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Preparing for the 2007 Tax Season
Review Last Year’s Return
April 15 seems a long time from now, but it will be here before you know it. If you start preparing now, you can avoid last-minute stress and reduce the chance of making mistakes. The key to simplifying the process is to have a good system for organizing tax information. This is true whether you do your own taxes or you hire someone to do them for you. Being organized not only will help you prepare your tax return more easily, it also will be invaluable if you’re ever audited.
First, let’s review the actual tax deadlines. Next year most taxpayers must file their federal tax returns by Tuesday, April 15. This means your tax return must be postmarked on or before that date. If you won’t have all your tax information available by then, you can file an extension request. If you file for an extension, you’ll still have to pay any taxes you expect to owe by April 15, but you’ll have until Wednesday, Oct. 15, to file your final tax return. If you file an extension request, we suggest you do so by April 1 to have it done before the actual deadline.
Most states have the same tax-filing deadlines as the federal government, but not all do. Check with your individual state tax agency to confirm your state tax-filing deadline.
Set Up Folders
We recommend you keep all tax-related information in one place so that nothing is forgotten. We suggest that at the very least, you set up one manila folder for income-related items and one for tax-deductible expenses.
If your situation is complicated, however, it might make sense to set up additional folders for specific activities. For example, if you have a rental property, you may want to maintain a separate folder for all income and expenses related to it. By having these folders set up now, you’ll have a place to put your tax documents as they arrive in the mail.
In your income folder, you should place W-2s, 1099s, year-end bank statements (if interest was earned) and year-end investment statements. If you sold any investments during the year, add information needed to determine your cost basis to this file to make it easier to figure out your capital gain or loss.
In your deductions folder, keep your statement of mortgage interest paid (Form 1098), receipts for charitable donations, property taxes paid and state income taxes paid. Also keep receipts in this folder for miscellaneous itemized deductions such as financial-planning fees, invest-ment management fees, unreimbursed business expenses and tax preparation fees. Miscellaneous itemized deductions can be deducted only to the extent they total more than 2 percent of your adjusted gross income.
If you have a lot of medical and dental expenses, we suggest you set up a folder for these receipts and insurance statements. But you’re only allowed to deduct out-of-pocket medical and dental expenses to the extent they exceed 7.5 percent of your adjusted gross income (found on line 37 of the federal 1040 form). Therefore, if you know medical ex-penses won’t approach 7.5 percent of AGI, there’s no need to go to the trouble of gathering these records. If you aren’t sure, go ahead and save medical receipts to be on the safe side.
If you pay for long-term care insurance, remember that the IRS allows you to treat a certain amount as a medical expense. For 2007, this can be anywhere from $290 to $3,680 depending on your age, but it can never be more than the amount you actually paid. A chart showing the maximum amount you can deduct is found in the instructions for federal Schedule A.
Although we’re talking about 2007 taxes, now is also the best time to set up your 2008 income and expense folders. After all, you may already be incurring expenses you’ll be able to deduct on your 2008 tax return. With your focus being on 2007 taxes, you want to be sure you don’t lose track of those 2008 receipts.
You may prefer to start at the beginning of the year with one tax folder into which you put all your tax receipts. Then when it’s time to get ready to give the information to your accountant, organize the receipts into subfolders. Use whichever method works best for you — if it makes sense to have a dozen folders, that’s fine. The more organized the information when submitting it to your accountant, the easier it should be to complete your return.
Review Last Year’s Tax Return and IRA Contributions
As you’re gathering tax information, it’s a good idea to refer to last year’s tax return to help you remember everything you’ll need to file this year’s return. In addition, if you have any carryforward deductions or credits you were unable to claim last year, you don’t want to forget to claim them this year if you’re eligible.
You have until April 15, 2008, to make your 2007 IRA contribution. If you made your 2007 contribution many months ago, you may have forgotten about it, or you may have intended to contribute but actually didn’t. To avoid missing your chance to contribute and to be sure you don’t overcontribute, we suggest you confirm whether you’ve already contributed to your IRA for 2007.
You can contribute up to $4,000 to a traditional IRA regardless of your total income as long as you or your spouse has at least that much in earned income. This means that if you work and your spouse doesn’t, you could contribute $4,000 for you and $4,000 for your spouse as long as you earned at least $8,000. If you’ll be at least 50 years old by the end of 2007, you can contribute an addi-tional $1,000 for a total of $5,000. Depending on your income level and whether you participate in a qualified retirement plan, you may or may not be able to deduct your IRA contribution, but you can still make one.
