Frequently Asked Tax Questions -- April 6, 1997

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, Sunday April 6, 1997.


Ten Items to Consider Before Filing Your Tax Returns


Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.

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Ten Items to Consider Before Filing Your Tax Returns

1. Filing Techniques:

Always double-check: (1) your math; (2) names, address and social security numbers; and (3) lines on the forms where you entered information. Review last year's return for potential unused losses or credits that can be applied to this year's return. Send your return by certified mail, return receipt requested, place your social security number on any checks and always keep a copy of your return along with a copy of the canceled check with your tax records. The minimum requirement for retaining business receipts has been increased from $25 to $75.

Tax records should be maintained in separate folders for each year. Keep your return, any W-2s and Form 1099s and copies of receipts and canceled checks evidencing deductions in the folder. Records should be maintained for at least 6 years, but records involving the purchase of a capital asset (such as the closing statement for the purchase of real estate) should be retained as long as you own the asset, plus 6 years.

Note: In general, individuals with gross incomes under $6,550 and joint filers under $11,800 are not required to file; however, they should file to claim a refund if they had taxes withheld.

2. Filing for an Extension to File Your Taxes:

If you can't file your return on time, you may apply for an automatic extension but you must complete Form 4868 and you will then have until Friday, August 15th to file your return. You must pay at least 90% of the eventual tax due to avoid penalties. California requires you to pay 100% of the taxes due, but will grant you an automatic 6-month extension. Make additional tax payments to California on Form 3519.

3. New Rule for Dependents:

Dependent identification numbers (usually social security numbers for U.S. citizens and residents) must be on your return to claim a dependent exemption and child care credits. The IRS may disallow these tax benefits for missing or incorrect numbers, unless the dependent was born in December 1996. Apply with Form SS-5.

4. Creative Use of the Dependency Exemption:

You may claim a dependency exemption if you supply more than 50% of the support for a U.S. citizen or resident, or a resident of Mexico or Canada, provided that person lived in your home are part of your household during the entire year and who gross income (excluding nontaxable income) is less than $2,550 in 1996. The person does not have to be related to you. Thus, a dependency exemption may be claimed in same-sex living situations, when one partner earns less than $2,550.

5. Employer-Paid Educational Assistance:

The exclusion for employer-paid educational assistance (up to $5,250 per individual) was reinstated for courses starting between January 1, 1995, and May 31, 1997. Graduate-level courses starting after June 30, 1996, no longer qualify for the exclusion. If your employer included educational payments in your W-2s for 1995, you could be entitled to a tax refund. Your employer should provide you with Form W-2c to correct any overstatements of income in your 1995 or 1996 W-2s.

6. Deducting Adult-Education Expenses:

If your employer did not pay for educational expenses or you are taking graduate study courses, remember educational expenses may be deducted if they are either mandated by your employer or incurred to maintain or enhance your present skills. You cannot deduct educational expenses if the courses qualify or retrain you for a new trade or profession or are part of "entry level" education, such as the minimum educational requirements to become a teacher, doctor or attorney.

7. Opening an IRA at the Last Minute to Reduce Your Taxes:

One of the last tax breaks open to you before April 15th is an Individual Retirement Account. As long as you open such an account before the due date of your return, you can place money in an IRA and deduct the payment (within the limits pertaining to IRA deductions) in tax year 1996. You can also contribute to an existing IRA prior to the due date of your return. Unfortunately, the IRA deduction for a non-working spouse remains $250 for 1996. Starting in 1997, this deduction increases to a maximum of $2,000 each for joint filers.

8. Paying Taxes on Household Workers:

If a household worker is your employee and earns more than $1,000 per year, you must file a Schedule H, part of to Form 1040. Your employee was entitled to receive a W-2 statement from you before January 31st. You and your employee are required to pay social security taxes (the combined rate is 12.4%) and Medicare taxes (the combined rate is 2.9%). Failure to deduct the employee's share of these taxes makes you liable for the full amount. You must also pay an additional 6.2% Federal Unemployment Tax. These tax payments are not deductible; however, you might be entitled to a child-care credit if the domestic worker was employed to care for your children.

Note: If your worker is an independent contractor, these rules do not apply. The IRS has recently liberalized the independent contractors rules, and part-time household workers may qualify for this exception. California, however, has not followed the IRS's lead.

9. Adoption Credit:

As of 1996, there is a new $5,000-per-child credit for certain adoption expenses. The credit is phased out ratably, in general, for adjusted gross incomes between $75,000 to $110,000. The credit is increased to $6,000 for a U.S.-born special-needs child. Unused credits may be carried forward for 5 years. You may forego the exclusion and receive tax-free employer-provided adoption assistance for up to $5,000 as well. Credit is applied on a per-child basis and is available in the year the adoption becomes final.

10. Non-Physical Injury Awards and Punitive Damages:

Damages for physical injuries or physical sickness will continue their tax-free status, but amounts received after August 20, 1996, for non-physical injuries (emotional distress, defamation, discrimination, wrongful termination) and "punitive" damages (generally, damages which punish the wrongdoer rather than reimburse the victim) are fully taxable. This change does not apply to payments made by an agreement, court decree or mediation award in effect on or before September 13, 1995.


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**