TOPICS OF INTEREST

Mortgage Interest - Schedule A Deduction
January Alert
Will You send 1099s
Got It All?
Good Time To Plan
Stock Market Losses May Provide Tax Relief
Tips For You

Mortage Interest - Schedule A Deduction Alert

To fully deduct the home mortgage interest, the interest must be acquisition or equity debt.

Qualifying acquisition debt is:

1. Any mortgage that was taken out on or before 10/13/87; or

2. A mortgage that was taken out after 10/13/87 to buy, build or improve the home AND the total debt was $1 million or less

Acquisition debt is based on the balance on the original mortgage and cannot be increased unless the taxpayer uses the proceeds for additional acquisition or improvement expenses.

Qualifying equity debt is ANY mortgage taken out after 10./13/87 for purposes OTHER THAN to buy, build or improve the home; AND

1. The mortgage totals $100,000 or less; and

2. The mortgage does not exceed the equity in the home.

Both the IRS and the FTB are putting increased auditing resources into examining mortgage interest. Be Aware!

January Alert

Many tax records show up in your January mail. Usually IRS gets a copy too. Don't miss any of these!

W-2s. Read them carefully. Contact your employer if there is a problem. If one is missing after January, contact your employer. If you can't locate the employer, you'll need to collect your pay stubs.

1099s. There should be a 1099-INT or 1099-DIV for each account which pays interest or dividends. Even tax-exempt interest must be listed on your return.

Other 1099s. If you sold real estate, look for 1099-S. For stock sales it's 1099-B. Pensions show up on 1099-R. There are several others. If you sell or transfer mutual funds and reinvest dividends, I need a complete history of your activity. Bring all year-end statements.

Form 1098. This is your mortgage interest. Commercial lenders use this form. If you have a private loan, your need your payment book, or a statement from the lender to verify the amount.

Other income. Look for other reports of income You may see forms for state tax refunds, unemployment income, prizes, gambling wins, or rents you collect. Read each of these carefully.

Your Records. Check your own records carefully for both income and deductions. Review your calendar and your check register. Look back over the year in your mind. I'd prefer that you have receipts for all expenses, but if you recall paying a deductible expense it should be claimed.

Start compiling the information right away. Don't wait until the day before you give the information to me. Make careful lists of missing items. Write down any questions you might have for me.

Take a few minutes each week to review your information. Short reviews will help you remember items you might miss. It's your money-- protect it!

Will You Send 1099s?
You may need to send Form 1099 to someone else. There are two cases:

Business/Rental. You must report payments for services.

"Nominee" amounts. If you are named as receiving income, but part of the income belongs to another, you are nominee.

You must issue Form 1099 to the other party by January 31. IRS wants a copy by February 28. There are penalties for not sending them!

Business/Rental. If you paid $600 or more to anyone during the year you may need to issue the form. Look at "business" expenses only. Expenses in your personal life are not reported. Nor are payments to a corporation.

If any part of the payment was for services, report the total amount on Form 1099. Paying for merchandise alone doesn't count. Rent you pay to an agent instead of to a landlord are excepted. Look for repairs, painters, consultants, builders and the like.

You need name, address, and Tax I.D. Number for these people. Call them or send Form W-9 to request the information. If someone uses their own name, they should give you their Social Security Number (like 555-55-5555). If they give a business name, you should see an Employer I.D. Number (like 55-5555555).

Nominees. Limits are lower. If you pay $10 or more to another, you may be liable for the form. You file the same type of 1099 as you received, but you are filing as a "middle man."

Getting the Forms. I can help, or you can get forms from IRS. If you need my help, please call early! My tax season is hectic and the deadline comes quickly. Get forms from IRS at 1-800-829-3676. Or download them at www.irs.gov. You need Form 1099-MISC and Form 1096.

Got it All?
Here's a list of items frequently missed. Check it against your list.

Refinances. I need to see the settlement statement. Maybe it's best to bring all the paperwork.

Child Care Expenses. I need full name, address, telephone, and I.D. number of care providers.

Estimated Tax Payments. If you paid estimates, I need dates and amounts for all payments. Look in your check register near April 15, June 15, and September 15 and January 15.

Sales of Property. The most important thing is the settlement statement. Bring all the paperwork.

Student Loans. Form 1098-E reports your interest. I need this plus information about the nature of the loan.

College Tuition. Form 1098-T lists college tuition paid. I need the form and full details on who took the courses. This may help you get valuable tax credits or deductions.

Sales of Stock. Brokers send Form 1099-B to show sale price. I need the original purchase price and date. Can you find the "buy" slip?

Business Records. Please separate purchases of major equipment from other supplies.

Contributions. Be sure you have the proper receipts. We don't attach them to the return, but you must keep them.

Employer Reimbursements. If your employer reimburses any of your expenses we need records to insure we claim only the excess.

Partnership Information. Schedule K-1 from a partnership will likely be the last piece of tax data you receive. They always seem to be late. Don't worry. We can do everything else, then, be ready to go when the K-1 shows up.

