Odds of Being Audited

According to IRS statistics, the chances of being audited by the IRS is about one in 100, or one percent. A deeper look, however, reveals the the IRS audits certain tax returns much more often than other returns. IRS audit statistics suggest that high-income taxpayers and those who own small businesses are more likely to be audited that middle and low income taxpayers who earn the majority of their income from wages and salary or brokerage-style investments.

The reasons certain groups get audited more than others are two-fold. First, and foremost, there is more money to be gained by auditing higher income taxpayers. For example, consider a middle income wage earner, who is married filing jointly, bringing down a salary of $70,000 with no other income. Taking the standard deduction for 2011, of $11,600 for married couples filing joint, that leaves $58,400 of taxable income.

Do the math and that taxpayer isn’t going to pay any more than around $7,500 and likely much less if there are any kids. Assuming that our fearless taxpayer files his income taxes and fudges a child care credit or student loan interest deduction, he might shave a few hundred bucks off his total. If he is caught and audited, then the IRS can recover that and penalties and interest (particularly if it is proven to be fraudulent). Either way, the sum total of collection by that IRS audit won’t be more than a $1,000. That’s hardly worth the time and effort.

Don’t get me wrong, the IRS can and does audit returns like this all the time, primarily to avoid the appearance of “never” auditing certain kinds of tax returns. All it takes is one person getting audited to scare-straight dozens of their friends and acquaintances. However, at the end of the day, this taxpayer isn’t really “worth” the cost of an audit.

Who Gets Audited By the IRS?

A high-income taxpayer on the other hand can generate a significant tax recovery. When someone’s total tax liability is $5,000, even a big cheater won’t owe too much extra if audited. However, when someone’s total tax liability is $25,000, $50,000 or more, a successful audit might recover $10,000 or more, especially if there are penalties and interest involved.

The other reason higher earning taxpayers get audited more often is that they have more ways to cheat. Someone who earns a salary and takes the standard deduction has very little room to be sneaky. After all, their salary is reported to the IRS as well as the taxpayer. Trying to cheat on that number is flat-out stupid, considering a computer will crosscheck each and every one of those.

On the other hand, higher salaried taxpayers tend to itemize their deductions. Many of those tax deductions, such as mortgage interest are also reported to the IRS and thus not likely to be underreported. However, there are plenty of deductions that can be exaggerated very easily. Catching these things is the bread and butter of audits.

For the same reason, small business owners are frequent audit targets. There are many deductions for small business owners and other than the requirement to keep receipts and records, many are completely undocumented directly to the IRS. The 2011 Section 179 tax deduction alone is worth up to $250,000 this year. That’s some real money worth collecting.

Related posts:

1. Mortgage Tax Deduction End of Year
2. 2009 End of Year Tax Strategies – Calculate Dollar Amount of Tax Moves

IRS Audit Odds originally published at Finance Gourmet

Good Time to File Bankruptcy

One of the things that trips many bankruptcy filers up, even after speaking with a bankruptcy attorney, is that the bankruptcy court will take 40 percent of your unpaid earnings. If you get paid once per month, this can be a very big deal. For example, if you get paid on the 30th of each month and you file your bankruptcy petition with the court on the 28th, you will have to pay almost half the amount of your pay check to the bankruptcy trustee. In a case like this, you would be much better off waiting the following month to file for bankruptcy.

However, there is a catch. You don’t want to file too soon after being paid because the other thing that the bankruptcy court is entitled to is almost all of the cash in your bank accounts on the day you file. For example, if you got paid $3,000 on the 30th and then you filed your bankruptcy petition on the 1st and there was $2,900 left in your bank account, you’ll have to pay that $2,900 to the trustee, even if you have long since spent it since you filed. Don’t forget, the numbers that matter are the ones that exist on the day you file.

Which brings us to the next issue in bankruptcy filing timing. Spend your money before you file. Be careful HOW you spend your money. Buying “things” like jewelry or other items is a very bad idea. The court can ask you to forfeit those items, especially if you bought them close to the filing date or if those items exceed the amount of allowable bankruptcy exemptions in your state. However, buying groceries, filling prescriptions and making sure your gas tank is full are very good ways to spend your money down before filing bankruptcy. No one can complain that you want to eat and stay healthy. More to the point, there is really no way to ask you to forfeit food, gas, and medicines.

