Tax Detective Tips

January 30, 2014

If you’re like me, the most daunting task at tax time is just gathering all the info you’ve collected throughout the year that’s needed to fill out your return (yes, this is even true of tax professionals) . Unless you’re blessed/cursed with the habit of neatly organizing and filing every scrap of paper or email receipt you receive, you’re probably concerned about missing something…and there’s a good chance you might.

Maybe you’ll forget about an account that earned a little interest, or a short-term job you took last spring…although of course if you miss some income the IRS is usually happy to remind you with a nice letter–as well as some interest, and maybe penalties, for the service. Or you might forget an important deductible expense, in which case the IRS is not nearly so reliable in terms of sending you a reminder…instead the value of that deduction may simply be lost forever if not caught.

So here’s a few tips to help you miss fewer income and deduction items when you file…

Income Items

  • The best tip to help not overlook income items is don’t rush to file your return. Yes, just about all employers and banks and other institutions that report income are supposed to provide you with the right forms by January 31. But, the reality is often these items come late…or they go to the wrong address…or you get a W-2 or 1099 in late January only to get a corrected form in mid-February. For all but the simplest situations, I generally don’t advise people to file before mid-February…the odds are just too high that you’ll wind up missing something and then filing an amendment later, or getting a letter from the IRS about missing income. (Anxious to get a big refund? Next year try adjusting your withholding so you get more money during the year and don’t have to wait for your tax refund.)
  • Don’t rely on the postal service. Not to knock the postal service, it’s just that more and more companies are starting to use electronic delivery of tax documents as the default. You might not even notice when signing up for an account that you opted for this…in many cases you have to actively elect to have paper tax documents mailed instead of delivered electronically. So at the end of January, log into your bank accounts and any other financial accounts you have and look for a “tax documents” link. At this time of year, most online accounts will make this information pretty easy to find.

Deduction Items

  • Once again, go online. Rather than waiting for items to show up in the mail, try some of these resources:
    • Own a house or other real estate? If so, start by logging into your mortgage lender’s website. You’ll probably be able to access your Form 1098 that will list your mortgage interest paid and, in some cases, your real estate taxes paid. If your real estate taxes aren’t on Form 1098, try your county website! For example, both Alameda County and Contra Costa County, where I have a lot of clients, allow you to look up taxes paid on a property just by entering the address. Just try googling “lookup property taxes paid [your county name]”. (You may need to add the state if you’re in a county with a common name.)
    • Take any classes during the tax year? What about the previous year, or starting right after the end of the tax year? Log into the student finances portion of the school website and look for Tax Form 1098-T. While you’re logged in, you might be able to check your student activity to see when they actually received payments. (I’ve seen numerous 1098-T’s that didn’t get the year right on payments, so it’s good to double-check when the school actually credited your account if you can.) And don’t forget if you have a student loan to check what you paid there. This will appear on Form 1098-E. (Noticing a pattern here? When looking for deductions, Form 1098 is often what you’re looking for.)
    • How about car registration? This one may not be a big-ticket item, but it can help get a little extra savings if you’re already itemizing your deductions. You might not have saved the renewal notice with the amount, but in most states you can look it up online. Here in California, you just need your license plate and the last 5 digits of your VIN number to look up the deductible Vehicle License Fee for your vehicle.
  • Review your bank and credit card statements. Yeah, this is probably a lot of info to sift through, but this mining exercise often pays off when you find that big expense from a year ago that you’d completely forgotten about. Of course, you can make this process much easier if you pro-actively follow the next couple tips…
  • Use separate accounts whenever possible. If you have any type of self-employment income, even just an occasional freelance activity, you really should get an account that’s just for income and expenses from that activity. This will make it much less likely that you’ll miss something deductible. This also applies to rental property. Having a separate account for each business or rental activity is generally a good idea for a variety of reasons, and this is one of them. (However, don’t forget the rule that just because you pay for something with a “business” account doesn’t automatically make it a “business” expense…you still have to be disciplined to only use each account for its intended purpose.) And while it may not make sense to have a separate account for your mortgage, a separate account for charity, etc. it might still make sense to pay all of your deductible expenses (charity, mortgage, medical, etc.) out of a single account if you have multiple personal accounts. Again, this will just make it that much easier at the end of the year to identify your deductions by having them all in one place.
  • Finally, use apps. There are numerous apps and online tools like that allow you to collect all your transactions in one place and quickly categorize them. (Most sites automate the categorization to some degree, but this is usually hit-or-miss so it’s best to review how they’re categorizing things periodically.) Personally, I really like Expensify for my business. Expensify provides a smartphone app that you can use to quickly snap pictures of receipts with your phone and upload them to your account where they’re automatically scanned and categorized. (You can also import transactions from many banks and credit card companies.) What I like about this is that in addition to collecting and sorting your data, the picture of the receipt is stored and you can create a PDF with copies of all your expenses and the receipts to go with them. So if you’re audited and have to provide supporting evidence for your expenses, just print the report with all the receipt copies and get ready for the most quick and painless audit you can imagine.

