Retired, Fired, or Lost Money in 2011? Lower Income Can Mean Higher Tax Benefits
Thomson Reuters tax analyst examines nine U.S. tax implications of a decline in income
“With the U.S. economy still unsettled and unemployment still high, many taxpayers retired, were fired, or lost money in the markets in 2011. For anyone with lower income for 2011 than in 2010, there’s a possibility of increased tax deductions and credits,” according to Lesli S. Laffie, a senior tax analyst for Thomson Reuters.
Taxpayers whose income declined in 2011 should consider the following nine implications when filing 2011 tax returns:
- Can you avoid AMT? The alternative minimum tax (AMT) is a parallel tax system that does not permit several of the deductions permissible under the regular tax system. Taxpayers who may be subject to the AMT must calculate their tax liability under the regular federal tax system, and under the AMT system taking into account certain “preferences” and “adjustments.” If their liability is greater under the AMT system, they’ll owe AMT instead of regular tax. In computing AMT for individuals, the AMT tax rate is applied against the taxpayer's alternative minimum taxable income (AMTI), as reduced by an exemption. For the 2011 tax year, the exemption is $74,450 (if married filing jointly, $48,450 if single, and $37,225 if married filing separately). The exemption phases out for AMTI above certain threshold levels. “If your 2011 AMTI is under the exemption amount, none of your income will be taxed at AMT rates,” noted Laffie.
- Is a medical deduction available? Lower income for 2011 may help taxpayers qualify to deduct medical expenses on Form 1040 Schedule A, if out-of-pocket health care costs for that year exceed 7.5 percent of 2011 adjusted gross income (AGI). “And while employee medical insurance premiums are paid in pre-tax dollars, and so, are not deductible,” Laffie observed, “premiums paid under COBRA (after a job loss) are generally higher and are paid in after-tax dollars, increasing deduction potential.”
- Can you deduct miscellaneous itemized deductions? Smaller 2011 income may help taxpayers qualify to deduct miscellaneous itemized deductions on Schedule A, if they are not subject to AMT and they exceed 2 percent of their AGI for that year. “This would include costs like job-search expenses, safe deposit box fees, tax return preparation charges, and investment expenses other than interest,” noted Laffie.
Are you eligible for a credit for your dependents? A child and dependent care credit up to $1,050 for one qualifying individual (QI) or $2,100 for two or more QIs may be available for expenses the taxpayer incurred during 2011 for the care of QIs and household services in order to be gainfully employed (which includes both working and actively looking for work). The credit is a percentage of eligible employment-related expenses (capped at $3,000 for one QI and $6,000 for two or more QIs) incurred by the taxpayer for the tax year, reduced by employer-provided dependent care assistance received.
For credit calculation purposes, the amount of employment-related expenses cannot exceed 2011 earned income (if single) or the lesser of the individual’s or the spouse’s 2011 earned income (if married filing jointly). “Unemployment compensation doesn’t qualify as earned income for this purpose, but self-employment (SE) income does,” Laffie said. “If you had no earned income at all for 2011, no child and dependent care credit will be available, but you may be able to take a partial credit if you (if single) or you and your spouse (if married filing jointly) had some 2011 earned income (including SE income).”
For eligible taxpayers, there is also a child tax credit of up to $1,000 per qualifying dependent child under age 17, that starts to phase out when modified AGI (MAGI) exceeds $110,000 (if married filing jointly), $75,000 (if not married), or $55,000 (if married filing separately). The credit is refundable, subject to certain limits.
- Can you take an education credit for education costs to prepare yourself for a new career? Up to a $2,000 Lifetime Learning credit may be available if taxpayers incurred higher education expenses in 2011 and their MAGI was under $51,000 if single ($102,000 if married filing jointly). The credit starts to phase out above those MAGI amounts. Laffie noted, “You qualify even if you took only one course in 2011, but other rules apply.”
- Is a saver’s credit available? For those who made retirement plan contributions in 2011 before layoff or retirement (such as to a 401(k) plan or IRA), a 10 percent, 20 percent, or 50 percent nonrefundable “saver’s credit” may be available, if certain requirements are met and 2011 AGI does not exceed $56,500 (if married filing jointly), $42,375 (if head of household), or $28,250 (if other). The credit percentage depends on the contribution made and the taxpayer’s AGI level. “However,” Laffie warned, “the credit is reduced by certain retirement-plan distributions the taxpayer (or spouse, if filing a joint return) took during a “testing period.” The maximum credit is $1,000.
- Do you qualify for the EITC? Taxpayers may be eligible for a refundable earned income tax credit (EITC) of up to $5,751, depending on their earned income and family size, among other qualifications. Single and childless workers may also be eligible for a reduced credit. “The IRS’s online EITC Assistant can help taxpayers quickly determine their eligibility.”
- Less income may mean more tax savings. “The decrease in income for 2011 may put more or higher 2011 tax deductions and/or credits in reach.”
- Cannot pay your taxes? What if the taxpayer owes taxes when he or she files, but cannot pay? “Don’t panic!” advised Laffie. “File your return on time (by April 17, 2012), even if you can’t pay.” To reduce interest and penalties, taxpayers should include as large a partial payment as possible, and consider borrowing from family or friends, paying by credit card, or liquidating assets. For the balance, taxpayers should consider:
- Asking the IRS to allow payment within 10 days.
- Securing a short-term payment plan from the IRS. This is fee-free, can be requested online (call the IRS if the amount owed is more than $25,000), and can allow up to 120 days to pay, but interest and penalties will still apply.
- Getting a payment extension of six months or more from the IRS by filing Form 1127, if the taxpayer can show “undue hardship” (i.e., a substantial financial loss if required to pay the tax on the date due). The taxpayer will owe interest until the taxes are paid.
- Filing Form 9465 (if the amount owed is up to $25,000) or Form 9465-FS (if the amount owed is up to $50,000), or applying online, to request a monthly installment agreement to pay over as long as 72 months. “But be aware that you must have filed all returns that are due, there is a fee for an installment agreement, and the IRS can modify the terms later if, for example, you miss a payment or it determines that your financial condition has significantly changed,” noted Laffie.
- Making an offer-in-compromise (for less than the amount owed, see Form 656-B), if the taxpayer will never be able to pay the bill in full.
Taxpayers should consult with a personal tax advisor before applying these or other tax strategies.
Up-to-date analyses of legislation and regulations affecting individual taxpayers are available to tax and accounting professionals on the industry-leading, award-winning Thomson Reuters Checkpoint research platform.
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