Be very sure you understand that the amount in your account on the day you file is what matters, not when you spent the money. For example, if you write a check for $200 worth of groceries on the 8th, file bankruptcy on the 9th and the check clears on the 10th, the amount of money that counts against you for the purposes of asset counting in your bankruptcy is the amount in your checking account on the 9th, which includes the $250 you already spent. For this reason, it can be useful to withdraw cash. However, large cash withdrawals right before filing can be suspicious. Keep all your receipts to prove that you spent that money on necessities. You can also use your checking account debit card instead. Debit card transactions often clear in 24 hours, so you just have to wait one day. However, be careful of weekends and bank holidays when transactions may be delayed in reporting. You can also simply time your filing for a time after your checks and debit card transactions have cleared.

If you file anytime between December and April, don’t be surprised if your bankruptcy trustee keeps your case open long enough to take any tax refund you are getting. Don’t try spending your refund right before filing either, that usually won’t fly. Either adjust your withholding to avoid a refund (late in the year). If you still owe taxes from the previous year, this doesn’t apply to you. The IRS will intercept any refund before it ever goes to you and apply it to your outstanding taxes, before the court can lay any claim to it. This works in your favor since most federal income taxes cannot be discharged in bankruptcy.

Pay Bills Before Bankruptcy

It doesn’t make sense to pay bills due on credit cards before filing. Those debts, including any late fees, will be wiped out in the discharge. As far as your credit score goes, bankruptcy is bankruptcy. Your credit report won’t look any better if you have slightly lower balances on your credit cards before you file. You might want to take a look at your credit score before you file. To avoid having to pay, get a free credit score from CreditKarma.com. (See my Credit Karma scam article and my CreditKarma.com review article for more details.) You may, however, want to wait to sign up for Credit Karma free credit monitoring. You’ll just get a lot of depressing emails as everyone reports your bankruptcy and charge offs.

While it is not smart to pay bills like credit card bills, it is very smart to pay utilities and other bills. Paying those bills takes money out of your accounts in a way that cannot be reclaimed by the bankruptcy courts. So, in our example above, the best time to file for bankruptcy is soon after you get paid, but not until you have paid your electric bill, cable bill, cell phone bills, kid’s tuition or day care fees, and so on. Each of those things will reduce the amount of cash you have to report without raising any white flags. In order to keep the amount of unpaid earnings you have to pay to the court low, pay those bills in advance so that you can file soon after you get your paycheck before more unpaid earnings build up.

Grab the FinanceGourmet Feed to keep up to date on our series of bankruptcy filing help articles as well as our other personal finance tips.

Related posts:

1. What Happens If You Don't File Your Taxes On Time
2. Economy Outlook 2010 – Bankruptcy Filings Increase First Half of 2010

Best Time to File Bankruptcy originally published at Finance Gourmet

2011 Capital Loss Deduction

When it comes to taxes, the more tax deductions the better. And, when you lose money on an investment, a tax deduction can take out a little of the sting. However, deducting capital losses can be tricky. Get the rules straight to save on taxes and avoid making mistakes.

Just like with capital gains, there are two kinds of capital losses, short-term capital loss and long-term capital loss. Generally, a long-term capital loss occurs when you have a loss on an investment that you have held for at least one year. Conversely, a short-term capital loss occurs when there is a loss on an investment held for less than a full year.

The tax deduction for capital losses is limited to $3,000 per year against regular income. That means that you can get a full deduction of up to $3,000 each year, regardless of whether you have any other capital gains. Capital losses are a itemized deduction, so they won’t help if you are taking the standard deduction.

Offset Capital Gains with Capital Losses

However, you can offset an unlimited amount of capital gains with corresponding capital losses. For example, if you had an investment that gave you a $10,000 capital gain, and you have another investment that generated a $10,000 capital loss, you can offset the entire $10,000 gain. That means that you do not pay any capital gains taxes on the $10,000.

There is a catch, however.

In order to offset gains with losses, the type of loss must match the type of gain. In other words, in order to offset long-term capital gains, you must have long-term capital losses. You cannot use a short-term capital loss to offset a long-term capital gain, or vice versa.

