Understanding Taxes, Extensions, and Penalties

Yes, today’s the day—the dreaded time that we all do not look forward to each year—the tax filing deadline.

This year, since the 15^th of the month fell on a weekend, the IRS designated April 18, 2023, as the official tax filing deadline.

In 1913, the tax code could be printed on one page. As of 2020, that number had climbed to 6,871 pages, which, needless to say, makes understanding taxes a challenge.

Most of us are not CPAs, so thankfully, we don’t have to read it. However, we all should try to keep current on annual changes, as they can make a big difference to your bottom line.

Now, I realize you may be scurrying to get your returns finished in time to beat the deadline, but many of you are probably going to file an extension, so that information may come in handy.

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For example, in 2022, here are the major changes to the code, courtesy of Charles Schwab:

1. For 2022, Income tax brackets shifted a bit:

Source: IRS

2. The standard deduction increased slightly

The 2022 standard deduction increases to $12,950 for single filers and married couples filing separately and to $19,400 for single heads of household, who are generally unmarried with one or more dependents. For married couples filing jointly, the standard deduction rises to $25,900.

3. Itemized deductions remain mostly the same

For most filers, taking the higher standard deduction is more practical and saves the hassle of keeping track of receipts. But if you have enough tax-deductible expenses, you might benefit from itemizing.

The following rules for itemized deductions haven’t changed much for 2022, but they’re still worth pointing out.

State and local taxes: The deduction for state and local income taxes, property taxes, and real estate taxes is capped at $10,000.

Mortgage interest deduction: The mortgage interest deduction is limited to $750,000 of indebtedness. But people who had $1,000,000 of home mortgage debt before December 16, 2017 will still be able to deduct the interest on that loan.

Medical expenses: Only medical expenses that exceed 7.5% of adjusted gross income (AGI) can be deducted in 2022.

Charitable donations: The deductions for charitable donations are not as generous as they were in 2021. In 2022, the annual income tax deduction limits for gifts to public charities are 30% of AGI for contributions of non-cash assets—if held for more than one year—and 60% of AGI for contributions of cash.

Miscellaneous deductions: No miscellaneous itemized deductions are allowed.

4. IRA contribution limits remain the same and 401(k) limits are slightly higher.

The traditional IRA and Roth contribution limits in 2022 remain the same as the prior year. Individuals can contribute up to $6,000 to an IRA, and those age 50 and older also qualify to make an additional $1,000 catch-up contribution. If you’re able to max out your IRA, consider doing so—you may qualify to deduct some or all of your contribution.

However, the 2022 contribution limits for 401(k) accounts have increased to $20,500. If you’re age 50 or older, you qualify to make an additional $6,500 catch-up contribution for this tax year as well.

5. You can save a bit more in your health savings account (HSA).

For 2022, the maximum you can contribute to an HSA is $3,650 for an individual (up $50 from 2021) and $7,300 for a family (up $100). People age 55 and older can contribute an extra $1,000 catch-up contribution.

To be eligible for an HSA, you must be enrolled in a high-deductible health plan (which usually has lower premiums as well). Learn more about the benefits of an HSA.

6. The Child Tax Credit is lower after a one-year bump.

Tax credits, which reduce the tax you owe dollar for dollar, are normally better than deductions, which reduce how much of your income is subject to tax.

In 2021, the American Rescue Plan Act (ARPA) temporarily enlarged the Child Tax Credit. But in 2022, the credit returns to $2,000 per child age sixteen or younger. The credit is also subject to a phase-out starting at $400,000 for joint filers and $200,000 for single filers. For other qualified dependents, you can claim a $500 credit.

7. The alternative minimum tax (AMT) exemption is higher.

Until the AMT exemption enacted by the Tax Cuts and Jobs Act expires in 2025, the AMT will continue to affect mostly households with incomes over $500,000. For 2022, the AMT exemptions are $75,900 for single filers and $118,100 for married taxpayers filing jointly. The phase-out thresholds are $1,079,800 for married taxpayers filing a joint return and $539,900 for all other taxpayers. (Once your income for the AMT hits the phase-out threshold, your AMT exemption begins to phase out at 25 cents for every dollar over the threshold.)

