By Dave Carpenter — AP Personal Finance Writer
If Timothy Geithner can get confused over the laws governing the withholding of tax, anyone can, experts say.
U.S. tax laws are particularly complicated and full of land mines for the unsuspecting, as everyone from the Treasury secretary nominee to self-employed business owners and average taxpayers can confirm.
The Association of Chartered Certified Accountants, the global body for professional accountants, views the U.S. tax regime as one of the world's most complex, according to Chas Roy-Chowdhury, London-based head of taxation.
"Even tax professionals could get it wrong," he said, referring to the requirements involving self-employment taxes that tripped up Geithner as well as U.S. tax law in general.
Pitfalls abound, especially for amateurs.
Here are some questions and answers about possible errors related to the withholding of taxes, and what you can do to protect yourself.
Q: What did Geithner do?
A: A U.S. employer normally would withhold half of your Social Security and Medicare taxes from your salary and pay the other half, but the International Monetary Fund does neither so it's the employee's responsibility. Geithner failed to pay self-employment taxes for money he earned from 2001 to 2004 while working for the IMF.
He paid some of the taxes in 2006 after an IRS audit discovered the discrepancy for the years 2003 and 2004. But it wasn't until President-elect Barack Obama selected him late last year to head Treasury that he paid back most of the taxes, incurred in 2001 and 2002.
Q: How could someone like Geithner have made this "innocent" mistake, as Obama calls it?
A: Numerous tax experts say they understand how he might have either gotten ensnared by or overlooked the arcane IMF-related filing requirements. Some note that the tax filing advice given to IMF employees is voluminous and complicated.
Don Williamson, an accountant and professor of taxation at American University's Kogod School of Business, calls Geithner's actions "negligent and perhaps reckless." But he says he deserves at least a partial pass for the faulty 2003 and 2004 returns, since that involved a technical matter his tax preparer should have known about.
Q: How frequently does this happen?
A: Geithner's error apparently is a common one for people hired by international organizations and foreign embassies that don't pay the employer share of Social Security taxes. The IRS estimated in 2006 that as many as half those employees had made tax-filing mistakes.
Q: What about ordinary taxpayers — how often do they make this kind of mistake?
A: Rather than an error, this is more often a case of people learning when they start filling out their tax forms that they owe much more than they thought because of self-employment, according to Mel Schwarz, a partner with accounting firm Grant Thornton who specializes in tax policy.
"It is easy to miss and it can cause a real panic if you don't realize your liability until the last minute," Schwarz said.
Q: What exactly is the self-employment tax and who pays it?
A: It's a Social Security and Medicare tax primarily for individuals who work for themselves — those who operate a trade, business or profession, alone or as a partner. You must report net self-employment earnings of $400 or more on Schedule SE (1040), with the tax calculated from that.
Q: How do I know how much to pay?
A: You figure it using Schedule SE (Form 1040). But a key sticking point is that you must make estimated tax payments throughout the year on self-employment earnings for which you don't have income tax withheld, if you expect to owe $1,000 or more. The IRS Web site has more details.
Q: What kind of penalties could I face if I'm caught underpaying?
A: You will have to pay a penalty of 0.5 percent of your unpaid taxes for each month the tax is late. You also will owe the government interest, currently 6 percent.
If you paid at least 90 percent of your actual tax liability, the penalty does not apply during the automatic six-month extension granted for you to pay in full.
Q: What if I don't pay at all?
A: You face a penalty of 5 percent per month, up to a total of 25 percent.
Whatever you do, don't skip filing because you are afraid you don't have the money. Talk to the IRS about paying in installments. That's much preferable to subjecting yourself to the failure-to-file penalty.
Q: If I've discovered an error, what should I do?
A: File a corrected return. And if it's a huge error, go to an attorney.
The IRS statute of limitations for income tax errors, excluding ones involving outright fraud, is generally three years after the due date. For income tax fraud or evasion, the statute runs for a much longer time.
Q: What if I'm uncertain about whether earnings are subject to employment taxation?
A: A taxpayer with such concerns should ask both the employer's human resources department, if that applies, and the Internal Revenue Service, advises Avram Sacks, a Social Security law analyst for Riverwoods, Ill.-based Wolters Kluwer, which provides tax information and services to tax professionals. If the answers don't match, the employee needs to inquire further. Having a good accountant who has experience in the types of issues confronting the taxpayer also is very helpful, particularly if the issue is arcane.
Q: Will I be protected from this kind of problem if I have an accountant?
A: Relying on an accountant or tax professional obviously should lessen the chances of it happening. But ultimately it's the taxpayer who's responsible if a flawed return is filed under his name. Ask Geithner.
"Taxpayers, especially sophisticated ones, have a duty to know enough to avoid the 'too good to be true' consequences of receiving a check for tax benefits and not seeing the result on a return," said Royal Dellinger, a Rockville, Md., accountant who has handled tax returns for several IMF employees.
Q: Will electronic tax preparation help protect me?
A: Tax software can be a helpful tool but should not be relied upon completely, especially in the case of nonstandard issues.
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