As tax-filing seasons go, the past two years have been unlike any other. Income tax filings have been delayed and this year taxpayers need to get updated information on child tax credits and stimulus. It’s created a filing panic as we approach the May 17 filing deadline for 2020 federal income taxes. So, here’s everything you need to know to file correctly and avoid tax debt.

Table of Contents:

Featured 2021 tax question: Do I have to file my taxes to get my stimulus?

The biggest change to income tax filings has to do with Economic Impact Payments (EIP)—better known as stimulus payments. If you’re owed money from the first or second round of stimulus, your 2020 tax return is the only way to get it now. And your 2020 return may also directly impact how much money get from the third round of stimulus (and when you get it).

“Filing a 2020 tax return is critical for people who may not legally be required to file. First, it is the only way to get stimulus check money they are owed from the first and second checks, explains Clare Herceg, founder of Let’s Get Set, a fintech startup that’s helping new parents claim taxes and stimulus money. “These funds are issued to them through the Recovery Rebate Credit as part of their tax refund. Filing a return is also the best way to make sure you are in the system to get your third check—the $1400 one.”

Read more about how your 2020 tax return is critical if you’re missing stimulus payments »

Featured 2021 tax question: Is cryptocurrency taxed and, if so, how?

This is becoming a hot topic during tax season as more people dive into investments in cryptocurrency. But what effect do crypto transactions have on an investor’s taxes?

Mike Habib, IRS Licensed Enrolled Agent, MyIRSTaxRelief.com covers the basics of tax filing for cryptocurrency transactions…

Mike Habib, IRS Licensed Enrolled Agent, MyIRSTaxRelief.com
Mike Habib, IRS Licensed Enrolled Agent, MyIRSTaxRelief.com

Bitcoin, and other virtual currencies, are a bit like Ed Sheeran at this moment in time, in that it is virtually everywhere. Although the thought of dealing with the IRS is probably the last thing you want to think about right now, the simple fact remains that burying your head in the sand is simply not an option when it comes to Crypto tax help.

As you know, one of the reasons why cryptos are now so highly sought after is the fact that more and more businesses, big and small, are accepting virtual currencies, Bitcoin, as a form of payment. You can now walk into coffee shops in many towns and cities, order a small coffee and perhaps a slice of cake if you’re treating yourself, and pay for it via Bitcoin. But, and this is a big but, you must report all Bitcoin transactions when doing your taxes, no matter how small they may be. This is because even the smallest crypto transactions are taxable.

IRS placed a crucial question on page one of the 2020 1040 tax return. It reads, “At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” Taxpayers should keep good records of all cryptocurrency transactions, such as the date purchased/sold and the amount purchased/sold.

Cryptocurrency is currently taxed as property. Taxpayers are required to report all transactions involving virtual currency in U.S. dollars on their tax returns, and to do so, they need to determine its fair market value as of its transaction date.

Gary Massey, MasseyandCompanyCPA.com explains how crypto transactions can lead to tax trouble…

 Gary Massey, Managing Director, Massey and Company
Gary Massey, CPA and Managing Director, Massey & Company

The IRS is actively going after taxpayers who are involved in cryptocurrency.  These taxpayers are often discovered through a “John Doe Summons,” where companies are required to provide the IRS with a list of customers who trade in cryptocurrency.

Taxpayers who are suspected of improperly reporting cryptocurrency on their tax returns will receive a letter from the IRS.  This letter requires a response by a specific date.  An extension of time to respond may be requested if needed.

The taxpayer will need to file an amended or delinquent return reporting their cryptocurrency transactions or submit a letter explaining their position.  These submissions must be signed and dated under penalty of perjury and must be truthful, accurate, and complete.  Back taxes, penalties, and interest will most probably apply.  Nevertheless, procedures are available to provide relief, including offers-in-compromise, installment agreements, and penalty abatement.

However, in extreme cases, improperly reporting cryptocurrency on a tax return may be considered criminal if the facts show that the violation was intentional and the amount at stake is significant. Due to widespread publicity in the press about cryptocurrency, taxpayers will probably not be able to argue that they were unaware of the law.   Therefore, the only recourse of a taxpayer suspected of a significant cryptocurrency violation is to hand over their information to the IRS, cooperate, and hope the case does not become criminal.

General question about taxes in the U.S.

CPA Paul Miller of Miller & Company, the best-rate tax accounting firm in NYC provided some insight on some general questions about how the U.S. tax system works.

Featured Question: What is the VAT Tax, and would it work in the U.S.?

Tax expert and CPA Paul Miller responds…

Paul Miller, CPA and Managing Member, Miller & Company
Paul Miller, CPA and Managing Member, Miller & Company

VAT stands for value-added tax, which is a consumption tax that is levied on a product repeatedly at every point of sale at which value has been added. I believe this or a different version is critical to getting the US out of debt.  The US needs to add a national sales tax on every transaction; whether it’s stock sales, house sales, or an internet sale, the US needs to take this revenue and direct it towards the debt, which is a serious issue politicians are ignoring.

