly VAT exclusive turnover that is inclusive of the value of the exempted supplies and also other incomes that are non taxable up to an amount of £125,000.

• The annual VAT inclusive turnover of the business should not exceed an amount of £150,000. If this happens, the business is required to exit the scheme since it will prove costly.

The working principle

Companies with zero expenses

For example, if the turnover of the business is £51,000, the VAT will be charged as below:

£51,000 x 0.175 = £8,925.

The total revenue will therefore stand at £59,925. The percentage of the VAT flat rate is applied directly to the figure mentioned. For example, if there is an assumption that the flat rate percentage is 15 percent, then the calculation will be as follows: £59,925 x 0.15 = £8,988.75.

The amount of £8,988.75 must be paid of to the HM customs and Excise as tax. Notably, there is a difference of £63.75 between the total amount that is charged for the supply of the services and goods (£8,925) and the amount that is paid in the form of tax (£8,988.75). This implies that if the company has got minimal or no expenses, it would have gained £63.75 by the close of the financial year.

Companies with several expenses

In the situation whereby the company has got numerous expenses during the year, it is wise to avoid the VAT Flat Rate Scheme. This is due to the fact that the business would be in a position to offset the VAT that was paid on the costs against the amount of VAT that was received for supplies of both services and goods.

For instance, if the company makes a sales turnover of £50,000 and incurs expenses of £15,000, the expenses will be as follows:

£15,000 plus £2,625 = £17,625

It is possible to offset the figure of £2,625 against the amount of £8,988.75 that was charged for services and goods.

The £2,625 can be offset against the £8,750 of VAT charged for the supply of goods or services: £8,925 - £2,625 = £6,30. Therefore, the amount of money that is paid out in form of tax would be £6,125. This figure is less that the £8,988.75 that was paid as the VAT Flat Rate that was shown in the example. In such a situation, the company should avoid being in part of the Flat Rate VAT Scheme.

It is therefore important for the company to seek the services of professionals who are better placed to provide the best advice about VAT tax related issues. Otherwise, without a clear understanding of how the figures are arrived at, it may become rather difficult to make the best decision.

About the author: Isaac writes for Drummond Bookkeeping & Accountancy Services LLP, Drummond provide their services to the wider South West region but focus on providing bookkeeping in Plymouth for small and medium sized businesses.

3 reasons why you should consider an accounting career

By Linda

Accountants are individuals that help a business by compiling financial data, analyzing the financial information, and creating consolidated and organized financial statements. For people that are interested in accounting, pursuing an education in accounting could be a great option. There are three key reasons why you should consider learning accounting.

 

Career opportunities

The first reason why you should learn accounting is that it could provide you with many different career opportunities. Due to the complexity of the tax code and the importance of having a strong financial system established, accountants are frequently in high demand by employers. Those that complete an accounting program will always have an easy time finding a job, and the compensation provided to accountants is typically much higher than those in other professions. Accountants that further their education to get a master’s in accounting and to qualify for the CPA exam will find that they will have even more opportunities available to them. Accountants are frequently hired by accounting firms, consulting firms, and individual businesses that are looking for in-house accounting help.

 

Understand tax code

Another reason why you should learn accounting is that it could help you to understand the current tax code. If you are a small business owner, you will find that there are many different tax deductions and credits available to you. If you have studied accounting, you will have a better understanding of what these deductions and credits are. This will not only help you to take advantage of these when you are submitting your taxes, but will also help you to better plan for the future as you will know how each decision you make could impact the tax status of your business going forward. Another advantage is that you will receive education on where to study changes on the tax code, which could continue to provide you with benefits going forward as the tax code continues to change.

 

Save money on staffing

If you run a small business, there is a strong likelihood that you will need to take out a loan at some point. Almost all banks will require that you provide them with accountant-prepared financial statements on a regular basis. To do this, you will either need to outsource the accounting work to another company or hire an employee to perform this work for you. In either situation, you will end up investing a lot of money just to have your financial reports completed as accountants tend to be well-compensated employees. If you have a background or education in accounting, then you will be able to avoid most of these costs as you will be able to complete these financial reports on your own if you have the time to do so.

Linda is one of the leading Accountants in Sydney, Australia. She believes Accounting is a great option for students who are good with numbers and looking for an exciting career with strong job security. Linda writes for many leading business and finance news sites and is currently in the process of writing her first book on how to start your own business.

Financial Quote: Taxes

"Taxes dutifully paid as agreed, the bank called to thank me for the bailout and raised my fees." -Taxpayer

How Property Tax Lien Foreclosure and Non-Payment of Mortgage Affects Taxes

In the event of foreclosure from non-payment of mortgage, the debt due may be 'canceled', the IRS considers cancelled debt  taxable in certain cases. In other words taxable income that would otherwise not have been gained in the event of non-foreclosure is the affect of foreclosure where debt is canceled. Also, income from the sale of property via foreclosure may be taxable to some extent.

Since foreclosure can occur from non-payment of taxes in addition to non-payment of mortgage, the unpaid taxes can lead to a tax-lien foreclosure. In this event the property can be foreclosed by the government from non-payment of property tax and sold. Essentially this process cancels the taxes due via the tax lien foreclosure where the owner owing taxes loses the property.

Preparation of a Tax Return For a Non-Profit

Non-profit organizations are required to file tax information with tax authorities, however these types of companies and organizations may be exempt from several types of taxation such as State and sales taxes because of the nature of their business (managementhelp.org). 

These businesses perform a wide range of social services that can benefit a community or groups of people in a way that cannot be easily profited from. The current tax deadline for non-profits is May 15, which is near a month after the individual tax-filing deadline. This article will discuss the tax return preparation for these types of organizations in terms of non-profit classifications, tax filing forms, filing procedures and non-profit tax filing tips.

Types of non-profit organizations

A complete list of non-profit classifications can be found at the following reference link and typically include the 501 number designation followed by a letter and another number in brackets. These numbers represent the type of non-profit organization for tax filing, governmental and funding reference purposes. To avoid confusion, to be officially recognized as a tax-exempt non-profit, the organization must be registered as such with the appropriate government entity in addition to applying for tax exemption with the U.S. Internal Revenue Service. Several 501 non-profit label designations are given to the various types of non-profits.

Tax filing forms

There are many forms that are used for non-profit corporations and/or organizations. These forms are designed for those business types and include the '990 series', applications for tax exemption and other organizations such as tax exempt political organizations. A list of several of the IRS forms that may be needed for tax filing are provided below as sourced by the Internal Revenue Service, http://www.irs.gov.

Form 1023 : "Application for Recognition of Exemption" (For 503(c)'s)
Form 1024 "Application for Recognition of Exemption Under Section 501(a)"
Form 1120-POL "U.S. Income Tax Return for Certain Political Organizations"
Form 8868 "Application for Extension of Time to File an Exempt Organization Return"
Form 990 - "Return of Organization Exempt From Income Tax"
Form 990-N "Tax filing form for non-profits with annual income is $25,000 or less"
Form 990-EZ - "Short form Return of Organization Exempt From Income Tax"
Form 990-PF - "Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation"
Form 990-BL - "Information and Initial Excise Tax Return for Black Lung Benefit Trusts and Certain Related Persons"
Form 990-T "Exempt Organization Business Income Tax Return"

Filing procedures and online non-profit tax returns

Filing taxes for non-profit corporations online or e-filing is a similar process to individual e-filing. Either a known online tax filing preparation software is used or one is found through the Internal Revenue Service. The same forms and documentation requirements are needed for online tax filing, however this expedites and records the information in the IRS database(s) faster than filing via mail and paper.

