‘Tis the Time of Year When the IRS Wants to See Your Filing Face
It’s the least-appreciated rite of spring: deciphering the ever-evolving, immensely complex and often inexplicable U.S. Tax Code.
Although three major tax overhauls were passed last year, most Americans will find filing their 1996 returns similar to filing in 1995. Last year’s laws changed only a handful of the rules that immediately impact individuals. The changes will be more significant in coming years.
Nonetheless, there are a few new glitches--and a number of old ones--capable of tripping up even the most ardent taxpayer. Here’s a walk-through guide of what’s new, old and how you can best handle that vexing 1040.
* Filing Status: Before you jot down a cent in income, you must check a box stating whether you are married, single, a head of household or a qualifying widow or widower. The tax you’ll ultimately pay hinges greatly on that tick mark.
Think there’s nothing you can do about being a single filer, who qualifies for the smallest standard deduction and just one measly $2,550 personal exemption? Perhaps. But a savvy taxpayer would consider whether he or she supports another “qualifying person.”
Some singles not only support themselves, but also provide more than half the financial support for a parent, relative or child. If you do, you may have a dependent, which could allow you to qualify for “head of household” status, which gives you a higher standard deduction and, often, a lower tax rate.
* Exemptions: To claim a dependent exemption in 1996, the dependent must have a Social Security number. No Social Security number, no deduction. The only exception this year is for a child born in December 1996 who hasn’t yet been assigned a number.
Even with a Social Security number, the IRS might accidentally disallow your dependents if you have an unusual last name, said Kathy Burlison, tax research and training specialist at H&R; Block in Kansas City, Mo. Hyphenated and dual last names often get transposed in both Social Security and IRS computers, she said.
In these cases, it’s sometimes advisable to include with your return additional documentation, such as copies of the applicable Social Security cards.
* Income: By now you should have received wage statements from your employer, and your bank, broker and mutual fund companies should have provided forms indicating how much interest and investment income you’ve earned--and paid.
Generally, these income figures can just be plugged into your return. But there are exceptions.
Tip income, for example, is taxable and subject to federal withholding. If you regularly receive tips as part of your pay, you are supposed to report the amount to your employer, who will include the income on your W-2 form.
If you haven’t reported tip income exceeding $20 in any given month, you must report it to the IRS and the Social Security Administration on Form 4137, which allows you to figure the amount of Social Security and Medicare taxes due on those unreported tips.
If you are self-employed or work full or part time as an independent contractor, you must fill out Schedule C, which delineates how much profit or loss you sustained from your business.
This form allows you to write off business expenses without being constrained by miscellaneous itemized deduction limits.
Those who work from home may have another tax break and another form to fill out--Form 8829: Expenses for Business Use of Your Home.
Those with self-employment income also must file a Schedule SE and compute and pay self-employment taxes for Social Security and Medicare.
(Incidentally, while those with unreported tip income, and self-employed people paying Social Security and Medicare taxes, may figure out their additional tax hit at this point, they won’t report it in the “income” section of the return. Instead, these payments are reported on the back of the form in the “other taxes” section.)
Meanwhile, employees who switched jobs in 1996--taking a 401(k) plan with them--or who moved their IRA to a new broker, also have extra work to do. That’s because employers and IRA custodians are required to report pension distributions.
If your distribution was nothing more than a rollover--a nontaxable event in which you shifted a qualified retirement plan from one account to another--you’ll have to note the same on your tax return.
The way to deal with these distributions is to add them into your reported income--line 15a or 16a on the 1040--and then subtract them out by noting zeros on line 15b or 16b. That tells Uncle Sam that you haven’t forgotten to follow his rules.
Finally, if you receive Social Security income, you must fill in an 18-line work sheet to determine how much of your Social Security income is taxable.
* Adjustments: Do you contribute to an IRA, Keogh or SEP? Do you pay self-employment taxes or health insurance premiums for you and your family as a business owner? Do you pay alimony? If so, you can subtract the amount you’re paying from your taxable income. Those who fill out the standard 1040 form will report these adjustments to gross income on lines 23a to 30.
* Exemptions and Deductions: Your next step is to determine how much you can subtract from your adjusted gross income figure. The more you can subtract through personal exemptions and deductions--either standard or itemized--the less taxable income you have and the less tax you pay.
If you use the standard deduction--about 70% of the nation’s filers do, according to the IRS--this process is a simple two steps.
