The IRS annually publishes their list of the “Dirty Dozen” Tax Scams, alerting taxpayers to the most recent and widely-used scams involving taxes and the IRS.  The list for 2010 is out, and it contains some new scams, as well as some from prior years.

Unfortunately, tax preparer fraud is at the top of the list.  As an ethical, competent preparer I take great offense at those who act in a unethical manner in this regard.  Anyone who prepares your return for a fee must sign the return as a paid preparer.  Some unethical preparers will negotiate a reduced fee if they agree not to sign as a paid preparer.  If someone else prepares your return and does not sign it, and there is an error or you get audited, you are on your own as there is no evidence there was a paid preparer.  Another red flag are preparers who advertises they can you a higher refund than anyone else.  This is illegal and unethical.  Choose your preparer carefully.  It is good to obtain the services of a CPA or an Enrolled Agent.  Both of these groups are held to high ethical standards.

Another IRS hot button is hiding income offshore.  Attempting to evade U. S. income tax by hiding income in offshore banks, brokerage accounts, or through façade entities is illegal.  Frequently associated with this scam are the use of debit and credit cards, wire transfers, and other fund-transfer methods.  If an offshore investment that avoids U. S. taxes seems too good to be true, you should walk away.

Phishing is alive and well on the Internet in regard to IRS scams.  Be aware that the IRS does not communicate with taxpayers via e-mail, Facebook,  Twitter, phones, or faxes.  If you receive an e-mail supposedly from the IRS, telling you that you have a refund coming, forward the email to phishing@irs.gov.

Filing phony substitute W-2’s via Form 4852 is another common scam.  This is done to reduce taxable income to zero and obtain a larger refund.  A related scam is reporting non-taxable Social Security benefits with exaggerated withholding amounts.  Just be aware that it is illegal to file false information regarding an IRS document and the IRS is likely to detect the false filing.

Another on the IRS dirty dozen is the abuse of not-for profit organizations.  There are numerous instances of taxpayers making contributions of property to legitimate charitable organizations but listing a grossly overstated value for the contribution or reporting it as donated to multiple organizations.  Be aware that certain contributions must be backed up with a qualified appraisal.  A variation on this scam involved the donation of the asset to an organization and the organization selling it back to the donor at a much lower price.

Fuel tax scams is another item on the IRS list.  When you purchase fuel such as gasoline for non-highway use, you are entitled to a credit for the taxes paid on that fuel.  The IRS has apparently seen a significant increase in claims for this credit, often from taxpayers whose occupation would not lend itself to non-highway use of fuel.

These are only a few of the “dirty dozen.”  For a complete list, go to www.irs.gov and type in “Dirty Dozen 2010.”  If you suspect fraudulent tax activity you may report it to the IRS using Form 3949-A, Information Referral.  Whistleblowers may provide allegations of fraud to the IRS on Form 211 and may be eligible for a reward.

In short, be aware that anything that sounds too good to be true, or talks about “insider secrets” to beat the IRS are most likely to be fraudulent schemes.   If you are presented with such an opportunity, do not act on it immediately.  Think on it, investigate it, go to a respected tax advisor for an opinion.  There are legitimate ways to reduce taxes and there are the short cut methods.  The short cuts usually lead down a wrong path.

In today’s recessive economy, businesses are seeking to reduce costs.  Companies have cut back on services, reduced payroll, and approached the problem from many perspectives.  Unfortunately, some companies have sought illegal means to reduce their costs.  But this is not new, some have always attempted to cut corners to save a few dollars.

Specifically, I am referring to companies reducing their payroll tax costs by classifying W-2 employees as independent contractors, giving them a 1099-MISC at year’s end.  This move can save the employer 7.65% of payroll by not paying the employer’s portion of social security and Medicare.  In addition, the company avoids payment of state and local unemployment taxes.  This tactic can also result in savings from not providing benefits to the independent contractors.  Sounds good, but it is probably illegal and places a greater tax burden on the employees.