Procedures for filing a non-profit tax return involve 1) identifying the type of non-profit 2) locating the necessary filing forms 3) properly completing and submitting tax forms. In cases where tax status and/or financial circumstances are blurred, uncertain or complex, the assistance of a professional tax assistant may well be worthwhile as the consequences could include audits, or refilling or additional information requests which can cost valuable time.

Non-profit tax filing tips

• Verify non-profit status and type

• Gather all appropriate documents

• Record all charitable donations and documents

• Read filing instructions such form 990 instructions, form 557 and 598 (about.com)

• File online for faster returns and/or processing

• Consult tax preparation services if need be

Non-profit corporations and businesses are required to report annual income, asset and expense information just like for profit companies, however non-profit groups may be tax exempt, freeing them from the tax burden since profit is not a primary motive for these types of businesses. Several forms and procedures exist for filing taxes as a non-profit, some of which are provided in this article. The deadline for filing taxes as a non-profit is May 15 and online tax preparation software and/or services exist to expedite the process and make it more efficient.

Non-Profit Tax filing sources:

1. http://www.irs.gov
2. http://www.muridae.com/nporegulation/documents/exempt_orgs.html
3. http://taxes.about.com/b/2006/05/15/deadline-to-file-form-990-for-nonprofits.htm
4. http://www.irs.gov/pub/irs-pdf/p4453.pdf
5. http://www.managementhelp.org/legal/lgl_need.htm
6. http://www.not-for-profit.org/page2.htm
7. http://managementhelp.org/tax/np_tax.htm

Red Flags On Your Business Tax Return That May Trigger an IRS Audit

The U.S. Internal Revenue Service has decades of experience dealing with tax returns and in that time has developed statistical, formulaic and numerical data on higher risk tax filings in terms of potential tax evasion. The IRS has developed an audit alert warning system that is triggered by certain risk factors that correlate with information submitted and/or not submitted on tax filings. These triggers may be applied to business tax filings. Some of the "red flags" that may cause an IRS audit are as illustrated in the following sections.

Business tax filing red flags

Unreported Business and/or staff Income:

Businesses such as restaurants and sole proprietorships may erroneously or fraudulently under-report certain forms of income leading to a lower reported taxation to the IRS. Certain types of businesses such as those mentioned above are more likely than others to report incorrect amounts and are thus at greater chance of being audited.

Over reported Expenses:

Another potential trigger for a business audit is over reporting business expenses such as automobile expenses, meal expenses, or inventory space used. Typical businesses of certain sizes generally have a 'normal' range of expenses that can be expected, however tax filings that fall outside of this range or are quantitatively unrealistic may set off an Internal Revenue Service warning algorithm.

Inconsistency with Historical Tax Filings:

Businesses may follow various trends such as accounting methods, income growth, expense deductions, employee withholding, depreciation etc. When these trends become unrealistic the probability increases the tax filing is erroneous. For example, if a business reports depreciation of 2% every year for 5 years in a row and then reports depreciation of 7% this indicates a change in accounting methods from straight line depreciation to accelerated depreciation. Changes like this and other adjustments to accounting systems may have to be formally reported and could lead to an audit.

Missing IRS Forms:

Every business, whether it be a sole proprietorship, partnership, limited liability corporation, S-Corporation or C -Corporation has certain filing requirements which include specific forms to be completed and sent to the IRS. For example, partnerships are required to file a form 1065 or U.S. Return of Partnership Income. If these forms are missing or incomplete there is a significant chance the IRS may inquire further, request more information or audit the business.

Sole proprietorship and other red flags

Taxable Income Range:

The greatest amount of tax filing audits occur for tax forms reporting taxable income in excess of $100,000.00. By reducing one's taxable income to under this level one is statistically reducing one's chance of being audited by approximately 45.23%. If one reports income below $50,000.00, the tax filer is reducing statistical probability of audit by around 16.89%

Incorrect 1099 or other Previously Reported Information:

Employers and financial institutions all report data to the Internal Revenue Service independently. This means the IRS has a means of comparing one set of information with another. For example, form 1099's which are other income earned forms are reported to the IRS separately by financial institutions. Misstating the same information the IRS already knows about can trigger an audit. Other information that may be previously reported to the IRS includes interest on loans, mortgage payments, and property tax. Erroneously reporting these figures is also liable to activate a red flag with the IRS.

Income Tax Deductions:

Another area that is subject to triggering a potential audit is the quantitative amount of deductions made on a tax filing. If the deductions are disproportionately large or numerically inconsistent with the tax filers other financial data, the audit alert may trigger causing an audit inspection. For example, a sole proprietor may over report home office space used for inventory storage. If that proprietor has a home that is 1300 square feet and the expenses reported are for a space of 980 square feet, this may exceed the logical space for a home that can be utilized for storage as most homes require a certain amount of square footage for living space.

U.S. Internal Revenue Service audits are prompted by computer algorithms based on historical financial and tax reporting statistics. Essentially, dishonest tax reporting is recordable in the form of tax filing patterns and/or trends. Some of these patterns and trends are correlated with the red flags illustrated above and may cause an IRS tax audit. Additionally, some tax filing classes such as those within a certain type of business or taxable income range are statistically more likely to be audited than others. This is because these businesses or tax filers are either likely to generate more tax revenue for the IRS and/or have a historical likelihood of erroneously reporting tax data than other tax filing categories.

Sources:

1. http://biztaxlaw.about.com/od/businessaudits/a/audit_red_flags.htm
2. http://sbinformation.about.com/od/taxes/a/avoidsbaudit_ga.htm
3. http://www.irs.gov
4. http://www.wwwebtax.com/audits/audit_avoiding.htm

Tax Aspects of LLCs

A Limited Liability Corporation (LLC) is a company formed under legal protection from personal liability of the owner(s)/member(s). This means if the company should fall into financial difficulty the debts of the company cannot be paid from the owner's personal assets.

Limited Liability Corporations generally have lower tax filing requirements, and Government associated regulation that would be the case with larger more complex corporations.

Taxation of Limited Liability Corporations is accorded its own specific rules and regulations, some of which are made available through the Internal Revenue Service. Income or losses from LLC's are either taxed on form 1040's as individual income if only one owner/member exists, and on a form 1065 as capital gains or losses if more than one member owns the company.

Furthermore, in the case of a LLC with multiple members, the tax benefits are the same but the tax paperwork requirements are different. The taxation of short term capital gains is subject to the same tax bracket as an individuals regular income bracket i.e. gains incurred within a time period of under a year fall into the tax filers adjusted gross income tax range.

The IRS tax forms needed for Limited Liability Corporations include any one of the following depending on the type of LLC, and are available through the Inernal Revenue Website www.irs.gov and/or through contact with the I.R.S.

• Forms1120, or 1120S, and sometimes 8832 if filing as a corporation.

• 1065 if filing as one of a group of members/owners

• Schedule C , E or F if an individual owner of a LLC

• W-2's (Employees)

Tax advantages of LLC's:

If a Limited Liability Corporation has only one member, the member remains legally free from the company's liability, and may file a company's income and expenses associated with his or her personal tax disclosures.

The benefit this allows is single taxation of earnings rather than double taxation through both the owner of the LLC and the LLC itself. Additionally, income earned through the LLC can be withdrawn as a dividend or profit distribution without concern of taxation through the LLC.

When filing as a partnership, LLC's can deduct bad debt, property depreciation, tax, salaries, interest expenses and employee benefit programs on IRS form 1065.

LLC's may be subject to tax exemptions

If a Limited Liability Corporation qualifies for tax exemptions, the benefits of these exemptions is passed on to the owners through a higher income that is only taxed once. For example, a LLC may be exempt from property tax in various jurisdictions making the net profit of that LLC higher due to lower operating costs. This profit is then passed on to owners.

