Special Features

 

NBR's Tax Tips Q&A ... for tax year 2005

Friday, April 14, 2006

Question & Answer Topics:

• Alternative Minimum Tax Issues
• Dependents and Related Issues
• Education Issues
• Gifts, Estates and Inheritances
• IRA's 401(k)s, and other Retirement Issues
• Real Estate Issues
• Stocks, Bonds and other Investment Issues
• Tax Preparation and Questions About Forms
• Miscellaneous

ALTERNATIVE MINIMUM TAX ISSUES

I'm receiving soc.security and fortunately have no limit on AMT. I can earn and still rec. soc.sec. benefits.
Does withdrawing a taxable amount from a retirement fund constitute earned income, or do I need to pay tax on that amount??
-- rgram, KTEH, Los Gatos, CA

I assume you older than your "normal retirement age" so the Social Security "earnings test" does not apply. For those born in 1937 and earlier years, normal retirement age is 65 and the age is gradually increasing to 67. For those born between 1943 and 1954, for example, normal retirement age is 66.

For Social Security beneficiaries who will reach their normal retirement age after 2006, the earnings test reduces benefits by one dollar for every two dollars that their earnings exceed $12,480; for someone who will attain normal retirement age in 2006, the test reduces benefits by one dollar for every three dollars that earnings exceed $33,240.

Withdrawals from an IRA do not count as earnings for purposes of this test. However, withdrawals from a traditional IRA are taxable income.

--Kevin McCormally
Kiplinger Washington Editors

 

What are the chances of Congress changing the limits of, or getting rid of, the AMT tax this year, 2006, and making any decision retroactive to January? I understand losing it will cost billions to gov't. BUT they shouldn't get used to spending what never should have been theirs in the first place. thanks,
-- Eleanor Byers, KQED, San Jose, CA

We fully expect the Congress to do SOMETHING about the AMT this year, but we do not expect the lawmakers to abolish the parallel tax system that is catching more and more Americans in its net.

A temporary increase in the AMT exemption amounts expired at the end of 2005 and, at the very least, we expect Congress to retroactively reinstate the higher exemptions for 2006. Failing to do so would subject millions more Americans to the AMT and we don't think Congress will stir up that hornets' nest in an election year. Some lawmakers want to make the higher exemptions permanent and index them for inflation. That idea has a chance this year.

--Kevin McCormally
Kiplinger Washington Editors

After a long costly legal battle, I received a award from my sisters estate and I received a 1099 for this. My question is - Can I deduct the legal expenses on my return to help off-set the 1099 income.
-- Joe Urbancik, Scotch Plains, New Jersey

To the extent the legal fees can be associated with taxable income, that portion can be deducted as a miscellaneous itemized deduction on Schedule A. (If part of the fees are attributable to tax-free income, that portion can't be deducted.) A couple of tricks about miscellaneous deductions, though. Such expenses are deductible only to the extent they exceed 2% of your adjusted gross income -- and as your income is pushed up by the settlement, so is that 2% threshold. Also, if you are among the increasing number of Americans subject to the alternative minimum tax, miscellaneous expenses are NOT deductible at all.

--Kevin McCormally
Kiplinger Washington Editors

This is the first year that I got caught in the AMT by <$10K. I was wondering if there are any legal methods to avoid the AMT?
--Overtaxed Citizen, Montgomery, NJ

Great question. The fact is, one positive thing you've got to say about the alternative minimum tax is that Congress did a great job making sure it was tough to avoid!

One thing I joke about is one way to protect yourself is to put your kids up for adoption, since having a large family is one thing that makes you vulnerable. Dependent exemptions reduce your taxable income under the regular rules but NOT under the AMT. Another way to protect yourself is to move to a lower-tax state or sell your house and move into an apartment. The regular rules allow a deduction for state and local taxes (income and property), but the AMT doesn't allow either.

If you receive incentive stock options, one thing you CAN do is watch how many you exercise carefully. The "spread" -- the difference between what you pay for the stock and what it's worth at that time -- is considered income for AMT purposes at the time of the exercise but isn't income on the regular tax side. (The spread doesn't count under the regular tax until you sell the stock.) Too much ISO income can throw you into the AMT.

Also, you need to watch realization of capital gains if your income puts you close to or in the "phase out zone" for the AMT exemption. Your exemption depends on your filing status. For 2005, it's 58,000 if married filing jointly and $40,250 if you're single. But the exemption is phased out as income exceeds $150,000 for joint filers or $112,500 for singles. The exemption is reduced by 25% of the amount AMT income exceeds those levels. Although long-term capital gains are taxed at 15% under both the regular and AMT rules, a big gain that wipes out part of your exemption forces more income to be taxed at AMT rates and thus makes it more likely your AMT bill will exceed what you owe under the regular rules.

--Kevin McCormally
Kiplinger Washington Editors

Can the amount of qualified dividends trigger AMT (Alternitive Minimum Tax)?
-- William Labancz, WCMU, Roscommon

Great question. The answer is both no and. . .sorta.

The 15% rate for qualified dividends applies under the AMT as well as under the regular tax, so it would appear that there's no AMT threat here.

However, to the extent that qualified dividends push your AMT income into or through the AMT exemption phase out zone, they can increase your AMT liability.

Your AMT exemption depends on your filing status. For 2005, it's $58,000 if married filing jointly and $40,250 if you're single. But the exemption is phased out as income exceeds $150,000 for joint filers or $112,500 for singles. The exemption is reduced by 25% of the amount AMT income exceeds those levels. So, if qualified dividends wipe out part of your exemption, it will force more income to be exposed to the AMT's 28% rate, and thus makes it more likely your AMT bill will exceed what you owe under the regular rules. If the phase out is not an issue for you, though, qualified dividends can't trigger or exacerbate the AMT.

Aren't taxes fun?

--Kevin McCormally
Kiplinger Washington Editors

IRAs, 401(k)s AND OTHER RETIREMENT ISSUES

When I transfer money from a 401K to a ROLLOVER IRA, does this Have to be included with my traditional IRA's as a basis in form 8606. If so, this will hurt by lowering my percentage in calculating money put in years ago with AFTER TAX money. Can you clarify?
-- Robert, WKNO, Collierville TN

Yes, rolling over a 401(k) to an IRA will effectively dilute your basis and therefore reduce the percentage of any distribution that is considered a tax-free return of basis. Under the rules your basis as tracked on the 8606 -- which is the total of your nondeductible contributions -- is spread over all of your traditional IRAs. Here's a simple example.

Let's assume you have just one IRA, it is worth $10,000 and your basis is $5,000. If you withdraw $1,000, 50% of it would be a tax-free return of basis.

Now, if you roll over a $100,000 401(k) payout to that same IRA, the IRA is now worth $110,000 (assuming the distribution mentioned above had not been made) but the basis is still just $10,000. If you withdraw $1,000 from the bigger IRA, just 9% of the withdrawal would be tax-free.

I hope this clarifies things

--Kevin McCormally
Kiplinger Washington Editors

my father passed away and left me some money in mutual funds.I had five years to leave them in his retirement account before having to do anything with them. Can I roll them over into another investment without having to pay any taxes on it. I live in Washington.
-- Johna, Enumclaw Wa.

As long as the money stays in an IRA, either your late father's or a new IRA that you, as the beneficiary, roll the money into, no tax is due. You can redeem all the mutual fund shares and reinvest the money in almost anything you want without tax consequences. . .as long as the money stays in the IRA. It is when you have the money distributed to you that it becomes taxable to you.

As I mentioned in my commentary, IRAs and other retirement plans are a big exception to the general rule that inheritances are tax free. IRA distributions will be taxed to you just as they would have been taxed to your father: fully taxable in your top tax bracket (assuming he had made no nondeductible contributions to his account).

--Kevin McCormally
Kiplinger Washington Editors

I am 81. A company I own stock in is being bought out by another company. Can I roll the capital gain into my IRA to avoid taxes?
-- Viewer on WTVS

You can't roll the capital gain into your IRA, but are you SURE you have a capital gain. With so few details I can't be sure, but this transaction could be a nontaxable exchange, with your basis in the shares of Company A transferring to shares you received in Company B. In that case, your gain wouldn't be taxable until you sell the shares in Company B. If you received cash in the deal, however, your gain would be taxable in the year of the transaction.

--Kevin McCormally
Kiplinger Washington Editors

: in 2005,using funds in my regular IRA account I invested in a real estate limited partnership. Funds were sent directly by the custodian to the partnership and income from this investment is sent directly to the IRA custodian. The partnership sent me a Schedule K-1 showing interest income. Is not income earned in a regular IRA tax deferred? If not, where is this income figured on the return? Schedule E has a place for income from
partnerships but if shown there it is included on line 17 income, Form 1040. Could you advise on the treatment of Schedule K-1 income earned by a regular IRA?
-- Gary B., WUND, Virginia Beach, VA

Is this a Master Limited Partnership, sometimes called a public partnership? If so, it's possible that it is generating what's called "unrelated business taxable income" and such income IS taxable even though the investment is inside the IRA, when the UBTI exceeds $1,000 for the year. This is very complicated stuff, but my understanding is that, when such income is taxable, it's up to the IRA custodian to pay it, with funds inside the IRA. If this is what's going on in your case, I suggest you contact the IRA sponsor.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

 

My sister is filing single and has AGI of $59612. Is she allowed to invest in regular IRA upto $4500 (being over 50yrs) and reduce the AGI. Tax act allows her to go ahead but I have read somewhere that IRA deduction
phases out at $60,000 for single and she may only be able to invest a small amount say $200
-- Ak Malik, WOSU, Columbus OH

The first questions: Is your sister covered by a retirement plan where she works, such as a 401(k) or defined-benefit pension plan. If she is not covered by a plan at work, then there is no income test when it comes to IRA contributions. She can contribute and deduct the full $4,500 regardless of how high her income.

Now, if she is covered by such a plan, you are correct that the right to the IRA deduction is limited. For 2005, the deduction phases out as adjusted gross income (before subtracting the IRA deduction) on a single return rises from $50,000 to $60,000. With the $59,612 AGI you cite, the IRA deduction would be limited to $200. She could still contribute the full $4,500 to the IRA, but it would make much more sense to shift the contribution to a Roth IRA. She wouldn't get the deduction there, either, but all withdrawals (principal and earnings) would be tax free in retirement.

--Kevin McCormally
Kiplinger Washington Editors

I'm 62 and my wife is 66. My concern with taxes is When we are each 701/2 and have to "draw down our retirement money. If my life expectancy is 87, for instance, we have to take out 1/17th of our IRA the first year, 1/16th the second, 1/15th the third, and so forth, each year with a larger tax on our social security taxes. The IRS can tax up to 85% of your social security if a couple is above a certain agi.
-- Darrell, KFME, Fargo, North Dakota

You are correct that mandatory withdrawals from traditional IRAs are taxable income and therefore come into play in the formula for determining how much of your social security benefits are taxable. For a married couple, when "provisional income" exceeds $44,000, 85% of benefits can be taxed. Provision income is adjusted gross income (which will include IRA distributions), plus any tax-exempt interest, plus half of your social security benefits.

One way to hold down mandatory distributions and the impact on social security benefits is to convert part or all of your IRAs to Roth IRAs. You never have to take money out of your own Roth and money that is withdrawn is not taxable -- so it has no impact in the social security taxation calculation.

The drawback, of course, is that you must pay tax now on any amounts converted to a Roth. Although that might assure that 85% of your benefits would be taxed in the year of the withdrawal, it might limit taxation later.

Figuring whether to convert and pay taxes sooner rather than later is complicated. We generally do not think it's a good idea if you would have to use IRA money to pay the tax.

I hope this is of some help.

--Kevin McCormally
Kiplinger Washington Editors

 

Question #1- I have a stock in my Traditional IRA that has become worthless as of 11/21/2005. The company is Loral Space and Communications. May I claim this as a loss on my taxes? If not, how do I handle this?

Question #2 - What about other stocks in a Traditional IRA that have lost value,(ie. N P Energy Corporation, 400 shares now worth $.88), can these stocks be taken as a loss on my taxes? My husband has this stock in his IRA. We are using Turbo Tax to work our taxes.
-- Hindy, KQED, San Jose

Losses inside an IRA generally have NO tax consequence. You can't deduct the worthless stock, you can't deduct the drop in value of other stocks and even if you sold those stocks to "realize" the loss, the fact that the investment is inside this tax shelter means no deduction. This is the mirror image of the fact that trades for a profit inside the account are not taxed.

The one, very narrow and rarely applicable, exception to this rule is if you had made nondeductible contributions to the IRA. Such contributions create a "tax basis" in the account. And, if you close your IRA -- or all of your traditional IRAs if you have more than one -- and the total withdrawn from the accounts is less than your basis, then the difference is considered a loss. But it's not a capital loss; instead it is an ordinary loss which is deducted on Schedule A as a miscellaneous expense. . .and that means it is deductible only to the extent all your miscellaneous expenses for the year exceed 2% of your adjusted gross income.

Bottom line: investment losses inside the IRA tax shelter rarely can be deducted.

--Kevin McCormally
Kiplinger Washington Editors

Hello Mr. Mccormally--- This tax question is related to IRAs. I have been getting different answers. Can I open different kinds of IRAs at the same time?...one Roth and one Traditional? If that's the case, then can one conbribute $4,000.00 a piece to both IRAs? To my logical, one can. With a Roth, one can report the contribution and pay any interest for the current tax. With a traditional, you just report the contribution and don't pay any interest upon age of retirement. Please consider this possibly, if this move is sound. Thank you for your help.
-- Jose, KCET---Los Angeles

Yes, you can have both a traditional and a Roth IRA and contribute to each of them in the same year.

But I'm afraid having one of each kind of IRA does not get you TWO $4,000 contribution limits. The most you can contribute to IRAs for 2005 (excluding any rollover from a qualified plan) is $4,000 if you were younger than age 50 at the close of the year. (Older taxpayers get a "catch up" contribution that pushed the 2005 limit to $4,500.) You can put $2,000 each into your IRAs, or break down the contribution however you choose...but you're stuck with the $4,000 limit.

--Kevin McCormally
Kiplinger Washington Editors

 

May I claim my broker transaction fees of $8.00 for each stock trade? (I made many trades).
In what order do I put my stock trades on an attached list for the IRS? Does the IRS want the date, stk name, buy price, cost basis, profit/loss in that order? Thank you Mr. McCormally
-- Carol, KCET, West Covina, California

You don't deduct your brokerage commissions on the trades; instead those costs increase your basis in the shares you purchase and reduce the proceeds of the sale when you sell. Thus, if you pay $8 to buy 100 shares at $10, your basis in the 100 shares is total of $1,008, for a per-share basis of $10.08.

As for how to list the transactions, I suggest following the lead of the Schedule D: Description of assets; date acquired; date sold; sales price; cost or other basis; gain or loss.

--Kevin McCormally
Kiplinger Washington Editors

my mother passed away and left her IRA to my child, age 13 this year. My child had to accept a RMD of $1,385. does my child file her own tax return or can I include the distribution on my return, and what happens next year when my child is 14 and the RMD will be $3,285 ?
-- Mike C., WGPTV, Flowery Branch GA

This is a great question.

First, you may not report your daughter's IRA income on your return. Parents can only do that if the child's only income is from interest and/or dividends.

In this case, the required minimum distribution from the IRA is considered unearned income and thus a return must be filed, since the unearned income amount exceeds $850. Under the rules for 2005, for a child under age 14, the first $850 of unearned income can be tax free; the next $850 is taxed at his or her rate...probably 10% (assuming she doesn't have a lot of other taxable income). Since that covers the '05 distribution, that's that. If the total had exceeded $1,700, the excess would have been taxed at your rate.

Since your daughter turns 14 in 2006, you don't have to worry about the kiddie tax anymore, so on her '06 return, the taxable part of the distribution will continue to be taxed at her rate. . .even though it will exceed $1,700.

Remember, I don't make the rules, I just try to explain them.

--Kevin McCormally
Kiplinger Washington Editors

Kevin, we are a married couple making adjusted gross of 165K. We use TurboTax for our taxes and have not been able to deduct our ridiculous high college tuition of our two kids or qualify for any IRA deductions or contributions because of our AGI. I only found that I can contribute to a traditional IRA with the only benefit of tax deferred growth. My question is, what will be the difference between contributing to an IRA tax differed or increasing my contribution to a 401K through my company? Thanks.
-- Jose Perez, Florida

Increasing your 401(k) contributions will offer an additional tax break -- since pre-tax money will go in to the 401(k). An extra $4,000 into the company plan will reduce your take-home pay by just $3,000 if you're in the 25% bracket (and, when you take your state rate into account, I'm sure you're in a higher bracket, so the reduction would be less).

The trade off, of course, is that you'll pay tax on that $4,000 when you take it out of the 401(k) in retirement. Whereas with the nondeductible IRA, the $4,000 would be tax-free, although it will come out pro-rata along with taxable earnings. So, just a portion of our IRA payouts will be tax-free.

Generally, if your choice is pre-tax 401(k) versus nondeductible IRA, the 401(k) is the way to go.

To complicate matters further, some advisors would suggest skipping the tax shelters all together and putting the money in, say, an index fund that pays few dividends and delivers most growth via long-term gains that will be taxed at 15% in retirement. 401(k) withdrawals will be taxed in your top tax bracket.

Sorry for the confusion. Remember, I don't make the rules....

--Kevin McCormally
Kiplinger Washington Editors

In doing our taxes with TurboTax, I input that my wife and I would do Trad. IRA's of 4K and 4.5K. T/T comes back advising that we will not get the full 8.5K toward our taxes this year. As I am 55 and have a 401(k), my
question is can I do what the T/T says as the credit and the rest in a Roth IRA for myself, T/T said something like 2.8K plus her 4K = 6.8K, could I put the remainder amount of 1.7K in a Roth IRA? (My total would still be the 4.5K I am allowed in a IRA).
-- Jerry, KTEH, San Jose, Ca

Let's see if I can figure out what's going on. If you had at least $9,500 of taxable compensation for the year and you were over age 50 and year-end (and your wife was 50 or younger), then you can put up to $9,500 in a pair of traditional IRAs. If the program is allowing only $6,800 of deductions, then I assume you also have a retirement plan at work and your income puts you in the phase-out range. The right to deduct traditional IRA contributions is phased out -- for those with retirement plans at work -- as income rises from $70,000 to $80,000. You can still put the full amount in the IRAs, but your deduction is stunted.

If this is the case, then you could put the maximum amount that is deductible in traditional IRAs and put the excess in a Roth.

By the way, I'm a great fan of the Roth. Why not put the entire $9,500 in twin Roth accounts? Sure, you give up a tax break now...but all withdrawals will be tax free in retirement.

--Kevin McCormally
Kiplinger Washington Editors

My wife is a government employee contributing the maximum amount ($15,000 + $5000 catchup) to her Thrift Savings Plan, which is pre-tax money. She also wants to contribute to her IRA. Are the earnings required to contribute to an IRA based on gross earnings or after-tax earnings? In other words, if she earns $25,000 before she retires mid-year, can she still contribute to an IRA although her take-home pay isn't enough to fully fund her IRA, or does she have to have $4500 in take-home pay in order to fund her IRA?
-- Stuart B. Harnden NHPTV - 11, Bedford

Take home pay isn't the key. Taxable compensation is. So, if your wife makes $25,000, she can put $20,000 into the TSP and still put $4,500 into her IRA since, after the $20,000 pre-tax goes into the retirement plan, she'll still have $5,000 of taxable compensation. If she made only $20,000, however, and funnelled the full amount into the TSP, she'd have no taxable compensation and, thus, no IRA contribution.

