Estimated Tax Penalty

Around this time of the year, many people throughout the US are getting notices from the IRS asking them to pay estimated tax penalty. Many people do not understand why they have to pay estimated tax penalty if they have paid all the taxes owed.

Taxes are due when income is earned so even if a person pays all the taxes owed for the prior year by April when the person files a return, the person may still have to pay a penalty when the person did not pay enough estimated taxes by the deadlines for such taxes.

Estimated tax is the method used to pay tax on income that is not subject to withholding such as income from an employer. This includes income from self-employment when someone is an independent contractor, interest, dividends, alimony, rent, gains from asset sales, or prizes and awards.

Estimated tax is due 4 times a year. The IRS imposes estimated tax penalty on the amount of tax underpaid from the date the installment was due to the date the installment was paid. The installment that needs to be paid each quarter depends on the person’s income for the prior year, unless the person completes a form explaining that income is not the same each quarter or each year.

For someone who has a mix of employer income and self-employment or independent contractor income, the taxes from the employer income may be used to offset the amount that is due for estimated taxes on the non-employer income.

A person does not have to pay estimated tax for the current year if the person meets all three of these conditions:

  • Had no tax liability for the prior year
  • Were a US citizen or resident for the whole year
  • Prior tax year covered a 12 month period

The IRS may waive the estimated tax penalty if:

  • Failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty, or
  • A person retired, after reaching age 62, or became disabled during the tax year for which estimated payments were required or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.

Tax Planning 101

Though many people work or go into business to make a lot of money, when it is tax time, the purpose of tax planning is to arrange financial affairs to pay as little in taxes as possible. The three main ways to reduce your taxes is to reduce your income, increase deductions, and make use of tax credits.

To reduce income, Adjusted Gross Income (AGI) is what determines the amount of taxes a person needs to pay. Many tax calculations go off of the AGI. For instance, what you can deduct for medical expenses in the Schedule A depends if your AGI exceeds a certain amount. The tax rate and various tax credits depend on the AGI. AGI is a metric when it comes to your finances.

What goes into AGI is your income from all sources such as independent contractor work, salary, bank interest, less any adjustments to your income. The higher the total income, the higher the AGI. The more money a person makes, the more taxes you will pay. Reduce taxes by reducing your income. One way to reduce income is to contribute money to a 401(k) plan. Your contribution to a retirement plan reduces your wages. Notice the W-2 you get at the end of the year will show reduced income, and this lowers your tax bill. Another way is to obtain commuter checks if your employer offers this benefit. Rather than pay after tax, you pay before tax for bus, train, and other public transportation fares. If you pay a lot for medical expenses, consider contributing to a flexible spending plan. You pay for medical expenses before tax.

AGI can also be reduced with deductions. You can also buy medical insurance. If you are self-employed, you get to deduct your premiums. If you do not work for an employer that offers a 401(k) plan, you can contribute to an IRA retirement plan, and make income adjustments. If have student loans to pay, you can deduct the interest paid. There are deductions for alimony paid, and for teachers, they can deduct classroom related expenses.

Taxable income is what’s left after you have reduced your AGI by your deductions. Besides the deductions a person does not need to itemize, a person can reduce income even more with itemized deductions. These include expenses for health care such as doctor visits not covered by insurance, state and local taxes, personal property taxes such as vehicle registration fees, mortgage interest, contributions to charity, job-related expenses such as professional license dues, tax preparation fees, and investment expenses. Throughout the year, prepare for tax season by keeping track of your itemized expenses with receipts for meals out with business clients, mileage tracking for job interviews, and other records.

Your personal exemptions can reduce your income after you itemize deductions. The exemptions depend on your filing status and how many dependents you have. You can increase your personal exemptions by getting married or having more dependents such as having a baby.

After calculating the tax amount, use tax credits to reduce your tax. There are tax credits for college expenses, adoption, college expenses, and retirement.

Tax-Related Identity Theft

In May 2012, the New York Times had a story describing the dramatic rise in identity thieves targeting the United States Treasury.  In a 2011 Annual Report to Congress, a taxpayer advocate reported tax-related identity theft as a serious problem facing taxpayers.  Criminals have sought to profit off the tax system by submitting fraud refund claims.  The criminals often steal and use the identity of another taxpayer.

With the Internet making everything so public, such as people’s photos, email addresses, phone numbers, and property ownership, it may be easy to use someone’s identity.  Take for instance, Open Book Bar Prep, which has used the photo of Congressman Dennis J. Kucinich to create fake testimonials on Yelp!, and to imply that the Congressman has tax problems in fake testimonials on the services from Strategic Tax Lawyers, LLP.