It does not matter if your capital loss is short-term or long-term when it comes to deducting the $3,000 above and beyond any investment gains that you have for the year.

Capital Loss Carryover

If you have more losses than gains to be offset, only the first $3,000 of the losses can be deducted from ordinary income. However, the remaining amount is not lost. Rather, losses can be carried forward to be used on future year’s taxes.

Revisiting our example, assume that you have a $10,000 capital gain for the year, but you have $20,000 in capital losses. You can completely offset the $10,000 gain, meaning you owe no capital gains taxes this year. However, you can only deduct $3,000 of the remaining $10,000 of losses against your regular income. That leaves $7,000 of loss that can be carried forward to next year’s taxes.

In the following year, you can use the entire $7,000 to offset any capital gains. If you have no gains, you can still deduct the $3,000 allowance against ordinary income for the year.

So, if the following year you have $5,000 in capital gains, you can offset all $5,000 and still use the remaining $2,000 in losses as a deduction against ordinary income.

How To Claim a Capital Loss

Capital gains and losses are calculated and reported using Schedule D of Form 1040 and entered on Line 13 of Form 1040.

What is most important about capital losses is that you remember to carry them forward. Users of tax software like Turbo Tax or Tax Cut have this data automatically carried forward by the program if you import last year’s tax returns when you start filing your taxes with the software. However, taxpayers who do their taxes by hand or that switch accountants or tax software need to ensure that their previous year losses are carried forward. Large losses can take years to use up if there are no corresponding large gains to use them against.

Many people have big capital losses to use thanks to recent market volatility. Even if you have tens of thousands of dollars of losses or more, be sure to continue to carry the amount forward. Some day, you’ll make money on an investment and those losses will keep you from having to pay taxes on your gains.

Capital losses can be carried forward forever with no limit on how long they may be used.

Be sure to also understand short sales for capital gains.

Related posts:

1. 2011 Section 179 Deduction Limits for Small Businesses Taxes
2. Standard Deduction 2011 and 2011 Tax Brackets

Capital Loss Tax Deduction 2011 originally published at Finance Gourmet

Update: Consumer sentiment also rose. That is a little bit more good news for the economy.

Unfortunately, the news isn’t anywhere good enough to declare an economic recovery. The “good news” about the labor market we have been getting for the last several months means more about the job market bottoming out than it does about it getting better. Essentially, if you were drawing a graph of the U.S. labor market, these last couple of months of good economic news and indicators means you can stop drawing your line down. It does not mean, however, that you can start drawing that line back up.

There are two major stumbling blocks now to an economic recovery. The first is the very unstable situation in Europe. What once looked like a problem for a couple of the continent’s weakest economies now looks like a full-fledged crisis for the entire European Union. Any collapse, or loss of faith, there and the U.S. economy will be pulled back under. The second issue rearing its head is the expiration of current payroll tax cut.

Established a temporary tax cut (aren’t they all?) the current tax cut reduced the amount workers pay for FICA (Social Security taxes) from 6.2 percent to 4.2 percent.

See information about small business FICA taxes.

That tax cut expires on December 31, 2011 and it means that millions of Americans will be surprised in January by lower take home pay just when they start getting their bills for the holiday shopping season. Nothing slams the breaks on a weak economic recovery like consumers that tighten their wallets and avoid spending.

Pretty much every reputable economist out there agrees that eliminating the payroll tax cut will not only reverse the stimulating economic effect it had, but will also act to slow growth, just when it is getting started.

Of course, like everything in Washington these days, extending the tax cut is caught up in partisan bickering by politicians who grow ever more loyal to their parties while caring less and less about what it good for the country and the U.S. economy. Time will tell if the party bosses can wring enough bragging rights from some sort of agreement to get the extension before it is too late. Even one round of smaller paychecks could have a chilling effect on consumer spending.

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Jobless Claims Continue to Fall originally published at Finance Gourmet

Check here to learn how to deduct mortgage interest on your taxes.