Misclassification of employees as independent contractors is an area of concern to the IRS and to state departments of labor.  As this behavior becomes more widespread, the IRS is increasing its efforts to detect these misclassified workers.  The first Employment Tax National Research Project in 25 years was recently announced by the IRS.  This project has two main goals:

• To secure statistically valid information for computing the Employment Tax Gap and
• To determine compliance characteristics so the IRS can focus on the most noncompliant employment tax areas.

In other words, they are attempting to find out the magnitude of the problem and find out the characteristics of those not complying with the law. This will allow the IRS to audit companies with the greatest perceived compliance risk.  The project will involve randomly selecting 2,000 taxpayers each year over the next three years, and doing a thorough employment tax audit of those taxpayers.

Presently, the IRS has a list of 32 points that it uses to help make a determination of the proper status of an employee.  Additional factors are included for service providers or sales persons.  These factors can be found on Form SS-8. This form can be completed and submitted to the IRS for a determination of the proper classification of an employee or group of employees.  Since business practices have changed significantly over the past 25 years since the IRS last visited this issue, there could be some changes in the relevant factors.

While it is not the purpose of this article to discuss these factors in detail, it can be said in summary that it boils down to control.  Form SS-8 distinguishes three categories – financial control, behavioral control, and the relationship between the worker and the firm.  Although no one factor is decisive, the IRS will look at all relevant factors to reach a decision.  It is a good exercise to review these factors and make an educated guess about how the IRS would classify your employees/independent contractors.

If an employee has been classified as such and receives a W-2, switching them to a 1099 contract employee is generally not a valid move.  If you misclassify employees as independent contractors, the savings may be short-lived as the IRS is likely to investigate and discover the misclassification.  That will result in payment of the tax in addition to penalties and interest.

Finally, employees who feel that they have been misclassified may file an SS-8 form.  If they receive a favorable determination, and the employer does not issue a W-2, they may file a Form 4852 as a substitute W-2.

It seems that more and more people are working in one state and living in another.   Or, they may be working in multiple states during the year.  This creates problems when filing state income tax returns at year-end.  While each state has laws that differ in regard to taxation of income earned by non-residents, there are a few principles that tend to be common among the states.

First, you are subject to tax on all your income in your state of residence, regardless of where it was earned.  Basically this means that whatever income is reported on your Federal 1040 will be reported on your return for your state of residence unless it is exempt income.  You would file as a full-year resident.  You will also be subject to income tax in the state in which the income was earned.  You will need to file as a non-resident, reporting only the income earned in that state.

Fear not, however. You will not normally pay tax on the same income to both states.  As a rule, your state of residence will grant you a credit for state taxes paid to the other state.  However, this is not necessarily a dollar-for-dollar credit.  You home state will tax the income at its regular rate.  The credit will only be granted for the amount of tax that you would have paid if earned in your home state.  In other words if the tax rate in the non-resident state is higher, you will not get a full credit in your state of residency.

There are some exceptions to this rule.  Some states have reciprocal agreements that specify if you work in one state and live in another you do not pay tax in the state where you work.  For example, workers in Washington, D. C. who are not residents are exempt from the D. C. income tax and pay the tax in their state of residence.   Other states may not grant a credit for state taxes paid to certain other states.

A second multi-state situation occurs when you move your residence from one state to another during the year.  In these cases, you generally file as a part-year resident in each state, reporting the income earned in each state on that state’s respective return.  Your deductions, exemptions, and credits are normally allocated based on the length of time you were a resident of that state.

In some cases, special laws are applicable to those moving out of the state.  For example, Federal law allows you to exclude up to $250,000 ($500,000) of gain on the sale of your principal residence if you qualify.  Most states also have this exclusion, but if you move out of the state, the gain may be taxable income.

