View these questions and answers for helpful tips on tax related issues. If you have a question that you do not see listed here, you can contact Diane via a short form.
Keep detailed records of your income, expenses, and other information you report on your tax return. A good set of records can help you save money when you do your taxes and will be your trusty ally in case you are audited.
There are several types of records that you should keep. Most experts believe it’s wise to keep most types of records for at least seven years, and some you should keep indefinitely.
Keep records of all your current year income and deductible expenses. These are the records that an auditor will ask for if the IRS selects you for an audit.
Here’s a list of the kinds of tax records and receipts to keep that relate to your current year income and deductions:
While you’re storing your current year’s income and expense records, be sure to keep your bank account and loan records too, even though you don’t report them on your tax return. If the IRS believes you’ve underreported your taxable income because your lifestyle appears to be more comfortable than your taxable income would allow, having these loan and bank records may be just the thing to save you.
Keep the records of your current year’s income and expenses for as long as you may be called upon to prove the income or deduction if you’re audited.
For federal tax purposes, this is generally three years from the date you file your return (or the date it’s due, if that’s later), or two years from the date you actually pay the tax that’s due, if the date you pay the tax is later than the due date.
For some states, you should keep your records for four years.
Yes, keep your old tax returns.
One of the benefits of keeping your tax returns from year to year is that you can look at last year’s return while preparing this year’s. It’s a handy reference, and reminds you of deductions you may have forgotten.
Another reason to keep your old tax returns is that there may be information in an old return that you need later.
One example of information you may need years later is the tax basis of your home. If you sold your home some years ago and replaced it with the one you live in now, you filed a Form 2119 with your old return. On Form 2119, you figured the tax basis of your current home. When you sell your current home, the starting point to find out what your gain (or loss) is comes from the Form 2119 for the old house.
Here’s a reason to keep your old returns that may surprise you. If the IRS calls you in for an audit, the examiner will more than likely ask you to bring your tax returns for the last few years. You’d think the IRS would have them handy, but that’s not the way it works. Your old returns are more than likely in a computer, in a storage area, or on microfilm somewhere. Usually what your IRS auditor has is just a report detailing the reason the computer picked your return for the audit. So having your old returns allows you to easily comply with your auditor’s request.
You may want to keep your old returns forever, especially if they contain information such as the tax basis of your house. Probably, though, keeping them for the previous three or four years is sufficient.
If you throw out an old return that you find you need, you can get a copy of your most recent returns (usually the last six years) from the IRS. Ask the IRS to send you Form 4506, Request for Copy or Transcript of Tax Form. When you complete the form, send it, with the required small fee, to the IRS Service Center where you filed your return.
Unless you own or operate your own business, partnership, or S corporation, recordkeeping does not have to be fancy.
Your recordkeeping system can be as casual as storing receipts in a box until the end of the year, then transferring the records, along with a copy of the tax return you file, to an envelope or file folder for longer storage.
To make it easy on yourself, you might want to separate your records and receipts into categories, and file them in labeled envelopes or folders. It’s also helpful to keep each year’s records separate and clearly labeled.
If you have your own business, or if you’re a partner in a partnership or an S corporation shareholder, you might find it valuable to hire a bookkeeper or accountant.
For homeowners, it’s the home equity loan. Other consumer related interest expense, such as from car loans or credit cards, is not deductible.
Interest on a home-equity loan can be deductible. So avoid other nondeductible borrowings and use a home-equity loan if you plan to borrow for consumer purchases.
You may be able to take an immediate expense deduction of up to $250,000 for 2008, for equipment purchased for use in your business, instead of writing it off over many years. Additionally, self-employed individuals can deduct 100% of their health insurance premiums. You may also be able to establish a Keogh, SEP or SIMPLE plan and deduct your contributions (investments).
You sometimes may benefit from filing separately instead of jointly. Consider filing separately if you meet the following criteria:
Separate filing may benefit such couples because the adjusted gross income “floors” for taking the listed deductions will be computed separately.
You generally can’t deduct your medical and dental expenses, since they are deductible only to the extent they exceed 7.5% of your Adjusted Gross Income. But you can effectively get a deduction for these items if your employer offers a Flexible Spending Account (FSA), Health Savings Account or cafeteria plan. These plans permit you to redirect a portion of your salary to pay these types of expenses with pre-tax dollars.
If you’re planning to make a charitable gift, it generally makes more sense to give appreciated long-term capital assets to the charity, instead of selling the assets and giving the charity the after-tax proceeds. Donating the assets instead of the cash avoids capital gains tax on the sale, and you can obtain a tax deduction for the full fair market value of the property.
If you also have an investment on which you have an accumulated loss, it may be advantageous to sell it prior to year-end. Capital losses are deductible up to the amount of your capital gains plus $3,000. If you are planning on selling an investment on which you have an accumulated gain, it may be best to wait until after the end of the year to defer payment of the taxes for another year (subject to estimated tax requirements).
For growth stocks you hold for the long term, you pay no tax on the appreciation until you sell them. No capital gains tax is imposed on appreciation at your death.
Interest on state or local bonds (“municipals”) is generally exempt from federal income tax and from tax by the issuing state or locality. For that reason, interest paid on such bonds is somewhat less than that paid on commercial bonds of comparable quality. However, for individuals in higher brackets, the interest from municipals will often be greater than from higher paying commercial bonds after reduction for taxes.
For high-income taxpayers, who live in high-income-tax states, investing in Treasury bills, bonds, and notes can pay off in tax savings. The interest on Treasuries is exempt from state and local income tax.
Consider setting up and contributing as much as possible to a retirement plan. These are allowed even for sideline or moonlighting businesses. Several types of plan are available: the Keogh plan, the SEP, and the SIMPLE.
