Tax Preparations

Washington Post business writer Kathleen Day was online Wednesday at 1 p.m. ET to discuss what you can do before the end of the year to help make preparing for tax season a little easier.

For this discussion, she was joined by Grace Allison , lawyer and tax strategist for The Northern Trust Co. Allison is a frequent speaker and writer on tax issues, particularly those involving gift-giving, estate planning and new tax legislation.

A transcript follows .

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Kathleen Day: Hello and welcome to today's chat. I have received dozens of e-mails from readers with excellent tax questions following the tax-tips story in Sunday's business section. My guest today to help answer such queries is Grace Allison, who for over 15 years has been a tax expert in personal finance at The Northern Trust Co. Charitable giving is among her areas of expertise.

Today we're here to talk about what steps people can take by the end of December to maximize tax breaks for the year. We'd like to hear your questions and comments, but one word of caution: While we can suggest strategies or recommend where to get more information, neither myself nor Ms. Allison can give individualized tax advice or advice about specific investments.

I'll make one pitch before we start: I'm always looking for readers willing to share personal finance stories. If you're someone who has had or is in the midst of a particular problem or solution involving money management - taxes or otherwise - please e-mail me at dayk@washpost.com.

I'm particularly keen to find people who might let us follow them through the tax preparation ritual. Now to today's topic!

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Marietta, Ga.: I am 75 years of age and have quite a bit of money in an IRA--over $2MM My MRD is now averaging a significant amount and I need to invest the proceeds in the type of assets that will yield the greatest income. Should the investment types be more hi-yielding bonds, mutual funds, individual stocks, etc.? I have done well investing in energy stocks over the years but must admit I am too concentrated in just a few stocks (70%) and have been for 15 years. I know I have been both lucky and foolish but am now willing to undergo a rebirth and change my foolish ways. All of my assets are with Fidelity.

Thanks for any suggestions...Jim

Kathleen Day: you should definately consider diversifying----especially because you have held the securities for longer than a year so will be charged at the long-term capital gains rate of 15 percent, which is the lowest it's been since the 1960s.

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Washington, D.C.: Good afternoon! My wife and I bought a condo at the end of September with almost nothing down; we're financing it with two mortgages. I'm covering the two with one paycheck, which is stretching me kind of thin. My wife (who is paying our condo fee) is also feeling the pinch.

Should we adjust our withholding now, to get more in our paychecks and a smaller refund in April, or should we wait to do this until January 2007? Thanks!

Grace Allison: Your estimated tax payments should be designed to cover your anticipated tax liability. Using a tax refund as a forced savings technique is generally not a good idea because you lose the ability to invest the money until you receive the refund back. So your plan to reduce your estimated income tax payments, based on your real anticipated income tax liability, sounds like a winner. Just be sure your calculations are accurate!

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Dupont: My wife and I will be moving to England for 2 to 3 years in February/March. Any immediate tax advice? And are there local experts familiar with expatriate tax filings--I'll be working for a UK firm but still have to file in the US, as I understand it.

Kathleen Day: i suggest you talk to a financial planner before you leave who you think you can have a good relationship with long-distance----your UK firm surely has come across this issue before, I bet, and I would ask someone there who they could recommend overseas. but talk to a professional before you go just in case there are strategies you should implement now. it will be easier than doing them from far away

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Arlington, Va.: Were there any significant changes to the tax code that will effect large numbers of personal returns?

Grace Allison: One big change is the temporary increase in the AMT exemption, in effect for 2006 only. The AMT exemption for marrieds has been increased to $62,550; the AMT exemption for singles has been increased to $42,500.

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Athens, Ga.: Thanks for answering questions. I realize this is small potatoes, but I would like to know if or how I should report earnings and pay federal taxes for a very small retail (mostly mail order) business I ran out of my home earlier this year. I have already paid all state sales tax owed. I am no longer pursuing the business, and I made only about $580 total profit. I kept receipts and records of all debits and credits. What do I report to the government on my married joint tax return? Is there a minimum amount that you have to report?

Grace Allison: If your business was a sole proprietorship, look at the instructions for Schedule C on your Form 1040. Look also at the IRS website, www.irs.com for publications on reporting income from a sole proprietorship.

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Tallahassee, Fla.: A young adult age 21 with a 529 plan valued at about $11,000 withdraws the funds and use as a part of the down payment to purchase a home. What are the tax liabilities?