--Kevin McCormally
Kiplinger Washington Editors

Your kid IRA commentary was great. If a minor child has put all earned income into self-employed 401k for 2005, and has additional interest income, can the child put money in Roth IRA?
-- Tina, rmpbs, colorado springs

Good idea but, sorry, the law writers are ahead of you. The contribution is limited to the amount of compensation includable in gross income and, if all the wages when into a 401(k), $0 is includable in gross income.

--Kevin McCormally
Kiplinger Washington Editors

 

I have a 401k worth about 160k. I also have a Roth IRA worth about 4k. I want to transfer my 401k to my Roth. I understand I will have to pay taxes on the 160k. My question is ,can I transfer a little bit at a time,
say 10k to 20k,to minumize the tax bite.
-- SJA, WVIZ, SANDUSKY ,OHIO

You can't move the money directly from a 401(k) to a Roth IRA, but you can accomplish what you want to -- to gradually shift the money from the 401(k) to a Roth to hold down the tax bill on the conversion. The money must first go to a traditional IRA and then be converted to a Roth. But it is completely up to you how much to convert each year. Some taxpayers are careful to hold the converted amount down to the level that prevents being pushed into a higher tax bracket, for example.

You may recall that in the first year conversions were allowed (1998), taxpayers who converted to allowed to pay the tax bill over the four subsequent tax years. Although that kind of deal isn't available any more, you can accomplish much the same thing by, for example, converting one-fourth of the amount you want to convert each year for four years. You get to set the schedule of the conversion...and paying the tax bill on it.

--Kevin McCormally
Kiplinger Washington Editors

Ten years ago our son opened a regular IRA with $1,600.00 that he made from a summer job. He didn't deduct that amount from his income that year, and he didn't fill out an 8606 form. This year he has converted the
amount (which has grown to $4,273) to a Roth IRA. What should he do now?
-- Carmen, KUHF, Houston, Texas

I think this is much more common than you may imagine. One government study found, for example, that financial institutions reported receiving nearly twice as much nondeductible IRA money as was reported by taxpayers on Forms 8606. Of course your son should have filed the 8606 to establish his "basis" in the account, and thus prevent being taxed on that amount as part of the conversion.

Your son needs to report the conversion on a Form 8606 to go along with his 2005 return. On line 17 in Part II, it asks for the basis in the account. I suggest entering the $1,600 there, with a note that the $1,600 was a nondeductible contribution made in 1995. It's possible that the IRS will ask if a 8606 was filed for that year and, if it does, a $50 penalty could be imposed. Avoiding the tax on the $1,600 is more valuable than that.

--Kevin McCormally
Kiplinger Washington Editors

If I contribute more than allowed to a ROTH IRA, I'm assessed a 6% tax on the excess (right?). Does the excess contribution grow tax free, and is it free of tax when distributed?
-- Ron, WGBN, Ft Mitchell, KY

The key to the excess contribution penalty is that it is NOT a one-time thing. It is assessed every year that the extra money is in the account. So, although the amount would grow tax free inside the Roth, you'd pay a pretty penny via the penalty year after year.

--Kevin McCormally
Kiplinger Washington Editors

For more than 5 years I possessed a real estate stock that paid good dividends. The company was sold and the stock I owned was cashed out causing a nice profit. I tried to obtain the estimated tax paperwork from the IRS and other places being told the IRS form 505 was not available. Finally, the IRS sent the 505 to me. My occupational income was more than usual, also. This has put me into a very high bracket and the tax will be
substantial. Plus, there may be penalties for not filing the estimated tax for 2005. My query: Is there any relief I may be able to take advantage of now? For example, can I make a last minute contribution to something like a retirement fund?
-- A. J. Chemajh, KAET, Tempe, AZ

This is tough. If you were self-employed, you could still make contributions to a tax-deferred retirement plan -- Keogh contributions can be made as late as the due date of the return, plus extensions, if the plan was opened by the end of the previous year, for example. But it doesn't sound like you qualify. Deductible IRA contributions can be made as late as April 17 but, again, it sounds like your income is too high if you have a retirement plan at work. For 20905, those covered by an employer plan lose the right to deduct IRA contributions as adjusted gross income rises from $50,000 to $60,000 on a single return and from $70,000 to $80,000 on a joint return.

Although I can't think of any retroactive deductions that can cut your tax bill, you may be able to reduce or eliminate any late payment penalty. Although you can be penalized if you owe more than $1,000 with our return and you have failed to pay at least 90% of your tax liability for the year via withholding or timely estimated payments, there are exceptions to that rule. Generally, for example, the is no penalty if you paid as much tax during 2005 as you actually owed for 2004. That exception is designed to help people who see a spike in income such as you experienced in 2005. Also, if the real estate stock sale was late in the year, you are not penalized for not paying tax on such income before you receive it. In that case, the annualized income installment method might help you.

The exceptions are outlined in publication 505. http://www.irs.gov/pub/irs-pdf/p505.pdf

--Kevin McCormally
Kiplinger Washington Editors

Can a 14 year old fund an Roth IRA with money from the sale of her 4-H animal?
-- N. Livingston, KIXE, Palo Cedro, CA

If she reports the income from the sale on a Schedule F, that income would count as compensation and thus would serve as the basis for an IRA contribution. If the income is so low as to not require a return -- but it is farm income -- then it still counts. Keep records in case the IRS ever asks about the 2005 compensation that serves as the basis for the IRA contribution.

--Kevin McCormally
Kiplinger Washington Editors

 

About kids IRA that was mentioned on TV today on PBS. How is it tax deductible-- where/how do you claim it? Where can I find more info about it?
-- nitinr, Cary, NC

I'd recommend a Roth IRA for a child because it's unlikely that he/she needs the tax deduction. With a Roth, although no deduction is allowed for contribution, all withdrawals can be tax-free in retirement. With a traditional, deductible IRA, all withdrawals are taxed in retirement.

If you want to deduct IRA contributions, you claim the write off on line 32 of the Form 1040.

You can find a lot of great stories about IRAs at our website www.kiplinger.com

--Kevin McCormally
Kiplinger Washington Editors

On monday nights show 03/27/06, it was mentioned that investing in a Roth IRA, at 8%. Where can that rate be had? Thank you.
-- Michael, whyy, Deptford, NJ

Great question. I don't know of any risk-free investment that pays 8% right now; the top-yielding 5-year bank cds are paying about 4.6%. When we talk long-term investing at Kiplinger, we're generally talking stocks and, for us, stocks usually means stock mutual funds. Over the long-term, stocks have returned an average annual return of just over 10% -- and by long-term I mean since 1926, a period that includes the Great Depression. I just checked and the 10-year annualized return of Vanguard's Index 500 fund has been 9%, and that period included the tech-wreck bear market of 2000-2002. Since 1976, that fund's average annual return is over 12%.

I used 8% and 10% in my commentary as illustrative returns, although I believe such returns are attainable over the long term, not pie in the sky.

--Kevin McCormally
Kiplinger Washington Editors

Kevin who do I contact to set up a IRA for my grand son? Like what company or also where can a guy get 8% or 10% like was noted on todays business report 03-27-06.
-- lap, St. Clair Shores, Mi.

First, of course, your grand son had to have income from a job last year in order for you to help him start an IRA. (Believe me, he'll thank you for it!)

As to where to open the account, many banks are happy to open IRAs for minor as are many mutual funds and brokerages. The reason some are reluctant is that their lawyers tell them that minors can't sign binding contracts so they worry that, if the account loses money, the owner might come back and complain. Because of this concern, some sponsors that accept accounts from minors ask an adult to co sign the application. The last time I checked, Merrill Lynch, Charles Schwab and T.D. Waterhouse all accepted IRAs from minors. When it comes to fund families, check out American Century, Vanguard, Oakmark, T.Rowe Price, Masters Select, Legg Mason and Vanguard.

Where can a get 8% to 10%? I confess that don't know of any risk-free investment that pays 8% right now; the top-yielding 5-year bank cds are paying about 4.6%. When we talk long-term investing at Kiplinger, we're generally talking stocks and, for us, stocks usually means stock mutual funds. Over the long-term, stocks have returned an average annual return of just over 10% -- and by long-term I mean since 1926, a period that includes the Great Depression. I just checked and the 10-year annualized return of Vanguard's Index 500 fund has been 9%, and that period included the tech-wreck bear market of 2000-2002. Since 1976, that fund's average annual return is over 12%.

I used 8% and 10% in my commentary as illustrative returns, although I believe such returns are attainable over the long term, not pie in the sky.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

i am 62 yrs old my son will be 16 in june 06 he will be receiving a social security check for the next2 yrs while in high school can we open him a ROTH I R A with out him working ?? THANK YOU
-- D J PARTYKA, UNCTV, ROCK HILL S.C.

Not if the social security benefit is his only income. You must have earned income in order to contribute to an IRA and earned income is income from a job or self-employment.

--Kevin McCormally
Kiplinger Washington Editors

Is Retirement Saving contribution credit Due on this yeart ?
-- Dely Lee, Montevideo MN

Yes, the Retirement Saving Contribution Credit is still available. You may be able to take the tax credit if you make eligible contributions to an IRA or company retirement plan for 2005. You may be able to take a credit of up to $1,000 (up to $2,000 if filing jointly). This credit could reduce the federal income tax you pay dollar for dollar. For details, see chapter 4 of IRS Publication 590

http://www.irs.gov/publications/p590/index.html

--Kevin McCormally
Kiplinger Washington Editors

Can we donate money to a Roth IRA, for our grandson, who is 6 years old?
-- Mike, wipb, Berne,in

Only if the little guy is a model or in some other way earned some money in 2005. Just being cute just doesn't cut it with the IRS.

IRA contributions can only be made by someone who had compensation from a job or self-employment during the year.

--Kevin McCormally
Kiplinger Washington Editors

I considered setting up an IRA for my 18-year-old son, but found that he didn't earn enough to do that. I heard your piece on Monday night and now I'm perplexed. Did I misunderstand something?
-- Jack de Golia, KUSM-TV, Dillon, MT

I'm confused. As soon as someone has any earned income -- that's income from a job or self-employment -- he has enough income to open an IRA. The point of my commentary is that although teens and young adults often feel they can't afford to set aside money for retirement, as soon as they have jobs, parents or other generous souls can help them fund the IRA. If I'm misunderstanding your question, please get back to me.

--Kevin McCormally
Kiplinger Washington Editors

I just caught the end of 3/27 that you mentioned IRAs for children that can be set up today. I didn't hear how it can be set up if the child is not paying its own taxes yet. My son is 12.
-- Karen, rocky mtn pbs, conifer, colorado

Your son needs to have had earned income from a job in 2005 to qualify for an IRA. If he made money -- mowing lawns or neighbors, perhaps, -- he can qualify, even if he didn't make enough to demand a tax return.

Here's a q&a from my colleague Kim Lankford that explains some of the details:

Q: I was thinking about starting a Roth IRA for my young son. However, I was wondering if there are any restrictions, such as whether he has to earn the money.

A: That's a great idea. Investing in a Roth IRA for your child is an excellent way to give him a huge head start on saving for the future. But there's one big catch: The child needs to have earned income -- even if it's just from delivering newspapers, babysitting or mowing lawns (but not just from their regular allowance).

If your child is too young to earn money -- and hasn't started a career as a baby model -- then you'll need to find some other ways to save for now. Check out our ABCs of Saving for College for other savings ideas for young children.

But as soon as your son does earn money, opening a Roth IRA for him can be a very powerful way to save. He'll be able to invest the amount of his earned income, up to $4,000 in 2006, just like anyone else (the maximum increases every few years).

Make sure your child keeps records that list the date of each job, the person who paid him and how much he earned -- then keep the records in your tax files, just in case the IRS ever has questions.

He doesn't need to invest the actual money that he's earned himself -- most 12-year-olds would have a tough time understanding why everything they earned had to be set aside for the future. As long as he has a job, you can give him some money to invest in the account, as long as it doesn't exceed the limit.

Even investing just a little money in the account when he's young can make a big difference in the future. If you invest $2,000 when he's 12 in a Roth IRA and the investments earn 8% per year, that one contribution will grow to more than $$138,000 by the time he's 67 years old. Continue to invest just that much every year, and his account will grow to more than $1.8 million by retirement. Invest the maximum, now $4,000, and he'll have more than $3.6 million -- tax-free. What a great path to start your kid on.

Some IRA administrators give parents a tough time, though, when they try to open an IRA for their kids because minors can't legally enter into binding contracts. But most fund companies and brokerage firms just require an adult to co-sign the paperwork. Charles Schwab, Merrill Lynch, T.D. Waterhouse, Vanguard, T. Rowe Price, Dodge & Cox and Oakmark, for example, all allow kids to open Roth IRAs.

--Kevin McCormally
Kiplinger Washington Editors

I have money in After Tax IRA and in PreTax IRA. These accounts are kept separate. Can I withdraw my After Tax IRA only? (I am past 65). I know the tax basis. Will I be paying tax on gain only?
-- Rasik Shah, HoustonPBS

By after-tax IRA, I assume you mean you have a Roth IRA. If so, then, yes, you can choose to withdraw from either the Roth or the traditional IRA...or both of them. It's up to you. If you withdraw from the Roth, all withdrawals will be tax-free, assuming the account has been opened for at least five years. If it has been opened for less than five years, then the first withdrawals from the account are still tax-free. Under the law, the first money out of the IRA is considered to be your after-tax contributions -- always tax-free. Only after you have withdrawn all of your contributions do you begin to tap into earnings. And, if the account has been opened for at least five years, then earnings, too, are tax free in retirement.

--Kevin McCormally
Kiplinger Washington Editors

Hi Kevin: I have a question regarding an over contribution to my 2005 Roth IRA. The contribution was fully used to buy a stock in the Roth. The value of the stock has gone down since the purchase. To remove the over contribution ($1000) through the transfer of a portion of the shares from the Roth to a taxable account, are the shares valued at what I paid when I purchased the shares or at the point of transfer? For example, I bought 100 shares at $50/share and the over contribution amounts to $1000. Would I have to remove 20 shares (20 x $50/share - original price) to the taxable account or 40 shares (40 x $25/share - current price)? Thanks,
-- Bill, KQED, San Francisco

The loss during the time the money was in the account IS taken into account when figuring out how much you have to withdraw to correct the excess contribution. The exact calculation can be very complicated, especially if there was other money in the account, as the loss has to be prorated over the entire amount. According to the IRS, the IRA custodian should help you figure this out. . .and, in fact, needs to help so it can property code the 1099 form you'll get showing the distribution. So, ask the IRA sponsor for help. If you're interested, here's a link an IRS notice that explains the calculation: www.irs.gov/pub/irs-regs/12425602.pdf. Good luck.

--Kevin McCormally
Kiplinger Washington Editors

 

I now have an IRA account. I would like to put future contributions into an Roth-Ira. Can I do tat, have both?
-- Bruno Spckermann, KQED, Belmont, Ca

Absolutely. You can have either or both kinds of IRAs...the key is that no more than $4,000 can go into your IRA(s) for 2005 ($4,500 for those 50 and older at end of '05) no matter how many accounts you have. (The contribution limit for '06 is still $4,000 for those under 50 and $5,000 for those 50 and older.)

--Kevin McCormally
Kiplinger Washington Editors

My wife and I are 59 years old and plan on retiring around 66. We have currently 700 k in mutial funds. Wife doesn't work; my annual salary is 68k. In bank savings we have 54k This year because appro 400k is in taxable funds my quartly taxes will run 3600.00 Do I take part of the payment from my mutial funds and savings(bank) or how would you suggest that I pay the taxes rather than depleating my savings.. I do fund a roth each year. Thanks,
-- Bob and Sherry, WFYI Indianapolis, Ind.

Although I usually encourage people to reduce withholding on their paychecks -- since most people get refunds -- the easiest way to cover the quarterly tax bill would be to increase withholding at work. Can you afford to do that to reduce what you have to make in quarterly payments?

As for where to get the cash to cover the quarterly payments, it would probably be best to tap the bank account rather than the mutual funds, because I would hope the funds are returning more than the pittance you're probably making in the bank. At year-end, you could sell some fund shares (perhaps matching winners and losers to hold down tax bill on the trades) to replenish your cash safety net...if you think that's necessary.

--Kevin McCormally
Kiplinger Washington Editors

I have a traditional IRA and a Roth IRA that I transfered from one brokerage to another (the mutual funds were sold at the old brokerage and the cash was transfered to the new brokerage, who then bought new mutual funds). The traditional IRA was reinvested in a traditional IRA and the Roth was reinvested in another Roth. Do I have to note this in any way in my taxes this year or do I just ignore the transaction in terms of taxes?

If you did direct transfers of the IRAs -- that is, you had one sponsor send the money directly to the new sponsor of each account -- then you have nothing to report.

If, however, you did what's called a "rollover" -- so you actually cashed out one account, had a check written to YOU and then redeposited the money in the new IRA -- then you do need to report the transaction to the IRS. No tax is due, as long as the money was safely in the new IRA within 60 days of the time you took it out of the old one. What you do is report the distribution on line 15a of the Form 1040 and then show $0 as the taxable amount on 15b.

--Kevin McCormally
Kiplinger Washington Editors

 

I am 53 years old. I have made about $20K in non-deductible contributions to traditional IRAs over the last 15 years. Due to stock market fluctuations, their value as of 12/31/05 was about $22K. Am I correct that if in 2005 I converted the entire amount of my traditional IRAs to a
Roth IRA, my tax liability is limited to the tax on the gain of about $2K? Thank you.
-- Greg Nelson, OPB TV, Portland, OR

You're correct, if this is your only traditional IRA.

When you convert a traditional IRA to a Roth, you are taxed on the amount by which the converted amount exceeds your basis in the account. Your $20,000 in nondeductible contributions is your basis. However, if you have more than one IRA, you must combine all of your traditional accounts when determining the basis and the proportion of any distribution or conversion that is a return of basis.

Let's say, for example, that in addition to the IRA you describe, you have another traditional IRA funded by deductible contributions that also holds $18,000. In that case, your total basis of $20,000 would represent 50% of the total in the two accounts. And, if you converted $22,000 to a Roth, $11,000 (50%) would be considered nontaxable basis and you would be taxed on $11,000 in the year of the conversion.

If, however, the account you describe is your only traditional IRA, then just the amount above your $20,000 basis would be taxed.

You should have copies of Form 8606 in your records tracking your basis in your IRA.

--Kevin McCormally
Kiplinger Washington Editors

I used to have $100,000 in my Roth IRA. I'm 60 now. Can I sell what is left of my Roth ($6,000) and get any tax benefit? I have a 403b that has a 60,000 profit. Can I claim the loss as a miscellaneous itemized deduction (not a capital loss)?
-- The Big E, WTTW, Lemont, IL

Sorry to hear about the devastating loss in your Roth IRA -- from $100,000 to $6,000. Ouch!