Some states have separate forms for part-year or non-residents.  Others just have separate schedule as a part of their regular individual return.   Since the laws vary so significantly from state-to-state check with a local tax preparer or the state revenue department to determine your filing obligations.  Finally, I would add that, in our present economic situation, states are looking for every dollar of revenue they can get, so they are likely to be aggressive about making certain they collect the amount of tax they feel is owed to them.

The IRS recently announced new requirements for paid tax return preparers.  As it currently stands anyone can hang out his or her shingle, proclaiming themselves to be tax return preparers.  Although these actions are commendable, there is doubt about their effectiveness at combating the problem of incompetent and unethical tax return preparers.

The IRS plans to implement several steps designed to improve tax return preparation.  The first step is to require all paid tax return preparers to register with the IRS and obtain a preparer tax identification number.

Secondly, the IRS is going to require competency tests for all paid preparers except attorneys, certified public accountants, and enrolled agents who are active and in good standing with their respective licensing agencies.   Related to this requirement is a series of competency tests for all paid tax preparers except those in the previously mentioned groups.  I have a problem with the exclusion of attorneys and CPA’s.  Enrolled agents already have a continuing education requirement in tax, so that exclusion seems valid.  However, as an attorney or CPA, there are no requirements for competency in the tax area to maintain a license.  There are many practicing attorneys and CPA’s who know little or nothing about the tax law – their practice is in other areas.  It appears that there will be a series of examinations to “certify” preparers for different types of returns, although this is not certain at this point.

Treasury Department Circular 230 is the document that prescribes ethical standards for tax return preparers.  It currently applies only to attorneys, CPAs, and enrolled agents who practice before the IRS.  Practicing before the IRS generally gives the preparer the right to represent clients in an IRS hearing.    Under the new proposals, Circular 230 will apply to all paid preparers.

Again, I see a problem with this.  Suppose an unethical preparer tells his client that he will take a reduced fee and not sign the return.  Since most taxpayers are unable to deduct the fee for tax return preparation, some will be inclined to accept such an offer.  There are an estimated 700,000 paid preparers who do not sign the return as paid preparers.  These provisions, while bringing them under the ethical rules of Circular 230 will do nothing to compel them to sign the return.  The existing penalty is $50 for each violation.  Is bringing them under the rules of Circular 230 going to make them sign the return?  I have my doubts.

A problem I see with registration and education requirements is that those who operate “in the shadows” will stay there.  What about these proposals will compel them to become registered, obtain continuing education, and abide by the rules of Circular 230?

These steps will be implemented over a period of time.

In a series of related efforts, the IRS is going take immediate action to step up oversight of preparers.  This includes sending letters to 10,000 preparers who prepare large number of returns, urging them to be “vigilant” in areas where errors are frequently found.  Additionally, a number of preparers will receive visits from IRS agents to “discuss their obligations and responsibilities to prepare accurate tax returns.”  An additional initiative involved wider use of investigative tools including visits to preparers by IRS agents posing as taxpayers.   I see these efforts as intrusive to ethical, competent preparers while not reaching the vast number of unethical preparers who don’t sign the returns.

It is estimated that 70-80 percent of taxpayers hire someone to prepare their income tax return.  This is a choice that should be made carefully, and not just based on the company having someone standing on the street corner with a sign and an Uncle Sam outfit, urging you to use their services.  Some tips to selecting an honest, professional preparer include:

Be wary of those who claim they can obtain larger refunds than others.  That’s unethical to begin with and indicates they may take unethical liberties to obtain a large refund.  It is acceptable to state that “no one can obtain a larger refund for you.”

• Avoid preparers who base their fees on a percentage of the refund.  More unethical conduct.
• Use a reputable preparer who signs the return and gives you a copy.  Both are required.
• Consider whether the individual or firm will be around in November to answer questions about the return.
• Check credentials.  Only attorneys, CPA’s and enrolled agents can represent taxpayers before the IRS in all matters.  Other may only represent taxpayers for audits of returns they actually prepared.  And if they didn’t sign it, you’re on your own.
• Find out if the preparer is affiliated with professional organizations that provide continuing education and other support in tax matters.  Does the organization have a code of ethics?

