Penalties for Deducting from Retirement

401(k)s have become the majority of retirement savings for many people today as the era of defined-benefit pensions is trickling to a close. With the economic downturn and the lingering recession, many people have tapped into their 401(k)s as a source of money. This is obviously not an ideal situation, but one that is, unfortunately, necessary for many people out there right now. Let’s look at the main drawbacks to touching this money before rules permit.

1. The investment is no longer growing – Withdrawing this money means that the investment no longer accumulates interest and grows over time. This lost time for the money to the compound will substantially shrink your nest egg.

2. You will owe more taxes to the IRS – Early withdrawals are taxed as ordinary income. So not only is your money no longer growing at the same rate, you now have to pay taxes on money that was previously tax-sheltered.

Assessed Penalties – The IRS will assess a 10% penalty on early withdrawals. So if you withdrawal $10k, you will have to pay a penalty of $1k on your money.

Studies have shown that many people (as high as 60% in some surveys) withdraw money from their employer’s tax-sheltered retirement accounts when changing jobs, but this is clearly unwise. This money should only be pulled out prematurely as a last resort in an emergency situation.

Now I could be remiss if I didn’t mention some exceptional circumstances that are exempt from the 10% penalty levied by the IRS:

Borrowing for a loan – You can borrow up to half of your accumulated assets in an employer-sponsored account or $50k whichever is less. These loans must get repaid with after-tax monies. If you change employers during the loan repayment period, the unpaid balance becomes due within 30 days. If not repaid in this time frame, it becomes a withdrawal and taxes are assessed accordingly. You cannot borrow from IRA accounts.

Early retirement – You may be able to avoid a penalty if you are disabled or retire early and you are willing to take annual distributions according to an IRS-approved annuity schedule for a period no less than five years. You will still require paying taxes on the amount withdrawn.

Qualifying expenses for school, medical bills, or home buying – You can make a withdrawal from an IRA (not an employer-sponsored plan) without penalty in order to pay medical expenses over 7.5% of your AGI, if you pay medical insurance premiums after being on unemployment for 12 weeks, you pay for qualified high education expenses, or you take out less that $10k for qualifying first-time home buyer expenses. You will also have to pay taxes on the amount you take out.

Withdrawing early will lose you a lot of money. There is a ten percent early withdrawal fee straight off, and then there is both federal and state taxes. The state tax percentage is different in every state, and federal percentage levels vary depending on your income bracket (which may be raised this year because the money you withdraw will count as income for the year). Due to these varying factors the percentage varies from person to person but you can estimate that you will lose thirty to forty percent of the money you withdraw, as well as the money you would have earned during the time this money would have been invested until you reached retirement. This very high loss is why financial experts will advise you to find any other way to avoid withdrawing from a 401k.

There are some exceptions to these rules with some plans, so you’ll need to look over your employers options. Some will let you withdraw under special circumstances, such as economic hardship or for tuition, and some will allow 401k loans. Of course, even under these circumstances, there will still be the penalties explained above.

The penalty for withdrawing from a 401k is high and drastically reduces the amount of money you’ll have right now, as well as for your retirement.

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What is the Earned Income Tax Credit

The earned income tax credit was established in 1975 to combat trends that have led to a high child poverty rate, and boosting the incomes of low and moderate income workers. Another goal of the credit is to help welfare recipients make the transition back to work. The credit is available to employees who meet certain criteria or qualifications.

It is a refundable credit that may be available to you if you are a lower income worker and meet other certain criteria such as your adjusted gross income is under a specific limit set forth by the IRS. Earned income tax credit is by definition a credit and therefore not considered income by the government. It is a unique credit which lower income workers can deduct on their tax return every year.

Even if you had no tax withheld or do not owe any tax to the IRS on your tax return, you should still try to get the credit. Some people might still get some money back because the earned income credit is a refundable credit. However, if you fraudulently claim the earned income credit it is disallowed for ten years from the most recent tax year from which it is found by the IRS to be fraudulent.

If your adjusted gross income is greater than what you made your earned income credit is calculated with your adjusted gross income and compared to the amount you would have received with your wages. Income limitations eligibility for the credit is determined by your families size, marital status and income. This credit is for full time, part time, single or married workers raising at least one qualifying child at home. Some childless workers can obtain the credit too. Your accountant will inform you if you can claim it.

