Tuesday, April 6, 1999 at 3 p.m.

April 15 is just around the corner, and while the IRS is gentler and kinder this year, there are certain precautions you can take to safeguard your money and simplify your tax filing.

Today I invited Jim Baker, president of Edelman Tax and Valuation Services Inc. in Fairfax, to join me in a live discussion to help answer your pressing tax questions.

Jim Baker

For background, read Washingtonpost.com's special report on taxes – including calculators, planners, Post columnist advice, tax software and a Web guide – and browse an archive of my past columns and live discussions.

Please note: Michelle Singletary cannot offer specific personal financial advice or answer detailed questions about individual situations.

Michelle Singletary: Welcome again to my online discussion. This week we're talking taxes. While Jim will be answering some specific tax questions, our goal is to also talk issues. For example, do you hate paying taxes? If so why? And, what should congress do about this marriage penalty? Is shacking up the answer to your tax problem? So hit us with your best questions.

Michelle Singletary: Jim, this reader sent me an e-mail this morning with an interesting tax problem. Here's her situation: My husband was divorced from his first wife in 1989. According to the new tax laws, the custodial parent (his ex) can automatically claim their two sons as dependents on her income tax - unless she signs a waiver allowing him to claim one or both. Our problem is she won't sign the paper and she's on welfare. She doesn't work. Yet she doesn't want to be locked into letting my husband have the tax deduction. This has been going on for five years. What advice can you offer?

Jim Baker: Michelle:

The tax rules are always very fair in this area. According to the rules, the parent who has custody of the child for the greater part of the year is generally treated as the parent who provides more than half of the child's support.

It does not matter whether the custodial parent actually provided more than half of the support.

Perhaps gaining custody of the children will solve this problem.

Arlington, VA: I've never understood why people would pay $50+ to have their taxes done by a tax preparation company -- these companies don't employ CPAs to handle these returns, just people who have a taken a tax prep class. Luckily, I've been able to turn several friends away from these firms -- they all thought a CPA, or at least someone with an accounting degree, handled their return. These friends have either decided to do the returns themselves, or have gone to a real accounting firm -no, I'm not a CPA -- I just have several friends who are-.

Do you think these companies are misleading the public?

Jim Baker: I completely agree!

It doesn't make sense to pay a lot of money if your tax return is fairly straight forward. In addition, just because someone is a CPA doesn't mean that they are good at tax law. CPA's expertise can lie in accounting, or businesses, audits, or any other accounting type function.

EA's, or Enrolled Agents, have passed a lengthy IRS examination and should also be considered when choosing a tax preparer.

Michelle Singletary: Personally, I know doing your own taxes can be pretty scary but it's also a good time to go over all your finances since everything is right there. Many of us should stop handing over the running of our finances to people.

Michelle Singletary: What do you think about people who opt for rapid refund? Personally, I think generally the money you lose in the deal is too high a price to pay. I would advise against it unless perhaps your landlord is ready to put you out of your home and the refund is needed that day. And, it's sad that the very people who use this option are often the ones that need every cent of that tax refund.

Jim Baker: I agree that unless you must have the money for an urgent situation, you must weigh the cost of using this option.

Example: say you are due back $1,500, the rapid refund costs $25, and without the rapid refund, you can get your money from the government in 3 -4 weeks. By my calculations, you are paying a 20% fee. ($1,500 x 20% = $300 annually, divided by 12 months = $25. My guess is that in many cases, the fee is greater than $25 and subsequently, a much higher fee to you.

Arlington,VA: This may be a dumb question, but here goes: I make about $5,000 more than my boyfriend -he makes $47,000, I make $52,000- and according to my tax calculation, I'll shell out $1,600 in income taxes this year, while he pays nothing. Neither of us own homes, both of us took the standard deduction. What gives? Once you pass the $50K mark, are you considered "wealthy" or something?

Jim Baker: It doesn't sound right to me. The income tax rates are graduated rates, and there wouldn't be that much of a tax discrepancy for $5,000 of income.

I'm wondering if when you say "I'll shell out $1,600 in income taxes this year while he pays nothing", you are referring to the amount due after taking into account any withholding. In other words, you both may be paying about the same in taxes (perhaps you are paying a little more because of your higher income), but he is simply withholding at the right amount and you are under withholding.