The amount of income taxes you pay annually is usually one of the largest, if not the largest, financial transactions you will have in a given year.  Make sure that the person you entrust with this task is someone in whom you can place your confidence.

The devastation from the earthquake in Haiti has been felt by all of us.  The outpouring of aid to that impoverished island nation has been unprecedented.  But the needs have also been great.  Politics has been put aside, those of the liberal and the conservative persuasion have rallied to assist in the tragedy that has impacted Haiti.

In a rare move, Congress has passed legislation to encourage contributions for the relief efforts in Haiti.  Charitable contributions made for the relief of earthquake victims in Haiti may be deducted on your 2009 income tax return, rather than waiting to take the deduction on your 2010 return.  Normally, a deduction is allowed only in the year in which the expenditure is made.  Based on the language in the legislation, it is not mandatory to deduct it in 2009.  If you choose to wait until 2010 to take the deduction, that is acceptable.

Four conditions must be met in order to deduct the contribution in 2009:

• The contribution must be made after January 11, 2010 and before March 1, 2010.
• The contribution must be a cash contribution.  This simply means that the contribution cannot be in goods such as food or clothing.
• The contribution must be for the relief of victims in areas affected by the Haitian earthquake on January 12, 2010.
• All other usual requirements for deducting charitable contributions are met.  Primarily, this means that the contribution must be made to a qualified charitable organization.  If you are in doubt you can check the IRS list.  This list of qualified charitable organizations is published in IRS Publication 78, or it may be viewed at http://www.irs.gov/charities/article/0,,id=96136,00.html.

Since a number of contributions are being made via dialing a cell phone number, the IRS will accept a telephone bill showing the name of the organization, along with the date and amount of the contribution as meeting the recordkeeping requirement.

I would encourage you to donate, but do so wisely.  Be certain that the organization to which you donate will use those contributions for timely relief to Haiti.  On a personal note, I would encourage donations to His Nets, Inc. (www.hisnets.org).  His Nets distributes insecticide-treated mosquito nets to help prevent deaths from malaria.  His Nets has people in Haiti, and anticipates getting nets to the people in a matter of days.  People are having to sleep outside, and in doing so, are at risk of contracting malaria.  A net can help prevent these deaths.  One net costs $6.00.  I am treasurer of this organization, and I can assure you that every dollar you give His Nets for Haitian relief will go toward the purchase of nets.

Sounds like a good deal.  You paint my house, I prepare your tax return.  Or an employer gives an all-expense paid vacation to employees meeting certain performance goals. Everyone benefits and no one pays taxes on the transaction.  Not so fast.  These transactions are known as “barter” and are subject to income tax laws, the same as if you had received cash.    Bartering is the exchange of one product or service for another and the fair market value of the goods or services received is taxable income.

In a direct barter exchange you deal with the other party face to face.  Generally speaking, no tax-related paperwork is required but this needs to be recorded in your accounting records and reported on your tax return.  It’s just like a sale for cash.  Whether you are a cash-basis or an accrual-basis taxpayer, the IRS treats bartering as income received.

For example, suppose you are a plumber.  Your neighbor is an income tax preparer.  He prepares your income tax return and you fix his kitchen sink.  The value of the services rendered to your neighbor is $250.  You report $250 income from the barter transaction.  The cost to you for tax preparation  is $250.

It is not uncommon to participate in a barter exchange.  This simplifies bartering as you don’t have to find someone who has what you want and needs what you have.  With a barter exchange, you receive credits for goods or services you perform, which may be exchanged for goods or services you need.  Use of a barter exchange does not change the nature of the transaction.  It remains taxable income.  However, use of a barter exchange carries an additional twist to the process.  The barter exchange is required to issue you a Form 1099-B.