Make Mortgage Payment Early to Deduct More

One of the biggest tax deductions that is available to ordinary taxpayers is the mortgage interest deduction. Simply put, the 2011 mortgage interest deduction is the ability to deduct whatever amount you pay in mortgage interest from your income taxes. There are several rules and exclusions, but they don’t apply to most taxpayers unless you have more than $1 million in mortgages or several houses. This is one of those tax deductions with no income limits.  You do need to itemize your deductions in order to claim the mortgage interest deduction. For many people, the amount of their mortgage interest deduction determines whether it is best to itemize or claim the 2011 standard deduction amount.

In a normal year, you make 12 mortgage payments. Add up the total amount of interest paid, and that is how much you get to deduct. Your mortgage company will actually do it for you because they are required to submit a 1099-INT to both you and the IRS. This means the IRS knows how much money you actually paid on your mortgage, so this isn’t a good place to get creative. You can find the 2011 1099-INT forms on the IRS website. (Update: The 2011 1099-INT forms are now also available.)

However, as with most tax deductions, you get to claim the amount amount you pay during the year regardless of when it is actually due. Thus, if you pay your January mortgage payment in December, you get to deduct it on this year’s taxes. That means you get to deduct the amount of interest paid on 13 payments instead of just 12.

For example, let’s assume for the ease of math that you pay $1,000 per month in interest on your mortgage. (Keep in mind that only the interest part of your payment is deductible. The amount that goes to principal and the escrow payment is NOT deductible.) If you made all the payments at the regular time during 2011, then your 2011 mortgage interest deduction would be $12,000.

That’s not too shabby. But, if you pay your January 2012 payment during December 2011, then you have made 13 payments during the 2011 tax year instead of 12. That means that on your 2011 taxes you can deduct $13,000 instead of just $12,000. That extra $1,000 deduction can be very valuable especially at higher tax brackets. In the 30 percent tax bracket, making your payment just a few days early saves $300 on your taxes.

The Catch to Paying Your Mortgage Early

There is, of course, a catch to using the tax trick of paying off your mortgage early.

By making your January 2012 payment in 2011, you have eliminated one of the payments you would normally make during 2012. That means that you can only deduct 11 mortgage payments worth of interest in 2012 because the January payment was not made during 2012, it was paid in 2011.

In our example above, by paying the January 2012 payment early, you got to deduct $13,000 in 2011. But, that means you will only be able to deduct $11,000 on your 2012 taxes. There is a way around this. If you make your January 2013 payment during December 2012, then you can deduct the full-year of interest of $12,000. However, there is no way to get that extra deduction again until you bite the bullet and take only 11 months worth of interest payments as your mortgage deduction in some year.

Mortgage Interest Deduction Audits

Here is the mistake that many taxpayers accidentally make.

In 2011, they read about this really great idea to make their January mortgage payment early in order to get a bigger interest deduction. So, they pay 13 months worth of payments during 2011 and they deduct 13 months worth of interest. So far, so good.

However, in 2012, they forget that they did that. The mortgage company sends them a 1099-INT that shows a full 12 months of interest payments for 2012 and they deduct the full 12 months of interest, even though they can only legally deduct 11. Then, are those who try and use the trick again in 2012 by paying their mortgage early and deducting 13 months of interest when they only qualify for 12 months of interest payments.

Remember those 1099-INT forms that the mortgage company sends to both you and the IRS?

That is how you get caught. The IRS computers run the numbers on the forms against the numbers you claim and sometime in 2013 or 2014, a letter shows up in the mail saying that a routine examination of your return has discovered a possible error. If you are really unlucky, your return will get flagged for a full-scale audit. Typically, however, you’ll just be subject to an “information audit” where the IRS will require you to provide documents to support your deductions.

It won’t take long for cancelled checks and mortgage statements to reveal that you claimed too many deductions in 2012 and owe back taxes and interest on the amount. Theoretically, if the IRS can prove you did it on purpose, you can also be on the hook for fraud and additional penalties, but this kind of mistake happens all the time and non-accountants routinely fall victim so they probably won’t go after you for that.

How To Maximize Tax Deductions by Paying Mortgage Early

Paying your mortgage early to increase your mortgage deduction amount in 2011 works best for people who either have income that varies from year to year, or people who know that they are going to get hit with a big tax bill and will adjust for it on their 2012 taxes.