Social Security Benefits. Be sure you have the actual Form 1099-SSA. We must declare the GROSS amount you were paid, not your net monthly benefit.

As always, if you should hear from IRS, don't respond. Call me first. I am familiar with procedures and can help avoid costly errors.

Good Time to Plan

Now is normally an ideal time to take a look at your tax position. There will be no surprises in February or March if you do a little bit of work now.

Income. You should be able to make a good estimate of the year's income. Look at wages. interest, dividends, pensions and other items. The total number is less important than how the number compares to last year's income. Will your income be up? Or will it be down?

Deductions. Do the same thing to estimate your deductions. Again, it's more important to compare with your last year's return than to calculate the actual number.

The Doubling Effect. Income tax doesn't follow a simple progression. Change your income by 10% and your tax bill changes nearly 20%. That's why it's important to check the numbers during the year.

Why does this happen? A quick way to see this on your own return is to compare your actual income with your "taxable" income. Drag out your last return. Your total income is on the line called "Adjusted Gross Income". That's the bottom line on page I of Form 1040. "Taxable Income" is a few lines later (Line 39 on Form 1040). It will be smaller than your actual income. Now you can see that a 10% change in your actual income causes a larger change in your taxable income.

Tax brackets can magnify the difference. Imagine that your taxable income was just below the point where the 1 5% tax bracket changes to 27%. Your last $1,000 of taxable income cost you $150. The next $1,000 of taxable income will cost $270. Quite a difference!

Large Income Change?
Income swings of 20% or more are harder to understand by "feel". If there is a large change in your income, please call me.

Withholding OK?
If you depend on withholding to pay your tax bill, we might need to change your W-4. There's no need to wait until we calculate your next return.

Paying Estimates?
If you pay quarterly estimated taxes, we may need to change the amount of the last payment or two.

How Can Planning Help?
We want to change the future. This doesn't involve magic. It involves decisions. Decisions about when you do certain things.

You pay taxes on an annual basis. We'd like to control the timing of financial events. We don't want to change the events themselves, simply their timing. Ideally we want to tax your income when your brackets are low, and claim your deductions when tax brackets are high.

Timing Tax Payments. Some of you prefer to overpay and collect refunds. This may not be the wisest way to manage your money. but it is certainly understandable. Others prefer to "break even." A few of you like to hold the Government's money as long as possible without incurring penalties. This choice is yours. My job is to help you have a reasonable expectation of the total bill.

Timing Deductions. You cannot control all your deductible expenses. Some items, however, are flexible. Near the end of the year there are several. Will you write the check in December? Will you wait a few days for January? Sometimes you have control over business expenses. Do you need that new piece of equipment now, or can it wait a few months? Is it time to stock up on business supplies? Should you give that old furniture to charity during this year, or should you wait until January?

Timing Income. It is more rare to be able to control the timing of your income. Businesses have some control over the timing of billings. Employees may have some leeway in when to receive a bonus. Savings Bonds pay interest when they are cashed. Is it time to cash some of these? You can decide whether or not to sell a stock.

No Silver Bullet. There is no magical solution to make your taxes disappear or even cut them in half. Careful planning, however, may save a few hundred dollars. I'd like to see you keep as much of your money as possible. Right now we may find some ways to save. Once January comes all I can do is calculate the bill. It's your money--protect it.

Stock Market Losses May Provide Tax Relief

BEAR MARKET. We don't like the term, but it's beginning to look like an accurate name. This year more investors than ever will be showing losses. Perhaps you can at least salvage something by making the most of the tax laws.

I won't try to tell you whether to buy or sell. Your investment decisions are far more important than their tax impact. To sell a stock which is down in value may or may not be a wise investment decision. The loss may or may not reduce your tax bill. Knowing the difference may help in your decision.

It's been quite a while since many folks have had to cope with losses. It might help to start with the basics:

Q: What is a capital loss?

A:  It is a realized loss from selling a stock, bond, or mutual fund that is not held in a retirement account. For example, if you bought 10 shares of GettingRich.com at $50, then sold them at $10, you realized a loss of $400. You probably paid commissions on both transactions. The commissions are used to increase your loss.

All sales for the year must be calculated. Some might result in gains. You must include gains from mutual funds which declare "distributions" during the year. Gains and losses for the year are netted to a single total. If the total is a net gain, it will be taxed. But if the net is a loss, you may deduct no more than $3,000 of net loss on your tax return. Any excess loss, or "carryover", is pushed into the following year. The net loss acts like a deduction. It can offset income from other sources.

Q: Is there any way to avoid this $3,000 limitation?

A: There is a narrow exception for stock in certain small companies called section 1244 companies. They are companies with less than $1 million of equity when the stock was issued. The company will know if it qualifies. To promote investment in small companies, the law allows you to deduct up to $50,000 in annual stock losses from this special stock. Couples may deduct up to $100,000 of such loss. There are no other exceptions.

Q: What if I have a capital loss within my retirement account?

A: Unfortunately the loss can't help you. Just as you were not taxed on the gains when the fund was growing, these losses are not recognized.

Q: How are capital gains and losses taxed?