Kathleen Day: he or she will be taxed on any amount she or he uses for any other purpose than college. The rate will be the income rate that applies for that person and depending on the state could invovle some penalty charges, too. If possible if would be better, and likely cheaper, to find the downpaymet money elsewhere!

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Ft. Washington, Md.: Kathleen and Grace, I am in need of a good tax preparer, can you recommend one.

Thank you, Darlene

Kathleen Day: You should talk to friends, family and collegaues at work to see if anyone has used someone they like. Word-of-mouth recommendations tend to be best.

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Washington, D.C.: I am a single filer making $75,000 (gross) per year. I pay about $1,000 per month in student loan debt (mostly interest). What is the cut off to receive a deduction for student loan interest payments? I seem to remember my income puts me out of the range for claiming this deduction. If so, any chance of the IRS raising the ceiling on this particular deduction?

Thanks!

Kathleen Day: I haven't heard of plans to change the cut off but that doesn't mean there won't be. Check the irs website for the rules that apply now.

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Georgetown, D.C.: What's the latest with Roth IRAs? I understand there's an income limit at which point one can no longer contribute. Is this true, and if so, what are the limits for 2006? Thanks.

Grace Allison: The income limits depend on your filing status.

For single individuals, the phase-out is modified AGI between $95,000 and $110,000; for joint filers, between $150,000 and $160,000. These AGI limits are not indexed for inflation.

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Milwaukee, Wisc.: Do I get a tax deduction from IRS if I donate to an overseas charity that is not registered with the IRS but is registered with the Indian government? Thanks.

Grace Allison: Many foreign charities have formed related U.S. charities in the "Friends of X" mode. If this is the case, you could give to Friends of X instead of to the Indian charity. Otherwise, you are out of luck.

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Alexandria, Va.: My wife and I are planning to shift our individually accumulated collection of taxable mutual funds to several index funds. Selling the old and buying the new funds before the year-end distributions made sense. To avoid 2% trading fees, we were going to hold off on selling those purchased in the last 90 days. Is there also a benefit to hold off on selling those funds purchased in the last year in terms of a tax rate difference (ST vs. Cap Gain)?

Kathleen Day: To avoid being charged at the higher short-term capital gains rate, which can be as high at 35 percent depending on your income,you must hold a security for a year or more. Doing that will mean whatever gain you have will be taxed at the long-term capital gain rate of 15 percent, which is probably much lower.

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Washington, D.C.: I'm at my first job and will be filing taxes for the first time. I'm not sure what to expect and all of the forms and procedures seem overwhelming. Do you have any advice on where to start? Thanks!

Grace Allison: An excellent resource is the IRS website, www.irs.gov. There will be lists of publications covering most of your concerns. Good luck!

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Greenbelt, Md.: If the employer pays 80% of tuition for college, how do I go about or can I claim the remaining 20% on my taxes?

Kathleen Day: It's possible you could deduct them, but I don't know the rules off the top of my head and you have to be careful. you should check the irs website or ask a financial expert----there are many good planners that charge by the hour. Perhaps you have a couple other questions you could ask to make the $100 to $200 hourly fee worth while. Or maybe you have some friends who have just one or two quesitons and you could pool your questions!

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Bethesda, Md.: IRA contributions new for 2006-7

How and where will the contributions be reported on form 1040? Interested in tax bracket effects, etc. thanks

Grace Allison: Assume you are talking about the new provision allowing direct contributions from an IRA to charity. The deal here is: no charitable deduction, but the distribution itself is not subject to tax. The new Forms 1040 have not been published yet--watch for them on the IRS website, www.irs.gov!

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Adams Morgan, Washington D.C.: I want to work with my teenage son to open a Roth IRA for him, and essentially gift him with an amount equal to his 2006 earnings (which is not that much, maybe $ 1,000). Does the account have to be opened before 12/31, or just before tax filing, or what?

Grace Allison: Before tax filing.

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Arlington, Va.: Hello Kathleen and Grace,

If I receive a gift of $12,000 or less this year, does the donor have to file a gift tax return?

Kathleen Day: it depends on what else tht person has given for the year. Possibly not if that's the only gift.

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Shelby Twp., MI 48316: My mother recently passed away and I was able to sell her home by submitting a quick claim deed that was initiated/signed about 3 years ago. This however was not my primary residence. I took care of her during the last 5 years (maintaining her house,etc.)because she suffered from Dementia. The sale price was $150,000 which was split between my brother and me. How best can I handle this gain of $75,000 for tax purposes. Can I income average? Is there a way to justify the sale as a primary residence.

