With very few exceptions, all income earned by American taxpayers – both individuals and entities – is taxable in one way or another. This, not surprisingly, includes income earned by renting property. Whether this income is payable by the individual or an entity depends on who the legal owner of the property is, but the income remains taxable. In fact, people failing to report, or under-reporting rental income is a major source of the “tax gap”, the difference between the amount owed each year and the amount collected each year by the Internal Revenue Service (IRS). This means that owners of rental property face additional scrutiny in the audit process, so the owners or beneficiaries of rental property should be sure to keep proper records.

Generally speaking, rental income includes any and all monies received in exchange for the use or occupation of property, and though this most commonly refers to real estate, it may also apply to other rental properties like storage units or household items (like renting household appliances). Most landlords operate their rental properties on a cash basis, which means that both the amounts received and the relevant deductions are claimed for the specific period of time in which these amounts were received or spent. This makes the reporting of rental income much easier than the alternative models, however it also leads many people to under-report since they do not consider all income received as rental income, though the IRS does.

The basic rent amount is self-evidently something that has to be reported as rental income, but there are also a myriad of other amounts on money received that also count as rental income and must be reported as such. These include, but are not limited to: (a) rent payments made in advance; (b) fees charged for the early termination of a lease; (c) some expenses paid by the tenant for the landlord; (d) property or services received in place of money; and others. Further, there are special provisions for rent-to-own payments and other arrangements related to rental agreements.

Security deposits are not usually considered income and should not be reported as such upon initial receipt. However, if the land lord opts to retain all or part of the security deposit once the initial agreement is concluded because the tenant did not live up to his obligations; this retained portion of the security deposit becomes income and has to be reported as such. This is one of the most common mistakes made by landlords and one that RS auditors are careful to look for when examining a landlord’s records.  

Offsetting this reportable income is also a wide range of deductions that can be claimed as expenses by the landlord. These can range from major devaluations through depreciation to minor deductions such as the purchasing of materials for maintenance of the rental property. The overall tax ramifications of owning and renting property can be complicated, so it is frequently in the landlord’s best interest to hire a tax professional to help them determine what has to be reported and what deductions can be claimed.

Anyone that regular follows the news and arguments in Washington about taxes knows that capital gains are taxable to one extent or another because the capital gains tax has been the subject of a great deal of vigorous debate in Congress and between the political parties. As such a contentious tax, it is frequently changed or modifies by Congress. For example, for 2008 through 2010, at least some net capital gains will not be taxed if they would otherwise be taxed at lower rates than the standard 15 percent that is the usual for capital gains taxation. The rules change a lot, so people with significant capital gains (or capital losses) should consult with a tax professional.

Generally speaking, almost everything that is purchased for personal or investment purposes is considered a capital asset by the Internal Revenue Service (IRS). When these assets are sold, the difference between the base value or price of the asset and the actual amount realized in the sale is either a capital gain or a capital loss. If the amount realized was above the basis value, then it was a gain; if it was below the basis price, it was a capital loss. Capital gains are generally taxed at around 15 percent, but as noted previously, this changes a lot each year depending on the political wrangling in Washington. Capital losses are also at least partially deductible, again depending on a myriad of factors related to the asset and the sale.

The extremely simplified definition provided above notwithstanding, capital gains and losses are an extremely complex tax matter, explained in detail in IRS Publication 550, which for 2009 runs to more than eighty pages. There is an endless array of exceptions and exemptions based on the nature of the asset, the nature or timing of the buying or selling of the asset, how long the asset was held, where the asset was sold and the amounts realized from the sale. Even fairly simple capital gains or losses – like those related to a personal home – can become extremely convoluted since there are all kinds of incentives and disincentives related to home ownership as well.

