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Color of Money Live With Michelle Singletary
Kathy Burlison
Manager of Tax Operations Field Training for H&R Block

Tuesday, January 18, 2000 at 2 p.m.

Michelle Singletary
Michelle Singletary

There's a Greek chorus out there that believes tax efficiency is an end unto itself. God forbid you miss out on a tax deduction. God forbid you generate a "tax consequence." It's perfectly legitimate and advisable to take advantage of any and all tax breaks you can. But do you want tax strategies to run your life? Picking the right tax strategy is often arguable, but you shouldn't let a tax deduction trap you into an otherwise bad move. Join me Tuesday to discuss which tax breaks might be right for you. Should you save in your kid's name? Is it a good move to buy a house for the tax break? An expert from H&R Block will be on hand to try and help answer those and other basic tax questions.

Michelle Singletary: Welcome back for another discussion about money. This week it's those darn tax bills we all have to pay. In my column this Sunday I talked about not letting taxes affect your good mind. Generally, I pay what I have to and avoid what I legally don't have to folk over. But I'm not willing to spend a great deal of my life trying to find ways to cut my tax bill. Today I'm joined by an expert from H&R block whom I hope can answer some of your questions or if you want to vent go right ahead. But if you have a question please keep it simple and short.

Alexandria, Va.: I'm planning on liquidating my stocks soon in order to have a down payment for a home. But the fees at my large brokerage are staggeringly high. Would it be worth the trouble to transfer my holdings to a cheaper, do-it-yourself brokerage -i.e., Charles Schwab, etc.- and -then- liquidate? Am I right in thinking that will help to avoid the high brokerage fees when I sell off the stock? Thanks.

Kathy Burlison: You'll want to do a bit of investigating with both brokerage firms first. You'll want to know the transfer costs at each firm, as well as the cost of selling at the new firm. Then, compare the total costs of transfer and sale from the new firm to the cost of selling directly from your current firm.

Baltimore, Md.: Michelle, I think your column is great, I have benefited from your wealthy financial advice. My question is: If I sold some stock for the purchase of a new home, Will I be penalized?

Kathy Burlison: There's nothing called a "penalty" for the sale of stock, unless you're taking it out of a retirement plan. But you will probably pay some tax. The difference between the sales price and your basis in the stock is taxable. If you've held the stock more than one year, it's taxed at a maximum rate of 20 percent.

Michelle Singletary: What are the the mistakes people often make on their tax return?

Kathy Burlison: Some of the most common errors that the IRS cites are math errors! They also list errors in looking up tax rates, listing accurate social security numbers, and in calculating the earned income credit. Sometimes it's just the language that's confusing . . . you can be the head of your household if you live alone, but you're probably not "head of household" for your taxes!

Michelle Singletary: Could you explain what a "basis" is and how it might affect someone's taxes?

Kathy Burlison: Most of the time, basis is the same as cost . . .what you paid for something. But the tax code doesn't use the term "cost" because you might own something you didn't buy, such as a gift. So there are different rules for figuring basis depending on how you got the property. When you sell the property, the higher your basis, the smaller your gain (or the bigger your loss), meaning lower taxes for you.

Baltimore, Md.: I usually take the standard deduction rather than itemize deductions. However, I am considering itemizing next year because I may buy a house and make some large charitable contributions, which I'd like to be able to deduct. How can I tell how charitable giving will change what I owe on my taxes? Thanks.

Kathy Burlison: If, once you buy the home, you already have enough to itemize, all of your charitable giving will usually reduce your taxes. To calculate your savings, first figure your tax bracket . . . both federal and state. If you're in the 15 percent federal bracket and pay 5 percent in state taxes, your total tax rate is 20 percent. Multiply your charitable giving by your total tax bracket to figure your savings.

Michelle Singletary: People are often asking or really mad as hell about the so-called "marriage penalty." What exactly is the marriage penalty and is there anyway for folks (married ones that is) to avoid paying higher taxes? Does the marriage penalty mostly affect couples making about the same income?

Kathy Burlison: The "marriage penalty" happens when two people get married and pay more in taxes than they would have if they were single. People with similar incomes are more likely to be hit by the "penalty." On the other hand, if one spouse has much higher income than the other, the couple may have a marriage benefit . . .their taxes may be lower than when they were single. Under current tax law, there's no way for a married couple who's affected by it to avoid the marriage penalty . . .other than normal tax reducing tactics.

