If you've been working on your 1987 tax return, you know there are now several categories of interest expense, and that each category is subject to different tax treatment. In order to simplify the sorting process next year when you work on your 1988 return, I suggest you carefully document and segregate interest paid for each category.
This is particularly important if you borrow money, then use the proceeds for more than one purpose. The IRS has some strict rules on accounting for comingled dollars. For example, if you borrow money to buy securities, the cost is investment interest, deductible up to the amount of your investment income; 40 percent of any excess is deductible for 1988.
But if you put the funds you borrowed for securities in your checking account, then pay for some new furniture before paying for the securities, the IRS will consider it all personal interest -- even if you had enough money for the furniture before you deposited the loan proceeds. (Exception: If the funds are withdrawn to pay for the securities within 15 days of deposit.) )
Interest expense can be placed in any of five categories:
Passive activity (sometimes called "tax shelter") interest.
Business interest (including rental real estate).
Residential mortgage interest.
Personal interest, which includes everything that doesn't fit one of the other cubbyholes.
The lesson is to keep careful records of interest paid for each category and to use separate accounts for money held for different purposes. Don't mix borrowed dollars with your own money in the same account unless the loan proceeds are going to be used for personal purposes. Unless you lead a very uncomplicated financial life, learn and remember the five categories and keep them in mind whenever you're engaged in a transaction that involves borrowing and interest.
I have a one-participant Keogh plan based on self-employment income that nets about $1,000. I haven't seen any information lately about the mini-Keogh that allowed up to a $750 deduction for low earnings from self-employment. Is that still allowed, or am I limited to 15 percent of such a small income? Also, I am wondering if it is now subject to the adjusted gross income limitation; our joint income is over $40,000 and my husband has a 401(k) plan where he works.
Alas, the mini-Keogh is no more; regardless of the size of your earnings from self-employment, you're limited to the percentage ceiling. But that ceiling may not be 15 percent -- it depends on the type of Keogh plan you have. For a profit-sharing plan, the ceiling is 15 percent of net earnings after deducting the Keogh contribution itself.
But if you have a money-purchase or other defined-contribution plan, the ceiling jumps to 25 percent before the Keogh contribution, equal to 20 percent of pre-Keogh net earnings. (The third type of Keogh, the defined-benefit plan, permits larger contributions but requires complex calculations and the assistance of an actuary, and generally should be avoided for owner-only plans.) Your adjusted gross income and the fact that your husband participates in a qualified pension plan has no effect on your eligibility for a Keogh plan; those rules, new for 1987, apply only to IRAs.
Did you run into trouble contacting your broker or having your orders executed during the stock market turmoil last fall?
The Donoghue Organization, publisher of the "Donoghue's Moneyletter" and other publications on personal finances and investing, will send you a free copy of a special report, "Turning the Tables on Your Broker: How to Fight Back Against Errors, Problems and Fraud in Your Brokerage Account." Write, mentioning this column, to Donoghue's Moneyletter, Dept. DP, Box 540, Holliston, Mass. 01746 and ask for the report. Coincidentally, an article on the same subject, titled "When Your Broker Fouls Up," appears in the January 1988 issue of Changing Times magazine.
Abramson is a family financial counselor and tax adviser. Questions of general interest on tax matters, insurance, investments, estate planning and other aspects of family finances will be answered in this column. Advice cannot be given on an individual basis. Address all questions to E.M. Abramson, The Washington Post, Business & Finance News, 1150 15th St. NW, Washington, D.C. 20071.