Other tax deductions include losses incurred through the LLC. Thus even though the owner's personal assets are not at stake, the benefits of a failing or company experiencing losses can still be maximized upon as capital loss deduction on IRS Form1040.

TIPS on LLC taxation

• LLC's may be suitable for small startup companies or companies that do not require a large amount of capitalization to operate.

• Forming an LLC may be right for you and/or your business partners if you want to protect your 

personal assets and avoid double taxation.

• As a business owner, or as a partnership LLC, administrating tax reporting requirements may be more simple and easy to operate as an LLC.

• If switching an existing company into an LLC be aware that the valuation the LLC may be considered higher by the IRS, thus incurring a potentially unwanted capital gain.

• Tax accountants and lawyers may also be of assistance when forming and LLC or preparing LLC tax documents.

There are many advantages to Limited Liability Corporations including convenience, simpler taxation, avoidance of double taxation and of course limited liability. Considering formation as a LLC may involve state regulations that vary across one's nation. 

That is to say, incorporation requirements may vary from state to state thus presenting particular advantages and/or disadvantages to incorporation in one state over another. It may be advisable to consider these incorporation guidelines prior to incorporation as an LLC in regards to potential forms of lower taxation, ease of operations, administrative regulations and operating limitations.

Overview of the American Opportunity Tax Credit

The American Opportunity Tax Credit is an educational tax credit that mostly benefits parents of students under the age of 24 and recipients of the Hope Scholarship Credit. This tax credit was instituted when Section 1004 of Division B, Title 1, sub-title A of the American Reinvestment and Recovery Act of 2009 became law in February of 2009.  The tax credit increases and expands the tax credit that can be claimed by students or parents of students by increasing Hope tax credit income caps, qualifying expenses, and

To qualify for, and claim the American Opportunity Tax Credit

Tax filers must 1) Complete an IRS Form 8863, 2) Not claim a tuition and fees deduction on line 34 of the IRS’ 2009 Form 1040, and 3) have proper documentation for the qualifying educational expenses. The amount of the credit can be no more than $2,500 for tax year 2009 and is recorded on page 2, line 49 of 2009’s form 1040; the first $2000 of applicable educational expenses is also eligible for complete credit according to the IRS. Unlike a deduction, a credit reduces the amount of tax due rather than the taxable income. This can create significant tax savings.

For tax filers with dependent children

The American Opportunity Tax Credit can be claimed for each child that attended a qualifying education institution for the 2009 tax year, and up to $4000 can be claimed for each student according to IRS Form 8863.  However, since the first $2000 is fully credited, only 1 child with a full $4000 of expenses would be needed to reach the maximum credit i.e. the credit itself amounts to 25% of the claimed expenses after a $2000 reduction. For example, if a parent of a student with a single filing status claims the full $4000 for the tax year, the full credit can be granted because $2000 x .25= $500 + $2000 x 1=$2500.00.

Students who were in school at or above half-time enrollment can claim the American Opportunity Tax Credit on their own tax filing if they are over 24 years and meet specific qualifying criteria implemented by the U.S. Internal Revenue Service (IRS). These criteria are illustrated in Part IV of the IRS 2009 Form 8863 instructions. They include age, income, parental and tax filing status requirements. 

American opportunity tax credit tips to consider

The American Opportunity Tax Credit may not be the best choice for everyone, nor may every student or parents of students qualify for the credit. This is because of the existence of other tax reducers, and limitations on the use of the tax credit. These limitations are described in the IRS Form 8863 Instructions, and include income, age, amount, type of expenses, financial assistance and educational enrollment status.

• If the tuition and fees deduction on line 34 of the IRS 2009 Form 1040 leads to greater tax savings than the American Opportunity Tax Credit, the deduction may be a better choice. This deduction is calculated on IRS Form 8917 .

• Qualifying expenses for some students may be eligible for a higher maximum credit than the American Opportunity Tax Credit. For example, the maximum credit for the Hope credit is $4000.00 in 2009.

• Since the American Opportunity Tax Credit can only be claimed for the first 2-4 years of post-secondary education, it may be advantageous to claim this credit  and save additional credits for later educational expenses if a realistic chance of these expenses in the future exist.

• The American Opportunity Tax Credit can only be claimed in full if the claimants taxable income is below $80,000 for single filers and $160,000 for married filers filing jointly.

• Tax credit cannot be claimed for income earners above $90,000 and $180,000 respectively.

• Claimants of the 2009 Hope tax credit or the 2009 Lifetime Learning Credit cannot simultaneously utilize the American Opportunity Tax Credit.

• Recipients of Federal grant money or scholarships must deduct the amount of any non-taxable funding from eligible expenses as per the Form 8863 instructions.

Sources:
1. http://www.irs.gov (U.S. Internal Revenue Service)
2. http://www.gpo.gov (U.S. Government Printing Office)

Capital Loss Carryover Explained

A 'capital loss carryover' is the use of un-deducted investment losses for the purpose of reducing taxable income. In other words, the capital loss carryover provision in the IRS Tax code allows tax payers to use loss from sales of capital assets as deductions to future years' taxes.

To illustrate capital loss carryover, if Mrs. Smith loses $10,000 in the stock market in 2010, but is only allowed to deduct $3000 of those losses from 2010's taxable income, then the remaining $7,000 can be deducted in increments of $1500-$3000 (1) for subsequent years until the loss is exhausted. 

Benefits of capital loss carryover:

There are several benefits of capital loss carryovers. These benefits allow investors to reduce their exposure to investment risk, liability and potentially serve as a tax planning tool that can extend tax savings.

For example, in 2010 the tax bracket for single filers with income over $171,851 was 33 percent of the amount over $171,850 plus $41,827.25.(2) If a 2010 single tax earner making $173,000 in taxable income is able to deduct $3000 in capital loss this places her in the 28% tax bracket.

The tax savings plus the capital loss carryover loss reduction add up to nearly $897 for $3000 of loss. Moreover according to the 2010 tax rates, $41,827.25 + .33($1,150)=$42,206,75- .28($87,600)+$16,781.25=$41,309.25. Since $42,206.75-$41,827.25=$897.00, nearly 30% of the capital loss carried over is eliminated through tax savings. The benefits of capital loss carryovers are listed below.

• Reduces income tax
• Lowers risk of investing
• Eliminates a percentage of capital loss
• Provides incentive to invest
• Can be deducted indefinitely

How to determine and carry over capital loss:

Capital loss carryovers are legislated by Title 26, Subtitle A, Chapter 1 of the U.S. Code. (3) Capital loss carryover is calculated and carried forward fairly simple. Several forms and/or documents are needed to calculate, verify and record the capital loss carryover. These forms serve as proof of the capital loss carryover and should be kept for as long as an outstanding capital loss carryover balance exists.

IRS Forms needed:

• IRS Form 1040
• IRS 1040 Schedule D Line 16
• Capital Loss Carryover Worksheet P.D-7
• 1099 MISC

For capital losses extended over multiple years, excess capital loss must be recorded on the following year's Schedule D using the capital loss worksheet. For example, if in 2009, $3000 of $6000 in long term capital loss is deducted from income, then the remaining $3000.00 is recorded on line 15 of the 2009 Capital Loss Worksheet and on line 14 of the 2009 Schedule D.(4)

For a skipped year of capital loss carryover an amended IRS 1040 and/or Schedule D and Capital Loss Worksheet may need to be filed to update the amount of capital loss carried forward. Additionally, according to the IRS, each year of unused capital loss carryover must be 'reflected' in the capital loss carried forward.

To illustrate skipped capital loss carryover further, the amount of capital loss for a skipped year should be deducted from the total unused capital loss. For example, if in 2007, $9000 of capital loss was incurred but not used, in 2009 only $3000 of capital loss would be able to be used. For additional clarification, contacting the IRS at 1-800-829-1040 for further instructions may be helpful.