Washington: Michelle,

Speaking of "Head of Household", what is the official IRS definition? Thanks

Kathy Burlison: Without getting into all the technicalities (and the "unlesses"): its a tax filing status that offers lower tax rates and a higher standard deduction for certain taxpayers. To qualify, you have to financially maintain a home for a qualifying individual, such as a child, a parent, or other close relative. In most cases, the other person must live with you and in some cases must be your dependent.

Bowie, Md.: Why are the politicians afraid of a flat or value added tax?

Kathy Burlison: I'm not sure I'm comfortable trying to explain a politician's motivations. But there certainly is a lot of talk . . . it's a tough question with a lot of economic and political considerations in addition to the straightforward tax considerations.

Washington: Is there any limit to what amount you may deduct for charitable donations? What portion of donations are deductible? The full value?

Kathy Burlison: Each year, for most types of contributions, you can deduct up to half of your income (or, technically, your adjusted gross income--AGI). For property that you contribute, the deduction is usually the lesser of the current value (fair market value) or your cost. In some cases, you can contribute property that's increased in value (appreciated property) and take a deduction for the current value . . . but the deduction is limited to 30 percent of your AGI. Anything you don't get to deduct because of the income limits you can carry over to deduct next year.

Michelle Singletary: I find a lot of people (okay, me) are confused about the tax implications between the Roth IRA and the traditional IRA. Can you explain how differently they are treated? Who should consider a Roth?

Kathy Burlison: If you can't deduct contributions to a traditional IRA and you qualify for a Roth, the Roth is better. If you can deduct your contributions to a traditional IRA, there's no simple answer . . .you'll need to do some heavy math.

Here are some differences:

1) If you follow the rules, the earnings in a Roth account aren't taxed when you take them out. The earnings in a traditional IRA are taxed when you take them out.
2) Contributions to a Roth are not deductible, so they don't reduce your taxes now. Contributions to a traditional IRA may be deductible . . . if they are, they help you save on your taxes.
3) If your income is too high, you can't contribute to a Roth. There are no income limits for contributions to a traditional IRA (but there are income limits for deducting that IRA).
4) Those are basic differences . . . there are more.

Bowie, Md.: I often hear that if you try to use the home office deduction that it will send up a red flag and you are more likely to be audited. Is that true? And, are there any new changes to the home office deduction rules?

Kathy Burlison: My experience would indicate that an office in home deduction does make your return more likely to be audited, but it's hard to tell what the IRS will do this year. They may be interested in the deduction because there are changes this year that mean that the deduction is available to more people. For the last few years, you could only deduct a home office if it was where you engaged in your main money-making activity for your business . . .for example, a plumber wouldn't get the deduction because she (or he) couldn't fix his customers' pipes in his home. But this year, the plumber might qualify for a deduction if the home is where he does his administrative work, such as billing, and he doesn't have another place where he does that work.

Fort Washington, Md.: I am thinking of purchasing a condo. My purchase is for investment purposes, as I already have a single family home. I plan to put $10,300 down on a foreclosed unit currently valued at $40,000. If I put this
much down, is any of it deductible? Maybe you could tell me what type of costs are deductible when purchasing a second piece of property. After the purchase, my plan is to have the condo available to rent. I figure
I'll probably clear at least $150-200 on a monthly basis after monthly expenses.

Kathy Burlison: The down payment won't be directly deductible, but you will get the advantage of depreciating the cost of the property (over almost 40 years). Anything costs of repairing the property can be deducted in the year they're paid . . . costs to buy it or improve it are depreciated. Some deductible expenses: administrative and maintenance expenses, mortgage interest, property taxes, insurance, your transportation or travel costs to inspect the property, repair it or collect rent.

Bowie, Md.: I will be itemizing for 1999 for the first time because I purchased a home last year. Can I deduct charitable contributions that I made in previous years, but was unable to claim because I was taking the standard deduction? I have receipts going back several years.

Kathy Burlison: Unfortunately, no. But you may want to take another look at those past years' returns to make sure that you can't itemize on them. You can still amend returns as old as 1996.

Green Valley, Ill.: I cashed in my 401 k plan , as I retired on Jan 4, 1999. Taxes plus an 85% tax on my SS.
Is there any way I can reduce these, such as spreading the load over 5 years?

Kathy Burlison: Five year averaging is gone, but 10 year averaging is available if you were born before 1936. You may want to consider rolling your distribution into an IRA so you can take your money out as you need it and lower your taxes.

