20 Foolish Tax Tips for 1998 Tax Preparation [Tax Q&A]

Death & Taxes

20 Foolish Tax Tips for 1998 Tax Preparation

By Roy Lewis
March 5, 1998

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

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

2. Use the "Qualifying Widow/Widower" filing status. If you were unfortunate and lost your spouse in calendar year 1997 or 1996, have at least one dependent child in your household, and you have not remarried, there is a special filing status for you that will save you tax dollars.

Use the "Head of Household" filing status when your ex-spouse claims your child(ren) as a deduction. If you are divorced, you may have agreed to give the tax deductions for your kids to your ex (usually allowed when the ex makes timely child support payments). Nevertheless, you may still use the Head of Household filing status if the children actually reside with you and you have physical custody of them. But don't forget, if you have negotiated the dependent exemption, the custodial spouse may have to file IRS Form 8332 to "release" the exemption to the non-custodial spouse.

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

5. Don't forget interest paid on student loans. If you paid interest on a student loan or qualified higher education loan, don't forget to deduct the qualified interest paid on line 24 of Form 1040. Many people are under the impression that the student loan interest deduction will only apply to them if they itemize their deductions. Nothing could be further from the truth. Qualified student loan interest paid is the only interest that can be deducted (as an adjustment to income) even if you don't itemize your deductions, so don't overlook it.

6. Segregate your mutual fund capital gains distributions from your regular distributions. Remember that capital gains receive a special lower tax treatment. When you report your mutual fund dividends on Schedule B, pay particular attention to your capital gains distributions as reported on your mutual fund statement. Make sure to report only your "ordinary" dividends on Schedule B, line 5. Report your capital gains distributions on Schedule D, line 13. Don't pay ordinary rates on capital gains income when you don't have to.

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

8. Maximize your IRA contributions. Did you know that alimony received is considered "earned income" for IRA contribution purposes? Did you also know that even if your spouse is a homemaker with no W-2 earned income, you may still be able to make a full $2,000 IRA contribution for him/her? These contributions may or may not be deductible, depending on your individual circumstances. But they are available to you. And, don't forget that you can make a contribution to your 1998 traditional or Roth IRA as late as April 15, 1999.

9. Roth IRA conversions. Did you convert your traditional IRA to a Roth IRA in 1998? If so, you have some computations to make, and you'll make those computations on IRS Form 8606. Remember also that you are able to spread out your taxable Roth IRA conversion income over a four-year period, which may save you some tax dollars. Form 8606 will explain this and other Roth conversion computation issues. Conversely, if you recharacterized your Roth IRA back to a traditional IRA in 1998, the instructions to Form 8606 are required reading. It's tricky� don't get trapped.

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

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

12. Refinance points. Did you refinance your primary or secondary residence in 1998? If so, you may have paid loan "points." You may be able to amortize those points over the life of the loan and generate an additional interest deduction. And, better yet, if this refinance paid off a prior loan, you may be able to "accelerate" the unamortized points you have remaining for the prior refinance. For additional information, check out the instructions for Schedule A in your Form 1040 Forms and Instructions booklet.

13. Non-Cash Charitable Contributions. Did you give that old sofa to Goodwill Industries? Or how about those clothing items you donated to the Salvation Army? Don't forget to get receipts for your contributions and deduct the fair market value (FMV) of those items as a charitable contribution. Not sure how to place a value on the stuff? Check out For a small fee, you can get a list of values for these types of items. And since most people underestimate the value of the goods they donate to charity, you might be able to recover the cost of the list in the form of reduced taxes. For additional information, check out IRS Form 8283 and instructions. And don't forget about your charitable travel. Do you use your auto for charitable purposes? If so, you can deduct 14 cents per mile for all qualified charitable travel. Not only that, you may deduct your out-of-pocket expenses when you are serving a qualified organization (for example, Scout leaders can deduct the cost of uniforms).

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

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

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

17. New Credits. There are a number of new tax credits available for 1998. Do you have dependent children? If so, you may qualify for the child tax credit (check out line 43 of Form 1040). Did you pay tuition and fees for qualified higher education expenses for yourself, your spouse, or a qualified child? Then the Hope or Lifetime Learning credits may apply to you. Read more about these credits in the instructions to line 44 of Form 1040 and the instructions to IRS Form 8863. And if you paid qualified expenses to adopt an eligible child, check out the instructions for line 45 of Form 1040, because the adoption tax credit may be in your future. You can read more about this credit in IRS Form 8839.

18. Foreign Tax Credit. Do you have mutual funds that invest in international stocks? Or do you own individual stocks in non-US companies? If so, you probably are charged a "foreign tax" on the dividends you receive. Not sure how to report those foreign taxes? You can certainly take them as an itemized deduction. But for those who don't itemize, if you meet certain requirements you can simply drop the foreign tax paid on line 46 of Form 1040 without being required to complete Form 1116. This is brand new for 1998, so make sure you know the rules. You can make your tax filing life much easier this year. Check out the instructions for Form 1040, line 46 for additional information. Or read more about the foreign tax credit issues in the instructions to IRS Form 1116.

19. Excess Social Security Withholding. Did you have more than one job in 1998? Did you receive more than one W-2 form? Were the total wages paid to you by those two (or more) employers greater than $68,400? If so, it is likely that you had excess Social Security taxes withheld. You can recover those excess social security taxes on Line 62 of Form 1040. If you look in your 1040 Forms and Instructions book, you'll find a worksheet to help you determine if excess Social Security tax was withheld from your wages and the amount to report on Line 62.

20. Estimated Tax Penalty. You complete your taxes and find that your balance due to Uncle Sammy is greater than $1,000. Oops. You may have entered the "underpayment penalty" zone. You may be inclined to compute the underpayment penalty and pay that penalty with your tax return. Or Uncle Sammy may compute that underpayment penalty and bill you later. But there are a number of "safe harbors" you may fall under that may allow you to avoid the underpayment penalty. For a complete discussion of the underpayment penalty, see my article entitled Estimated Taxes in the Taxes FAQ area.

So, there you have it. If you recognized all of these issues, you get the TMF Taxes seal of approval. And if you are confused about one or more of these items, check out the Taxes FAQ area for additional information. If you are still confused about some of these issues, you can always drop me a question in the Tax Strategies message folder.

[Want to learn more about taxes and investing? The Motley Fool Investment Tax Guide is now available through FoolMart. There is still time available to do that tax planning (and tax saving) before the end of the year. Click here to read more about this Investment Tax Guide.]

Please note that Roy cannot answer individual questions via e-mail. If you have tax questions, please ask them on the taxes message board. Thanks!

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