* Add the number of individuals in your family--you, your spouse (if any), children and other dependents--and multiply by $2,550. Subtract the result from your adjusted gross income.
* Match your filing status to the appropriate standard deduction--$4,000 for singles; $5,900 for head of household; $6,700 for qualifying widows and married couples filing jointly; $3,350 for married couples who file separately. Subtract that from the result of step one.
This is your taxable income. Look up your tax in the IRS tables.
The other 30% of taxpayers--those who itemize deductions--will flip to their Schedule A itemized deductions form and begin to enumerate the many tax-deductible things they’ve done during the year, such as paying state income and property taxes, mortgage interest expenses, “points” when securing a home loan and giving to charity.
In addition, employees who had unreimbursed business expenses that exceeded 2% of their income can write off the excess under miscellaneous itemized deductions; and those who had unreimbursed medical expenses that exceeded 7.5% of income can write off the excess here too.
The only other trick to filling out this section: If you are a high-income filer--and that definition is spongy, triggered at different income levels at different places in the Tax Code--you may not get the full benefit from either your personal exemption credits or from your itemized deductions.
Congress decided to phase out tax breaks for people who earn more than certain threshold amounts.
What is high income? For purposes of the personal exemption credits, it’s anything more than $88,475. For purposes of itemized deduction limits, it’s $117,950 or more--or $58,975, if you are married and filing separately.
If your income exceeds those levels, you might want to hire a professional tax preparer.
* Credits: If you have a child who is younger than 13 or who is disabled, and you pay baby-sitting expenses so that you (and your spouse, when applicable) can work or attend school, you may be able to claim a credit--that’s a dollar-for-dollar reduction in the tax you owe--equivalent to between 20% and 30% of your qualifying expenses.
To claim this credit, fill out Form 2441, “Child and Dependent Care Expenses,” and record the result on line 39.
If you are elderly or disabled, or if you pay taxes on foreign investments, you can win a credit if you fill out the appropriate form: Schedule R for the elderly and disabled; Form 1116 for the foreign tax credit.
Oddly, the earned income tax credit--a highly lucrative tax break for the working poor--doesn’t appear here. That’s because it’s one of the few tax credits that’s refundable, meaning you can get back more tax than you paid in through withholding.
If you are eligible for the EITC, you’ll report the credit amount in the “payments” section on line 54. Who is eligible? Parents who earn less than $28,495 and have two or more eligible dependents; parents who earn less than $25,078 and have one dependent; and individuals who earn less than $9,500 annually and have no children.
Be careful to include Social Security numbers for every dependent claimed--even newborns or the IRS will deny the deduction.
Happy filing.
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From Lincoln to Clinton: Important Dates in U.S. Tax History
* 1862: Abraham Lincoln enacts an emergency measure to pay for Civil War: minimum 3% tax rate.
* 1872: Lincoln’s income tax law lapses.
* 1894: A 2% federal income tax is enacted.
* 1895: Income tax is ruled unconstitutional by the U.S. Supreme Court in Pollack vs. Farmers Loan & Trust.
* 1909: The 16th Amendment, authorizing Congress to collect taxes on income, is proposed.
* 1913: Wyoming casts the 37th vote, ratifying the 16th Amendment. One in 271 people pays 1% rate.
* 1926: The Revenue Act of 1926 reduces taxes because too much money is being collected.
* 1939: Revenue statutes are codified. One in 32 citizens pays 4% rate.
* 1943: One out of three people pays taxes. Withholding on salaries and wages is introduced.
* 1954: The 875-page Internal Revenue Code of 1954 passes. It is considered the most monumental overhaul of federal income tax system to date, with 3,000 rule changes.
* 1969: The Tax Reform Act contains major amendments to the 1954 overhaul.
* 1984: The Reagan Tax Reform Act is the most complex bill ever, with more than 180 technical corrections.
* 1986: The Tax Reform Act reduces tax brackets from five to two.
* 1993: Clinton’s Revenue Reconciliation Act passes by one vice presidential vote.
* 1995: A major budget stalemate shuts down government. Clinton vetoes the Revenue Reconciliation Bill of 1995.
* 1996: Clinton signs more than 700 changes into law: Health Insurance Portability Act, Small Business Job Protection Act, Taxpayer Bill of Rights 2 Reform Act, Welfare Reform Act
Source: CCH Inc.
