Tax Time: Bracket Breakdown

Washington Post staff writer and Cash Flow columnist Albert Crenshaw was online Monday, Feb. 27 at 11 a.m. ET to answer questions about the Earned Income Tax Credit for lower income workers, alternative minimum tax for the upper middle class and the fading benefits for high-income earners.

A transcript follows .

For the latest news and information you need to prepare your taxes, visit www.washingtonpost.com/tax .

____________________

Frederick, Md.: I sold some mutual funds on Dec 05 so I had some gains. The problems with that I own about $1,500 tax to IRS. I have been told I need to pay penalty since it is more than $1,000 tax you owned. My question is how to explain the tax IRS without penalty.

Albert Crenshaw: In theory, your withholding and quarterly estimated tax payments are supposed to add up to all or a percentage of last year's tax. The percentage depends on your total income. My experinece with the IRS is that if you fall short of those thresholds becuase of something that happened late in the year and that wasn't too large and hasn't happened before, they are relatively lenient about the penalty. If this happens again, note that you can make an estimated tax payment by Jan 15 to bring you up to the safe harbor, and then you don't have to worry about the penalty.

_______________________

Manassas, VA: Calc. Capital gains with div.reinvstment over 20years. Sell 500 shares.

Determine annual cost & # shares/year. Stock splits results in 1/2 the value going forward. How accurate must this be?????

thanks,

dwc2-comtekmail.com

Albert Crenshaw: As in so many tax questions, the answer is, you're supposed to be exactly accurate. However, it's never been clear to me how the IRS can figure out whether what you've done is right, short of an audit. My advice is, try to be as accurate as you can. It's a lot of trouble but showing care and effort is a good defense if the IRS comes after you.

_______________________

Baltimore, Md.: We live in Baltimore, and received 5 acres of land in Ohio from my in-laws as a gift 10 years ago. It was assessed at less than $10K. We have just sold the land for $90K. What are our tax liabilities from the fed, OH and MD?

Thanks,

Ngoan

Albert Crenshaw: I think you'll need professional advice for this one. When is an asset is transfered by gift, the "basis" -- the cost, which you subtract to calculate your gain -- transfers also. So your basis is whatever your in-laws paid. Most states require people who have incoms from the state but live elsewhere to file a non-resident income tax return, and they typically use a formula related to your overall income to figure your tax. And your home state will also want to tax it, though there usually cross-deductions or credits for tax paid to other states. It's very state-specific.

_______________________

Alexandria, Va.: I just got a nice promotion and pay raise in November and while it didn't affect my 2005 taxes much, I'm worried about getting kicked into a higher bracket for 2006.

How big a difference is the higher bracket, and how can I figure out if I'll end up saving tax dollars by contributing more to an IRA, to charity, etc? I want to figure this stuff out now so I don't have regrets next April.

Albert Crenshaw: It's good that you are thinking ahead. In general, salary changes are picked up by regular withholding, so you don't need to worry about being underwithheld unless you have other income. I'd recommend buying, or going online to use, tax-preparation software. Computers are great for playing what-if games, because you can change one or two numbers and see all the ramifications. Remember, if you have a retirement plan at work, you may not be able to deduct an IRA contribution. But if you have a 401(k), you may be able to increase your pre-tax contribution, which has the same effect. Charitable contributions are good (but you have to itemize, which I assume you do, to deduct them). However, you may need to watch out for the alternative minimum tax if you boost your deductions too much -- and that's another reason to use software, which will spot the AMT if it becomes applicable.

_______________________

Burke, Va.: I read that the IRS was tracking people's political afflination in 20 states, and has been witholding information on its audit, collection, and enforcement activities. After reading about the nonprofit who said critical things about Tom DeLay getting audited this makes me nervous that if you belong to the wrong political party, you could have a politically motivated audit.