Capital loss carryover tips:

When deciding whether or not to use a capital loss carryover or to determine if one qualifies for the capital loss carryover it can be helpful to be familiar with the IRS tax code, tax planning techniques and capital loss carryover rulings, instructions and uses.

• Cost basis is added to sale price ex. Transaction fees
• Capital loss in excess of $3000 can be used in a following tax year
• If Married filing separately, maximum annual capital loss claim is $1500
• A capital loss carryover is not the same as a 'capital loss carryback'
• Capital loss carryover can be used as long as there is some left
• Capital assets include real property and personal property

In summary, using capital loss carryovers are a way to lower tax costs via loss on the sale of capital assets which include a wide range of property such as real estate, stocks, and bonds. Capital loss carryovers are the use of capital loss from a previous year in which a capital loss was not utilized. It is useful to keep good records of capital losses and to prepare them accordingly in order to benefit from this tax incentive.

Sources:

1. http://www.irs.gov/taxtopics/tc409.html (IRS: Capital loss carryover)
2. http://bit.ly/c2Kf6h    (Money-zine tax rates)
3. http://bit.ly/8ZVMbf   (Law Cornell: US Code)
4.  http://bit.ly/bEGbgp (Schedule D: '09 Instructions)
5. http://bit.ly/77iBsY    (Schedule D: 2009)

The pros and cons of filing taxes electronically

Taxes can be filed electronically either through a tax preparation software or directly via the online version of tax software producers or accounting service providers. Electronic filing of taxes has been an official method and accepted by the U.S. Internal Revenue Service since 1986 (irs.gov). There are many advantages to both Government and tax filers when tax information is filed electronically.

The Internal Revenue Service Restructuring and Reform Act of 1998 was enacted as law for the purpose(s) of modernizing and streamlining the tax authority's operations in addition to assisting tax payers with their tax preparation and making adjustments to other tax filing rules. However, even with the many advantages, there are also some disadvantages of electronic tax filing that may sometimes by overlooked. This article will discuss the pros and cons of filing taxes electronically.

Pros of electronic tax filing

The number of tax filers who have used electronic tax filing has increased steadily for several years. This is due to the pros of electronic tax filing in addition to the U.S. Department of the Treasury's administrative goal of making the tax filing process digital. For the government, a predominantly digital tax filing process saves the government money in data entry expenses and shifts responsibility of finding errors to the tax preparation software, and individual tax filer. The tax filer pros of filing taxes electronically are listed below:

• Faster refund: Refund processing time may take as little as 2 weeks
• Efficient: Recording and transmitting of tax information is faster
• Less paperwork: Paper tax forms such as form 1040 do not need to be mailed
• Digital copy: Digital copies can be stored on a computer or disk
• No mailing costs: Transmitting of data itself is included in the service
• Can transfer federal information on to State tax application
• Math check and guided completion aids in tax filing accuracy
• Reduces need for expensive "anticipated refund loans"
• Online payment of taxes via multiple methods

Con of electronic tax filing

• Not always free: For high income earners and State tax returns a fee may be charged
• Will owe taxes faster if tax is due: If a tax filer owes taxes, the more efficient method could lead to faster processing of official acknowledgement of owed taxes.
• May not accommodate some complex tax filing procedures: 2% of tax forms and/or procedures cannot currently be accommodated by electronic tax filing.
• No paper copy unless one is printed: Paper copies may be desirable in some cases
• Personal information transferred through a third party: When intermediary services are used, their database may store personal tax information.
• Increased risk of computer identity theft: Stored tax information may exist on 1) personal storage devices, 2) a financial services firm and 3) the tax authority.
• Computers may inaccessible by some segments of the population

Disadvantages of electronic tax filing are sometimes overlooked in the interest of acquiring a faster tax return. Some of the cons of digital tax filing may be minor as data encryption become more advanced and there may always be people who are either located to remotely to have internet access or do not have access to a computer. Despite these cons of electronic filing, the availability of electronic tax filing is useful if not beneficial to many tax filers for the reasons illustrated in this article.

The U.S. Department of the Treasury has actively promoted electronic tax filing for several reasons which include 1) reducing costs 2) modernizing the tax processing system and 3) reducing paper requirements of the IRS. The number of electronic tax filings have become a major form of tax filing in recent years and are likely to continue as such in the future if past tax filing statistics trends remain strong indicators.

Source(s):

1. http://www.irs.gov/efile/article/0,id=120353,00.html
2. http://www.treas.gov/press/releases/rr1915.htm
3. http://www.irs.gov/newsroom/article/0,id=170407,00.html
4. http://www.pmstax.com/gen/bull9808.shtml

Taxes on Internet Sales

Technically, the purchase of goods sold over the internet are taxable if the corporations the products are purchased from operate within the same state. Such sales tax is not prohibited by the Internet Tax Freedom Act that was extended by George W. Bush in November of 2007 for 7 years. Since companies are able to set up out of state operations to qualify them for non taxation privileges, these companies do not have to pay taxes on sales to buyers within other states.

While states may not be required to collect taxes on internet sales, consumers may still be responsible for paying and reporting such taxes in the event of same state/business purchases. Enforcement of this law has not taken a high priority in recent years therefore many consumers are either unaware or negligent of such tax responsibilities. Some companies voluntarily collect internet sales taxes however others don't due to lack of legal restrictions requiring them to do so.

The Internet tax freedom act

The Internet Tax Freedom Act includes the internet tax non-discrimination act. Specifically, this act bans the taxation of internet service but not selling via the internet. States that wish to collect sales tax from sales within their state may request the collection of sales tax however sellers are not currently required to collect the sales tax themselves. This may change in the future but as of the date of this article, no such legality exists. If purchases are made from an internet site that is located outside of one's state, only that state may collect taxes on sales.

Supreme court prohibition of Internet sales tax

A 1992 Supreme court case entitled "Quill v. North Dakota", essentially outlawed the charging of taxes buy corporations selling goods to buyers in other states. Moreover, if a company has no presence within the state of sale, the Supreme Court decision maintains that the state to which goods are shipped cannot tax the corporation making the sale. While this case pertained to a mail order business, the principal of inter-sales through businesses not operating in the state of delivery applies to e-commerce as well. Consequently, the charging of sales tax is not applicable for purchases made online from such companies.

The stream lines sales tax project and internet sales tax

In light of complex, outdated and new developments in e-commerce, a legislative movement has begun to stream line sales tax and includes the potential for internet sales in that effort. The stream line sales tax project is an interstate initiative that simplifies and standardizes taxation collection. The result of a more standardized, and reduced taxation system between states could then allow the federal government to pass tax legislation that enables interstate taxation that includes internet sales tax.

Internet sales tax on sales from outside the United States

Depending on the tax treaties with a foreign country, tax may or may not be required for sales of products purchased over the internet. However, ambiguity exists regarding location of internet operations and their jurisdiction of operation. For example, a company that is required to charge tax on sales made for delivery outside of the United States may have an offshore subsidiary through which it does business. If that offshore jurisdiction is not subject to internet sales tax, the charging of tax on international sales tax may be disputed.

Summary of Internet sales tax

As it stands at the moment, internet sales tax is not largely enforced due to the nature of internet commerce i.e. since it is often without state borders, compliance with State laws and tax policy is not always required in addition to a lack of laws requiring businesses within a state to collect sales taxes from internet purchases. The internet is growing industry and the potential loss of sales taxes increases each year which gives states all the more incentive to push for a more concrete internet sales tax.