Each year, the IRS identifies identity theft claims, but some fraudulent claims are never identified, imposing burdens on honest taxpayers.  Identity thieves usually file multiple tax returns claiming refunds using Social Security numbers that are not their own.  When a legitimate taxpayer files the return, the refund may be blocked because the Social Security Number was previously used by an identity thief.

According to the New York Times, the Treasury Department’s Inspector General for Tax Administration testified that the IRS detected 940,000 false returns in 2010, avoiding $6.5 billion in payments to identity thieves.  However, the IRS missed 1.5 million fraudulent returns, resulting in over $5.2 billion in fraudulent refunds.

Congress may increase the criminal penalties for those caught filing fraudulent returns.  To improve on detecting taxpayer identity theft, the IRS distributes PINs to prior victims.

To protect against taxpayer identity theft, follow these tips: 

1. Check your bank account statements and balances frequently.

2.  When paying at a restaurant, follow the wait staff or pay at the counter to ensure the machine used to swipe your card is legitimate equipment.

3.  If a machine at a gas pump or ATM spits out a receipt, keep the receipt to reconcile with a bank statement.  Do not leave receipts at the machine for someone behind you to view your transactions.

4.  Use email services that are less targeted by spammers and phishers.  For example, Laszlomail may be less targeted that Gmail when it comes to virus attacks and bulk messages because it is not well known.

5.  Change passwords in email accounts often when using public computers at libraries and job search centers.

Misclassification of Employees as Independent Contractors

The IRS is cracking down on businesses who classify workers as independent contractors, but who should be employees. In 2011, the IRS created a new program regarding workers misclassified as independent contractors or nonemployees. Businesses classify workers as independent contractors because they want to save on payroll tax.

The Voluntary Classification Settlement Program (VCSP) lets employers voluntarily reclassify workers as employees for future tax periods without an IRS audit context and outside the need to go through usual correction procedures. To keep businesses out of trouble with the Department of Labor (DOL) or state taxing authorities, the IRS advised people interested in the program that it will not share information about VCSP applications with the DOL or the states. This will incentivize people to reclassify because they will worry less about penalties from the DOL or the states, and in the end, the DOL and states win because as workers get reclassified, there are fewer worker complaints to the DOL, and more state tax revenue.

An employer contacted by the IRS about an SS-8 determination letter is eligible for VCSP, but an audit of a parent, subsidiary or member of the employer’s consolidated group is considered an audit of the applicant and would make the employer not eligible for VCSP.

Signing the VCSP closing agreement is not an admission of any liability or wrongdoing for prior years. Rejection of a VCSP application will not automatically trigger an audit. More details on VCSP are found at the IRS website:,,id=246014,00.html.

Recent studies suggest about 10% to 30% of employers misclassify their workers as independent contractors per the Internal Revenue Code 20-factor test. The DOL, the National Labor Relations Board, the Equal Employment Opportunity Commission, and states all use different tests to evaluate if a worker is an employee or an independent contractor. An employer may be able to justify classifying a worker as an employee in one context and at the same time, classify the worker as an independent contractor in another situation.

Misclassification can have significant financial consequences for businesses when audited. These consequences can put a company out of business and result in back taxes, penalties and interest. The financial consequences are calculated based on what a business should have paid for taxes had a worker been appropriately classified as an employee rather than an independent contractor.

For individuals or businesses with complex tax questions, contact an experienced Massachusetts tax attorney.

The Rollover IRA and Taxes

Someone who has changed jobs might be wondering what to do with the 401(k) savings left with a former employer. One option is to put the money in a rollover IRA. A rollover IRA can help someone keep savings on track while still saving on taxes.

A rollover IRA lets an individual move assets from a retirement plan to an individual retirement account without having to pay taxes. That money grows tax-deferred.

With an IRA, there are more investment options than keeping the money with a former employer. Usually employers do not like to give 401(k) participants many options because they worry about employees getting confused when there are too many choices. They also may have obligations as trustee to keep options diversified. Sometimes when there are too many choices, there may be more than one option in an investment strategy, making the types of funds available not considered diverse. With an IRA, a person can access stocks, bonds, exchange-traded funds, and mutual funds.

A person can sign up for an IRA account through a local bank, or through an investment company. At a bank, funds are FDIC insured. However, the return may not be high. Usually bank products are limited to CDs and money markets. If the IRA is with an investment company, the funds may not be FDIC insured, but the company may be a member of SIPC so there may be other insurance protection if the financial institution goes out of business.