For tax year 2007, the earned income credit is allowed if your earned and adjusted gross income is less than $12,590 ($14,590 for married filing jointly), you have no children and you are 25-64 years of age. This is calculated as 20 percent of your federal wages, minus your state income tax liability. For some workers a similar program is also available on a state level. Some states such as Wisconsin, Illinois, Michigan, and New York have their own programs. In New York City for instance, if your wages are more than the amount of the New York City tax that you owe, you can claim a refund.

The earned income tax credit is exempt under the laws of a handful of states, but there is no federal exemption that preserves the earned income benefit for the people it was intended to assist. If the credit is greater than your tax obligation then you will receive the additional amount as a refund.

The credit does not include these as income when qualifying: interest and dividends( as long as its below $2550), social security, welfare benefits, pensions, or annuities, veterans benefits, Workers compensation, alimony, Child support, unemployment compensation, taxable scholarships or fellowship grants. Even though all of the above are considered taxable income, the IRS only includes what you report on your W2 for the earned income credit.

 

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What Counts as Work Expenses?

Work expenses are one of the gray areas when it comes to tax deductions. Generally, all expenses incurred wholly for the business will be allowed for deduction. However, one needs to be careful when deducting expensive business travel, gifts to business acquaintances, home business use and business meals. You need to follow the guidelines provided by the IRS when deducting such expenses. Claiming large and extravagant expenses is a red flag and can easily attract an IRS audit. One of the controversial business expenses claimed in the past was a breast enlargement by an exotic dancer. The dancer argued that the enhancement surgery would increase business opportunity. The court ruled in favor of the dancer. On the other hand, a taxpayer who had deducted his wedding costs as a business expense because he had invited business associates lost his case to the IRS both in the Tax Court and in the Court of appeal. In these cases, it may be wiser to not “push your luck” with the deductions you claim.

You may incur travel expenses while journeying away from home on behalf of your employer. You can deduct travel expenses incurred in relation to a temporary assignment, but not travel expenses incurred in relation to a permanent assignment. Some of these deductible expenses include travel to and from your assignment, taxi fare, meals, lodging, cleaning and laundry expenses, and baggage charges. Your job assignment is temporary if it posts you in a location for less than one year.

If you are a federal employee investigating a crime or involved in the prosecution of one, the one-year rule for temporary work assignments does not apply. This means that you can get tax deductions related to a temporary assignment even if you are at that location longer than one year. To qualify for this exemption, the Attorney General must verify that you are traveling while performing duties for the federal government, or that you are traveling while performing duties for the federal government on a temporary duty status, or that you are traveling while providing support services for the federal government during the investigation or prosecution of a federal crime.

Local transportation costs like airfare, rail, bus, taxi, or personal auto can be deducted when you are traveling to an assignment other than your main place of work. Traveling from home to work and back again everyday is not a deductible expense. You can deduct travel expenses between your home and a temporary work location if the work location is not within the metropolitan area where you normally work and reside.

You can deduct transportation costs for traveling between your home and an office location if your home is your main place of business.

Entertainment expenses are deductible only if they are directly related to the primary conduct of your business. You can deduct 50% of business meals and entertainment expenses unless they meet certain exceptions.

You can deduct $25 worth of business gifts that you give to an individual during the course of the year, unless they are widely distributed items of four dollar value or less and have your name clearly and permanently printed on them or if they are signs, racks or other promotional materials displayed on the business premises of the receiver of the items.

 

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Who Can You Claim as Dependent on Your Taxes?

If you are a parent or taxpayer who supports relatives, you can benefits from various tax deductions, tax credits and lower tax rates directly related to dependents. The issue of claiming dependent on your tax return can be a tricky one, especially when it comes to non-children dependents. This article helps you to understand what is dependent, who can claim one, and what are the tax benefits you can obtain when claiming dependents.

A dependent can be a valuable addition to your tax return, decreasing your tax liability and maybe even earning you a refund. Every tax season, however, there is confusion about who exactly qualifies as a dependent.

Many people don’t realize that there are actually two different types of dependents: qualifying children and qualifying relatives.

These two categories have different requirements and are often treated differently by the tax code. Though both are considered “dependents,” if a credit refers specifically to a qualifying child, a qualifying relative does not count.

