Ask Liz Weston

Dear Liz: I would like to give my three children monetary gifts they can use for college or a car. I understand that I can give them up to $13,000 as a nontaxable gift. Is that correct? How would I file the tax return, and would I be allowed to pay the tax on their gift?

Answer: It sounds like you’re misunderstanding how the gift tax works.

You could give your kids a monetary gift of any size, and it wouldn’t be taxable to them. But it could have gift tax implications for you.

If you give more than $13,000 to any one person, you’re supposed to file a gift tax return (IRS Form 709) noting the fact. Any amount over $13,000 per person per year is deducted from your lifetime gift tax exemption, currently $1 million. Once you’ve used up that exemption, you would owe tax on any later gifts in excess of $13,000 per person (or whatever the annual exemption is then). You’d have to be really generous to ever pay a tax.

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.

After all the extra work and activities of the holidays, I’m ready to put my feet up. But now’s not the time to slack off: there are still a few things to accomplish before the end of the year. Such as:

Return the misfires. Most merchants put a limit on how long you can return an item, and without a gift receipt you’ll usually have to accept what the item is currently selling for. That value may be dropping fast, so hustle yourself to the mall.

Use those gift cards. The longer you delay, the greater the chance you’ll lose or forget them or that insidious fees will eat away at their value. If you won’t use it, you could regift it or sell it to Plastic Jungle, Swapagift or one of the other card-buying sites.

Contribute to Goodwill or other charity. If you itemize your taxes, year-end donations of items in good condition can win you a valuable tax break. So can monetary donations—just make sure you get a receipt.

Make any other year-end tax moves. Taxes have become so complicated that I think most people would benefit from talking to a tax pro and getting their advice. But I think Jeff Schnepper did a good job summarizing some of the options in his recent MSN column.

Set up a system to track your money. If you’re not already using Mint, Quicken or a similar money-monitoring system, set up your accounts so you can get a fresh start with the new year.

photo credit: JasonBlait

Shopping during a tax holiday can be stressful, since so many other people will be at malls and stores trying to take advantage of the savings. If you’re up for the challenge, however, here are the states offering tax holidays. (A few have already passed, but most are still to come.)

Thanks to Kiplingers’ magazine for providing this list of states offering upcoming tax holidays. You can find the full article by CLICKING HERE.

Alabama
* When: August 7-9
* How much: 4%
* On what: Clothing less than $100, computers less than $750, school supplies less than $50 and books less than $30

Connecticut
* When: August 16-22
* How much: 6%
* On what: Clothing and footwear less than $300

District of Columbia
* When: August 1-9 and November 27 through December 6
* How much: 5.75%
* On what: Clothing, footwear and accessories less than $100

Georgia
* When: July 30 through August 2
* How much: 4%
* On what: Clothing and footwear less than $100, personal computers and accessories less than $1,500 and school supplies $20 or less

*Georgia shoppers also will save October 1-4 on energy- and water-efficient products.

Iowa
* When: August 7-8
* How much: 6%
* On what: Clothing less than $100.

Louisiana
* When: August 8-9
* How much: 4%
* On what: The first $2,500 of any purchase

Mississippi
* When: July 31 through August 1
* How much: 7%
* On what: Clothing and footwear less than $100

Missouri
* When: August 7-9
* How much: 4.225%
* On what: Clothing $100 or less, school supplies less than $50, computers less than $3,500 and software less than $350

New Mexico
* When: August 7-9
* How much: 5% to 8.5625%
* On what: Clothing less than $100, computers less than $1,000, other computer equipment less than $500 and school supplies under $15

North Carolina
* When: August 7-9
* How much: 7%
* On what: Clothing less than $100, school supplies less than $100, instructional materials less than $300, computers less than $3,500, computer supplies less than $250 and sports equipment less than $50

North Carolina shoppers also will save November 6-8 on Energy Star products.

Oklahoma
* When: August 7-9
* How much: 4.5%
* On what: Clothing and shoes less than $100

South Carolina
* When: August 7-9
* How much: 6%
* On what: All linens, school supplies and clothing, accessories and footwear

Tennessee
* When: August 7-9
* How much: 8.5% to 9.75%
* On what: Clothing less than $100, school supplies less than $100 and computers less than $1,500

Texas
* When: August 21-23
* How much: 6.25% to 8.25%
* On what: School supplies and clothing and footwear less than $100

Vermont
* When: August 22
* How much: 6%
* On what: All purchases less than $2,000

Virginia
* When: August 7-9
* How much: 5%
* On what: School supplies less than $20 and clothing and footwear less than $100

And October 9-12, Virginia shoppers will save the state sales tax on Energy Star and WaterSense products less than $2,500.