If you close the account -- and any other Roth accounts if you have more than one -- and the total retrieved from the account(s) is less than the total of your contributions, then you have a loss. Note that the high point of your Roth, the $100,000, doesn't necessarily matter. If you had converted and contributed a total of $80,000, for example, and the account had appreciated to $100,000 before falling to $6,000, then your loss would be $74,000 ($80,000 - $6,000) not $94,000 ($100,000 - $60,000). The loss the paper gains doesn't count.

The loss inside a Roth is NOT a capital loss but rather must be treated as a miscellaneous itemized deduction. That means it is deductible only to the extent that all your miscellaneous expenses exceed 2% of your adjusted gross income. If your AGI for the year is $100,000, for example, the first $2,000 of the Roth loss wouldn't count. Also, if you are subject to the alternative minimum tax, none of your miscellaneous expenses (including the Roth loss) are deductible.

The situation in your 40-3(b) does not come into play at all.

--Kevin McCormally
Kiplinger Washington Editors

Early in 2005 I withdrew my entire IRA (about $38K) to live on while continuing to pursue a new career in fiction writing. The writing didn't work out. As I understand it the $38K is taxable income plus a 10% penalty for early withdrawal (I'm 48). I'm not currently able to pay this. Is it better to file my return with no payment or not file a return at all and deal with it when I do have the funds to pay off the IRS? If I do the latter, how long before the IRS comes looking for me??

Related question: At one time my IRA was worth over $75K. This was eaten away by the market bust in 2000-2001 (I was in some bad mutual funds back then). Is there any way to write-off those heavy losses against what I owe for the IRA withdrawal?
-- Anton Pavlovich, KCET, Hollywood, CA

First, sorry the writing career didn't pay off.

Second, I suggest you file your return on time, even if you don't have the money to pay. The late filing penalty is one of the most severe the IRS imposes, up to 25% of the tax owed with the return. The penalty for late payment is 1/2 of 1% per month that you're late. In either case, you'll owe interest on the late payment. If you file with a balance due and no payment, the IRS will send you a bill. At that point, you could request an installment payment plan.

As for how long it would be before the IRS starts looking for you, figure that sometime late this summer or early fall the agency's computers will discover a 1099 form sent by your former IRA sponsor showing the payout and no return from you reporting the receipt of taxable income.

Finally, I'm afraid you can't deduct losses inside an IRA.

Good luck

--Kevin McCormally
Kiplinger Washington Editors

Two weeks ago, I received a letter from the IRS informing me the I had miscalculated the taxable portion of my Social Security and that my SEP IRA deduction had been disallowed. I called them and after talking to a woman who was obviously incompetent, I was mysteriouly transferred to another agent, who was very pleasant. After some discussion, she recalculated the taxable portion of my Social Security had been calculated properly. The actual amount of my Social Security had been keyed incorrectly. As far as the SEP IRA was concerned, I explained that I had requested a deduction for a regular IRA, not an SEP IRA. She was unfortunately not able to do anything about correcting this IRS keying error at her level and told me that she was submitting some kind of review request, which could take up to 30 days. Now, I'm sitting here waiting for them to call. Is there anything else I can do to expedite this matter, or do I just sit and wait? Thanks for your attention
-- Al, WMEB, Bangor, ME

First, sorry to hear about your troubles. Just FYI, one reason the IRS likes electronically filed tax returns is that they PREVENT such keyboarding errors by IRS employees.

It sounds like you've done everything okay so far...I hope you got the name of the helpful person you spoke with. I don't think there's much more you can do, but wait the 30 days. I suppose this is slowing down a refund. Sorry about that, too.

One thing you might want to do is to write to your congressman/woman or Senators to document your case. When I worked on the Hill 30 years ago, nearly every office had a caseworker who spent a lot of time on IRS problems this time of year. A call from a congressional office might speed things up. The Capitol Hill switchboard number is 202-224-3121.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

 

Foreign tax gets deducted from some of my IRA account dividends. This does not seem to count as a withdrawal that I have to pay tax on. Therefore: If my financial advisor deductes his fee for managing the IRA from the IRA is that a withdrawal? If no, I'm trying to decide if paying his fee with pre-tax money is to my financial advantage. Seems to me it would be smarter to pay the fee with pre-tax money. Currently I'm paying the fee from after-tax money. Thanks for your tax advice on NBR.
-- David Plum, kqed, Mountain View

Fees that are deducted from the IRA are not deductible but such fees that are billed and paid separately can be deducted as miscellaneous itemized expenses. The trick, of course, is that such expenses are deductible only to the extent they exceed 2% of your adjusted gross income and not at all if you are subject to the alternative minimum tax.

The real benefit of paying such fees separately is that it allows more money to remain in the IRA tax shelter growing for your financial security in retirement.

--Kevin McCormally
Kiplinger Washington Editors

Can I deduct short term loss in an IRA account from my income for the year?
-- Ak Malik, Columbus OH

No, losses inside an IRA can not be deducted. On the bright side, of course, gains realized inside this tax shelter are not taxed until the money is withdrawn form the IRA, assuming this is a traditional IRA. If it's a Roth IRA, gains would never be taxed.

--Kevin McCormally
Kiplinger Washington Editors

I inherited a number of annuities and several IRA accounts. I do not have the initial cost base for one account. This account has also gone through a 1035 exchange in 1994. The 1099-R that I received for this account has reported the entire gross distribution as taxable, because a cost basis is not available. Is there some remedy to estimate a cost basis?
-- Tim Lewis, MPBN, Freeport, Maine

Oh, my! This is a toughie. Generally, of course, the basis of inherited property is its value at the time of death of the previous owner. But that rule doesn't apply to annuities, which are considered income in respect of the decedent, and taxed to the new owner just as the income would have been taxed to the previous owner. In other words, you do need to know the original basis.

The 1035 exchange -- which is a tax-free trade of one annuity for another -- further complicates matters, but also serves as evidence that there IS some tax basis so that part of your income under the annuity should be tax-free. I'd suggest contacting the insurance company that issued the annuity you have inherited and ask if its records show the originating firm for the annuity that was exchanged in 1994. Then contact that company to see if its records show how much the original owner invested in the policy.

It's a lot of work, but pinpointing a basis -- or coming up with a reasonable estimate of a basis -- will save you money on your taxes.

Good luck. You'll need it.

--Kevin McCormally
Kiplinger Washington Editors

In 2005 I changed jobs. I contributed 14K dollars to my 401K in my previous job then I went to work for a nonprofit institute I have contributed 14K for 403B. Do you think I have contributed above the limit or
it is okay?
-- Punit Kumar, MPTV, Milwaukee,WI

The 401(k) and 403(b) rules are coordinated, so you have over contributed for 2005. The 2005 limit for either type of retirement plan -- or a combination of the two -- is $14,000 (or $18,000 for those 50 or over by the end of the year).

You need to contact one or both or your 2005 employers and explain the situation and withdraw funds from one or both of the accounts to bring you under the limit. The excess deferral will be considered 2005 income, not 2006 income, so I think you'll need the employer to issue a new W-2. Income attributable to the excess deferral must also be taken out of the plan. That income IS considered income in the year it is distributed -- 2006 in this case.

I hope this is helpful. Good luck unwinding this situation.

--Kevin McCormally
Kiplinger Washington Editors

 

DEPENDENTS AND RELATED ISSUES

We are California residents. Our daughter, who is 19, attends a college in New Jersey. She worked during the school year in New Jersey and earned less than 1,000$, In summer, she worked in California and earned about 7,500$. If she files a tax return, can we still claim her as a dependent and receive Hope credit which we are eligible for with our AGI? Also, does she file California resident form and New Jersey Non-resident form? Thanks.
-- Mary, KQED, Fremont, California

Your daughter's income no longer comes into play when figuring whether she qualifies as your dependent. As long as she did not provide more than half of her own support in 2005, you can claim her as a dependent. (Even under the old rules, a child who was a full-time student under age 24 was not covered by an earnings test).

The state question is more complicated because state part-year returns can be wildly complex. First, if your daughter had any state income tax withheld in New Jersey, she needs to file to reclaim that money. I'm not sure if she has to file in N.J. otherwise, though, because her income may be below the state filing threshold. My daughter lives in California, so I know your daughter's income is high enough to trigger a return in California. Sorry I can't be of more help on this one.

 

--Kevin McCormally
Kiplinger Washington Editors

my mother passed away and left her IRA to my child, age 13 this year. My child had to accept a RMD of $1,385. does my child file her own tax return or can I include the distribution on my return, and what happens next year when my child is 14 and the RMD will be $3,285 ?
-- Mike C., WGPTV, Flowery Branch GA

This is a great question.

First, you may not report your daughter's IRA income on your return. Parents can only do that if the child's only income is from interest and/or dividends.

In this case, the required minimum distribution from the IRA is considered unearned income and thus a return must be filed, since the unearned income amount exceeds $850. Under the rules for 2005, for a child under age 14, the first $850 of unearned income can be tax free; the next $850 is taxed at his or her rate...probably 10% (assuming she doesn't have a lot of other taxable income). Since that covers the '05 distribution, that's that. If the total had exceeded $1,700, the excess would have been taxed at your rate.

Since your daughter turns 14 in 2006, you don't have to worry about the kiddie tax anymore, so on her '06 return, the taxable part of the distribution will continue to be taxed at her rate. . .even though it will exceed $1,700.

Remember, I don't make the rules, I just try to explain them.

--Kevin McCormally
Kiplinger Washington Editors

Can I include my father as a dependent without him loosing his supplemental social security income?
-- Dorothy, kcet, Los Angeles, CA

I am not an expert on the SSI program, but I don't see why claiming your father as a dependent would affect his eligibility. I suggest you call a local social security office to make sure.

--Kevin McCormally
Kiplinger Washington Editors

I send about 1/3 of my post tax income to support my brothers who are both american citizens..they are both under 18 and full time students but do not live in the US can I still calim them as dependants?
-- Ahmed, Cleveland, OH

One test for claiming a dependency exemption is that the person for who it is claimed must pass the U.S. Citizen or Resident test as outlined below.

Citizen or Resident Test
You cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident, U.S. national, or a resident of Canada or Mexico, for some part of the year. However, there is an exception for certain adopted children, as explained next.

Adopted child. If you are a U.S. citizen who has legally adopted a child who is not a U.S. citizen, U.S. resident, or U.S. national, this test is met if the child lived with you as a member of your household all year. This also applies if the child was lawfully placed with you for legal adoption.

Child's place of residence. Children usually are citizens or residents of the country of their parents. If you were a U.S. citizen when your child was born, the child may be a U.S. citizen even if the other parent was a nonresident alien and the child was born in a foreign country. If so, this test is met.

Foreign students' place of residence. Foreign students brought to this country under a qualified international education exchange program and placed in American homes for a temporary period generally are not U.S. residents and do not meet this test. You cannot claim an exemption for them. However, if you provided a home for a foreign student, you may be able to take a charitable contribution deduction. See Expenses Paid for Student Living With You in Publication 526, Charitable Contributions.

U.S. national. A U.S. national is an individual who, although not a U.S. citizen, owes his or her allegiance to the United States. U.S. nationals include American Samoans and Northern Mariana Islanders who chose to become U.S. nationals instead of U.S. citizens.

If your brothers pass this test, you might be able to claim them as dependents. See IRS Publication 501 -- http://www.irs.gov/publications/p501/ar02.html#d0e4142 -- for more info.

--Kevin McCormally
Kiplinger Washington Editors

My mother, an 84 year-old lady, has been living with me for several years, to whom I have been providing food, shelter and other living expenses for those years. She is currently receiving a Supplemental Security Income (SSI) of about $4,800 per year from the Social Security Administration. Can I claim her as my dependent when I do my 2005 Income
Tax Returns? Thank you!
-- Ting-Ting Fan, MPT, Arlington, VA

It certainly sounds like your mother qualifies as your dependent, assuming the SSI payments represent her entire income and you provide more than half of her support. (If other family members help support her an together the group of you provide more than half of your mother's support, you could claim her as a dependent under a "multiple support agreement" (using IRS form 2120). You can't claim your mother as a dependent if she received more than $3,200 of income during 2005, but for this test tax-free SSI benefits don't count as income.

--Kevin McCormally
Kiplinger Washington Editors

my partner owes child support, how can we file without having our refund withheld/taken?
Is it possible to file seperately? what are the options?
-- P Jones, Philadelphia, pa

When you say partner, I assume this is not your husband or wife. If that is correct, you can not file jointly and must file separate returns. In that case, your partner's tax liability can not be withheld from your refund.

If your partner is your husband or wife, I believe filing separately would protect your refund, but it could result in a higher overall tax bill since the married filing separately filing status rarely reduces the couple's tax liability.

--Kevin McCormally
Kiplinger Washington Editors

If I am paying for my girlfriend's university in foreign country and her living, can I use those expenses in tax exemption? I normally send money via wire transfer or other money transfer programs.
-- Shailesh Patke, Inkster, MI

To qualify as a dependent and entitle you to a tax exemption, a person must either be related to you or live with you for the entire year. Since neither seems to be the case with your girlfriend, I'm afraid you can not claim an exemption.

--Kevin McCormally
Kiplinger Washington Editors

Hello Kevin. My relatives came from overseas in 2003 and unfortunately my father-in-law had some emergency medical treatment for around 3500 dollars. Is there any way I could account this money spent in my tax return. I haven't accounted this in either my 2004 or 2005 tax returns. Really appreciate your response.
-- Ravi, WGBX, Acton, MA

If you claimed your father in law as a dependent in the year the expenses were paid -- or if you could have claimed him if it were not that his income was too high to qualify -- then you can count those medical expense among your itemized deductions for the year involved. Of course, medical expenses are deductible only to the extent that they exceed 7.5% of your adjusted gross income. (So, if your AGI is $100,000, for example, the first $7,500 of expenses don't have any tax-saving power.) If you could have deducted the expenses on your 2003 return but failed to do so, you can file an amended 2003 return using Form 1040X.

--Kevin McCormally
Kiplinger Washington Editors

1. I am in the process of selling raw land and will have capital gains. Will I be able to shelter sme of it by "gifting" some money to my family members, in particular to my grandchildren in the form of Cloverdale
or 529's. If this is no allowed, can I give it to my children to give to their children? If this is allowed how can I do it? I am actually planning to carry a note for two years; if I am allowed to give, can I stretch it over the note period?
2. If a child, 15 years of age, have over $1,600 unearned income and he is being claimed as a dependent by his parents, does he have to pay taxes for his total income, say $2,000 or is the first $1,600 exempted from taxes?
Thank you for your advice.
-- Jo Philip, Channel 9, San Francisco, CA

You can not reduce the tax on the profit from the sale of the land by giving the proceeds away. Once you sell the land, the profits are taxable to you.

Now, you could give (all or part) of the land away. When the new owner sells, the profit would be taxed to him or her. That could save the family some money because the top rate on long-term capital gains is now 15% but, for taxpayers who are otherwise in the 10% or 15% bracket, the top capital gains rate is just 5%. So, you might be able to shift some of the gain into a lower bracket.

There is no tax deduction allowed for contributions to a Coverdell education savings account and no federal deduction for contributions to 529 state college savings plans (although many states allow residents to deduct part or all of what they contribute to the state's 529 plan).

As for your 15 year old, someone who is claimed as a dependent can not claim his/her own personal exemption, but he or she can claim a standard deduction. For a single dependent, the standard deduction is the greater of $800 or the individuals earned income plus $250 (but not more than $5,000).

So, if the 15 year's only income is $2,000 of investment (unearned) income, then $1,200 of it would be taxed ($2,000 - $800).

I hope this helps.

--Kevin McCormally
Kiplinger Washington Editors

 

REAL ESTATE ISSUES

Ohi kevin. i own raw land in new hampshire and would like to sell it and buy a condominium zoned for commercial and residential use in massachusetts. does this type of transaction qualify for 1031 exchange treatment if i meet all the other tests of such an exchange? thanks.
-- bill, wgbx, boston, massachusetts

Sure, raw land can be traded for improved property in a like kind exchange, sometimes called a tax-free swap. Here's a comment from the IRS website:

Properties are of like-kind, if they are of the same nature or character, even if they differ in grade or quality. Personal properties of a like class are like-kind properties. However, livestock of different sexes are not like-kind properties. Also, personal property used predominantly in the United States and personal property used predominantly outside the United States are not like-kind properties.

Real properties generally are of like-kind, regardless of whether the properties are improved or unimproved.

See IRS publication 544 at www.irs.gov for details.

--Kevin McCormally
Kiplinger Washington Editors

n the sale of residential rental property that has been fully depreciated-- sale $30,000 where do I report on tax form 4792 or schedule D and is the full amount taxed as capital gains or normal income ? Depreciaton is $30,000 taken over 27.5 years prior to sale.
-- Ken Lucke, klrn, victoria, texas

The profit attributable to depreciation -- all of it in this case since your basis is $0 -- is taxed at a flat 25% rate on Schedule D.

--Kevin McCormally
Kiplinger Washington Editors

A loss in investment property entered on Turbo Tax changes to $3,000 regardless of the amount of loss. Plus, it shows that $5,500 of the loss can be taken in 2006. If correct, please explain the rationale. If not correct, please give me the reporting form to use and what can actually be deducted from an $8,500 investment property loss. It involves land bought in an exclusive retirement area in Arkansas with several golf courses etc for investment purposes that was finally sold at a big loss.
-- RR, The Colony, Texas

I'm not sure what's going on with TurboTax but in general, you can deduct capital losses only to the extent of the capital gains you report for the same year PLUS up to $3,000 of excess loss can be deducted against other kinds of income. Is it possible that the $3,000 figure is the loss showing up on the front of the 1040? That is the most that can be deducted there? Any excess loss is carried forward to future years.

I hope this is of some help.

--Kevin McCormally
Kiplinger Washington Editors

I live in CA and purchased land in WA state in 2005. On the settlement form from the title company there is an entry for excise tax charged to me. When I checked with the local taxing authority I was told it is a state tax. My questions is, can I take the excise tax I was charged as a deduction on my federal taxes? I've searched through IRS publications and can't find a definitive answer. Thank you.
-- Suzanne Raley, KQED, Palo Alto

I'm not sure what kind of tax this was, but it is clear (see IRS Publication 527) that transfer taxes on the purchase of a property are not deductible but are rather added to the basis.

--Kevin McCormally
Kiplinger Washington Editors

In the past year the city government acquired some property from me for road purposes. I had owned this real estate for over 30 years. In order to offset the gain, I sold some common stock which I was losing money on, thinking the stock loss would offset the gain realized in the sale of the real estate. Is this permissible under the tax laws?
--Wayne Childers, KLRU, Austin, TX

Absolutely..this is the tax savvy way to do things, assuming you sold the stock and the land in the same year. Both the real esate sale and the stock sales are reported on your 2005 Schedule D, and the loss on the stocks offsets the taxable gain on the land.