A: Whew! That's a tough question. I won't try to describe it all. All losses are handled pretty much alike. It's the gains that cause confusion. Gains are taxed at different rates depending upon how long you held the investment. Anything held for a year or less is taxed at normal rates. Gains from assets you held more than a year can never be taxed at more than 20%. That's a far cry from your wages or interest income. They can face tax rates as high as 38.6%. Assets held more than 5 years can have even lower rates.

Q: Should I sell stocks that I'm holding at a loss?

A: Perhaps. First you must decide whether the stock is worth holding for its investment potential. Don't let your income tax position make the decision! If you've already decided the stock is not worth holding, look at your net gain/loss position for the year. If you have a net gain, this loss can be used as an offset.

As a simple example, suppose you already sold ABC stock and made a $3,500 gain. You also hold XYL stock that is down in value by $2,000. If you keep the XYZ you will pay tax on the ABC gain. If you sell the XYZ, you can net the transactions and pay tax on only the net $1,500 gain. Don forget, if you like XYZ as a long-term investment, you'll regret your decision if XYZ rebounds later.

Q: Why can't I sell stocks that are down and simply buy them back?

A: Because the IRS has a trap for you. They call this a "wash sale". If you buy the same stock or a "substantially identical" security within 30 days of your sale IRS will disallow the loss and tack it on to your eventual sale of the stock you just bought. That's 30 days before or after the sale!

Q: What if, instead of buying the stock back, I simply buy an option to purchase the stock in the future?

A: It's still a "wash sale". IRS will use the "substantially identical" rule to stop this one. You simply must wait until the 31st day.

Q : Would this happen if I sold a growth mutual fund and immediately bought another growth fund?

A: Usually not. Check with the broker. To be "substantially identical" the funds would have to have the same manager, fee structure, and other factors.

Q: I know I pay tax on "distributions" from mutual funds. Can they distribute losses as well?

A: No. The distributions are your share of gains made from selling parts of the portfolio. Losses are reflected only in the share price of the fund.

Speaking of mutual funds - be sure to keep good records of all purchases, dividends, and distributions. Why? Imagine a fund based on growth alone. Even if it never paid dividends, you are forced to declare the distributions and pay tax on them. When you finally sell the fund it is possible there is little or no gain. You already paid tax on most of the gains as they were distributed. Similarly, if you reinvest your dividends, you are continually buying more of the fund, which reduces your final gain. The records are crucial to help avoid declaring too much gain. Generally there is an annual summary showing all your activity for the year. Be sure to keep these.

If yon have large gains or losses this year. please give me a call. I'd like to help you anticipate your tax bill. Maybe I can help you save some money.

Tips For You

Joint-Custody Tax Trap. Many divorced parents have joint custody agreements. Tax law awards a personal exemption to the parent who has custody for the greater part of the year. In a recent court case a father claimed his daughter, saying she spent more than half the year with him. However, he could not provide evidence. The mother testified their custody was "50/50" and said the agreement was for the daughter's benefit, and not to be manipulated for a tax benefit. The Court didn't find dad's evidence convincing, but was convinced by morn's testimony. Result: Neither parent got to claim the daughter! (Now, why couldn't the parents work this out in advance!?)

Jennifer A. Rogers, TC Summary Opinion 2002-4 1.

Deductible Meals. Meals in connection with a business activity are generally 50% deductible.

Charitable - 100%. Meals connected with a charitable function are different. For instance, meals at a fundraising event, golf tourney, or other affair. The meals are 100% deductible if: (1) Primary purpose of the event is to benefit a charity. (2) The sponsoring agent contributes 100% of the net proceeds to the charity. (3) Volunteers are used to perform substantially all the work of carrying out the event.

Donating Your Discards. We have all donated clothing and other items to one charity or another. What is their value? IRS says you may claim the "fair market value" of the items. But how does one find this value? I recommend a visit to a local thrift store. They are in business full-time, and deal with the public regularly. Best of all, most donors are surprised by the values. The average taxpayer claims only about 30%-50% of the amounts actually charged for such items in these stores. Don't be afraid to maximize your deduction!


Large Gifts. I get many questions about occasional large gifts. Most often these are family issues. A parent may help a child buy a home or start a business. What are the tax issues for the recipient and for the gift-giver?

Recipient. There is no tax issue at the time of receiving a gift. If the gift is an asset rather than cash (real estate, for instance, or stock) there may be an issue for the future. You receive the asset exactly as the giver owned it. If you receive stock the giver bought for $10 per share, you treat $10 as your cost even if it was trading at $50 at the time of the gift.

Giver. If the gift's value is more than $12,000 in any year, the giver is required to file a gift tax return. Any value beyond $12,000 uses up some of the giver's lifetime gift and estate tax exemption. The exemption is currently $1,000,000. If the giver uses up the exemption, giver will pay a gift tax on each subsequent gift above the $12,000 annual limit.

Malcolm can be reached by mail at:
3 Ocean Parkway
Bolinas, CA 94924   

Tel (415) 868-1854
Fax (415) 868-1855
e-mail: malcolmponder@hotmail.com