Ask Liz Weston

Get smart with your money

Taxes

Q&A: Capital gains tax on mutual funds

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Dear Liz: My mother, who is approaching 100 and in good health, has a significant mutual fund holding. It is mostly made up of capital gains. She does not need this fund for her daily living expenses. The question she has: Are the taxes on disposition the same before or after she dies? I am thinking of things like the capital gains tax exemption (never used) as well as inheritance taxes.

Answer: The capital gains tax exemption applies to the sale of a primary residence — a home, not a mutual fund. If your mother sold the fund today, she would owe capital gains tax on the difference between the sale price and her “cost basis.” Her cost basis is what she paid for the fund originally plus any reinvested dividends. The top federal capital gains tax rate is 20%, although most taxpayers pay a 15% rate.

If her objective is to get the maximum amount to her heirs and minimize the tax bill, she should bequeath this investment to them at her death. Then the mutual fund will get a “step up” in tax basis to the current market value. When the heirs sell the investment, they’ll only owe taxes on the appreciation that occurs after her death (if any).

You asked about inheritance taxes, but only a few states levy taxes on inheritors. Typically, it’s the estate that would pay the taxes, and only those above certain amounts. In 2016, the federal estate taxes exemption is $5.45 million

Q&A: Long-term capital gains tax

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Dear Liz: I’m very confused about the long-term capital gains tax. Several years ago, I bought a house for $525,000 in Texas. I’ve been thinking about selling, and my real estate agent informed me that my home is now worth $1.5 million. I am a disabled veteran and have no tax liability because my income is tax-free. Since this is my primary residence, I know that the first $250,000 in gains is exempt from tax. What I just don’t understand is what my tax liability will be on the rest of the money.

Answer: If you sell this house, you’ll essentially go from the bottom tax bracket to the top. Single people with incomes over $415,050 in 2016 are subject to the 39.6% marginal tax rate.
Most people pay capital gains tax at a 15% rate, but those in the top bracket face a 20% rate.

Improvements you’ve made to the house and some other expenses, such as selling costs, can reduce the amount of gain that’s subject to tax.

This big windfall could have other effects on your taxes, so you’ll want to consult a tax professional before proceeding.

Q&A: Why your W-4 forms are likely ‘wrong’

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Dear Liz: After being an unmarried couple for 15 years, we were married in February 2014. Though I sent this information to my company’s benefits department, I neglected to change my W-4 status from “single” to “married.” I’m crossing my fingers that when all is said and done, we have paid the correct taxes when we filed for 2014 (we filed jointly as married) regardless of what was withheld pursuant to the W-4. Or do I need to inform the IRS of the oversight for the 2014 and 2015 tax years?

Answer: Best wishes on your marriage, and don’t worry. Since you were married as of Dec. 31, 2014, and you filed as a married couple for 2014, you’re good — assuming, of course, you used current tax software or IRS tax tables for married filing jointly.

The W-4 form is meant to tell your employer how much of your paycheck you want withheld. Most people’s W-4s are “wrong” in the sense that they have the government withhold too much. They get fat refunds that average close to $3,000, but they aren’t penalized for doing so (other than not having access to their own money until they get that refund, of course).

If you’re getting refunds, you can tweak your withholding when you visit your benefits department to update your W-4. The IRS and TurboTax, among other sites, have online calculators to help you figure out what you should have withheld.

While you’re there, check your beneficiaries for any workplace retirement plans and life insurance. Federal law says your spouse must be the beneficiary of your retirement plan unless he or she signs a waiver. Life insurance, by contrast, goes to the named beneficiary even if you subsequently marry.

Q&A: Delayed tax refunds

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Dear Liz: How long is too long for an IRS tax refund to be disbursed? I got my state tax refund in a matter of weeks. The IRS refund has been “under review” for almost five months.

Answer: A sizable surge in tax refund theft as well as a database breach that exposed more than 300,000 taxpayers’ returns have kept the IRS pretty busy. At the same time, big budget cuts have left the agency with fewer people to help with these issues.

Five months is a long wait, but people who have been the victims of refund theft report waiting nine months or more to get their money back.

You can try contacting the IRS directly at (800) 829-1040, although you’re likely to be on hold for quite a while. If you can’t get a response, you can contact the IRS’ Taxpayer Advocate at (877) 777-4778, but be advised its resources have been trimmed as well and it may just refer you back to the IRS.

Q&A: Lost tax return

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Dear Liz: My CPA sent my completed tax return to my home address via first-class mail with no tracking number. The large envelope should have arrived in two days. Over a week has passed and it’s nowhere in sight. I am freaking out as it has all my financial data and is a gateway to fraud of every sort!

The various post office officials have really done nothing to assist in its location. I have credit freezes at all three bureaus and my bank accounts require passwords. What else can I do to try to avert disaster? I have been so distraught it has literally made me ill. And before you say it, yes, this mode of transit will never happen again.

Answer: It shouldn’t have happened in the first place.

With so much identity theft and tax refund fraud these days, it’s astonishing that tax preparers continue to send sensitive, personal information through the U.S. mail with no tracking — and in envelopes helpfully marked with the CPA firm’s name to make the returns easier for thieves to spot.

Your credit freezes should prevent identity thieves from opening new credit accounts in your name using purloined information, but they won’t stop tax refund fraud.

There’s typically not much you can do to protect yourself from this crime. People who have already been the victims of such fraud can request an “identity protection personal information number” or IP PIN from the Internal Revenue Service to prevent future fraudulent filings.

The IRS also allows residents of Florida, Georgia and the District of Columbia to request IP PINs as part of a pilot program, but residents of other states aren’t eligible.

You can try to file as early in the year as possible, but that’s no guarantee a criminal won’t file using your Social Security number first — and then it can take months to get any money you’re owed.

To help protect your bank accounts, see if your bank offers something called “two-factor authentication.” Two-factor authentication requires something you know, such as a password, plus something you have, such as a token that creates unique number codes or code that’s texted to your cellphone.

If your bank doesn’t offer this layer of protection, and only ascertains your identity with the use of security questions, strongly consider moving your accounts to another bank.

Security questions are easy to hack, as evidenced by the massive breach of the IRS’ Get Transcript service, where hackers were able to successfully answer the security questions for hundreds of thousands of taxpayer accounts.

Four ways to get a jump on tax season

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bigstock-U-s-Income-Tax-Return-Form-28476797-e1390508229663Taxpayers face a cliffhanger again this year as Congress dithers about extending more than 50 expired tax breaks, including popular deductions for college tuition and fees, mortgage insurance and sales taxes.

As we wait for lawmakers to act, though, we still have time left in the year to make adjustments based on changes that have already happened. In my latest for Reuters, I share four ways to get a head start on tax season.

In my latest for Bankrate, how to find an honest financial advisor.