Seeking Clarity at Tax Season: Tackling Common Confusions

With looming deadlines, multiple checklists and a variety of forms, it is understandable why individuals may feel overwhelmed. These are the hallmarks of tax season for many taxpayers.
As taxpayers move through the filing process it is easy to get confused, and there are many chances to make mistakes.

Answering some common questions may be helpful to ease some of the stress.

Here are some areas of confusion taxpayers have frequently cited.

1. Managing withdrawals from IRAs and retirement accounts

These rules can be very complicated, whether a taxpayer is making a required minimum distribution (RMD) or considering tapping into an account before retirement. Recent new rules around inherited IRAs and retirement accounts can exacerbate this confusion. (See our recent article, “Heirs must act on inherited retirement accounts this year.”)

What IRS table do I use to calculate my RMD?

Most account owners will consult the IRS uniform table. However, those with a sole beneficiary spouse who is more than 10 years younger can use a different table (Joint Life and Last Survivor Expectancy Table) which will result in a slightly lower distribution. The younger the spousal beneficiary, the lower the required distribution. Note that different IRS tables and rules apply to beneficiaries of retirement accounts. Lastly, for those with a mix of traditional pre-tax assets and after-tax assets within a retirement account, additional care must be taken to make sure income is not reported on a portion of the distribution that has previously been taxed. For example, this can happen if a non-deductible IRA contribution was made years ago and hasn’t been tracked properly now that a distribution is occurring.

How can I avoid a 10% early withdrawal penalty on my IRA or retirement account?

Many account owners are aware that an early withdrawal penalty does not apply in the cases of death, disability, and attaining age 59½. However, there are many other exceptions to the penalty which can cause confusion. Over the past few years, we have seen a major proliferation of new exceptions to the early withdrawal penalty. Adding to the confusion, there are disparities between IRAs and other retirement accounts like 401(k) plans. The table below highlights the exceptions and how they apply to different types of accounts.

2. Reporting distributions from 529 college savings plans

This can be confusing merely due to the forms taxpayers receive when distributions occur. In particular, IRS form 1098-T is issued by the college or institution and reports tuition payments and other expenses. IRS form 1099-Q is issued by the custodian of the college savings plan and reports total distributions from the plan while breaking out earnings and basis (i.e. contributions). Taxpayers may be surprised when receiving these forms to find out that the amount reported on the 1099-Q form (what they withdrew to pay for college) may be much higher than what is reflected on the 1098-T (reporting of expenses from the college). A common area of confusion is that the 1098-T form does not include other common, qualified expenses (for 529 plans) such as room and board. Taxpayers need to make sure all qualified expenses are reported to avoid a non-qualified distribution where earnings are subject to taxes and a 10% penalty.

3. Deducting charitable gifts

This area is clearly one of the most confusing areas of the code for individual taxpayers. The amount of the deduction can vary depending on a variety of factors including:

The type of organization the donation is being directed to (public charity or private foundation).
The type of property being donated (ex, cash, appreciated stock, tangible property).
The taxpayer’s adjusted gross income (AGI).

For a more detailed look at charitable giving, see “Understanding charitable giving strategies.”

Here are some other points to keep in mind when reporting charitable gifts on a tax return:

Remember you can only deduct charitable contributions if you are itemizing deductions on your tax return.
For those claiming the standard deduction and over the age of 70½ a tax-free qualified charitable distribution (QCD) from an IRA may make sense (Learn about this special provision in “Donating IRA assets to a charity”).
For noncash contributions of $250 or more, the IRS requires a receipt from the organization indicating the dollar amount or description of the property donated. If the noncash contribution exceeds $500, the taxpayer must complete form 8283 (Noncash Charitable Contributions) and provide a detailed description of the property, fair market value, as well as the method for determining the value.
Larger non-cash contributions (over $5,000) require a qualified appraisal.
If you receive a benefit from the contribution (for example, a charity dinner), you can only deduct the difference between the amount donated and the fair market value of the goods or services received.

Seek professional guidance

Whether an individual prepares their own taxes or seeks professional guidance, getting organized is the top priority. Preparing in advance for a meeting with a tax professional can make the tax filing process much smoother. Organizing tax forms and making sure the correct documentation is in place is critical for success. See our recent article, “Early planning can mean smooth sailing for tax season.”

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Posted in Taxes, Wealth PlanningTagged charitable deductions, charitable giving, donating IRA assets to charity, IRA, retirement, retirement account, RMD, standard deduction, tax filing, tax season

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