HOW AND WHEN TO ITEMIZE CAN SAVE YOU MORE MONEY THAN YOU THINK
To itemize or not to itemize: What you need to know to make the right decision. Each year, when you file your income tax return, you can choose between itemizing or claiming the standard deduction. Itemizing allows you to deduct your actual allowable expenses while the standard deduction provides a flat amount to be deducted from your adjusted gross income.
It has been reported that a large percentage of taxpayers may be paying more in taxes than they need to because they take the standard deduction. Also, Arizona rules are slightly different than federal rules. They are noted later. Here's how to ensure you're not one of them.
THE NUMBERS TELL THE STORY
The only sure way to determine which method saves the most tax dollars is to run the numbers. Use Schedule A to list all your deductible expenses and compare the total to the standard deduction for your filing status. If your actual itemized expenses exceed the standard deduction, you'll save money by itemizing.
For 2002, the standard deduction is $4,700 for single filers, $7,850 for married filing jointly, and $6,900 for heads of household. If you're over age 65 at the end of the tax year or legally blind, you're entitled to an additional standard deduction ranging between $900 and $1,150, depending on your filing status. (Not true in all states).
IDENTIFY ITEMIZED EXPENSES
It's important to understand which expenses you can itemize. Some of the more common deductible expenses include:
· Home mortgage interest expense on up to $1 million in home acquisition debt and $100,000 in home equity debt.
State and local income and property taxes. (For Arizona, state income tax is not allowed).
· Charitable contributions to qualified organizations. Gifts of $250 or more require a statement from the charitable organization showing the amount contributed and whether you received any goods or services in return. Keep in mind that a cancelled check is not sufficient proof.
Medical expenses exceeding 7.5 percent of your adjusted gross income (AGI). Examples of deductible medical expenses include fees for doctors, dentists, chiropractors; insurance premiums for medical and dental insurance; prescription medications; hospital care; X-ray and laboratory services; and other related costs. All medical expenses are 100% deductible.
- Miscellaneous expenses exceeding 2 percent of your AGI. This category includes unreimbursed employee business expenses, investments expenses, and tax preparation fees, among others.
- Casualty and theft losses are deductible in the year the loss took place. Uninsured losses caused by theft, vandalism, fire, storm, or similar causes are deductible only if you itemize and only to the extent they exceed 10 percent of your AGI. The first $100 in losses for each event is nondeductible.
MAKE YOUR DEDUCTIONS WORTH A "BUNCH" MORE
If you tallied all qualified expenses and came up short for 2002, don't assume you can't itemize in future years. Consider the strategy of alternating between taking the standard deduction one-year and "bunching" deductible expenses into the year you itemize. Bunching refers to the process of timing your expenses so that they are higher in one year and lower the following.
The easiest deductions to juggle between tax years are charitable contributions, state and local income and property taxes, and your January home mortgage payment.
For example, you could double up on your charitable contributions and make every other year rather than annually. In the year you decide to itemize, you can make your January mortgage payment in December to boost your mortgage interest expense.
You should also try bunching deductions subject to AGI-based limits like medical and dental expenses and miscellaneous itemized deductions. Timing elective medical procedures, such as braces and laser eye surgery, is a common way to qualify for the deduction.
BE AWARE OF PHASE-OUT RULES
Be aware that if your AGI exceeds certain amounts, your total allowable itemized deductions may be reduced. For 2002, itemized deductions decrease by 3 percent of the amount your AGI exceeds $137,300 for single and joint taxpayers ($68,650 for married filing separately).
This reduction cannot exceed 80 percent of total itemized deductions and excludes deductions for medical expenses, casualty and theft losses, and investment interest expenses.
AMEND IT
What if you discover you could have saved money by itemizing? If you are willing to recalculate your taxes, you can file an amended return. Form 1040X will let you negate your original standard deduction and, in its place, list all the money-saving deductions you should have taken.
Just be sure you still have the paperwork and receipts to substantiate your deductions in the event of an audit. Generally, tax returns must be amended within three years of the original filing deadline.
TREASURY DEPT: IRS AUDITORS WRONG ALMOST HALF THE TIME
IRS centers established to help taxpayers prepare returns gave incorrect or inadequate answers to 43 percent of questions asked by Treasury Department investigators posing as taxpayers.
Internal Revenue Service employees provided complete and correct answers to only 45 percent of the questions asked by auditors, and correct but incomplete answers in 12 percent of the cases.
The investigators concluded that approximately 500,000 taxpayers who visited the centers during the course of the study, from July to December last year, could have received incorrect responses to their tax-law questions.
The IRS disputed the calculations, but agreed that the agency needed to improve its record. They have taken steps to teach employees more about tax law, implementing continuous education and training programs. The IRS set a goal to give accurate responses to 80 percent of questions this year and 85 percent next year.
There are 500 taxpayer-assistance centers throughout the country.
