Ernst & Young Tax Partner Greg Rosica tells The Street TV's Gregg Greenberg the most common tax filing errors by investors. In other words, here is what NOT to do! (Click For The Video)

10 tax breaks for investors / You don't have to be a big-time venture capitalist to take advantage of favorable tax treatment for investments ranging from real estate to stocks.

Kathy Kristof of Kiplinger’s Personal Finance  & MSN Money writes:The U.S. tax code holds many breaks for investors. You're probably familiar with some of them, such as tax-free income on municipal bonds. Others are more obscure.

Yet, during tax season, it's helpful to review all the breaks you can take -- even if you missed them in 2012. They may help trim your tax bill in the future.

Some of the tastiest tax treats were originally designed for a rarefied clientele: venture capitalists and multimillionaire "angel" investors, who make a living finding and financing small companies. But new rules allowing corporate "crowd funding" arrangements may make these tax rules far more pertinent to average investors who might become tempted to help finance a friend's or neighbor's new enterprise.

Here's a guide to 10 sweet tax treats for investors -- some ordinary, some extraordinary.

Preferential rates

Marginal income tax rates rose to a maximum of 39.6% in 2013, from 35% last year. But profits on the sale of stocks and bonds held for more than a year are taxed at preferential rates that cap at 23.8% for those in the highest income brackets and drop to 15% for middle-income filers and to zero for those in the 10% and 15% marginal tax brackets.

Most dividend income is also taxed at these lower rates. But beware selling investments if you've owned them for less than a year. Short-term gains get hit with higher ordinary income tax rates. And some types of dividend income, such as the income thrown off by real estate investment trusts, is taxed at those higher rates, too.

Capital-gains exclusion

If you buy stock in a "qualified small business" and hold that stock for at least five years before selling, you don't have to pay tax on the gain at all. The profit is excluded from your income. What's a qualified small business? The definition is long, but the main qualification is that it must have less than $50 million in assets both before and after issuing stock. Additionally, you must have purchased the stock at original issue or received it as payment for services provided to the company.

Incidentally, this tax break officially expired at the end of 2011, but Congress reinstated it recently in the legislation to avoid the "fiscal cliff." Now the break covers stock purchased in 2012 or 2013. As long as you buy before the expiration, you qualify for the exclusion if you hold on for at least five years, says Mark Luscombe, principal tax analyst with CCH, a Riverwoods, Ill., publisher of tax information.

Capital-gains rollover

Don't want to hold that qualified small-business stock for five years, but you're interested in buying shares in another qualified small business? There's another tax provision designed just for you. Assuming that you held the first stock for at least six months, you can defer the tax on your gain by rolling the proceeds from the sale into the purchase of another qualified small business.

Philip J. Holthouse, a partner in the Los Angeles tax firm of Holthouse, Carlin & Van Trigt, says this law was specifically designed to help angel investors, those affluent investors who provide capital to start-ups, sometimes making a fortune and other times losing a fortune. The law allows angel investors to keep more of their profits for reinvestment and to net their gains and losses over a longer stretch.

Valuable losses

If you invest in a really small company -- one with less than $1 million in assets -- and lose your shirt, you may be able to write off the loss as an ordinary loss rather than a capital loss, says Holthouse. Based on "1244" rules, up to $50,000 in losses on a qualified small domestic corporation can be used to reduce your ordinary income, which otherwise would be taxed at a maximum rate as high as 39.6%.

Tax-free income

If you invest in municipal bonds issued by an entity in your state, the income earned on those bonds is likely to be "double tax-free" -- exempt from both federal and state income taxes. If you buy out-of-state muni bonds, the interest is usually free from federal tax.

However, there are a few caveats. The most noteworthy is that tax-free muni-bond income is added into the calculations that determine how much of your Social Security benefits are taxable. For middle-income seniors, that can push thousands of otherwise untaxed income into the taxable column, making municipal income a little less tax-free than it might appear.

New-markets tax credit

The new-markets tax credit is an incentive to invest in so-called "community development" corporations. These are for-profit companies that do a wide array of community work, much of it involving helping low-income individuals save for major goals or items, such as paying for college, starting a business or funding retirement.

While these entities are designed to be profitable, the profits are not likely to rival less-philanthropic enterprises, so the U.S. Department of the Treasury spikes the return by providing tax credits. Each year, investors in qualifyingcommunity-developmen​t companies get tax credits amounting to 5% to 6% of their investment. Over the course of seven years, that returns about 39% of investors' capital in the form of dollar-for-dollar reductions in the amount of tax they owe.

Low-income housing credits

The government provides generous tax credits to those who invest in low-income housing. The credits vary based on the type of housing and whether it was built new or rehabilitated, but the projects are often designed to give investors tax breaks that exceed their total investment in the real estate, says Holthouse. Typically, the developer of a project will secure the tax credits and sell interests in the deal to investors through limited partnerships.

Passive-activity losses

If you invest in rental real estate, you may be able to write off as much as $25,000 per year if the depreciation and other costs of owning and renting the property exceed the income earned from it. The $25,000 write-off begins to phase out for those earning more than $100,000 and is eliminated completely when earnings exceed $150,000.

Company stock in a 401k

If you own the stock of your employer in a 401k or in an employee stock-ownership plan, there's a special provision that allows you to transfer your employer's stock from the plan into a taxable account without paying tax on the current value of the stock. Instead, you pay tax on your "basis" -- what you paid -- for the shares. Tax on any appreciation in the stock would be deferred until you sold the shares, then the tax would be calculated at capital-gains rates, rather than ordinary income tax rates that usually apply to distributions from retirement plans.

To illustrate the tax savings, consider an employee who bought $100,000 in shares in his employer's company over a 30-year career. At the end of that career, these shares were worth $500,000. When the employee retires, he can transfer those employer shares into a brokerage account and pay tax only on the $100,000. When he eventually sells the shares, he'll have to pay tax on the deferred $400,000 gain (assuming the stock maintains its value) but at capital- gains rates, not ordinary income tax rates.

