Ask Liz Weston

Tax fraud and tax-related identity theft isn’t exactly rampant–there were 50,000 complaints in 2006, compared to nearly 10 million cases of identity theft total. But it does appear to be on the rise, and the last thing you want after the hassle of preparing your return is to find out your refund has been swiped by some bad guy.

Janice Chaffin, head of Symantec’s Norton Business Unit, offers these tax season safety tips:

1. Carefully select your tax prep provider or software.
Visit the IRS Web site for approved software partners that support online filing. If you use a tax prep provider, don’t just go with someone who promises big refunds. Ask if friends have used him/her before.

2. When ready to eFile, make sure your Internet connection is safe.
When you are using an online tax prep service, look for indications that the connection is encrypted (you should see the address change to “https” and a lock symbol appear in the browser frame). Don’t prepare or file taxes on a shared, insecure connection like the open Wi-Fi network in your neighborhood coffee shop.

3. Turn off (or remove) any peer-to-peer file sharing services.
If you use peer-to-peer services (like LimeWire, Kazaa, BitTorrent), you can inadvertently allow a criminal anywhere in the world to find your tax file record (usually a pdf file) on your computer, revealing all your personal information. It is best not to use these services, during tax season or any other time of the year.

4. Encrypt and secure any pdf copies of the return on your computer
In your My Documents view, right-click a file name to select “Encrypt.” Print out a copy and put in a safe location in your home. Back up or store additional copies to save someplace else.

5. Make sure your Internet security software is on and up-to-date.
Symantec advises all computer users to keep their security software updated; keep their computer systems clean and continue to use general best practices for staying safe online. Find more information on how to prevent criminals from invading your computer here.

Dear Liz: I am freaking out and losing sleep. I got a letter about five years ago from the IRS telling me I owed it money, so I stopped filing my taxes. Now I feel scared and nervous and don’t know how to fix this. I have my paperwork and want to file all my returns and see how much I owe. I usually get refunds so hopefully the tax bill won’t be too bad, but I just don’t know where to start. Should I hire an attorney or just throw myself on the mercy of the IRS? Money is tighter than ever, but I feel that I can’t move forward until I resolve this issue.

Answer: It’s too late for you, but others who may be tempted to ignore their obligation to file tax returns need to know two things.

The first is that the failure-to-file penalty is much worse than the failure-to-pay penalty. Since the IRS offers payment plans, it’s better to file than not, even if you can’t pay right away.

The second is that you have only three years to file a tax return before you lose any refunds to which you might have been entitled.

In short, not filing can cost you, big time. You don’t need to throw yourself on the IRS’ mercy, but you should find a good tax preparer who has dealt with this issue before. Many have, as there seems to be no shortage of people like you. Your local certified public accountant society or the National Assn. of Enrolled Agents, at www.naea.org, can provide referrals.

W-2s and other tax documents are starting to arrive in the mail, signaling the beginning of the U.S. tax season for individual taxpayers.

Oh, yay.

Not only are taxes a pain to confront, but they’re easy to get wrong. Here are five big mistakes to avoid:

Failing to file. Every year, I hear from people who have hidden under a rock for years–years–when tax season rolls around. They want to come clean, but are afraid the IRS will send storm troopers to carry them away. Relax: simple failure-to-file isn’t a crime, although it can be costly. Failure to file penalties are much worse than failure to pay penalties, and you lose out on any tax refunds you might have gotten after three years have passed. The fix is straightforward: find yourself a CPA or other good tax pro, bring what documentation you have and take your medicine.

Doing complicated taxes themselves. I’ve used a tax pro ever since starting my first freelance business many years ago, and that was even in the years when I was doing our taxes eight or nine times a year to test out various tax software. My pro has always found deductions I missed and been a great resource year-round. If you’ve got a business or a lot of investments, find yourself an expert. At the very least, you should be using software like Turbotax–today’s tax code is simply too complex to tackle by hand.

Paying with a credit card. Whatever rewards you’re getting from using a card are more than offset by the fees charged to use plastic. If you can’t pay right away and have a very low rate on your card, charging could make sense, but the IRS’ payment plans also come with pretty low interest rates.

