TIP OF THE MONTH - March 2008

PENNY WISE

Each year, when the tax season rolls around, we get a number of new clients who want us to prepare their tax return. Usually, they had been preparing their returns themselves, but the returns became too complicated and they needed professional help. Unfortunately, we find that these taxpayers often made mistakes in the earlier years that led to the overpayment of taxes and the potential for being singled out for audit. Among the more common errors are:

Not taking legitimate deductions, such as a deduction for a home office, for fear that it might trigger an audit.
Failing to deduct tax deductible expenses, especially travel, tolls, tips, taxi and other fares for lack of a receipt.
Losing the interest deduction by using credit card loans and other personal loans instead of home equity loans for purchase of a car or other big-ticket item.
Reporting income that does not need to be reported such as tax-exempt income or rental income from a vacation home that's rented less that 14 days per year.
Paying IRS penalty notices out of fear, even if the assessments are incorrect.
Failing to take deductions such as for charitable contributions because the credit card charges have not been paid until the following year.

Another faux pas? Well, hopefully last year you DID NOT give away stocks you owned with a built-in loss to a charity or used it as a gift to a relative. Instead, you should have first sold the investment to take advantage of the resulting capital loss to shelter your capital gains or income from other sources. You should then have donated the cash or given it to your relative. Getting the idea….perhaps this is a good time to consider the current year?

You may also wish to give away appreciated investments to children or grandchildren who are in the 10% and 15% income tax brackets. Effective 2008, the gain on the ultimate sale will not be taxed, provided the investment has been held for more than a year. Frankly, even if the stock has been held for less than a year, the recipient may still only pay perhaps a 10% tax on the gain. Were you to keep the stock and sell it on your own, you'll probably pay 15% on the long-term gain (rather than 5%) while paying as much as 35% on short term gains. Not considered are state and local taxes.

The combination of these mistakes plus a lack of proper tax planning caused these taxpayers to pay considerably more income taxes than was necessary. What's more, usually the extra tax far exceeded the cost of professional tax preparation. Without wishing to sound self-serving, unless you are highly conversant with the tax code, you'll usually come out way ahead with professional help.