20 Foolish Tax Tips
Tax Preparation
March 18, 1998

Preparing your taxes can be a difficult undertaking, whether you use a computer tax preparation program, do them by hand, or even hire a tax pro. Regardless of what method you use, use these 20 Foolish Tax Tips before you sign your tax return and mail it into Uncle Sammy.

Income and Adjustment Items:

1. File when you should: You, or your children, or even your elderly parents may not technically be required to file a tax return, but if you worked for wages and/or had federal taxes withheld, the only way you can recover those federal taxes is to file a return and claim a refund.

2. Use the "Qualifying Widow/Widower" filing status: If you were unfortunate and lost your spouse in 1996, or in 1995 and have at least one dependent child in your household, and you have not remarried, there is a special filing status for you that will save you tax dollars.

3. Use the "Head of Household" filing status when your ex-spouse claims the child as a deduction: You may have negotiated the tax deductions to your ex during the divorce (usually allowed when the ex makes timely child support payments). Nevertheless, you may still use the Head of Household filing status if the children actually reside with you and you have physical custody of the kids.

4. Don't report too much wage income: If you have a deferred compensation plan at your place of employment (401k, 403b, etc.), remember to report as wages only that amount reported to you in Box 1 of your W-2 form. Don't report the salary that you actually earned.

5. Don't report interest on Series E, EE, or Treasury bonds/bills/notes on your state tax return: Remember that while this interest is taxable for federal purposes, it is not taxable for state purposes. Remember to make the appropriate adjustment on your state tax return.

6. Segregate your mutual fund capital gains distributions from your regular distributions: Remember that capital gains receive a special lower tax treatment. When you report your mutual fund dividends on Schedule B, pay particular attention your capital gains distributions as reported to you on your mutual fund statement. Make sure to "back out" those capital gains distributions on Schedule B, line 7, and carry them directly to Schedule D. Don't pay ordinary rates on capital gain income.

7. Add your broker commissions and other fees to the cost of your stock: When you buy stock, you'll pay broker commissions. You may also pay transfer fees. These expenses are added to the purchase price of the stock, and remain with the stock until sold. When you sell the shares, make sure to include these expenses with your actual stock purchase in the "Cost or Other Basis" section of Schedule D.

8. Maximize your IRA contributions: Did you know that alimony received is considered "earned income" for IRA contribution purposes? Did you also know that even if your spouse is a homemaker with no W-2 earned income that you may still be able to make a full $2,000 IRA contribution for him/her? These contributions may or may not be deductible, depending upon your individual circumstances. But they are available to you.

9. Note any penalties for early withdrawal: Did you have to close out that bank Certificate of Deposit early in order to make your latest stock purchase? If so, you most likely paid an "early withdrawal" penalty that you can use as an adjustment to your taxable income. See Form 1040, line 29.

Itemized Deduction Items:

10. Property tax deduction for second homes and/or investment property: Many people are under the impression that property tax deductions are only available for your primary residence. Nothing could be further from the truth. Property taxes are deductible for all real property, third or fourth homes, vacant lots, raw land, etc.

11. Investment interest: Did you pay a little (or a lot) of interest to your broker on your margin account? Did you pay some interest to a finance company to buy that raw land investment property? If so, you may be the proud owner of deductible investment interest. The rules can get pretty complicated, so make sure to check out IRS Form 4952 and instructions.

12. Refinance points: Did you refinance your primary or secondary residence in 1997? If so, you may have paid loan "points." You may be able to amortize those points over the life of the loan and generate an additional interest deduction. For additional information, check out the instructions for Schedule A in your 1997 Form 1040 Forms and Instructions booklet.

13. Charitable travel: Do you use your auto for charitable purposes? If so, you can deduct 12 cents per mile for all qualified charitable travel. Not only that, you may deduct your out-of-pocket expenses when you are serving a qualified organization (for example: Scout leaders can deduct the cost of uniforms).

14. Non-Cash Charitable Contributions: Did you give that old couch to Goodwill Industries? Or how about those clothing items to the Salvation Army. Don't forget to get those receipts and deduct the FMV of those items as a charitable contribution. Not sure how to place a value on the stuff? Check out http://www.taxsave.com. For a fee of $15, you can buy a list of prices for these goods. And since most people underestimate the value of the goods, you might be able to recover the cost of the listing in the form of reduced taxes. For additional information, check out IRS Form 8283 and instructions.

15. Exchange Students and Foster Children: You may deduct, as a charitable contribution, up to $50 per school month for housing an exchange student (grade 12 or lower) sponsored by a qualified organization. You may also be able to deduct, as a charitable contribution, expenses that exceed payments received from a charitable organization for providing support for qualified foster care individuals placed in your home.

16. Investment Expenses: Many investment expenses (such as investment legal and professional fees, fees for investment advice, fees for tax preparation/advice, investment and/or tax books, magazines, subscriptions, safe deposit box fees, IRA custodial fees, certain investment travel expenses, and certain investment entertainment expenses) may be deducted as a miscellaneous itemized deduction on Schedule A. For additional information regarding investment expenses, see IRS Publication 550.

Tax Credits and Other Items:

17. Child and Dependent Care Credit: Mom and Dad both work? Had to pay somebody to watch Junior while Mom and Dad are at work? Well, if Junior is under age 13, Mom and Dad may qualify for the dependent care credit. How about if Mom works but Dad is a full time student with no earned income? The dependent care credit may still be available. Don't forget about a spouse who is disabled and can't care for him/herself. Even if there are no children involved, the dependent care credit may still be available. For additional information, check out IRS Form 2441 and instructions.

18. Foreign Tax Credit: Do you have mutual funds that invest in international stock? Or do you own individual stocks that are foreign based? If so, you probably are charged a "foreign tax" on the dividends that you receive. Not sure how to report those foreign taxes? You can certainly take them as an itemized deduction. But for those of you who don't itemize, or find it more valuable to take the credit, you can complete IRS Form 1116 and take those foreign taxes as a credit against your U.S. taxes.

19. Excess Social Security Withholding: Did you work more than one job? Did you receive more than one W-2 form? Were the total wages paid to you by those two (or more) employers greater than $65,400? If so, it is likely that you have excess social security taxes withheld. You can recover those excess social security taxes on Line 58 of the Form 1040. If you look in your 1040 Forms and Instructions book, you'll find a worksheet to help you determine if excess social security was withheld from your wages, and the amount to report on Line 58.

20. Estimated Tax Penalty: You complete your taxes and find that your balance due to Uncle Sammy is greater than $500. Oops. You may have entered the "underpayment penalty" zone. You may be inclined to compute an underpayment penalty and pay that penalty with your tax return. Or, Uncle Sammy may compute that underpayment penalty and bill you later. But there are a number of "safe harbors" that you may fall under that may allow you to avoid the underpayment penalty. For a complete discussion of the underpayment penalty, see my article entitled Estimated Taxes in the Taxes FAQ area.

So there you have it. If you recognized all of these issues, and didn't miss a single one, you get the TMF Taxes seal of approval. And if you are confused about one or more of these items, drop me a question in the Taxes FAQ area.

-- Roy Lewis (TMF Taxes)