Are businesses protecting your Social Security number?
Dear Liz: Your recent column about disclosing Social Security numbers raises an important question. Federal tax law requires millions of Americans to disclose their Social Security numbers to those who pay a recipient at least $600 in a year. In practice, many payers request this information when paying much less than that. Millions of people have their Social Security numbers floating around on millions of computers, many of which are not secure. Why doesn’t anyone write about this or discuss the consequences of being required by law to disclose your Social Security number all over the place? This requirement is a recipe for identity theft.
Answer: You’ve pointed out another problem with using Social Security numbers as an all-purpose identifier. Federal and state laws require businesses that collect Social Security numbers to protect that information. But the fact remains that the more entities that have your number, the more vulnerable you may be to identity theft.
As an individual, you’re unlikely to change the IRS’ mind about the necessity of collecting this information. But when you’re asked for your Social Security or tax ID number, it’s fair to ask the requester how your information will be protected. That at least puts the requester on notice that you expect the laws regarding the safeguarding of personal information to be followed.
Tax strategies for self-employment income
Dear Liz: I’m 25 and trying to maximize my tax savings and retirement contributions. I currently have two jobs: One is the typical salaried position with taxes withheld where I earn $45,000 a year, while the other is self-employed work I do on the side that grosses about $7,000 a year. Currently I have a Roth IRA that I max out and a 401(k) that gets the equivalent of 13% of my salary when combined with my employer’s contribution.
Given that I don’t get a refund on April 15 and end up having to pony up a lot of money, is there a way for me to set aside my self-employment income into a retirement account such that I can just bypass all taxes on it, including payroll taxes? Would a traditional IRA work that way? If so, how would the IRS know that I’m putting money aside from my self-employment income and not from my regular day-job income?
Answer: To answer your last question first, the IRS doesn’t really care where the money comes from when you pay your tax bill. It mostly just cares about getting paid.
That said, you probably won’t be able to avoid self-employment taxes on your side business income, although you should be able to reduce or even eliminate owing income taxes on the money, said Eva Rosenberg, an enrolled agent who writes about taxes at TaxMama.com. (Self-employment taxes are your contributions to Social Security and Medicare.)
“The only way to reduce self-employment taxes is to reduce self-employment income,” Rosenberg said. “Putting money into retirement plans of any kind will only reduce income taxes.”
One way to reduce your self-employment income is to incorporate and then have your corporation contribute to your retirement plan directly, “thus wiping out most of your wages,” Rosenberg said. “However, the cost of incorporating and the annual filing and fees related to all that will certainly exceed your self-employment taxes on $7,000.”
What might make more sense if you want to reduce your income taxes is to contribute the maximum $5,000 to a traditional IRA, which offers a tax deduction for contributions, instead of funding a Roth, which does not. Even though you have a retirement plan at work, you can deduct your full contribution if your modified adjusted gross income is under $56,000.
Another option is a solo 401(k), which would allow you to put aside up to 100% of your compensation (although again, you would still owe self-employment taxes on that compensation).
Also, if you expect to owe more than $1,000 at tax time, you should be making quarterly estimated tax payments instead of waiting until April 15 to pay your tax bill.
Don’t be too quick to destroy paperwork
Dear Liz: I’ve seen some writers suggest that people can destroy financial and tax information after three years. Let me tell you my story. Before my sister died, I had to take care of her finances. She had little money left but she had to go into an assisted-living facility. I had to show proof of five years’ earnings and financial statements. So please tell people not to shred or discard information after three years.
Answer: It sounds as if you were getting your sister qualified for Medicaid, the government program that covers health and custodial care for the indigent. Medicaid now has a five-year “look back” period that penalizes transfers of money or assets when people apply for coverage. The look-back period is designed to discourage people from artificially impoverishing themselves by transferring assets to others so that they can qualify for Medicaid to cover nursing home bills.
