Boneheaded Tax Moves

Don’t Fail to Report All W-2 and 1099 Income
There aren't too many secrets you can keep from the IRS. Its computers know how much you got last year from wages, nonemployee compensation, royalties, dividends, interest, retirement-plan and IRA withdrawals and securities sales. Maybe the only thing they don't know is how much you earned on last summer's garage sales. So don't omit any of that official income from your tax return. Your odds of getting away with it are near zero -- despite an overall 1040 audit rate of only about 1%. It just isn’t worth trying to beat the system. You'll owe interest and penalties on the tax that should have been paid.

One income item that's easy to miss is an IRA rollover. While it’s true you don’t owe any taxes, the IRS computer wants to see your withdrawals on Line 15a (these amounts show up on 1099-Rs from IRA trustees). Then report the taxable amount (zilch if you rolled everything over) on Line 15b. If you just leave the two lines blank, you’ll get a bill for taxes, interest and penalties because the government thinks you are trying to dodge taxes on your withdrawals. Then you’ll have to write letters explaining that you did a rollover and therefore don’t owe anything. No fun.

Don’t Blow Off Schedule D
In the good old days, you didn’t need to fill out Schedule D when your only long-term gains were from mutual fund distributions. You just entered the total of your capital gain distributions on the front page of Form 1040. Then you computed the tax savings from the lower capital gains rate on a worksheet that wasn’t actually filed with your return.

Unfortunately, you now need to file Schedule D to get the lower rates. If you try to take a shortcut by simply entering your mutual fund gain distributions on line 13, you’ll be charged your regular tax rate. So you’ll either get a lower refund or an unexpected bill from the IRS. You’ll also receive a copy of Schedule D along with an invitation to amend your return.

Don’t (That’s Right) File by April 15
If you have an equity-laden Roth account from a 1998 conversion of a traditional IRA, you should extend your return to August 16. The extension gives you four more months to watch the market. If the value of your Roth account plummets during that time, you have the option of unwinding the conversion by transferring the funds back into a traditional IRA before the extended due date. That allows you to avoid paying tax on value that has vaporized. See "Roth IRAs and Your 1040" for details.

Don’t Drop the Ball on Your Big Donation
To claim a deduction for a noncash charitable donation (other than publicly traded securities) over $5,000, you must get a written professional appraisal and file Form 8283 (Noncash Charitable Contributions) with your 1040. The appraiser must be qualified and must sign your Form 8283. For donations of closely held stock, this requirement kicks in at $10,000 of value.

If you fail to get an appraisal, the IRS can limit your writeoff to the basis of the donated asset, even if there is no question that its value was much higher. This seems like a silly rule, but a recent court decision upheld it. So spend the extra bucks to get an appraisal and make sure your generosity results in the expected tax savings.

Don’t Claim Your College Kid
Both the Hope and Lifetime credits for college tuition are phased out starting at an adjusted gross income (AGI) of $80,000 for joint filers and $40,000 for singles. At $100,000 and $50,000, respectively, you are completely out of luck. In this case, it could make sense to allow your child to take the credit instead. For this to work, you must forgo the $2,700 dependency deduction. For high earners this can be relatively painless, because the dependent writeoff is itself phased out between AGIs of $186,800 and $309,300 for joint filers and $124,500 and $247,000 for singles. So losing the deduction may actually cost you little or nothing. Remember, however, the education credit is worthless to your child unless he or she earned enough to have a 1998 tax bill.

Don’t Waste Your Home Equity Loan Break
As you know, you can generally borrow up to $100,000 against your home's equity and write off the interest as an itemized deduction. But you don’t want to use up all or part of your $100,000 limit when the interest is deductible for another reason, like when the borrowed funds are used to start up or expand a business. Interest on a loan used to inject capital into a proprietorship, S corp., partnership or LLC business is fully deductible as long as you are active in the venture. In this case, you want to treat the loan against your house as a business loan rather than home equity debt. (This characterization is strictly for tax purposes; the debt is still a home equity loan for legal purposes.) Do this by filing the following statement with your 1040: Taxpayer hereby elects to treat the following debt as not secured by taxpayer's residence. Then list the amount of the loan and the name of the lender.

Taking the interest writeoff as a business expense -- rather than an itemized deduction -- has several beneficial side-effects. It reduces your self-employment tax; lowers your AGI; dodges the AGI-based phase-out rules for itemized deductions of high-income taxpayers; and avoids the AMT disallowance for home equity loan interest when the proceeds were not used to acquire or improve a first or second home. Your full $100,000 limit is saved for another day, because you didn’t treat the earlier loan used for business as a home equity loan. For example, in a year or two, you might decide to take out another loan against your house to pay off auto loans and credit card balances. You can borrow up to $100,000 and deduct the interest on Schedule A.

Don’t Forget to Take Minimum Withdrawals
If you turned 70 1/2 last year, you must take so-called minimum withdrawals from your traditional IRAs and qualified retirement plan accounts by April 15. Uncle Sam wants his cut of the taxes on those payouts, whether or not you actually need the money. April 15 is also the deadline for naming a beneficiary for your accounts (usually your spouse or child). Doing so will lessen the minimum withdrawals, which allows you to defer taxes longer.

If you don’t pull out the required amounts by the magic date, you will be charged a 50% penalty on the difference between your actual withdrawals (if any) and what you should have taken. So there’s no percentage in noncompliance. Make sure your IRA trustee or benefit-plan administrator is ready to roll and knows who you want listed as the account beneficiaries. For example, if they have your age wrong, you’ll be the one the IRS goes after for the 50% penalty when the required payouts don’t occur. For more information, see "Calculating Minimum IRA Withdrawals."

Don’t Overlook the Bank of the IRS
We self-employed folks have a handy source for short-term loans. It’s our friendly Internal Revenue Service. Since there's no payroll-tax withholding for the likes of us, we cough up our expected taxes for the year via "estimated payments." These are due on the 15th of April, June and September, and Jan. 15 of the following year. What if one or more installments are underpaid or even missed completely? No big deal. You will be charged an interest penalty, but the current rate is only 7%.

For 1999, your first chance to borrow at these low rates is by underpaying or flat out skipping the April 15 estimated payment. Voila! Your cash needs are satisfied without having to charge up credit cards or hassle with a loan officer.

Remember, however, this is not a long-term solution. By next April 15, you must catch up by paying in the correct amount of estimated taxes for the 1999 tax year. Otherwise, you’ll be hit with a 0.5% per month penalty (on top of the interest charge) starting on that date. Does the government like that I am telling you about this little trick? No. Is it perfectly legal? Yes. I have done it myself.