Understanding tax issues and rules can help you to avoid costly mistakes and take advantage of benefits that could reduce your tax liability. In this article, we address some common tax questions, which can help you to get a general sense of some of the things you can do in certain situations. Remember, however, to consult with your tax professional for advice on issues that are specific to your circumstances.
Forgetting to Include Income
I recently found out that I did not include some of my income on my tax return. What should I do?
You must file an amended tax return: IRS Form 1040X. According to the instructions for Form 1040X, your amended return must be filed within three years after the date you filed your original tax return, or two years after the date you paid your taxes for that year, whichever is later. If you filed your return before the due date, it is considered to have been filed on the due date. For instance, if you filed your 2012 tax return on January 1, 2013 , it is considered to have been filed on April 15, 2013, and the three-year period starts April 15, 2013. Be sure to indicate the year of your original return on the form, and include any required attachments and explanations of your reasons for filing an amended return. (For more insight, see Inaccurate Tax Return: Now What?)
Paying Estimated Taxes
I read somewhere that some individuals must pay estimated tax each year. However, I received conflicting information from another source. What is correct?
Let's start by defining estimated tax. It is a prepayment of income tax and/or self-employment tax that you may owe for the current tax year on amounts that are not subject to withholding tax, such as interest income, dividends, alimony, rent and gains from the sale of assets. If you receive a W2 from your employer, they will likely take tax out throughout the year. Thus, you wouldn't have to pay estimated taxes unless you had other sources of income. In general, you are required to pay estimated tax for the current year if the following applies:
- You expect to owe at least $1,000 federal tax for the current year.
- You expect your withholding from your pension, salary and/or other income subject to withholding tax, along with your credits to be less than the smaller of:
- 90% of the tax to be shown on your current year's tax return.
- 100% of the tax shown on your previous year's tax return, which must be for the full 12 months of that tax year.
If you are required to pay estimated tax, you must remit your payments to the IRS on the following schedule:
|Period for which Payment Is Made||Payment Due Date|
|January 1 through March 31||April 15|
|April 1 through May 31||June 15|
|June 1 through August 31||September 15|
|September 1 through December 31||January 15|
If your tax year is a fiscal year (not January to December), see the instructions for IRS Form 1040-ES.
You should consult with a competent tax professional for assistance with determining the amounts you need to remit each due date. If your payments are less than they should be, you could end up owing the IRS penalties.
Note that you may not need to pay estimated tax for the current year if you meet the following three requirements:
- You were a U.S. citizen for the entire year.
- Your previous tax years spanned 12 months - as opposed to a short year (less than 12 months). A short year could occur if you received income for a period of less than 12 months.
- Your tax liability for the previous year was zero, or you were not required to file an income tax return.
Also, if you receive income from pension and wages, you may be able to avoid estimated tax by having additional amounts withheld from these payments.
There are other factors that may affect your estimated tax, so, again, consult with you tax professional for assistance, and be sure to discuss how your tax-filing status and payments by your spouse (if applicable) would affect your estimated taxes.
Reducing Tax on Income from a Small Business
My after-tax income from my small business is greatly reduced by the incomes taxes I pay each year. A friend of mine told me I could reduce the amount of taxes I owe by shifting my income elsewhere. Is that true?
Generally, you can reduce the amount of taxes you pay by shifting the income from your business from yourself to family members who are in a lower income tax bracket. For instance, instead of paying yourself the usual salary, you could employ a family member who is in a lower tax bracket and pay him or her part of the salary you would receive for service performed for the business. The family member must perform services for your business and the compensation you pay that family member must be reasonable. For instance, paying your daughter $100,000 per year to add postage stamps to the pieces of mail you send out each week would not be reasonable compensation in the eyes of the IRS.
Employing family members is just one method of shifting income to reduce your tax burden. Talk to your tax and financial professional about this and other methods, such as gifting assets and designating a beneficiary to receive your insurance policies and/or retirement assets instead of withdrawing the amounts during your lifetime.
We hope you found these questions and answers helpful. Bear in mind, however, that the information provided here are only guidelines, and must not be construed as tax or legal advice, financial-planning services or estate-planning services. Individuals, businesses or any other parties should consult with their financial professional, tax professional or legal professional for advice related to their specific needs.