Taxes are a necessary evil, but you don't want to make matters worse by paying unnecessary federal tax penalties. Here are five to avoid:
1. Not taking required minimum distributions. This is the granddaddy of tax penalties. After you reach age 70½, you must begin taking annual "required minimum distributions" (RMDs) from your tax-advantaged retirement plans (unless you're still working) and from traditional IRAs. (For the year you turn 70½, you can postpone the payout until April 1 of the following year, but that will require you to take two withdrawals in the same calendar year.) The RMD is based on your age—entered into a life expectancy table—and your account balances at the end of the year in which you turn 70½.
Failing to take RMDs can result in a 50% penalty tax on the amount that should have been withdrawn (on top of the regular income tax you owe on the distribution). Unless you can show reasonable cause for missing an RMD, you'll be stuck with this penalty.
2. Making early withdrawals. On the opposite end of the spectrum, you may be penalized for withdrawing funds from your qualified plans and IRAs too soon. Generally, a 10% penalty tax applies, in addition to the regular tax you owe on the distribution, unless you've already reached age 59½ or the payout is because of death or disability. However, the tax law provides several exceptions to the early withdrawal penalty, such as payments used for deductible medical expenses.
Another key exception is available for substantially equal periodic payments (SEPPs). If you take SEPPs over your life expectancy, or over the life expectancy of you and a beneficiary or beneficiaries, there's no penalty if those payments continue for at least five years or until you reach age 59½, whichever is longer.
3. Not reporting income from foreign accounts. Your tax return may not be the only document you're required to file each year. If you have financial interests in foreign banks totaling more than $10,000 at any time during the year, you must report the account information to the IRS using the FBAR form (short for Report of Foreign Bank and Financial Accounts).
Beginning with the 2016 tax year, FBARs have to be filed by the tax return due date, plus extensions. (Previously, the deadline was June 30 of the year following the year of the foreign account activities, and no extensions were allowed.) The penalty for failing to make the filing is severe—a fine of up to $250,000 and a prison sentence of up to five years can be assessed for a willful violation. Other penalties may be imposed for providing false information.
4. Not having health insurance. Under the Affordable Care Act (ACA), also known as Obamacare, most people must have health insurance or must pay a "shared responsibility payment." For 2017, the amount of that payment is equal to the greater of 2.5% of your annual household income or $695 per person for the year ($347.50 per child under 18), up to a maximum of $2,085 per family.
This penalty kicks in when you, your spouse, or a dependent go without coverage for more than three months, with certain exceptions. Consult with your tax and financial advisors to see whether you qualify for a premium tax credit or an exception to the penalty.
5. Missing the deadline for your tax return. Generally, if you don't file your tax return on time, or if you fail to pay the tax you owe by the tax return due date (even when you receive an extension for filing your return), you'll be assessed a penalty.
The penalty for filing late is 5% of the unpaid taxes for each month or part of a month that a tax return is late. It begins accruing after the tax-filing due date and can't exceed 25% of your unpaid taxes. If you don't pay your taxes by the tax deadline, you normally face a penalty equal to 0.5% of the unpaid taxes. This applies for each month or part of a month after the due date and starts accruing the day after the tax-filing due date.
Again, the six-month filing extension, which is automatic if you request it, is not an extension for paying your taxes. You still must make a reasonable estimate and pay that amount.
This article was written by a professional financial journalist for Preferred NY Financial Group,LLC and is not intended as legal or investment advice.