You may be saying, “Wait a minute.  Isn’t a 1099-B the form I get if I sell stocks or other securities.  Yes, that’s correct.  The actual name of that form is “Proceeds from Broker and Barter Exchange Transactions.”  The barter part is often overlooked.

Obviously, you should maintain records of any bartering transactions you enter into.  The IRS suggests that you label all barter income and expense documents as “bartering” and retain all original source documents such as invoices or Forms 1099-B.

Bartering as compensation is another issue in this regard.  A business may pay bartered goods as a bonus or part of the compensation package to employees.  Referring to the all-expense paid trip mentioned at the beginning of this article, if that trip was obtained by the employer in exchange for advertising (to use an example) the company should report that barter exchange in its records.  But it also must report the bartered items as compensation on the employee’s W-2.  It is also subject to employment taxes.  The same reporting holds true if the company “gives” the bartered item to an independent contractor.  It must be reported on a 1099-MISC issued to that contractor.

It has been said many times that “there is no such thing as a free lunch.”  Once again, that proves to be true as that bartered lunch could be taxable income.

2009 was a year that saw a number of changes in our tax laws.  Some of these changes are permanent, others are in effect only for a limited period of time.  I will discuss here some of the more important ones, but this is by no means an exhaustive list.

If you bought a new vehicle between February 18, 2009 and December 31, 2009, you can deduct the sales tax paid even if you don’t itemize your deductions.  It must be a new vehicle, and the tax deduction is limited to taxes on the first $49,500 of cost of the vehicle.  Passenger automobiles and light trucks qualify if under 8,500 pounds gross vehicle weight; motor homes have no weight limit; and motorcycles that do not weigh more than 8,500 pounds all qualify.  You may also deduct $500 ($1,000 married filing jointly) of property taxes on your residence if you do not itemize.  A new form Schedule L is available for those taking the standard deduction, but with adjustments such as these two items.

The first-time homebuyer credit has been extended and expanded.  A first-time homebuyer is eligible for a credit of up to $8,000 on homes under contract before May 1, 2010 and closed by June 30, 2010.   Income limits are $225,000 for taxpayers filing jointly; for others, it is $125,000.  Due to widespread fraud, a copy of the closing statement must be attached to the return.

If you have a traditional IRA, 2010 might be a good year to convert it to a Roth IRA.  Qualified withdrawals from a Roth are tax free.  However, taxpayers whose income exceeded $100,000 have been prohibited from converting to a Roth IRA.  Beginning in 2010, that limit is permanently removed.  When a traditional IRA is converted to a Roth, you must pay taxes on the amount converted.  However, for 2010 conversions, the tax may be paid in 2011 and 2012.

If you end up owing taxes on your 2009 return, you might want to examine your withholding.  In 2009 and 2010 taxpayers are eligible for the Making Work Pay Credit, which is equal to 6.2% of your earned income, limited to $400.  However, withholding tables were adjusted to reflect this credit, so if you are not eligible for the full credit, or your withholding was adjusted for a greater amount than the credit, you may end up with a smaller refund or having to pay.

The Hope Education Credit has been renamed and expanded.  It is now the American Opportunity Credit.  It is a credit of up to $2,500 for qualified education expenses paid but is not limited to students in the first two years of college.

I would remind you that you must have a receipt for a charitable contribution of any amount.  The old $250 law has been repealed.  For contributions of property you must get an acknowledgement of the donation from the charitable organization, but it is your responsibility to place a value on the contribution.  Programs such as “It’s Deductible” and “Deduction Pro” can be very helpful in determining the correct amount to deduct.  If your non-cash contributions are over $500 you must complete Form 8283.  Mileage driven for charitable organizations is deductible at 14 cents per mile, this amount is unchanged for 2010.  You can also deduct any out-of-pocket expenditures on behalf of a charitable organization, but you cannot deduct the value of your time.  I would also add that contributions made to charitable organizations that are designated for specific individuals or purposes may not be deductible.