If your income varies because you earn commissions, own your own business, or you get bonuses that are different sizes each year, then you want to pay your mortgage early in a year where your income will be high. Even if it is high the next year, you can pay early again and keep your full-year interest deduction. Eventually, when you have an off year or your bonus is smaller than usual, you can not pay early and only deduct 11 months of payments. This “reloads” this tax deduction increase trick for another year when your income is higher.

For people who get an unexpected windfall during the year that may result in a higher tax bill, that extra $300 deduction will give you some extra room when filing in 2012 for your 2011 taxes. Just be sure to adjust your withholding for 2012 so that you don’t come up short again.

Paying your mortgage early is a good end of year tax tip. However, be sure you fully understand what you are doing and how it affects your future taxes. If you pay early this year, you have to pay early for every other year until you are ready to take the smaller 11-month size deduction.

Subscribe to the Finance Gourmet Feed to get all of our coming 2011 end of year tax tips.

Related posts:

1. 2012 Standard Deduction Amount Set
2. 2009 End of Year Tax Strategies – Calculate Dollar Amount of Tax Moves

Mortgage Tax Deduction End of Year originally published at Finance Gourmet

Standard Deduction 2012

The 2012 standard deduction is the amount that taxpayers will use to file their taxes before April 15, 2013. For taxes to be filed before April 15, 2012, taxpayers need to use the standard deduction 2011 amount set in the fall of 2010.

The amount of the standard deduction for 2012 for taxpayers who are married filing jointly is $11,900. This amount is up $300 from the 2011 standard deduction amount of $11,600. For taxpayers who are filing single, or who are married filing separately, the 2012 standard deduction is $5,950 which is an increase of $150. For those taxpayers who file as head of household, the standard deduction in 2012 is $8,700.

Various other tax credits and income tax deductions are also indexed for inflation. For the 2012 tax year, the maximum earned income tax credit, or EITC, increased to $5,891, which is up form the 2011 maximum of $5,751. Accordingly, the maximum income limit for the EITC increased from $49,078 in 2011 to $50,270 in 2012.

IRS Annual Gift Limit 2012

The IRS permits tax-free gifts to any persons up to a certain limit each year. The annual gift limit is per person, so a couple who is married filing jointly can actually give double the amount of the IRS gift limit each year. Additionally, when giving to a married couple that files jointly, each spouse can receive the full gift amount. For parents looking to give a tax-free annual gift to their married children, that means that a full four times the amount of the limit can be given tax-free.

The 2012 gift limit is $13,000. The annual gift exclusion is unchanged from 2011.

Therefore, a married couple can give $26,000 to a single person, or a full $52,000 to another married couple without triggering gift taxes or any estate tax issues.

Speaking of estate taxes, the 2012 estate tax exclusion is $5,120,00. That is an increase from the estate tax deduction in 2011 of $5 million.

IRS Tax Updates

Although the IRS releases updated tax numbers, deduction amounts and tax credit eligibility throughout the year, the release of widespread numbers like new 2012 tax brackets and other widely claimed tax deductions happens in October of the previous year to allow for official publication of IRS manuals and rules to be completed in time for the start of the tax filing season on January 1st of the following year.

You can subscribe to emails from the IRS or just check the Internal Revenue Service website in late October or early February each year.

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2012 Standard Deduction Amount Set originally published at Finance Gourmet

With short sales, however, there are a couple of tax tricks to know about how they get reported.

Long-Term or Short-Term Short Sales

The most important thing to understand about short sales, is that they are almost always considered short-term capital gains or losses.

Unlike a traditional investment where you buy and hold the property, with a short sell, you do not own the property at all. You borrow the shares from your brokerage who gives you the proceeds of the sale. You close the sale by buying back the same shares you sold.

It may seem like you determine whether a short sale is long or short-term by the amount of time that passes in between when the short sale is initiated and when it is closed. However, this is not the case.

In order to be a long-term capital gain, you have to OWN the property in question for more than one year. With a short sale, you never own the property. Or, if you prefer, you own the shares for a few seconds between when you execute the buy order and the brokerage takes those shares to repay the loaned shares. In other words, all short sales are short-term capital gains or short-term capital losses.