With an IRA, retirement plans can be consolidated. A person is able to manage investments in one place. With a 401(k) plan, money may not be able to be moved out of the plan. Consolidating retirement plans helps a person diversify and rebalance funds easier.

A rollover IRA helps to avoid early withdrawal penalties and taxes. Funds are not taxable as long as they are in the IRA account.

Consult with an experienced Massachusetts tax attorney to learn more about individual tax planning.

Dual US Citizens and Residents Penalties

The federal government is cracking down on taxpayers who are dual citizens or residents of the United States and another country. These people may have knowingly or unintentionally failed to timely file US federal and/or state income tax returns.

For example, individual U.S. citizens or permanent residents often fail to file if they live outside of the United States for an extended period of time and have not formally expatriated for U.S. immigration and tax law purposes. Their failure to file may be motivated by an attempt to save money, but it’s a mistake that exposes them to civil and criminal penalties. Ironically, their U.S. taxes due may not be substantial, since the taxes due are net after application of the foreign tax credit rules, foreign earned income exclusions, other provisions in the Internal Revenue Code allowing for a reduction of U.S. income tax, and applicable income tax treaties or conventions.

Another example, dual residents, despite taking advantage of a tie-breaker provision in an applicable treaty, may not realize that they are accountable to file FBAR and other ownership disclosure forms. These people may think, in good faith, that they were “non-resident”.

Dual residents or citizens also may fail to timely file Reports of Foreign Banks and Financial Accounts (FBARs) under the FINCEN regulations. The FBAR must be filed by any United States individual by June 30 of the year after the calendar year in which the United States individual (U.S. citizen or U.S. resident, corporation, trust, partnership or limited liability company created, organized or formed under U.S. law) has a financial interest in, or signature authority over, foreign financial accounts (FFAs) (including bank, securities and other types of accounts) where the aggregate value of the FFAs is more than $10,000 at any time during the calendar year. According to federal regulations, “signature authority” means the authority, either alone or in conjunction with another, to control the disposition of money, funds or other assets held in a financial account by direct communication to the person with whom the financial account is maintained. If you sign a signature card, you have “signature authority”.

The federal government is aware there are many people who fail to meet their personal obligations under Title 26 on federal income tax and Title 31 on FBAR reports for several years. The IRS released a fact sheet (FS-2011-13) on December 7, 2011, summarizing federal income tax return and FBAR filing requirements. The fact sheet discusses how to file a federal income tax return or FBAR and warns of potential penalties. Taxpayers who owe no U.S. income tax may not be subject to delinquency penalties for failure to file or pay.

Remember, U.S. citizens, even if also citizens of a foreign country and no matter where they reside, are required to annually file U.S. federal income tax returns reporting their income from U.S. and foreign sources. In addition, many U.S. states will try to assert tax jurisdiction over former residents who have moved abroad.

Stay up to date on federal and state tax laws by consulting with an experienced Massachusetts tax attorney.

Massachusetts Sales & Use Tax

Since August 1, 2009, the Massachusetts sales tax percentage is 6.25 percent of the sales price or rental charge of tangible personal property or specified telecommunications products and services sold or rented in Massachusetts.

The sales tax generally is paid to the vendor as an addition to the purchase price. The purchaser pays the sales tax to the merchant at the time of purchase; the vendor then remits the tax to the Commonwealth. For automobile and trailer sales, however, the sales tax is paid directly to the Commonwealth by the consumer.

Since August 1, 2009, the Massachusetts use tax is 6.25 percent of the sales price or rental charge on tangible personal property 1 (including mail order goods or products purchased over the Internet) or specific telecommunications services on which no sales tax, or a sales tax rate less than the 6.25 percent MA rate, was paid and which is to be used, stored or consumed in the commonwealth. The use tax, unlike the sales tax, usually is paid specifically to the state by the purchaser.

Case in point: You order household furniture for your MA enterprise or residence from an out-of-state firm and pay no MA or other state sales tax. You are compelled to pay the 6.25 percent Massachusetts use tax. The use tax applies because the items were not exposed to a sales tax in the other state and because it is for use in the commonwealth.

Concrete individual property involves electronically transferred software.Telecommunications services consist of telephone and other transmissions of data (such as beeper services, cellular telephone services and telegram services). Cable television and Internet access are exempt from the sales tax. Usually, the tax on the sale or use of telecommunications services is a tax on the transmission of messages or information by various electronic means, but not on the sale or use of data itself.