8. The estate tax exemption is even higher.

The estate and gift tax exemption, which is indexed to inflation, rises to $12.06 million for 2022. But the now-higher exemption is set to expire at the end of 2025, meaning it could be essentially cut in half at that time if Congress doesn’t act.

The annual gift exclusion, which allows you to give money to your loved ones each year without incurring any tax liability or using up any of your lifetime estate and gift tax exemption, increases to $16,000 per recipient (up $1,000 from 2021).

Taxpayers who don’t meet their tax obligations may owe a penalty.

Why File an Extension?

If you just can’t get your taxes filed on time, the IRS allows you to file an extension, via e-file form 4868.

This form must be filed by the tax deadline of April 18, 2023. However, even if you file for an extension, you must pay the taxes you believe that you will owe.

The IRS offers several options for payment:

IRS site (either before or after you have e-Filed the free tax extension). Note that there are payment plans available.

Direct State Tax Payment; File State Extension: Click on this link for a list of online state tax payment options and resources.

eFile Tax Tip: e-File something (return or extension) even if you can’t pay anything by April 18, 2023! After that date, the deadline is October 16, 2023, to file a return.

Tax Penalties

The IRS has lots of penalties, and you will be subject to them if you don’t:

· File your tax return on time

· Pay any tax you owe on time and in the right way

· Prepare an accurate return

· Provide accurate and timely filed information returns

· They may charge interest on a penalty if you don’t pay it in full. The IRS charges some penalties every month until you pay the full amount you owe.

Types of Penalties

For the following penalties, you will most likely receive a notice or letter:

1. Information Return applies to taxpayers who don’t file or furnish their required information return or payee statement correctly by the due date.

2. Failure to File applies when you don’t file your tax return by the due date.

3. Failure to Pay applies when you don’t pay the tax you owe by the due date.

4. Accuracy-Related applies when you don’t claim all your income or when you claim deductions or credits for which you don’t qualify.

5. Erroneous Claim for Refund or Credit Penalty applies when you submit a claim for refund or credit of income tax for an excessive amount and reasonable cause does not apply.

6. Failure to Deposit applies when you don’t pay employment taxes accurately or on time.

7. Tax Preparer Penalties apply to tax return preparers who engage in misconduct.

8. Dishonored Checks or Other Form of Payment applies when your bank doesn’t honor your check or other form of payment.

9. Underpayment of Estimated Tax by Corporations applies when you don’t pay estimated tax accurately or on time for a corporation.

10. Underpayment of Estimated Tax by Individuals applies when you don’t pay estimated tax accurately or on time as an individual.

11. International Information Reporting applies to certain taxpayers who fail to timely and correctly report foreign-sourced financial activity.

And be aware that—in addition to the penalty—the IRS will also charge you interest on the penalty.

And in case you are a little late paying past tax returns, in August of 2022, the IRS filed Notice 2022-36, which provides penalty relief to most people and businesses who file certain 2019 or 2020 returns late.

The penalties for which relief may be provided are:

· Information Return

· Failure to File

· Failure to Pay

· Accuracy-Related

· Failure to Deposit

· Dishonored Check

· Underpayment of Estimated Tax by Corporations

· Underpayment of Estimated Tax by Individuals

· Other penalties as applicable

Please seek the help of a professional tax advisor to determine if you are eligible for any of this tax relief.

Know, however, that the IRS doesn’t usually make such grandiose gestures; the pandemic was a big exception to the agency’s normal tax penalty behavior.

Having said that, there are a few methods to remove or reduce a penalty, providing “you acted in good faith and can show reasonable cause for why you weren’t able to meet your tax obligations.” Again, please seek the advice of a professional.

But if the IRS finds that the penalty is warranted, the price can be steep:

Late filing: 0.5% of the tax owed after the due date, for each month or part of a month the tax remains unpaid, up to 25%.

Negligence or disregard of the rules or regulations, the Accuracy-Related Penalty is 20% of the portion of the underpayment of tax that happened because of negligence or disregard.

Civil fraud penalty: If there is any underpayment of tax on your return due to fraud, a penalty of 75% of the underpayment due to fraud will be added to your tax.

In addition to the above—and other penalties—the IRS can garnish wages, take money in your bank or other financial accounts, and seize and sell your vehicle(s), real estate and other personal property.

Bottom line: you don’t want to tangle with the IRS.

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