Beware the Tax Apocalypse in Retirement

Amid all the gloom and doom about forced retirement, skyrocketing healthcare costs and nest egg-cracking financial markets, there's another threat facing baby boomers: future tax liabilities.

The generation that has depended solely on 401(k)s and tax-deferred individual retirement accounts may not realize how much of a tax hit it will take when it starts withdrawing the money and living on it.

With the prospect of rising tax rates after the Bush tax cuts expire, some retirees could find themselves paying even more in taxes than they did when they were working. "It continues to surprise our clients that taxes are that big of an expense in retirement," says Mark Davis of SunTrust Investment Services, Inc.

He estimates that clients who optimize retirement withdrawals to minimize their taxes can end up with as much as 33 percent more to spend in retirement years than they would if they ignored the impact of taxes.

How to do that? Here are a few options.

-- Build a tax-diversified portfolio going in. If all your savings are locked away in a 401(k) or tax-deferred IRA, you will end up paying income taxes on all your withdrawals. It's better to have other accounts to pull money out of.
To really optimize your post-retirement withdrawals to minimize taxes, it would be good to have a tax-deferred account, a tax-free account (such as a Roth IRA or a healthcare savings account) and a regular taxable investment account. You can use the taxable account to take capital losses as they occur, and to keep income taxed at lower capital gains and dividend rates.

-- Consider taxes as you decide when to start your Social Security benefits. That's a complex consideration, so it's best to have an expert with a spreadsheet help you. The basic issue is this: Many advisers recommend that you delay starting your benefits as long as possible, to maximize the monthly payments you'll ultimately receive. But if you have to withdraw money from a tax-deferred account to live on while you're waiting to start Social Security, that could backfire. If your combined marginal state and local tax rate is 35 percent, and you're deferring $20,000 in Social Security, that could conceivably cost you as much as $7,000 a year to defer those benefits.

-- Know your limits. It's good to know your tax bracket and whether or not you are on the verge of being in a higher or lower bracket. For example, the 25 percent federal tax bracket starts at $35,350 in income ($70,700 for couples filing jointly)and runs all the way up to $85,650 for single filers and $142,700 for joint filers. If you have multiple accounts, you can finesse your withdrawals to keep your marginal income below a bracket line.

-- Don't forget Social Security taxes. It is likely, though not certain, that you will have to include a portion of your Social Security benefits into your taxable income. If your income, including 50 percent of your benefits, exceeds $25,000 for singles or $32,000 for couples, then half of your benefits will be taxable. Once that figure exceeds $34,000 for singles and $44,000 for couples, 85 percent of your benefits would be taxable. That means you could end up giving back as much as 21 cents in taxes for every dollar in benefits you collect.  If you can use withdrawals from tax-free accounts to keep your income below that breakpoint, that would save you money, too.  To get an idea of whether and how much of your Social Security benefits will be taxed, you can use the calculator at the website of CompleteTax.

-- Optimize what you put where. Bond and bank account interest is typically taxed at higher ordinary income levels, while dividends and capital gains are taxed at lower levels, which currently max out at 15 percent. So match up the right investments in the right vehicle, suggests Davis. That means putting your bonds in a tax-deferred rollover IRA (or tax-free Roth)and putting your stocks in a regular taxable account.

-- Don't forget munibonds. Interest on municipal bonds is typically not subject to state and local taxes, so folks in high-tax states might find these bonds or the mutual funds that hold them attractive. And there is a bonus there: In recent topsy-turvy markets, munis have skirted, and occasionally out-yielded U.S. Treasuries. That's unusual. If you are going to invest in munis for income, don't put them in a tax-free or tax-deferred account.

-- Where you live matters. It's not just the cost of living that makes some places, such as Florida and Delaware, retiree magnets -- it's the fact that those states have much lower state tax structures. Florida has no income tax at all. If you're going to be living solely on tax-deferred withdrawals, Florida might start seeming more attractive than you ever thought it would be.

-- Remember not to let the tail wag the dog. You can have a richer retirement life if you keep taxes to a minimum, but - of course - taxes shouldn't be the driver in how you invest, where you live, or how you run your life. Use strategies like these to minimize taxes when you can, but don't make them the focal point of your retirement plan or day.