Recent Changes to Massachusetts Tax Laws: An Overview

For many state residents, taxes are an afterthought, one that gains a mountain of attention in April and reverts back to a molehill once everyone’s paperwork is in order. Few consumers take time to consider how the sales tax they pay – which is smaller in Massachusetts than in most of the United States – can help or hinder the economy on a larger scale. As many are aware, this coming November could mean many changes in local taxes and for the Massachusetts budget, changes that could impact you on a day-to-day basis. Before heading to the polls on November 2nd, be sure to familiarize yourself with some of the most important issues.

Question 1 – Sales Tax on Alcoholic Beverages

Not so long ago, alcohol purchases were tax-exempt. This changed last year, when the Senate voted to lift the exemption, opting for the statewide average of 6.25%. While the month of September always brings a rise in alcohol sales thanks to the influx of college students, most other months have found liquor store owners struggling. Formerly regular customers are crossing state lines to buy alcohol in New Hampshire, where no sales taxes are applied, and businesses have had to cut down on employees and advertising. Taxes from alcohol sales will go towards federally funded addiction recovery programs, and most supporters argue that because alcohol is not a necessity, it should not be tax exempt. Many donations have been made to campaigns supporting both sides of the issue.

Question 2 – Comprehensive Permits and Regional Planning Initiative

Question 2 revolves around a law that’s been in place for over forty years, allowing organizations building low- or moderate-income to obtain a single zoning permit, as opposed to separate permits from each agency or official with any jurisdiction over any aspect of the housing in question. Voting No on Question 2 would make no change to the standing law, which advocates claim is responsible for having created approximately 58,000 affordable homes for seniors and working- and middle-class families. Voting Yes is a vote to abrogate the current law, an action supporters believe is necessary for housing development reform.

Question 3 – Sales Tax Cut, From 6.25% to 3%

This proposed law would reduce the state sales tax by half, beginning on January 1, 2011. This is important to voters on either side, as its implementation would impact residents on a daily basis in noticeable ways. While it might cut the cost of a family’s groceries for the week, it would halve the state’s budget for public programs, and the jobs of thousands of municipal employees could be put at risk. Arguments from the Yes voters are based on lower taxes inevitably stimulating the economy, and each household keeping approximately eight hundred dollars more per year than they do now.
Almost twice the amount of residents are expected to vote this year than in the last elections.

Massachusetts Health Care Reform, Taxes, and Your Business

According to the state’s website, the goal of health care reform in Massachusetts is to make quality, affordable health care available to every resident.

The law now places certain responsibilities on employers to ensure that health insurance is accessible to as many individuals as possible.

Businesses are affected in many unique ways according to their size. Generally speaking, businesses with fewer than 11 full-time equivalent employees are exempt from most requirements of the law. However, their employees who live in Massachusetts are still required to have health insurance.

Small employers who wish to contribute toward their employees’ group health coverage can purchase health insurance through the Health Connector, or they can purchase through existing channels.

Businesses with 11 or more full-time equivalent employees must offer Section 125 plans to enable their employees, including employees who may not be eligible for the employer’s group health plan, to purchase health insurance on a pre-tax basis.

Those who do not may be required to pay a surcharge if their employees (or dependents of their employees) make significant use of the state’s Health Safety Net, formerly the Uncompensated Care Pool. This is called the Free Rider Surcharge.

If you’re a business owner with questions regarding health care reform as it relates to your business and its taxes, it is important that you discuss the ramifications of health care reform with an experienced business taxation legal professional. You may have several options that you did not realize were available to you.

The Greater Boston Chamber Releases Its Third Competitiveness Scorecard

The Greater Boston Chamber released its third Competitiveness Scorecard, analyzing cost and competitiveness issues facing the Massachusetts economy. This edition focuses on the state’s corporate tax burden and business climate competition. Here are a couple findings:

“In FY 2009, Massachusetts’ corporate tax burden was the 8th highest in the country. This burden is 39% higher than the national average, and higher than a number of states that compete with the Commonwealth for job growth and business expansion. To cite just a few examples, compared to Massachusetts’ corporate tax burden Colorado’s is 76% lower, Connecticut’s is 63% lower, North Carolina’s is 55% lower, and Maryland’s is 40% lower. More examples are provided in the Scorecard.
In FY 2010, Massachusetts ranked the 4th worst on the Tax Foundation’s corporate tax index. The Tax Foundation, a nonpartisan, nationally-recognized tax research organization, bases its index ranking on a formula that weighs corporate income tax as well as policies governing net operating losses (NOL), credits, deductions and exemptions, and related tax base issues.”

Source: Greater Boston Chamber of Commerce Blog