More tax season tips

February 27, 2011

Just a quick add-on to last week’s post, here are a few more quick tips to keep in mind during tax season…

  1. Don’t miss out on the Retirement Savings Contribution Credit (or Saver’s Credit). If you’re single and make less than about $30,000/yr, or married w/ a combined income of less than $60,000/yr, you may be eligible for this credit. If you contribute to an employer-based retirement plan, or to an individual retirement plan such as a Roth IRA or Traditional IRA, you can receive a tax credit for up to 50% of the amount you contribute to the account. It’s the IRS giving you money for giving yourself money. And if your employer does matching contributions, you can really leverage your contributions. More information available from the IRS.
  2. If you want to check the status of your refund after you’ve filed your return, go to the source: The IRS. You can use the “Where’s My Refund?” tool from the IRS to check on the status of your return after it’s been transmitted to them by your tax software or tax preparer. (Also available in Spanish.) This will be the most up-to-date information available about the status of your refund.
  3. Use the best filing status. It’s very common for newly married couples to want to file separately at first since they don’t feel like they’ve “merged” their finances. In nearly all cases, using the Separate filing status will result in a worse result. There are a few exceptions to that, but in general avoiding the Married Filing Separate status will save you a lot of money.

That’s all for this week. I’ll try to keep this updated with common errors we’re finding.


Avoid these simple tax mistakes

February 19, 2011

Now that tax season is in full swing, it’s going to be hard to stay updated with regular postings here, but I’ll do my best. In this article, and probably most articles through mid-April, I’m just going to provide some quick tips based on mistakes I’ve seen in reviewing returns that taxpayers have prepared on their own with tax software.

  1. Are you a registered domestic partner or have a same-sex spouse? If one partner’s employer provides health insurance to the other partner, this is unfortunately taxed as income on the federal tax return. However, California provides a deduction on the state return for this amount, and other states that have same-sex spouses and registered domestic partners may allow it as well. Check your state law. In California, it’s a subtraction from wages (reported on Line 7 of Schedule CA). And depending on your income and the cost of health insurance, this can save you several hundred dollars on your tax bill. NOTE: Many tax professionals miss this little-known deduction, so even if you had a professional do your taxes, you should double-check that they caught this.
  2. Do you pay for your own health insurance and receive income as an independent contractor? Make sure you deduct that health insurance. In general, medical costs must exceed 7.5% of income to be deductible, so many people just ignore these costs on their tax return. But in the special case of health insurance and self-employment earnings, you can actually take a deduction for the entire cost of health insurance in most cases. And for 2010, the health insurance cost also reduces your Self-Employment tax as well.
  3. Did you sell stock or other assets? Many people who don’t frequently sell stock or other assets, or who received it as a gift or inheritance, don’t know what their cost basis is in the asset. As a result, they pay much more tax on the sale than they should. Your cost basis is generally what you paid for the stock; plus the value of reinvested dividends. If you received stock from your employer, your cost basis is the amount that was reported as income on your W2. (Frequently this is the Fair Market Value of the stock, minus any amount you actually paid, on the exercise date.) If you received assets as a gift, your basis is whatever the donor’s basis was. And if you inherited assets, your basis is generally the Fair Market Value of the asset on the date of death of the decedent.
  4. Look closely for withholding on 1099 statements. Most people catch withholding on their W-2, but sometimes taxes are withheld on pension/IRA distributions (1099-R), unemployment (1099-G), Social Security payments (SSA-1099), and occasionally even interest payments or proceeds from stock sales (1099-INT and 1099-B). Don’t forget to take credit for these payments you’ve already made to the government! No need to pay the same tax twice.

These are just the most common mistakes I’ve seen in the last week or two. In my experience, the majority of self-prepared tax returns contain one or more mistakes. More often than not, they’re minor oversights like #4. These can be eliminated by simply carefully examining all of your tax documents, and carefully reading each screen if you’re using tax software. However, occasionally, there are deductions or credits that aren’t widely known and the software doesn’t do a great job of telling you about (like #1).  In these cases, a professional review is probably your best bet to uncover the mistake.