[Source: Linda Stern -- Reuters]

Start Planning Now for Next Year's Taxes

The tax deadline may have just passed but planning for next year can start now. The IRS reminds taxpayers that being organized and planning ahead can save time, money and headaches in 2013. Here are eight things you can do now to make next April 15 easier.

1. Adjust your withholding Why wait another year for a big refund? Now is a good time to review your withholding and make adjustments for next year, especially if you'd prefer more money in each paycheck this year. If you owed at tax time, perhaps you'd like next year's tax payment to be smaller. Use IRS's Withholding Calculator at www.irs.gov or Publication 919, How Do I Adjust My Tax Withholding?

2. Store your return in a safe place Put your 2011 tax return and supporting documents somewhere secure so you'll know exactly where to find them if you receive an IRS notice and need to refer to your return. If it is easy to find, you can also use it as a helpful guide for next year's return.

3. Organize your recordkeeping Establish a central location where everyone in your household can put tax-related records all year long. Anything from a shoebox to a file cabinet works. Just be consistent to avoid a scramble for misplaced mileage logs or charity receipts come tax time.

4. Review your paycheck Make sure your employer is properly withholding and reporting retirement account contributions, health insurance payments, charitable payroll deductions and other items. These payroll adjustments can make a big difference on your bottom line. Fixing an error in your paycheck now gets you back on track before it becomes a huge hassle.

5. Shop for a tax professional early If you use a tax professional to help you strategize, plan and make financial decisions throughout the year, then search now. You'll have more time when you're not up against a deadline or anxious for your refund. Choose a tax professional wisely. You are ultimately responsible for the accuracy of your own return regardless of who prepares it. Find tips for choosing a preparer at www.irs.gov.

6. Prepare to itemize deductions If your expenses typically fall just below the amount to make itemizing advantageous, a bit of planning to bundle deductions into 2012 may pay off. An early or extra mortgage payment, pre-deadline property tax payments, planned donations or strategically paid medical bills could equal some tax savings. See the Schedule A instructions for expenses you can deduct if you're itemizing and then prepare an approach that works best for you.

7. Strategize tuition payments The American Opportunity Tax Credit, which offsets higher education expenses, is set to expire after 2012. It may be beneficial to pay 2013 tuition in 2012 to take full advantage of this tax credit, up to $2,500, before it expires. For more information, see IRS Publication 970, Tax Benefits for Education.

8. Keep up with changes Find out about tax law changes, helpful tips and IRS announcements all year by subscribing to IRS Tax Tips through www.irs.gov or IRS2Go, the mobile app from the IRS. The IRS issues tips regularly during summer and tax season. Special Edition tips are sent periodically with other timely updates.

The IRS emphasizes that each household's financial circumstances are different so it's important to fully consider your specific situation and goals before making large financial decisions.

Beyond the Buffet Rule: Ten Tax Breaks That Should Disappear

When Senate Republicans blocked consideration of President Obama’s “Buffett rule” minimum tax on millionaires Monday, they dismissed it as a gimmick.  True enough. But that means it would fit right in with the current U.S. tax code, where gimmicky, politically driven and unnecessarily complicated provisions abound.

In honor of tax day (and the rule named after Berkshire Hathaway CEO Warren Buffett) here are 10 of the worst gimmicks that are already a part of our income tax code.

1. Alternative minimum tax. This shadow tax system, created in 1969 to ensure a small number of rich folks paid at least some tax, afflicted 4.3 million upper middle class households in 2011 and in 2012 is menacing an additional 27 million —who will probably be saved by a last minute AMT “fix” passed after the November election. Of course it is Congress itself that created this peril. First, as part of the 1981 Reagan tax cuts, it indexed regular tax brackets, but not the AMT, for inflation. Then, in 2001, it made the Bush tax cuts look cheaper than they really were by cutting regular tax rates but not the AMT rate. Without those two bits of politically expedient tax writing, fewer than half a million families would now be paying the AMT, according to calculations by researchers at the Tax Policy Center.  Those who owed AMT for 2011 had to wrestle with the 54-step Form 6251, Alternative Minimum Tax and possibly the 57-step Form 8801, Credit for Prior Year Minimum Tax, too. Sure, using software like  Intuit’s TurboTax or  H&R Block’s At Home makes the calculations manageable. But the AMT still makes planning difficult and punishes innocent folks with no more exotic “tax shelters” than  high state and local tax deductions or lots of kids. It also raises real money—$39 billion in 2011 and, if Congress doesn’t pass a fix, $132 billion this year.