--Kevin McCormally
Kiplinger Washington Editors

In 2005, I refinanced my home mortgage and took some money for home improvement cost. No, I did not add any new money for the refinancing. Should I consider this money a part of itemized deduction in schedule-A ? Thank you.
-- Kallol, Channel 13, Jersey City, New Jersey

The law allows you to deduct interest on up to $1 million of "home acquisition" debt and up to $100,000 of home equity debt. If you had used part of the cash out refinancing to pay for capital improvements to your home, that amount would have counted toward the $1 million acquisition limit. Money not used for improvements could be considered home equity debt and the interest on up to $100,000 of such debt IS deductible on Schedule A.

--Kevin McCormally
Kiplinger Washington Editors

 

Hi Kevin. I sold my 1989 mobil home at a heavy loss in 2005. Bought the same in 1999 for $100k. I sold for $63k net. Is there any way of deducting the loss? Thanks Kevin.
-- Hemmige Varadarajan, KQED, Sunnyvale, CA

Not if it was your principal residence. Although Congress has often debated making the loss on the sale of a home deductible, the lawmakers have never approved such a deduction. Now that most home sale profit is tax-free, I doubt that Congress will change the no-deduction rule for home sale losses.

Now, if the reduced sales price was due to damage caused by a storm, for example, you may be able to deduct a casualty loss.

--Kevin McCormally
Kiplinger Washington Editors

I sold some real estate at a profit in December. I am filing an extention and wanted to send some money to reduce my penalty and interest on the capital gains.Aprox what per centage should I send? I am currently trying to get in with a tax pro. Married filing joint will gross about 50,000. Thank you.
-- Dave, kaet channel 8, Tempe ,Az

Assuming it was a long-term gain, the tax will be 15% of the profit. It's impossible to say how much you should send in with your Form 4868 extension request, though, since I don't know how much was withheld from your salary. As I noted in one of my early commentaries, the vast majority of workers have too much withheld from their pay. If you were overwithheld during 2005, that excess will help pay the tax on your real estate gain. Your best bet is to do a rough estimate of how much tax you'll owe with your return. I know that sounds difficult, but pull out last year's tax papers and see if your financial life in '05 was pretty similar to '04, except for that real estate gain. If so, you can do a quick and dirty estimate of the real estate profit and compare your likely tax bill for '05 with what's been withheld. Then, send in enough to come within 90% of what's owed for the year.

--Kevin McCormally
Kiplinger Washington Editors

 

We just sold our house this month for an amount over $500,000 filing jointly. After computing the taxable gain using the $500,000 exception, we were left with a capital gain of $2000, but this was only because of a 2119 form filed in 1994 that gave us an adjusted basis for our previous house sold in that year that was $200,000 lower than the selling price. Is there a way to go back and apply the $500,000 exemption to that
sale since the required 2 years out of five was met then also? If not, is there any other way we erase this long term capital gain?
-- Dylan Stephens, HN13, Kailua-Kona

Sorry, but the law creating the $500,000 tax-free profit rule wasn't around in 1994. Back then, when you sold one home, you could avoid paying taxes on the profit by buying a new home within two years and "rolling" the profit form the first home into the second. Say you bought a house for $100,000 and sold it many years later in 1994 for $300,000 and, within a few months, bought a new home for $350,000. In that case, no tax was due on the sale but, alas, your basis in the new $350,000 home was still just $100,000. By rolling over the profit, you just postponed the tax, not eliminated it. And, it sounds like that's the situation you're in today....

On the bright side, thanks to the special 15% rate for long term capital gains, our tax on that $2,000 profit will be just $300--not bad on a $502,000 profit.

--Kevin McCormally
Kiplinger Washington Editors

I sold my house last years,what's time limit for me to buy other house before the IRS hit me whith the capital gain taxs????
-- Barry, WNET13, NEW YORK

The law on home sales changed in 1997 so there is no time limit for reinvesting the money. Before the change, you could avoid tax on the profit if, within two years of the sale, you purchased a new home that cost more than the place you sold.

Now, however, up to $250,000 of profit is tax-free ($500,000 if you are married and file a joint return) if you owned and lived in the house for two of the five years leading up to the sale. It doesn't matter if you buy a new home or not. And, you can use this break over and over again in your home-owning career -- as long as you don't use it more than once ever two years.

If you met the two-of-five years test and your gain was less than $250,000 (or $500,000), you don't even have to report the sale to the IRS.

--Kevin McCormally
Kiplinger Washington Editors

 

What are the rules covering Moving expenses ?
--Mariang, WDET, Reno, NV

In a nutshell, to be deductible, the move has to be closely related to taking a job at a new job location and the new location must be at least 50 miles farther from your old house than your old job was from the hold house. If you qualify, you can deduct the cost of moving yourself, your family and your household goods to the new location. See IRS publication 521, Moving Expenses, for the details.

You can deduct moving expenses even if you do not itemize deductions. Qualifying costs are written off on the front of the Form 1040.

http://www.irs.gov/pub/irs-pdf/p521.pdf

--Kevin McCormally
Kiplinger Washington Editors

Dear Kevin, My Mother passed away four years ago, and left her timeshare to four siblings. My sister would like to buy out everyone's share. Would this be reportable income? Thank you.
-- Joan, WPBS, CHASE MILLS, NY

It depends on what's happened to the value of the timeshare since your mother died. At that time, the tax basis of the timeshare would have been "stepped up" to its value on the day of your mother's death -- any appreciation since that time would have become tax-free. Now, if the value of the timeshare had declined since that time, the basis would have been "stepped down" to date-of death value.

Let's say the value was $10,000 at the time your mother died and left it in equal shares to four children. Effectively, each of you has a basis of $2,500. If you sell your share to your sister for more than $2,500, then you should report the transaction on Schedule D where the profit would be treated as a long-term capital gain.

If you sell for less than your basis, though, you don't need to report the transaction to the IRS because the sale of such personal-use property can't produce a deductible loss.

I hope this helps.

--Kevin McCormally
Kiplinger Washington Editors

I got a few thousand dollars as an out-of-court settlement towards the repair of the faulty construction and also our pain and sufferings for the new house from the builder. Our lawyer gave me 1099-MISC noting the settlement value(after deducting his professional fees)in Box-7 as NON EMPLOYMENT COMPENSATION. My question is where (which forms) and how to show this in the tax return. Is this taxable? Would you plese guide me.
-- GUS, Jackson, MS

First, I suggest you check with the attorney to make sure the entire net amount of the settlement is taxable income. One tax attorney I spoke with about your questions suggests that the amount to pay for repair of faulty construction -- if the repairs were actually made -- might not be taxable, since it did not add to your weath but instead restored your property to its original value. The amount for pain and suffering would be taxable income (assume the pain and suffering was not the result of a physical injury) and you would report the taxable amount as "other income" on line 21 of the Form 1040.

--Kevin McCormally
Kiplinger Washington Editors

Hi. I have a house overseas, I would like to sell it and transfer the fund to U.S. How much & how should i pay the taxes? thanks
-- Arden, QED, Pittsburgh, Pa

American citizens are taxed on their worldwide income, so selling a house located in a foreign country will trigger a capital gains tax just like selling an investment property here in the states. You would report the sale on Schedule D and, assuming you owned the property for more than a year, your long-term capital gain will be taxed at 15%. If you make this an installment sale, so the new owners pay you the proceeds over more than one year, the tax would be due as you receive the money.

--Kevin McCormally
Kiplinger Washington Editors

I bought a piece of raw land for $25,000 in 1976. It is now worth $800,000. If I build a home on the property, live in the home for two years, then sell the home, can I take a $500,000 (I am married) exemption on the profit? Thank you.
-- Mari Rosenberg, KQED, Scotts Valley, CA

Great question...and I think it works. I just ran through the IRS regulations on the exclusion of home sale profits and I see no reason this would not qualify. The rules say you must own and live in the property for two of the five years leading up to the sale in order to take up to $500,000 of profit tax free. The fact that the profit may have build up before the home was built does not seem to me to alter that outcome.

--Kevin McCormally
Kiplinger Washington Editors

I have a home office deduction and in order to avoid confusion or taxation on capital gains when we sell the house, do I have to depreciate a portion of the house asset? I do understand that the gains are not taxable if I meet certain requirements (living in prop for 2 out of 5 years.)
-- Mark Dietlin, NHPT, Portland, ME

This is tricky because whether or not you claim the deprecation, the law says you must reduce your basis by the amount of depreciation allowable. Here's a q&a from the IRS website that is very similar to yours:

"I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house, the basis won't be affected?
If you qualify to deduct expenses for the business use of your home, you can claim depreciation for the part of your home that is a home office. Generally, the part of your home that is a home office is depreciated over a recovery period of 39 years using the straight line method of depreciation and a mid-month convention. If you do not claim depreciation on that part of your home that is a home office, you are still required to reduce the basis of your home for the allowable depreciation of that part of your home that is a home office when reporting the sale of your home. For more information, refer to Publication 587, Business Use of Your Home"

The amount of profit attributable to this reduced basis is not tax free when you sell your home. Instead, it is taxed at a flat 25% rate.

 

--Kevin McCormally
Kiplinger Washington Editors

I bought a lot in 1987 & sold it for a loss in 2005. Can I take a loss on it in schedule D line 8 (long time)?
-- Don Page, Appleton, WI.

Sure. The land would be considered investment property and selling for less than your basis would create a long-term capital loss. Report the sale on Line 8, Part II of the Schedule D.

--Kevin McCormally
Kiplinger Washington Editors

 

I sold my home in 2005 and moved. After settlement we walked away with $ 90,000 which we immediately put down on a new construction home. Do I pay taxes on the 90,000 ? Can I write off any moving expenses ?
-- Ron, WHYY, Philadelphia, PA

How much you walked away from the settlement table with doesn't matter. The key is whether you had a taxable gain. Your gain is the difference between your tax basis (basically, that's what you paid for your home, plus the cost of any capital improvements while you lived there, minus any gain from previous residences that might have been rolled over into your home under the laws in effect before mid-1997) and the proceeds of the sale. Any excess is capital gain but if you owned and lived in the house for at least two of the five years leading up to the sale, then up to $250,000 of such profit is tax free ($500,000 of profit can be tax free if you're married and file a joint return).

Whether or not moving expenses are deductible depends on whether the move was associated with taking a job at a new job location. If so, and if the new job location is at least 50 miles farther away from your old home than your old home was away from your old job location, then you can deduct moving expenses. See IRS Publication 521 for details at http://www.irs.gov/pub/irs-pdf/p521.pdf

--Kevin McCormally
Kiplinger Washington Editors

 

In 2005, we built a new house. Halfway thru construction the contractor told us that he put the house over an underground power line. The electric co. charged us $2980, to reroute the line around the house. We had to upgrade the line from one transmission box on the property of our neighbor to our east to the other transmission box on the property of our neighbor to the west. This was a one time charge from the electric co. that is not an "improvement that would be added to the basis of the property". Can this entire amount of $2980 be included on Schedule A line 6. The electric co. didnt itemize any charges in their invoice. Your response would be greatly appreciated. Thank you very much.
-- Paul Litzner, Kaet, Phoenix Az

I'm not sure I agree with your premise that the cost can not be included in the basis of the home. A tax attorney I checked with told me that, based on your e-mail, he thought the cost would be considered part of the cost of construction of the home and therefore included in the tax basis.

In any event, I do not believe the expense could be considered a real estate tax deductible on Schedule A.

--Kevin McCormally
Kiplinger Washington Editors

 

I bought a 3-family rental property last year. I actively manage the property myself, like fix-ups and do rentals, etc. I like to know if there is a max $25k deduction limit per year on Sch E per property. I know on passive property, it does..like for limited partnerships.
-- Henry Moy, WGBH-TV, Burlington

Great question. Yes, basically there is a $25,000 cap on the amount of real estate losses that can be deducted against other kind of income. Excess losses are considered "passive" losses and suspended until the underlying property is sold. At that point, the suspended losses can be deducted.

Here's a section from my book, Kiplinger's Cut Your Taxes, that discusses this matter:

Surviving the Passive-Loss Rules

As part of the crackdown on tax shelters, discussed earlier, Congress severely limited the ability of investors in “passive activities” to deduct losses from those investments against other kinds of income. Rental real estate is specifically labeled a passive activity.

That could have been a knockout blow for a lot of landlords who count on tax losses to make their real estate investments financially feasible. But the law includes a major exception to the passive-loss rules that makes rental real estate an oasis in the otherwise barren tax-shelter landscape. And special relief has been added for real estate professionals. First a look at the basic exception, then at the special rules for real estate pros.
If you qualify for exception, you can continue to deduct up to $25,000 of rental real estate losses against other income, such as your salary or interest and dividends.

To qualify, you must actively participate in the management of the property. Fortunately, the demands for passing that test aren’t particularly onerous. You don’t have to be on call for middle-of-the-night repairs, or to cut the grass and collect rents. The IRS rules don’t say exactly what you do have to do, but even if you hire a management firm to handle day-to-day matters, you can be actively involved as long as you approve tenants, set the rent and okay capital improvements.

The $25,000 exception isn’t for fat cats, though, no matter how actively they’re involved. It is phased out as adjusted gross income (which is basically your income before subtracting itemized deductions, exemptions and rental losses) moves between $100,000 and $150,000. The $25,000 loss allowance is reduced by 50% of your AGI over $100,000. This is how the tax break evaporates as your income rises:

If AGE Is	You May Deduct Rental Losses Up To
Up to $100,000	$25,000
110,000	20,000
120,000	15,000
130,000	10,000
140,000	5,000
150,000	0

The $25,000 allowance and the phaseout schedule are the same whether you are married filing a joint return or single filing an individual return. If you are married filing separately, however, and you and your spouse lived together at any time during the year, neither spouse gets a loss allowance. In other words, although filing separately might pull AGI on one or both returns below the $150,000 level, the maneuver won’t work to revitalize passive losses that would be denied on a joint return. If you are married and live apart from your spouse for the entire year, you can deduct up to $12,500 of otherwise disallowable losses if you file a separate return.

The $25,000 allowance doesn’t protect losses generated by a limited partnership or any rental property in which you own less than 10%. But note this important point: Passive losses that you can’t deduct immediately are not useless. They are suspended rather than obliterated. You can store the losses for future years and deduct them when you have passive income to shelter. And when you ultimately sell a rental property that generated passive losses, any unused losses are liberated to be deducted against any type of income, including your salary.

There’s also a special break for real estate professionals that can free them from the general rule that rental real estate is automatically a passive activity. To qualify, basically, more than half the time you spend working during the year (and a minimum of 750 hours) has to be in the real estate business—-defined to include property development, rental, management and real estate brokerage businesses. Of the 750 hours—that’s 100 7 1/2 hour days—-at least 500 must be devoted to the rental activity, or only 100 hours if no one else spends more time on it than you do, to qualify. Thus, a builder or a real estate broker who spends only a few hours a month managing a rental would not qualify for this break. If you file a joint return, however, you can qualify if either you or your spouse passes the tests. The prize for passing, of course, is that rental losses aren’t branded as passive and therefore can be deducted against other kinds of income.

--Kevin McCormally
Kiplinger Washington Editors

If I reside in my home (principle residence) for 4 years and now sell it at a loss. Can I claim capital loss in my 1040?
-- Mason, WHYY, Avondale, PA

Afraid not. Although it's often been discussed in Congress, as the law stands now you can not deduct the loss on the sale of your home.

--Kevin McCormally
Kiplinger Washington Editors

On 05/03 purchased my residence on a large lot. Subdivided into 6 lots and sold two on 8/05 and 10/05. Collecting interest only until buyers obtain construction loans. How do I report and what is my basis on sales?
-- John Rodeback, KCET, Burbank, CA

You'll need an appraisal or some other reasonable estimate to spread the cost of the property over the various parcels to come up with a basis for your home and each of the five unimproved lots. The sale of the lots will result in a short-term gain or loss (depending on the sales proceeds compared with the basis) but it sounds like you made an installment sale and will not receive the proceeds of sales until 2006. If so, you would not report the gain until 2006 although you would report interest received in 2005 on your 2005 return. See IRS publication 537 (http://www.irs.gov/pub/irs-pdf/p537.pdf) for more on installment sales.

--Kevin McCormally
Kiplinger Washington Editors

1. I am in the process of selling raw land and will have capital gains. Will I be able to shelter sme of it by "gifting" some money to my family members, in particular to my grandchildren in the form of Cloverdale or 529's. If this is no allowed, can I give it to my children to give to their children? If this is allowed how can I do it? I am actually planning to carry a note for two years; if I am allowed to give, can I stretch it over the note period?
2. If a child, 15 years of age, have over $1,600 unearned income and he is being claimed as a dependent by his parents, does he have to pay taxes for his total income, say $2,000 or is the first $1,600 exempted from taxes?
Thank you for your advice.
-- Jo Philip, Channel 9, San Francisco, CA.

You can not reduce the tax on the profit from the sale of the land by giving the proceeds away. Once you sell the land, the profits are taxable to you.

Now, you could give (all or part) of the land away. When the new owner sells, the profit would be taxed to him or her. That could save the family some money because the top rate on long-term capital gains is now 15% but, for taxpayers who are otherwise in the 10% or 15% bracket, the top capital gains rate is just 5%. So, you might be able to shift some of the gain into a lower bracket.

There is no tax deduction allowed for contributions to a Coverdell education savings account and no federal deduction for contributions to 529 state college savings plans (although many states allow residents to deduct part or all of what they contribute to the state's 529 plan).

As for your 15 year old, someone who is claimed as a dependent can not claim his/her own personal exemption, but he or she can claim a standard deduction. For a single dependent, the standard deduction is the greater of $800 or the individuals earned income plus $250 (but not more than $5,000).

So, if the 15 year's only income is $2,000 of investment (unearned) income, then $1,200 of it would be taxed ($2,000 - $800).

I hope this helps.

--Kevin McCormally
Kiplinger Washington Editors

 

I own a home in which I lived from 1991 to 1994 and then rented it till today. I have questions on tax consequences of selling it. How do I calculate my potential tax liability? How long will I have to live there to claim it as a primary residence and get $250K gain without taxes? Can I have two homes as primary homes if none is rented? these are not in same state! I am a consultant, so can work from anywhere! I thank you for your answer or direction for enlightenment!
-- Ajit Ghorpade,WHYY, King of Prussia, PA

Let's start from the bottom: No, you can't have two primary residences at the same time.

Now, for the tax liability if you sell the rental property. You would have a long-term capital gain to the extent that the proceeds of the sale exceeded your basis in the property. Your basis is what you paid for the house when you bought it as your home (or, if it was worth less than what you paid at the time you converted it to a rental, that lower value would be your basis) minus all the depreciation claimed during the years you rented the place. If you made capital improvements during those years, that expense would add to your basis. Your capital gain would be taxed at 15%.

If you move back into the house as your principal residence and live there for two years before selling, up to $250,000 of gain could be tax free. Note, however, that the gain attributable to the depreciation while the place was rented (depreciation reduces the basis dollar for dollar and hence increases the gain when you sell) would be taxed at a flat 25% rate. Gain attributable to appreciation in the value of the property, however, could qualify for tax-free home profit treatment.

I hope this helps.

--Kevin McCormally
Kiplinger Washington Editors

I live in a Miami-Dade Florida and need roof repais as a result of Wilma. On the tax forms it asks for cost or basis, insurance payments, and estimated value before and after repairs. Can I just put in the costs of the
repairs and what I received from the insurance company and let the IRS do the rest? Also do I then have to file an amended return for 2004?
-- Viewer on WPBT, Miami, Florida

This is a great question that leads us right into the muck of the tax law.

