Free loans to the IRS and other tax goofs
Want to know what taxpayers do wrong? For one thing, most folks answering our 2006 tax survey expect a refund. Hello! Letting Uncle Sam hold your money is dumb.
By Jeff Schnepper
MSN Money has been surveying readers about their taxes for three years, and I am concerned. Readers keep making the same mistakes:
l They let the government keep their money for way too long.
l They wait too long to get started on their taxes.
l Because they wait too long, they probably pay too much to the Internal Revenue Service.
And a few do some really stupid things that could possibly land them in jail.
Admittedly, our survey is not scientific. But it has truths we all probably will recognize. Here are the conclusions I draw from the survey — and what I think you can do to help your tax situation.
He who hesitates must file an extension
Almost 20% of the 1,584 readers who responded to this February’s survey said they don’t even start to think about taxes until April 1 — and 6.9% say they often need an extension.?
For those procrastinators out there, we’ve got some good news.
In past years, you were allowed an extension of four months, until Aug. 15. You didn’t need a reason — the extension was automatic. If you couldn’t get to it by Aug. 15, you could apply for a second two-month extension, until Oct. 15. But, for the second extension, you needed a good reason and IRS approval. Practically, it was a no-brainer. You simply said you were waiting for a late 1099 form or a late K-1 form, and you got your extension. But you did have to file that second extension.
Now, there’s no second extension; the first (and only) extension is good for six months, until Oct.15. You file the same old Form 4868, "Application for Automatic Extension of Time To File U.S. Individual Income Tax Return."
The form basically asks three questions:
l What do you expect your tax to be?
l How much have you paid in so far?
l What’s the balance?
You can download Form 4868 from the IRS Web site and mail it in. Or, you can file the form over the phone by calling 888-796-1074. (Remember to attach a copy of the form to your tax return when you file.)
Remember, this is only an extension to file. It is not an extension to pay.
In other words, you must pay any balance due by the federal tax deadline — April 17 in 2006. (It could be April 18 if you live in a state which, like Massachusetts, celebrates Patriot’s Day.) If you come up short and you haven got at least 90% of your tax in on time, you will owe interest and, potentially, penalties.
Unless you make a lot of money and have a complex financial life, an extension also means you can make mistakes in filling out your return now and in planning for next year’s return.
Surprise: Refunds are bad!
More than 62% of those who responded to our survey said that they expect to get a tax refund for their 2005 taxes. More than half of them expect a check for more than $1,000.
The proportion expecting a refund rose from last year, despite the fact that the percentage of respondents expecting a return of $1,000 or more was about the same in both years.
I’m a little discouraged about this result.
Fact is, tax refunds may make you feel good; everybody likes to get money. But once you understand what going on, you realize big refunds don’t make sense. A big refund means that you allowed the IRS to hold your money — interest-free — for the year.
It’s not that the IRS is giving you anything. It was always your money, and you let them keep it without any return to you. They don even say "thanks."
If you get a $1,000 refund, that $83.33 a month you could have spent or, better, invested. The IRS held it, paying no interest, for a year. (At 4.5% or so — the rate on a 13-week Treasury bill at the end of last year — we’re only talking $45. But, to me, it is the principle that matters.)
Let me make an offer you can’t refuse. (Well, maybe you can.) Instead of sending the money to the IRS, send it to me. Not only will I return it to you on April 16, 2007 — April 15, 2007 falls on a Sunday — but also even enclose a personalized thank-you card. Let’ssee the IRS match that.
If you don’t want to send the money to me, then shoot for the safe harbors. That where, regardless of the amount you owe April 16, there’s never any interest or penalty if your balance is paid on time.
One safe harbor is to have 90% of your total 2006 tax paid by April 16 of next year. But, that means you have to estimate income, expenses, credits and all the rest.
A second safe harbor is to have 100% of your prior year’s total tax paid in. For 2005, that would be line 62 on your 2004 Form 1040. If your 2004 adjusted gross income was more than $150,000, then the 100% figure increases to 110%.
Any expected tax in excess of this 100%/110% number should be paid into a money-market account or a CD or government security that matures on or before April 16. At least that way, you get the interest. There’s no risk to your principal, and you have the cash available to pay any additional tax then due.
Ignorance is not bliss!
More than 37% of the respondents were confused by the tax law changes. It’s not surprised. Even the professionals get overwhelmed and confused. Through 2005, we’ve had 39 major tax law changes in the last 42 years!
That explains why more than 16% of our respondents said they expect to spend more than six hours preparing their taxes. Nearly 8% said they expect to need more than 20 hours. These numbers become even more astounding when put in perspective. Nearly 43% expect to hire a professional tax preparer to do their taxes. Another 29.5% plan to use software programs.
Here are some figures directly from the IRS instructions for 2005 returns. If you itemize your deductions and have no business income, but did sell some stock, the IRS expects you to spend 27.5 hours doing your 1040 return. If you used tax software, it increases to 37.8 hours!
I wonder how long it took the IRS employees in a December 2003 survey to incorrectly prepare 19 out of 23 simple tax returns?
You won the audit lottery!
More than 10% of this year’s respondents admitted fudging on their taxes. That’s up from 8.5% a year ago. Of this group, 27% told us that they fabricated deductions, and 3.4% professed to actually making up fictional children or other dependents. Since Social Security numbers are required for claiming dependents, I wonder how they did that? Or are they pulling our leg?
Of those who fudged, 37% agreed that it was their policy to trim their taxes "by any means possible." Another 31% said they fudged because they felt the odds of an audit were slim. In fact, almost 39% believed that their chances of being audited this year were one in a million.
But beware! The actual audit rate numbers are much higher than that. For fiscal year 2004, 0.77% of individual tax returns filed were audited. That about one out of every 128 returns filed.
For fiscal 2005, ending Sept. 30, 2005, the IRS audited about 1.2 million individual tax returns — up more than 20% from the year before. Rather than one in a million, the real odds were closer to one in every 108 returns.
If you made more than $100,000, the audit rate jumped to 1.58%, double what it was four years ago. That’s one out of every 63 returns filed!
Do you still feel lucky?
And if a respondent was audited, how did he do? About 40% said they paid more money to the government; about 44% said they came out about even. Only 15% got an additional refund.
Don’t go to jail!
Not unexpectedly, almost 42% of those who responded were pretty darned reluctant to pay their taxes. Another 56% found good reasons to pay, ranging from feeling it was their patriotic duty to wanting to support American troops, especially in Iraq.
But, surprisingly — to me, anyway — 2.4% agree that the IRS is illegal and they don’t recognize the government’s right to tax.
Everyone’s entitled to an opinion, even a wrong one. But this issue was settled long ago. If you continue to contest the legality of our tax system, you’re going to lose! And, you face a potential $25,000 penalty just for bringing up the argument and wasting a court’s time.
Interestingly, of the 38 respondents who thought the IRS was an illegal organization, only one failed to file a return for that reason.
I guess the other 37 were getting refunds.