With so many people experiencing economic difficulties it is not uncommon for someone to help out by paying the mortgage payment or property taxes for a friend or relative.  I would remind you that, in order to deduct mortgage interest or property taxes, you must be legally liable for the amount and you must make the payments.  If both criteria are not met, you cannot take a deduction.

Mileage rates for 2009 are 55 cents per mile for business, 24 cents for moving or medical miles, and 14 cents for charitable mileage.  In 2010 the business rate drops to 50 cents, the moving and mileage rate to 16.5 cents, and the charitable rate is unchanged.

A couple of other items are not changes for 2009, but are some things to consider in your tax planning.  If you are offered disability insurance through your employer and your employer pays the premium any benefits you receive will be fully taxable.  However, if you pay the premium any benefits are tax-free.

I would also remind you that the IRS does not correspond with taxpayers via e-mail, so if you get an e-mail that purports to be from the IRS, delete it immediately, as it is spam.

Finally, a few tips about paid preparers.  First, if you pay to have your return prepared, be certain the preparer signs as paid preparer.  To fail to do so is illegal, and you cannot raise the defense that your prepare did not complete your return properly if it is not signed.  Secondly, I would also advise you to have your return prepared by a CPA or Enrolled Agent.  These two categories of preparers, along with attorneys and actuaries  are the only individuals allowed to practice before the IRS.  This means that preparers in these categories may represent you in an IRS audit situation.  Otherwise, you are on you own.  Third, keep in mind that the preparer is not an auditor of your return.  If there has a question about the validity of an item you submit, your preparer should make reasonable inquiries about that item.  But ultimately, whatever goes on your return is your responsibility.

In closing, I feel somewhat like Bob Erickson.  Annually, at the IRS Nationwide Tax Forums, Bob’s assignment is to give an overview of changes in the tax law for the current year.  Once he confessed that his recurring nightmare was that some year would arrive and he would have nothing to talk about.  Then, he said, he woke up and realized that would never happen.  This is where we are now.  It does not appear that any more changes will be enacted for 2009.  But Congress has a whole year ahead to make changes that will require us to keep  busy staying abreast of what’s new.  Change will happen.

In 2009 and 2010, taxpayers may receive a tax credit for energy efficient improvements made to their principal residence.  However, you need to be very careful to make certain that all the provisions of the law are met, as this is a detailed piece of legislation with specific requirements.

Generally, you can deduct up to 30 percent of the cost of qualifying improvements up to a maximum of $1,500.  Unfortunately, the $1,500 limit is a combined limit for 2009 and 2010.  Qualifying improvements include insulation, windows, doors, fuel cells, roofing, heating and air conditioning units, water heaters, geo-thermal heat pumps, biomass stoves, solar energy systems (but not for pools), and small wind energy systems.

The improvement must be placed in service between January 1, 2009 and December 31, 2010.  The improvements generally must be for the taxpayer’s principal residence.  However, geothermal heat pumps, solar panels, solar water heaters, fuel cells, and small wind energy systems qualify if installed in a second home.  The credit for windows, doors, insulation, roofs, heating and air conditioning, or non-solar water heaters is not available for new construction.

Energy standards for the current credit are more stringent than for the 2007 credit.  The manufacturer must certify that the improvement meets the standard and must provide a written statement to that effect.  The statement may be in printable form on the manufacturer’s website.

In order to take the credit, Form 5695 should be completed and included with your 1040.  The credit is to be taken in the year the improvements were made.

There are two credits for the purchase of certain energy-efficient vehicles.  The credit for hybrid gasoline-diesel, diesel, battery-electric, alternative fuel, and fuel cell vehicles varies in amount.  The credit is based on a formula determined by the vehicle weight, technology, and fuel economy.  It is limited to the first 60,000 vehicles per manufacturer.  The credit for Toyota and Honda has been phased out at this time.

