Preparing your taxes can be a difficult undertaking, whether you use tax-preparation computer software, fill out the forms yourself, or hire a tax pro. Regardless of your preferred method, keep these 20 Foolish tax tips in mind before you sign your 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 might 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. For more information, see IRS Publication 4 (Student's Tax Guide) and IRS Publication 554 (Older Americans' Tax Guide).
2. Use the "Qualifying Widow/Widower" filing status: If your spouse passed away last year, you are still considered married for the whole year in terms of your filing status. If you have at least one dependent child in your household and have not remarried, you could be entitled to claim a special filing status for the next two years after the death of your spouse. This special filing status will save you tax dollars. Specifics can be found in the Filing Status chapter of IRS Publication 501.
3. Use the "Head of Household" filing status when your ex-spouse claims the child as a deduction: You might have negotiated the dependent exemptions available to your ex-spouse during the divorce (usually allowed when the ex makes timely child support payments). Nevertheless, you can still use the Head of Household filing status if the children actually reside with you and you have physical custody of them. See Head of Household Status for more information.
4. Don't report too much wage income: If you participate in a deferred-compensation plan at your place of employment -- 401(k), 403(b), etc. -- remember to report as wages only the amount reported to you in Box 1 of your W-2 form. Don't report the salary that you actually earned.
5. Don't report interest earned on Series E, EE, or Treasury bonds/bills/notes on your state tax return: While this interest is taxable for federal purposes, it is not taxable for state purposes. Remember to make the appropriate adjustment on your state tax return.
6. Segregate your mutual fund capital gains distributions from your regular distributions: Remember that long-term capital gains receive a special lower tax treatment. Also note that there is a new section on the Form 1099-DIV that you received from your mutual fund company: Qualified five-Year Capital Gains. These gains may be taxed using the "superlong-term" capital gain rates, so make sure that you compute those gains correctly. When you report your mutual fund dividends on Schedule B, pay particular attention to your capital gains distributions as reported to you on your mutual fund statement. Make sure to take any capital gains dividends (including qualified five-year gains) and report them directly on Schedule D. Don't report your capital gain dividends on Schedule B and pay ordinary tax rates on capital gain income.
7. Add your broker commissions and other fees to the cost of your stock: When you buy stock, you'll pay broker commissions. You might 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 reduce your gross sales price by the amount of these expenses. And don't forget to reconcile your sales to the Form 1099B that was provided to you by your broker.
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 might still be able to make a full $3,000 (or even $3,500 if your spouse is over age 50) IRA contribution for him/her in 2002? (These contributions may or may not be deductible, depending on your individual circumstances). If you made Roth IRA contributions or conversions, be sure to keep track of them. It will be very important if you find that you ever have to take an "early" distribution from your Roth IRA. IRS Publication 590 covers all forms of IRAs. (For more on opening and IRA, see our 60-Second Guide.) And also, don't forget that there is a new credit for certain taxpayers who make retirement savings contributions (such as a contribution to an IRA, 401(k), 403(b), etc.). There are some drawbacks, and the income limitations are fairly low. But make sure that you don't overlook this very valuable credit by reviewing the new rules and guidelines.
9. Adjustment for student loan interest: Did you pay interest on a student loan this year? If so, you might be able to reduce your income by the amount of the interest that you paid, to a maximum adjustment of $2,500. For tax year 2001, the interest must be paid in the first 60 months of the loan, and the loan must have been used for qualified education expenses. But in tax year 2002, the 60-month rule has been lifted and your interest may qualify for the deduction regardless of how long you've been paying on your loans. The beauty of this is that you do not have to itemize your deduction on Schedule A to claim the adjustment for student loan interest paid. For more information, read the instructions for Line 25 of Form 1040 for 2002. See Interest Tax Deduction for School Loans for more information.
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 available only for your primary residence. Not true. Property taxes are deductible for all applicable real property -- third or fourth homes, vacant lots, raw land, etc. But -- and this is a very big but -- if you have rental properties, different rules apply.