Yes, the form calls for all that information because IRS regulations say all of it is necessary to figure your casualty loss. Your basis is important because, if the insurance settlement happens to be more than your basis --unlikely in your case since a roof is involved but very possible in cases of total destruction -- the law says that in certain circumstances you could have a taxable gain rather than a casualty loss.

And, the loss itself is the decline in fair market value as a result of the storm.

That said, some shortcuts are allowed, and the IRS stresses that, after last year's hurricanes, it is doing everything it can to be as helpful as it can. Check out IRS publication 547 at http://www.irs.gov/pub/irs-pdf/p547.pdf and you'll see that you can use the cost of repairs as an indicator of the decline in fair market value -- as long as the repairs are actually made, are not unreasonable and do not substantially INCREASE the value of the property. So, for example, you can't a cheap roof with a really fancy, expensive one and claim the entire difference between the cost and the insurance settlement as a casualty loss. The key to issues like this is that you proceed in a reasonable way.

I'd suggest trying to come up with a basis for your home (that's what you paid for it, plus the cost of any capital improvements and minus any gain you rolled over from previous home sales before the law changed in 1997) and plug that figure into the form. Then, estimate the value of your home before the damage and reduce it by the cost of repairs (as noted in Pub 547) for the cost afterwards. Subtract the insurance settlement and I think you could argue that's a reasonable way to figure your casualty loss.

Note, however, that your loss might be higher if, for example, landscaping was damaged as well as the roof. The cost of restoring landscaping can also serve as a proxy for the reduction in fair market value.

I also check with neighbors to ask how they're handling this and, if you hear of more creative ways, please let ME know. Thanks.

--Kevin McCormally
Kiplinger Washington Editors

Dear Kevin: I bought my house for 150k and after 2 yrs sold for 195k.Do I have to report the sale?. thanx
-- morry, wunc, Raleigh,N.C

No. Since you owned and lived in your home for at least two of the five years leading up to the sale, at least $250,000 of profit is tax free (for married couples filing jointly, the tax-free amount is $500,000).Since there's no way a sale for $195,000 could produce more than a quarter of a million dollars of profit -- and therefore there can't be any tax to collect -- the IRS doesn't even want to hear about the sale.

--Kevin McCormally
Kiplinger Washington Editors

 

STOCKS, BONDS, AND OTHER INVESTMENT ISSUES

I am 81. A company I own stock in is being bought out by another company. Can I roll the capital gain into my IRA to avoid taxes?
-- Viewer on WTVS

You can't roll the capital gain into your IRA, but are you SURE you have a capital gain. With so few details I can't be sure, but this transaction could be a nontaxable exchange, with your basis in the shares of Company A transferring to shares you received in Company B. In that case, your gain wouldn't be taxable until you sell the shares in Company B. If you received cash in the deal, however, your gain would be taxable in the year of the transaction.

--Kevin McCormally
Kiplinger Washington Editors

In the past year the city government acquired some property from me for road purposes. I had owned this real estate for over 30 years. In order to offset the gain, I sold some common stock which I was losing money on, thinking the stock loss would offset the gain realized in the sale of the real estate. Is this permissible under the tax laws?
--Wayne Childers, KLRU, Austin, TX

Absolutely..this is the tax savvy way to do things, assuming you sold the stock and the land in the same year. Both the real esate sale and the stock sales are reported on your 2005 Schedule D, and the loss on the stocks offsets the taxable gain on the land.

--Kevin McCormally
Kiplinger Washington Editors

Do I need to report on my Schedule D stocks that split? Also I have "company A" stock that got bought out by "company B" in 2005, do I need to report a sell of "company A" and a buy of "company B" in my schedule D?
if not when I sell "company B" in the future I will report buy "company A" and sold "company B"?
-- Derek, 13 WNET, New York, NY

No, you don't report a stock split on your tax return. That simple affects your basis. Let's say you had 100 shares of company A and you have a 2-for-1 split so you now have 200 shares. If your basis in the stock was $25 a share before the split, your basis is now $12.50 -- the $2,500 basis is now spread over 200 shares.

Your company A to company B issue sounds like a non-taxable exchange (assuming no cash was involved). So, again, there's nothing to report to the IRS at this time. What happens is your basis in Company A now becomes your basis in the new Company B shares...and, when you sell the Company B shares, you simply report the Company B sale, using the Company A basis. Your holding period reaches back to the purchase of the Company A shares.

Aren't taxes fun?

--Kevin McCormally
Kiplinger Washington Editors

Are the margin interest for investment in stocks, allowed as deduction in the stock profits or IRS returns for individuals? Please advise the best option for individuals. Thanks.
-- Ray Shah, koce, Anaheim, Ca

Investment interest -- including that paid for margin borrowing -- can be deducted on Schedule A of the individual income tax return, the same form where mortgage interest is written off. The catch is that the deduction for investment interest is limited to the amount of investment income you report for the year. And, in this case, the definition of investment income specifically excludes long term capital gains or qualified dividends that are taxed at the special 15% rate. Congress doesn't want you writing off interest in, say, the 28% bracket to invest in assets that produce gains taxed at only 15%. Your investment interest write off is limited, basically, to what you report in interest, short-term gains, nonqualifying dividends and other investment income that does not get preferential treatment.

If this limit restricts your write-off this year, however, any excess margin interest can be carried forward to be deducted in future years.

--Kevin McCormally
Kiplinger Washington Editors

Kevin, I have interest expenses in a broker account. I also get dividnd income and short and long term gains from stock I trade in that account. I have not been able to find a way to ofset my interest exopenses
against this short term gains. The only place is on form 4952 4f, I can elect to include my dividens but not the gains on the stock.
-- David, Boca raton, Florida

This is one of the many tricky parts of the law. You can deduct investment interest expenses, but only up to the amount of investment income you report during the year. The trick here is that investment income does NOT include long-term capital gains or qualified dividends that are taxed at the special 15% rate. The Congress doesn't want you deducting investment interest in the 33% bracket, say, if your investment income is being taxed at 15%. Now, the lawmakers are kind enough to say that if you forego the low capital gains or qualified dividend rates, then that income counts as investment income for determining how much investment interest you can write off.

Your short-term gains, interest income and nonqualifying dividends -- all of which are taxed in your top tax bracket -- do qualify as investment income in setting the maximum investment income limit.

--Kevin McCormally
Kiplinger Washington Editors

I do all stock trading on internet. How do I cover all costs related to trading if I take standard deduction?
-- K.P. Desai, Dallas, Tx

The cost of brokerage commissions are not deductible, even by those who itemize. Such costs have a tax impact, though, because the cost of buying is added to your basis in the stocks and the cost of selling reduces your proceeds of sale -- in either case, the costs reduce your taxable profit or increase your loss when the stock is sold.

--Kevin McCormally
Kiplinger Washington Editors

Hi Kevin - I watch nightly business report program daily and like your tips. I trade stocks and have a question:
Can loss above and beyong $3000 be carried forward any number of years or after 2 or 3 years, it cannot be??
-- Anil, Milwaukee, WI

Thanks. Happy you enjoy the commentaries.

Capital losses can be carried for as long into the future as you're around to carry them over. Any leftover losses die when you do, however.

Each year you can use any amount of carryover losses to offset that year's capital gains, and up to $3,000 of excess loss can be deducted against other kinds of income, such as your salary or self-employment income. After that, any excess is carried over to the next year.

--Kevin McCormally
Kiplinger Washington Editors

I am using a credit card offer to advance me $15000 at 1.90% APY for an unlimited period. I invested this money in a money market paying 4.70% APY. Can I deduct the 1.90% interest as an interest expense? If so,
must I itemize? Thanks very much.
-- Richard B. Reinman, KNME, Albuquerque, NM

Yes, the interest on the credit card can qualify as investment interest as long as you can show that the cash advance was invested in the money market fund. Such investment interest is deductible up to the amount of investment income you report, and the interest on the money fund would qualify as investment interest for this purpose. And, yes, you must itemize deductions to claim this write-off. It is not available to taxpayers who use the standard deduction.

--Kevin McCormally
Kiplinger Washington Editors

The investment company that manages the account apportioned their fee into (1) dedicated to tax exempt munipal bonds and (2)the non-tax-exempt income. Question is: Can the total investment fee be claimed as a deduction in schedule A, line 22, Or only the portion dedicated to Non Tax-exempt income ? Thanks.
-- Anwar Ahmed, Houston PBS

I'm not sure what fee you're talking about, but the law is clear that you can not deduct as an investment expenses any costs incurred to produce tax-exempt income nor the interest on any debt incurred to borrow funds to invest in tax-exempt bonds.

--Kevin McCormally
Kiplinger Washington Editors

I purchased 38000 US Treasury Inflation Notes 3.875% maturing Jan 15, 2009 in late 2004. The purchase price was $50000. At the time the inflation adjusted principal was $44150. My questions are why was the purchase price so much more than the adjusted principal? Do I
have to pay taxes on the annual OID and why isn't it reflected already as the premium paid in the purchase price? And was this a poor investment since the value of the bonds have decrease with the increasing interest rate and should I keep or sell these bonds which I purchased for income purposes?
-- Roger Li, New Hampshire Public TV

The reason a bond trades for more than it's face value (the inflation adjusted principal in this case) is because market forces demand the premium price because the bond is paying a higher interest rate (or a higher inflation premium as may be the case here) than current market rates. This is not OID, which is original issue discount.There are two ways to handle the premium, tax wise. One is to amortize the premium each year you own the bond, basically by allowing a portion to offset part of the interest income on which you pay taxes; the other is to claim a capital loss when you redeem the bond if your basis is higher than the amount you receive.

TIPS are further complicated because each inflation adjustment you receive on the premium increases your basis in the bond, just as amortized market premium could be reducing it. This is a very complicated beast.

--Kevin McCormally
Kiplinger Washington Editors

I sold stock that has been with me for so many years that, as a result of reinvestments, splits, etc. I haven't a clue of my basis. How shall I proceed with Schedule D ?
-- Howard, WTTW, Skokie IL

Boy, I wish there were an easy answer. Unfortunately, you need to try to come up with a basis. The company may be able to help you with the issue of splits (check the company's Web site) and you can check your old tax returns for help on reinvestment of dividends. Each year you reinvested dividends, you should have record the amount of dividends as taxable income for that year.

The IRS gets a copy of the 1099 B Form showing the proceeds you received when you sold the stock. You have to come up with a basis figure to report on your return -- and subtract from the gross proceeds -- to come up with you taxable gain or loss.

Sorry I can't be of more help.

--Kevin McCormally
Kiplinger Washington Editors

Dear Mr. McCormally: I was unemployed most of the year in 2005 and had no wages. However, I made $14,000 in capital gains. Do I have to pay a 15% rate, or a 5% rate. Thanks.
-- George, WPBT, Miami, Florida.

Assuming your $14,000 is a long-term capital gain is your only taxable income for the year, you will pay tax at a 5% rate...but not on all of the gain. The 5% rate applies for people who are otherwise in the 10% or 15% tax bracket. The top of the 15% bracket on single returns for 2005 is $29,700 (it's $59,400 on joint returns), thus you're sure to qualify for the 5% rate.

Assuming you're single , over age 13 and not claimed as a dependent by someone else, you get a $5,000 standard deduction plus a $3,200 personal exemption that, together, will make $8,200 of the gain tax-free. Only the remaining $5,800 of the gain would be would be taxed -- for a tax bill of $290.

--Kevin McCormally
Kiplinger Washington Editors

My parents gave me some stock 2 yrs ago. I sold it today. How do i figure my cost basis?
-- Glenn Bankhead, WETA, Reva, VA

Believe it or not, that depends on whether your sold the stock for a gain or a loss...which, of course, you can't know until you know the basis.

It's not quite a complete Catch-22 however.

When someone gives away stock, he or she also gives away the basis in that stock. So, you need to ask your parents what their basis in the stock was. That becomes your basis. . .assuming you sold the stock for more than the basis so you have a taxable gain.

If the value of the stock had fallen between the time your parents bought it and the time of the gift, however, and you sold for a loss, then your basis is either the original basis or the value of the stock at the time of the gift, whichever is less. This rule basically prevents taxpayers giving away a tax loss which might be more valuable to one taxpayer than another (one in a higher bracket, for example).

For example, say your parents gave you 100 shares of stock for which they paid $5,000 but which were worth only $2,500 at the time of the gift. If the stock turns around and you sell for $6,000, your basis for determining gain is $5,000. If you sell for less than $2,500, however, the basis for figuring your loss is the $2,500 value at the time you received the gift. The loss in value while your parents owned the stock is ignored. What if the selling price falls between $2,500 and $5,000? You have neither gain nor loss.

If you use the donor’s basis as your own, your holding period for figuring whether you have a short- or a long-term gain or loss includes the time the donor owned the property. If you use the fair market value at the time of the gift as your basis, your holding period starts the day after you get the gift.

--Kevin McCormally
Kiplinger Washington Editors

 

I inherited some California municipal bonds in 2004 that matured in 2005. It is my understanding that the estate paid a heavy estate tax on these bonds, because they paid a high rate of interest. My question is as follows: What is the cost basis of my municipal bonds? Is the cost basis the same as the value declared on the IRS 706-Estate Tax return for each bond, or is it the par(face) value?
-- Mike Armijo, KQED, San Rafael, CA

Your basis would be the bonds fair market value at the time the previous owner died, which should be the value shown on the federal estate tax form. Any appreciation in the value of the bonds during his or her lifetime becomes tax-free upon death. (The bonds would have been worth more than their par value if the coupon rate was higher than current market rates.) Only appreciation after your inherited the bonds is taxed to you.

If you sold the bonds for less than your basis, in fact, you can claim a tax-saving capital loss, even though the inheritance put you in a better position financially. In the section of the Schedule D where you report the sale of the bonds, write "inherited" in the box where you are supposed to enter the date that you acquired the bonds. Regardless of how long you owned the bonds before selling, the sale results in a long-term gain or long-term loss.

--Kevin McCormally
Kiplinger Washington Editors

Determining cost basis for sale of 500 shares of GE from over 6200 total. Three Splits and one was 3:1. Dividends were used to buy shares for 20 yrs. thru 1999. The 3:1 split makes $40.00 aver- age/share= $13 .35 (my cost) since split was after 1999????
-- Dave Critchley, WETA, Manassas, VA

If you did not advise your broker to sell specific shares -- e.g., the 600 shares purchased at a certain date at a certain price -- then the famous FIFO rule comes into play: first in first out. That means the first of your shares
are the first ones sold. The basis of those shares is their cost, adjusted for the split. (And, note this: Unlike mutual funds which allow you to use an average basis per share when figuring gain or loss, you must use the actual basis when individual stocks are involved.)

Since I don't know the specifics, here's an example of how it works.

Original cost: Let's say you buy 1,000 shares at $40, for an original cost basis of $40 per share. (Ignoring commission costs.)

Two for one split: $40,000 basis is now spread over 2,000 shares, so basis per share is now $20 per share.

Two for one split: Basis is now spread over 4,000 shares, so basis is now $10 per share.

Three for one split: Basis is spread over 12,000 shares so basis is now $3.33 per share.

So, under FIFO, the sale of up to 12,000 shares would involve a cost basis per share of $3.33.

I hope this helps.

--Kevin McCormally
Kiplinger Washington Editors

 

EDUCATION ISSUES

Hello. You mentioned a tax refund for student that got affected by Huricanne Katrina . Can you tell me where to find this in the IRS website or where to enter it (form number) in my tax return. Thanks.
-- Caroline, Channel 9, santa cruz, ca

I was talking about the Hope and Lifetime Learning Credits which are available for post-secondary education. These education credits are claimed on line 50 of the Form 1040. Generally, the Hope credit can be worth up to $1,500 per student for the first two years of college education. The Lifetime Learning credit is generally worth up to $2,000 per family (regardless of the number of qualifying students). For students at colleges in the Katrina zone, the credits are doubled for 2005 and 2006.

See this IRS publication for more details: http://www.irs.gov/pub/irs-pdf/p970.pdf

--Kevin McCormally
Kiplinger Washington Editors

Hello Kevin. My Daughter is at Harvard Business School in Phd. program. The university pays all her tuition and she is getting 30k/year for just attending the school. She does not have to do any TA or RA to get the 30k. There are 8 students in the program and none of them received 1099 from the university. Since she started the program last fall, she got only about 10k in 2005, but will receive 30k this year. She worked until fall of last year, so she has other income. We don't know if she needs to pay taxes on the money she is getting from the university and I will appreciate if you could please shed some light on it. WHat will happen if she does not pay taxes on this money? Thanks in advance for your help.
-- Kusum, Fremont, Ca

It sounds to me like this would not qualify as tax-free scholarship or fellowship. And, although colleges and universities are not required to report fellowship payments that are considered taxable income to the IRS on a 1099, such payments that are not used to pay qualifying educational expenses (including tuition, fees, etc.) are considered taxable income and should be reported as wage income on the federal tax return. If your daughter does not report the income and the IRS discovers her failure to do so, she would owe back taxes, interest and probably penalties, too. How would the IRS know? The agency sometimes subpoenas college records to check for compliance.

--Kevin McCormally
Kiplinger Washington Editors

 

RE: Tuition credits. I just heard the very end of your commentary tonight on the Nightly Business Report. I have one son in college at Bloomsburg Univ. in PA (Senior yr) and another at the University of Delaware (Freshman year). Does the Katrina related tax credit relate to me at all. I think my TaxCut program automatically filled it in but I thought it must be wrong since we are no where near New Orleans, etc. Thanks.
-- Rick, WHYY, Reading, PA

The special Hope and Lifetime Learning credit rules apply only to students at qualifying schools in the "Gulf Opportunity Zone" which includes parts of Mississippi and Alabama as well as parts of Louisiana, but, you're right, not parts of Pennsylvania or Delaware. You can qualify for the Hope and Lifetime Learning credits with the regular limits, though. Are you sure that's not what TaxCut gave you?

--Kevin McCormally
Kiplinger Washington Editors

My older daughter is in graduate school and has student loans. After her younger sister finishes college, I would like to help her repay these loans. Is it possible for me to contribute directly to the loan institution without hitting the $12,000 per year gift limit? Thanks.
-- Jim McCormick, WUNC-TV, Raleigh, NC

Sorry, but no. The exception to the gift tax rules applies only if you pay educational expenses directly to the college. Repaying college loans doesn't count, so you'd be limited by the $12,000 annual gift tax exclusion. Of course if you and your spouse together repay the loans, the limit jumps to $24,000 a year...and if you spread the repayment over two calendar years, you get up to $48,000 without worrying about the gift tax.

--Kevin McCormally
Kiplinger Washington Editors

 

Kevin, we are a married couple making adjusted gross of 165K. We use TurboTax for our taxes and have not been able to deduct our ridiculous high college tuition of our two kids or qualify for any IRA deductions or
contributions because of our AGI. I only found that I can contribute to a traditional IRA with the only benefit of tax deferred growth. My question is, what will be the difference between contributing to an IRA tax differed
or increasing my contribution to a 401K through my company? Thanks.
-- Jose Perez, Florida

Increasing your 401(k) contributions will offer an additional tax break -- since pre-tax money will go in to the 401(k). An extra $4,000 into the company plan will reduce your take-home pay by just $3,000 if you're in the 25% bracket (and, when you take your state rate into account, I'm sure you're in a higher bracket, so the reduction would be less).