Capital gains or losses are reported on Schedule D of the 1040 form used for filing a individual tax return. Discarding IRS Publication 550, just the line-by-line instructions for Schedule D run to ten pages and include four different worksheets which are used to calculate amounts to be reported. Bear in mind that all of the amounts used to do this also have to be documented so that the numbers claimed can be substantiated if requested by the IRS. Further, this document is full of sentences that are barely comprehensible to most people, like: “Figure the amount of gain treated as unrecaptured section 1250 gain for installment payments received in 2009 as the smaller of (a) the amount from line 26 or line 37 of your 2009 Form 6252, whichever applies, or (b) the amount of unrecaptured section 1250 gain remaining to be reported.” [Instructions for Schedule D 2009, PDF Page 9]

Needless to say, non-experts may find it well worth the extra expense to hire a tax professional to help with detailed capital gains/losses filing. Not only is it complicated and time consuming, but mistakes can be very costly.

One of the most daunting aspects of the American tax system is just the simple fact that it changes each year. Some of these changes are built into the legislation that enacted the measure, which is why many limits and income restrictions change every year. Other changes stem from the fact that the progressive tax system used by the United States is specifically designed to perform more functions than merely raising revenue for the federal government. Instead, it is used to promote activity that the political leadership views as desirable, discourage activity that it does not like and to mitigate the effects of various economic problems and trends in society. This last purpose means that in times of economic distress or turmoil, there are often a lot more changes than happen when things are running smoothly and that has certainly been the case over the last few years.

In an effort to stimulate the overall economy, as well help particular sectors that have been hard hit in the recent downturn, there are a lot of tax changes that have been implemented for 2009 and 2010 that taxpayers should be familiar with. If the taxpayer is using a professional tax preparation service, the service should be aware of all of the new changes, but otherwise it is up to the taxpayer to find out about them. Though some of the new measures are relatively minor and not worth the trouble for many taxpayers, other measures can result in real savings for many average people and should be used.

For example, the American Recovery and Reinvestment Act of 2009 (ARRA) is part of the overall stimulus program being implemented by the federal government to help mitigate the effects of the ongoing recession. This act provides a number of tax breaks that apply to people who are buying homes, people that have purchased new cars, people that have made their homes more energy efficient, people paying for higher education as well as people that have recently become unemployed and used unemployment compensation. The exact details of these various programs can be found on the website of the Internal Revenue Service (www.irs.gov) and elsewhere online.

Another example of recent changes that many common people can benefit from are the increased amounts being offered for standard deductions. This is a real plus for people that do not regularly itemize their deductions, but do claim standard ones as appropriate. The basic deduction amounts have increased for married couples filing jointly, singles, and heads of household. Similarly, a new standard deduction has been introduced for state and local sales taxes and excise taxes paid during the purchase of a new vehicle after February 16, 2009. The standard deduction for state and local real estate taxes has also been increased in 2009.

The ARRA also included the Making Work Pay tax credit which is likely to have a profound effect on many people’s taxes because it lowered the amount of withholding held by employers. The basic idea was to permit workers to receive more of their wages immediately as opposed to waiting for their refunds. However, this also means that some people that usually receive refunds may not for 2009, or people that usually owe may owe more than normal this year.

The American tax code is extremely complicated, and though this means that it can be a pain to file your annual return, it also means that there are a lot of ways to either increase the amount of your refund or decrease the amount of your tax liability. Despite this, most people are aware of at least some of the basic deductions and credits they can claim, such as dependents and certain tax credits like the Earned Income Tax Credit (EITC). Nevertheless, there are a number of deductions that can save a lot of money that some people may overlook, some of which do not involve itemizing your deductions.

If there is a deduction that can be claimed that does not require one to itemize, they are technically known as adjustments to your income. The amount after these adjustments is known as your adjusted gross income (AGI), which plays a big role in determining what can or cannot be claimed. Adjustments like dependents are well known, but there are some other adjustments that are frequently overlooked. One example of this is contributions to a retirement plan like an IRA, 401(k), or similar plan. Another adjustment that is commonly overlooked is interest on student loans, up to a limit of $2,500 as long as the loan qualifies. There are other adjustments as well, such as capital losses and some business expenses.

