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Archive for Sunday, February 18, 2001

Reasons abound for starting income-tax preparations now

February 18, 2001

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I always start February feeling smug and end the month kicking myself.

In a burst of New Year's resolve, I label a manila folder "Tax Documents." By early February, all the papers are properly filed; at the end of the month I usually haven't done anything with them.

Most of us put off doing our tax returns, but it's really not a good idea. If you're due a refund, you'll just get it later, losing out on any investment returns that could have been earned in the meantime.

Sure, you can get an automatic extension and have until August to file. But if you owe Uncle Sam and don't pay enough by April 16, interest and penalties can start piling up even if you get an extension.

Most important, though, doing taxes in a last-minute rush courts error. A mistake that triggers IRS questions could cost you a paperwork headache just as you want to relax this summer. And by hurrying you could miss a deduction and pay more than you owe.

Here, then, as the tax season gets rolling, is a case for getting started:

Beware the AMT. The alternative minimum tax is a remnant of the days when rich people could use loopholes to avoid paying any income tax at all. The worst of these have been closed, but the AMT is still here. And it affects ever-increasing numbers of middle-income taxpayers nudged by inflation into the at-risk group.

Basically, the AMT can increase your tax burden by denying deductions to which you otherwise would be entitled. People who may be subject to the AMT have to do their tax calculations twice and pay either the regular tax or the AMT, whichever is larger.

The bigger your income, the more likely you will be subject to the AMT. CCH Inc., a Riverwoods, Ill., tax-information firm, says the most recent figures, for 1998, showed a 40 percent increase in AMT filings compared with the previous year. Only 1 percent of returns showing adjusted gross incomes between $50,000 and $100,000 paid the AMT, but the figure soared to 16 percent for taxpayers with AGIs above $200,000.

Are you a likely AMT victim?

The AMT tends to hit taxpayers with high levels of itemized deductions or personal exemptions, as well as people who exercised stock options or earned interest on private activity bonds (such as bonds issued to finance things such as stadiums). But the only way to know for sure that you're free of the AMT is to do the calculations.

Above-the-line deductions. These are subtracted from your income before you arrive at the adjusted gross income figure (AGI). They are especially valuable because you can take them even if you don't take the "itemized" form of deductions that are subtracted after you figure the AGI.

Above-the-line deductions can be taken for such things as contributions to traditional IRAs (read on for eligibility rules), contributions to medical savings accounts, costs of a job-related move at least 50 miles away, self-employment expenses such as taxes and health insurance premiums, student-loan interest, alimony and some home-business expenses.

By contrast, itemized deductions involve such things as insurance on a home mortgage; state, local and real estate taxes; and gifts to charity.

Itemized deductions are valuable only to the extent that they total more than the standard deduction you can claim if you do not take itemized deductions. For a single person, the standard deduction for 2000 is $4,400; for a married couple filing a joint return, it's $7,350.

In other words, if your itemized deductions total $5,000 and you are married, the itemized deductions are worthless why take them and give up the extra $2,350 promised by the standard deduction? But the above-the-line deductions would be valuable no matter what, so long as you don't overlook them.

Traditional IRA. Now that 2000 is past, there aren't many maneuvers left to reduce your 2000 tax liability. About all you can do is be sure to claim the deductions, credits and exemptions to which you are entitled. But there is one exception: You have until April 16 to make an IRA contribution for last year that may entitle you to an above-the-line income deduction. Contributions to traditional IRAs, but not Roths, can be deducted by some people.

If you do not participate in a pension plan including a 401(k) at work and don't have a spouse who does, you can deduct up to $2,000 in traditional IRA contributions regardless of your income.

If you are single and are covered by a pension plan at work, you can deduct up to $2,000 so long as your adjusted gross income is $32,000 or less. The deductible amount gradually decreases as AGI rises to $42,000, when no deduction is allowed.

For married couples filing jointly, each person can deduct up to $2,000 so long as the couple's AGI is $52,000 or less, even if one or both spouses has a pension plan. The deductible amount declines to zero for AGIs exceeding $62,000.

Remember, each person's contribution generally must come from earned income, not gifts or investment earnings. One exception is the nonworking spouse of a person who does not have a pension. This spouse can make a deductible contribution so long as the other spouse's income at least equals the two spouses' combined contributions.

Moreover, nonworking people with spouses who do have pensions can make fully deductible IRA contributions if the couple's AGI is less than $150,000. The deductible amount gradually falls to zero as AGI rises to $160,000.

Washington is full of talk of tax cuts, but that's no reason to hold off doing your 2000 return, since it's unlikely changes would be retroactive to last year. If some are, you could file an amended return later.

So, get going!

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