The trade off, of course, is that you'll pay tax on that $4,000 when you take it out of the 401(k) in retirement. Whereas with the nondeductible IRA, the $4,000 would be tax-free, although it will come out pro-rata along with taxable earnings. So, just a portion of our IRA payouts will be tax-free.

Generally, if your choice is pre-tax 401(k) versus nondeductible IRA, the 401(k) is the way to go.

To complicate matters further, some advisors would suggest skipping the tax shelters all together and putting the money in, say, an index fund that pays few dividends and delivers most growth via long-term gains that will be taxed at 15% in retirement. 401(k) withdrawals will be taxed in your top tax bracket.

Sorry for the confusion. Remember, I don't make the rules....

--Kevin McCormally
Kiplinger Washington Editors

can i deduct my 19 year son if he is a full time college student we live in florida and he attends a univesity
-- Kim Jones, Port Charlotte, fl

It sounds to me like your son qualifies as your dependent and, if so, you can claim a dependency exemption for him -- that will reduce your 2005 taxable income by $3,200 and save you $800 if you're in the 25% bracket.

To qualify as a dependent, a child must pass four tests:

1. Relationship — the taxpayer’s child or stepchild (whether by blood or adoption), foster child, sibling or stepsibling, or a descendant of one of these.
2. Residence — has the same principal residence as the taxpayer for more than half the tax year. Temporary absences (including time away at college) don't count against you here.
3. Age — must be under the age of 19 at the end of the tax year, or under the age of 24 if a full-time student for at least five months of the year, or be permanently and totally disabled at any time during the year.
4. Support — did not provide more than one-half of his/her own support for the year.

--Kevin McCormally
Kiplinger Washington Editors

Dependent daughter takes out student loan with mother as cosigner. Can mother take tuition expense deduction since daughter has not income?
-- Mike, Milwaukee WI

Yes, because the mother is a co-signer she is legally obligated to repay the loan. Here's the pertinent section from IRS Publication 970, Tax Benefits for Education. (http://www.irs.gov/publications/p970/index.html)

You can deduct interest paid on a student loan for your dependent only if you:
1. Are legally obligated to make the interest payments,
2. Actually made the payments during the tax year, and
3. Claim an exemption for your dependent on your tax return.

--Kevin McCormally
Kiplinger Washington Editors

If I am paying for my girlfriend's university in foreign country and her living, can I use those expenses in tax exemption? I normally send money via wire transfer or other money transfer programs.
-- Shailesh Patke, Inkster, MI

To qualify as a dependent and entitle you to a tax exemption, a person must either be related to you or live with you for the entire year. Since neither seems to be the case with your girlfriend, I'm afraid you can not claim an exemption.

--Kevin McCormally
Kiplinger Washington Editors

 

My husband and I have been separated for 5 years - he is California and me in Virginia - he files head of household because he has his mother as a dependent - I file married filing separately but in doing so I cannot get the education deduction nor the credit and I have spent so much out of my pocket to attend university? Why is the rule this way?
-- Viewer from Springfield, VA

That's a question for your congressional representatives. However, I think I know the answer. Many tax breaks that have income-qualifers are not allowed on married-filing-separately returns to prevent taxpayers from "gaming" the system by splitting their income to get below an income threshold. In your situation, I think you are being caught up in this effort unintendedly.

--Kevin McCormally
Kiplinger Washington Editors

 

I'm confused about the pros and cons of taking an Education Expense Deduction, Lifetime Learning Credit, or Hope Credit. I've been at work getting my degree for over 20 years now and I'm not sure I'll ever finish. My question is how long the deduction will last versus how long the Lifetime Learning Credit and Hope Credits will last? If the credits expire in 2010, for example, perhaps I should take the credit rather than the deduction. My qualified education expenses last year were only about &amp;500.
-- Tim Clemence, WHYY, Mount Laurel, NJ

There is no limit to the number of years for which you can claim the Lifetime Learning credit nor the deduction (you can only claim the Hope credit for the first two years of college). So, you should choose whichever tax saver saves you the most. If you're in the 25% bracket, for example, a $500 deduction would save you $125 in tax. If you're in the 15% bracket, though, the $500 expense would save you just $75.

The lifetime learning credit is 20% of the first $10,000 of qualifying expenses. Regardless of your tax bracket, then, $500 of expenses would translate into $100 of tax savings.

--Kevin McCormally
Kiplinger Washington Editors

 

TAX PREPARATION AND QUESTIONS ABOUT FORMS

Hello, My question is regarding to married couple filing separately. In a case that two incomes differ greatly, the lower income person would qualify for some credits (like child tax credit) that would otherwise not possible when two income combined (over $110,000). am i making any sense? if so, should interest/divided income be splited 50/50? thanks
-- Steve, WHYY, Philadelphia, PA

It's stunning how complicated the answer is to your simple question.

First, be careful because in some cases, credits are not allowed at all on married filing separately returns. With other credits, the phase out zones are lower on such returns. The child credit, for example, begins to phase out at $55,000 of income on separate returns but $110,000 on joint returns.

When it comes to reporting interest or dividend income, state law and the specific kind of account comes into play. Sometimes it's 50/50, sometimes it depends on which spouse contributed the money for the investment.

It is very rare that married filing separately pays off.

--Kevin McCormally
Kiplinger Washington Editors

Last July, I rolled over my 401k from my old job to my new job. I received a 1099 form distributing the funds to me. This was not income for me but a rollover to an existing 401k. Where is the line on the Form 1040 form to declare the rollover. Thanks
-- Tanya, WNET, East Orange, NJ

Report the full amount on line 16a -- so the IRS can match the number with the copy of the 1099 it received -- and put $0 on 16b as the taxable part. Write "rollover" on the form so it's clear to the IRS that this was a tax-free rollover.

Surprisingly simple, eh?

--Kevin McCormally
Kiplinger Washington Editors

Does it reduce the chances of an audit if asking for an extention on sending in my income tax return until October?
-- tim, wilmette,illinois

I don't think so when you file affects the odds of an audit. I've talked with lots of folks about this over the years, both inside the IRS and inside the tax profession and they have all told me that timing doesn't matter. It's what's on your return that does. Whether you file in February or October, the numbers on your return have to run the IRS gauntlet -- a computer program that weighs the likelihood that an audit would produce extra money for the government. Audits are not random.

--Kevin McCormally
Kiplinger Washington Editors

I notice my tax program (TaxCut) does not use my residential rental depreciation as an expense. Is that because the income was less that what I spent on repairs last year?
-- Diana, KQED, San Martin, CA

There is an order in which deductions are taken and I believe depreciation is the last thing to reduce taxable income. So, if other expenses wiped out the income, then there would be no need to claim the depreciation write-off.

--Kevin McCormally
Kiplinger Washington Editors

I have not filed since 1998 but if I had I would have gotten a refund each year. I would like to file and get current on my returns. I understand that I will not get a refund except for the last three years, if due. So do I need to file a return from 1998 to date or do I just file the last three returns 2003, 2004 & 2005.
-- Ken, Sebring, Florida

You can only get refunds back three years, so 2002 is the earliest tax year that's still open. That return was due April 15, 2003, so the door for that refund slams shut at midnight April 17, 3 years after the due date.

You can also file now for 2003 and 2004, but there's not quite the same urgency. Call the IRS at 800-829-1040 for advice on where to find the necessary forms.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

In 2005, I refinanced my home mortgage and took some money for home improvement cost. No, I did not add any new money for the refinancing. Should I consider this money a part of itemized deduction in schedule-A ? Thank you.
-- Kallol, Channel 13, Jersey City, New Jersey

The law allows you to deduct interest on up to $1 million of "home acquisition" debt and up to $100,000 of home equity debt. If you had used part of the cash out refinancing to pay for capital improvements to your home, that amount would have counted toward the $1 million acquisition limit. Money not used for improvements could be considered home equity debt and the interest on up to $100,000 of such debt IS deductible on Schedule A.

--Kevin McCormally
Kiplinger Washington Editors

Hello. You mentioned a tax refund for student that got affected by Huricanne Katrina . Can you tell me where to find this in the IRS website or where to enter it (form number) in my tax return. Thanks.
-- Caroline, Channel 9, santa cruz, ca

I was talking about the Hope and Lifetime Learning Credits which are available for post-secondary education. These education credits are claimed on line 50 of the Form 1040. Generally, the Hope credit can be worth up to $1,500 per student for the first two years of college education. The Lifetime Learning credit is generally worth up to $2,000 per family (regardless of the number of qualifying students). For students at colleges in the Katrina zone, the credits are doubled for 2005 and 2006.

See this IRS publication for more details: http://www.irs.gov/pub/irs-pdf/p970.pdf

--Kevin McCormally
Kiplinger Washington Editors

I made 403 and 457 contributions to the IRS limits. However I had $3,200 in interest, capital gains and dividends. So I owe IRS and CA taxes. Friends say I must be doing something wrong; I say with no dependents, home, medical etc. expenses, it is taxable income.
-- Marc, KCET, venice beach CA

Do you mean that even after making the retirement plan contributions you owe extra money with your return? That's certainly possible. You owe money with your return whenever what you paid during the year -- via withholding and/or estimated tax payments -- is less than your tax bill for the year. Most people get refunds because they pay too much during the year and then get the excess back.

You are correct that interest, dividends and capital gains are all taxable income.

If you owe more than $1,000 with your return, you could be penalized for not withholding enough during the year. If that's the case, you may want to adjust your W-4 at work so that more is withheld from your checks.

From a financial planning standpoint, it really is better to owe a little bit with your return than to get a big refund (no matter how much we Americans love our Springtime refund checks).

--Kevin McCormally
Kiplinger Washington Editors

 

I have been preparing my own tax returns for over 20 years, own my home, make about $80,000/year and just last year realized that I was not taking my CT tax payment off of my schedule A. This means for many years I
added the refund, but did not show the payment. Any suggestions?
-- Joan, cptv, sherman, ct

Yikes! Uncle Sam owes you money. Unfortunately, you can't recover everything you're owed, because the law only gives you three years to fix such mistakes. What you need to do is file amended returns for 2002, 2003 and 2004 (and take the deduction on your 2005 return). I'm assuming that you itemized deductions in each year.

Time is of essence when it comes to your 2002 return. Because returns are open to amendment for only three years after their due date, the door closes on 2002 returns on April 17 this year.

You need to file amended returns, on Form 1040X, for each of the years that is still open to amendment. Filing a 1040X is relatively simple. (Honest!) Basically, you'll show the amount of itemized deductions you claimed on the original return, the higher amount you're claiming now with the inclusion of the state income tax, the new, reduced tax bill and the refund you're owed. The IRS owes you interest on the refund amount, back to the original due date. You can find the 1040X and its instructions at www.irs.gov.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

After my CPA filed my tax forms electronically, I received a corrected 1099 Div from a REIT fund.
I took the form to the CPA but she won't look at it until April 1l. Is my tax bill likely to change from the way the CPA originally figured it? I haven't paid the fed and state taxes yet. Thank you.
-- Bosley,KCET, Rancho Palos Verdes, CA

Whether your tax bill will go up or down depends on what the correction is...if the corrected form reports more taxable income, your tax bill is likely to go up; if it reports less, it will likely go down. I say likely, because if your taxable income is under $100,000, the tax tables jump in $50 increments, so a small change in taxable income could mean nothing to your bottom line.

Rather than file forms that have to be corrected later, you may want to ask your CPA if you should file an extension to push the deadline to October 15.

--Kevin McCormally
Kiplinger Washington Editors

In your March 20 tax tip it was stated that the penalty for failure to file a tax return can be as much as 25 percent of the tax owed. Does this include any and all interest, as well.
-- Daniel Balombin, WVIZ - Cleveland, Ohio

No. The interest charge for late-paid tax -- currently at a 7% annual rate -- is in addition to the failure to file, failure to pay penalties.

--Kevin McCormally
Kiplinger Washington Editors

According to your article dated 3/20/2006, if you file a return that is not older then three years the IRS should pay interest on the refunded amount. I had this situation last year when I filed my taxes that were several years old and was due a refund. The IRS refunded the calculated amount, but no interest. I called the IRS and they said they don’t pay interest on refunds even though there several years old. Can you please point me to an IRS document that explains the rules for paying interest on an old refund?
-- Viewer on WTTW, Chicago

First, let me apologize because I was mistaken about interest on refunds in the case where the return was not filed on time -- which is what I was talking about in the commentary you cite. Although I had been advised by a source at the IRS that interest was paid in such instances, I double checked after receiving your message and discovered that IRS proposed regulation (Section 301.6611-(1)(e)) say no interest is paid on refunds if the return for the year in question was not filed by the due date of the return.

In some cases, however, interest IS paid on refunds. That's the case, for example, when an amended return -- for a year for which the original return was filed on time -- calls for a refund. In that case, interest is paid back to the due date of the original return.

Again, I'm sorry for my error. Thanks for calling it to my attention.

--Kevin McCormally
Kiplinger Washington Editors

In your 3/20/06 tax tip it was said that the penalty for failure to file a return can be as much as 25% of the tax owed with the return. Does that 25% amount include all interest as well?
-- Dan B, WCLV - Cleveland, Ohio

No, the interest charge is in addition to the penalty. The failure to file penalty (5% a month up to a maximum of 25%) can be offset by the 1/2 of 1% a month penalty for late payment -- so the combined penalty is 5%, as noted in the following from the IRS web site. But, again, interest -- currently at 7% -- is in addition:

What kind of penalties and interest will I be charged for paying and filing my taxes late?
Interest, compounded daily, is charged on any unpaid tax from the due date of the return until the date of payment. The interest rate is the federal short-term rate plus 3 percent. That rate is determined every three months.

For current interest rates, go to News Releases and Fact Sheets and find the most recent Internal Revenue release entitled Quarterly Interest Rates.

In addition, if you filed on time but didn't pay on time, you'll generally have to pay a late payment penalty of one-half of one percent of the tax owed for each month, or part of a month, that the tax remains unpaid after the due date, not exceeding 25 percent. However, you will not have to pay the penalty if you can show reasonable cause for the failure. The one-half of one percent rate increases to one percent if the tax remains unpaid after several bills have been sent to you and the IRS issues a notice of intent to levy.

Beginning January 1, 2000, if you filed a timely return and are paying your tax pursuant to an installment agreement, the penalty is one-quarter of one percent for each month, or part of a month, that the installment agreement is in effect.

If you did not file on time and owe tax, you may owe an additional penalty for failure to file unless you can show reasonable cause. The combined penalty is 5 percent (4.5% late filing, 0.5% late payment) for each month, or part of a month, that your return was late, up to 25%. The late filing penalty applies to the net amount due, which is the tax shown on your return and any additional tax found to be due, as reduced by any credits for withholding and estimated tax and any timely payments made with the return. After five months, if you still have not paid, the 0.5% failure-to-pay penalty continues to run, up to 25%, until the tax is paid. Thus, the total penalty for failure to file and pay can be 47.5% (22.5% late filing, 25% late payment) of the tax owed. Also, if your return was over 60 days late, the minimum failure-to-file penalty is the smaller of $100 or 100% of the tax required to be shown on the return.

--Kevin McCormally
Kiplinger Washington Editors

Hello, I was confused about the special reduced tax rate of long term capital gaines. Both short and long term gains are added together and added to 1040 line 13. how come they are treated differently? thanks
-- Steve, WHYY, Philadelphia, PA

Great questions, but don't worry. Even though the Schedule D calls for you to add short- and long-term gains together, they are broken out to give you the advantage of the special 15% rate for long-term gains IF you follow the instructions and use the special worksheet in the instruction packet to figure your tax. The worksheet is a monster (one reason I love tax software is that it handles all the numbers crunching) but it works. Be patient. In some cases -- if you have gain from collectibles, for example, or recaptured depreciation gain -- you have to use an even more complicated worksheet that's in the Schedule D instruction packet.

--Kevin McCormally
Kiplinger Washington Editors

When I get my 1099 with all my stock trades, it will contain trades made & then broken up by my brokerage, e.g., 1,000 shares GE sold, but done in 200, 100, 300, 400 blocks. On my shedule D, I simply consolidate the trade as 1,000 shares sold - all buy dates & sale dates are
the same assume. Does the IRS care ? I know my brokerage said the IRS directed them not to show that grand total of stock sales for some odd reason, as if they did not anyone focusing on matching grand total sales. thanks a lot.
-- Jim, KCET, Huntington Beach CA

Although I believe the IRS will simply match grand totals from each broker's 1099-B, the IRS wants you to report each transaction separately. If all the buy and sell dates are the same, I don't understand why the transactions are reported separately.

--Kevin McCormally
Kiplinger Washington Editors

My husband and I have not submitted a tax return for the past three years because we haven't found time to complete the paperwork, not because we don't have the funds. Will the IRS allow us to submit an estimated tax return and avoid the interest & penalties by paying an estimated amount now & agreeing that we will submit our accurate tax returns forms by the end of this year? Is there any other way of avoiding the extra expense?
-- Mary, KQED-TV San Francisco

The IRS doesn't have a provision for estimated tax returns. And interest you owe on late-paid taxes can't be avoided. In many cases, however, the IRS does reduce penalties due when taxpayers come forward voluntarily to straighten things out. One of the stiffest penalties applied by the IRS is the one for failure to file a return. As I noted in my commentary earlier this week, that penalty can reach 25% of the amount of tax owed with the return.

I suggest you contact an accountant, enrolled agent or other tax preparer to chart a course of action to get those returns filed.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

Your commentary on the $89 charge when a person had just a W-2 and one item of interest income is proof that you are not a tax preparer. The implest returns have the possibility of the most errors. Did the prepared inform the client about IRS options? Diod the preparer discuess education credits. How about the credit for a ROTH IRA. And in California we have renter's credit for low income people. Other states have a food credit (Hawaii), Even if the answer to all of these is NO, the prepararer has then earned his $89. It is analogous to going to a doctor, the docotor then tells you you are not sick, so thenyou don't want to pay the doctor. How many people blindly include their state inconme tax refund on the federal yaxable income, when actially their prior year sales tax deduction would have been the same amount? How many people forget education credits. etc.

Us tax preparers actually do not want the $89 return. I prefer a return that I can get my teeth into. My 35th year in 2006. When I started retirement income credit was a big deal. Irt is still around. Do you know how to recognize it? Of course I love your commentaries. But remeber there is a big difference betweena a CPA and a tax preparer. (We really can spell, I am just typing this in the dark).How about a commengtary on how the IRS went after that SURVVIR winner criminally. How about warning people to pare down their mortgages for what we know is coming.
-- Viewer on KCET

You make some very good points and I apologize if you thought I was disparaging all tax preparers. I went out of my way to point out that many more than earn their keep, and I am certainly deeply indebted to scores of preparers who have helped me over the years. You are absolutely correct that when it comes to taxes WHAT YOU DON'T KNOW can really hurt, so preparers who ask the right questions can save taxpayers a lot of money. In the case of my friend's $89 return, however, it was literally a W-2...period. No credits, no adjustments to income...in other words, nothing to miss.