The real catch behind many deductions is that in order to claim them, you have to file the “long form” 1040 and itemize all of your deductions on Schedule A. This can be a time consuming and annoying process for many people, so they just opt not to itemize their deductions. Nevertheless, itemization can really make an enormous difference in the amount of money owed, either an IRS refund back to you or as a liability owed by you to the IRS. Either way, itemizing is frequently well worth the additional time and hassle involved, especially if you hire a tax professional to do the hard work on your behalf.

Even when people decide it is worth the effort to itemize their deductions, there are many deductions that are commonly overlooked. Some of the most common deductions over looked include: interest paid on a home mortgage, interest paid on a home equity loan (or second mortgage), state and local taxes or sales taxes, medical expenses, and personal casualty or theft losses (including amounts lost through financial schemes and scams). As is usually the case with anything done by the IRS, there are many restrictions and strict guidelines that have to be followed in order to claim these deduction legally, so if you are not using professional services, you should take the time to carefully read IRS Publication 17, which describes most of these matters in good details and tells taxpayers where to look for more detailed information.

There are many tax breaks – adjustments, deductions, and credits – that can be claimed, so there are many potential tax breaks to be found. The real issue is determining which ones you qualify for and being careful to claim them correctly. Remember that you are liable for any mistakes on your return, so it is in your best interest to pay close attention to what you claim.

One of the defining characteristics of the American tax code is that it is used for more than merely raising government revenue. Instead, the progressive tax system is also used to encourage behavior deemed socially beneficial, discourage behavior considered socially undesirable and to remedy or relieve temporary economic difficulties. The homebuyer tax credits fall into the latter category, being specifically designed to help ease the collapse of the real estate market that began in late 2007 and has continued ever since. The basic idea was to use the tax code in order to provide prospective homebuyers with a good incentive to buy new homes despite the collapse of the residential real estate market.

The first measure was passed in 2008 in the form of the Housing and Economic Recovery Act, which offered a tax credit of up to $7,500 for first time homebuyers. The tax credit was not an actual grant of money, but instead operated like an interest-free loan that would have to be repaid through the tax system gradually over the subsequent fifteen years. This original plan only applied to homes purchased between April 8, 2008 and January 1, 2009 and had to be claimed by filing the new Form 5405 that was created specifically for this purpose. The problem was that during the period covered by this law, residential real estate markets were in free fall all across the country with properties losing value on a monthly basis. Further, in the wake of the subprime mortgage crisis, most lenders tightened up their lending standards dramatically resulting in the credit crunch. The result was that this initial measure only met with limited success.

The limited success of this original plan resulted in it being substantially expanded through the Worker, Homeownership and Business Assistance Act of 2009. This act expanded the time frame (up through April of 2010), increased the credit amounts, and – perhaps most importantly – extended the tax credit to people that already owned homes, removing the “first time” requirement that was part of the original measure. This extension of the plan to people that already owned homes was essential to the measure’s success since by the latter part of 2008 the only people that had enough collateral and good enough credit to get a new mortgage loan were the same that had already owned homes and had equity in them.

As is the case with most tax credits and other incentive programs administered through the tax code, there are a number of conditions that have to be met in order to qualify. For example, the property in question has to be the taxpayer’s primary residence, so people buying rental properties cannot claim the credit. All the specific details can be found by looking for the “First-time Homebuyer’s Credit” on the IRS website: www.irs.gov.

The substantial amount of the tax credit, despite the fact that it has to be paid back, has made the measure very popular and some lenders will even accept the credit as a down payment of the new mortgage. Further, since the time period has been expanded, most housing markets have already bottomed out, meaning that buyers are much more willing to buy new homes. Finally, the credit crunch is also starting to relax some, meaning that mortgages are gradually getting easier to get. The result is that the extended and improved tax credit is likely to be much more successful than the 2008 measure.