2.   Expiring tax provisions. Congress has been extending a growing list of tax breaks (tax expenditures, in tax geek speak) for only a year or two at a time so as not to have to budget for their true cost. This has the added advantage for the pols of keeping lobbyists begging for extensions and making campaign contributions. The research and development credit, which enjoys broad bipartisan support, has been temporarily renewed 14 times since its creation in 1983 and  expired once again on Dec. 31. It’s just one of 59 tax provisions that lapsed at the end of 2011 and have yet to be renewed—creating enormous uncertainty for taxpayers and a mess for the IRS.  Moreover, at the end of 2012 another 36 provisions, including all of President Bush’s individual tax cuts and  President Obama’s payroll tax cut will expire. What then? Don’t look for answers until after the election. And then, who knows? A recent survey of 180 tax executives and lobbyists found that 62% expects a short term extension of some or all of the Bush tax cuts and 34% believe a gridlocked Congress will end up letting all the tax cuts expire.

3. Roth IRAs and Roth conversions. As budget gimmicks go, this one is a whopper.  You put after tax dollars into a Roth and all growth and withdrawals in retirement are tax free—meaning that revenue losses get pushed outside Congress’ traditional 10 year budgetary window. In fact, when Congress first allowed these accounts in 1997 at the urging of the late Sen. William V. Roth (R-Del) , it used them s a “revenue raiser”— taxpayers with income of $100,000 or less could elect to pay tax on their traditional pre-tax IRAs immediately and convert them into Roths where future growth would be tax free. In May 2006, Congress repeated the gimmick, extending conversion rights (beginning in 2010) to higher income taxpayers too. Congress booked that as raising $7 billion, but economist Leonard Burman, then director of the Tax Policy Center, estimated at the time that the provision would reduce revenues by more than $14 billion over the long term.  That provision also opened the door  for higher income folks who aren’t eligible to contribute to Roth IRAs to do so through a complicated backdoor  process. (The revenue loss could be greater than anyone imagines. Forbes recently turned up evidence that Max R. Levchin, chairman of social review site Yelp, has a Roth IRA worth almost $100 million and that billionaire tech investor Peter Thiel has held Facebook stock in a Roth.)

4. The $250 Educators Expense deduction. This costs just $200 million a year, but is a prime example of how political pandering junks  up the tax code. During the 2001 tax cut debate, some pols  wanted to subsidize teacher salaries with a $1,000 refundable teachers’ credit.  What emerged instead was a temporary (and since renewed) $250 “above the line” deduction for teachers, counselors and administrators in kindergarten through grade 12 who pay for school supplies out of their own pockets.  Though meant as a sop to teachers, the break  often ends up confusing them instead, says Philadelphia tax lawyer and Forbes blogger Kelly Phillips Erb, a.k.a. Taxgirl. “I was talking about this with one of the teachers at my kids’ school,’’ she reports. “They thought that if you take the deduction, that’s all you can claim.” In fact, Erb points out, a teacher who itemizes deductions and has $1,000 in unreimbursed expenses could claim $250 above the line and another $750 as an unreimbursed employee business expense deduction on Schedule A.  “Many teachers don’t understand this because they think they’re limited to the $250. Part of the stupid result of having such specific tax breaks,’’ she opines.

5. The kiddie tax. This tax is meant to keep wealthy folks from shifting income to their children, but ends up creating loads of extra paperwork for ordinary families as well as the IRS.   If a child is under 19 (or under 24, if a full time student) and has investment income of more than $1900, that income is taxed at his or her parents’ usually higher tax rate. But to enforce that, any child who has $950 or more of unearned income (interest, dividends and capital gains) or $950 in total income, with $300 or more of that unearned, has to file a return. Nearly 60% of 10 million returns filed for kids in 2005 showed $50 or less in total taxes owed, according to a tax simplification report issued in 2010 by President Obama’s Economic Recovery Advisory Board.

6. Phase-outs. A huge number of tax benefits for retirement savings, education, children and the like are phased-out (meaning, taken away) as a taxpayer’s income rises. Both Democrats and Republicans buy into these phase-outs, but they make planning difficult, require complicated worksheets and can create freakishly high marginal tax rates on some working folks.