To be a dependent a relative must meet the following criteria:

-Residency: The relative must have lived in your house for the entire year unless the relative is one of the following: child, stepchild, foster child, descendant of any of them, brother, sister, half-brother, half-sister, stepbrother or stepsister, father, mother, grandparent or other direct ancestor (does not include foster parent), stepfather, stepmother, niece, nephew, uncle, aunt, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.
-Support: The relative’s annual gross income must be less than $3,500 and you must be responsible for providing more than half of his for her support

Support includes amounts paid or incurred for the following items:

-Food
-Lodging
-Clothing
-Education
-Medical and dental care
-Recreation
-Transportation

Any item that is paid for the household as a group (for example food for the household members) and not directly for the relative, should be allocated evenly between the members of the household.>

Tax Benefits related to dependents

The tax law provides for several tax credits, tax deductions and other tax benefits resulting from claiming child and or relative dependents. Here is a list of those benefits:

-Personal exemptions
-Filing status – head of household
-Child tax credits
-Child and Dependent Care Credit

In the discussion below we shall analyze the various benefits and describe how to maximize them when you file your annual tax return.

Personal exemptions

Personal exemption works like a tax deduction, it reduced the taxpayer gross income by the amount of the personal exemption and results in a lower taxable income.

A word of caution: you cannot claim someone as dependent if he or she can be claimed as dependent on someone else’s return and if in fact he or she is claimed as dependent on someone else’s return. Additionally, personal exemptions are subject to phase-out limits, thus the higher the income shown on your 1040, the more you loose from your personal exemption deduction. For current year phase-out calculation, please refer to IRS Publication 501.

You may be eligible to claim personal exemption for any qualifying dependent (see discussion above). The amount of the personal exemption is set up by the IRS as it is indexed annually for inflation. For 2009, personal exemption is set up as $3,650, up from $3,200 back in 2005.

Taxpayers will lose some of their personal exemptions if adjusted gross income exceeds certain threshold amounts. However, taxpayers can lose at most two-thirds of their personal exemptions. You’ll need to use a worksheet in IRS Publication 501 to calculate your personal exemption amount if your adjusted gross income is over the threshold amounts shown below.

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Brief Intro to Taxes

Most people become apprehensive when its tax time, as they really don’t enjoy the prospect one bit. Actually, for the majority of people, it’s a highly nerve-racking experience and one that they would prefer not having to go through. However, the fact is that every year you need to file taxes. Otherwise, you may have to face grave consequences and this is what motivates people to file their taxes.

A lot of people would feel relieved regarding their taxes in case they were aware there are several ways of filing them and that there are many options you can pick from. There are some situations where you may favor one filing method over the other. Prior to learning about these and what suits you best, you will have to understand what the various ways of filing taxes are.

Generally, each of the filing methods is categorized as either online or paper filing. The following are a few of the ways of filing taxes this current year:

-If your earnings are below $54,000 you can go to the IRS website and file your returns online for free

-If you earn above $54,000, the IRS e-file is an option. The IRS website can provide you with additional details.

-Take a printout of forms from the website of the IRS and send it to the IRS.

-Hire a professional tax consultant and file a tax form.

-Take the services of an accountant to assist you with filing taxes.

-Go to a tax attorney or a tax agent if you believe you might have a difficult case. (For instance, if you are late in filing your returns).

-Make use of a software program in order to file a hard copy return. People mostly uses programs such as Turbo Tax and Quicken.

-Draw on your own tax knowledge. If you possess adequate knowledge to file returns yourself, or have uncomplicated taxes, you can file taxes on your own and mail the papers to the IRS.

These are a few of the easy ways of filing returns this year. To determine which suits you best, you will have to study your individual situation. In case your tax case is fairly simple, you may be capable of using one of the several methods with negligible or no external assistance. But, in case you have an intricate tax situation, then you may require the assistance of a qualified tax preparer. However, in cases such as where you may have to pay overdue taxes or for a number of years you have not filed returns, you may require assistance from someone expressly trained in this kind of problem.

Regardless of the filing method you choose, simply ensure to file your returns by the closing date. Although the majority of people hate doing it, the outcomes of not meeting the tax deadline can be even serious. Therefore, go through the above methods and select the one that’s apt for you but ensure you have your paperwork filed come what may.

No matter how you file your taxes this year, just make sure you file them. Whether through software, an accountant, a tax attorney, an enrolled agent, or a tax preparation company, most people need some help when filing their taxes. Consider the many options you have to file and bask in the comfort of having your taxes done correctly this year.

 

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Your First Tax Return

We will have some great content coming but we will start by talking about one of the basics: how to file your taxes.  Watch this video for a great first step!