Albert Crenshaw: The IRS says it got political affiliation more or less by accident when it used public-information data bases. It says it has stopped now. But, really, I'm not too worried about the IRS using political criteria for audits. It's so swamped with work, it has all it can manage to try to chase serious cheating. The Delay incident is, however, a bit alarming because it suggests that the IRS, which sometimes uses tips to figure out who to go after, is susceptible to manipulation by outsiders who have an ax to grind with a particular taxpayer or group. Such axes are as likel to be personal as political.

_______________________

Rockville, Md.: Regarding gifted assets, does the IRS get the best of both worlds?

A person can gift assets (cash, stocks, etc.) to somebody else with estate tax issues upto $11,000 per year. But let's say that asset only cost the giver $1,000 but is worth $11,000 at gift time. My understanding is that the recipiant has to maintain the giver's cost basis of $1,000 when it is eventually sold BUT the giver cannot not give any more to that recipiant that year.

Is that true? If so, the IRS considers the gift value at $11,000 for on purpose and only $1,000 for another.

Also, for the mutual fund question. I purchased Quicken a number of years back. I contacted my mutual fund company and they mailed me year-end statements for all the years I had the funds. Spent about 2 days entering historical data. A few minutes when statements arrive and my records are accurate.

Albert Crenshaw: The annual gift-tax exclusion means that the donor doesn't have to pay gift tax on giftst of up to $11,000 per person per year. But the basis does transfer, so the recipient may well be liable for capital gains tax when he sells a gifted asset. The annual exclusion is therefore often used for cash.

Mutual funds are getting better and better about providing shareholders with at least an average basis in their shares. This is useful particularly if you're selling all your shares. However, if you're selling only some, you may find it advantageous to use a specific cost basis, which is allowed. But once you start with that method, you have to stick with it. And if you own individual stocks and reinvested their dividends, which some companies allow, don't expect help from the company.

_______________________

Washington, DC: Just completed my 2005 taxes and am expecting a big refund. I would like to adjust my exemptions so that I get that money during the year. Is there a formula for how much less is withheld for each exemption? Thanks.

Albert Crenshaw: Some people view a big refund as a great way to save, while others, more correctly in my view, see it as a free loan to Uncle Sam. So I think adjusting your withholding is a good idea. But it really is hard to figure exactly The W-4 form, which you submit to your employer to set withholding, has some info in its instructions that may be helpful. Each additional personal exemption reduced taxable income $3,200 in 2005. I don't know what the 2006 figure is, I'm afraid.

_______________________

Chevy Chase, Md.: Late one night last week, my TurboTax software graciously informed me that my husband and I have entered the horror zone of AMT. Any tax refund we were expecting instantly evaporated. We have no investments, are trying to save for our children's college. We live in a small house ( in an expensive area) but took out a 15 year mortgage when rates were low a few years ago. We try to be conservative financially (haven't taken a real vacation in years) and provide our kids with a comfortable home, activities and summer camp. We both work very hard at full time jobs. We are barely saving for retirement. I am thinking we it's time to go to a financial planner. Something we have never done. We never took much interest in this sort of thing. What strategies can we use to address this? We are paying a huge amount of our income in tax now and I feel like I must be doing something wrong -like if I made less money I would end up with more in the end.

Albert Crenshaw: The AMT is truly one of Congress' great disasters. And the way things are going, by 2008, it will be cheaper, by some estimates, to repeal the regular tax and keep the AMT. I think going to an accountant or planner is a good idea. There aren't many mechanisms for reducing your AMT income, since the AMT was designed to hit people who use regular tax breaks. Maximizing your 401(k) can help, and investing in index funds, which don't throw off much current income, or general obigation municipal bonds, also can reduce the bite. Meantime, write your senators and congressman and tell them how unhappy you are. We need an outcry here.

_______________________

re: Alexandra and pay raise: Please point out to Alexandria that getting pushed into a higher tax bracket does NOT mean that he/she will pay a higher tax rate on all his/her income.

For example, the IRS tax rate schedule for 2005 -

http://www.irs.gov/formspubs/article/0,,id=133517,00.html - shows that when a single person's taxable income jumps over $71,950, the new/higher 28% tax rate is only applied to the income over $71,950. The first $71,950 is taxed at the blended rate of 20.36%

Albert Crenshaw: That's right -- but being in a higher bracket makes deductions more valuable, and that is a great incentive to do more planning.