7. Overlapping educational incentives. You can make a good argument that tax breaks aren’t an efficient way to subsidize higher education—but that’s for another day. What’s patently absurd is the number of overlapping and confusing tax breaks for education, each with its own pol wanting his own.  Obama has his prized $2,500 American Opportunity Credit, Republicans have the Coverdell Education Savings Account (named after the last Senator from Georgia) and Sen.  Charles Schumer (D-NY) has promoted a college tuition deduction. IRS Publication 970, Tax Benefits for Education, runs to 87 pages and features a two-page table describing the differing eligibility rules and definitions of qualifying educations expenses for 11 different tax breaks. The smorgasbord of breaks leads some taxpayers to miss out on the best and millions others to claim benefits they may not be eligible for,  according to a recent report from the Treasury Inspector General for Tax Administration.

8. Too many retirement accounts. This is akin to the education tax break problem. There are more than a dozen different types of tax-advantaged retirement savings accounts and each has a different set of rules governing contributions, distributions and when you can take money out early without paying a 10% penalty, leading to expensive mistakes by taxpayers. For example you can take an early penalty-free “hardship withdrawal” from your 401(k), but not from your IRA. On the other hand, you can withdraw money early, penalty free, from an IRA, but not from a 401(k), to pay college bills. (For more problems with all these accounts, see #3, Roth IRAs and Conversions.)

9. Seniors tax breaks. While Republicans complain that half of Americans don’t pay income taxes, you haven’t seen them taking on special tax breaks for seniors.  Yet according to a Tax Policy Center analysis, the largest group excluded from tax because of tax breaks (as opposed to simply being too poor to owe income taxes) are seniors, who get a bigger standard deduction than younger folks and more importantly, special tax treatment for their Social Security benefits.  In all, 16.7 million elderly households will pay no tax in 2011 because of those two breaks and a special credit for elderly low income folks. Seniors do pay for their tax break in complexity—a 20 step worksheet is used to determine what percentage of their Social Security check (from 0% to  85%) is subject to tax.

10. Façade easement donation deduction.  Taxpayers “donate” the ability to change the fronts of their buildings—which may anyway be protected by zoning or historic district designations—to a preservation organization and them claim a charitable deduction. Dean Zerbe, a former Senate Republican staffer and now national managing director for alliantgroup and a Forbes contributor, cites this as an example of the kind of special tax break that creates huge enforcement problems for the IRS, while doing little real good and mostly benefiting wealthy folk “who live in rich enclaves in DC and New York.” Says Zerbe:  “Just kill it.”

[Source: Janet Novak, Forbes Magazine]

Why the IRS Wants to Give You a Refund

For many Americans, Tax Day—April 17, this year—means writing a check. For most it means a refund. Last year, the Internal Revenue Service refunded $300 billion, or 25 cents for every $1 it collected. More than 80% of the 143 million returns filed resulted in a refund.

Paying more in taxes during the year than one actually owes amounts to an interest-free loan to the government. Economists used to consider it irrational: The smart thing to do is reduce withholding to come close to matching one's tax obligation.


But new evidence—and insights from behavioral economists—challenge that view and suggest that many people, particularly lower-income Americans, use the tax system to force themselves to save. Now, the government is looking for ways to take advantage of what Mark Iwry, the Treasury point man on saving and retirement issues, calls "savable moments."

"People want to have a ready way to save," says Michael Barr, a University of Michigan law professor and a former Obama and Clinton Treasury official. "For some families, tax time is a good time to do so."

In the mid-2000s, Mr. Barr and colleagues surveyed about 650 low- and moderate-income families in the Detroit area who had filed tax returns in 2003 or 2004. About 82% received refunds—either because they had overpaid or because they qualified for the federal Earned Income Credit, a federal cash bonus to low-wage workers that is paid through the IRS. The average refund exceeded $2,000, a significant sum for people who say they have trouble making ends meet.

Retailers often target refund recipients, and half the Detroiters said they spent all the refund, most often to pay bills or debts or to buy appliances or cars.

Half the recipients saved at least some of the refund. "There is a desire to save," Mr. Barr says. "The saving is not for retirement. It's for short-term goals, for financial stability, so if tough times hit, they don't have to go see the payday lender or go to family and friends or stop eating."