The Stream lined sales tax project is one such effort and aims to expedite and abridge the tax collection process thereby justifying collection of internet taxes between states i.e. differences between states signing onto the agreement may create a unity of state taxation making federal legislation on the matter easier to pass through the legislative bodies of Government. As of yet, the U.S. senate has not passed a law allowing states to require collection of taxes by internet businesses, but that point may come in the future and as internet sales increase.

Sources:

1. http://www.usa-sales-use-tax-e-commerce.com/international_internet.asp
2. http://smallbusiness.findlaw.com/business-operations/internet/internet-taxes.html
3. http://www.newrules.org/retail/inttax2.html
4. http://tinyurl.com/47d26a2 (NOLO)
5. http://www.informationweek.com/news/showArticle.jhtml?articleID=202801131
6. http://salesandtransaction.thomson.com/pdf/Tresh%20Presentation2.pdf
7. https://www.sstregister.org/sellers/SellerFAQs.Aspx#faq1

First Time Home Buyers Guide to Taxes

Tax relief for first time home buyers can be a much welcomed benefit of owning a home. This is partially due to the large expenses that come with buying a home for the first time. For example, closing costs, furnishing, repairs, moving expenses, home insurance etc. can add up to thousands of extra dollars in the first year of ownership.
                          
Income tax deductions and credits can help reduce the financial burden for first time home buyers.  However, there are also some taxes that are unavoidable such as property tax that is also a significant cost for first time home buyers. Several areas of taxation affect first time home buyers; some of these are listed and then discussed below.

Mortgage interest deductible on IRS Schedule A:

Many home buyers buy homes to make more productive use of money that is paid in rent as it builds net worth over time which helps with credit, financial stability, raising a family etc. When a home is purchased with a mortgage the interest paid on that mortgage for any given tax year may be deducted from taxable income using an IRS Schedule A. This may help lower the total taxes due to the Federal Government.

Capital gains tax exclusion

In the 2009 tax year, up to $250,000 of capital gains can be excluded from taxable capital gains for tax filing as a single person with primary residences that qualify for the exclusion. Among the rules of qualification are residence within the home for at least 2 of the previous 5 years with any depreciation from business use of the home deducted. For more information on this capital gains exclusion for home owners IRS publication 523 may be of assistance.

FHA loans down-payment percentage and tax credit

The tax credit mentioned in paragraph 1 may be used for the down payment of a Federal Housing Administration (FHA) loan. This application must be successfully approved and processed by the mortgage lender and may only apply to specific types of loans and costs. First time home buyers may receive low down payment percentage loans of 3.5%; even with a tax credit application ones debt to credit ratio may rise overall. Information on the FHA tax credit advance can be found at the following Department of Housing and Urban Development link (HUD) and is also subject to the time period in which the credit is in effect.

Property tax and property tax deductions

Homes are often taxed at the municipal level at a rate approximately between 1-2% of the home’s value as assessed or determined by the tax authority. The taxable property amount may be lower than the market price of a home. For example, a home that could be sold for $80,000 in the real estate market may only be taxed for an assessed value of $70,000. This tax is also deductible on IRS Schedule A if itemized deductions are used on the tax payers Federal tax return. More tax information for first time home buyers can be found in IRS Publication 530. 

First time home buyer tax credit through April 30, 2010: (expired)

Perhaps the most beneficial aspect of buying a home is capital appreciation, but until April 30, 2010 another incentive for first time home buyers exists. This incentive is the first time home buyers tax credit. This credit can be as high as $8,000.00 which in many cases is a recovery of sizable sunk home costs such as down payment. There are several requirements for this program such as purchase date, income amount, and residential history. For more information on this program please visit the first time home buyers tax credit information at Federal housingtaxcredit.com or the following articles on the first time homebuyer tax credit.

First time home buyer tax tips

• Not paying taxes at any level may lead to a tax lien foreclosure on a property which involves Government seizure of the property. To avoid this type of scenario paying taxes, creating payment plans and exploring alternatives may be helpful.

•  Property that is rented and not lived in may not qualify for first time home buyers tax credit thats buyers contract qualification expires in 2010.

•  Real estate used for income generating purposes may deduct expenses such as condo fees from business expenses and may also depreciate the value of the property.

•  A home may not incur a net gain in terms of capital appreciation if the homes value does not exceed the amount paid in mortgage interest.

•  For each type of home buyer tax issue it can be a good idea to research aspects unique to that situation. For example, determining Modified Adjusted Gross Income to determine how close to meeting or not meeting the first time home buyer tax credit one is.

Sources:

1. http://www.irs.gov (Internal Revenue Service)
2. http://www.hud.gov (U.S. Department of Housing and Urban Development)

Website Reviews: IRS.gov

The U.S. Internal Revenue Service website (IRS) is a website designed to assist the public in becoming informed about the tax filing process and rules associated with that process. The IRS website has navigation and search options that help visitors locate the information they are looking for. The IRS also provides explanations of rules derived from the Internal Revenue Code via online publications. While some of the underlying tax codes and tax preparation service providers are linked out to other websites, a great majority of information is contained within the website. This article will discuss some of key aspects of the IRS website.

Key features of the IRS website

There are several key features of the IRS website that make it quite useful and potentially beneficial. The website is quite full of useful information that can help make the tax filing process easier, more informed and potentially more accurate. A few of the key features of the website are listed as follows:

• Refund status lookup on the home page
• Ample access to forms and publications needed in the filing process
• English and Spanish navigation options
• Guides to efiling, freefiling and other online filing methods
• Search features that
• Category tabs to distinguish between types of filers ex, individual or business

IRS forms and publications

Whether one is navigating on behalf of oneself, a client, business, government agency or other relevant tax concern, the U.S. Internal Revenue Service home page has the choice of two languages English or Spanish and quickly enables one to access the table of forms and/or publications needed for tax preparation. The forms and publications can be downloaded or viewed online as either pdf files or html. What's more, the forms and publications table allows browsers to match the form numbers with the form name making the search for the correct form quicker.

Navigating the IRS website

In terms of navigation the IRS website is functional as most if not all the links are operational and the forms makes use of standardized formatting. Additionally, tabs on the home page quickly allow the website user to become orientated and finds one's way around the website without becoming too lost. The search feature is a useful way to type in keywords that may help one find a more specific piece of information cataloged within the vast website. The colors of the website are easy on the eyes, i.e. mostly white and different shades of blue with contrasting links. Help links and search tips further aid the ease of navigation on the website.

Quality of tax information

The quality of the information on the IRS website is good. While it does not give tax advice it does provide a great deal of information about the regulations and forms that one might obtain tax advice for. Thus, the website is a useful resource for tax preparation information.

The IRS website also includes contact information, legal information, tax preparation links, a site map and frequently asked questions links. The IRS website can be a useful resource to tax filers, tax preparers or persons researching tax information for other reasons. For the most, part, almost all the information one needs to file taxes is on the website and it seems though of the few things that are missing is actual advice on how to file taxes to avoid overpaying the Government.

Overall, the IRS Website,  is a functional, and useful website to persons interested in the federal tax process. The site has some useful key features that allow one to check on one's status or find contact information for the large organization. Additionally, the site is relatively easy to navigate and contains a lot of standardized tax information and sources that can be quite beneficial in becoming familiar with the tax related information. While the IRS website does not replace the advice of a tax attorney or tax accountant, there is ample information contained within the website that one may be able to forgo the use of such services in some cases.

Source: http://www.irs.gov (U.S. Internal Revenue Service)

Why a step-up in cost basis can affect taxes

A step up in cost basis can dramatically affect taxes because it amounts to an increase in the value of wealth passed between deceased and living persons. The step up in cost basis regulation is contained within Title 26, Subtitle A, Chapter 1 of the U.S. code alternatively named the I.R.S. tax code. This regulation requires property to be adjusted to fair market value following the death of the owner, but is capped at no more than $1.3 million in so far as the tax code permits.