Michelle Singletary: In fact, I lived in the condo for 10 years and got a good tax break but now I can't sell the condo. So for me I'm not sure it was smart to buy a condo for the tax break especially since I now can't sell it. By the way, anybody in Baltimore looking for a nice two-bedroom condo.

Michelle Singletary: This is an interesting question, especially for single folk earning good salaries with few deductions. What can they do to lower their taxes? I ended up buying condo at age 22 to help. But I'm not sure it was a good idea.

Jim Baker: First, you should contribute the maximum to your company retirement plan, such as a 401k or a 403b for example. This is an excellent way to not only lower your taxes, but save for the future. If you are self-employed, you should set up a SEP (Simplified Employee Pension), which will enable you to set aside up to 15% of your net earnings to a retirement plan, while reducing your tax liability.

Michelle Singletary: I got ahead of myself but you guys get the point.

Washington, DC: I am 24 years old -income $28,000- and am going to invest $2000 in an IRA before April 15 for 1998. I have not invested in an IRA before. I have read that the Roth would be better for someone who is not going to withdraw for many years. Is a Roth the way to go? Can I invest the entire $2000?
I have already filed my Federal tax returns -through their walk-in help office-. The tax preparer did not file a Form 8606. Do I need to file an 8606?
I also paid student loan interest of less than $30 in 1998 -so the tax preparer filed a form 1040, not 1040EZ-. When I file my Virginia return, do I need to file the 760 or can I file the 760S? Thank you.

Jim Baker: Although some may disagree with me, I feel that if you are eligible for a deductible IRA, you should contribute to this first before you contribute to a Roth IRA. This is because you can get a tax deduction today, instead of the promise of one for tomorrow. And yes, you can contribute the entire $2,000 to an IRA since your compensation exceeds this amount.

Regarding your question on whether you need to file an 8606, no, you would not need to file one if you make either a traditional deductible IRA contribution or a Roth contribution.

Finally, It's my understanding that the Form 760S can be used despite the fact that you used the long 1040 form to file your federal return.

Michelle Singletary: So Jim, is it a good idea for people with good incomes to buy a condo or house to reduce their taxes? It's advice that is given an awful lot these days.

Jim Baker: Not necessarily Michelle. Buying a house can lower your tax bill because you can deduct the mortgage interest, real estate taxes, and... because you now itemize, you can deduct charitable contributions and other items that you weren't able to using the "standard" deduction.

But....What if you are transferred to another state? Or if you decide you don't like the area you're in? Or, meet someone and get married and you move to their house? You could be stuck with some real estate that you don't want. And in the end, it could cost you more than the tax savings from increased deductions.

Arlington, VA: Woman with "dumb question" again. Both my beau and I claimed 1 last year -a mistake I -will not- repeat-. And yes, the $1,600 I'll pay on April 15 is in addition to what was withheld from my paycheck. I can't figure out what I'm doing wrong. Any ideas?

Jim Baker: You need to adjust your withholding. Go to your employer and fill out form W-4. If your situation will be identical in 1999 as it was in 1998, my off the cuff guess is that you need to lower your exemption amount by 2 or 3.

Perhaps more importantly, have a tax professional look at your return. Perhaps there is a deduction being overlooked that can lower your taxes.

Hunter Glen, Michigan: I'm married and have two children, but I'm a libertarian and don't believe in paying taxes. Is there a way to opt out, you know, the way Quakers can opt out of the
draft?

Jim Baker: Not that I'm aware of.

If you figure this one out, be sure to let me know!!

:-)

Michelle Singletary: I think you make a good point about owning vs. renting. Besides not everyone is ready for the financial responsibility of owning a home. And, often people buy too much house "buying" into this idea that the more house the better because your income will go up and you get a tax break. Please. Trust me you should own a house more for the tax break - as my husband and I try to nurse dead brown grass and keep the birds out off our attic.

Los Angeles, CA: I filed an extension to do my 1997 taxes last year. I was unable to locate my w-2's in the process of moving. I'm still unable to locate one of them for a specific company I worked for. Is there a way I can obtain the income information for this company at this point?

Jim Baker: Yes there are a several things you can do.