In fact, Mr. Barr and co-author Jane Dokko of the Federal Reserve Board, found these folks don't want smaller tax refunds. In the survey, researchers offered them choices: Withhold $100 a month more and get a bigger refund (an option favored by 35%), withhold the same amount and get the same refund (46%) or withhold less and get a smaller refund (only 19%). This and other survey findings appear in a coming Brookings Institution book, "No Slack: The Financial Lives of Low-Income Americans."

Behavioral economists have found that people respond better to a nudge than a simple up-or-down choice, an observation that has led many employers to automatically enroll workers in retirement-savings plan (and allow them to opt out) instead of asking if they want to enroll or not. A 2005 academic experiment in which some H & R Block customers were offered a 20% or 50% match when they learned the size of their refund if they put money into an Individual Retirement Account proved more successful than the little-understood Saver's Credit in the tax code that offers much the same incentive.

Pushed by the Treasury and outside academics, the IRS has been experimenting with ways to nudge people to save at refund time. In the mid-2000s, it began allowing taxpayers to split tax refunds between, say, a checking account and a savings account or an Individual Retirement Account. Last year more than 750,000 people took the option, an increase of 36% from 2010.

But that requires the person to have a pre-existing savings account or an IRA; a lot of low-income people don't. Last year, the Treasury mailed letters to 808,000 taxpayers likely to have low or moderate incomes and offered to load their refunds on a debit card; only 239 took the offer, according to the inspector general for tax administration.

Another experiment appears a bit more promising. Two years ago, the IRS began asking taxpayers if they wanted to use some or all of their refund to buy a U.S. savings bond. Last year, about 30,000 people bought $11.5 million in savings bonds. The program is very small, but growing. So far this year, sales are running 60% above year-ago levels.

While the Treasury is doing away with paper savings bonds for everyone else, it has made an exception for these savers, figuring making the savings tangible is important.

The goal is "to create as many avenues as possible to make it easier to save," Mr. Iwry says. "Someone who begins saving at least part of their tax refund might acquire the habit and start saving in other ways as well."

None of this is going to solve the national savings dearth. Most personal saving in the U.S. will continue to be done by people with lots of money to spare. These experiments, instead, are aimed at making individuals a bit more financially secure, a creative attempt to promote a culture of saving in a country with too little of it.

[Source:  Yahoo Finance]

Don't Forget These Five Tax Breaks

Tax breaks for college costs. The American Opportunity tax credit can lower your tax bill by up to $2,500 if you spend at least $4,000 in tuition, required fees, books and course materials for the year. It applies to the first four years of postsecondary education. To qualify, your modified adjusted gross income must be less than $160,000 if you are married filing jointly, or $80,000 if you are single (the credit phases out completely at $180,000 for married couples, or $90,000 for single filers). The Lifetime Learning Credit applies to all years of postsecondary education (including graduate school) and can lower your tax bill by up to $2,000 per return. To qualify for the full credit, your modified adjusted gross income must be less than $100,000 if you are married filing jointly or $50,000 if you are single. The size of the credit phases out until your income reaches $120,000 if you are married filing jointly or $60,000 if single. 

Extra credit for saving. If you contributed to a traditional or Roth IRA, a 401(k) or another retirement savings plan, you may qualify for the retirement savers’ tax credit, which can reduce your tax bill by up to $1,000 per person. To claim the savers’ credit for 2011, your adjusted gross income must be $28,250 or less if you’re single; $42,375 or less if you file your tax return as head of household; or $56,500 or less if you are married filing jointly. 

Credit for child care. If you have kids under age 13 and pay for care while you work, you could qualify for the child-care tax credit. You can count up to $3,000 in child-care expenses for one child, or up to $6,000 for two or more children. The size of the credit gradually shrinks as your income increases. Families who earn less than $15,000 can claim a credit for 35% of qualifying expenses; families who earn more than $43,000 can get a credit for 20% of eligible costs. Expenses that count toward the credit include day care, preschool, before-school and after-school care, summer day camp, and a nanny or other babysitter. You may also be able to take a credit worth up to $200 if you’ve maxed out the money from your flexible-spending account to pay for child care and you have two or more children and spent more than $6,000 on their care. See IRS Publication 503 Child and Dependent Care Expenses.