Grace Allison: Back up here! On your mother's death, all of her assets, including her home, get a step-up in basis to fair market value. Therefore, there should be no gain, since gain is the excess of fair market value over basis.

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Harrisburg, Pa.: This seems like a silly question, but I couldn't find an answer on the IRS website. When does the 2006 1040 form and instructions go public/get published? I want to file as early as possible this year. Thanks.

Grace Allison: The timetable varies from year to year. This year, the forms might be later than usual, especially if the IRS waits to see if Congress is going to pass the pending tax extenders package.

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20036: This may be a little basic, but I donated a car to the Salvation Army in the spring of 2005 and forgot to claim it on my taxes (I was going through a divorce and barely remembered to file in the first place). What, if anything, can I do?

Grace Allison: You can file an amended Form 1040 for 2005 (a 1040X) --but be sure to check out the car donation rules at www.irs.gov!

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Fredericksburg, Va.: We're betting that taxes are now about as low as they will be for some time, so we're considering converting some IRA money into Roth accounts this year. What are some of the basic things we should consider in making the conversion?

Kathleen Day: First you have to make sure your income qualifies you for a roth. If it doesn not, new rules will allow you to make the conversion in 2010,regardless of your income, but you could start putting more into your IRAs now in anticipation of that.It depends on what you benefit you are tryin gto capture from the Roth. If you do qualify for a Roth and have money in a traditional IRA, you have to consider the taxes you will have to pay on the money you will be putting into the roth and weigh that against other potential investments.

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Washington, D.C.: I'm single with no dependents. I've just started a new job and the amount of tax being witheld from my paycheck seems high (both federal and D.C.). How can I make sure that I'm not having too much witheld? I don't want to run into tax difficulties next year. Thanks very much.

Kathleen Day: your employer should be able to help you with that----the benefits deparment can probably walk you through the basics, such as making sure you are taking yourself as an exemption.The real test will be if you get a refund---if you are then you should consider how to change your withholding amounts so you aren't giving the federal government an interest-free loan of your money!

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Washington, D.C.: If I'm given a personal loan by a family member, how must I show that I am putting a good faith effort into repaying that loan?

Grace Allison: You should be paying the loan according to its terms to the best of your ability, which generally means making scheduled payments of principal and interest. Otherwise, there is a risk your parents will be treated as having made a gift to you--and may owe gift tax.

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Lansdale, Pa.: Could you please give some information about "qualified dividends". On our 2004 tax return we declared Exelon dividends as qualified but now the IRS says that is not so. Could you please give some info or point me in the right direction. Many thanks.

Grace Allison: Generally, qualified dividends are dividends from U.S. corporations and from qualified foreign corporations. To determine whether the IRS is right in this case, try contacting the Shareholder Services department of Exelon--there should be contact information on Exelon's website.

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Georgetown: I asked my tax adviser whether I should convert the funds in my traditional IRA (about $28k) to a Roth IRA. I know that would be taxable income, and I would take a tax hit, but then the money is non-taxable forever (as it grows). True? He advised against it, saying that he thinks that the tax laws governing IRAs will change by the time I retire (I am 42). He thinks I probably won't get taxed on my traditional IRA money in the future. Should I convert now, or not?

Kathleen Day: He may be right but it's a political question. Will Congress change the laws again? They will certainly feel pressure to do so with the baby boomers starting to hit retirement age and with concern running high that most americans probably aren't saving and haven't been saving enough to provide adequately for retirement. But he could be wrong and then you would not have the Roth for whatever purpose you intended it, either to you yourself or to give as a gift.

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Arlington, Va.: I am single, no children, late 30s, and will make about $145,000 (gross) this year due to some bonuses at work. Apart from my mortgage and some charity, I don't have any real deductions. I am already putting 12 percent into my 401 (k). I understand that I am no longer eligible for a Roth IRA. Is there anything I can do this year to reduce the tax burden, that doesn't tie up my money for years?

Grace Allison: You might want to talk with your financial advisor about investments in tax-exempt bonds.

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Riverdale, Md.: What catagory do I file under. I am filing for divorce and currently legally seperated? Previous years we filed as joint.

Kathleen Day: There are rules about that. You should check the IRS website.

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Arlington, Va.: A few months ago I got married and I am wondering how this will impact my 2006 tax situation. My wife and I both received refunds for 2005 (as single filers) and our overall financial situation has not changed considerably . . . except that we will now file jointly. Any advice on what to expect or tips to make our first joint filing easier? thanks

Grace Allison: Try filling out a 2005 tax return, showing yourselves as married filing jointly--to see how much tax you might owe in 2006. There is no substitute for running the numbers.

