Lancaster PA Probate and Estate Administration Law Blog

On March 26 the IRS released its annual list of the worst 12 tax scams for the year. The IRS cautions taxpayers not to fall for any of these scams - often these scams are at their peak during the filing season as people prepare their tax returns. This week's column presents one-half of the "Dirty Dozen".

1. Identity Theft and Refund Fraud

Tax fraud through the use of identity theft tops this year's Dirty Dozen list. For the 2013 tax season, the IRS has put in place a number of additional steps to prevent identity theft and detect refund fraud before it occurs. The strategy uses a three-pronged effort focusing on fraud prevention, early detection and victim assistance.

                                                     Not this Dirty Dozen.   

Taxpayers who believe they are at risk of identity theft due to lost or stolen personal information should contact the IRS immediately so the agency can take action to secure their tax account. Taxpayers can call the IRS Identity Protection Specialized Unit at 800-908-4490.

Phishing is a scam typically carried out with the help of unsolicited email or a fake website. If you receive an unsolicited email that appears to be from either the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System (EFTPS), report it by sending it to phishing@irs.gov. The IRS does not initiate contact with taxpayers by email to request personal or financial information.

3. Return Preparer Fraud

About 60 percent of taxpayers will use tax professionals this year to prepare their tax returns. Most return preparers provide honest service to their clients. But some unscrupulous preparers prey on unsuspecting taxpayers, and the result can be refund fraud or identity theft. Taxpayers are legally responsible for what's on their tax return even if it is prepared by someone else.

 "A baby will make love stronger, days shorter, nights longer, bankroll smaller, home happier, clothes shabbier, the past forgotten, and the future worth living for."      ----Author unknown

Congratulations! You're having a baby. It's so exciting, and nerve-wracking, and fun, and OMG how are we going to do this?

You're picking out a crib, wondering which diapers to use, what color should you paint the room. But there is something more important than all of that. You need to make sure your baby will be cared for even if you are not here. Bringing a child into the world means you care for that child, and caring means making sure he or she will be cared for no matter what happens to you.

Did you know that according to the Orphan Society of America, almost three million children are living without parents in the United States? Did you know that 4.1 percent of the children in the United States are parentless?

Suppose a young couple has a three-year-old toddler. Tragically, both parents are killed in a car accident. Their families try to figure out what is best for the child. Imagine the grandparents and aunts and uncles who could be pushing for guardianship of the child. The potential for disagreement is obvious. Without a will where the parents choose a guardian, any family member could create litigation which is costly, detrimental to the child, and puts a strain on family relationships.

The first order of business is to make a will. Maybe you don't have many assets, but you do have something very valuable - your baby. The most important thing you must do in a will is to name guardians. These named individuals are your choice of who will care for and raise your child if you can't. You can even specifically exclude someone from caring for the children.

If you are in business, whether self-employed or running a company, you must send a 1099 form (with copies to the IRS) to anyone that you pay money to, unless they meet one or more of the following exceptions:

the recipient is a corporation

you included the payment in a W-2 form (to an employee)

the payment is for a tangible product (office supplies, computers, etc), or

the total payments during the calendar year were less than $600.

To make sure that you are reporting the payment item correctly, you should ask the individual or other payee to fill out a Form W-9, Request for Taxpayer Identification Number and Certification, complete with name, address and social security number or taxpayer identification number. It is recommended that you get the completed W-9 before you make the payment. If you pay someone and they refuse to give you a W-9 or their social security number, you should file the 1099 without the number. The IRS will be in contact with them, and they can explain to the IRS why they won't provide their social security number.

Individuals are not required to send 1099-MISC for personal payments. You are not required to send a 1099-MISC to an independent contractor to whom you made a personal payment unrelated to a trade or business. For example, you don't have to issue a 1099-MISC to your landscaper or house painter.

The IRS started its 1099 information return program in the 1980s. Its purpose is to make it harder for people to work "under the table." The 1099s allow the IRS to run a matching program using social security numbers and tax ID numbers to catch people who receive interest or dividends, receive payment for services, or collect rents but don't report the income.

Most tax practitioners will agree that of all the enforcement programs the IRS has, the 1099 matching program works pretty well.

There are a number of 1099s through which businesses of all kinds report the money they pay, including 1099-INT for interest income, 1099-DIV for dividends and several other 1099 forms to report other specific monetary transactions. 1099-MISCs are used to report free-lance or self-employment income, rental income, prizes and other miscellaneous types of income.

Individual taxpayers are most familiar with a 1099-MISC being used by a trade or business to report payments of $600 or more for services performed by people not treated as employees (such as subcontractors). If you work as an independent contractor, freelancer or consultant, you receive a 1099-MISC reporting what was paid to you from each payor during the calendar year. If you received a 1099, the IRS received a copy of it. Your 1099-MISC income should be reported under schedule C or C-EZ and SE for Self Employment, as part of your regular 1040. Not only do you owe income tax on these earnings, you also owe self employment tax.

Most of the tax increases in the American Tax Relief Act of 2012 (ATRA) were aimed at the wealthiest taxpayers. Unfortunately, the tax increases will hit trusts hard.

The Tax Changes

First, the Patient Protection and Affordable Care Act (often called "Obamacare") imposes a 3.8% surtax on net investment income. "Net investment income" generally is the passive investment income earned by a trust or estate.

Second, the top income tax rate went up from 35% to 39.6% and the maximum rate on dividends and capital gains will be 20%, up from 15 % in 2012. (The combined rate will be 23.8%.)

The Collateral Damage

Why are trusts hit so hard? The trust income tax brackets are compressed. For individuals, the Obamacare surtax doesn't hit until a taxpayer has more than $200,000 of income ($250,000 for married filing jointly). For trusts, the surtax hits when income is over $11,950.

For individuals, the top income tax rate of 39.6% doesn't apply until income is over $400,000 ($450,000 for joint). A trust hits the 39.6 % top bracket when trust income is over $11,950.

The 39.6% top bracket plus the 3.8 % surtax, totaling 43.4% is the trust's combined tax on income over $11,950. Ouch, that hurts. $11,950 is not very much income.

Trustees and Executors should pay particular attention to income accumulating in the trust or estate. With the new tax brackets, it will be more important than ever before for trustees and executors to distribute income to beneficiaries so that it can be taxed at beneficiaries' much lower rates rather than being taxed at the trust or estate level.

For capital gains, which do not get passed out to beneficiaries with distributions, trusts and estates will pay 23.8% when income exceeds $11,950. This means that all trusts, including relatively small trusts, will likely have to pay the combined rate of 23.8% on capital gains.

Strategies

For estates and trusts that may be subject to the 3.8% surtax, the time to plan for reducing or eliminating the surtax is now. Strategies for reducing or eliminating the surtax may include: investing in tax exempt bonds, choosing a tax year beginning in 2012 instead of 2013 for estates, making estate or trust distributions to individual beneficiaries who will not be subject to the surtax, and creating above-the-line deductions.

Assets like tax-exempt municipal bonds and life insurance may become more favorable investment options when compared to other investment assets whose income is subject to the surtax. Trustees of trusts with IRA assets, both traditional and Roth IRAs, should consider that these assets will be even more tax-advantaged in 2013 when distributions from these accounts are not subject to the surtax.

Trustees should become familiar with the mechanics of charitable lead trusts and charitable remainder trusts, which may become more popular in light of the income deferral feature of charitable remainder trusts and the ability to shift investment income to charities in charitable lead trusts. Charitable remainder trusts are exempt from the surtax because they are exempt from income tax. Charitable lead trusts will be subject to the surtax, but the surtax may be partially or entirely avoided by the required annual distributions to charities.