The second vehicle credit is between $2,500  and $7,500 and is for plug-in hybrid electric vehicles.  The amount of the credit depends on the capacity of the battery system.  It is effective for vehicles purchased between January 1 and December 31, 2009. It has been extended beyond that date but phases out based on the number of vehicles sold by the manufacturer.

It is obvious that the energy credits are not simple credits to take on your tax return.  Foremost, you should be certain that the property being purchased will qualify for the credit. For the residential energy credits, it must be in writing.  For vehicles, ascertain that the credit for the particular vehicle is still available.  Forms for claiming the credit vary depending on the specific credit that you are taking.

Mandatory e-filing of your 1040 in on the horizon.  The recently enacted “Worker, Homeownership, and Business Assistance Act of 2009” requires that any individual return filed by most preparers must be submitted via e-file.   This is to be effective for 2010 returns, which will be filed beginning in 2011.  If you prepare your own return, there is no current requirement that it be submitted by e-file.

Specifically the legislation states that “any individual income tax return prepared by a tax return preparer be filed on magnetic media” if two requirements are met.  Magnetic media includes e-filing and is the type of submission contemplated by this legislation.    The first requirement is that the preparer reasonably expects to file more than ten returns in a given calendar year.  With such a low threshold, this obviously includes most legitimate paid preparers.

However, it is the second requirement that is somewhat ambiguous.  It states that the return in question must be e-filed if prepared and filed by the preparer.  Taking this language at face value, a preparer can prepare a paper return for a client, give the return to the client, and the client mails the return to the IRS. The preparer has prepared the return, but it has been filed by the taxpayer.  Based on the language, one would think this really doesn’t change anything, as clients who want to file a paper return simply must file it themselves.  This does not seem to be the intent of the legislation, so I anticipate that the Treasury Department will issues regulations defining the filing of a return for purposes of this legislation.

There is no doubt that e-filing of returns going to be a larger part of your future.  According to the IRS, they can process an e-filed return for about three dollars less than it costs to process a paper return.   Taxpayers who are due refunds are more likely to e-file, as it allows them go get their refund within a couple of weeks when utilizing direct deposit (another Treasury money-saver).  But in requiring return to be e-filed, the Treasury Department is shifting its costs to the taxpayer, requiring them to bear the cost of e-filing the return.    Should e-filing of all returns be mandatory, the taxpayer would likely incur additional costs for preparation of the return if they are currently filing a self-prepared return.  If they still opt to prepare their return, they would likely incur a fee for e-filing.  Spreading the e-file requirement to all types of returns could also adversely affect small preparers who prepare only a limited number of returns for entities other than individuals.

Another adverse impact of the current legislation would likely be to drive small preparers underground.  Those preparers who do not have e-file capability could simply not sign the return as a paid preparer and allow taxpayers to file the return as if they had prepared it themselves.  This would add to the existing estimated 700,000 preparers who illegally prepare returns, but do not sign as paid preparers.  This illegal preparation industry harms taxpayers, as the taxpayer cannot argue that their preparer prepared an incorrect return if it is not signed by the preparer.  Should the taxpayer wish to sue the preparer, there are no grounds for suit, as there is no evidence linking the preparer to the return.

Despite any semantic problems with the current legislation, there is little doubt that e-filing for the future will be on the rise.  The IRS can process a return at less cost, the incidence of errors is decreased, and processing time for the returns is less.  On the other side of the coin, however, e-filing can create a logistical burden for taxpayers with no internet access if they prepare their own return.   Secondly, additional cost is likely to be incurred by some taxpayers who do not already utilize the e-file process.  Third, when taxpayers owe, there is likely to be some confusion in coordinating the filing of the return and the payment of the amount due.  Finally, rather than bother with e-filing a return, some taxpayers may simply opt to drop out of the system and not file returns at all.