Lots of accountants and tax software promise to find every single deduction or credit you’re eligible for. But the simple fact is if you don’t bring all the right info to the table, only Nostradamus can actually find everything for you (and last I heard he’s no longer accepting new clients). Hopefully these tips will help you wring out a little extra savings on your tax return…and maybe offer some shortcuts in finding all the right info too.


Tax changes for 2013…wrapping up

January 23, 2014

As we’ve seen in the last few weeks, 2013 was a relatively calm year in terms of tax changes. (Of course there’s plenty of sources that benefit from saying there’s been enormous, far-reaching changes — usually in breathless, hyperbolic language — and they’re at it again this year.) There’s been an enormous change affecting a very small percentage of taxpayers (federal government allows same-sex married couples to file joint returns). There’s been a more modest change affecting a comparably small percentage of taxpayers (those with income in top 1-2% experience tax increases that are quite modest by historical standards). And there’s been another modest change affecting a slightly larger percentage of taxpayers (new method for deducting home office expenses).

This week, I’ll finish with a look at a couple more minor changes affecting a modest number of taxpayers.

Taxpayers with significant medical expenses will be able to deduct less of those costs in 2013. Medical expenses have always been challenging to deduct. Not only do you have to itemize your deductions, but you also must have expenses that exceed 7.5% of your Adjusted Gross Income (AGI). Beginning in 2013, and only for taxpayers under age 65, the threshold you must exceed goes from 7.5% to 10%. So, for example, if you have an AGI of $100,000 and $10,000 in medical expenses, you would have been able to deduct $2,500 in 2012 ($10,000 – 7.5% of $100,000). But in 2013, this same scenario results in no deduction, because 10% of $100,000 is $10,000, which leaves nothing left to deduct.

The last change isn’t one that really shows up in the bottom line, but is a really nice change when it comes to planning. (So, of course, tax preparers love it!) The Alternative Minimum Tax (AMT) has finally been permanently indexed to inflation. This means taxpayers no longer have to wait until Congress passes legislation each year (usually at the very end of the year) to know what the inflation-adjusted tax brackets will be for purposes of the AMT. Without these annual fixes, the AMT would have wound up significantly increasing the tax liability of many middle-class taxpayers. It never actually did have this effect…Congress always would make the inflation adjustment…but it was always frustrating to not know the impact of AMT until the very end of each year. Now that AMT is permanently indexed to inflation, this annual exercise in Congressional procrastination is over.

So that’s about it for 2013. There’s some more fiddling around the edges, but nothing of significance for any significant percentage of taxpayers. Of course, that won’t stop politicians and media types from cranking up the hype machine for another tax season. Enjoy the fireworks!