Washington: Hi Kathy, this should be an embarrassing question but it isn't for me its just reality. What can a person do regarding expenses on your children per year, despite the fact that whomever the child resides can claim them on their taxes. This seems unfair in some way. I spend quite a bit of money on my children -this isn't a complaint but strictly a tax question-, per year plus the child support I send. My children use my water, electricity, food, etc. The child support could at one time be written off, now they -IRS- don't allow it. Are there any loop holes or new laws to help those parents who are fair but are treated unfairly.

Thanks for any advice-

Kathy Burlison: If you're not a good terms with your ex, it's something you might want to work on. The parent the children move with ("custodial parent") can sign a waiver allowing the other parent to claim the exemption for the children. If you're in a higher tax bracket than your ex, it might be time to negotiate . . . if you claim the kids, you'll share the savings. One other, not so friendly, option . . . if the divorce decree allows you to claim the children, you get the deduction . . . it may not be worth the court costs!

Falls Church, Va.: I'm a divorcee with an annual income of $45K. Divorce wiped out my savings, maybe $5K left. No children. Rent keeps going up each year. What benefits are there to me in home ownership? How do I make sure ownership doesn't sink me -i.e., taxes, insurance, upkeep, etc.-?

Kathy Burlison: When you're buying a home, you get to deduct the mortgage interest and property taxes . . . plus, financially, you're building equity that you can use later in life through borrowing against the property or selling it. Here's some simple math to see where you'll stand:
1) Find out your standard deductions.
2) Calculate what your itemized deductions would be now without buying a home (state income taxes, personal property taxes, contributions, etc.)
3) Subtract item 2 from item 1 (this is beginning to sound like an IRS form!)
4) Figure out what your interest and property tax payments will be.
5) Subtract item 3 from item 4
6) Multiply item 5 by your tax bracket.

After writing all this . . . it may be easier to talk to a tax preparer!

Michelle Singletary: I have a follow-up question to the divorce and kids and deduction question. If there is more than one child involved, can the parents share in the deductions. In other words, can the dad take one kid and the mom take the other?

Kathy Burlison: They sure can! The custodial parent can sign the waiver for as many or as few children as he or she want. Also to consider, the child tax and education credits can't be waived . . . they go to the parent claiming the child. So you're not just signing away the deduction for the exemption . . . be careful to do all the math!

Michelle Singletary: Okay, as a follow-up to the question about when someone should buy a home...After they do all that math (my head hurts just looking at the steps) what should they do with the numbers? And, can this decision or should this decision be based on the numbers alone?

Kathy Burlison: Oops . . . there are even more numbers to deal with! Once you finish steps 1-6, you know how much you'll save by buying a home. You'll want to compare that number to how much more (or less) it will cost you to buy rather than rent, including insurance, maintenance and repairs. This way you'll have a complete idea of how buying a home will affect you financially. But you're right, Michelle, there's more to it than just the numbers . . . you need to think about your lifestyle and whether you'll enjoy owning a home . . . or resent the demands on your time and money!

Michelle Singletary: What other red flags does the IRS look for in returns they may want to single out for an audit?

Kathy Burlison: The IRS will automatically catch just about anything that doesn't match what's reported to it such as wage and interest income. Historically they've also been especially interested in deductions that allow you to convert nondeductible personal expenses into deductible business expenses . . . for example, meals, travel, and entertainment. They'll also want to look at those things that look unreasonable . . . large expenses on a small income.

Baltimore, Md.: Is it true that if I had some debt forgiven in a bankruptcy that I have to claim that debt amount as income on my taxes?

Kathy Burlison: You'll need to do some calculation. Forgiven debt is usually taxes, but (and there's always a "but" in taxes!), there are several exceptions. This is a complicated area that you hope to not have to deal with more than once in your lifetime . . . it's probably worth an investment in some professional tax help.

Michelle Singletary: Ah man, can't believe an hour has gone by already. Well, great questions. And, glad to see so many people already starting on their taxes or at least thinking about that dreaded day. I'm sure I'll have another chat about taxes between now and April 15 so keep your calculator out. Anyway, thanks for joining me and thanks a bunch to Kathy and H&R Block. Don't forget every other Tuesday at 2 p.m. at this very site I talk there is always a discussion about money. So, come on back.

© 2000 The Washington Post Company

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