Major disadvantages of step ups in cost basis is the amount of wealth that is taxed either via inheritance tax, or estate tax. An advantage however, is that realized capital gains can shrink lowering the resultant capital gains tax for the beneficiary responsible for liquidating the property.  Even with a reduction in capital gains tax however, the step up in cost basis ends up making an estate and inheritance cost more. Since inheritance and estates are sometimes taxed, the affect can still increase the amount of taxes due.

The step up in cost basis is an important aspect of estate tax planning and individual tax strategy. Being aware of how it can affect taxes and the methods by which it may be reduced or beneficial is key to making the most of this financial requirement. Estate planning is particularly relevant to step ups in cost basis because the financial instrument in which wealth is held and through which it is transferred affects how the property will be taxed regardless of the step up in tax basis.

Several financial instruments may be utilized to bypass immediate estate, capital gains and inheritance taxes. Examples of these estate planning tools include family limited partnerships, various forms of trusts, and gifting.  Although not all financial instruments avoid taxation, they can defer taxation until a suitable tax strategy has been developed. When estates are valued below a certain amount, neither the estate or inheritance tax may be applicable making a split estate an option to consider.

Depending on which state a beneficiary or beneficiaries live, the step up in cost basis may affect taxes differently. For example, not all U.S. states have an inheritance tax. Inheritance and estate tax may in some cases be avoided when held in joint tenancy. Since two or more persons own the property, the property does not transfer and is therefore not an inheritance per se because it is already owned.

As tax regulations are updated and changed, the step up basis on assets can affect taxes differently. For example, in 2010 the estate tax rules are set to expire thereafter reinstating the taxation of estate value. Specific taxes to be aware of when it comes to step ups in cost basis are capital gains tax, inheritance and estate tax, in addition to value limits and caps on transactions relating to such. These taxes can reduce the value of an estate significantly. Navigating the tax strategy and financial options with a skilled and knowledgeable financial professional may be of great value in some circumstances.

Sources: 

1. http://bit.ly/c2ncMG (Cornell University Law School)
2. http://bit.ly/cRsFXK (Estate Find Law)
3. http://bit.ly/c0XnQo (Bankrate.com)
4. http://bit.ly/auDihg (Avoid probate.com)

Taxes on Life Insurance Death Benefits

Lump sum payments from life insurance payments, payable upon death are not taxable so long as they do not exceed the present value of the policy. For example, if person X holds a life insurance with beneficiary Y listed to receive $100,000.00 in the event of death before a certain age and under certain circumstances only, then the present value of the policy is $100,000.000 and will be not taxable. However, any cash value the policy has accumulated will be surrendered in the event of a face value payout.

There are instances in which life insurance death benefits are taxable. Specifically in cases of 1) interest earned and 2) estate taxation benefits. Since payout of insurance death benefits may be received in installments, additional interest may accumulate on the value retained by the life insurance company. Additionally, in the case of estate taxation, the death benefits are not taxable as income ,but rather as estate taxes.

Taxation of interest on death benefits

Any amount of interest earned and paid out to the life insurance beneficiary that is over and above the face value of the insurance policy is taxable as income. Depending on how that interest is accumulated i.e. through which financial instruments can have an influence on the taxation levels of the additional income. For example, if the interest is earned through ownership of company stock that pays qualified dividends, that interest may be taxed at either 5% or 15% depending on the income level of the recipient. Or the interest may not be paid out, in which case it could be classified as tax deferred income.

Estate taxation on benefits

If an insured person dies an the face value of the insurance death benefits are less than $1-$3.5 million depending on the year, no estate taxes may be payable. However, if there are other assets in the estate, any amount over the tax exempt amount may be taxable.

When an insurance holder passes away, an Estate tax return may have to be filed prior to the nearest following tax filing deadline. Specifically, an IRS form 706 Schedule D may be needed to be filled out along with the other required information of the form 706.

In some cases, estate taxation may be avoided through the use of specific trusts such as an AB Trust, QTIP trust or Life Insurance trust. In the case of a life insurance trust, life insurance proceeds may be withdrawn without estate taxation and in the case of an AB trust, the value of the state is divided making the total estate value lower for the surviving relatives and hence less likely to be taxable under estate regulations.

Multiple insurance policy death benefits and additional tax tips 

In some cases there may be a number of insurance policies in existence including but not limited to auto insurance, employer insurance, and one or more types of life insurance. In such cases, the amount of the total proceeds may exceed the tax exempt estate limit, making any amount above that limit potentially taxable. To limit taxation in such instances as above, it may be advantageous to utilize one or more of the following techniques:

• Establish Trusts: i.e. charitable, AB, or life insurance, credit
• Hold assets in a family owned business
• Life insurance benefits may be payable into a shared annuity insurance policy, in which case the payments are distributed as an annuity  and avoid estate tax and/or are tax deferred income.
• Charitable contributions up to $12,000 per beneficiary may lower the estate value enough to be non taxable.
• Consult an attorney practiced in Estate law
• Seek the advice of a licensed Tax Accountant
• Contact the Internal Revenue Service for answers to additional questions.
• Research applicable laws, tax code, forms and methods of taxation.

Summary

Taxes on life insurance death benefits are for the most part payable through estate taxation, rather than income taxation except in cases of interest income on deferred payments. Additionally, if the total face value of death payout insurance is less than the pre-determined estate tax minimum taxable amount, then the death payout may not be taxable assuming no other income that causes the estate value to rise above the taxable minimum is realized through the estate. It may be possible more than one insurance benefit becomes payable in which case the use of trusts such as Life insurance trusts may be beneficial from a tax perspective.

Sources:

1. http://www.irs.gov/publications/p525/ar02.html#d0e5141
2. http://www.irs.gov/pub/irs-pdf/f706.pdf
3. http://www.ins.state.ny.us/que_top10/que_life_who.htm
4. http://www.irs.gov/businesses/small/article/0,id=108143,00.html
5. http://www.nolo.com/article.cfm/ObjectID/DAC2BB31-35E4-43B2-9BDFA70AD3775418/
6. http://law.freeadvice.com/estate_planning/asset_protection/techniques_estate_taxes.htm

Taxes on Short-Term Disability Benefits

Taxes on short-term disability benefits are determined by the method of coverage and the reporting of coverage as per the U.S. IRS Revenue Rule 2004-55.(1)  For example, for employer provided disability insurance coverage, the cost of coverage can be either reported as income or not. In the latter case, the benefits received in the instance of disability benefits may be taxable whereas the reverse may be the case for the former. Short term disability benefits are reported on lines 20 and 21 of the 2009 IRS Form 1040. To avoid taxes on short-term disability benefits the following actions may be helpful:

1. Complete an IRS Form W4-V for Voluntary withholding of coverage premiums.
2. Pay for disability coverage privately.
3. Earn under the income cap limit for Social Security Disability Benefits.

To illustrate more specifically, pre-tax and after-tax income received from short-term disability benefits may be taxable for the individual in the former case and non-taxable in the latter. The reason for the difference in taxation is the manner in which the benefits are handled. In the former case, the employer does not pay taxes on the benefits for the employee but in that latter case it does. 

These stipulations are illustrated by U.S. Internal Revenue Service (IRS) Revenue Ruling 2004-55 which according to Mellon Financial Corporation applies to all tax payers.(4) The ruling represents a means by which short-term disability benefits may not be taxable. However, as mentioned previously, the original disability coverage must be reported as income for any future benefits to be tax free. In the case of partial contributions being reported, a partial tax break may be incurred according to a Mutual of Omaha benefits claim procedure guide.(3)

Types of short-term disability benefits 

The type of short-term disability, timing of coverage and sources of coverage financing can also influence taxation of benefits. For example, benefits from privately financed disability insurance is not taxable as per the aforementioned revenue bulletin. Some of the different scenarios in which benefits may be received are listed below. Each of these scenarios have potentially taxable or non-taxable benefits.