Another good resource to start with is IRS Publication 17.

Advantages for same-sex spouses in the tax code

February 8, 2011

This post is hopefully the first of what I hope will be several on this topic (though it may be a few months before I have time to return to it). I’ve been thinking lately about some of the ways in which Registered Domestic Partners and Same-Sex Spouses can take advantage of the tax code and their unique relationship status for their benefit. I’m certainly not saying that same-sex partners get a great deal under the current laws, but I have begun to see that a few opportunities do arise from the fact the Federal government has chosen to not recognize members of these relationships as spouses.

While taking a Graduate level course in estate taxation, I was recently introduced to Internal Revenue Code Section 2702.  This section was introduced to deal with “abusive” trusts that were being established to avoid Gift Tax on the transfer of assets to family members. Without going into too much detail, effectively what was happening was individuals were giving members of their family a “remainder interest” in property, while maintaining an “income interest” for themselves, by creating a trust that was set up to last for a specific period of time, say 15 to 20 years. When a gift is given, but the transfer doesn’t take immediately, the value is reduced to account for the fact that an asset you don’t receive immediately is worth less than an asset you do receive immediately. The IRS has tables to determine the value, and they’re based on the assumption the asset produces income. For items like land or art, there is no “income” from the item, so the tables produce ridiculously low values for what the asset will be worth when it is transferred in the distant future. This is considered an “abusive” strategy and Section 2702 prohibits family members from engaging in such transactions. But, if you wanted to give your same-sex spouse, or the descendants of your spouse, a gift under these terms, you’re free to do so. You can take advantage of the fact the IRS doesn’t legally recognize you as “family.”

This got me thinking, and I quickly came up with two more situations (more common situations!) where not being legally recognized as “family” could work to the advantage of same-sex spouses.

Like-kind exchanges (or 1031 exchanges) are a way to sell appreciated property without recognizing gain. There are special rules and restrictions that apply to like-kind exchanges between “related parties.” But once again, the IRS can’t legally consider same-sex spouses to be “related parties.”

Finally, the most common situation that same-sex spouses could benefit from is by having one spouse file as Head of Household. Filing Head of Household gets you better tax treatment than just filing single, and many couples with kids have tried to come up with various ways that one partner can file Single while the other files Head of Household — or both file Head of Household (because the combined benefits of two people filing this way is better than the rates for a married couple filing jointly). Most heterosexual couples will find the criteria very tricky for getting the Head of Household status…but not so for same-sex spouses. This is a great way to equalize treatment in separate property states. In community property states (like California), it’s a little tricker to pull this off, but it can be a very valuable benefit.

Now I must admit I’d much rather be able to simply help my same-sex spouse clients to file a Married Filing Joint return. The benefits of being treated equally I’m sure far outweigh the financial benefits of some loopholes in the tax code. But until that happens, I’m happy to find every loop hole I can to help same-sex partners get every benefit legally available.

Who knows? Maybe those opposed to same-sex unions will be so outraged when they find out about these “benefits” that they’ll realize what a waste of time and energy it is to try and create two separate classes of legal unions between people who love each other.

Harvesting capital GAINS

February 4, 2011

This is a bit of a rehash of a previous post on this topic. But the law has changed enough since then that I decided to rewrite this as a stand-alone without all the updates at the beginning.

There’s a popular tax strategy known as “harvesting losses” which has to do with strategically selling assets, generally stocks, that have lost value in order to generate tax savings. That strategy is widely discussed elsewhere; this post is about a similar strategy with a crucial difference…harvesting capital gains.

