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 1. The Gift That Ends Up Taking You probably know you need receipts to back up any donations of $250 or more. But did you know you must actually have those receipts in hand by the time you file? Otherwise, the tax law says no write-off is allowed. Period.
Speaking of donations: If you contributed a used car to charity last year, you are — through no fault of your own — on shaky ground with the IRS. But you can firm things up. I recommend attaching a statement to Form 8283, Non-cash Charitable Contributions. In it, describe the car's age, condition and mileage, and include photocopies of classified ads for comparable cars. Why all the trouble? Many taxpayers have been claiming excessive deductions for donated clunkers. So the IRS is now more likely to scrutinize any return with a used-car donation. |
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2. The Rollover Fumble This is something I messed up on my own return a few years ago. Say you left your old job or retired in 2001 and rolled over your retirement account, tax-free, into a traditional IRA. What you'd receive from your former employer is a 1099-R that shows a taxable retirement-account distribution, even though it was tax-free. Or maybe you rolled over an existing IRA tax-free from one brokerage house to another. Again, you'd receive a 1099-R showing a taxable distribution, even though you didn't actually have one.
The solution: Include the 1099-R figure on Line 15a of your 1040 (or Line 16a if it was a retirement-plan distribution). Then show the taxable amount — zero if you rolled everything over — on Line 15b or 16b, respectively. Be sure to write "Rollover" next to Line 15b or 16b. Blank lines will trigger an IRS inquiry about why you failed to account for the distribution shown on your 1099-R. Then — like me — you'll become pen pals with the government as you try to explain what happened. Not fun. |
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3. Home Cooking If you bought an existing home last year, you may find a tax goodie buried under the blizzard of paperwork. I'm talking about your right to deduct any mortgage points paid by the seller. I know that being able to write off an expense someone else has paid for sounds too good to be true. But it is true, so don't overlook it. The only catch: you must reduce the tax basis of your new home by the amount of seller-paid points that you deduct. That will mean a bigger profit when you sell, but since you can usually exclude home sale gains up to $250,000 ($500,000 if you are married), the bigger profit probably won't actually result in any extra taxes.
Another little known deduction: If you refinanced the mortgage on your home and paid any points, you have been slowly amortizing the cost of those points over the life of the loan. But say you sold your home in 2001. Many people forget they can deduct the unamortized balance in the year of sale. Use the write-off on Schedule A as "qualified residence interest."
Here's another deduction many people miss simply because they aren't aware of it: If you sold a house last year, take a look at your real-estate closing statement. It probably shows that you prepaid a portion of the property taxes that came due after the date of sale. You can deduct this amount on your return. |
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| 4. Mutual Contempt Were all of your 2001 long-term capital gains from mutual funds distributions? If so, check the box on Line 13 of your 1040. Then compute your tax using the Worksheet in the 1040 instructions. This ensures you'll benefit from the lower long-term capital-gains rates without having to fill out the dreadfully complicated Schedule D. If you do nothing, your long-term gains will be taxed at your regular income-tax rate (up to 39.1% for 2001). |
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5. Who's in Charge Here? One of the most common mistakes I see is people filing as single taxpayers when they qualify for the much-more-favorable head-of-household (HOH) filing status. After I advised a client about this issue last year, he took my advice to his accountant. A few weeks later, amended returns claiming refunds for the last several years appeared in his mailbox. And needless to say, I am now his sole tax preparer!
Say you're single and your unmarried child lives with you. If you pay more than half the household's costs, you qualify. This is true even if your child had too much 2001 income (over $2,900) to be claimed as a dependent. You may also qualify if you are still married and lived with your child but apart from your spouse for at least the last half of 2001.