Q:What is the difference between the tax brackets in the U.S.?

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A: The income tax rates start at 10% and go up to 37%.  All the brackets have income thresholds. 
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Q:How do tax rates in the U.S. compare to other countries in the world?

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A: The current US corporate tax rate is 21%, which is a very competitive tax rate in the global tax world.  Most countries are about 28%, which is where Biden wants the U.S. rate to be. Some countries have very high corporate rates, such as the Netherlands at 52%, while others offer much lower rates like Ireland at 12.5 % and with a special tax on shifting global profits of 2.2 to 4.5%. 
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Business tax questions

What businesses are exempt from paying taxes in the U.S.?

Investment Advisor Andrew Rafal from Bayntree explains…

Andrew Rafal, Investment Advisor, Bayntree
Andrew Rafal, Investment Advisor, Bayntree

There are certain organizations that are exempt from having to pay federal income taxes. To qualify the purpose of the business must not be to generate a profit. Religious organizations, fraternities, educational organizations, and some trade/labor associations are some examples of groups that receive tax-exempt status.

Most of them register with the IRS as a 501(c)(3) within the Internal Revenue Code.

Tax lawyer Benjamin Goldburd offers more detail…

U.S. tax-exempt organizations are typically those that are dedicated to a public good instead of private profit.

These are most often religious, educational, social, some political or scientific organizations that are organizations focused on a public good. They typically take in public or private donations in order to fund their operations. These operations vary from the actual production of a product, performance of a service, or even providing funding to those that need it.

Benjamin Goldburd, Tax Lawyer, Goldburd McCone
Benjamin Goldburd, Tax Lawyer, Goldburd McCone

Less well-known organizations are those that are formed for political campaigns, welfare and social clubs, labor organizations, and business leagues. Each of these has its own filing requirement to gain tax-exempt status. Religious organizations that can be classified as a church or other religious institutions are tax-exempt automatically from formation and do not require the typical 501(c)(3) documentation nor IRS reporting. Many religious organizations choose to file anyway for the purposes of transparency to their members.

It is important to note that an organization is not simply granted tax-exempt status because it requests it. Most organizations are required to file for such exemption with a detailed form from the IRS (Form 1023 typically). Such a form will outline what exactly the organization is doing that requires an exemption and who will be involved. The form is quite detailed and should be prepared by a professional in order to be sure an exemption will be granted, and that the organization is properly formed.

Another important item to note is that tax-exempt organizations have to keep to many compliance requirements in order to stay tax exempt. This includes things like:

  • the requirement of an impartial board of directors
  • making sure no one is being paid too much for their job
  • proper budgets that keep records of charitable funds
  • being sure there is no misuse of exempt funds

The IRS takes these requirements very seriously, and any realization of the misuse of exempt funds can come with hefty fines to the organization and/or the persons involved. A professional can guide you in the production of compliance documentation to manage these requirements.

Lastly, just because an organization is “tax-exempt” does not mean that they are ALWAYS tax exempt. They are exempt on the monies brought in that are directly attributable to the organization’s charitable works. However, if a charity owns its own business that is unrelated to the charity itself, they will have something called unrelated business income tax or UBIT, and need to pay taxes on that income.

Tax filing questions

Featured question: How is offshore income and income earned in foreign countries taxed?

Tax lawyer Benjamin Goldburd of Goldburd McCone Attorneys explains…

U.S citizens, or tax residents, are taxed on their worldwide foreign income regardless of where they resided. That means that if you have foreign income from anything, you are taxed at your personal rate regardless of where you earned it, or where you are living.

However, there are some tax breaks and credits like a foreign tax credit that will reduce the tax owed. If you live and work abroad, you may qualify to exclude earnings from such income to an amount adjusted annually for inflation ($107,600 for 2020).

Further, in countries where the U.S. has an executed tax treaty, the tax that you pay in such a country can offset any income tax due. In some countries the income offset can be one to one, meaning every dollar of tax paid in the foreign country is credited in the US, but in other countries, the offset can be less.

It is also important to note that each country’s tax freebies, credits, or reductions or eliminations may not match the US. Take Canada for example.  Canadians have the principal residence exemption, which means that they do not have to pay tax on the gain of sale of their main residence.  Not so for Americans. We are allowed a $250,000 tax exemption on profit ($500,000 if married filing jointly). This means that if a U.S. citizen with a Canadian residence sells their home for more than $250,000, they will not owe tax in Canada, but they might owe tax in the USA. It is a good idea to hire a professional to review your foreign tax positions to be sure you are in compliance.