Again, thanks for writing. You've been doing this stuff for just a few more years than I have. Boy, have we seen a lot of changes...

--Kevin McCormally
Kiplinger Washington Editors

I own an interest in a limited partnership. Their K-1 is always the last one I receive. When are they required to send these forms?
-- Ronald Carford, WEDU, Apollo Beach, FL

This is a real Catch-22. The partnership has until ITS due date to send the K-1 to partners. Since that's April 17 this year, there's a good chance you won't have what you need to file YOUR return until after the deadline. You'll need to file for an extension, using form 4868, if you don't have the K-1 in time.

--Kevin McCormally
Kiplinger Washington Editors

Of the tax tips you provide on the NBR broadcast, I do not recall one that either of the most popular tax software could not handle properly. Do you believe these programs are sufficiently accurate for most DIY tax people to preclude the need to delve deeply into the tax publications or employ a professional tax preparer?
-- PGS, WETP & WKOP, Knoxville, TN

Absolutely. I'm a real fan of tax software and, full disclosure, have been involved for years with TaxCut, which at one point was called Kiplinger TaxCut because of our input into the program. We still provide tax tips and advice in the program and I am confident TaxCut or it's main rival TurboTax can accurately complete almost all tax returns. . .without any need to delve into the law.

I like to say that TaxCut disguises the complexity of the law. You answer questions posed by the program and can rely on the software to handle all the numbers crunching.

If you are comfortable using a computer, I suggest you give software a try for your personal return. The program can even handle complex business returns, although the more complex the return, the more intimidating it can be to do it yourself. For the vast majority of taxpayers, however, tax returns are more intimidating than complicated.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

ON 1099DIV IS A NON-TAXABLE DISTRIBUTION REPORTED ON YOUR TAX
RETURN ? IF SO WHERE THANKS.
-- Harold, KIIN, Moline, IL

Such nontaxable distributions--which are a return of part of your investment-- used to be reported on the Schedule B, but that is no longer the case. You do not report them anywhere on your tax return.

However, such distributions do have a tax impact when you later sell your shares because your basis in the shares is reduced by the amount paid to you. The reduced basis will mean additional gain when you sell, so keep track of the paper reporting the nontaxable distribution.

--Kevin McCormally
Kiplinger Washington Editors

My son receives SSI for a mental disability. Occasionally he works part time. If we report his income, is SSI reported the same as a regular social security? (He is not claimed by us as a dependent.)
Gayle, kcet, Seattle, Washington

No, SSI payments are not taxable, as noted in this quote from IRS Publication 997, Tax Highlights for Persons with Disabilities (http://www.irs.gov/pub/irs-pdf/p907.pdf)

Supplemental security income (SSI) payments. Social security benefits do not include SSI payments, which are not taxable. Do not include these payments in your income.

--Kevin McCormally
Kiplinger Washington Editors

When should you decide to get another tax-man to do your taxes? If your tax-man is not a CPA. should you still go to him year after year? How much is the normal cost for getting your taxes done if you file the long form.?THANK YOU!
-- William Gensler, Blandon, PA

One reason to switch tax advisors/preparers is if you think you're not getting your money's worth. As I said in my commentary, ask yourself what you're getting for your money. If it's basic tax preparation, is it worth what you're paying? If your tax life is routine -- a W-2 reporting wages, a 1098 reporting interest paid, some 1099 forms reporting dividends, interest or proceeds from sales of stock or funds -- your tax return is pretty simple and should be a relatively quick job. Of course, if your preparer gives you peace of mind, that certainly
has a value, too.

When it comes to a CPA, you ought to be getting a lot more than form-filling-out work, That is, the tax advisor should be offering you advice on how to hold down your tax bill throughout the year.

I'm sorry I can't give you a specific answer. I hope this is helpful.

--Kevin McCormally
Kiplinger Washington Editors

GIFTS, ESTATES AND INHERITANCES

You discussed the "step-up" in basis for stocks transferred through inheritance on Nightly Business Report for Tue April 11. However, I have only just heard a disturbing rumor that when the Federal Estate Tax is eliminated (temporarily?) in 2010, that step-up feature disappears! What's up?
-- DBRJ, WUNF, Marshall, NC

As the law now stands, when the estate tax disappears, there will be a major change in the step-up rules. But the step up is not abolished all together. Basically, up to $1.3 million of gain on appreciated assets will be tax-free for assets left to heirs other than a widow or widower (that is, up to $1.3 million in basis step up will be allowed). The law allows an addition $3 million of basis step-up for assets left a surviving spouse.

But we don't think this rule will ever go into effect. Back in the 1970s, Congress okayed a "carry over" basis rule that put an end to the step up, but it was repealed if the face of massive taxpayer complaints. We think this rule will die, too, as part of a compromise result in the current battle to permanently end the estate tax.

--Kevin McCormally
Kiplinger Washington Editors

What is the date that I can use for date of receipt of an inherited stock - the date of death or the date I received the stock or either?
-- Walt, kteh, Los Altos, CA

I'd use the date you actually received it. As inherited property, the profit or loss is automatically long-term, so holding period doesn't matter. Your basis is the assets value on the date of death of the previous owner.

--Kevin McCormally
Kiplinger Washington Editors

I paid my dauther $4,000 as gift for her birthday, I wrote word GIFT on the check. Is sh has to clam that to IRS? Thanks
-- Houshang, Channel 9, Danville, Ca.

Gifts are not taxable income to the recipient, so if it was a true gift made out of generosity, there's no reason to report it to the IRS.

Gifts in excess of $12,000 a year can trigger the federal gift tax, but that clearly doesn't apply in this case.

--Kevin McCormally
Kiplinger Washington Editors

I saw a tax tip on tonight's broadcast of Nightly Business report. It went to fast for me to catch and I did not find a copy on the website. The tip was in reference to Inheritance of Stock and or property from an Estate. Can you get me this information in hard or soft copy? How should I see this on a K1 from the Estate or Trust that this was set up by the Estate? What about if a company that I inherited stock from sold a Real Estate property and provided a cash distribution of the procceeds? Thanks,
-- Dave, WGTV, Kingston, NY

The K-1 from the estate should show just the taxable distribution. The assets in the estate enjoy the same "step up" in basis I discuss in my commentary so, when they are sold, only appreciation from the date of death of the owner is taxable income. And the K-1 should only show taxable distributions. Check with the executor to be sure.

Here's a copy of the commentary:

Nightly Business Report Commentary
April 11, 2006
Kevin McCormally

Profiting – tax free – from the sale of inherited property

One of the most complicated things about doing a tax return is figuring the “tax basis” of the stocks, bonds or other assets you sold during the previous year. You have to know the basis to figure your gain or loss. Usually, basis begins with what you paid for the property. But what if you didn’t buy it? What if you inherited from someone else? How on earth are you supposed to figure out what they paid for it?

Fortunately, you don’t have to. You see, when you inherit property, your basis generally becomes the asset’s value on the date the previous owner died. All appreciation up to that point is tax-free. This rule not only saves you the hassle of plowing through paperwork, it could save you a bundle if during 2005 you sold stocks, bonds, real estate or other investments that you had inherited.

Here’s a quick example. Let’s say your father bought a block of stock for $5,000 many years ago and it was worth $50,000 when he died and left it to you. Your basis is “stepped up” to $50,000. If you sold for $55,000, you owe tax on just $5,000 of gain. If you sold for $40,000, you pocket $40,000 tax-free and get to deduct a $10,000 loss.

This also works for assets owned jointly by married couples—whether it’s stocks, bonds or a vacation cottage. When one spouse dies, at least half the basis is stepped up. In community property states, in fact, the full basis can be.

Unfortunately, this “step up” in basis doesn’t work for all inherited property. If someone leaves you a 401(k), regular IRA or annuity, you will be taxed on the money as you withdraw it.

But if you sold inherited investments last year, be sure to get your share of this multi-billion dollar tax break.

--Kevin McCormally
Kiplinger Washington Editors

My older daughter is in graduate school and has student loans. After her younger sister finishes college, I would like to help her repay these loans. Is it possible for me to contribute directly to the loan institution without hitting the $12,000 per year gift limit? Thanks.
-- Jim McCormick, WUNC-TV, Raleigh, NC

Sorry, but no. The exception to the gift tax rules applies only if you pay educational expenses directly to the college. Repaying college loans doesn't count, so you'd be limited by the $12,000 annual gift tax exclusion. Of course if you and your spouse together repay the loans, the limit jumps to $24,000 a year...and if you spread the repayment over two calendar years, you get up to $48,000 without worrying about the gift tax.

--Kevin McCormally
Kiplinger Washington Editors

Dear Kevin, My Mother passed away four years ago, and left her timeshare to four siblings. My sister would like to buy out everyone's share. Would this be reportable income? Thank you.
-- Joan, WPBS, CHASE MILLS, NY

It depends on what's happened to the value of the timeshare since your mother died. At that time, the tax basis of the timeshare would have been "stepped up" to its value on the day of your mother's death -- any appreciation since that time would have become tax-free. Now, if the value of the timeshare had declined since that time, the basis would have been "stepped down" to date-of death value.

Let's say the value was $10,000 at the time your mother died and left it in equal shares to four children. Effectively, each of you has a basis of $2,500. If you sell your share to your sister for more than $2,500, then you should report the transaction on Schedule D where the profit would be treated as a long-term capital gain.

If you sell for less than your basis, though, you don't need to report the transaction to the IRS because the sale of such personal-use property can't produce a deductible loss.

I hope this helps.

--Kevin McCormally
Kiplinger Washington Editors

My wife recently inherited an annutiy worth 250k from her father. What are the tax consequences if we cashed out to put into the stock market or another investment?
-- Ken, Southfield, Mi

Unfortunately, annuities are a big exception to the general rule that inheritances are tax free. Annuities are considered "income in respect of a decedent" and as such are taxable to the new owner just as the money would have been taxed to the person who died. So, you need to know how much after-tax money your father-in-law invested in the annuity. The insurance company should be able to help you on this point. If, for example, he paid $100,000 for the contract, that portion of the $250,000 would be tax free and the other $150,000 would be taxable in the year you cash it in. This is treated as ordinary income, taxed in your top bracket, rather than a tax-favored capital gain.

If you and your wife receive payouts over a series of years, the payments are taxable as you receive them.

--Kevin McCormally
Kiplinger Washington Editors

I iherited rental property from my father. Do I have to recapture the depreciation when I sell it.
-- Les, KUAT, Tucson

No, there is no recapture in this case. Your basis is the full fair market value at the time of death of the previous owner. Only appreciation (or gain attributable to depreciation) after that time is taxed to you.

--Kevin McCormally
Kiplinger Washington Editors

what does the "gift tax" actually do for me and the recipient tax-payment-wise? Second, what is the definition of an "investor" to allow deductions for financial magazines, cable TV primarily for watching business/stock news etc.?
-- Susan Peruzzi, viewer on Voice Of America in Quito

The federal gift tax exists primarily to prevent people from getting around the federal estate tax by giving away their assets before death. Each year, every American and give away $12,000 to any number of people without having to worry about the gift tax. If you want to give $12,000 to each of 100 friends, for example, you could give away $1.2 million gift-tax free. When larger gifts are involved, everyone has a credit to offset the tax on up to $1 million of taxable gifts in his or her lifetime. To the extent you use your credit to cover the gift tax during life, that amount of the credit is not available to offset estate taxes after death.

When the gift tax is owed, it is owned by the giver of the gift, not the recipient.

I hope this answers your question.

--Kevin McCormally
Kiplinger Washington Editors

 

I inherited a US Savings bond. When I cash it in is it a capital gain or, is it ordinary income? My name was listed on the bond as "or". Thanks.
-- Dr. K, WETA, Arlington, VA

Unlike most inheritances, U.S. savings bonds do not go to the beneficiary income tax free. The interest income you collect is considered "income in respect to the decedent" and is taxed to you just as it would have been taxed to the original owner -- that is, as ordinary interest income. That means it will taxed in your top tax bracket rather than get the benefit of the special capital gains rate.

--Kevin McCormally
Kiplinger Washington Editors

My parents gave me some stock 2 yrs ago. I sold it today. How do i figure my cost basis?
-- Glenn Bankhead, WETA, Reva, VA

Believe it or not, that depends on whether your sold the stock for a gain or a loss...which, of course, you can't know until you know the basis.

It's not quite a complete Catch-22 however.

When someone gives away stock, he or she also gives away the basis in that stock. So, you need to ask your parents what their basis in the stock was. That becomes your basis. . .assuming you sold the stock for more than the basis so you have a taxable gain.

If the value of the stock had fallen between the time your parents bought it and the time of the gift, however, and you sold for a loss, then your basis is either the original basis or the value of the stock at the time of the gift, whichever is less. This rule basically prevents taxpayers giving away a tax loss which might be more valuable to one taxpayer than another (one in a higher bracket, for example).

For example, say your parents gave you 100 shares of stock for which they paid $5,000 but which were worth only $2,500 at the time of the gift. If the stock turns around and you sell for $6,000, your basis for determining gain is $5,000. If you sell for less than $2,500, however, the basis for figuring your loss is the $2,500 value at the time you received the gift. The loss in value while your parents owned the stock is ignored. What if the selling price falls between $2,500 and $5,000? You have neither gain nor loss.

If you use the donor’s basis as your own, your holding period for figuring whether you have a short- or a long-term gain or loss includes the time the donor owned the property. If you use the fair market value at the time of the gift as your basis, your holding period starts the day after you get the gift.

--Kevin McCormally
Kiplinger Washington Editors

 

I inherited a number of annuities and several IRA accounts. I do not have the initial cost base for one account. This account has also gone through a 1035 exchange in 1994. The 1099-R that I received for this
account has reported the entire gross distribution as taxable, because a cost basis is not available. Is there some remedy to estimate a cost basis?
-- Tim Lewis, MPBN, Freeport, Maine

Oh, my! This is a toughie. Generally, of course, the basis of inherited property is its value at the time of death of the previous owner. But that rule doesn't apply to annuities, which are considered income in respect of the decedent, and taxed to the new owner just as the income would have been taxed to the previous owner. In other words, you do need to know the original basis.

The 1035 exchange -- which is a tax-free trade of one annuity for another -- further complicates matters, but also serves as evidence that there IS some tax basis so that part of your income under the annuity should be tax-free. I'd suggest contacting the insurance company that issued the annuity you have inherited and ask if its records show the originating firm for the annuity that was exchanged in 1994. Then contact that company to see if its records show how much the original owner invested in the policy.

It's a lot of work, but pinpointing a basis -- or coming up with a reasonable estimate of a basis -- will save you money on your taxes.

Good luck. You'll need it.

--Kevin McCormally
Kiplinger Washington Editors

I inherited some California municipal bonds in 2004 that matured in 2005. It is my understanding that the estate paid a heavy estate tax on these bonds, because they paid a high rate of interest. My question is as follows: What is the cost basis of my municipal bonds? Is the cost basis the same as the value declared on the IRS 706-Estate Tax return for each bond, or is it the par(face) value?
-- Mike Armijo, KQED, San Rafael, CA

Your basis would be the bonds fair market value at the time the previous owner died, which should be the value shown on the federal estate tax form. Any appreciation in the value of the bonds during his or her lifetime becomes tax-free upon death. (The bonds would have been worth more than their par value if the coupon rate was higher than current market rates.) Only appreciation after your inherited the bonds is taxed to you.

If you sold the bonds for less than your basis, in fact, you can claim a tax-saving capital loss, even though the inheritance put you in a better position financially. In the section of the Schedule D where you report the sale of the bonds, write "inherited" in the box where you are supposed to enter the date that you acquired the bonds. Regardless of how long you owned the bonds before selling, the sale results in a long-term gain or long-term loss.

--Kevin McCormally
Kiplinger Washington Editors

 

MISCELLANEOUS

My daughter did an internship at a local newspaper. They did not take out any taxes and did not give her a W2. Where on the 1040 should this income be reported.We put it under other income and the tax bill was a lot
higher than if we put it in wages. What is the right thing to do.
-- Viewer on WCVE, Richmond, VA

This is a toughie. Sounds like the paper treated your daughter as an independent contractor, meaning she should report the income on a Schedule C and pay social security taxes on it as well as income taxes. You might want to call the paper's payroll office and ask if this was the intent. There's a chance they should have treated her as an employee, withheld income tax and paid half of her SS taxes.

--Kevin McCormally
Kiplinger Washington Editors

 

Some state counties are imposing a $20.00 per month tax/surcharge to be added to each uses cell phone. Is this deducable?
-- Dick, koac, corvallis or.

I don't see how such an excise tax would be deductible; it's not an income tax or a property tax or a personal property tax or a sales tax...the taxes that are deductible. Sorry.

--Kevin McCormally
Kiplinger Washington Editors

I filed amended state tax returns for tax year 2002 & 2003 and received refunds in 2005. Do I have to file amended federal tax returns for 2002 & 2003, or just include the refunds in 2005 tax return since I received the refunds in 2005?
-- Feng Lin, wttw, Glen Ellyn, Illinois

I've never seen this specific question addressed, but in other instances, you would be required to file amended federal returns to true up the financial situation for each year. The IRS doesn't like to let taxpayers shift income and deductions between years because it can skew the tax results and encourage gaming the system. If what you are proposing were allowed, for example, someone would be encouraged to overpay state taxes in a year the deduction would be particularly valuable on the federal return, then claim the refund when the taxable income might be taxed at a lower rate.

My bet is that you need to file amended returns. Give the IRS a call at 800-829-1040.

Sorry I don't have a definitive answer.

--Kevin McCormally
Kiplinger Washington Editors

In 2005, I donated a 45-year-old car to a recognized charity, which has appraised it at $3,900 but hasn't sold it yet, choosing to have needed repairs made first at its own significant expense (and sending me both a Form 1098C and a letter to this effect). My late aunt purchased the vehicle new in 1960 for $2,301 and gave it to her brother (i.e., my father) shortly before her death in 1968. My father gave it to me in 1970. It is my CPA's conclusion that, because the car was a gift, I have a zero cost basis and cannot claim its fair market value (or even the charity's selling price, had the car already been sold). Is my CPA correct or does a more favorable interpretation reside elsewhere in the tax code (e.g., antiques and collectibles)? I have an exit appointment with the CPA early in the morning on the 14th, which is to include the electronic filing of my completed return.
-- Jim Rekulak, WNET, Irvington, New Jersey

I think I disagree with your CPA...and I checked with a tax attorney who disagrees, too.

I see this as the donation of appreciated property, and your basis doesn't matter. You can deduct the full fair market value of the property, and it sounds like that's $3,900.

Ask your CPA why the general rule would not apply here. If you had sold the car for $3,900 and your CPA argued that your basis was $0 would he/she have had you report a $3,900 gain or $0?