The 1099 series of forms are known as “information returns” and required by the Internal Revenue Service (IRS) to be issued by almost all non-employer payers – people, organizations, or institutions that pay money to American taxpayers – in the United States. These information returns show the amount of money paid to the taxpayer as well as other relevant information related to the payments, such as withheld amounts and other details. The information on the 1099 is then entered on the taxpayer’s personal or business income tax return to document the amount of money earned through these alternative income methods. Basic wages, salaries, and tips are not reported on 1099 forms, but on employer issued W-2 forms. Every 1099 is issued in triplicate, with one copy being held by the payer, one copy being filed directly with the IRS and one copy being sent to the person that received the payment.

There are almost twenty different types of 1099 forms that are issued for different types of income, as well as a number of other forms that are also used to report certain payments though they are not 1099s. Some forms of 1099 are much more common than others. For example, a 1099R reports income earned in various retirement plans and arrangements like IRS, 401(k)s, and various qualified plans and are therefore received annually by anyone with some sort of retirement plan. On the opposite end of the spectrum, the 1099OID is fairly uncommon and relates to money earned by purchasing bonds at a rate lower than their eventual redemption value, a rather complex taxable amount that only really applies to people with complex investment structures.

In general, most 1009s are issued by financial institutions, investment firms, and brokerages, though there may be occasions when individuals are required to issue 1099 forms. For example, if a person uses a contractor and pays him or her and the amount exceeds $600, that person has to issue a 1099MISC (miscellaneous), to that contractor for the amount paid. Frequently landscaping and other household maintenance and improvement workers operate as independent contractors, in which case the customer has to issue a 1099-MISC for the amount paid to that contractor. More often than not, if a contractor requires a 1099MISC they will notify the client of this fact in advance and show them how to proceed. However, if this is not the case, the client can find all of the relevant information on the IRS website: www.irs.gov.

Since a copy of every 1099 is sent directly to the IRS, these documents play a key role in determining whether or not the taxpayer is reporting everything earned properly or not. When an audit is initiated, the IRS will compare all of the taxpayers 1099s to all of the amounts claimed on their return. If there is a disparity – either more or less money reported on 1099s than claimed on the individual return – then the taxpayer is usually in trouble. For this reason it is important to ensure that all 1099s owed are duly issued before the end of the calendar year. If a person is expecting a 1099 and does not receive one, it is very much in their best interest to contact the payer to ensure that the 1099 was issued and to request a copy of it.

Few things in American society are as dreaded as being audited by the Internal Revenue Service (IRS). The tax code is so complex, it is almost a given that if the auditors dig deep enough and look hard enough eventually they will find mistakes and then charge all the relevant penalties (and interest for older errors). The general process is that the IRS computers compare your newest return to your previous returns and the differences are calculated providing a “DIF Score”. If this score is high, indicating a significant change in your filing, it means your return is given additional attention and perhaps audited. Although the DIF Score factors used to determine who gets audited and who does not is kept secret, there are certainly things that will make it more likely that you will be audited. Further, there are specific things you can do to lower your chances of being audited.

First and foremost, use your common sense when filing your annual tax return. If something seems too good to be true, it probably is. So just because you have recently opened a home office does not mean you can suddenly claim your mortgage payments for the year or the total value of your home as a business deduction. People making large and unusual claims on their taxes are automatically highlighted for closer scrutiny, so if you do make a large and unusual deduction or claim for a tax credit on your return, be very sure well in advance that it is legitimate. If you are unsure about a possible deduction or tax credit, read up or consult an expert before you claim it.

Fair or not, there are certain categories of taxpayers that are almost always more likely to face an audit than other people. One of these groups are people that earn more than $100,000 per year because the penalties and interest received from people with high incomes is much more likely to justify the IRS expense in auditing the person. Another group are people that are self-employed because they have much more leeway to hide income or claim illegal deductions by treating personal expenses as business ones. People that earn a lot of their income from cash transactions – like professional gamblers, doctors, and servers – are also more likely to be audited since they have better opportunities to under report their actual earnings. People in any of these groups are more likely to be audited, but people in more than one of these categories at the same time are almost guaranteed to be audited.