Assuming he's in the 28% bracket, that would save him a fortune -- the difference between sharing 28% of the deferred gain with Uncle Sam and paying taxes at the 15% capital-gains rate. In this case, that would be a $52,000 benefit.

Donating appreciated stock

If this stockholder got really generous, he might not need to pay tax on that gain at all. He could donate the stock and take a write-off for its current market value. Naturally, he'd be out the stock, which means he'd give up something of real value. But it also would eliminate the need to pay capital gains on the profit -- and he'd get a write-off, too.

PLANNING FOR INCOME TAXES: EXEMPTIONS & INVESTING FOR RETIREMENT

Harlan Coben for Code451 writes: Tax Planning: Should you try to receive a larger lump sum via your tax refund or claim more exemptions and increase your take home pay year-around?

Until today, I would have strongly recommended the latter, afterall why give the government a tax free loan? However, a few days ago I was filing my fiances taxes and found that her refund was relatively small. She didn’t owe anything, but wasn’t getting a chunk of cash back that she was accustomed to receiving. From an accounting perspective, I tried to explain why this was but she truthfully hates numbers and didn’t want to hear it so I let it go. It struck me as interesting however because I couldn’t think of anything more useless than paying excess income taxes throughout the year in order to get a refund that doesn’t pay interest. However, it all depends on how the money would be used during the year and what it is used for when the lump sum refund comes.

Sad as it may be, when the average person gets an increase in income, their spending increases to use the additional income. Let’s say you normally get a refund of $5,200 each year; were you to receive that on bi-weekly paychecks instead, you would take home an additional $200 per paycheck. Wouldn’t that be wonderful? But what would you do with it? Statistics say that most of us would spend more money in our day-to-day lives and have nothing to show for the additional income. Does that really benefit your financial well-being? Probably not…

What if you got the $5,200 refund in February or March? Perhaps it allows you to take a vacation during the summer without using credit cards, take care of costly home or automotive repairs you couldn’t afford otherwise, or payoff credit card debt lingering from Christmas. So for most of us, it seems much more advantageous to allow the government an interest-free loan by taking higher tax withholding than by receiving a smaller increase on each check.

I can think of two exceptions to this conclusion:

• If you’re underwater already, meaning you’re going into debt each month because the ends do not meet, the additional income on the paycheck-to-paycheck basis would be more useful because it would mitigate the accumulation of debt.
• If you are disciplined enough to use the additional income to save on your own throughout the year, you would not only accumulate the lump sum but would also be paid interest on your savings providing even more income.

The problem is most of us are not disciplined and would allow the additional money to get wrapped up in our day-to-day spending eliminating any substantial financial benefit from your income. I have heard that some individuals will ramp up their exemptions on their W-4 in order to have fewer taxes withheld. Take caution in such an endeavor as the IRS discourages such practices and federal law mandates that you pay quarterly income taxes if the amount being withheld is insufficient.

Surprisingly, this very brief domestic discussion changed my perspective on withholding tax completely. It is more beneficial to most taxpayers to allow standard withholding and receive a large refund at year’s end.

For a more detailed look at personal exemptions, visit the Internal Revenue Service’s page onPublication 501. (Personal Income Taxes)

 INVESTING FOR RETIREMENT

Earlier this week, I discussed the practicality of determining how many exemptions to claim as it impacts tax planning. While that topic holds a great impact on your current paycheck and any annual refund you may expect in the end you receive the same amount of money over a 1 year period regardless of what decisions are made. There are a great many factors that can impact your taxable income: dependents, mortgage interest, marital status, investment income, etc. to name few. Those are all critical pieces but most individuals allow those chips to fall as the may seeking to impact their tax liability through other means. In my opinion, the most critical variable of your overall personal finances, as it relates to tax planning as well as current and future cash flow, is retirement investments. The decisions made investing for retirement hold a major impact on your tax liability today as well as when you begin taking retirement distributions later in life.

What retirement account is best for you?

The primary question is when do you want to be taxed? The answer…whenever your tax bracket is lower. Most of us expect our income to increase marginally each year for cost of living increases, promotions, investment returns, etc. If that’s the case, it is reasonable to expect your tax percentage will also increase over time. If that’s the case, you’d be better off paying your taxes now. The medium used to invest after-tax dollars for retirement is a Roth IRA (or Roth 401K if your employer offers such).

(What is a Roth IRA?)

Essentially you invest money into an IRA (or 401K) designated as a Roth; unlike traditional IRA’s or 401K’s those funds are not tax deductible increasing your current year tax liability. The wonderful result of paying more taxes now are tax-exempt distributions during retirement (or after the age of 59 ½). In addition to paying a lower tax rate now than you would later in life, consider that your investments will grow over time due to increase in value, reinvested dividends, splits, etc. So not only are you saving taxes on the contributions, but also allowing you to generate earnings on those investments over the years tax-free!

However some individuals are in the top tax brackets now and will likely have a high net worth at retirement and who’s primary source of income will have ended at retirement therefore drastically reducing your overall tax liability. These individuals are currently seeking to minimize their current liability and will be able to afford to be taxed on future distributions. For those fortunate to earn on this level, it may be more advantageous to invest within a traditional IRA or 401K.

(What is a tradiional IRA?)

In this instance, your retirement contributions are tax deductible leading to a lower tax liability in the current year. However all distributions, principle contributed as well as any earnings on your investments are taxed when received.

Because the earnings over many years of investing will typically be significant, those opting for a Roth IRA will almost always, regardless of tax rate, benefit more as a result of those earnings being distributed tax free. I recommend anyone in low or middle tax bracket opt for a Roth IRA and gain the tax advantage in the future. Those in max tax brackets now should consider the following, invest retirement funds in a traditional IRA which generates a tax deduction in the current year. Use the tax savings from that deduction to invest in a Roth IRA allowing a portion of future distributions to be tax free.

Note that Roth contributions are capped at $5,500 per year (for all individuals under the age of 50. Those over 50 may contribute $6,500 under the “catch-up” rules.