First, contact the employer and have them send you a copy.

Second, if you cannot contact them, contact the IRS and ask them what wage information this employer submitted to them on your behalf. Remember, the IRS knows what you made because the employer has already told them.

Finally, do this soon! If you owe any additional taxes after you file, you may have to pay a penalty and interest. Filing sooner rather than later will reduce this amount.

Michelle Singletary: Jim is getting some good questions and he's trying to get to more. We have just a little more time so keep reading and asking.

College Park, MD: I was helping a relative do their taxes recently and found that they owed a penalty. When I filled out form 2210, I discovered that if you underpaid by $1000, you owe no penalty but beware if you owe $1001 because the IRS charges a penalty on this whole amount, not just the amount over $1000! It really bothers me when things like that are not prorated to be even! Especially in the case above where the penalty is a little over 5% of the full amount, in this case $50 for underpaying by a mere dollar more than your neighbor! PS i called the IRS to check if this was right and the person I spoke with said it was but that I shouldn't fill out 2210 because it was too complicated, I should just let the IRS send me a bill. No thank you! If it's too complicated, make it easier!

Jim Baker: You're correct. You are allowed to underpay your taxes by $1,000 without a penalty. Anything over that amount and the penalty kicks in. By the way, this $1,000 amount is new for the 1998 returns. Last year, for 1997 returns, the amount was $500. A new and friendlier IRS?

What you can do is fill out the 2210, but "annualize your income". This allows you to tell the IRS when you earned your income. If you earned most of it in the last 6 months, as opposed to the first 6 months, this will reduce your penalty. If you earned your income more in the first 6 months, or evenly throughout the year, don't bother filling out this section.

Consider adjusting your withholding or estimated quarterly payments so this doesn't happen again. Use Form 1040ES for this calculation..

Centreville, VA: It has been the law in Virginia for at least a year that a judge can order the custodial parent to sign the necessary tax forms to grant a child deduction to the minority custody parent if it's deemed to be fair. Va Code 20-108.1-B-15. "Tax consequences to the parties regarding claims for dependent children and child care expenses" can be considered to rebut the guideline support and Va Code 20-108.1-E- "Except when the parties have otherwise agreed, in any proceeding under this title, Title 16.1 or Title 63.1 on the issue of determining
child support, the court shall have the authority to and may, in its discretion, order one party to execute all appropriate tax forms or waivers to grant to the other party the right to take the income tax dependency exemption for any tax year or future years, for any child or children
of the parties for federal and state income tax purposes. "

Jim Baker: This advice is certainly worth checking into.

But... make sure your cost (including your time, lawyer's fees, etc.) to obtain this court order is less than the tax benefit you will receive by claiming the child!

Arlington, VA: Why do I have the feeling every April 15th that if you are a two income professional couple with no children, you are expected to carry the burden for those who have decided to have many children, and who have not invested enough in their careers to increase their incomes. While preparing my return, I notice that all of the deductions, exceptions, etc. we heard so much about last year only apply to those with small incomes, or with children. I know I sound like a snob, but I work very hard for my salary, and am getting frustrated by the increasing amount going to the government each year. Do many share this opinion?

Jim Baker: No, you're not alone.

The government now allows child care credits for each child you have and education credits for your dependents, obviously, lowering the tax bill for married couples with families.

Germantown MD: Is there a formula for figuring out the number of exemptions to take on the W-4? My husband and I will get a refund of about $3000, but I'm not sure how to adjust our withholding for this year.

Jim Baker: Yes, there is a formula and you can find it on Form W-4, which you can obtain this from your employer or the IRS.

Michelle Singletary: Ah, I know the feeling. After getting over all the childbirth pain of having my second child, I leaped for joy when I realized I can now claim the darling little rug rat on my taxes. But alas I care more about my waistline than my bottom line to have any more children for tax purposes. But seriously, let's remember why we pay taxes, even often they feel too high and unfair. We need to somehow pay for all this stuff we want -good roads, good public schools. In addition, I do feel the government should be helping those who can't always do for themselves.

Hunter Glen, MI: stop using the roads
breathing clean air
living in freedom and then
you can "not believe in taxes"
you idiot!

Michelle Singletary: That's what I'm saying.