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Columbia Heights, D.C.: I moved out of my rental apartment in SW D.C. last February because the owners were converting the building into condos and I chose not to buy. I received a $15,000 payment from the building owners to do so. I am assuming that since that payment is income, that I will need to pay taxes on it, but is there any special treatment for that situation in federal tax law?

Kathleen Day: I assume there are but it's too specific to know the answer off the top of my head. check the irs website. Or perhaps you could go back to the condo conversion lawyers and ask.

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Burlington, Vt.: Comment rather than question:

1. As a CPA who prepares tax returns for a number of clients, I think it would be worth a reminder that the single best tax preparation "tip" for those who are preparing their own tax returns, as well as those who use a professional preparer, is to keep good records.

Many, many perfectly legitimage deductions are lost because taxpayers forget about them and don't have good records of their business expenditures/charitable contributions/medical expenses/investment expenses, etc. A good tax preparer will probe for additional likely items, but even so, without records the taxpayer is making a guess, which may not be supportable if questioned by the IRS.

2. For those using a professional tax preparer, fees can be reduced and a better result achieved if the taxpayer has organized those records, not necessarily summarizing them, since there are often items of information on original documents that are relevant and easier to access in that way than from a summary. Summaries should be made of the multiple-small-item categories such as charitable donations, medical expenses, charitable and medical miles (separately).

Grace Allison: Great advice!

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Adjusting Withholdings: "Using a tax refund as a forced savings technique is generally not a good idea because you lose the ability to invest the money until you receive the refund back."

And then you read every other article out there entitled "Americans Have Negative Savings." If people do adjust their withholding by $20 or $30 per paycheck, do you honestly think they'll put that money in the bank? The only bank they'll put that money in is the First National Bank of Starbucks. That's their choice, of course. But in the end, who ends up with more money?

Kathleen Day: If you have a refund than yes saving it is a great idea---but it would be even better to avoid having the refund by making sure your withholdings throughout the year are at the right amount. Getting a refund means you have been giving the government use of your money for a year. You would have been better off saving that money all along and earning interest on it.

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Washington, D.C.: My daughter turned 18 last April. When I do my next return, do I need to not put her in as a dependent and write-off or is it a decision I have to make? Is she instantly not part of the family return as of 18?

Kathleen Day: she can still be a dependent if she's a student, but it will be your choice.

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Washington, DC: Ms Day/Allison:

If my wife and I give $24,000 to our daughter next year, will there be any tax consequences for us (our daughter will not be taxed because $24000 is the limit for any one year)?

Grace Allison: Talk with your tax advisor about whether you need to file a gift tax return. If you gift split (and are not in a community property state making a gift from community property), you need to file a return in order to make the gift-splitting election. If each gives $12,000 to your daughter from his or her own funds, and there are no other gifts requiring that a gift tax return be filed, then there is no need to file a return. But check it out!

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Gaithersburg, Md.: I have a question about claiming money earned from "odd jobs" - this year I performed a lot of "odd jobs" with the help of other people. I would get paid and split the check with the others by writing them personal checks - how do I account of only the money I earned or will I be taxed on the whole amount?

Kathleen Day: each person is responsbile for paying taxes on the amount they earn. so you pay only on the portion you keep and the others must pay on what they earned. You may run into another problem though: if those others are essenitally your employees,you are supposed to be reporting to the IRS what you are paying them. if they are not and you are just getting the check because it's easier for hte person you did the work for, then each person has to keep tabs on his earnings.

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Arlington, Va.: Hello ladies,

I am going to cash some bonds before the end of this year. I did so last year, and I believe the only reason I didn't face a payment for failure to pay estimated taxes is because I was a full-time student at the time. I am no longer a student. I've never paid estimated taxes because I am a W-2 employee. How do I go about determining my tax bracket and paying estimated taxes? Where do I send the check and what is the form to fill out?

Thanks!

Grace Allison: Once again, the IRS website, www.irs.gov, to the rescue.

Look at Form 1040-ES and the instructions, which are pretty self-explanatory. If you need help, there is probably an IRS publication on estimated taxes as well, also available at the website.