West Virginia
* When: September 1 through November 30
* How much: 6%
* On what: Energy Star products less than $5,000

For more, read:

• 5 ways to cut back to school costs
• The hidden costs of teenagers
  
• The hidden costs of parenthood

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’ve been contributing to a traditional individual retirement account for the last few years. Taking one of your recommendations, I would like to move the money to a Roth IRA. I understand that I’ll have to pay taxes on the conversion, but will there also be any penalties involved? If so, how much of a penalty? If there is no penalty and only taxes, what is the rate I should be expecting?

Answer: Roth IRAs offer tax-free withdrawals in retirement, which is why they’re a great deal for many savers, and conversions are about to become easier.

Currently there is no penalty for converting a traditional IRA to a Roth, but you will owe income taxes that are determined by your tax bracket. If you’re in the 25% federal tax bracket, for example, you’ll owe taxes equal to 25% of the amount you convert, assuming your contributions were all tax-deductible. (If you made nondeductible contributions, those will reduce the tax bill proportionately.) You’ll also need to factor in state and local income taxes.

You can convert to a Roth this year only if your modified adjustable gross income is $100,000 or less. Next year, however, the income limit on Roth conversions is scheduled to be removed. Also, for 2010 only, you can opt to have the taxable income from your conversion reported in two equal installments in 2011 and 2012, putting off the tax bill you owe.

Make sure you have enough cash to cover the taxes without raiding the IRA you’ll be converting. But being able to put off the tax bill, and paying it over two years, should lessen the burden. Talk to your tax pro for details.

You’ve filed your return (hopefully) and are kicking back — or kicking the trash can in tax frustration. Either way, the folks at BillShrink.com – which likes to help you find the best deals on cell phones, credit cards etc. — compiled this little list of tax stats for consumers:

$1,500: That’s 10% of the average family’s tax bill they could recoup if they got on a better wireless plan, switched credit card providers, and drove to a cheaper gas station according to BillShrink.com.

60: The number of times around the Earth all the pages of tax forms and instructions filed each year by U.S .taxpayers would stretch if laid out end to end.

4/16: Unofficially known as “Divorce Day” because of the sharp increase in federal filings after plotting spouses have access to uploaded financial information

1916: Year in which the word “lawful” preceding “income” was removed from the Internal Revenue Code, making illegal income also taxable.

120: Average number of days a U.S. taxpayer will work each year to pay tax liabilities.

48: Number of hours within which you are required to pay sales tax to the Tennessee Department of Revenue for all purchases of illegal drugs.

351,191,000—Visits to IRS.gov in 2008, a 61% increase from 2007.

2015: Year in which electronic returns are projected to outnumber paper returns.

1817-1861—Years in which the United States Federal Government collected no internal revenue.

9,097,000—Number of words in the IRS tax code, a 652% increase from 1955.

If you’re done filing your taxes, now is a great time to do some spring-cleaning of your financial paperwork.

Here are three important concepts to keep in mind when deciding what to keep and what to toss, from my MSN column, “Purge your financial paperwork“:

• Think “seven to life.” It’s not a prison sentence, just the range of time you should keep your most vital paperwork. Most tax-related documents should be kept for seven years, or — if the document deals with a potentially taxable investment or asset — for as long as you own the asset, plus seven years. There are only a few documents you need to keep for life, and these typically reflect milestones: birth, death and marriage certificates, adoption papers and divorce decrees, for example.

• Most documents you’re likely to need can be re-created. You can order certified copies of those certificates, for example; and financial institutions are required to keep copies of your bank, brokerage and credit card statements for seven years. You may face hassles, expense and delays in getting those re-creations, which is why you want to have your own document storage system. But you shouldn’t panic if you lose or shred something that turns out to be important, and you should never — ever – risk your life trying to retrieve mere paperwork in a disaster.

• Electronic is OK. The IRS has long accepted electronic records in place of paper. If you want to scan or download your documents into your computer instead of keeping them in physical form, that’s probably fine — just check with your accountant first to make sure he or she has no objections.

For more on cleaning up paper clutter, read:

• Organize your financial life
• Purge your financial paperwork
• Streamline your finances in 8 steps
• 10 ways to simplify your financial life