Long-Term Short Sale Exception

There is a way to have a long-term short sale, although it is not very common. If you don’t do it intentionally, it won’t happen.

Consider an investor who owns 1,000 shares of IBM stock. The investor chooses to sell 1,000 shares of IBM short instead of selling their current holdings. Some brokerages won’t allow this, but it is easy enough to execute via two brokerages.

If you have already owned the IBM stock in question for a period of more than one year, and if, and only if, you use those previously owned shares to close the short sale position, then the short sale may be reported as a long-term capital gain or loss.

However, this will be considered a “constructive sale” and you will have to report the gain as of the date of the short sale and your basis resets.

There is no way for a short sale to be a long-term investment unless you already own what you are selling short.

All of this, of course, assumes that you have not trigged the rules for wash sales.

Reporting Short Sales on Schedule D

Like other investment gains and losses, gains and losses from short sales are reported on Schedule D.

Enter the data from the short sale in the same manner as a regular trade. However, pay attention to what the columns say so that you get the income taxes right.

Column C is the date sold, this is the date you started the short sale, not the day it closed. Column A is when you “acquired” or bought the shares to close the position. Likewise, the Sales Price (Column D) is what you received when you sold short, and Cost Basis is what you paid to close the short.

There is no need to specially mark a short sale. You are the first person to sell a stock short and the IRS is well aware that if the Date Sold precedes the Date Acquired that you have engaged in a short sale. As long as you enter the right numbers in the right columns, all of the math on the form works out the same.

Related posts:

1. How To Deduct Mortgage Interest on Income Taxes
2. New Home Sales Rise

Reporting Short Sales for Income Taxes originally published at Finance Gourmet

2011 Mileage Rate Update

However, the IRS increased the optional standard mileage rates for the last six months of 2011 citing, “increased gas prices … having a major impact on individual Americans.” The 2011 IRS mileage rate increased to 55.5 cents per mile from the original IRS 2011 mileage deduction rate of 51 cents, which still applies to the first six months of 2011.

In other words, when you figure out your income tax deductions for your 2011 taxes in 2012, you’ll have to use two different mileage rates to get the correct deduction for miles driven for business purposes. As always, the IRS requires contemporaneous driving records in order to deduct the mileage on your taxes. Using those records, taxpayers will multiply each deductible mile by 51 cents for trips between January 1st and June 30th and 55.5 cents per mile for trips between July 1st and December 31st.

Other IRS Mileage Rates for 2011

The standard IRS mileage rate is the one for business purposes. However, there are two other cases where you can deduct mileage.

Certain miles driven for medical purposes or for moving purposes may be deducted. The rate for this deduction was 19 cents per mile at the beginning of 2011. The mileage rate increases to 23.5 cents per mile for the second half of 2011.

Miles driven for charitable purposes can also be deducted in some cases. Mileage for charity is deducted at the rate of 14 cents per mile. The charitable mileage rate was not increased by the IRS.

Options Business Standard Mileage Rate

Income tax deductions for mileage may be computed in two ways. The most commonly used method uses the standard mileage rate set by the IRS. The deduction is computed by multiplying the standard rate times the number of miles driven.

However, taxpayers may also deduct the actual costs of operating a vehicle. Doing so, requires drivers to keep all receipts for fuel and maintenance and then to computer the vehicle’s depreciation. Most people forgo this extra effort and just use the mileage rate.

Businesses Reimbursement Rate for Mileage

Most American companies use the IRS mileage rate for reimbursing employees for miles driven on behalf of the company. There are two main reasons for this. First, companies deduct the money they reimburse to employees as a business expense. The IRS can’t complain the company is using too high or too low of a rate if it is using the same one as the IRS. Second, companies are shielded from employee complaints about the rate being too high or too low by saying that they are not responsible for the rate and that the IRS sets it.

However, there is no automatic requirement that companies raise their 2011 mileage reimbursement rates just because the IRS made a mid-year increase in the rate.

Check with your company to verify what your reimbursement mileage rate should be for the rest of 2011.

No related posts.

IRS Mileage Rate 2011 Increase originally published at Finance Gourmet

Unfortunately, while the internet has given people easy access to vast amount of information, it does so without any verification that the information published is true.