Two more things to keep in mind:

  1. If you have foreign bank accounts with more than $10,000, regardless of whether there is income, you must file Foreign Bank and Financial Accounts Reports with the IRS.
  2. If you own shares of stock of a foreign company, you might be required to pay tax on the possible income from such a company whether or not the foreign company actually pays you anything. The new concept is called Global Intangible Low-Taxed Income or GILTI. If you own at least 10% of a foreign company, this might apply to you.

Q:Do I have to pay taxes on freelance work?

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A: This depends on how much money you make from your freelance work. Once you hit at least $400, you have to pay taxes on it. It’s recommended that you set aside 25-30% of your freelance income to ensure you have enough when you file your taxes.

Learn how much you owe on your side hustle or freelance income » 

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Q:How much tax do I pay on a 401k withdrawal?

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A: As long as you’re over age 59, you can start to withdraw money from your 401k without penalties. However, those withdrawals are subject to income taxes. The amount withdrawn will be added to your other income sources to determine your taxable income. The IRS requires your plan administrator to withhold 20 percent for federal withholding. However, your tax can be higher than this rate, depending on your overall income. You should estimate your total income and withholding to determine if it is necessary to make any additional estimated tax payments.
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Q:I can’t pay my taxes. Should I file anyway?

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A: If you know you won’t be able to pay your taxes, it might seem like a good idea to just not file until you can at least get back on your feet and have the money to pay. But really, this is the worst choice you can make when it comes to debt. Learn why you don’t want to try and dodge the IRS and what can happen if you do.

Learn more about what happens if you can’t pay your taxes »

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Q:If I don’t send in my payment by the 15th of April what happens? How much is added for a late fee?

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A: The major penalty that the IRS will hit you with is the failure-to-file penalty. So, as long as you file on time, you avoid the biggest penalty, even if you can’t pay by the 15th. The failure-to-pay penalty kicks in if you don’t pay an outstanding balance by the 15th. However, it is manageable at .5% per month. There is also a modest interest rate that the IRS will charge you.
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Q:What is a tax extension?

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A: There are a couple of different types of tax extensions: an extension to file and an extension to pay. Neither will get you out of the penalties that apply when you don’t pay all of your taxes on time.

Read about the form you need to file to get a tax extension »

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Q:What should I claim on my W-4 if I’m a single parent?

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A: In general, single parents claim themselves and their children as dependents. This is predicated on you have only one job, little to no other income, and claiming the standard deduction. So, for example, if you are a single mother with twins, you can safely claim three dependents on your W-4. If you have joint custody of a child, you can only claim the child as a dependent if the child lives with you more than half of the year and you cover more than half of the child’s expenses.
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Q:Which parent can claim a child on their taxes?

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A: This can be tricky because there are a few factors to consider. As long as a parent has the child’s name, date of birth and Social Security number, they have the ability to claim a child as a dependent on their tax return. However, that does not mean that the parent is entitled to claim the child for tax benefits. In general, to claim a child as a dependent, you must provide 51 percent or more of the support a child receives. The child must also live with you for 51 percent or more of the year. As long as the child lives with you for more than half of the year and you cover more than half of the expenses for the child, you can claim them on your taxes.

If both parents attempt to claim a child on their individual tax returns, the IRS will ask for proof from both parents to see which one meets the 51 percent requirement. Whichever parent can provide that proof will receive the tax benefits.

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Tax debt questions

Q:What is tax debt?

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A: You incur tax debt when you owe money to the Internal Revenue Service (IRS) after the filing date. If you filed on time but only paid part of your tax bill, the remaining balance is considered tax debt. This balance is subject to penalties and will grow with time.

Find out what the IRS does when you don’t pay »

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Q:How does the IRS find out I have tax debt?

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A: If you don’t file, then how does the IRS even determine how much you owe in back taxes and when to audit you? With today’s technology and our cultural dependence on databases, you’re going to have a hard time hiding forever. The IRS uses third-party information to find out that you have unreported income.

Find out how you know if you owe the IRS »

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Q:What do I do if my spouse hasn’t paid our taxes?

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A: If your spouse causes problems with tax debt, such as not filing, not paying on back taxes and even underreporting income, you may not find out until the IRS comes after you for the debt – even if you’re divorced. We help you understand your rights to claim Innocent Spouse Relief and tell you what you need to know to qualify.

Read about what it means for you if your spouse owes back taxes »

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Q:How fast will the IRS garnish my wages if I don’t pay my taxes?

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A: Before the IRS can garnish your wages, they must issue a series of notices prior to issuing the garnishment. That process can take months or years. In some cases, wage garnishment never happens. In general, the size of the balance will impact the likelihood of facing collection activity, such as garnishment. So, the chances of facing wage garnishment will generally increase as penalties stack up.
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Still have questions? Get a free evaluation from a certified tax professional.

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Article last modified on May 14, 2021. Published by Debt.com, LLC