Seven Tips for Taxpayers with Foreign Income

The IRS reminds U.S. citizens and residents who lived or worked abroad in 2012 that they may need to file a federal income tax return. If you are living or working outside the United States, you generally must file and pay your tax in the same way as people living in the U.S. This includes people with dual citizenship.

Here are seven tips taxpayers with foreign income should know:

1. Report Worldwide Income. The law requires U.S. citizens and resident aliens to report any worldwide income. This includes income from foreign trusts, and foreign bank and securities accounts.

2. File Required Tax Forms. In most cases, affected taxpayers need to file Schedule B, Interest and Ordinary Dividends, with their tax returns. Some taxpayers may need to file additional forms. For example, some may need to file Form 8938, Statement of Specified Foreign Financial Assets, while others may need to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, with the Treasury Department. See Publication 4261, Do You Have a Foreign Financial Account?, for more information.

3. Consider the Automatic Extension. U.S. citizens and resident aliens living abroad on April 15, 2013, may qualify for an automatic two-month extension to file their 2012 federal income tax returns. The extension of time to file until June 17, 2013, also applies to those serving in the military outside the U.S. Taxpayers must attach a statement to their returns explaining why they qualify for the extension.

4. Review the Foreign Earned Income Exclusion. Many Americans who live and work abroad qualify for the foreign earned income exclusion. This means taxpayers who qualify will not pay taxes on up to $95,100 of their wages and other foreign earned income they received in 2012. See Forms 2555, Foreign Earned Income, or 2555-EZ, Foreign Earned Income Exclusion, for more information.

5. Don’t Overlook Credits and Deductions. Taxpayers may be able to take either a credit or a deduction for income taxes paid to a foreign country. This benefit reduces the taxes these taxpayers pay in situations where both the U.S. and another country tax the same income.

6. Use IRS Free File.  Taxpayers who live abroad can prepare and e-file their federal tax return for free by using IRS Free File. People who make $57,000 or less can use Free File’s brand-name software. People who earn more can use Free File Fillable Forms, an electronic version of IRS paper forms. Free File is available exclusively through the IRS.gov website.

7. Get Tax Help Outside the U.S. Taxpayers living abroad can get IRS help in four U.S. embassies and consulates. IRS staff at these offices can help with tax filing issues and answer questions about IRS notices and tax bills. The offices also have tax forms and publications. To find the nearest foreign IRS office, visit the IRS.gov website. At the bottom of the home page click on the link labeled ‘Contact Your Local IRS Office.’ Then click on ‘International.’

Practitioners Say DOMA (Same Sex Marriage) Ruling in ‘Windsor’ Could Present Many Tax Planning Challenges

Denise Ryan for Bloomberg BNA writes:  The outcome of the same-sex marriage estate tax case United States v. Windsor in the U.S. Supreme Court will present challenges to estate and tax practitioners if Section 3 of the Defense of Marriage Act is ruled unconstitutional (United States v. Windsor, U.S., No. 12-307,oral argument scheduled 3/27/13).

Oral argument in the case is scheduled for March 27, and the court's decision could affect federal rights for same-sex couples in connection with tax and estate planning issues.

Currently, a same-sex couple may be married under the law of the state where they live but they are still legal strangers under federal law.

In June 2012, the U.S. District Court for the Southern District of New York granted summary judgment to Edith Windsor and held that the $363,053 she was required to pay as executor of the estate of her wife, Thea Spyer, was improperly assessed because of the definition of marriage in the Internal Revenue Code required under DOMA (Windsor v. United States, 833 F. Supp. 2d 394 (S.D.N.Y. 2012); 110 DTR K-1, 6/8/12).

The Second Circuit Oct. 18, 2012, held that Section 3 of DOMA was unconstitutional, because it violates the Constitution's Equal Protection Clause (Windsor v. United States, 699 F.3d 169 (2d Cir. 2012); 202 DTR K-3, 10/19/12).

In December 2012, the Supreme Court granted certiorari to the government in its challenge to the constitutionality of Section 3 (236 DTR K-3, 12/10/12).

Tax Issues for Estate Planning

The Windsor case raises estate planning issues for same-sex couples because while a same-sex couple may be married under the law of the state where they live, they are still legal strangers under federal law.

Major tax items affected in estate planning for same-sex couples include the federal estate tax exemption, gift taxes, individual retirement arrangements, and issues regarding jointly held property, Melanie Lee of Lee Law Office PLLC in Richmond, Va., told BNA March 13. The federal unlimited marital deduction that allows a spouse to leave his or her entire estate tax free to the surviving spouse applies only to opposite-sex couples because of DOMA, Lee said.

The court may change this, said Lee, but for clients in states like Virginia that do not recognize same-sex marriage, it will continue to be a concern regardless—the Windsor case will only address Section 3 of DOMA but not Section 2, allowing states to continue to discriminate against same-sex couples.

Gift Tax Limitations

Lee noted that gift tax issues arise with same-sex couples when one partner transfers property to the other or into both names. Under current law each person can claim a lifetime gift exclusion on property valued up to $5.25 million without paying gift taxes, and the lifetime gift exclusion need only be applied to gifts above the annual gift exclusion of $14,000—“this amount can be doubled for a legally married couple to $28,000,” Lee said.

“Gifts between same-sex married couples are counted as regular gifts as if they are strangers,” said Lee.

For individual retirement accounts, Lee explained that the ability of a surviving spouse to roll over the assets of the IRA and defer distribution, which allows the asset to continue to grow tax free, is an option not available to same-sex couples.

“Currently same-sex married couples do not have the estate planning tax privileges heterosexual married couples have,” Vivian L. Holley of the Law Offices of Vivian L. Holley in San Francisco told BNA March 13. “This especially impacts both the couples whose estates exceed $5.25 million on the federal level, and as little as $1 million for some states, Holley said.

Holley also said that, because of DOMA, same-sex married couples are not entitled to the privilege of the unlimited marital deduction. If a same-sex spouse inherits his or her spouse's estate in excess of these, he or she will be subject to a tax that quickly reaches the 40 percent level.

