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Tax Deadline Knocks at the Door: Some Answers

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Your palms are sweaty, your breathing is labored and you feel a little dizzy. That can only mean one of two things: you're in the front row of a Justin Bieber concert, or you just realized that you've got only hours to file your 2011 tax return. With Tuesday's deadline approaching, we asked members of the American Institute of Certified Public Accountants to answer questions from readers.

Q: I installed a high-efficiency air conditioning unit in June 2011. Am I eligible for a tax credit?

A: Maybe. Your first hurdle involves checking with the manufacturer to see if the equipment received the proper "tax credit certification." You may find this information included in the original packaging or on the manufacturer's website. If the product was certified, then you must complete Form 5695 and attach it to your tax return. The credit for 2011 is generally 10% of the cost, up to specific limits for each type of improvement. Your credit may be reduced if you have taken advantage of any energy-efficiency tax credits in the past. There is a good one-page summary by the IRS at irs.gov/pub/irs-pdf/p4845.pdf.

-- Jonathan Horn, CPA, New York City

Q: My wife co-signed a credit card for her son. He didn't pay the bill and the company is trying to collect from her. If the debt is settled or forgiven, will she owe tax on the forgiven debt?

A: The answer depends on whether she is on the hook because her son discharged the debt through bankruptcy or if it's just because he's not paying. If the former, she will receive a Form 1099-C for the forgiven debt, but she may be able to make a case that she did not receive the benefit of the debt incurred and therefore should not have to pay tax on the debt forgiven. If her son just isn't paying the debt and she settles it, the debt forgiven will be taxable income to him.

-- Kelley Long, KCL Financial Coaching, Chicago

Q: If I convert a traditional individual retirement account to a Roth this year, can I split the taxable income between two years?

A: No. The ability to split taxable income over a two-year period for individual retirement accounts converted to a Roth IRA was limited to 2010.

There used to be an income threshold to convert an IRA to a Roth IRA. This no longer applies. However, converting an IRA to a Roth IRA has important tax considerations. You can find more information at 360financialliteracy.org. Search under "Roth IRA."

-- Leonard Wright, AICPA Money Doctor, San Diego

Q: Will I get penalized by the IRS if I move all my money from my 401(k) into something safer and less volatile, such as a bond or money market account?

A: With only a couple of exceptions, all 401(k) withdrawals are taxable as ordinary income in the year you make the withdrawal. An additional 10% early distribution penalty tax will be assessed if you're not at least age 59 when you take your distribution. You may be able to escape the penalty if:

Your employment terminates and you are at least 55 years old.

You begin substantially equal periodic payments over time (at least five years) for income purposes.

You are in debt for medical expenses that exceed 7.5% of your adjusted gross income.

You're required by court order to give the money to your divorced spouse, a child, or a dependent.

You die and the account is paid to your beneficiary.

You become permanently and totally disabled.

As an alternative, you may want to consult a personal financial planner (or your plan may have someone) who can offer you guidance on how the underlying assets within the 401(k) are invested.

-- Sharon Lechter, CEO, Pay Your Family First, Paradise Valley, Ariz.

Q: Two years ago I retired and used my 401(k) money to start a business. After the bottom fell out of the economy, the business failed and now I owe taxes I can't pay. I've seen ads for a company that claims it can reduce your tax bill. Is that legitimate? What other options do I have?

A: For any offer to reduce your taxes or make a debt to the IRS go away, bear in mind that anything that sounds too good to be true likely is. If you have a paid return preparer, see how they can help you use the programs offered by the IRS to help people pay their debts.

The IRS recently expanded its "Fresh Start" program to help people who can't afford to pay their taxes. Go to irs.gov and search under "Fresh Start" for information on installment agreements, offers in compromise and penalty relief. If you owe money for your state taxes, be sure to also check your state's website for information.

-- Annette Nellen, professor, Department of Accounting & Finance, College of Business, San Jose State University

Q: I was on unemployment for part of 2011. I read that the economic stimulus bill exempted unemployment benefits from taxes. Is that still the case?

A: In 2009, the American Recovery and Reinvestment Act excluded the first $2,400 of unemployment compensation from taxable income. This provision has expired and is not available for 2011.

-- Daniel T. Moore, D.T. Moore & Co., Salem, Ohio

Q: Our adult child lives separately from us but relies on us for tuition, room, board and health insurance. Can we claim him as a dependent on our tax return?

A: There are several tests to claim a dependent, one of which is the residency test. If you meet all the other tests, you may claim your child as a dependent if he/she lives with you for more than half the year. There is an exception for temporary absences due to education. You can claim your child as a dependent if the absence is temporary for education and you meet all the other tests. For further information about the other tests, check IRS publication 501.

-- Ernest Almonte, Almonte Group, Providence, R.I.

Q: My daughter was involved in a lawsuit and expects to receive a settlement. Will she owe taxes on the money?

A: This is definitely a situation that requires professional assistance from a tax adviser with experience in lawsuit settlements. There are different rules for various types of settlements. For example, personal injury settlements may be tax-free, while ownership disputes are generally taxable. The issue can be complex with parts of the same settlement having different tax treatments.

-- Janet C. Hagy, Hagy & Associates, Austin

Q: I invested in a company that went bankrupt last year. Can I deduct a loss for worthless stock?

A: If it can be shown that the stock is completely worthless, a capital loss can be claimed in the year that the stock became worthless. It must be shown that the stock has zero value. A bankruptcy process does not automatically mean that the stock is completely worthless, but it may provide information that supports the conclusion.

If a worthless stock loss can be claimed, it will usually be a capital loss, and may be limited in the amount deductible in the current year. You can use it to offset capital gains and up to $3,000 of other income. Any unused loss may be used in future years subject to a similar limitation.

-- John McWilliams, professor of accounting, Golden Gate University, San Francisco

Note: Answers are provided without having full knowledge of all the details of the taxpayer's circumstances and an opportunity to conduct in-depth research. The CPAs answering readers' questions cannot assume liability for tax advice provided in these answers, and before acting on any advice provided, taxpayers should consult a CPA or other competent professional. Also, the IRS requires the following notice: Any tax information in this Q&A is not intended to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

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