TAX TIME BLUES : What You Need to Know to Steer Your Return Through the Quagmire.
Preparing tax returns ranks right up there with starting a diet.
With just 18 days left until the April 16 filing deadline, fewer than half the 1.1 million Orange County taxpayers have mailed their state and federal income tax returns.
The rest of us are fighting our way through night sweats and anxiety attacks as we guiltily eye that bulging cardboard box or brimming desk drawer into which we shoveled receipts, bills and check stubs for 12 months last year and into which we now must dive.
But whether you file late or early, are wealthy or poor, there still are things to be learned--perhaps even money to be saved.
So read along as a six-pack of Orange County tax professionals take us on a tip-filled trip through the morass of our federal tax system, with the understanding that there are exceptions to every rule and that there is no substitute for getting advice tailored to your circumstances.
After all, when even the pros complain that the tax laws have gotten incredibly complex, they aren’t just trying to create more demand for their services.
Thanks to what Congress--but few others--called the Tax Reform Act of 1986, the federal income tax has become a quagmire.
It’s not that there wasn’t any tax reform, says Norman A. Barker, a partner and director of tax matters at the Irvine office of Ernst & Young, one of the so-called Big Six international public accounting firms.
The 1986 act did relieve about 6 million low-income people of the burden of filing tax returns; many of the most abused deductions were done away with; the maximum tax was dropped to 33% from 50% and tax rates overall were lowered substantially, he said.
But to do it, Congress created a Frankenstein’s monster of a tax code.
“If you took a poll of 1,000 tax preparation professionals, I doubt that you’d find five who would claim to know what all the tax laws are for 1989, and they’d be lying,” said Douglas Ammerman, a partner and tax specialist at the Costa Mesa office of KPMG Peat Marwick, another of the Big Six firms.
And if the big boys aren’t sure these days of what’s what, then what’s the little guy who struggles year after year with a paperback tax help book and a shoe box full of receipts to do?
Well, first of all, lighten up.
Unless you’ve got partnerships piled upon tax shelters heaped on real estate investments--in which case you’re suicidal if you haven’t already got a good tax accountant--things probably aren’t all that bleak.
If you made it through your 1988 tax return and your circumstances haven’t changed drastically, you should be able to get through the 1989 version with just a little more effort.
One change this year is in the so-called kiddie tax, instituted to prevent parents from shunting income to their kids to take advantage of the children’s generally lower tax rates. It treats all of a juvenile’s interest and dividend earnings as if they are part of a scheme to defraud the government.
Under the old law, interest earnings from assets given a child by grandparents or aunts and uncles or family friends were taxed as the child’s income.
Now, said Barker, the same money, even though the assets didn’t come from parents trying to avoid taxes, is taxed at the parents’ higher rate and can even bump the parents from the 28% bracket into the 33% bracket.
And if a child is a young entrepreneur and goes out and earns lots of money and puts it in the bank, the investment income from the money earned by the child’s own labor is subject to the same rules even though it had nothing to do with shifting income, he said.
Most of the changes in tax law since 1986 have been aimed at increasing revenue to the federal government by eliminating deductions, so investors--especially real estate investors--bear much of the burden.
Dale Stinchfield, a partner in the Laguna Niguel tax and accounting firm of Stinchfield, Horvath & Co., complains that Congress changed the rules in the middle of the game and didn’t make allowances for the disruption to players.
A South Orange County physician who is one of Stinchfield’s clients had purchased a bank’s headquarters building as an investment under pre-1986 tax rules that enabled him to deduct actual cash losses each year.
“But under the new passive investment rules, he can’t deduct his cash loss, so instead of a gain of $20,000, he’s out $50,000 a year,” Stinchfield said.
In another situation, a man walked into the accountant’s office with a year’s worth of receipts, canceled checks and other records, ready to start preparation of his federal income tax return.
The accountant gasped in horror while reviewing the client’s investment transactions for the year.
It seems that the client had sold a rental unit for a hefty profit and then plowed the profit back into another, bigger piece of income-producing real estate.
He figured that the rules about capital gains were the same as for owner-occupied residences--that he could defer the tax on the gain as long as he bought a new property for the same or more that he sold the old one for, and did it within two years.