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. Confused? See Investment Interest and Margin Interest for clarification.
12. Refinance points: Did you refinance your primary or secondary residence? If so, you might have paid loan "points." You might be able to amortize those points over the life of the loan and generate an additional interest deduction. For additional information, check out the instructions for Schedule A in your Form 1040 Forms and Instructions booklet, or check out my article on deducting loan points. (Looking to refinance while rates are still low? We can help.)
13. 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 can deduct your out-of-pocket expenses when you are serving a qualified organization (for example, Scout leaders can deduct the cost of uniforms). But what you can't deduct is the value of your time that you might donate to a charitable cause.
14. Non-cash charitable contributions: Did you give that old couch to Goodwill Industries? Or how about those clothing items to the Salvation Army? Don't forget to get receipts and deduct the fair market value of those items as a charitable contribution. Not sure how to place a value on the stuff? Check out www.taxsave.com. For a fee, you can buy a list of prices for these goods. Since most people underestimate the value of the goods, you might be able to recover the cost of the listing in the form of reduced taxes. For additional information, check out IRS Form 8283 and instructions.
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) can 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 and had to pay somebody to watch Junior during work hours? Well, if Junior is under age 13, Mom and Dad could 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 could 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 might still be available. For additional information, check out IRS Form 2441 and instructions (for Form 1040) or Schedule 2 (for Form 1040A). Also, see IRS Publication 503 for details on Child and Dependent Care Expenses and IRS Publication 903 for information on tax credits of interest to people with disabilities and their caregivers.
17. New Deduction for Educators: If you're a professional K-12 educator, there is a new deduction that might be right up your alley (even if you're not a teacher). And the best news is that you don't have to itemize your deductions in order to receive the benefit of this tax break. Since it's new, you might overlook it for 2002. Don't do it. Read more about it in my article on this very issue.
18. Foreign tax credit: Do you have mutual funds that invest in foreign stock? Or do you own individual stocks in overseas companies? If so, you probably are charged a "foreign tax" on the dividends that you receive. Not sure how to report those foreign taxes? You can certainly take them as an itemized deduction. For those of you who don't itemize or find it more valuable to take the credit, you can do so right on your Form 1040. While you no longer have to file IRS Form 1116 if you meet certain criteria, check it out anyway because the form and instructions provide valuable details on how to include the credit on your Form 1040. See if you qualify by reading The Foreign Tax Credit.
19. Education Credits: Did you know that you can claim a credit for qualified education expenses paid for yourself, your spouse, and your dependents? It's true. You can even claim credits for your child's college education. The HOPE and Lifetime Learning credits can be valuable tax busters for you. The rules can get a bit complex, and there are certainly restrictions. But if you or anybody in your family attends a higher education facility, it's something that you should take a closer look at. Review the instructions for line 48 on your 2002 Form 1040 and also review IRS Publication 970 for more information. Additionally, there is a new deduction (as opposed to a credit) for qualified education expenses paid in 2002. Check out the instructions for line 26 and get more details here.
20. Child credit: If your dependent is under age 17 at the end of the calendar year, you might qualify for a $600 credit when you file your tax return for the year. Why? Just for putting up with the kid. Really. There are no special qualifications other than the age of the dependent and your total income (high-income taxpayers don't receive the benefit of this credit). If you qualify, don't forget to reduce your taxes by the full $600 for each qualifying dependent for the 2002 tax year. Check out IRS Publication 972 for more information and qualification worksheets. This credit is in addition to any childcare credit that you are able to claim, so don't confuse the two. Also be aware that this credit amount is scheduled to gradually increase to $1,000 per child between now and 2010. Find more details on the child tax credit here.
Bonus Tip: The new tax rules ushered in not too long ago will provide additional relief to millions of taxpayers. Don't overlook the impact of those tax changes when you're doing your planning for future tax years! Read more about the new changes at How Will the Tax Cut Benefit Me? If you'd like even more information on the issues discussed in this column -- and more -- visit the IRS website.
Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.