“There are also issues involved with planning for cash flow because currently under DOMA a same-sex married spouse is not entitled to receive their spouse's Social Security benefits after death of the spouse, whereas a qualifying heterosexual spouse would be entitled to receive 100 percent of their spouse's benefits,” Holley said.

“Wealthy same-sex spouses do not have the flexibility that opposite-sex spouses enjoy in providing for each other during lifetime and after death,” said Lisa Monihan of Spieth, Bell, McCurdy & Newell Co. LPA in Cleveland.

Monihan said that an important result of the gift tax limitations rule is that when same-sex spouses share a household, or even a bank account, there could be gift tax consequences, and this is particularly important if one spouse is much wealthier than the other or is a much higher earner.

“Any expenses paid by one spouse on the other's behalf, any property purchased for or subsidized by one spouse for the other, and any funds contributed to a joint bank account that are later used by the other spouse are gifts for purposes of the federal transfer tax,” she said. The transactions count toward the annual exclusion, and any such transfers in excess of $14,000 per year count against the donor spouse's exemption amount.

“Similarly, any mandatory support or property settlement upon divorce, even if authorized by state law, could carry federal gift tax consequences,” Monihan said.

Gift-Splitting Option Denied

Opposite-sex spouses may “split gifts” so that one spouse may make gifts but for tax purposes the gift is treated as coming equally from both spouses, she said.

Monihan explained that this allows opposite-sex spouses to functionally pool their $5.25 million lifetime exemption amounts and their $14,000 annual exclusion amounts, allowing them to transfer $28,000 per recipient per year, and an additional $10.5 million over their joint lifetimes.

“Similarly, in the estate tax area, ‘portability’ allows a surviving opposite-sex spouse to use any unused portion of the first spouse's $5.25 million exemption, in addition to the $5.25 million exemption the surviving spouse has in his or her own right,” Monihan said.

These pooling mechanisms are useful where one spouse is very wealthy and the other spouse is less so, and they enable the spouses to provide for a common estate plan with maximum tax benefits without requiring that the wealthier spouse first give property to the less wealthy spouse, Monihan said. The pooling mechanism is particularly useful in blended families, she said, where the common goal is for the wealthier spouse to retain his or her property and, upon his or her death, to leave some or all of it to his or her children from a prior marriage, rather than to the subsequent spouse.

Monihan pointed out that same-sex spouses cannot aggregate their transfer tax benefits in this way.

Broader Impact With Retirement Accounts

“There are also income tax benefits enjoyed by opposite-sex spouses that are important in estate planning, which are much more important to less wealthy couples than the estate and gift tax benefits,” said Monihan, adding “the most significant income tax benefit relates to a person's individual retirement accounts, 401(k) accounts, 403(b) accounts, and 457(b) accounts.”

“These accounts provide valuable income tax benefits to the original account owner, and those benefits are also available to a surviving opposite-sex spouse who inherits the retirement account from the original account owner,” she said. Any other beneficiary, including a same-sex spouse, still enjoys some income tax benefits when he or she inherits a retirement account, but the benefits are much more limited than those available to an opposite-sex spouse, Monihan said.

State/Federal Filing Status

The legal relationship of same-sex couples also affects filing yearly state and federal tax returns. While some states recognize same-sex marriage, the federal government does not, resulting in the need for a same-sex couple to prepare two sets of federal tax returns, one to be used for federal tax filing based on the assumption the couple is not married, and another set based on the assumption the couple is married.

State returns are often based on the federal return, so if a couple lived in a state that recognized their marriage they would file their state return as married but then have to create separate returns or work around the federal return, Lee said. “Interestingly enough, the federal tax return doesn't ask for or request gender but filing jointly as married would be against the law,” she said.

“For same-sex married couples in California, they file a joint tax return in California but must file two individual tax returns for reporting income to the federal government,” Joel Loquvam of the Law Offices of Joel Loquvam in Beverly Hills, Calif., told BNA March 12. Loquvam explained that because California is a community property state, a “community property worksheet” is attached to the cover of each of the federal tax returns indicating why two “unrelated” individuals are reporting community property income.

“Interestingly enough, the federal tax return doesn't ask for or request gender but filing jointly as married would be against the law.”

Melanie Lee, Lee Law Office

“This results in higher fees being paid to a [certified public accountant], and much more complication for the taxpayer,” he said.

Holley also said that there are a multitude of tax filing issues for same-sex couples, beginning with the initial filing status. She used the example of California, where same-sex couples who are married may file a joint state tax return.

“For federal purposes, they are single, or at best, one is head of household, and they must file using a different status than on their state returns,” said Holley, and then, because of the discrepancy, there has to be an acceptable explanation for the discrepancy.” Similarly, the federal government might question declaring a dependent same-sex spouse as a “dependent” entitled to an exemption since they are “unrelated,” she said.

Complications of Transfers, Income Allocations

Holley gave another example when property changes title during a marriage or separation or divorce. “With a heterosexual marriage, property exchanges between spouses are treated as a nontaxable event, so, any gain in the value of the property over the time it is held is not reported or taxed,” she said. However, with a same-sex marriage, a property exchange between spouses is considered a sale to a non-spouse, so there are taxes due from the “seller” on any gain from the increased value of the property.

Monihan also pointed out there is a benefit for opposite-sex spouses who can work with tax return preparers or income tax return preparation software to file their federal and state income tax returns at relatively low cost. Monihan contrasted that to the process of preparing income tax returns for same-sex couples who are married in the eyes of their home state, but not the federal government, which could be time-consuming and would likely require the assistance of a professional who is experienced in tax return preparation for same-sex couples.

“Among other things, it is important to allocate income and deductions appropriately between the spouses; to do otherwise may cause a taxable gift, as well as any penalties associated with improperly prepared income tax returns,” Monihan said. The issue is compounded for couples who are required to file income tax returns in multiple states, some of which may recognize the marriage and some of which may not, she explained.