You’re right that destroying financial documents after three years may be a bit precipitous. The IRS typically has three years from the due date of the return, or the date it was filed, whichever is later, to conduct most audits. But the deadline can be extended an additional three years if the IRS believes you significantly underreported income. And certain documents need to be retained longer. That’s why many tax experts recommend hanging on to supporting documents for your tax return for at least seven years, and keeping the tax returns themselves indefinitely. You also might consider scanning important financial documentation into your computer and keeping back-ups offsite.
The good news is that many of the statements you’re likely to need can be reordered from the financial institution that originally issued them. There may be fees involved, but many banks, brokerages and credit card firms easily can provide you with statements dating back six years, if not longer.
U.S. mail isn’t a secure way to transmit tax documents
Dear Liz: I read your column about the reader whose tax papers were missing and couldn’t believe my eyes. A similar thing happened with me. My accountant mailed my returns to me as always, but this time they did not arrive the next day as they always did. I was worried sick because, of course, the Social Security numbers and all of our banks are listed in the returns. I was very worried that someone had stolen our returns and would use them either for identity theft or to drain our bank accounts. I filed a theft report with the Postal Service and fraud alerts with credit reporting agencies. Three long weeks later, I got an envelope from the IRS with the returns in it, requesting the missing signatures on the returns. Apparently the returns had been sent to the IRS rather than to us. I strongly suspect there is a flaw in the software the accountants are using this year that is sending the returns directly to the IRS instead of to the accountants’ clients for signatures. If you have the email address of your reader, please have him or her call the IRS, and I bet they have the return and all of the original paperwork.
Answer: Actually, the reader followed up to say her supporting paperwork eventually made its way to her mailbox. The return itself, as noted in the column, was electronically filed without her permission or review.
Whether there’s a software glitch or simply overworked preparers making mistakes is unclear. But these experiences do highlight the risks of using the U.S. mail for sensitive information. Here are another reader’s thoughts on the subject:
Dear Liz: As a tax preparer, I deal with clients who live 100 or more miles away, and I have never had a problem with mailing of documents in either direction. Perhaps they may be delayed somewhat, but they have always arrived. As to the issue of the preparer filing electronically without permission, the IRS mandates that a return can be filed electronically only after the preparer receives the taxpayers’ approval (IRS Form 8879 must be signed by the client). Therefore it appears that the tax preparer in this case may have acted in a manner not acceptable by taxing agencies. This is something taxpayers should be wary of in dealing with tax preparers.
Answer: That’s definitely true, but perhaps you should consider being a little more wary of the mail system. Just because nothing has happened yet to all that sensitive data doesn’t mean something can’t or won’t. It may cost a little more, but if your clients can’t drop off information and pick it up themselves, paying for delivery services that offer tracking information is a way to make these transactions more secure.
Don’t trust your tax papers to the U.S. mail
Dear Liz: I sent my tax preparer everything he needed for my return, including the originals of my W2 forms, bank 1099s, property tax bills (including a copy of the check showing the payment) and a year-end mortgage statement. A week later he said it was done and that he had mailed the return and paperwork back to me. It’s been three weeks and I still haven’t received the paperwork. What I did get was a direct deposit of my refund, so apparently he filed the return without telling me. I am sick to death that all my private financial information is floating around in the mail system somewhere and that it could get into the hands of a dishonest person.
Answer: You’ve learned a couple lessons, foremost among them that you need a new tax pro. Filing your return without letting you see it was a definite no-no.
Another lesson is that your private financial data probably shouldn’t be entrusted to the U.S. mail system. It’s more secure to drop your documents off with your tax preparer and pick them up yourself, along with a copy of your return, when he or she is done. The original return can be electronically filed using the IRS’ secure, encrypted system, eliminating the need to use the mail.
You can put 90-day fraud alerts on your credit reports at the three major bureaus (Experian, Equifax and TransUnion). Fraud alerts notify lenders that they should take extra steps to verify identity before opening accounts in your name. For more protection, you may want to consider a credit freeze, which doesn’t rely on lenders’ sometimes-wavering vigilance but that allows you to shut off access to your credit reports, preventing thieves from opening new credit accounts. For more information, visit the Consumers Union site www.financialprivacynow.org.