Of the 1.39 million audits conducted in 2008, only 310,429 were full field audits. Most audits do not require calling in the person, but instead are handled through correspondence. This means that if you are identified as someone that the IRS intends to scrutinize more closely, if you have all of your documentation on hand to substantiate your claims, you may be able to resolve the issue without going through a full, in person, audit process. Needless to say, you should be able to substantiate any deduction or tax credit claimed, so if you have the supporting documentation readily available and provide it to the IRS when they ask for it through the mail, you can avoid having to deal with the more intense scrutiny stemming from a full audit.

Despite DIF scores and other “red flags” that make audits more likely, there is also a large portion of audit targets that are generated at random, simply to keep everyone alert to the possibility. Since the process is random, there is no possible way to avoid an audit if your number comes up in this way, so no amount of pre-emptive measures are guaranteed to make sure your are not audited.

The Earned Income credit (EIC), or more properly the Earned Income Tax Credit (EITC), is a refundable tax credit that is available to many lower income tax payers based on a means test. Since enacted in 1975, the EIC has evolved into a much larger tax credit than originally envisioned and one of the most successful federal programs to assist low income people. In fact, the idea of the EIC has been so successful that today many American states have their own EIC programs for state taxpayers as well. The EIC was specifically designed to offset the burden of payroll tax deductions and to actively encourage people to work, which is why it only applies to people that earn income. Contrary to the conventional wisdom about the EIC, it is available to people with or without children, though workers without children receive lower benefits and have to meet some additional conditions in order to qualify.

There are a number of personal information requirement that are necessary to qualify for the EIC before the means test is applied. These include: (a) the taxpayer must be a U.S. citizen, full time resident alien, or a non-resident alien married to an American citizen; (b) the taxpayer has to have a valid Social Security Number (SSN); (c) the taxpayer cannot be filing as “married, filing separately”; (d) the taxpayer has to have earned some income through employment, self-employment, or some other recognized sources; (e) the taxpayer cannot be the qualifying child of another person; and (f) the taxpayer cannot file Form 2555 or 2555-EZ related to earning foreign income. If the taxpayer meets these initial conditions, then the means test is administered.

The means test looks at both the level of earned income as well as the amount of investment income earned by the taxpayer. The exact amounts differ each year, but the IRS posts regular limits tables on its website allowing the taxpayer or his or her tax preparer to see what the relevant limits are for any given tax year. The income limits are based on the taxpayer’s adjusted gross income (AGI) and the annual limits change depending on how the taxpayer chooses to file. For example, people that are filing as “married, filing jointly” typically get higher limits than those filing otherwise. Further, the limits also vary depending on the number of qualifying children the taxpayer is claiming. Every year there are also caps, that limit the upper amount that can ever be claimed as EIC regardless of the other factors, but these caps also differ depending on the filing status and number of qualifying children.

The EIC can also be paid, at least in part, in advance by employers if they are so inclined. This is a popular option for low income workers since they receive their EIC in the form of larger regular paychecks as opposed to in one lump sum each year. As is the case with most matters related to tax matters, the payment of advance EIC credit is also carefully regulated. For example, regardless of the EIC that a particular worker may qualify for, in 2009 the absolute maximum advance EIC that can be received from employers is $1,826. There are also regular changes and adjustments made almost every year for one purpose or another. As an example of this, the American Recovery and Reinvestment Act (ARRA) provides a temporary increase in the amount of EIC available to some recipients that only applies for 2009 and 2010 as part of the national stimulus and recovery process.

Like most bureaucratic organizations in the world today whose function involves a large amount of paperwork, the Internal Revenue Service (IRS) is now actively encouraging people to file their annual income tax returns electronically. This makes the annual filing faster and easier, ensures that the return is received on time and means it can be processed sooner, resulting in faster refunds or settled bill amounts for taxpayers. The IRS now offers three main ways to file electronically, though each has its own terms and conditions. Further, there are some types of filing – like claiming the making Home Affordable Tax Credit – that have to be done on paper.