Monihan said that the issues in preparing gift and estate tax returns are less complex, for two main reasons. First, among the states that have a gift or estate tax, the state returns are generally less closely tied to the federal returns, and even where the federal return is a springboard for the state return, it is generally not difficult to accommodate the difference in marital status for federal versus state purposes. Second, as a general matter, only wealthy individuals are obligated to file federal estate and gift tax returns, she said.

The vast majority of individuals fall below the filing threshold so that only a state return is required, Monihan said, and for them, there is no issue with preparing the state return reflecting their status as a married couple.

Executive Branch Says DOMA Unconstitutional

In September 2012, the government filed the petition for certiorari in Windsor and noted that the U.S. attorney general had sent a letter to Congress stating that he and the president had determined that Section 3 of DOMA was unconstitutional as applied to same-sex couples who are legally married under state law (189 DTR K-1, 10/1/12).

“Section 3 of DOMA violates the fundamental constitutional guarantee of equal protection,” the government said.

The government noted that heightened scrutiny is applicable to a small number of classifications, and “the court has yet to determine whether classifications based on sexual orientation qualify.” The government also argued that gays and lesbians have been subject to a history of discrimination, and sexual orientation bears no relation to the ability to contribute to society.

Lee said that she believes the administration's position does not affect tax and estate planning. “As an advocate for my clients there is a distinct difference between a law being enforced and being overturned, and in tax and estate planning we have to educate clients and base planning on current law,” she said.

“Because of DOMA, 1,138 federal rights—which are freely available to heterosexual married couples—are denied to same-sex married couples,” Loquvam said.

He went on to say that, while the administration has stated that DOMA will not be enforced, it is hard to gauge what would happen if the court found DOMA constitutional because of the act's sweeping effect on the lives of same-sex married couples. These rights include such things as receipt of a deceased spouse's Social Security, rights under the Family Medical Leave Act, and inheritance rights with respect to IRAs, among others.

“Of course, every practitioner must decide for him- or herself how to advise clients on this matter, and I believe that the prudent course of action is to continue practicing as we have unless and until there is a definitive change in the law, because it is not appropriate to prepare long-range plans in reliance on short-term policy decisions that may change at any time,” said Monihan. Because there is no specific guidance from the Internal Revenue Service on the subject, Monihan said that “we would have no basis on which to advise clients to ignore DOMA in creating an estate plan.”

Monihan noted that the administration's decision not to enforce DOMA is a small part of what practitioners consider, but it must remember that a future president could reverse the policy of non-enforcement if DOMA survives. “In the meantime, we try to create plans that are as flexible as possible, meeting the client's goals while minimizing the tax impact,” she said.

Estate planning is a long-term proposition, but in the end the advice to clients is not to let the tax tail wag the family planning dog, she said. “I think it is noteworthy that despite the administration's stance, the Internal Revenue Service has not yet refunded the estate tax paid by Edith Windsor after her wife's death,” Monihan said.

Implications of Court's Decision

While it is difficult to predict the possible outcome of the case, if the court finds DOMA unconstitutional, any retroactive effect of the decision could present opportunities for practitioners to advise their clients on filling amended tax returns and requests for refunds of estate taxes.

“If the court holds Section 3 unconstitutional, I would predict there will be a number of amended returns filed for clients that are legally married in other states,” said Lee, “as DOMA affects thousands of federal statutes including retirements, pensions, Social Security. I doubt the complexities would go away quickly.”

Loquvam said that, from an estate planning perspective, if DOMA is found unconstitutional, married same-sex couples should be able to file amended tax returns and, arguably, get tax refunds, and be able to utilize joint trust plans, which means less paperwork and more flexibility.

If the court overturns DOMA, there is a question of whether the decision will have a retroactive impact or only a prospective impact, Holley said, and the court may or may not give some indication about retroactivity. “I believe that in order to undo the previous tax treatment, there must be an interpretation that DOMA was illegal from the beginning so retroactive remedies would be allowed,” she said.

“Since the administration is anti-DOMA in principle, I would think they would try to allow some remedies to correct DOMA's earlier inequities,” Holley said.

“If the court strikes down Section 3 narrowly, the ruling may effectively recognize same-sex marriage for federal purposes only for residents of the states that recognize same-sex marriage,” said Monihan. She said that in contrast, the court may rule more broadly that such a distinction for federal tax purposes is itself unconstitutional—that the relationship status of an individual for federal purposes cannot constitutionally depend on where that person resides at a particular time, and same-sex marriage will therefore be recognized for all federal purposes.

Amended Returns Could Raise Issues

“If Section 3 is found unconstitutional as to any group of taxpayers, it would be void ab initio and any tax paid by those taxpayers would have been paid improperly,” Monihan said. Generally, IRS has discretion to accept or reject amended returns, but may not reject them if doing so would be arbitrary or unjust, she said, and courts have interpreted this to mean that if a return is amended in good faith and within a reasonable time after the original return is filed, the Service should accept the amended return.

Also, if Section 3 is held unconstitutional, it is very likely that the estate of a deceased same-sex spouse who has already filed a federal estate tax return and for which the statute of limitations has not run (generally, three years after the return is filed or two years after the tax was paid, whichever is later) will be permitted to file an amended return, Monihan explained.

For older returns, there is a good argument that rejecting an amended return would be unjust under the circumstances, and the same considerations apply to same-sex spouses who have made lifetime gifts to recipients including a recognized same-sex spouse in excess of their $5.25 million exemption, and have paid gift tax on those excess gifts, she said.

“It is also possible that IRS will establish a procedure for estates to claim a refund, rather than amend the previously filed estate tax returns, similar to the procedure under tax code Section 2053 for protective refunds,” Monihan noted. She said that taxpayers who have made lifetime gifts using up some portion of their lifetime $5.25 million exemption and who have (or have not) filed federal gift tax returns may be in a better position, because of the structure of the federal gift and estate tax returns, these taxpayers may be able to adjust their taxable gift history on a prospective basis only, without having to amend prior returns.

“The advisability of this approach will depend, first, on the scope of the court's ruling, and second, on any guidance issued by IRS in this area,” she said.