Finally, if you are single and can claim your parent as a dependent, you can probably file as HOH. This is true even if your parent has his or her own place. You are the HOH if you pay more than half the cost of your parent's home. |
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| 6. New Kid on the Block If you have a little bundle of joy who was born last year, don't forget to sign them up for a Social Security number before filing. It's required to claim your rightful personal exemption write-off ($2,900 for 2001). This requirement is non-negotiable. What happens if you file without the number? The IRS will disallow the exemption, recompute your tax, and either send you a bill or mail you a lower-than-expected refund. To get a number for your new child, fill out Form SS-5 (Application for a Social Security Card). To get Form SS-5, call the Social Security Administration at 800-772-1213 or visit the SSA's Web site at http://www.ssa.gov. |
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7. Exemption for College-Age Child Those new college-education tax credits are tasty. Unfortunately, they are phased out starting at an adjusted gross income (AGI) of $80,000 for joint filers and $40,000 for singles (complete phase out occurs at an AGI of $100,000 and $50,000, respectively).
When your income is way too high to take advantage, claiming your college-age child as an exemption could turn out to be a mistake. Why? Because if you forego the exemption ($2,900 for 2001), your child can use the education credit against his or her tax bill. On your side of the equation, giving up the exemption may actually cost you little or nothing. This is because the exemption is phased out between an AGI of $199,450 and $321,950 if you file jointly and between $132,950 and $255,450 if you are single. Remember: this strategy works only if your child had enough income last year to owe taxes (otherwise, the credit has no value to your child). |
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| 8. Tax Shelters 101 - Start A Business This is not for everyone, but if you have even an ounce of entrepreneurial spirit you can make it work, and have fun while doing so! Congress has long since realized the benefits of promoting capitalism, and they reward small business owners handsomely for adding to our economy. The most important strategy (and thankfully one of the easiest) for business owners is to use "pre-tax" or "business" dollars to pay for items that also provide personal benefit. From health insurance to new cars to family vacations a small business can help you stretch your dollars farther than any other tax shelter! And nearly any activity that you enjoy can qualify, from giving golf lessons to basket weaving. You will need to prove an honest attempt at managing the business, as well as evidence of a profit motive, or the IRS will consider your enterprise a "hobby" and disallow any deductions. However, properly structured, a home-based business can be both fun and financially rewarding beyond just the profit you make. |
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9. Get Out Of Debt Free Well, almost! Trading consumer debt for mortgage debt isn't exactly free, but it can be a lot closer to interest-free than your actual credit card rate if you have good credit and a properly structured mortgage. Suppose that you own real estate and haven't borrowed as much money as a mortgage lender would allow, and also carry consumer debt. You probably can refinance your mortgage and pull equity out to pay off credit cards or other expensive consumer debt lines. You can usually borrow at a lower interest rate for a mortgage, thus lowering your total monthly interest bill. Plus you may get a tax-deduction bonus, because consumer debt is not tax-deductible, but mortgage debt usually is (up to certain limits). Therefore, the effective borrowing rate on a mortgage is often lower than the quoted rate suggests.
Swapping consumer debt for mortgage debt involves one big danger: Borrowing against the equity in your home can be an addictive habit. I have seen cases in which people run up significant consumer debt three or four distinct times, then refinance their home the same number of times over the years to bail themselves out. At a minimum, continued expansion of your mortgage debt can handicap your ability to work toward other financial goals. At worst, it encourages bad spending habits that can lead to bankruptcy or foreclosure on a debt-ridden home. |
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10. Where's the Cash Flow? So you won't have the money to pay the feds by April 15? Don't make the common — and expensive — mistake of ignoring your tax-filing requirement until you've rounded up the bucks. Instead, you should either file your return by the deadline or apply to get an automatic extension until Aug. 15.
Either way, you can defer paying your tax bill until later. Sure, you'll be charged penalty interest. But the current rate is only 1% a month. (The rate is adjusted quarterly, so it may be higher or lower by the time you read this.) If you do nothing, you'll be penalized to the tune of 5% of the unpaid balance per month, up to a total of 25% (after five months). After that, you'll be charged interest at the 1% monthly rate. So, what if you extend until Aug. 15 and are still short on cash when that date rolls around? You can then try to arrange for installment payments of your tax debt. (Use IRS Form 9465 — Installment Agreement Request — to apply for an installment deal.) Alternatively, consider charging your tax bill on MasterCard, American Express, or Discover. The government now conveniently accepts all three. |
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