1. Short-term disability from social security: Subject to income caps, and specific reductions.

2. Private short-term disability coverage: If paid for by recipient, benefits are non-taxable.

3. Employer short-term disability coverage: If paid for by employer but not reported as income by employee, taxable benefits. If partially paid for by employee, partially taxable benefits.

Useful IRS forms and publications for disability benefits

Benefits from short-term disability coverage should be reported to the IRS because it is still considered income regardless of whether or not it is taxable. There are spaces for both the taxable and non-taxable amounts in IRS Form 1040. Other forms that may be needed are Social Security Statements or 1099 summaries, voluntary withholding forms and income forms in which benefits are included in income.

• IRS Publication 915: Social Security information
• SSA-1099: Social Security income statement
• Form W-4V: Voluntary tax withholding form
• IRS Form 1040: Standard tax reporting form
• IRS Form 1040 Instructions
• IRS Publication 525: Income tax information
• Form W-2: Employer income statement

The scenarios in which these forms and publications are used vary. IRS Publication 915 covers Social Security benefit reporting whereas the 1040 instructions have information for non Social Security benefit reporting. Other forms such as the W-2 are forms received by employers that indicate income received, which in some cases, can include disability benefits paid through an employers insurance provider.

Summary

Short term disability coverage may or may not be taxable depending on the method and means by which the insurance is provided, paid for and reported. Income is also a factor in the case of Social Security disability benefits. By not including disability coverage from an employer as income, one is taking the chance disability income will not be received. 

This is a decision to be made by the coverage recipient and may be assisted via a personal risk assessment or employment risks audit. The forms, sources and publications cited in this article may be of additional assistance in determining whether disability benefits will be taxed, and how to reduce or eliminate the amount of disability pension taxed.

Sources:

1. http://www.irs.gov/irb/2004-26_IRB/ar06.html (IRS Bulletin 2004-26: Revenue Rule 2004-55)
2. http://www.hcvadvocate.org/hepatitis/hepC/Taxing%20disability%20benefits.htm
3. http://www.mutualofomaha.com/documents/manual/std.pdf
4. http://www.buckconsultants.com/pdf/fyi_07_15_04b.pdf
5. http://www.nosscr.org/tax.html

Taxes on Lawsuit Settlements

Lawsuit settlements are only taxable sometimes, therefore some of the time paying taxes on lawsuit settlements can be avoided. If one has successfully won a law suit settlement, there's still work to be done when it comes to taxes. Specifically, how to identify, minimize or even eliminate tax on the settlement funds which could be costly. For example, a settlement of over $1,000,000.00 in one lump some payment could be taxed as high as 35% which could be $350,000.00. That potential tax may be a good enough reason to consider and weigh the options on law suite settlements.

Lawsuit settlement annuities

If law suit settlement funds are taxable, one way to avoid and/or reduce taxes on settlements is to receive the lawsuit settlement in the form of monthly payments or annuity. (lawsuitfunding.factexpert.com) If the type of settlement claim does not fall under common law excluding tax on the annuity settlement, then taxes might still be due under an annuity settlement, however, with an annuity total income is lower than if a lump sum has been distributed. 

Since these monthly payments will reduce annual income but still allow one to receive the sum of the settlement funds, tax can be saved. For example, suppose the $1 million dollar example above were distributed as an annuity over 10 years. That would mean $100,000 in income per year, which is taxable at a lower rate than $1 million, i.e. approximately 28% or $70,000 less than if the full amount were taxable. It is important to note that even annuity distributions may be taxable under tax code and law.

Lawsuit settlement law and tax code

Distinguishing taxable from non-taxable law suit settlement income is a matter of understanding what the tax authorities consider taxable.(blog.oregonlive.com) Moreover, if income from a settlement is taxable, but is not reported, the tax authority may have the right to seek out taxes due with or without interest and other charges. To determine if a lawsuit settlement is taxable a recipient of said award might be well guided to identify the award as compensation for damage caused by physical injury or non-physical injury. 

If a lawsuit settlement arises from circumstances such as breach of contract or the settlement includes punitive action i.e. court awarded punishment to the prosecutor, then this income is more likely to be taxable under tax code and law. The extent of tax codes, rulings and laws are significant and thus it may be advantageous to consult tax attorneys and/or accountants in light of the potential tax savings and/or avoiding any potential tax code violations and punishment.

References and sources for tax guidance on lawsuit settlements

When seeking to determine whether or not a lawsuit settlement is taxable, independent research, due diligence, legal consultation and/or accountant assistance may be indispensable. For this reason, the following list of sources is provided to help inform the reader of any caveats, income exclusions, income inclusions, IRS codes, court rulings etc. regarding the payment of taxes on settlements. These sources can be consulted for additional information, clarification of terms or rules, or professional consul.

The U.S. Internal Revenue Service : A source of information for settlement related taxation

Weitz & Luxenberg P.C. : A source for legal information and advice relating to lawsuit settlements

The United States Tax Court : A court directly involved in tax disputes with the Internal Revenue Service

Summary

Lawsuit settlements can vary in size, terms/ruling and nature. The size of the settlement can influence the percent level of tax if the settlement is taxable and the terms and ruling of the settlement can determine how the settlement funds will be received. Last, the nature of the lawsuit settlement influences how tax authorities interpret the settlement. 

For example, a smaller tax settlement, paid in terms of annuity into a tax protected trust fund in compensation for physical injury is less likely to be taxed than a large settlement, paid in lump sum to the recipient directly in settlement of loss and/or damage incurred through breach of contract.

Since the potential tax savings, interest on back taxes, and punishments or late fees on unpaid taxes can be quite high, it is a good idea to consult tax attorneys, professionals or accountants for written verification of tax filing requirements. The information in this article is not intended as legal advice but rather a source of information regarding taxes on lawsuit settlements.

Sources:

1. http://lawsuitfunding.factexpert.com/1448-lawsuit-settlement-taxes.php
2. http://www.bizjournals.com/sanantonio/stories/2001/11/19/focus4.html
3. http://www.weitzlux.com/irs/freetaxeslawsuitsettlementirs_925.html
4. http://www.weitzlux.com/irs_918.html
5. http://blog.oregonlive.com/taxes/2008/10/question_from_christopher_octo.html
6. http://www.answers.com/topic/punitive-damages
7. http://www.irs.gov/businesses/page/0,id%3D7052,00.html
8. http://www.ustaxcourt.gov/

Taxes on the Exchange of Stocks

Taxes on the exchange of stock are only incurred if 1) the exchange leads to positive gains and 2) the transaction(s) do not take place within tax deferred financial instruments such as a Roth IRA. When earnings are made from the exchange of stock they are called capital gains and come in two types short term and long term. Capital gains are reported on an IRS form 1040, schedule D. There are several rules, and techniques that are relevant to and have the potential to lower taxation of profits arising from the sale of stock.

Short-term capital gains

Short-term capital gains are acquired through positive exchange of stock held less than one year in time. The taxation rate for short-term capital gains is the same as ordinary income taxation rates. For example, if one's total taxable income inclusive of short-term capital gains is between $30,650-$74.200, then income over $30,650 including the capital gains is taxable at 25% . Short -erm capital gains not held and/or exchanged in a tax deferred financial instrument are reported in part 1 of schedule D. This form is available at www.irs.gov.