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Arlington, Va.: We are selling our horse that we bought for $15,000.00 2 years ago for $35,000. I believe we will have a long term capital gain. Can we increase our cost basis by adding the cost of training the horse over this time period? $400 a month is what we pay for training. If not is there anything else we can do to decrease our taxable gain?

thank you,

Nick O

Kathleen Day: That's a good question but too specific for me. Virginia is horse country and I'll bet there are lots of people, possibly even in your Vet's office, that have an answer. sorry. I wish I had a horse to have such a problem!

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Forced savings: I absolutely agree with the previous poster that, for some, getting a tax refund which is then deposited into savings, is the way too go. Many people are not disciplined enough to save the extra money from their paychecks. The extra money is just spent. Yes, they're losing out on interest that could have been made from investing all along, but at least they have some savings, which is better than nothing.

It would be nice if everyone could save as they go along, but it's not realistic for many.

Kathleen Day: you are absolutely right. If lending the government a portion of your paycheck over the year is the only to force savings discipline on yourself, then do it. It is tempting to spend what you have in hand! But if you could put that money automatically in an account with a tax benefit, you would also not see it and couldn't spend it and could be earning money on it. That's the only point but you make a good one too.

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Alexandria, Va.:

I would like to know if we get all the monies that we pay for properties taxes in the state of Virginia.

Also, i recently got married in July. Should I be filing for married or single for this year? I heard if both me and my spouse file as married, we might not get much of our taxes back?

Grace Allison: If you are asking if you can deduct your Virginia state real estate taxes as an itemized deduction, the answer depends on whether or not you itemize.

As far as figuring out whether you are better off filing jointly or separately, there is no substitute for running the numbers, i.e. compute your taxes both ways. Be aware that Congress has substantially reduced the "marriage penalty," so don't assume you will be better off filing separately.

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Hume, Va.: Hi, I have about $130,000 in Virginia Tax Credits that I would like to sell. Is there a tax package available that I can use to determine how much I can sell this year and not be subject to the AMT or other high tax issues? I have been doing my own taxes forever and don't have any other complicated issues, other than the large Federal charitable contribution (Conservation Easement) I received along with the Virginia Tax Credits.

Thanks, Dave

Kathleen Day: we suggest you run the numbers under different scenerios, but you also could check on some on-line chats to see if anyone else has had this problem and used a computer program to solve it. I'm not sure if Turbo tax or other popular programs can capture this problem, but it seems to be it's likely because your situation can't be that unusual.

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Indianapolis, Ind.: If you are in a high income tax bracket and are loosing your deductions, at what parental income does it make more sense not to claim your children/students as dependents, even though can cam claim them. I have two that are working and one is making $3000 ths year. The other is making around $8,000. Where is the deduction worth the most, ie., Parent or Student?

Grace Allison: In general, the tax benefit of claiming a deduction is worth more to the higher income taxpayer. But... there is no substitute for actually running the numbers to see which scenario yields the lowest tax burden in the aggregate.

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North Bethesda, Md.: For the person asking about converting the IRA to Roth. He/she needs to look at his/her tax rate today versus what he/she thinks it will be when retired. First, I'm assuming the growth rate and time in don't change for the IRA type and that growth is "G".

If he/she keeps it a traditional IRA, upon retirement, the value would be 28,000 x G. It all gets pulled out and taxed at tax rate "T". Now, he/she has 28,000 x G x (1-T).

If he/she converts to a Roth, the value is 28,000 x (1-T) since he/she needed to come up with the month to pay the taxes. It grows until retirement to 28,000 x (1-T) x G.

The only difference between 28,000 x G x (1-T) and 28,000 x (1-T) x G is the "T". If the tax rate is higher now, DON'T convert. If the tax rate will be higher then, convert.

Yes, since rates change, we don't know where the rates will be but you need to make a big assumption on that.

For me, I plan on having enought 401k/IRA/outside investments at retirement that my income will be the same (if not higher) at retirement so I converted.

Kathleen Day: wow, thank you for that comment!

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Gaithersburg, Md.: Can I claim a credit if I change a new air conditioning in my primary residence as home improvment to make energy-saving (cost of air con. is $5,000). What is the maximum I can claim.

Kathleen Day: the maximum you can claim is $500 or 10 percent of the purchase price, whichever is lower, but for $5,000 you get the $500. But be careful the unit has to qualify under IRS rules for being sufficiently energy efficient. And save your receipts, in case you are audited!

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Kathleen Day: We are going to wrap it up now--the hour sped by. Thanks for all your questions. We hope our answers were helpful. I I want to thank Grace especially for taking an hour to do this chat. We hope she will come back!

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