--Kevin McCormally
Kiplinger Washington Editors

 

Monday evenings Program talked about sales tax deduction. Could you give me the details? Thank-you.
-- Mary Zoner, WVIZ, Austinburg, Ohio

Sure, taxpayers who itemize deductions can choose between deducting state income taxes paid or state sales taxes paid. For most taxpayers who live in a state with an income tax, the income tax deduction will produce bigger tax savings. For taxpayers who live in a state that does not impose an income tax, the state sales tax deduction will be a better deal. The IRS has prepared tables estimating the size of deduction taxpayers deserve, based on where they live, the size of their family and their income. You can find those tables and more information about this deduction in the instructions for Schedule A, where deductions are itemized. You can find the instructions here: http://www.irs.gov/pub/irs-pdf/i1040sa.pdf

Here is the transcript of the commentary.

--Kevin McCormally
Kiplinger Washington Editors

When did Congress destroy the 65 year and older exemption? Looking forward to an extra exemption as I passed 65 last Aug I was today rudely awakened to the fact that despite my only modest retirement income I do not even qualify for this long coveted reduction of the tax burden. What a shame.
-- E Muller, Cobb CA

The extra standard deduction for taxpayers 65 and older was a victim of the Tax Reform Act of 1986, when a lot of tax breaks were eliminated in an attempt to "simplify" the tax law. It was allowed for the last time on 1986 returns. Taxpayers 65 and older who claim the standard deduction do get a special age-based break -- $1,250 is added to the standard $5,000 standard deduction on single returns and $1,000 (for each spouse who is 65 or older) is added to the $10,000 standard deduction on joint returns. Of course this does no good for people who itemize their deductions.

--Kevin McCormally
Kiplinger Washington Editors

Hybrid Cars Tax Credit: I understand the full credit will be allowed on the first 60 thousand Hybrids sold in this country. How do I know if I my Prius purchase qualifies ? How does the IRS know when I purchased my car ? What forms etc do I need to claim the credit on my 2006 return ? Your tips have saved me money in previous years plus you take a lot of the fear factor out of this chore. MANY THANKS.
-- Ol' Dad K, KCTS, Shoreline, WA

I'm happy you enjoy the tips...and that they've saved you money.

On the hybrid credit, the phase out doesn't start as soon as a manufacturer sells 60,000; it starts at the beginning of the calendar quarter following the calendar quarter that follows the quarter in which the 60,000 hybrid is sold. (Don't you love taxes?!) So, it could be as much as six months after the 60,000 is sold that the phase-out begins.

The key thing that means is that the IRS will know well ahead of time WHEN the credit phase out begins and the agency says it will announce the date. So, if Toyota sells it's 60,000 hybrid in July, for example, the IRS would announce sometime later in the year that the phase out would begin January 1, 2007. If you bought before then, you'd get 100% of the credit for the vehicle you purchased.

The IRS hasn't designed a form for claiming the credit, but presumably it would require date of purchase so the appropriate credit can be claimed.

Enjoy your Prius.

--Kevin McCormally
Kiplinger Washington Editors

 

According to an article in the wall street journal Mar 8,2006 I can deduct both my state sales taxes and state income taxes if I itemize my deductions. Is this correct?
-- J Duff, Evansdale Ia

No, that is not correct. Taxpayers may deduct one or the other -- either state INCOME taxes or state SALES taxes, but not both. Choose the deduction that saves you the most money.

--Kevin McCormally
Kiplinger Washington Editors

My 2004 tax return was never processed because when IRS received it, it was categorized as an amendment and not the original one. The reason of the latter, was that somebody else had already filed using my social security number. After a year of going back and forth with IRS, investigation requests, check trace forms, etc, I received a copy of a check and saw that the IRS had already mailed a check refund to a person named: Carlos A. Gutierrez, while my name is Carlos R. Gutierrez. At the end of 2005, after some time not hearing anything from the IRS, I received a letter addressed to Carlos A Gutierrez stating that the case was being closed because the check was already cashed. I replied to the address provided for appeals stating my case and requesting further investigation. It is March 2006 and still no answer from the IRS, therefore I am writing to ask if its worthwhile pursuing the case further? should I take time and present myself at local IRS office? Thanks for your help.
-- Carlos R Gutierrez, WBPT/Channel 2, Miami, Florida

Oh my. What a mess. Your case seems custom-make for the Taxpayer Advocate's office, a special division inside the IRS that is charged with helping taxpayers whose cases get caught up in the bureaucracy. I suggest you contact the Advocate's office at 1-877-777-4778 and explain your situation. Alternatively, you could fill out a Form 911 requesting help: http://www.irs.gov/pub/irs-pdf/f911.pdf.

One other thought: You may want to call your congressional representative or U.S. Senator to ask for help. Most offices have case workers who help constituents with their run ins with the IRS. The U.S. Capitol switchboard number is 202-224-3121 and your representatives probably have local offices, too.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

I received a $300.00 settlement from a PC company that lost the
computer monitor, which was sent to the PC company for warranty service.
Should I report this settlement to IRS? Thanks.
-- Jay Chen, KCET, Hacienda Hts., CA

I wouldn't report it; the $300 sounds more like an insurance settlement than income. Such settlements are taxable only if they exceed the value of the lost item and then only if you don't use the money to replace it. So, if your monitor was worth just $200 but you spent $300 or more to replace it, there would be no taxable income.

--Kevin McCormally
Kiplinger Washington Editors

From 1999 to 2001 we had a major medical expenses when my 3 year old daughter suffered mysterious cancer-like symptoms for several years. Deep in debt, my father-in-law funded a spec-house building project in which we made enough money to just about clear our medical costs. But I could not pay both medical costs and the self-employement taxes. Unable to pay them, I made the mistake of not filing. On my own initiative, I contacted IRS last summer/fall (2005) filed my taxes, paid the tax (no penalties or interest). I have now spent the last eight months trying to close the books on 2003. But IRS can't seem to wrap things up. How do I get them to provide me a bottom line on what I owe? Is there a way to get IRS to reduce or waive penalties and interest? They send me hate mail to pay up this or that amount, but it changes almost weekly. When I call them, they say.."disregard that bill...we are still adjusting.." This goes on incessently. I want to clear things up, but of course I never get to talk to the same person, and nobody I talk to ever has the power to provide definitive answers. How do I "get up the ladder" when I'm trying to get answers at IRS? Appreciate your help.
-- Jim Howard, KUSM, Great Falls, MT

First, sorry to hear about your troubles. It sounds to me like you're trying to do the right thing.

I've got a couple of suggestions.

Years ago, I worked for a member of Congress and we, like every other office I knew of, had a caseworker assigned to work with constituents who had trouble with the IRS. You might want to call your member of the House or one of your Senators to ask if they could intervene for you to get the answer you seek. The Capitol switchboard number is 202-224-3121, or check on-line to see if your representatives have local offices that might help.

Second, you might want to contact the IRS taxpayer advocate's office. Here's the IRS's own description of the office:

HAVE A TAX PROBLEM? ....NEED HELP?
The Taxpayer Advocate Service is an IRS program that provides an independent system to assure that tax problems, which have not been resolved through normal channels, are promptly and fairly handled. The National Taxpayer Advocate, Nina Olson, heads the program. Each state and campus has at least one local Taxpayer Advocate, who is independent of the local IRS office and reports directly to the National Taxpayer Advocate. The goals of the Taxpayer Advocate Service are to protect individual and business taxpayer rights and to reduce taxpayer burden. The Taxpayer Advocate independently represents your interests and concerns within the IRS. This is accomplished in two ways:

• Ensuring that taxpayer problems which have not been resolved through normal channels, are promptly and fairly handled;
• Identifying issues that increase burden or create problems for taxpayers: Bringing those issues to the attention of IRS management and making legislative proposals where necessary.

Here's how to contact an advocate:

How to Contact the Taxpayer Advocate Service?

• Call the Taxpayer Advocate Service toll-free telephone number: 1-877-777-4778 or TTY/TTD: 1-800-829-4059.
• Call, write or visit the Local Taxpayer Advocate office for your state. [ View Local Taxpayer Advocates by State]
• A list of Taxpayer Advocate Service offices may also be found in Publication 1546 (English, Spanish, Chinese, Korean, Russian, Vietnamese), The Taxpayer Advocate Service of the IRS.

Complete and submit Form 911, Application for Taxpayer Assistance Order. Form 911 may be obtained by:

• Download here: Blank Form 911
• Call the IRS forms-only number, 1-800-829-3676
• Send a written request for assistance (if Form 911 is not available), or
• Request that an IRS employee complete a Form 911 on your behalf (in person or over the phone).

You may FAX a Form 911, Application for Taxpayer Assistance Order (or written request) to your local Taxpayer Advocate. An Application for a Taxpayer Assistance Order requires the Advocate to determine if significant hardship exists and to review the case to determine what action should be taken to relieve the hardship. In certain situations, enforcement action may be suspended while your case is being reviewed. The Taxpayer Advocate resolves the majority of cases administratively. Even when hardship is not a factor, the Advocate is often able to help resolve the taxpayer's problem.

A key reason for the Advocate's office is to help taxpayers whose cases seem to get caught up in the IRS bureaucracy, who, like you say, seem to have trouble getting a straight answer.

In answer to your question about waiving interest and penalties, I know that penalties are often "abated" -- which is IRS lingo for reduced. Be sure to ask the Advocate or your congressional representative's staffer about this issue.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

Can I get a transcript of your comments dated March 20, 2006.
-- Frank Zibritosky, WQED

That transcript is available here. To view all transcripts of Kevin McCormally's "Tax Tips" series, go to the Features & Commentary section, select Special Features and scroll down to the Tax TIps with Kevin McCormally home page.

I filed my income tax returns and supposed to get the refund of $469, instead IRS sent me the refund of $4393. Do I need to inform IRS or maybe I calculated my tax wrong which I couldn't find any mistake. Please advise me what I shall do with this situation. Thanks.
-- Linda Wang, Houston, TX

I suggest you call the IRS at 800-829-1040, explain the situation and ask them to check your account. It's possible you made an estimated tax payment that you forgot or there is something else in your account to explain the bigger-than-expected refund. If not -- that is, if it's a clerical error by the IRS -- you'll be asked to send the check back in and the IRS will issue you a correct refund. If you cash the check and it's later determined it was more than you deserved, you'll be asked to return the excess, with interest.

--Kevin McCormally
Kiplinger Washington Editors

Two weeks ago, I received a letter from the IRS informing me the I had miscalculated the taxable portion of my Social Security and that my SEP IRA deduction had been disallowed. I called them and after talking to a woman who was obviously incompetent, I was mysteriouly transferred to another agent, who was very pleasant. After some discussion, she recalculated the taxable portion of my Social Security had been calculated properly. The actual amount of my Social Security had been keyed incorrectly. As far as the SEP IRA was concerned, I explained that I had requested a deduction for a regular IRA, not an SEP IRA. She was unfortunately not able to do anything about correcting this IRS keying error at her level and told me that she was submitting some kind of review request, which could take up to 30 days. Now, I'm sitting here waiting for them to call. Is there anything else I can do to expedite this matter, or do I just sit and wait? Thanks for your attention
-- Al, WMEB, Bangor, ME

First, sorry to hear about your troubles. Just FYI, one reason the IRS likes electronically filed tax returns is that they PREVENT such keyboarding errors by IRS employees.

It sounds like you've done everything okay so far...I hope you got the name of the helpful person you spoke with. I don't think there's much more you can do, but wait the 30 days. I suppose this is slowing down a refund. Sorry about that, too.

One thing you might want to do is to write to your congressman/woman or Senators to document your case. When I worked on the Hill 30 years ago, nearly every office had a caseworker who spent a lot of time on IRS problems this time of year. A call from a congressional office might speed things up. The Capitol Hill switchboard number is 202-224-3121.

Good luck.

--Kevin McCormally
Kiplinger Washington Editors

I am separated from my wife for some years now and she is using my medical insurance from my union. I always file taxes with her but she does not work only receives Social Security. She is getting Section 8 for housing assistance and they told her she can't file with me. Is this correct. Thanks
-- Gene, KNX, Alhambra, CA

This must be a Section 8 rule, not a tax rule, so I'm afraid I can't help. Section 8 housing assistance is based on income, so perhaps by filing a joint return with your, your wife's income appears to be too high to qualify.

--Kevin McCormally
Kiplinger Washington Editors

Why is e-filing so complicated when you have gambling winnings? It's a one line entry when you do a return by hand.

Sorry, but never having had the good fortune to have gambling winnings, I was not aware there was a problem with e-filing. In the past, I know the W-2G form had to be filed on paper, but I believe that requirement has been eliminated. If you can elaborate, I'll look into this for you.

--Kevin McCormally
Kiplinger Washington Editors

When does an eBay seller (in Maryland) have to file income tax returns? What minimum earnings? I do eBay as a hobby, do not have an eBay "store" and have sold perhaps $600.00 or less in 2006 on eBay. My husband & I have always done our own taxes, nothing complicated. He works, I do not have outside employment. Thank you so much!
-- Honest Abe (Nancy), WETA, Germantown MD

Whether your eBaying is a hobby or a business doesn't really matter to the IRS when it comes to reporting INCOME. You have to report your income from either. The differentiation matters only when it comes to DEDUCTING losses. Losses are deductible if you're running a business; they're not if you doing it as a hobby.

So, when is eBay income TAXABLE income?

The same rules apply as if you were not online.

If you run a garage sale at home, for example, and collect $5,000 -- but sell everything for less than you paid for it, then you have no profit and no reason to tell the IRS about the sale. If you sell an antique table that you paid $500 for $5,000, though, you've got a fat capital gain that the IRS would like to hear about (and share in your good fortune).

Same thing goes for eBay. If you're selling a few items to clean out the house and don't make a profit, don't report anything to the IRS. But if you're got a collection of Pez dispensers that's making a pretty profit, you might well need to report a capital gain or if you're more active, you might need to file a Schedule C business return showing the cost of your inventory, for example, and expenses, etc.

--Kevin McCormally
Kiplinger Washington Editors

 

I lived in MA. until october of 2005 then I moved to PA. I worked in both states during 2005. I sold all my stocks on dicember of 2005. Do I have to pay capital gains distributions in both states?
-- Heather, WGBH44, Hatboro, PA.

I'm not an expert in state tax rules but a quick review of a Massachusetts part-year-residents tax return suggest that you would NOT owe Massachusetts tax on capital gains realized after you left the state. You would only owe that tax in Pennsylvania. You will need to file state returns in both states, however.

--Kevin McCormally
Kiplinger Washington Editors

I've made 75,000 plus for the last three years. I have not paid any taxes, should I get an atourney or go directly to the IRS. Thankyou.
-- Jerald Cowan, KCET, Los Angeles

First, are you sure you owe the IRS money? Currently the IRS is holding almost $2 billion that IT owes taxpayers who failed to file 2002 tax returns. If you had taxes withheld from paychecks, the IRS could owe you money even though you failed to file. If that's the case, you could go straight to the IRS and ask for help retrieving your money.

I hope that's the case, but...

If you had no withholding and made no estimated tax payments -- so you're sure you would have owed money had you filed -- then you might want to consult a tax attorney. It's unlikely you would face jail time for failing to file if you came forward on your own. But an attorney might well be able to help you get financial penalties abated. You will have to pay interest on your back taxes, but negligence penalties can be waived or reduced.

--Kevin McCormally
Kiplinger Washington Editors

 

I am a self employed consultant and have been working for the same client in a different state than my home state for 3 years. My Tax accountant says if you are committed for more than a year then the new state becomes your home state and you are no longer allowed expense deductions. Could you explain why Senators and Congressman are allowed to take expense deductions and the simple people like myself are not allowed?
-- Karen, WMHT, Cincinnati, OH

You might want to direct this question to your members of Congress.

Your tax accountant is correct that when an assignment lasts over one year, it is no longer considered "temporary" by the tax law and therefore you are now eligible to deduct what are considered personal expenses -- such as meals and laundry, for example -- that can be written off when you are on a temporary assignment.

The law does specifically allow members of Congress to deduct up to $3,000 a year of such expenses without regard to the one year rule.

--Kevin McCormally
Kiplinger Washington Editors

 

If one lends$1,000 dollars to one's adult child - per a written agreement and collects interest on that loan that adult child cannot take an interest expense deduction for that interest paid out, correct? Then why must the parent-lender pay tax on that interest income.
-- Viewer on WFYI

Under the law, interest you receive on a loan -- whether to your child or to a bank, for example, -- is taxable income. The fact that the borrower can not deduct the interest does not matter.

--Kevin McCormally
Kiplinger Washington Editors

 

IRS' state sales tax tables appear to greatly underestimate amounts. By my reckoning, they only "suggest" about 50% of what I spend on sales tax. Would my estimated fiture that is 50% higher than theirs trigger an IRS flag?
-- J K Hecker, WPBT, Boca Raton, FL

If you have evidence that you paid more state sales tax than the table amount for your state, income and family size, then you can deduct the higher amount. The question the IRS would likely ask you on audit -- if your return were audited -- is how did you come up with the higher figure?

As to whether a higher deduction would be a red flag for an audit, I don't think it would necessarily prompt an audit of your entire return. Remember that it is permissible to add the sales tax on a car, boat or airplane to the table amounts, so the fact that you show a number higher than the table amount won't necessarily be suspicious. At the same time, it's possible a computer mismatch -- claiming more than the table amount for someone in your situation -- might trigger a letter from the IRS asking that you explain the discrepancy.

You may want to start saving receipts this year so you'll have evidence supporting a higher write-off on your 2006 return next Spring.

--Kevin McCormally
Kiplinger Washington Editors

After a long costly legal battle, I received a award from my sisters estate and I received a 1099 for this. My question is - Can I deduct the legal expenses on my return to help off-set the 1099 income.
-- Joe Urbancik, Scotch Plains, New Jersey

To the extent the legal fees can be associated with taxable income, that portion can be deducted as a miscellaneous itemized deduction on Schedule A. (If part of the fees are attributable to tax-free income, that portion can't be deducted.) A couple of tricks about miscellaneous deductions, though. Such expenses are deductible only to the extent they exceed 2% of your adjusted gross income -- and as your income is pushed up by the settlement, so is that 2% threshold. Also, if you are among the increasing number of Americans subject to the alternative minimum tax, miscellaneous expenses are NOT deductible at all.

--Kevin McCormally
Kiplinger Washington Editors

 

I live in the congressional distict formerly represented by Christopher Cox who resigned to head the SEC. It was several months before he was replaced. Am I subject to income tax during the period in which I did not have representation?
-- Bill McCaffrey, KCET, Newport Beach, CA

That's a funny quesiton to ask someone who lives in the District of Columbia and has no voting representation in Congress!

No, you don't get a tax break for not having a congressional representative during part of the year.

--Kevin McCormally
Kiplinger Washington Editors

 

We are a small S-2 corporation ($120K in sales) and are in the process of terminating our business. What would be a reasonable cost for a CPA to handle the project (forms, fees,etc.)?
--Richard Schottmiller, WXXI-TV, Henrietta, New York

I'm sorry, but I don't know what's involved in terminating a corporation in the state of New York and therefore don't have a clue as to what would be a reasonable charge. It should be based on the time involved to file the necessary forms. I suggest getting estimates form several accountants...although this not the best time of year to be asking for such estimates, since most tax firms are swamped with tax returns. Still, I'd ask some accountants for an estimate of what's involved in terminating your S corp. and an estimated cost for their
services. Just be prepared to wait a couple of months for their answers.
--Kevin McCormally
Kiplinger Washington Editors