Loquvam noted that IRS has a very proactive group in the Western region of the country that has worked with CPAs and tax professionals in responding to the changes brought about by same-sex marriage and the filing of joint returns on the state level and related individual returns on the federal level.

Court's Marriage Ruling Could Save Same-Sex Couples Big Money (Tax Advantages)

Blake Ellis for CNN Daily Finance writes: Should the Supreme Court overturn a federal law that defines marriage as solely between a man and a woman, some married same-sex couples will save $8,000 or more in income tax, a new analysis finds.

This week, the court will hear a casechallenging the Defense of Marriage Act, a 1996 law that prevents same-sex couples from receiving more than 1,000 federal benefits that opposite-sex married couples receive.

This includes the right to file federal taxes jointly -- which, depending on income, gives some married filers a "bonus" of thousands of dollars, while penalizing others.

A same-sex couple with combined income of $100,000, in which one person earns $70,000 and the other makes $30,000, currently pays an extra $1,625 a year by filing separately rather than jointly, according to an analysis H&R Block conducted for CNNMoney. The calculations assume a standard deduction, no children and no tax credits.

The extra tax liability jumps to nearly $8,000 when one spouse earns all $100,000 and the other reports no income. In this case, couples filing jointly owe tax of $11,858, while a same-sex couple filing separately owes $19,585 -- a 65 percent difference.

Cutting Tax Liability in Half

"[There's] a myth that any time married people file jointly they are worse off than filing singly, and that's just not correct at all -- sometimes they get a marriage bonus," said Jackie Perlman, a principal analyst at H&R Block Inc. (HRB).

That's because filing jointly merges the two incomes, shifting some of the higher-earning spouse's income into a lower tax bracket. In some scenarios, couples would even cut their tax bills in half by filing jointly -- typically when incomes are low, Perlman said.

As the gap between incomes shrinks, however, the difference in tax liability is less pronounced. In H&R Block's scenario, no extra tax is owed when each spouse earns an income of $50,000 and they file jointly instead of individually.

Other couples would end up owing more by filing jointly, especially if they miss out on deductions or credits like the Earned Income Tax Credit and the Child Tax Credit because, when combined, their income is no longer low enough to qualify or receive the full benefit. 

Another major tax issue at stake in the DOMA case is the estate tax. Currently, surviving spouses in federally-recognized marriages don't have to pay taxes on their deceased spouse's estate, while same-sex widows pay a 35 percent estate tax on anything in excess of a $5 million exemption.

The case challenging DOMA was filed by New Yorker Edith Windsor, who sued to get back the $363,000 in estate taxes she paid when her partner of more than 40 years died.

Her arguments are being presented on Wednesday. Meanwhile, opposition to the law is growing -- with the Obama Administration, a coalition of big businesses and even a group of prominent Republicans all signing legal briefs in support of gay marriage.

If the court decides to overturn DOMA, it could significantly impact the financial lives of same-sex couples married at the state level. But it's up in the air whether federal benefits would be extended to domestic partnerships and civil unions. Currently, same-sex marriage is legal in nine states and Washington, D.C.

'Small Price to Pay'

In addition to not being able to file jointly and owing extra estate tax in certain cases, many same-sex couples owe tax on medical benefits received through a partner's employer-sponsored health insurance plan, are denied thousands of dollars in spousal Social Security benefits or don't qualify for survivors benefits if a spouse or partner passes away.

Mikey Rox and Earl Morrow, from New York City, would boost their refund by nearly $2,000 a year by filing jointly. And the $2,500 in tax they currently pay on the health insurance benefits Mikey receives from Earl's plan would vanish.

Some couples could even get refunded for the extra tax they paid in the past three years as well, if they file protective refund claims with the IRS and amend their returns to file jointly. Adele and Jennifer Hoppe-House, from Los Angeles, expect to get more than $13,000 back by doing this if DOMA is struck down.

Even for those who would owe more tax if they were allowed to file jointly, the extra money is often a small price to pay to see DOMA overturned.

"I'm sure more people are going to get financial wins than losses, whether it's taxes or Social Security," said Nanette Miller, head of the LGBT practice at accounting firm Marcum LLP. "But it's not just an economic issue -- it's that they want that equality."

Should you worry about being audited and is it worth it to pay extra for audit protection?

Anya Kamenetz for Tribune Media Services writes: Tax time is upon us. This year, as my husband and I finished filing online, the software program asked if we wanted to purchase the company's audit defense product for an additional $39.95. I agreed without thinking much about it, but I realized that, as the author of this column, I should probably have done a little research first.
Here's what we are promised for that extra fee: The company will defend our return from audits for seven years. That includes scheduling and representing us at meetings with the IRS in the event of an audit, along with miscellaneous advice and assistance along the way.

Is it worth it to pay extra for audit protection? The short answer is: probably not, especially if you are filing a straightforward and basic return. To evaluate your risk of being audited so you -- unlike me -- can make an informed decision, consider the following factors.

1) Audit rates are going up, but mostly for the rich.

In 2011, the most recent year for which statistics are available, IRS audits jumped 62 percent for the wealthiest taxpayers. Almost one in three taxpayers earning over $10 million, and one in five of those earning between $5 and $10 million, got a call from the IRS in 2011.

However, overall just over 1 percent of all individual returns are audited each year. If you earn less than half a million dollars in household income, your chances are well below 3 percent of getting audited in a given year.

2) Complicated returns increase your risk.

If you are self-employed, filing a schedule C, your risk of an audit is raised. This is especially true if you have a business with very high expenses that is really more like a hobby -- for example, making collectible dolls to sell at flea markets. Home offices are a notorious audit red flag -- this deduction was simplified for 2013, but when filing your 2012 taxes you still need to fill out a complicated form showing that a portion of your home square footage is dedicated 100 percent to business. Other red flags, according to tax attorneys, are large itemized deductions such as those for business travel and entertainment, charitable deductions featuring lots of noncash donations (are your old shoes really worth $150?), and claims for medical expenses. All must be well documented with receipts.

3) So do errors.