Those enormous tax hikes…and some context

January 16, 2014
This is the 3rd  installment in a multi-part series on significant tax changes that took effect in 2013.
Amid much sound and fury, some (historically speaking) rather modest tweaks to the tax brackets were made in 2013. These will actually affect a very small percentage of taxpayers…if your Adjusted Gross Income (AGI) is less than $200,000, you’re in the clear.
But for those making more than $400,000-$450,000 (depending on filing status), the tax rate on income above that threshold will rise from 35% to 39.6%. This matches the highest level (in place through most of the 1990’s) that’s existed in the last 25 years, although it’s still much lower than the top rates from 50% to 94%(!) that existed for nearly all of the fives decades before the 1980’s. At this same income level, a new top rate for long-term capital gains and qualified dividends kicks in. This top rate will rise to 15% from 20%. This represents a continuation of long-standing policy to tax certain types of “unearned income” (government term) at significantly lower rates than “earned income”. (Tax policy gold star if you can name the only president to sign into law a bill that equalized tax rates for “earned” and “unearned” income…answer at end.)
There’s also an additional wrinkle for those with taxable income exceeding $200k-$250k (again depending on filing status). Most investment income will now be subject to a 3.8% Net Investment Income Tax (NIIT). This is in addition to the income tax ordinarily levied on that income. So long-term capital gains and qualified dividends now actually have an effective top rate of 23.8% (20% top rate plus 3.8% NIIT). Other types of investment income (interest, non-qualified dividends, rental income, most passive activities) now have an effective top rate of 43.4% (39.6% top rate plus 3.8% NIIT).
If you were considering selling stock with a large capital gain in 2012, hopefully you planned ahead and sold the stock before 2013 to avoid the new higher rates. If not, you can at least take solace in the fact the current capital gains rates are not the highest they’ve been in the last 35 years. In fact, that brings us to the answer to the earlier question about the only president to equalize tax rates for all types of taxable income: There was one brief period — in the late 1980’s — when “unearned” income was taxed at rates as high as “earned” income. As a result, capital gains were taxed at the highest rate of the last 35 years, a (by comparison) whopping 33%…thanks to President Reagan who signed this legislation into law.
If you guessed anti-tax crusading President Reagan raised capital gains taxes to the highest level of the last 35 years, you win a Nobel No Prize!

News for tax year 2013…Post-DOMA edition

January 9, 2014
This is the 2nd installment in a multi-part series on significant tax changes that took effect in 2013. This week I’ll look at something that affects a pretty small portion of taxpayers…but in a very big way.
The Supreme Court decision to strike down the Defense of Marriage Act (DOMA) in 2013 came as great news to many people in 2013, especially the same-sex couples who may now have their marriages recognized by the federal government. Couples affected by this ruling should be aware of some key issues as they head into tax season.
First of all, the Supreme Court decision applies only to legal “marriages”. So if you’re in a Registered Domestic Partnership, Civil Union, or similar “marriage-ish” legal relationship, the Supreme Court decision changes nothing for you. The good news is even if you live in a state that doesn’t recognize gay marriage, the IRS will recognize a marriage performed in any state where it is legal, regardless of what state you legally reside in. (Of course, if you benefit from one of the handful of loopholes that were available to same-sex couples with non-legally-recognized marriages, this might not be good news for you…maybe staying as RDPs might make financial sense in some less common cases.)
Here’s a few things to keep in mind during the first “post-DOMA” tax season:
  • States are still free to choose whether or not to recognize gay marriages. This means that even though you can now file a federal return together as a married couple, you still might have to deal with filing Single returns at the state level. States are taking a number of different approaches to this…some states are allowing you to use the same status as your Federal return, others are requiring you to prepare separate state returns as though you were un-married. So if you’re in a same-sex marriage but living in a state that doesn’t recognize it, it’s a really good idea to seek professional guidance in preparing your tax returns for 2013.
  • You have the option (but not requirement) to amend any year between 2010 and 2012 in which you would have paid lower overall tax by filing jointly. For many couples I work with, the community property rules in California effectively mean there is little to no benefit to amending prior year returns. (As mentioned earlier, in some cases same-sex couples benefited from loopholes.) However, if you were in a same-sex marriage in 2012 or a prior year, and one spouse received health insurance from the other spouse’s employer, then it may very well be worth amending the prior years. This is another area that can be complicated, so professional guidance is recommended.
  • Also, even if it’s not worth amending your income tax return, you might still want to file for a refund of excess employment taxes if you had “imputed income” as a result of your employer taxing your spouse’s health benefits. The IRS recently issued instructions for employers to file for a refund of their half of these employment taxes, but your employer should contact you about reimbursement of employment taxes you paid. However, even if your employer doesn’t contact you, you still have the option of filing on your own for this reimbursement…which may be necessary for years before 2013 because I suspect many employers won’t go through all the trouble of following this procedure for previous years when it’s relatively small amounts involved for most employers (compared to the cost of amending prior year payroll records). I know this gets pretty confusing, but basically if you have a legal same-sex marriage, and one spouse received health benefits from the other spouse’s employer, contact a professional who’s familiar with this ruling to see if you may be eligible for a refund of taxes that were paid as a result of the IRS not recognizing your marriage.