Long-term capital gains

Long-term capital gains are gains made from the sale of stocks and/or other assets such as property that have been owned for longer than one year. The taxation of long term capital gains is lower than short term capital gains and is determined by completing part II of a schedule D in addition to part III of schedule D and the capital gains worksheet contained in the IRS 1040 instruction manual. The current tax rates for individually held long term stock capital gains as of the writing of this article is 5% for tax filers under the 25% taxable income bracket and 15% for taxable incomes at or above 25%.

Stock tax tips

There are several ways to legally avoid taxation of capital gains i.e. taxes on the exchange of stock. While these methods may not allow free and immediate access to the funds, they may serve as a viable tax hedge in instances where annual income is too high to make net worth and or leveraging outside of tax deferred financial instruments too costly in terms of taxation. It is also important to be aware of any special stipulations or rules within the tax code that may be helpful.

• Stock Transfers: Stocks transferred but not sold, from one account to another can allow the sale of stock in the new account to be taxed at a lower rate if the individual or organization receiving the stock is a child, has lower taxable income or is a non-profit organization.

• Donated Stocks: Transfers may also be considered tax deductible charitable contributions in the case of stock transfers to non-profit organizations or trusts.

• Wash Sales: If stocks are traded more than once within a 30 day period and at least one of the sales resulted in a capital loss, that loss is not deductible as a capital loss and is known as a "wash sale".

• Non-Taxable Distributions: For stocks that also pay special dividends or qualify for dividends to be distributed as non taxable, capital gains can be offset by the cost of stocks in so much as the non taxable distributions have a value equal to or less than the original cost of stock.

• Retirement Accounts: Exchange of stock through a retirement account can be tax deferred meaning any capital gains acquired through the account will not be taxable until withdrawal of that income.

• Irrevocable Trusts: If a stock owner gives stocks to trust before the stock increases in value then 1) one's taxable income will be lowered by the amount of the trust donation if the trust is non-taxable 2) the stocks within the trust may be tax free after sale, if they are less than the estate tax minimum taxable amount and 3) Dividend income earned through the stocks in the trust may also avoid taxation.

• Capital Losses: In cases where net taxable income is just over a new tax bracket for a given year, it may be advantageous to sell at a capital loss if one's investments in tax deferred instruments such as deductible IRA's have been maxed out and if the capital loss is likely to be unavoidable. This in a sense lowers the amount of the capital loss via tax savings between approximately 10%-33% on each dollar of capital loss provided a taxable income exists.

Taxation of capital gains can be thought of as quite straightforward in comparison to some other taxation concerns. Generally, short-term capital gains are not as cost effective as long-term capital gains and in the case of investments sold through a retirement or tax deferred financial vehicle. Some exchanges of stock, such as "wash sales" may not be deductible and capital losses may be offset through certain non -taxable dividend distributions. Other ways to reduce tax on stocks is to transfer ownership of them to a child or non-profit organization before the exchange.

Sources:

1. http://www.irs.gov/publications/p550/ch01.html#d0e4968
2. http://taxes.about.com/od/capitalgains/a/CapitalGainsTax_4.htm
3. http://www.msnbc.msn.com/id/7070269/
4. http://www.inc.com/magazine/19970901/1322.html

Tax implications of covered call writing

To assess the tax implications of covered call writing one may choose to first understand what a covered call is and second become familiar with the tax implications associated with the covered call. Since covered call writing can involve both a loss or a gain, the tax implications will naturally vary dependent on the outcome of the covered call. This article will first illustrate the meaning of covered calls and then determine possible tax implications of such a financial transaction.

Defining covered call writing

Covered calls are a stock options trading method involving a combination of a 'long' position combined with a 'call option contract written by the security holder'. In other words the covered call involves two aspects 1) owning the security outright and 2) 'writing' the option to sell the underlying security at a strike price. In this case, the call is covered by the long position held by the security owner which means the call writer has hedged his or her call option with the ownership of the underlying security.

To illustrate further and in more simple terms, investor Y purchases 1000 shares of Greenmail Corporation at a price of $75.00/share, the investor then 'writes' an option to sell Greenmail Corporation at $80.00/share. If the contract costs the buyer $10.00/100 shares the total premium would be $100.00 if a contract for 1000 shares is purchased and the strike price is not exceeded by expiration of the call option. In the scenario the strike price is not met, the seller of the call option will keep the premium plus any difference between the strike price and the purchase price (www.optionseducation.org)

Tax implications

Since the covered call stock option may lead to a loss or gain of money for the seller of the call option, the tax implications can vary. That is to say, if the underlying stock price declines and is sold and the option expires without reaching the strike price, the difference between the profit gained from writing the call option and the loss incurred through sale of stock will determine any loss.

Since the above scenario could qualify as wash sale because of two separate purchases of the same security within a 60 day period where a loss is realized on the underlying stock price, the loss on the sale of underlying stock may not be tax deductible. However, using a cost basis adjustment on the sale and/or purchase of a subsequent option may also minimize the loss from the wash sale. A few potential scenarios and their possible tax implications are listed below however do not replace the advice of a professional tax consultant:

• Underlying stock price decline + sale of call option: Cost adjusted wash sale may lead to tax deductibility on capital loss if an additional purchase of identical or similar stock takes place thereafter.

• Stock price rises + sale of call option: Taxation on capital gain if such gain is not within a tax protected financial instrument such as an individual retirement account.

• Stock price flat (with no sale) + expiration of call option: Taxation of premium will be incurred if the options trading is not within a tax protected investment vehicle.

• Stock price declines with sale + expiration of call option:. In such a case the capital loss may be tax deductible if sold within the same tax year and the retained premium on the call option may be taxed as ordinary income. A cost basis adjustment may not necessarily be applied to the options contract.

Tips for covered call writing and taxation questions

• Awareness: Since the covered call is a combination of two transactions the possibilities of scenarios increases. Being aware of all the possible scenarios and understanding them completely can be helpful in making the most of the covered call strategy

• Research: The covered call is a hedge against a decline in stock price. However, since the stock price could decline dramatically, the benefit of the hedge realized declines with the proportion in the decline of stock price. Such being the case, due diligence into the security, the market and other factors such as technical analysis can also be helpful in minimizing potential loss.

• Tax advice: Contacting and retaining a tax consultant may be advisable in a number of cases especially if one is engaging in a variety of options strategies.

• Tax code and authorities: For additional questions regarding taxation of investment strategies the capital investments division of the government tax authority may also be of assistance.

• Wash sales: Becoming familiar with the tax implications of wash sales when using options is advisable. To gain a more complete understanding of these implications consulting additional resources is advisable.

• Investment strategy: Having a well contemplated and investigated investment strategy may assist in the effective implementation of a covered call and application of corresponding tax scenarios.

• Brokerage services: While the use of a brokerage service may not include tax advice, the brokerage may be of assistance in understanding various uses of options thereby contributing to a better-informed investment strategy.

Summary

Tax implications of covered call writing vary on the outcome of the covered call investment strategy. Since a range of possible scenarios emerge when engaging in such a strategy a thorough knowledge of the tax benefits and hazards can be considered advisable either through independent research or through consultation with a tax professional.

While the information in this article does not replace the advice of a tax accountant or tax authorities it is recommended as a supplementary source of information to an overall covered call options strategy. It may also be helpful to the options investor to consult and cross-reference multiple sources of information to verify and become aware of the complete range of possible investment and tax scenarios.

Sources:

1. http://fairmark.com/forum/read.php?3,28029
2. http://www.investopedia.com/terms/c/coveredcall.asp
3. http://www.optionseducation.org/strategy/covered_call.jsp
4. http://www.irs.gov/pub/irs-pdf/p550.pdf
5. http://www.fairmark.com/capgain/wash/wsoption.htm