Roth IRAs work differently, however. To be eligible to contribute to a Roth IRA, you have to be sure your modified AGI* doesn’t preclude you from doing so. The ability to contri-bute to a Roth IRA for 2007 phases out when modified AGI is $156,000 to $166,000 for taxpayers filing jointly and $99,000 to $114,000 for single taxpayers.
Remember that contributions to a Roth are never deductible. The earnings accumulate tax-free, however, and when you take the money out of a Roth IRA, there are no taxes due as long as your withdrawal is considered qualified.
Remember Gift Taxes
If you give money to another person, you can’t claim a tax deduction for it. But it’s important to keep track of these gifts because if you give someone other than your spouse more than $12,000 within one calendar year, you’re required to file a gift tax return. (The annual gift exclusion for 2007 and 2008 is $12,000, but it increases periodically for inflation.) Each person has a lifetime gift exemption of $1 million, so even if you make a gift of over $12,000, it’s unlikely you’ll actually have to pay any gift taxes.
If you give more than $12,000 to any individual other than your spouse, however, it’s important to file the gift tax return anyway for several reasons. First, if you don’t, you may have to pay a penalty if you’re au-dited. Second, if you elect on a gift tax return to split your gifts with your spouse, it allows you to give up to $24,000 to one person without any gift tax implications.
Third, if you want to contribute a large amount to a child’s or grandchild’s college savings plan, a gift tax return allows you to put in up to five times the annual limit without any gift tax implications. Finally, if you give a gift of land or other property that may be hard to value, filing a gift tax return may prevent a future tax dispute with the IRS.
Be Prepared for Last-Minute Changes
As we write this article, Congress is still deciding whether it will extend alternative minimum tax relief for 2007. If the debate continues and the extension is approved after the IRS forms go to the printer, your 2007 tax instructions and forms will be outdated. Watch out for last-minute changes such as this.
Another problem many taxpayers have had in recent years is that 1099 forms, which reflect investment income you receive, are sometimes revised a month or two after the initial 1099s are sent. This can really throw a monkey wrench into the process. We suggest you file early but not too early — not before March 1 — if there’s a chance you might receive a revised 1099. You may want to check in with your financial ad-viser before filing your return just to be sure you have all the final 1099 forms. Or, if you have online access to your accounts, check online for any updated tax documents.
Don’t Go It Alone
If you do your own taxes, we suggest you use a program such as TurboTax to guide you through the process. Others to consider are TaxCut and TaxACT. These three tax software programs are frequently mentioned as top picks in reviews. These programs prompt you for a lot of information you might not otherwise think of, and the tax calculations are done for you. We haven’t evaluated these programs ourselves, so we don’t endorse any one over another. You’ll need to decide which program is best for you in terms of features and price.
Each year the IRS offers free online access to various tax preparation software packages if your in-come is under a certain level. The rules on this vary from year to year, so we suggest you check the IRS website and look for the details of this year’s Free File program. Some states also offer residents the ability to file state returns online for free.
These days, keeping up with the complexities of tax laws is a full-time job. We think most people should hire professional tax preparers be-cause they may alert you to deductions you might not know about. If you need to find one, ask friends or family members whom they use and whether they’re satisfied with the service they receive.
Also, be sure the preparer you’re considering has the proper credentials. A certified public accountant, or CPA, is someone who has passed the required exam and has met the state experience and education requirements. An enrolled agent is a tax professional who’s qualified to prepare tax returns and can also represent you before the IRS in the case of an audit. A tax attorney is generally hired to handle complex tax situations and disputes with the IRS.
Everyone dreads preparing tax returns each year, but it’s a necessary task we all have to perform. Be sure to use the resources available to help you.
If you start early, at least there will be time to find missing papers and to make sure it’s all done correctly. Good luck.
Alexandra Armstrong is a certified financial planner practitioner and chairman of Armstrong, Fleming & Moore, Inc., a registered investment advisory firm located at 1850 M St. N.W. in Washington, D.C. Securities are offered through Commonwealth Financial Network, a member of FINRA/ SIPC. Investment advisory services are offered through Armstrong, Fleming & Moore, Inc., an SEC-registered investment adviser not affiliated with Commonwealth Financial Network.
Consult your personal financial adviser before making any decisions.
Ms. Armstrong can’t answer individual questions, but she welcomes suggestions for future article topics.
This material has been provided for general informational purposes and does not constitute either tax or legal advice. Investors should consult a tax or legal professional regarding their individual situation. The fifth edition of On Your Own: A Widow’s Passage to Emotional and Financial Well-Being,
co-authored by Alexandra Armstrong and Mary R. Donahue, is available on Amazon. com, Kindle and Nook.