_______________________

Alrington, Va.: Please list as many as you can of what deductions remain once taxpayers are caught in the AMT parallel universe. We can still exclude income through employer-sponsored retirement plan deductions, can't we? And IRA deductions? What about healthcare premiums? are those counted in the medical 10% floor? and I thought primary residence mortgage interest was sacred. I'm shocked to learn that that's gone under the AMT. So really, what's left?

Albert Crenshaw: The AMT comes at you two ways. First, by requiring that you add back some items that were not included in taxable income for the regular tax. This doesn't hit too many ordinary taxpayers, but if you buy "private purpose" municipal bonds -- typically industrial revenue bonds, hospital bodns and the like -- their interest is taxabelfor the AMT.

The second way is by trimming or eliminating deductions. State and local taxes are a biggie. It also eliminates personal exemptions, which benefit large families under the regular tax. For medical deductions, it raises the floor, nmaking them deductible to the extent they exceed 10 percent of AGI, rather than 7-1/2, as in the regular tax.

Youcan still deduct your gambling losses, though. Isn't that nice.

I'm getting a lot of questions about the details of the AMT, so let me recommend that AMT sufferers go to the IRS's web site, www.irs.gov, and type alternative minimum tax into the search field. The agency has lots of information on it, and it's actually fairly easy to understand (just not easy to like).

_______________________

Arlington, Va.: The IRS says this year's (2006) personal exemption is worth $3,300. FYI.

Albert Crenshaw: Thanks -- I'm still immersed in 2005.

_______________________

Washington, D.C.: Newlywed and completely bowled over by the tax bill on our combined $250K+ gross income for 2005. How do we best compute the withholdings we should have each pay period, given the phase outs of itemized deductions, personal exemptions, and IRA contributions?

Albert Crenshaw: Welcome to the world of the marriage penalty. You'll need to adjust your withholding because your taxes will go up disporportionately. This is because one spouse's income is added on top of the other's, rather than starting over at zero (and getting the benefit of lower brackets). The W-4 will help you on that, but as to getting your taxable income down, there are not too many escape hatches for earned income (wages/salaries). Depending on what kind of income you have, you can consider maxing out your 401(k) (you can't make a deductible IRA contribution and are over the limit for Roth IRAs), or if some of it is from self-employment, you can consier various retirement plans such as Keogh or SEP IRA plans. At your income level, you should talk to an accountant or other expert. They are usually worth their fees in situations like your.

_______________________

Woodbridge, Va.: Can you explain the income levels where AMT starts to become a worry? If your taxable income is X, then you may have to worry about AMT? It seems so confusing as to when you get hit with it.

Albert Crenshaw: We're running out of time, but the AMT has its original in an outcry in the late 1960s from teh discoevry that several thousand millionaires were paying no taxes -- legally. The idea was to prevent that. But Congress didn't make inflation adjustments, so over the years the formula slowly sucked up more and more people. Combined with changes in the regular tax rates, we now have a system in which the trully rich person -- income over $500,000 -- is less likely to have to pay the AMT than is a large family with an income 20 percent of that. The only way out is for Congress to raise regular taxes or cut spending drastically, neither of which is very palatable, either to lawmakers or to voters.

_______________________

Recently Married: I married in October, is this year the only year i will see a benefit in my taxes? i've been told that come next year, we will be crying about the marriage penalty. can you explain this?

Albert Crenshaw: Actually, if you married in October, you are deemedto have been married all year for tax puroposes. The marriage penalty is most likely to hit two-earner couples; if one of you doesn't work, or if one spouse's income is much larger than the other's, but may see a marriage bonus. Whatever the case, it will continue the same way as long as you stay married and your income remains about the same relative to each other.

I'm afraid we're out of time. I apologize for not getting to all your questions. Unfortunately, in tax there usually aren't simple answers.

_______________________

Editor's Note: washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.