If you forget to enter any of the investment income reported on your Form 1099s, or if you have any other missing pieces, this can cause the IRS to reconsider your return. Even arithmetic mistakes might bring your tax return greater scrutiny. This is where tax preparation software can come in handy, if you are doing returns yourself, to make sure you don't make any careless mistakes.

If any of these risk factors apply to you, or if you're just risk-averse by nature, you may be tempted, as we were, to pay for audit protection. Unfortunately, some consumers complain that the audit protection services offered by tax preparers are really not worth the money.

If they can show that you made a mistake in the information you submitted to the IRS, some audit protection services may use that as an excuse not to honor your claim. Also, many consumers say that using such services, instead of just communicating directly with the IRS, cost them additional delays, confusion and often money. Just imagine haggling with an insurance company over a small claim at the same time that you are negotiating with a tax auditor. In my book, that sounds very different from "peace of mind."

If your tax situation is too complicated to handle on your own and you want additional protection, it might be better to employ an accountant, certified financial planner or tax attorney to help prepare your return. As part of their basic business agreement, many of these professionals will agree to represent you and communicate with the IRS in case of any error or inquiry.  Remember, your biggest weapon against audit is to file accurate returns and have the records and receipts organized to back them up.

IRS Releases the Dirty Dozen Tax Scams for 2013

The Internal Revenue Service today issued its annual “Dirty Dozen” list of tax scams, reminding taxpayers to use caution during tax season to protect themselves against a wide range of schemes ranging from identity theft to return preparer fraud.

The Dirty Dozen listing, compiled by the IRS each year, lists a variety of common scams taxpayers can encounter at any point during the year. But many of these schemes peak during filing season as people prepare their tax returns.

“This tax season, the IRS has stepped up its efforts to protect taxpayers from a wide range of schemes, including moving aggressively to combat identity theft and refund fraud,” said IRS Acting Commissioner Steven T. Miller. “The Dirty Dozen list shows that scams come in many forms during filing season. Don't let a scam artist steal from you or talk you into doing something you will regret later.”

Illegal scams can lead to significant penalties and interest and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice (DOJ) to shutdown scams and prosecute the criminals behind them.

The following are the Dirty Dozen tax scams for 2013:

Identity Theft

Tax fraud through the use of identity theft tops this year's Dirty Dozen list. Identity theft occurs when someone uses your personal information such as your name, Social Security number (SSN) or other identifying information, without your permission, to commit fraud or other crimes. In many cases, an identity thief uses a legitimate taxpayer's identity to fraudulently file a tax return and claim a refund.

Combating identity theft and refund fraud is a top priority for the IRS, and we are taking special steps to assist victims. For the 2013 tax season, the IRS has put in place a number of additional steps to prevent identity theft and detect refund fraud before it occurs. We have dramatically enhanced our systems, and we are committed to continuing to improve our prevention, detection and assistance efforts.

The IRS has a comprehensive and aggressive identity theft strategy employing a three-pronged effort focusing on fraud prevention, early detection and victim assistance. We are continually reviewing our processes and policies to ensure that we are doing everything possible to minimize identity theft incidents, to help those victimized by it and to investigate those who are committing the crimes.

The IRS continues to increase its efforts against refund fraud, which includes identity theft. During 2012, the IRS prevented the issuance of $20 billion of fraudulent refunds, including those related to identity theft, compared with $14 billion in 2011.

This January, the IRS also conducted a coordinated and highly successful identity theft enforcement sweep. The coast-to-coast effort against identity theft suspects led to 734 enforcement actions in January, including 298 indictments, informations, complaints and arrests. The effort comes on top of a growing identity theft effort that led to 2,400 other enforcement actions against identity thieves during fiscal year 2012. The Criminal Investigation unit has devoted more than 500,000 staff-hours to fighting this issue.

We know identity theft is a frustrating and complex process for victims. The IRS has 3,000 people working on identity theft related cases - more than double the number in late 2011. And we have trained 35,000 employees who work with taxpayers to help with identity theft situations.

The IRS has a special section on IRS.gov dedicated to identity theft issues, including YouTube videos, tips for taxpayers and an assistance guide. For victims, the information includes how to contact the IRS Identity Protection Specialized Unit. For other taxpayers, there are tips on how taxpayers can protect themselves against identity theft.

Taxpayers who believe they are at risk of identity theft due to lost or stolen personal information should contact the IRS immediately so the agency can take action to secure their tax account. Taxpayers can call the IRS Identity Protection Specialized Unit at 800-908-4490. More information can be found on the special identity protection page.

Phishing

Phishing is a scam typically carried out with the help of unsolicited email or a fake website that poses as a legitimate site to lure in potential victims and prompt them to provide valuable personal and financial information. Armed with this information, a criminal can commit identity theft or financial theft.

If you receive an unsolicited email that appears to be from either the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System (EFTPS), report it by sending it to phishing@irs.gov.

It is important to keep in mind the IRS does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels. The IRS has information that can help you protect yourself from email scams.

Return Preparer Fraud

About 60 percent of taxpayers will use tax professionals this year to prepare their tax returns. Most return preparers provide honest service to their clients. But, some unscrupulous preparers prey on unsuspecting taxpayers, and the result can be refund fraud or identity theft.

It is important to choose carefully when hiring an individual or firm to prepare your return. This year, the IRS wants to remind all taxpayers that they should use only preparers who sign the returns they prepare and enter their IRS Preparer Tax Identification Numbers (PTINs).

The IRS also has created a new web page to assist taxpayers. For tips about choosing a preparer, red flags, details on preparer qualifications and information on how and when to make a complaint, visit www.irs.gov/chooseataxpro.

Remember: Taxpayers are legally responsible for what's on their tax return even if it is prepared by someone else. Make sure the preparer you hire is up to the task.

IRS.gov has general information on reporting tax fraud. More specifically, you report abusive tax preparers to the IRS on Form 14157, Complaint: Tax Return Preparer. Download Form 14157 and fill it out or order by mail at 800-TAX FORM (800-829-3676). The form includes a return address.