Through the use of tax-deferred retirement accounts you can invest some of the money you would have otherwise paid in taxes to increase the amount of your retirement fund. Many employers offer plans where you can elect to defer a portion of your salary and contribute it to a tax-deferred retirement account. For most companies these are referred to as 401(k) plans. For many other employers, such as universities, a similar plan called a 403(b) is available.
Some employers match a portion of employee contributions to such plans. If this is available, you should structure your contributions to receive the maximum employer matching contribution.
If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. This can defer the payment of taxes (other than the portion withheld) for another year. If you're self employed, defer sending invoices or bills to clients or customers until after the new year begins. Here, too, you can defer some of the tax, subject to estimated tax requirements.
You can achieve the same effect of short-term income deferral by accelerating deductions—for example, paying a state estimated tax installment in December instead of at the following January due date.
Most individuals are in a higher tax bracket in their working years than during retirement. Deferring income until retirement may result in paying taxes on that income at a lower rate. Deferral can also work in the short term if you expect to be in a lower bracket in the following year or if you can take advantage of lower long-term capital gains rates by holding an asset a little longer.
You can't take two different kinds of relief for the same item. You can sometimes take one type of relief for one education item and another type for another item.
Some benefits have income ceilings that bar or limit the relief as taxpayer's income rises.
There are two types of education credit, Hope Credit and Lifetime-Learning Credit, and you must choose. Briefly: the Hope credit is for the first 2 years after high school, so it fits community college or the first 2 years of a 4 year college. It must be for at least half-time study. The annual credit ceiling is $1,800 per student in 2008 (100% of the first $1,200, 50% of the next $1,200).
The lifetime learning credit fits any undergraduate or graduate study, but study less than half-time must be work-related. The credit ceiling is $2,000 (20% of expenses up to $10,000) per taxpayer per year.
For an academic period (quarter, semester, etc.) beginning in the first 3 months of a calendar year, you can pick which year to pay the expense and take the credit. That is, pay in December 2008 and take the credit in 2008 or pay in, say, February, 2009 and take the credit in 2009.
Your family may be able to save tax by foregoing the education credit and taking an available exemption for program distributions instead.
Sometimes. Examples are for relief provided for Coverdell education expense accounts (Section 530 programs), for qualified tuition (section 529) programs, for withdrawals from traditional and Roth IRAs, and for student loans.
An education IRA differs from other IRAs in the following ways:
Unlike other plans, 530 accounts may be used for primary and secondary education, including paying for room and board of children in private schools, and for computers and related materials whether or not away from home.
There can be a number of Section 530 accounts for any student. Various family members, such as grandparents, aunts and uncles, and siblings--and persons outside the family--can contribute to separate accounts for a student.
The original student beneficiary for the Section 530 account can be changed to another family member, such as a sibling--for example where the original beneficiary wins a scholarship or drops out.
Funds can be rolled over tax-free from one family member's Section 530 account to another’s—for example, to avoid distribution when the first family member reaches age 30.
The education tax credit (where applicable) can be waived in favor of tax-free treatment for Section 530 account distributions.
These, also called Section 529 programs, are college savings programs established by almost every state, and some private colleges. You invest now to cover future college expenses, by contributing to a savings account or buying tuition credits redeemable in the future. Investments grow tax-free, and distributions to pay college expenses can also be tax-free. You may choose any state’s plan, regardless of where you live.
In several major ways. Section 530 plans limit investment to $2,000 a year per student; 529 plans allow much larger investment. Section 530 plans allow wide choice of investment; 529 investment choices are limited and conservative. Section 530 is a single nationwide program; each 529 program is different. Though both are available for higher education, Section 530 can also be used for primary and secondary education. You are free to use both for higher education for the same student.
Yes. The 10% penalty on withdrawal under age 59-1/2 won't apply, but ordinary income tax will apply to at least some of the withdrawal.
Yes, generally under the same terms as traditional IRAs. Also, ordinary income tax is somewhat less likely, or may be smaller in amount, than with traditional IRAs.
Caution: This deduction is scheduled to end with the 2007 tax filing season. Many believe that the deduction could be restored in 2008. No further information is available at this time. The following information relates to 2007 only.
A limited deduction is allowed through 2007 for higher education tuition and related expenses. Deduction up to $4,000 is allowed on if taxpayer’s (modified) adjusted gross income is $65,000 or less ($130,000 or less on a joint return). If taxpayer’s modified adjusted gross income is more than $65,000 but not more than $80,000 (more than $130,000 but not more than $160,000 on a joint return), deduction is allowed up to $2,000.
Business expense deduction is allowed, without dollar limit, for education that serves the taxpayer’s business, including employment. Deduction is also allowed for student loan interest. A taxpayer may not take more than one deduction for the same item.
Not much, if it's not part of a degree or certificate program, and not work-related, the limited deduction (up to $4,000 for tuition and fees) may be your only option. Deduction is available through 2007, depending on your income. Some sideline interests might qualify for exclusion if paid for under an employer-provided education assistance program.
Since personal interest is generally non-deductible, deductions must meet several tests:
Yes, as home equity loan interest, not as student loan interest. In this case there's no income ceiling on your deduction, and certain other student loan limits don't apply.
Usually you're taxed on the unpaid loan balance. But tax can be waived if the debt is canceled because you participate in some approved government or other program.
Interest on redemption of Series EE bonds is tax-exempt if you redeem them in a year you have qualified education expenses. Exemption depends on the amount of your income in the year you redeem the bond.
Maybe not. Up to $5,250 can be tax free. Exemption can apply to graduate level courses.
Yes if it's to maintain or improve skills in your present job. No if it's to meet minimum requirements of that job, or to qualify to enter a new business. Employee's deductions are subject to the 2% floor on miscellaneous itemized deductions.