Using rewards points to pay your taxes. American Express just announced that you can do this with their rewards cards, but the exchange rate is awful. You need 200 points to pay $1 in taxes, according to CreditBloggers.com. (Normally, you want an exchange rate of at least 1 cent per point or mile; CreditBloggers points out you can get a $25 Barnes and Noble card on Amex’ site for 2500 points, and even the less desirable exchange rates that typically apply for merchandise typically give you 100 or so points to the dollar.)

Taking out a refund anticipation loan. If you file electronically and opt for direct deposit, you can get your refund in about 10 days. That’s all. It’s insane to pay an interest rate that’s effectively in the triple digits to get your money faster from a tax preparer that offers refund anticipation loans. If you need the money so badly, then file earlier in the season; your wait time may be even shorter.

Dear Liz: When the stock market dropped this past year, I decided that was a perfect time to max out my 401(k) deduction to the plan’s 35% limit. The problem is that the IRS maximum contribution is $16,500, and it’s nearly impossible to get my withholding to exactly match the dollar limit. If I am slightly over the maximum at the end of the year, what is the IRS likely to do to me?
Answer: It’s typically not the IRS that takes action in these situations; it’s the 401(k) plan administrator that will either stop your contributions once you hit $16,500 for the year or send you back a check for any amount over the limit you’ve contributed.

You’ll have to pay regular income taxes on that money, but you won’t otherwise be penalized for trying to be aggressive about your retirement savings.

It sounded like a heck of a story–too bad the facts get in the way.

The press release proclaimed that “taxes, not health care, are retirees’ biggest expense when they’re in their 70s,” according to a study commissioned by a financial group to whom I will not give a shred of publicity.

Surprising, yes? Except the only folks surveyed for this study were 70-somethings with a net worth in excess of $1 million.

The median net worth for a household headed by someone in his or her 70s was actually just a hair over $203,000 in 2007, according to the latest Federal Reserve Survey of Consumer Finances. “Median” means half of the households had less wealth. Only 13% of this age group had a net worth over $1 million back then. There are probably even fewer today, what with the housing meltdown and stock market crash.

Median income for this age group, meanwhile, was $30,645. It’s hard to imagine taxes being a major concern to the 50% of 70-somethings making less than $2,600 a month.

In fact, the Consumer Expenditure Survey indicates the average tax burden for those aged 65 to 74 is $1,374 a year, an amount that drops to $865 for those 75 and over.

By contrast, here are average health care expenses for older people from the 2004 National Health Expenditure Survey (the latest year available):

• Seniors age 65 and over spent an average of $4,888 per capita annually out of pocket for deductibles, copayments, premiums and other health care expenses not covered by insurance.
• Their spending is more than twice as high as the average nonelderly adult.
• The largest expenditures occurred among those 85 and older, who spent an average of $8,304, compared to $5,066 for seniors ages 75 to 84, and $3,851 for those 65 to 74.

Why did this release irritate me so? Because it pretended that a minor irritation of a privileged few was a bigger deal than a real, and growing, crisis for many older families.

Taxes are what a friend of mine would call a “quality” problem. You don’t pay them, typically, unless you’re making money.

Health care costs are simply a problem, and a big one for many older Americans.

Dear Liz: I am 74 and retired. Due to the economy I would like to cash out my retirement accounts. I have an individual retirement account, a Simple IRA and an annuity. Only other income is Social Security. How badly would this affect me?

Answer: That depends. How much do you love paying unnecessary taxes?

Cashing out any retirement account, other than a Roth IRA, typically triggers a significant income tax bill. Cashing in an annuity may also trigger surrender charges that can be substantial.

If you took too much risk with your investments, you can shift to safer options inside your retirement accounts. You would be smart to consult a fee-only financial planner first, so you can construct a portfolio that acknowledges your tolerance for risk while still giving you enough money to live on for the rest of your life.