Unfortunately, he figured wrong. The mistake cost him about $30,000 in capital gains taxes.
But, you don’t have to be a high-roller with money to pump into real estate speculation in order to make costly mistakes.
“People often don’t really know what their filing status should be, and that can cost them,” said Hal Kuchel, a tax planner and accountant in Brea.
“A single person with a dependent child often will file as a single person instead of as head of household” with its substantially lower tax liability in higher income bracket, he said. A single person who provides more than half the income of an elderly parent--even if that parent lives elsewhere--also can qualify as a head of household.
The savings start to become meaningful when taxable income tops $20,000.
A single person with a dependent and taxable income of $25,000, for example, will pay $4,596 in federal income tax for 1989. The same tax return with the “head of household” filing status checked off, requires only $3,777 in taxes, a savings of nearly 22%.
At the lower end of the income scale, taxpayers--especially those who prepare their own returns--often don’t take advantage of possible earned income credit, said Bill and Yvonne Kirkendall, income tax preparers with offices in Garden Grove and Long Beach.
“Parents with dependent children and adjusted gross family income below $19,340 last year can get credit for their Social Security taxes up to $910,” said Bill.
“That means that they can actually get cash back even if they had no other tax liability,” Yvonne added. “And $900 can make a lot of difference for many people, even in Orange County.”
The Kirkendalls said they also “find” money for a lot of clients who sell homes they earlier had refinanced. The points paid on a refinancing loan aren’t deductible in the first year as they are with the initial mortgage loan, Bill said.
“They have to be amortized over the life of the loan. But a lot of people forget when they sell and pay off the refinanced loan that they have all those points stored up that they can deduct. We recently got an extra $4,000 deduction for a client that way,” said Yvonne. “He thought we were geniuses.”
The pages and pages of rules for deducting moving expenses also can hide deductions from the uninitiated, she said.
“If you are moving more than 35 miles and doing it to get closer to your job, and you have incurred expenses in selling your old home or buying a new one--things like escrow fees, the cost of breaking a lease, realtors’ commissions and such--you can deduct up to $3,000 of those costs right away on the moving expenses form,” she said.
Judith Hood and Diane Burch, partners in a small CPA firm in Los Alamitos, deal with a lot retirees and say clients at or nearing retirement age have special tax problems, generally minimizing taxes and avoiding penalties as they begin drawing from IRAs, Keoghs, 401(k)s and other tax-deferred retirement plans.
One major problem is with transferring a retirement fund to a new institution upon retirement, Hood said. “We see a lot of people who don’t know that they have to roll over more than 50% of the money in the retirement fund--put it into another IRA, for instance--or they will be taxed on the whole thing as common income for the year,” she said.
Other tax tips from the professionals include:
* Lump as many medical expenses as possible into a single year to boost the total high enough to gain a deduction. The law says only out-of-pocket expenses in excess of 7.5% of gross income are deductible, so for most taxpayers it takes a surgery and other hefty bills--like orthodontics--to gain a tax benefit.
* Pay off credit cards and other consumer debt as soon as possible. The deduction for consumer interest fell to 20% for 1989, will be only 10% this year and disappears in 1991.
* Divorces can have positive tax consequences if the warring parties can agree on a strategy. Court-ordered alimony, for example, is taxable to the recipient while child-support isn’t. By changing a settlement to increase child support and reduce alimony, the total payment can be the same while the tax burden on the recipient is reduced.
And finally, if you usually receive a tax refund, adjust your withholding so you take home a little more money each week.
Unless it takes more than 45 days to send you your refund, the government doesn’t pay interest on excess money it has collected from you all year long.
And that’s just giving your money away.
...And Finally * The filing deadline this year is April 16, not April 15, which is a Sunday. * If you need federal tax forms and schedules, try your local public library or one of the two IRS walk-in assistance offices, at the federal building in the Santa Ana civic center or the Chet Holifield federal building in Laguna Niguel, at 24000 Avila Road. * The toll-free number for the IRS information service, if you can get through is 1-800-424-1014. * You can get an automatic three-month federal filing extention and a four-month state extension by mailing the appropriate extension request form by midnight, April 16. But if you woe taxes, be sure to include a check. The extension is for filing, not for paying.