The Free File program offered by the IRS offers two distinct services: Traditional Free File and Free File Fillable Forms. Traditional Free File is a partnership between the IRS and the Free File Alliance LLC that provides free tax preparation and filing for people with an adjusted gross income (AGI) under a specific amount. The qualifying amount for Traditional Free File differs each year, but in 2009 is for people with an AGI under $57,000. Free File Fillable Forms offers a range of the most popular tax forms online that can be filled out and filed electronically. Unlike Traditional Free File, there is no tax preparation assistance provided, but there are also no limits on who can use this feature to file their taxes as long as the relevant forms are available.

The IRS e-File program is actually carried out by tax preparers, non-profit tax assistance organizations, and included in many tax preparation software packages available on the retail market. Almost all the major filing types can be e-filed: personal returns, small business returns, large corporate returns as well as returns for charities, non-profits and people paying excise taxes. The e-file option has been the most successful electronic filing option and is now widespread. Most tax preparers will charge a small fee for e-filing a return, but there are usually free options available such as the Free File program described above, people e-filing with the assistance of non-profits, and those who own their own tax filing software like TurboTax.

The third option is the Electronic Federal Tax Payment System (EFTPS), which is commonly used by companies that choose to make regular payments to the IRS throughout the year. Though it is more popular for companies and entities, individuals are also welcome to use the system and some do. The EFTPS system allows business owners to make regular payments to the IRS weekly, monthly or quarterly and today almost ten million taxpayers are enrolled in the system.  The EFTPS system also allows people to make their regular payments – usually based on the estimated amount owed as determined by Form 1040ES – over the telephone as opposed to online. There are additional features included in the program as well, such as automatic bulk payments for employers sending in payroll taxes regularly.

Filing electronically is much better than manual filing in almost every respect and the IRS is actively encouraging taxpayers to use this option. It is faster and easier for both the IRS processors as well as for the taxpayer and is usually available for free or at a small nominal cost (which can, incidentally, be deducted as a Miscellaneous Expense).

Although many people consider the April 15 deadline for filing their personal tax return as non-negotiable, in reality getting an extension is an easy and painless process that is available to all American taxpayers. Almost anyone is allowed to file a Form 4868, which will grant them a four to six month extension of their tax filing deadline. However, it is important to note that an extension to file does not amount to an extension to pay any taxes due, so if you suspect that you will owe taxes you will be charged interest on any amounts due for the duration of your extension time.

One popular myth surrounding filing for an extension is that in order to do so you have to have a good reason. In reality this is not the case at all. The Form 4868 is a very simple form that asks for nine pieces of information. The only effect that your reason for filing for an extension has is if you tick the box for Line 8. Line 8 asks if you are a U.S. citizen or resident that is currently outside of the United States. If you tick this box, the length of your extension goes down from six months to four months. Otherwise the form does not ask for any further information regarding your reason for filing an extension and the instructions do not place any other reason based restrictions on extensions.

Generally speaking all you have to do is fill out Form 4868 and file it. Although you can file a paper version through the mail, it is usually a better idea to file your 4868 electronically, because then you will get a confirmation that the Internal Revenue Service (IRS) received your filing and, in some cases, a specific confirmation number to verify this. There have been some instances when a Form 4868 has been properly filed and is then misplaced by the IRS, putting the burden of proof on the taxpayer. Therefore it is always a good idea to receive and save acknowledgement of receipt or your confirmation number.

If you suspect that you will owe money and want to avoid having to pay most (or all) of the interest that will accrue during your extension, the Form 4868 also allows you to send in a check for any amount you think is appropriate. The amount sent in will be credited to your tax liability, so interest will only accrue on any amount owed in excess of that covered by your check. Again, you should be careful to document everything and record precisely how much you sent to the IRS just in case there is a processing error. You can also pay forward money that you think you owe via electronic funds transfer, credit card or debit card. The exact instructions in this respect are provided in the instructions for Form 4868.

Filing an extension is a quick and easy process and is available to virtually all filers, even those that have to file paper returns for whatever reason. As a consequence, there really is no justifiable reason for anyone to be late fling their annual tax return. In fact, this may well be why the IRS has a zero tolerance for late filers and automatically charges them with penalties.