It’s almost April 15th — the deadline for filing your 2008 tax return. But it’s also the deadline to make an IRA contribution for 2008. Don’t let your fear of the market prevent you from taking advantage of the chance to set aside tax-advantaged money before it’s too late.

Many people don’t realize you can contribute to an IRA or a Roth IRA even if you have a 401(k) or other retirement plan at work. Here are a few other commonly asked questions about IRAs. Responses are from Fidelity Investments, a leading provider of these investments.

Q. Should I skip my IRA contribution this year because of the wild swings in the stock market?
A. Experts say an IRA is still one of the best tax-advantaged vehicles for retirement savings in any market. If you can’t stomach the risks associated with stocks, you can always invest in CDs, bond funds and money market funds in addition to long-term equity funds–although in the long run you’ll be better off with at least some exposure to stocks.
Fidelity likes to use this example: An investor who makes a single contribution of $5,000 to an IRA this year may have more than $53,000 in 35 years, assuming an annual rate of return of 7%. (As you read here last week, stocks have yet to return less than 8.5% over any 30-year period in modern stock market history.)

Q. I just lost my job. What should I do with the 401(k) I have with my former employer?
A. You have several choices.

• Leave it with your former employer’s plan
• Move the assets to a new employer’s plan once you secure a job
• Roll over the assets to an IRA

Whatever you do, don’t cash out your 401(k) when you leave your job. You get socked with penalties (10%) and taxes for early withdrawal. Plus you miss out on the potential for long-term earnings growth. Better to consider one of the three options listed above. CLICK HERE for info from the IRS.

Q. What’s the difference between a Roth IRA and a traditional IRA?
A. A Roth IRA offers federally tax-free growth. You’re funding this IRA with money you’ve already paid tax on — and you’ll withdraw it with no tax consequence. A traditional IRA is a good option if you’re trying to lower your taxable income now. Traditional IRAs are funded with money that is often deductible from your current tax return. So you get a break upfront now — but have to pay tax on the funds when you pull them out in retirement. In both cases, there are eligibility requirements so go to Fidelity’s IRA EVALUATOR to see if you’re eligible and which investment might be best for you.

MORE INFO: See my columns for other ideas on retirement savings:

• No 401(k) match? Save anyway

• A 401(k) debit card? It’s not so bad

• Contributing to an ex-employer’s plan is not an option

• Is my pension fund locking me out of an IRA contribution?

You may have just lost your job, your house and your credit limits, but you still should file your tax return by the April 15 deadline, or at least get an extension. Failure-to-file penalties are way worse than failure-to-pay fines, and you have several options for dealing with a tax bill, including setting up a payment plan.

Some key points to remember:

• If you cannot meet the April 15 deadline, you can ask for an EXTENSION OF TIME TO FILE. But getting an extension doesn’t mean you get a break from paying. You still must send in an estimated payment.
• The failure-to-file penalty for returns filed more than 60 days after the due date (including extensions) is the smaller of $135 or 100% of the unpaid tax.
• It’s best to file and pay what you can. Interest and failure-to-pay penalties will just increase the amount you owe. In some cases, the penalty and interest charges could increase your tax bill by 25% or more.
• You can work out an installment pay plan with the IRS. (CLICK HERE FOR DETAILS) However, you can save money by paying the full amount as fast as possible to minimize the interest and penalties you’ll be charged. It also costs you to set up these plans:  The user fee for new installment plans is $105 and $52 for plans where payments are deducted directly from your bank account.  (Some low-income taxpayers can pay a reduced user fee of $43 for setting up the plan.)
• Lost your job? Severance pay and unemployment benefits are taxable. (Hopefully you had tax withheld or made estimated tax payments to avoid a big tax bill.) Food stamps are not taxable. For more info on job-related tax issues look for PUBLICATION 4128, TAX IMPACT OF JOB LOSS.

More info: check out my answers to other tax questions:

• Who realistically would itemize their deductions?

• Employers who do not withhold payroll taxes

• My son doesn’t declare income from renting out rooms

Also online: You can always visit the IRS site for forms and tips at www.irs.gov