Tax-Saving Strategies * Self-employed and missed the Dec. 31 deadline for a Keogh plan? You have until April 16 to set aside up to $30,000 in a deductible Simplified Employee Pension plan--or SEP. * If you pumped enough money into a 401(k) retirement plan to lower your adjusted gross income to $25,000 if single or $40,000 if married and filing jointly, you can set up an IRA for 1989 and shelter up to $2,000 more. Deadline is April 16. * People who worked two jobs in 1989 can claim a credit for excess Social Security tax if the total withheld by both employers exceeded $3,604.80. * Pay off credit card and other personal consumer debt if you haven’t already. Interest on it is only 20% deductible for 1989 and deductibility disappears in 1991. * California residents who rented for at least six month of the year get a state tax credit, $137 for married couples and $60 for singles.
Common Mistakes * Forgetting to sign return. * Forgetting to include Social Security numbers of taxpayers and/or dependents. * Math errors. * Excessive rounding-off. To avoid problems, round-off to the nearest dollar, not the nearest $10 or $100. * Failing to include all schedules and forms that back up deductions, income and investment earnings. * Not claiming proper filing status. A single parent can be a head of household. So can a single person who contributes the majority of an elderly parent’s income. * Forgetting to deduct state income tax payments made in excess of withholding.
How to Red-Flag Your Return * Take deductions for a home office if you are not self-employed. * Claim a self-employment business loss that wipes out your profit. * Deduct bad debt losses. * Close out an IRA or other qualified pension plan and don’t report the income or the fact that it was rolled over into a new qualified plan. * Understate your income. IRS computer programs now match payments to you against the income you claim.
Watch Out * Some 50,000 taxpayers, 2,000 of them in Orange County, were randomly selected for an intense audit of their 1988 returns. They are part of an ongoing program to develop data for taxpayer profiles. The odds that you will be audited are roughly one in 1,370.
Odds on Being Audited * Gross income is $25K-$50K: 1 in 100. * Gross income exceeds $50K: 1 in 55. * If you file a partnership return: 1 in 139. * If you report business income of less than $25K: 1 in 76. * If you report business income of more than $100K: 1 in 26.
Alterations for 1989 * Social Security numbers must be reported for all claimed dependents age 2 and older. * Claims for child care credit must include taxpayer identification or Social Security number of any child care provider paid more than $500. Maximum age of eligible children dropped to 12 years, from 14. * Consumer interest deduction and deduction for net loss on passive activities each cut to 20%. * Parents can include interest and dividend income of children under 14 on their own tax returns instead of filing separate child return. * Students can only be deducted as dependents after age 23 if they earn less than $2,000 for the year. * If you are feeling harassed by the IRS, you can file Form 911 this year--a complaint to the IRS ombudsman--and enforcement action is suspended until your complaint is answered.
New Rules For 1990 * Consumer interest deduction and passive activity net loss deduction both drop to 10%. * Business mileage deduction for personal automobiles increases to 26 cents a mile. * Maximum before-tax employee contribution to a 401(k) retirement plan increases to $7,979. * The self-employed can deduct 50% of self-employment (Social Security) taxes in lieu of the old 2% credit. * Interest on savings bonds purchased in 1990 and after can be deductable if the bonds are used to pay for college tuition. * Cellular telephones placed in service or leased in 1990 must be used for business purposes at least 50% of the time to qualify for an accelerated business deduction.
Don’ts for Donors * Don’t forget to get receipts whenever possible, especially for non-cash donations. * Don’t deduct the full payment for tickets to charity events such as banquets, balls and variety shows. Only the amount exceeding fair market value of the event is deductable.
Retirement Rules * There is a 10% penalty on most distributions from qualified retirement plans before you reach age 59. * Social Security income becomes taxable if combined income--earned, other retirement and investment income and 50% of Social Security income--exceeds $25,000 if you are single or $32,000 if you are married and filing jointly. * If taxes aren’t withheld from pension payments, you must make estimated quarterly tax payments to the IRS.
