Tax Tips and Pitfalls Here Are Some Tips For Finding Deductions by Teena A. Takata |
As April 15th approaches, here are some tips for finding deductions (and some credits) - and a couple of suggestions for what to do if you owe the federal government and cannot pay the taxes in full by April 15th!
A Few Definitions (skip this if you are tax-savvy!)
Adjusted Gross Income - The number at the bottom of page 1 of Form 1040. For wage earners, this is your wages, interest income, capital gain income, taxable pension income and taxable social security income, with some deductions, such as deductible alimony or a deductible IRA (see Form 1040 for a complete list). For the self-employed, your net business income is included in adjusted gross income.
Tax Credit - An item allowed as a direct, dollar-for-dollar credit. Some new 1998 credits to consider are Hope Scholarship, Lifetime Learning, Child Credit. An old credit that still helps many, many people is Child Care Credit.
Itemized Deductions and Standard Deductions - Everyone is allowed a "standard deduction" - single people are allowed $4,250, married filing a joint return, $7,100, even a dependent child is allowed $700. If you are age 65 or older on December 31 of the prior year, add $650 ($1,300 if both spouses) to the standard deduction. To "itemize" you need over those automatic amounts of eligible expenses, for items such as home mortgage interest expense, taxes (real property [such as your home], deductible car license fees, state income taxes, charitable contributions). Certain other items such as medical expenses also are itemized deductions, but have to be more than 7 ½% of adjusted gross income before they start adding to the itemized deduction "bucket". Employee business expenses are similar, but they must exceed 2% of adjusted gross income to start filling the itemized deduction "bucket".
More Information is Available for Everyone, Anytime
First, our magazine is published on the internet - and federal and state agencies have internet sites with downloadable forms and instructions - the federal site is www.irs.ustreas.gov, and our state, Californias web site is at www.ftb.ca.gov/. Rumor has it these sites are very, very busy near tax time - so download in off hours if you can!
Identify expenses - If you itemize -
- Make sure you deduct the deductible portion of your DMV fees - in California, this amount is clearly indicated on the billing notice you receive with each years renewal.
- Deduct all your state income taxes - in California (and other states with income taxes) - deduct the balance due with last years state income tax return, deduct the fourth quarter estimate for the prior year (if paid in January of 1998, it is a deduction in 1998), and all applicable state income taxes withheld from wages and retirement payments during 1998. California also has something withheld from wages called SDI, or State Disability Insurance - deduct that as a state income tax, too!
- Charitable Contributions - make sure you dont forget to deduct non-cash items for items donated to Goodwill, Salvation Army, Veteran Organizations, etc. During the year, make sure you collect receipts for these items. If you donated over $500 of a single type of item, then you need to complete a Form 8283 for more details.
- If you use your auto for business, you have a choice to deduct mileage at 32.5 cents a mile, or to work out your actual expenses. If you use the actual expense method, you also have to determine what percent your car was used for business, and you need a log documenting mileage driven for business. If you can only figure out the business miles, it might be advisable to just use the 32.5 cents a mile, and keep better records in the future. If you have good records and use the car for business, you have the right to deduct either the business portion of the lease payments (reduced for something called the auto lease inclusion) or you may depreciate the car (again subject to limits). One cautionary comment - if your employer reimburses you for mileage, then there may be no deductible net expense (for example, if you chose to use 32.5 cents a mile, and employer reimburses 32.5 cents per mile, there is no deduction). See Form 2106, Employee Business Expenses, and Form 4562, Depreciation.
Deductions for Non-Itemizers
- For the self-employed, take a hard look at expenses you incur to run your business. If you run your business from your home, part of your utilities and rent may represent business expenses. These are really important deductions, because they reduce the "self-employment tax" (about 15% of your businesss profit) and reduce your income tax (another 15%, if you are in a low bracket, rising to almost 40% in high brackets)
- Self employed with profitable businesses also benefit from taking a partial deduction for their health insurance costs on page one. Also, if the business is profitable, consider setting up a retirement plan, such as a SEP (you can do this until you timely file your return, even after making extensions), or at least an IRA account. An IRA contribution is limited to $2,000, and cannot exceed your earned income. A SEP contribution cannot exceed approximately 13% of your net business income on Schedule C. (If you plan ahead, open a "Keogh" type retirement plan by the end of the tax year, and if properly set up, you can put up to 20% of your net business income into that). You get tax deductions for these plans, but you also often can be penalized if you take funds out before age 59 1/2.
- Some people are eligible for deductible IRA contributions - but now also consider making a Roth IRA contribution. You are limited to a $2,000 contribution to all IRAs each year (and further limited to your earned income, except a "non-working" spouse, who can use his or her spouses earned income to allow an IRA to be funded).
- Student Loan Interest - only available if adjusted gross income is under $50,000 ($75,000 on a joint return); and the student must be a dependent of the parent, if the parent is making the payments on behalf of the student. Consider restructuring the obligor of the note to include the student, and having the graduate make the payments so they can take advantage of this benefit!
Tax Credits
- Our favorite is the old-time Child Care Credit. You can take up to 20%-30% of $2,400 spent each year to eligible child care providers directly off your taxes, if both spouses work and the child is under age 14. If you have two or more children in daycare, the amount increases. See Form 2441.
- A Child Credit is new for 1998. Credits of up to $400 for each child under age 17 are available, but start to "phase out" at higher adjusted gross income levels ($75,000 single, $110,000 joint). See Form 8812.
- In California, we have a new "renters credit" for 1998. It is a credit of $60 for single filers with adjusted gross income of $25,000 or less, and $120 for married filers with adjusted gross income of $50,000 or less.
- Hope and Lifetime Learning Credit - available only if taxpayers income is under $50,000 single, $100,000 joint - the credits can be up to $1,500. See IRS Publication 970 for more information. Sometimes "tax planning" can move the ability to take the credit to the childs return, where the parents have too much income to take the credit.
If all else fails, and you cannot pay what you owe by April 15th - you can file the return with an Installment Payment Request (Form 9465). This is the IRSs preferred approach.
You could also extend the tax return, and work hard at gathering the funds to pay the IRS by the extended due date or sooner, if possible (initially August 15, 1999, with one final extension available for good cause to October 15, 1999). Interest (at about 9%) and a late payment penalty of 1/2% each month applies.
Do not fail to file the balance-due tax return on time. The late filing penalty is 5% per month, with a maximum 5 month, or 25% penalty. (The failure to pay penalty of 1/2% a month also runs).
Teena A. Takata is a CPA who has worked primarily in the tax area for the last 20 years. Her firm specializes in tax planning (ie, minimization) for middle to small sized businesses, and also assists individuals and businesses who may not have filed for several years get current and back into the system. Her preferred small business accounting software is Quickbooks Pro, which she supports through email with many clients. She can be reached by email at Teena@besttax.com, but advises us she likely will not be able to answer tax questions from non-clients until after April 15th. If the above made your head spin, but you believe some opportunities may exist to minimize your tax, you may want to extend your return to provide you more time to study, and/or consult with a qualified tax preparer! We help educate our clients when they ask for help. You can also email Teena to sign up for her periodic newsletter, issued three to four times a year, that covers a variety of tax and business suggestions.
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Last modified: November 08, 2002