Out-of-pocket charitable deductions. Most people remember to deduct checks they paid to charity if they itemize. But you can also deduct the expenses you incurred in helping out a charity, such as the cost of ingredients for a dish for a soup kitchen, stamps for a mailing, copying, and car mileage (14 cents a mile). And don’t forget to count any money you’ve had transferred automatically from your paychecks to charity. 

Moving expenses. If you move because of a job, you may be able to deduct your moving expenses even if you don’t itemize. To qualify, you must be moving to a job at least 50 miles farther from your old home than your old job. You can write off the cost of hiring movers (or renting a moving truck) plus the cost of one-way travel to your new home for everyone in your household. Deductible expenses include airfare, train costs, or car mileage (for 2011, 19 cents a mile from January through June and 23.5 cents a mile from July through December). For more information see IRS Publication 521, Moving Expenses.


[Source: Kiplinger]

5 Excuses Not to File Taxes that the IRS Won't Buy

You might not like those IRS auditors, but take a moment to turn the tables. What if you were an auditor yourself and your day was filled with interesting, creative and downright ridiculous stories from people attempting to reduce their tax bill or get out of paying altogether? The IRS hears them all the time and because of that, they have put together a document that debunks what they call the frivolous claims that people make in their attempt to avoid paying taxes.

Taxes Are Voluntary
The first one in the document cites the idea that paying taxes is voluntary. Those who subscribe to this idea state that in the instructions for form 1040, the word "voluntary" is used in the language. In addition, court case, United States V. Flora uses language that states, "[o]ur system of taxation is based upon voluntary assessment and payment, not upon distraint."

However, "voluntary" does not refer to the payment of taxes. The IRS allows each citizen to calculate their tax bill on their own. The IRS may later adjust the calculations but they do not compute a person's taxes for them. This allows the person to claim deductions and credits before the amount is determined.

The Zero Return
Those who believe that they aren't required to pay taxes sometimes file a return showing no income and no taxes. These "zero returns" are peoples' attempt to voluntarily declare that they owe no taxes citing the same reasoning above.

The IRS cites a series of laws and court cases, including Section 61 of the IRS code that states everycitizen has to pay taxes on their gross income and must make reasonable attempts to pay what is owed. There are a several penalties that are imposed on these zero returns, so trying the zero return trick may cost a lot of money.

My Dollars Aren't Worth AnythingMost people know that Federal Reserve Notes, better known as the cash we use every day, aren'tbacked by gold or any other physical asset. Instead, they are backed by the accepted belief that these bills and coins represent value, but not everybody believes this. Some people believe that they don't have to pay taxes on the money they receive because it has no real value.

The IRS wants those people to know that Congress is empowered "[t]o coin Money, regulate the value thereof, and of foreign coin, and fix the Standard of weights and measures," according to article I of the U.S. Constitution. In United States V. Rifen , the opinion of the court was simply, "federal reserve notes are taxable dollars."

I'm Not a U.S. Citizen
According to some, just because they were born in the U.S. doesn't mean they are citizens of the United States. These people believe that they are citizens of their state, making them exempt from Federal taxes.

The IRS directs those people to the Fourteenth Amendment to the Constitution that defines a U.S. citizen as anybody born or naturalized within U.S. borders. This sets up dual citizenship in both the state and the country. Still not convinced? They list 16 other court cases debunking this claim.

My Religion Says I Can'tEver heard of people who believe that they don't have to pay taxes because of religious reasons? These people cite the first Amendment that says Congress will make no law that doesn't allow for exercise of religion, but that doesn't mean that claiming religion is equal to a tax-free life. In the 1982 case, United States V. Lee, the court found that claiming religion is not a basis for refusing to claim taxes because the tax system couldn't run efficiently if every denomination were to make separate claims. Additionally, the first amendment doesn't give a person the right to not act in accordance with state and federal law.

The Bottom Line
The 65-page IRS document may debunk some of the reasons outlined above, but that doesn't mean other people won't look for loopholes in the law in order to get out of paying taxes. When that happens, we can be sure that the IRS will update the list.

[Source: Investopedia]

Beware These 5 Terrible Tax Surprises

You've always followed the sage advice of the late singer-songwriter Jim Croce: You don't tug on Superman's cape, you don't spit into the wind, and you don't try to pull a fast one on the Internal Revenue Service.