So the vast majority of couples in same-sex marriages should see a tremendous simplification of their tax-filing requirements in the post-DOMA world…although some couples living in states that don’t recognize their marriages may have some new wrinkles to deal with. Even in states that recognize gay marriage, couples should still consult a professional in this first year in order to review the potential for refunds from prior years.

Review of tax changes for 2013…first installment

January 2, 2014

For all the rhetoric coming out of Washington, 2013 was actually a fairly calm year in terms of tax changes…at least in terms of tax changes that will affect many people. Although as we’ll see next week, a small percentage of filers actually experienced an enormous change. (Hint: it involves a Supreme Court decision…)

So without any big, sweeping changes to talk about, I’ll touch on a handful of changes over the next few weeks that will either affect a fairly significant portion of taxpayers, or have a very large impact on a small portion of taxpayers. This week I’ll start with an item that affects a fair number of taxpayer…the home office deduction.

The home office deduction is one of the more complicated pieces of the tax code that people commonly encounter. But in 2013 the IRS announced it will offer a very simplified option for taking the home office deduction. As I’ll explain, this option will be beneficial for most home-owners, especially in low cost areas. On the other hand, most renters, especially renters in expensive areas, will want to pass on this option. (Fortunately, the simplified option is just that, an option. You can still calculate your home office deduction under the old rules if you prefer.)

First, a quick background. The home office deduction is available to anybody who uses a portion of their home regularly and exclusively for business purposes. This part hasn’t changed.

Under the old method, the amount of the deduction was calculated by finding the ratio of the square footage of the home office to the entire square footage of the home. This ratio was then multiplied by various expenses related to maintaining a home such as utilities, insurance, mortgage interest, rent, etc. In addition, there are various instructions related to which expenses are always deductible, which expenses are only deductible to the extent of business profits, and so forth.

Under the new method, any area that meets the definition of a home office is eligible for a deduction of $5 per square foot, up to a maximum of 300 square feet (or $1500). So, for example, if you use a 200 square foot room as a home office during the tax year, you can deduct $1000 as a home office expense.

Homeowners can still deduct the full amount they pay for mortgage interest and real estate taxes on Schedule A. Homeowners no longer deduct depreciation, which means no longer having to track depreciation over time and add that depreciation to income when the home is later sold. For these reasons, many homeowners will likely benefit from using this simplified method. In addition to fewer record-keeping hassles, many homeowners will actually get a larger deduction overall when considering that mortgage interest and real estate taxes will still be fully deductible. This won’t be true in every case, particularly if you pay a lot for utilities, home insurance, or other expenses that aren’t otherwise deductible. But as a general rule, if you own your home, you might want to consider using the simplified method.

For renters, on the other hand, you’ll probably want to continue tracking what you pay in rent and other costs so you can keep using the standard method. The reason for this is simple — you usually can’t deduct rent unless it’s a home office expense. So, let’s say you rent in even a low-cost area where you pay only 50 cents per square foot in monthly rent (this works out to $750 per month for a 1500 square foot home, just to give you an idea). Even at this rate, you’re paying $6 per square foot each year in rent alone. Plus you’re probably paying utilities on top of that, and maybe even insurance and some other costs as well. So being able to deduct $5 per square foot isn’t a particularly good deal for you. And if you’re in a high-rent area, like the SF Bay Area, you’re probably paying at least $1 per square foot each month, or $12 per year, so taking a deduction of only $5 per square foot doesn’t make much sense.

It’s a common trade-off in the tax world. Everybody claims to want simplification. But the downside to simplification is some people pay more and some pay less. And not many people like simplification if it means they pay more in tax. Fortunately in this case, every taxpayer has the choice. If taking the simplified option will mean a much smaller deduction for you, then keep doing things under the old method. But if you can save money, or even come out close to even, then your tax return will be getting a little simpler in 2013.