Legislation enacted at the end of 2010 extended through 2012 a provision of the tax code that allows long-term capital gains to receive very preferential treatment. Taxpayers who fall in the 10% or 15% tax brackets are able to recognize gains on the sale of capital assets (generally stocks, bonds, real estate, etc.) and pay 0% tax on the gain as long as you’ve held the assets long-term (i.e. more than a year). Yeah, 0, as in nothing. Generally if you’re single with taxable income of $34k or less or married filing jointly with taxable income of $68k or less, then you’re in the 10% or 15% bracket. (NOTE: Taxable income means after subtracting deductions, so your actual income may be much higher.) And for those with significantly higher incomes, you currently enjoy 15% capital gains rates which is near an historic low. After 2012, these rates are scheduled to go back up unless the government acts to change the laws enacted by previous administrations.*

So here’s one great strategy, especially for those who can recognize gains at the 0% rate: sell stocks that have gone up in value, then immediately buy back stock in the same or similar companies. Why would you do this? To save several thousand dollars potentially.

Here’s how: by selling the stock now (and immediately re-buying the stock), you increase the basis at no actual cost to you. Basis is how you determine how much gain you have from a stock, and therefore how much tax you have to pay, and the more basis you have, the better off you are. Here’s an example:

Let’s say a couple has $40k in taxable income. (To give a fuller picture, we’ll say they actually have a household income of $70k, but between their deductions and exemptions for themselves and dependents, their taxable income is only $40k.) Suppose that couple has invested $25k in stocks over the last couple decades, and those stocks are now worth $50k. Their basis at this point is $25k.

But if they sell the stocks at the current value of $50k, recognize the gain of $25k, then re-buy the stock at $50k, they’ve increased their basis (or investment) in the stock from $25k to $50k. The additional $25k of income gets $0 tax because their taxable income (even after adding the gain from stock sale) is still in the 15% bracket. To see the real value in this strategy, let’s see what happens in 2013…

…Imagine in 2013 the higher-earning spouse is laid off, and to cover expenses the couple decides to sell the stock. If the stock is still worth $50k, and they sold-and-repurchased the stock in 2011, they will recognize no gain (i.e. no income) from the sale and have no tax to pay. BUT, if they did NOT sell-and-repurchase the stock in 2011, then when they sell the stock in 2013 they will recognize a long-term gain of $25,000. Based on the law as currently written, they will have to pay a 10% tax on the $25k gain, or $2,500. So in this simple example, the couple saves $2,500 from this very simple strategy.

It’s also possible that this couple will hold the stock for many years, during which time their income and personal tax bracket may rise, or tax rates in general may rise, or both. Regardless of what happens, the $25k in increased basis represents $25k that will never be taxed in the future (barring a complete legal overhaul of the nature of income tax in this country…which would be an event nobody can plan for anyways).

In general, if you’re in the 10% or 15% tax bracket, and have appreciated assets that can easily be sold and replaced (e.g. stocks and bonds), then you should strongly consider selling these assets and repurchasing similar (or same) assets in 2011 or 2012. This strategy may also make sense for upper income taxpayers as well, if they expect to sell assets in the next few years anyway, and do not anticipate their income going down substantially.

Of course, it’s always a good idea to review your specific situation with a tax professional before taking action. This advice cannot possibly take into account every variable that could affect your tax situation. I will point out one useful tool you can use, if you’re reasonably familiar with your own tax situation, is TaxCaster from TurboTax. Here you can enter all of your current information (income, deductions, marital status, dependents, etc.) and get a very good estimate of what your tax liability will be. Then go to the “Other Income” category of the app and in the “Gains/Losses (long-term)” category you can enter the gain you would recognize by selling appreciated stock you own. TaxCaster will immediately recalculate your tax liability with this new information. If your “Total Income” changes, but not “Your Refund”, this means you will likely not pay any additional tax by selling that stock. You can effectively increase your basis in the stock at no cost, potentially saving you thousands of dollars in taxes down the road.

A couple final NOTES: If your stocks pay large dividends, and the gain relative to the total value of the stocks is small, then this strategy also might not make as much sense. The reason is that by repurchasing the stock, you’ll lose preferential “qualified dividend” treatment on the stock for a year. In most cases, this effect will be very small relative to the basis increase that you gain. But in rare cases–with large dividends and relatively small built-in gains–the effect of losing qualified dividend status for a year might offset the gains from increasing your basis. ALSO, this analysis does not consider the impact of state taxes. States generally offer no special benefit for long-term capital gains, so you’ll likely recognize income at your regular state rates.