Hiding Income Offshore

Over the years, numerous individuals have been identified as evading U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities, using debit cards, credit cards or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.

The IRS uses information gained from its investigations to pursue taxpayers with undeclared accounts, as well as the banks and bankers suspected of helping clients hide their assets overseas. The IRS works closely with the Department of Justice (DOJ) to prosecute tax evasion cases.

While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirements that need to be fulfilled. U.S. taxpayers who maintain such accounts and who do not comply with reporting and disclosure requirements are breaking the law and risk significant penalties and fines, as well as the possibility of criminal prosecution.

Since 2009, 38,000 individuals have come forward voluntarily to disclose their foreign financial accounts, taking advantage of special opportunities to comply with the U.S. tax system and resolve their tax obligations. And, with new foreign account reporting requirements being phased in over the next few years, hiding income offshore will become increasingly more difficult.

At the beginning of 2012, the IRS reopened the Offshore Voluntary Disclosure Program (OVDP) following continued strong interest from taxpayers and tax practitioners after the closure of the 2011 and 2009 programs. The IRS continues working on a wide range of international tax issues and follows ongoing efforts with DOJ to pursue criminal prosecution of international tax evasion. This program will be open for an indefinite period until otherwise announced.

The IRS has collected $5.5 billion so far from people who participated in offshore voluntary disclosure programs since 2009.

“Free Money” from the IRS & Tax Scams Involving Social Security

Flyers and advertisements for free money from the IRS, suggesting that the taxpayer can file a tax return with little or no documentation, have been appearing in community churches around the country. These schemes promise refunds to people who have little or no income and normally don't have a tax filing requirement - and are also often spread by word of mouth as unsuspecting and well-intentioned people tell their friends and relatives.

Scammers prey on low income individuals and the elderly and members of church congregations with bogus promises of free money. They build false hopes and charge people good money for bad advice including encouraging taxpayers to make fictitious claims for refunds or rebates based on false statements of entitlement to tax credits. For example, some promoters claim they can obtain for their victims, often senior citizens, a tax refund or nonexistent stimulus payment based on the American Opportunity Tax Credit, even if the victim was not enrolled in or paying for college. Con artists also falsely claim that refunds are available even if the victim went to school decades ago. In the end, the victims discover their claims are rejected. Meanwhile, the promoters are long gone. The IRS warns all taxpayers to remain vigilant.

There are also a number of tax scams involving Social Security. For example, scammers have been known to lure the unsuspecting with promises of non-existent Social Security refunds or rebates. In another situation, a taxpayer may really be due a credit or refund but uses inflated information to complete the return.

Beware: Intentional mistakes of this kind can result in a $5,000 penalty.

Impersonation of Charitable Organizations

Another long-standing type of abuse or fraud is scams that occur in the wake of significant natural disasters.

Following major disasters, it's common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers. Scam artists can use a variety of tactics. Some scammers operating bogus charities may contact people by telephone or email to solicit money or financial information. They may even directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds.

They may attempt to get personal financial information or Social Security numbers that can be used to steal the victims' identities or financial resources. Bogus websites may solicit funds for disaster victims. As in the case of a recent disaster, Hurricane Sandy, the IRS cautions both victims of natural disasters and people wishing to make charitable donations to avoid scam artists by following these tips:

• To help disaster victims, donate to recognized charities.
• Be wary of charities with names that are similar to familiar or nationally known organizations. Some phony charities use names or websites that sound or look like those of respected, legitimate organizations. IRS.gov has a search feature, Exempt Organizations Select Check, which allows people to find legitimate, qualified charities to which donations may be tax-deductible.
• Don't give out personal financial information, such as Social Security numbers or credit card and bank account numbers and passwords, to anyone who solicits a contribution from you. Scam artists may use this information to steal your identity and money.
• Don't give or send cash. For security and tax record purposes, contribute by check or credit card or another way that provides documentation of the gift.

Call the IRS toll-free disaster assistance telephone number (1-866-562-5227) if you are a disaster victim with specific questions about tax relief or disaster related tax issues.

False/Inflated Income and Expenses

Including income that was never earned, either as wages or as self-employment income in order to maximize refundable credits, is another popular scam. Claiming income you did not earn or expenses you did not pay in order to secure larger refundable credits such as the Earned Income Tax Credit could have serious repercussions. This could result in repaying the erroneous refunds, including interest and penalties, and in some cases, even prosecution.

Additionally, some taxpayers are filing excessive claims for the fuel tax credit. Farmers and other taxpayers who use fuel for off-highway business purposes may be eligible for the fuel tax credit. But other individuals have claimed the tax credit although they were not eligible. Fraud involving the fuel tax credit is considered a frivolous tax claim and can result in a penalty of $5,000.

False Form 1099 Refund Claims

In some cases, individuals have made refund claims based on the bogus theory that the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS. In this ongoing scam, the perpetrator files a fake information return, such as a Form 1099 Original Issue Discount (OID), to justify a false refund claim on a corresponding tax return.

Don't fall prey to people who encourage you to claim deductions or credits to which you are not entitled or willingly allow others to use your information to file false returns. If you are a party to such schemes, you could be liable for financial penalties or even face criminal prosecution.

Frivolous Arguments

Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. The IRS has a list of frivolous tax arguments that taxpayers should avoid. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.

Falsely Claiming Zero Wages

Filing a phony information return is an illegal way to lower the amount of taxes an individual owes. Typically, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS.

Sometimes, fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any temptation to participate in any variations of this scheme. Filing this type of return may result in a $5,000 penalty.

Disguised Corporate Ownership

Third parties are improperly used to request employer identification numbers and form corporations that obscure the true ownership of the business.

These entities can be used to underreport income, claim fictitious deductions, avoid filing tax returns, participate in listed transactions and facilitate money laundering, and financial crimes. The IRS is working with state authorities to identify these entities and bring the owners into compliance with the law.

Misuse of Trusts

For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are legitimate uses of trusts in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS.

IRS personnel have seen an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering a trust arrangement.