The problem is compounded by those who read something inaccurate and then repeat it elsewhere. This makes the false information seem more valid because it is corroborated by another source, which, in fact, is just repeating something that was wrong.

That is why it is so important to verify financial planning information you read with an authoritative or trusted source.

You Owe Taxes On Matured Savings Bonds

Which brings us to IRS Publication 550 – Investment Income (that, my friends, is an authoritative source) and a popular, but dead wrong tax-savings strategy.

U.S. savings bonds are a safe, and therefore low-paying, investment issued directly by the United States Treasury Department. Grandmothers have been giving their grandchildren savings bonds since World War II. In fact, a lot of people have amassed a bunch of savings bonds in safe-deposit boxes, and even shoeboxes, over the years.

Savings bonds are easy to buy directly from the government at the TreasuryDirect.gov website (dot gov — not dot com).

Savings bonds mature after a certain number of years. When they reach their final maturity, they stop earning interest. But, something else happens too; the taxes become due on the interest.

Taxes Due On Saving Bond Interest at Final Maturity

Here is where that not-fully understanding the nuances of savvy personal finance comes into play.

Savings bond interest is exempt from state and local taxes. It is, however, not exempt from federal income taxes. In fact, interest on savings bonds is taxed just like any other interest, with one exception. The taxes on savings bond interest may be deferred until the bond is cashed, or the bond reaches final maturity.

The misinformation comes from folks who don’t notice the last clause of that sentence, likely because when they first learned about it, their bonds were years from maturity.

Now, there are numerous people who think that you can avoid taxes on savings bond interest from bonds that have already matured by not cashing them.

Of course, that is not true. Don’t believe me, read IRS Publication 550 under the U.S. Savings Bonds section and you will see under the heading Reporting options for cash method taxpayers:

Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year in which they mature.

That "the earlier of" is IRS-speak for whichever one of these these things happens first. In other words, they IRS does not care if you never cash in your savings bonds. There is no IRS penalty for not cashing in mature savings bonds, but you still owe the taxes on the interest.

The bad news is that many savings bonds are tagged with the social security number of the owner, so it’s only a matter of time before a computer gets around to deciding that the dollar amount is big enough to worry about. Worse, yet, for anyone being targeted for an audit, you can be this is a big fat red flag on your file.

Obviously, if you only have $300 of savings bonds, no one is going to bother unless they figure out a way to automate it. Of course, if you only have $300 worth of savings bonds, then why are trying to avoid the taxes? When you cash them in you’ll get $300 and you’ll owe less than a $100. You are still coming out ahead and you can start earning interest on what is left.

Otherwise, you can roll the dice and hope the IRS never bothers. Of course, if they do make the effort, you’ll owe interest and penalties on the taxes you owed but never paid on your unreported income.

Cash in your savings bonds when they mature. Don’t try and make this one of your tax tricks.

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Not Cashing Savings Bonds to Avoid Taxes originally published at Finance Gourmet

Wait! Actually, tax day 2011 is actually on April 18th thanks to a Washington D.C. holiday being observed on April 15th.

That means all you slacker, procrastinators, and just plain still working on them taxpayers out there get a whole other weekend to work on your income taxes.

Don’t forget, you can also file for an extension. Everyone is permitted an automatic tax filing extension of six months by filling out and submitting Form 4868 – Application for Automatic Extension of Time To File U.S. Individual Income Tax Return.

You still have to pay your taxes by April 15th. An extension to file is not the same as an extension to pay.

Wondering what happens if I don’t file my income taxes?

If you can’t pay your income taxes, you can ask the IRS for a payment plan. There is a fee for setting up a payment plan, however. If you can’t pay them now, but will be able to pay within a month or two, don’t set up a payment plan. Just send the IRS a check for some of your tax bill with your tax return. The IRS will send you a bill for the rest in 30 to 60 days. Pay the balance then and the interest and penalties may be lower than the cost of setting up a payment plan (you’ll pay interest on a payment plan as well).

The current IRS interest rate for 2011 2Q is 4 percent.

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Taxes Not Due Today – April 18 not 15 originally published at Finance Gourmet