Bethesda,MD: Is this the first year that you can deduct a student loan interest or was it possible last year and other years? I was told that I could not deduct $550 worth of interest on a student loan since I did not do it last year - which I did not know about!

Jim Baker: Yes, this is the first year student loan interest is deductible. And the really neat thing about this deduction is you DON'T have to itemize to get the deduction. Neat...

There are some income limitations and another rule is that the interest can be deducted as long as you are in your first 60 months of when loan payments are required.

Michelle Singletary: Well, we are just about done. Jim will answer a few more questions and then we will have to call it quits.

Silver Spring, MD: I was wondering about the different methods for determining capital gains on stocks that my husband and I sold last year. I had calculated them using the first in-first out method as well as computing the average cost basis. As expected, the average cost basis reduced the gains, but our tax preparer told us not to do it that way -since we would have to continue that method for the life of the fund-. I'm not quite sure why that wouldn't be the way to go anyway. Any advice?

Jim Baker: I see no reason why you shouldn't lower your taxes by using the average cost method. You're tax preparer is correct that once you elect to use this method, you cannot change to another method. But so what? I'll gladly take lower taxes today. Who knows, you may not sell the stock ever again so who cares if you're locked into a method?

Silver Spring, MD: Michelle, on a side note, you mentioned you were selling a 2-bdrm condo in Baltimore. Is this in the Federal Hill area in which case I'm interested.

Jim Baker: Michelle, I believe this is for you....

Michelle Singletary: Sob...Sob. The condo isn't in the Federal Hill area but in the lovely west side of town, right across from a beautiful park, on a bus line....Oh, that's right we're talking taxes. Sorry.

Arlington, VA: I anticipate owing the IRS about $4,000 this year. I do not have the funds to pay them on April 15. Nor do I have the credit to borrow the money. What can I do? Does the IRS have a payment plan? What forms do I need?

Desperate in VA

Jim Baker: There are a couple of things you can do.

New this year, you can charge your balance due on your credit card. Make sure you are aware of any fees charged to you by your credit card company. Now I'm not saying that this is the best choice, but it is a choice nonetheless.

Secondly, you can file Form 9465 with your tax return and request an installment agreement with them. On this form , you determine which day of the month you will pay them (yes, it must be monthly), and you can even have the amount debited from your bank account. The fee to set up an installment agreement is an initial fee of $43, plus interest and penalty on the unpaid taxes of about 15% annually. Compare this to your credit card rate. Usually, the IRS will accept a payment plan of up to 3 years, so $4,000 divided by 36 months = $112 per month. But try to pay off as much as you can as soon as you can...

centerville virginia: I am having a tough time with filing my federal returns. For the last 4 years i have been separated from my husband. And he has been filing his taxes with me and the children as his dependents. Each year I have not been getting any $$. I have complained to IRS and each year they have done nothing!! I have submitted his name to the fraud line, absolutely nothing has been done. This year the same thing!!! CAN YOU GIVE ME GOOD SOLID ADVICE, PLEASE.

Jim Baker: You can run into all sorts of problems if you are separated from your spouse but still filing jointly.

You should consider filing "married filing separately", instead of "married filing jointly". This way, any refund due you will come directly to you!

Michelle Singletary: Listen, I'm not a tax advisor but I hear all the time about people keeping ties with their ex to save on taxes. Why? Is the money you might save worth the liability you may have with a person you clearly can't live with. I say when you get rid of the ex let him or her take their tax liability with them.

Washington, DC: I work in DC and live in VA. Do I have to file the regular VA return, or do something different? What should my work have done so that I don't have to fill out lots of forms for DC and VA -I am going to check to see if I have filed these forms-? Thanks.

Jim Baker: Simply file the Virginia return. You do not need to file a DC return if your income from D.C. are wages only.

I must sign off now and go back to preparing income taxes (fun, fun, fun!)

This has been a great group with great questions. Perhaps we'll be talking again soon!

Bye for now!

Michelle Singletary: Well, that's it for today. Jim has been wonderful and kind to stay on past our time. Maybe he can come back after the tax season to help with the tax planning all of us should be doing all year long. Thanks to all who submitted questions. I'm sorry we couldn't get to more. Happy returns (hee, hee, hee).