Like it or not, the American tax system is extremely complex. The tax code alone runs to many thousands of pages and the additional regulations run to many more thousands of pages. The result is one of the most complicated tax systems in the world and many people spend their entire professional careers learning how to handle different aspects of the tax code and selling this expertise to people that have neither the time nor the interest to become experts themselves. Of course anyone is allowed to fill out their own tax returns, and if the person’s tax situation is very simple – people that qualify to use the 1040EZ and choose to do so – there is generally no harm in this.

However, the more complicated the tax situation becomes; the more important it is to at least consider hiring a professional. Many people end up getting themselves into trouble with the Internal Revenue Service (IRS) simply because they decide to file their own returns without understanding how everything actually works. For example, many deductions have relatively self-explanatory names – like “business expenses” – but these terms have very strict and well defined meanings in respect to taxes which may not include everything that common sense says is a “business expense.” Further, many deductions have very specific limitation on what can or cannot be claimed, and while an expert may know and understand what these limits are, a layman may not. In either case, if a person claims a deduction or credit that they are not entitled to, they may face penalties and other punitive measures.

Another reason that an expert may be useful is because the tax code and various limits and conditions change each year. For example, just because a person qualified for a particular deduction in one year does not mean they qualify for the same deduction the next year. Similarly, there are also usually a number of one time, or temporary, deductions or credits that only apply once. There are so many changes that many major tax forms change each year, so the IRS usually only issues the tax forms for a particular year a few months in advance of the April 15 due date. Keeping track of all of these changes and modified limits can be very time consuming, but most experts do this as a matter of course, so it is no problem for them.

Finally there is simply the matter of maximizing the tax benefits: maximizing the amount of a refund or minimizing the amount owed to the IRS. The whole notion of deductions and tax credits is very complicated. There are so many options available and each of them has very strict guidelines that have to be met in order to claim them. This is true even for basic claims that people think they understand – like dependents – even if in reality they do not understand specifically what the IRS means by these terms. The result is that in many cases a tax professional can not only help the taxpayer avoid getting themselves in trouble, but can also help them get a better return than they would have been able to come up with by themselves.

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.

Technically speaking, there is no specific age or time period that determines when a person must stop claiming a child as a dependent. In fact, even the elderly can be claimed as dependents as “qualifying relatives” regardless of their age. However, the determination of who can be claimed as a dependent is fairly complex. There are a number of basic terms and conditions as well as a series of tests that each potential dependent has to pass before they can legitimately be claimed as dependents, although age is not – in of itself – a major determining factor.

First there are a series of conditions that must be met before anyone can be claimed as a dependent, either as a “qualifying child” or a “qualifying relative”. These are: (a) no taxpayer can claim a dependent if he or she (or their spouse if filing jointly) can be claimed as a dependent of another taxpayer; (b) a taxpayer cannot usually claim a married person who files jointly as a dependent, though there are a couple of exceptions to this rule; (c) a dependent has to be either a U.S. citizen, resident alien, national or a resident of Canada or Mexico; (d) any dependent has to qualify as the taxpayer’s “qualifying child” or “qualifying relative”. Assuming each of these initial conditions are met, then the potential dependent has to pass a series of additional requirements.

To meet the requirements of being a “qualifying child” the child has to: (a) be the taxpayer’s child, step child, foster child, sibling, half sibling, stepsibling or a the descendent of any of these; (b) the child has to be either nineteen years old and younger than the taxpayer, twenty-four years old if they are also a full time student, or can be any age if the child is permanently and completely disabled; (c) the child has to have lived with the taxpayer for at least half the year being filed for; (d) the child cannot have provided for more than half of their own support during the tax year; (e) the child is not filing a joint return on his or her on behalf (with exceptions); and (f) if the child can be claimed as a dependent by another taxpayer, the person claiming has to be the one allowed to do so.

The requirements for a “qualifying relative” are a bit different. These include: (a) the person cannot be the “qualifying child” to either the taxpayer or anyone else; (b) either the person has to be related to the taxpayer as defined by the IRS or the person has to live as a regular full-time member of the taxpayer’s household in a legal living arrangement; (c) the person’s gross annual income cannot exceed $3,650, though there are exceptions for people receiving disability payments; and (d) the taxpayer has to cover at least half of the person’s annual living expenses throughout the tax year in question, though again there are some exceptions depending on circumstances.

The exact rules and guidelines are more complex and explained in detail in IRS Publication 501. As long as your child meets all of the appropriate conditions outlined above, the child can be claimed as a dependent. Noting that many of these terms and conditions may change over the course of a year, the dependent should be retested each tax year in order to guarantee that they still qualify as either a “qualifying child” or “qualifying relative”.

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).