PLAN PROPERLY AND UNMARRIED COUPLES CAN AVOID SERIOUS TAX DISADVANTAGES
Unmarried couples face certain disadvantages under the present tax system: they can't exclude the cost of employer provided health benefits for their partners from taxable income; they can't file joint income tax returns; they can't transfer property to each other tax-free under the spousal transfer rules; they can't take advantage of the rules on gift-splitting; and they can't protect transfers of property at death with a martial exclusion. Phase-out levels for other benefits such as education credits, deductions for student loan interest, contributions to Roth IRAs, and the child credit, all kick-in at lower levels for married taxpayers than for two singles combined.
On the other hand, there are numerous phase-outs and thresholds that favor singles. For example, the $3,000 limitation on deduction of capital losses is the same for individuals and for joint filers, the limit on itemized deductions phases in for two single taxpayers at a level that is more than twice that for joint filers. Unmarried couples that own businesses have even more advantages over married couples. Here's why….
Married persons must combine their interests and are treated as one person under rules that deny losses in transactions between related parties. Unmarried persons are not. An unmarried couple can each own a 50 percent interest in a business without being considered related to the business, or to each other for attribution purposes. That makes seven more tax advantages available to unmarried couples, provided they plan properly. Here they are:
- Unmarried couples can deduct losses on transaction with each other, or with a corporation that they own 50/50. One member of an unmarried couple can sell property at a loss to a corporation the couple owns, and recognize any loss on the transaction.
- An accrual basis corporation that is not an S corporation or personal service corporation, owned 50/50 by an unmarried couple can accrue and deduct a bonus to one or both of them in one year, and pay it in the next year, thereby providing significant deferral of tax liability.
- A member of an unmarried couple can use the installment method to report any gain on a sale of property, which is depreciable in the hands of the corporation, to a corporation owned 50/50.
- Members of unmarried couples using the installment method to report gain on a sale of non-depreciable property to, or purchase from, a corporation they own 50/50 need not be concerned about a subsequent disposition.
- A member of an unmarried couple can sell a building to be used in its business to a corporation the couple owns 50/50, and treat the gain as capital gain, even if the corporation can depreciate the property.
- Unmarried persons can make a like-kind exchange with each other or with a corporation that they both own without worrying about a subsequent disposition of the properties exchanged triggering recognition of income.
- Unmarried individuals owning a controlling interest in a corporation together can treat stock redemptions as sales or exchanges because one is not deemed to own the other's stock.
To secure the benefits of being treated as unrelated, unmarried partners must arrange business ownership so that they are 50/50 shareholders in a regular, or C corporation and own interest in real property separately, rather than jointly. Further, they must be prepared to demonstrate a bona fide, no-tax avoidance purpose for any transaction if challenged by the IRS.
Our tax people know how to help "single couples" keep their tax liabilities as low as the law permits. If you would like to discuss any of the points in this article, give us a call to schedule an appointment.
IRS IS TARGETING MORE WEALTHY TAXPAYERS IN RECENT AUDITS
The Internal Revenue Service flexed its financial muscles last year by auditing more high-income taxpayers in a stepped-up effort to snare tax cheats, the agency said.
After years of cutting enforcement activity to focus on making itself more customer-friendly, the IRS has vowed to hire thousands of new auditors and criminal investigators to review corporate finances, high-income taxpayers and offshore tax evasion schemes.
The IRS said its more aggressive efforts should allow it to capture some of the $250 billion each year in revenue that is lost.
The IRS audited 139,379 taxpayers with incomes of more than $100,000 in fiscal 2003, an increase of 24 percent from the prior year.
Overall, audits of all taxpayers jumped 14 percent to 849,296, yielding $35.5 billion in revenue.
Mark Everson, the IRS commissioner, told reporters at the agency's headquarters that the reduction in enforcement efforts had sent the wrong message to taxpayers.
"This drawing down of enforcement (staff) has had a negative effect" on the public paying taxes, said Everson. "People have seen others get away with things they shouldn't have been able to," he said.
The IRS was required by Congress in 1998 to improve customer service after the agency was alleged to have violated taxpayer rights. But as the IRS pushed to improve service, its ability to nab violators through audits stumbled.
The IRS cut its enforcement staff to 19,285 in 2003, a drop of more than 25 percent from 1996, while boosting its taxpayer service division.
Even with its stepped-up enforcement activity, the IRS audited only 1.1 percent of those earning more than $100,000 last year, down from 3.2 percent in fiscal 1996. And among all taxpayers, only 0.7 percent had their tax returns reviewed, down from 1.7 percent in the mid-1990s.
"(Audit rates) are still too low. We need to do more and continue to increase it, particularly on the big income area," said Everson. "But I don't think it's necessarily the case that audits need to return to rates of 10 or more years ago."
In an effort to get tougher on tax evaders, the Bush administration has proposed increasing funding for the IRS in fiscal year 2005 by 4.9 percent to $10.7 billion, with most of the increase earmarked toward focusing on high incomes and corporations.
If the budget request is approved by Congress, the IRS could add 5,000 more jobs next year.
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