*Of course, the political process is unpredictable and I make no claims on psychic powers. The 0% rates could be extended indefinitely, they could go up to 50%, it’s anybody’s guess.

Ten Tax Benefits for Parents

February 1, 2011

Having a child is about a lot more than tax breaks…but the tax breaks sure don’t hurt! Here’s 10 tax “benefits” for parents from the IRS…though I don’t quite agree with the IRS that numbers 6 & 7 are “benefits.” You be the judge… (I’ll throw in a couple more at the end to make it a true 10.)

  1. Dependents In most cases, a child can be claimed as a dependent in the year they were born. For more information see IRS Publication 501, Exemptions, Standard Deduction, and Filing Information.
  2. Child Tax Credit You may be able to take this credit on your tax return for each of your children under age 17. If you do not benefit from the full amount of the Child Tax Credit, you may be eligible for the Additional Child Tax Credit. For more information see IRS Publication 972, Child Tax Credit.
  3. Child and Dependent Care Credit You may be able to claim the credit if you pay someone to care for your child under age 13 so that you can work or look for work. For more information see IRS Publication 503, Child and Dependent Care Expenses.
  4. Earned Income Tax Credit The EITC is a benefit for certain people who work and have earned income from wages, self-employment or farming. EITC reduces the amount of tax you owe and may also give you a refund. For more information see IRS Publication 596, Earned Income Credit.
  5. Adoption Credit You may be able to take a tax credit for qualifying expenses paid to adopt an eligible child.  Taxpayers claiming the adoption credit must file a paper tax return because adoption-related documentation must be included.  For more information see the instructions for IRS Form 8839, Qualified Adoption Expenses.
  6. Children with Earned Income If your child has income earned from working they may be required to file a tax return. For more information see IRS Publication 501.
  7. Children with Investment Income Under certain circumstances a child’s investment income may be taxed at the parent’s tax rate. For more information see IRS Publication 929, Tax Rules for Children and Dependents.
  8. Higher Education Credits Education tax credits can help offset the costs of education. The American Opportunity and the Lifetime Learning Credit are education credits that reduce your federal income tax dollar-for-dollar, unlike a deduction, which reduces your taxable income.  For more information see IRS Publication 970, Tax Benefits for Education.
  9. Student loan Interest You may be able to deduct interest you pay on a qualified student loan. The deduction is claimed as an adjustment to income so you do not need to itemize your deductions. For more information see IRS Publication 970.
  10. Self-employed health insurance deduction If you were self-employed and paid for health insurance, you may be able to deduct any premiums you paid for coverage after March 29, 2010, for any child of yours who was under age 27 at the end of 2010, even if the child was not your dependent. For more information see the IRS website.

The forms and publications on these topics can be found at or by calling 800-TAX-FORM (800-829-3676).


IRS Forms and Pubilcations

IRS YouTube Videos

OK, so here’s the benefit the IRS “forgot” to mention on number 7. Though a child’s investment income is generally taxed at the parents’ rate if there is more than $1900 in investment income, there’s still an opportunity to lower your tax bill just a little bit by giving investments to your children. A single parent can give each child $13,000 in investment assets before triggering the requirement to file a gift tax return…married parents can give $13,000 each, or $26,000 total to each child. Do this for several years, and you could have assets earning significant income.

This used to be a very popular tax dodge for affluent individuals, so the IRS has limited the tax-free and reduced-tax earnings to relatively small amounts. However, if you’re planning to give assets to your children anyway, placing those assets in the child’s name now (with appropriate safeguards to make sure the assets aren’t all used in the iTunes Store) can reduce your tax bill by several hundred dollars each year.

And finally, to give us 10 TRUE benefits, you might consider contributing to a Qualified Tuition Plan for your child. You don’t get a deduction for contributions to these plans, but the earnings within the plan are tax-free as long as the funds are ultimately used for the qualified education costs of the plan beneficiary. Most states have their own “flavor” of these plans, with various tax incentives on your state tax return, so check with your bank or financial institution to see what’s offered in your state.