OK, maybe that last one wasn't one of Jim's lyrics, but the sentiment -- know the consequences before you act -- still applies.

Unfortunately, that's not always easy to do when it comes to Uncle Sam's tax collectors.

The tax law is complex and difficult for even experts to negotiate. Just when you think you've followed all the rules and researched all the angles, a tax regulation blindsides you.

Here are five terrible tax surprises that you might encounter during tax season and how to deal with the consequences.

Unemployment benefits

Yes, it's true. Under tax law, unemployment is considered wage income, and the IRS wants a cut of it.

Now that you're over the shock and anger, what can you do? When you apply for unemployment benefits, consider having federal income taxes withheld. This process is similar to regular payroll withholding. In this case, the form you fill out is the federal W-4V, Voluntary Withholding Request, or a similar IRS-acceptable document that the paying agency has created. This way, taxes will be withheld at the rate of 10 percent of each unemployment payment.

If you feel like you just can't surrender a chunk of each unemployment check to withholding, you should look into paying estimated taxes. This will help you avoid owing a large lump-sum tax bill when you file.

Alimony received

You survived the divorce. Now you have the IRS to deal with if you're getting alimony.

Ending a marriage is never a happy event. But at least you got a good settlement, and those regular checks from your (insert your own description here) ex-spouse are completely warranted. They also are completely taxable.

Alimony, separate maintenance payments and similar recompense from your former spouse are taxable to you in the year you receive them. Child support money, however, is not taxable. If your divorce decree calls for alimony and child support and specifies amounts for each, you only owe the IRS for the alimony payments. To avoid a big bill in April, make your IRS payments on alimony and other untaxed income via estimated tax filings.

The one good tax surprise here is for the ex who's paying spousal support. Those check amounts are tax deductible.

Forgiven debt

"Forgive but collect" is the IRS motto when it comes to canceled debt.

Getting your credit card bill cut from $8,000 to $4,000 certainly helped your personal bottom line. But it also could be a boon to the U.S. Treasury. Why? The tax law generally considers the amount you get any creditor to write off as earned, and therefore taxable, income to you. Expect the accommodating debtholder to send you (and the IRS) a Form 1099-C or similar statement detailing your discharge of indebtedness as miscellaneous income.

Not every debt settlement, however, has to pad Uncle Sam's pocket. Under the Mortgage Debt Relief Act that became law in 2007, some homeowners who are granted forgiveness of mortgage debt won't have to pay taxes on that amount.

There are some restrictions. The forgiven debt amount is limited to up to $2 million, or $1 million for a married person filing a separate tax return. The tax relief only applies to mortgage debt discharged by a lender between 2007 and 2012. And the forgiven loan must have been taken out to buy or build a primary residence, not a second or vacation home.

Prize winnings

Think you're pretty lucky because you won $1,000 in a radio contest? Uncle Sam is even luckier. He's due part of your winnings.

Prize winnings are included in the long list of "other" income that tax law says is taxable. And it's not just limited to cash awards. You have to pay taxes on the fair market value of any property you win.

Be careful when reporting the amount of a noncash prize. In most cases, companies and groups that award prizes, cash and property, will send you a 1099 form declaring the value of what you won. If your tax return reports substantially less than what the giver claims, your underreporting could mean a long, hard look from an IRS auditor.

And don't forget about gambling proceeds. They're taxable, too, but at least you get the chance to reduce the tax bite here by subtracting any betting losses from your winnings.

Some Social Security benefits

You spent the last 40 years fattening the U.S. Treasury thanks to those dang Social Security taxes that came out of every paycheck. Now you're retiring, and it's time to get your tax money back, free and clear, right?

Well, maybe. Maybe not.

Generally, if Social Security benefits are your only income, your benefits are not taxable. But if you collect Social Security plus other income, as much as 85 percent of those government checks could be subject to tax. To figure out just how much in taxes your Social Security might cost you, you'll have to do some calculating using the work sheet found in your tax Form 1040 or 1040a.

If you discover that you will owe taxes on some of your Social Security benefits, there are two ways to deal with them. You can make estimated tax payments on the government check amounts. Or you can have federal income tax withheld from your benefits by completing Form W-4V, Voluntary Withholding Request, and filing it with the Social Security Administration.

[Source: BankRate.com]