As most small business owners already know, tax planning plays a big role in maximizing profit and minimizing expenses, and tax deductions are a big part of this. The American tax system is designed for more than merely collecting revenue, but is specifically designed to encourage behavior that the government feels is beneficial to society and the state. Among the behaviors that are encouraged is small business, which means the tax code provides a myriad of tax benefits that are part of the larger goal of using the tax code to actively encourage small business activity. A wide range of business expenses are deductible from the amount owed in taxes each year if the business owner chooses to go to the trouble of itemizing them all.

Most small business expenses that are deductible fall within one of two categories: regular business expenses and capital expenses. Business expenses are those that are paid on a regular basis and are necessary for the successful operation of the business. These may include rent and utilities payments for a store front, travel expenses, and the cost of managing a payroll. Capital expenses are those related to buying specific assets meant to improve your business or enhance your service, like new equipment or vehicles. Generally speaking, capital expenses are not deductible as business expenses, but there may be other methods by which these amounts can be recovered in the tax code through amortization, depreciation or depletion. Knowing the difference between these two classifications of business expense can help small business owners avoid trouble with the Internal Revenue Service (IRS) due to claiming expenses as deductions incorrectly.

With most business structures – corporations, companies, partnerships – a separate tax return has to be filed and most of your business deductions are deducted from the business, not the owner’s personal taxes. There are some exceptions to this, such as pay outs from partnerships or limited Liability companies (LLCs) that have “flow through” taxation or for sole proprietorships. However, as a general rule business deductions are claimed against the business’s tax liability, not that of the individual running the business. There are also many times when personal and business expenses become confused, but the IRS has very strict guidelines regard what can – and can not – be deducted as a business expense.

Confusing personal and business expenses is a major problem and the IRS is now actively going after people that claim many of their personal expenses as business deductions. This has been a real problem due to the advertising efforts of online “tax planners” that make the factually incorrect claim that if a small business is based at home, the small business owner can claim most of their household expenses as business deductions. Although there are some home office expenses that can be claimed as deductions, the guidelines are very strict and spelled out in detail in IRS Publication 587. Further, people claiming home office deductions come under closer scrutiny and have to file a special form – Form 8829 – in order to ensure that the claims receive special attention from IRS processors and enforcement agents.

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.

Generally speaking, the Internal Revenue Service (IRS) does allow tax payers to deduct the costs associated with their tax preparation as a miscellaneous deduction on Schedule A (Itemized Deductions) of the form 1040. However, as is the case with most things related to tax deductions, this deduction does have specific limitations and restrictions. Further, there are new changes that have been introduced for the 2009 tax year that may deny you this deduction.

Deductions related to your tax preparation may include any money paid for reasonable and ordinary expenses related to preparing your taxes. These may include, but are not limited to: the cost of tax preparation software; fees paid to a professional tax preparer, planner, or attorney; electronic filing of your return; publications and reports purchased to aid in calculating your taxes; and expenses related to traveling to your tax professional’s office. Basically, any expense paid for the “determination, collection or refund” of federal, state, or local taxes can be deducted as a miscellaneous expense.

As is the case with all itemized deductions, in order to claim your tax preparation expenses you have to file the standard Form 1040 along with Schedule A. Further, you have to be able to substantiate your deductions; which means keeping your receipts and other evidence of the expenses you are claiming a deduction for. Further, in 2009 there is a new change which restricts the number of miscellaneous deductions that can be claimed by people that have an adjusted gross income (AGI) of $166,800 or more (or $83,400 if married filing separately). To see if your miscellaneous deductions are restricted under this new policy, the IRS provides a worksheet in the Schedule A instructions – related to Line 29 – which can be filled out to see if you can claim miscellaneous deductions in 2009.

Further complicating the picture is the fact that most miscellaneous deductions – including tax preparation expenses – are subject to an exclusion that is equal to two percent of the taxpayer’s AGI. That is, if the deduction does not equal or exceed two percent of the taxpayers AGI, it cannot be claimed and only the amount that does exceed two percent can be deducted. For example, if you have an AGI of $50,000, you could only claim tax preparation expenses that exceed two percent of the AGI, or those that exceed $1,000. Although this two percent exclusion does not apply to all miscellaneous expenses, it does apply to tax preparation expenses. One final complication is that only the expenses related to your personal tax preparation can be claimed on Schedule A; tax preparation fees related to other entities (businesses, rental properties, or farms for example) have to be reported on their appropriate schedules with the 1040.

Therefore, while it is true that expenses related to tax preparation can be deducted from your annual tax return, this does not mean that all such expenses can be deducted and it does not mean that all people can claim these deductions. Due to the two percent AGI exclusion, this deduction is frequently limited to wealthy people with complex tax situations.