Beginning in 2010 anyone is eligible to convert a traditional IRA or 401(k) plan into a Roth IRA.  Up to this point Roth’s were not for everyone, as there were two limitations on having a Roth IRA.  The first limitation prohibited contributions to a Roth if your adjusted gross income was in excess of $110,000 (or $160,000 married filing jointly).  The second limitation prohibited anyone with an adjusted gross income exceeding $100,000 from converting an existing traditional IRA or 401(k) to a Roth account.  Starting next year, anyone can convert a traditional IRA or a 401(k) plan to a Roth IRA without regard to income level.

Roth IRA’s can be very attractive retirement vehicles, as all qualified withdrawals from the account are tax free.  That’s right.  Make a non-deductible contribution to a Roth IRA today and never pay tax on that money again –not on the amount deposited nor on the earnings in the account.  In addition, there are no required distributions from a Roth IRA regardless of age.  If you don’t need the funds that are in the Roth account leave them there and your heirs will not pay tax on it either.  A Roth account must have been in place for five years prior to any withdrawals to receive the tax-free benefit.

Another advantage of a Roth account applies to working taxpayers over age 59 ½ who established their Roth more than five years ago.  Since there are no taxes to be paid and no requirements about withdrawals, this group of taxpayers can use a Roth as a tax-free savings account.

If you have contributed to a deductible IRA, you must pay tax on the amount converted.  So, if you have $50,000 in your IRA and wish to convert it to a Roth, you must include $50,000 in your taxable income.  If you have contributed to a non-deductible IRA, you would only pay tax on the earnings on the withdrawal when converting to a Roth. If you made $30,000 in  non-deductible contributions that have grown to $50,000, you would pay tax on $20,000 only.  From the point of withdrawal, any additional earnings would not be subject to tax.

Although the $100,000 limit has been permanently removed, there is a unique opportunity in 2010. For any conversion that is completed in 2010, the taxes on the conversion can be deferred and spread over two years, 2011 and 2012.

So, should you convert your existing traditional IRA to a Roth?  Unfortunately, there is no one correct answer to that question other than “It depends.”  Without doubt, anyone with more than ten years until retirement should consider such a move.   There should be a significant amount of growth in the account prior to retirement and tax rates are likely to increase over time.  Paying taxes now at a lower rate and on fewer dollars makes sense.  The remaining issue is your ability to pay the extra tax at this time.

For taxpayers closer to retirement, the choice is not as clear-cut.  There is likely  be an advantage to anyone converting regardless of the time span – assuming the market increases.  Probably the worst scenario is to convert to a Roth account, only to see the value of your account decline.

Assuming the market does not go into a decline you must weigh several factors in the decision to convert.

• How soon do you anticipate retirement and use of the funds?  In other words, how much opportunity is there for the money in your account to grow?  The longer the time frame, the greater the benefit to be obtained by converting.
• How does your tax situation compare now to when you are retired?  Will your marginal tax rate decline upon retirement?  If so, it might be more advantageous to keep  the traditional IRA and pay tax on your marginal rate in retirement.  Keep in mind that converting to a Roth could place you in a higher tax bracket for the year of conversion, resulting in more tax being paid.
• Without regard to your current marginal rate, what do you anticipate for the future?  The current individual tax rate structure is historically low.  Remember that in the early 1960’s the top marginal rate was 91 percent, a far cry from today’s 35 percent.  Considering that the federal government is currently running historic deficits, it is not wild speculation to think that rates may increase in the future.
• A final issue is your ability to pay the additional tax in the year of conversion.  If you do not have the cash available or must borrow the money to pay the extra tax, converting is probably not a wise move.

As stated earlier, the answer is not a “one size fits all.” You will need to take a hard look at your financial situation and expectations about the future to make an intelligent choice.  Your financial  professional can assist you in modeling various scenarios and help you make the right choice.