TaxHawk.com's Tax Tips

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Tip #1
Maximize your 401(k) or 403(b) contributions
Your taxable wages are lowered by the amount of your 401(k) or 403(b) retirement contributions. So if your wages are $40,000 and you contribute $3,000 to your 401(k) plan, then only $37,000 of wages are taxable income on your Form 1040. All earnings within your retirement account such as dividends and capital gains are tax-deferred until distributions are received after your retirement. If your employer offers a matching contribution, you have an immediate tax-deferred return on investment as well as a reduction of your wages on your W-2. Another benefit to consider is that any money in your 401(k) account is protected by law against creditors. So if you are ever hit by a lawsuit or have to file bankruptcy, your 401(k) money is safe. CAUTION: IRAs do not have the same protection against creditors that 401(k) plans have.

Tip #2
Home Equity Loans
Convert non-deductible interest expense such as interest on credit cards and automobile loans into deductible home mortgage interest. You can deduct the interest on a home equity loan or line of credit on Schedule A of your 1040, and the interest on your home equity loan is deductible no matter how you used the loan money. One item to note is that if your home equity loan is over $100,000, the deductible interest expense is limited to the interest on the first $100,000 of your loan. CAUTION: Consider the loan fees and compare interest rates when deciding if it makes sense to convert non-deductible loans into deductible home equity loans.

Tip #3
College Savings Plans
Consider a College Savings Plan for your child or grandchild. www.savingforcollege.com has a great analysis of all the different states that offer qualified tuition programs. States such as Utah and New Hampshire allow residents and nonresidents alike to participate in their program and attend college anywhere in the United States. The tax advantage is that the investment grows tax-deferred until the child goes to college and the child will usually be in the lowest tax bracket when income on the accumulated earnings does have to be recognized upon distribution of the earnings to pay for college. Some states also offer tax breaks for residents of their state if they use their home state's program. However, some states do not have very good qualified tuition programs, so check out your state's program at www.savingforcollege.com, then check out programs for other states that allow for nonresident participation.

Tip #4
Donating Appreciated Stock
Donate stock instead of cash to your favorite charity. If you hold publicly traded stock that has gone up in value, you can get a charitable deduction for the full value of the stock and avoid paying any capital gain tax. EXAMPLE:You donate 100 shares of Company X that you purchased two years ago for a total of $3,000 but which had a value of $13,000 on the day the donation was made. By donating the stock directly to the charity, you get a deduction of $13,000 and you avoid paying tax on the $10,000 capital gain you would have recognized if you had sold the stock. CAUTION: You must give the stock directly to the charity. Don't sell the stock and give the money to the charity.

The opposite is true for donating stock that has lost value. Never donate stock that has lost value. Instead, sell the stock and donate the cash to the charity. You will then get the benefit of the capital loss as well as the benefit of the charitable deduction.

Tip #5
RV Deduction
Deduct the loan interest on your RV, camper, or even your boat. You are allowed to deduct mortgage interest on your primary residence and one other residence. The definition of what constitutes a residence is very broad and includes RV's, campers, and boats as long as they have cooking, toilet, and sleeping facilities.

Tip #6
Cafeteria Plans
Take advantage of your company's cafeteria plan and other tax-free benefits. For example, your company's dependent care program is a great deal if you are in the 25% tax bracket or higher. The dependent care credit only gives you a tax credit of 20% of your child-care expenses, but through your company's cafeteria plan you will be getting a tax benefit equal to the tax bracket you are in. So if you are in the 28% tax bracket, you will be getting a tax benefit of 28% as well as a reduction of your state income tax.

Another example is medical expenses. Medical expenses can rarely be taken on Schedule A due to the 7.5% of AGI limitation, but through your company's cafeteria plan, you can fully deduct your medical expenses from your W-2 wages. The only catch is that if your unreimbursed medical expenses for the year are less than what you set aside from your wages, the difference is forfeited. The definition of what constitutes qualified medical expenses is very broad so make sure to visit your dentist, optometrist, acupuncturist, chiropractor, etc. in December if you haven't used up all of your current year medical expense contributions.

Tip #7
Index Funds
Investing in an index fund instead of a mutual fund can save you taxes since index funds do not buy and sell their stock holdings as often as mutual funds. The result will usually be a lower amount of capital gains to report on your tax return. Index funds also usually have lower fees than mutual funds.

Tip #8
1099 Matching
Make sure that your tax return numbers match the 1099s you receive from your broker, employer, or investment company. EXAMPLE: If you receive a Form 1099R showing a pension distribution of $12,410, then the $12,410 needs to be included on Form 1040 Line 16a as part of total pensions and annuities.

Tip #9
LLCs
If you are starting up a business, an LLC may be the right choice for you. LLCs offer the advantages of limited liability and partnership taxation. There are still good reasons for choosing to operate your business as a C corporation, S corporation, partnership, or sole proprietorship, but LLCs are often the best choice.

Tip #10
Owing the IRS Money
If you owe the IRS money and are not able to pay are not able to pay, you basically have three options. Each of these options can get complicated. Professional tax advice should be sought to best choose the option that meets your tax situation. Remember to file your tax return on time or file an extension even if you don't have the money to pay your tax. The penalty for not filing your return is 5% of your tax liability a month up to a maximum of 25%.

Option #1: Installment Agreements - If you owe less than $10,000 in taxes, you are legally entitled to an installment agreement if you meet certain conditions. Fill out Form 9465 and attach it to your return. In order to minimize your penalties and interest you should pay as much tax as you can when you mail in your tax return. Put down the amount that you can pay each month keeping in mind that the bill must be paid off within 3 years (including interest and penalties). Once the IRS receives your Form 9465, they will contact you with information on how to make the payments.

Option #2: Offer in Compromise - If you do not have the ability to pay your full tax bill even if you are given extra time to pay it, consider making an offer in compromise. Basically, the IRS looks at your current assets and your potential future income in determining whether the offer in compromise you propose is acceptable. If all the IRS can get from you is 10 cents on every dollar of tax liability, the IRS will probably accept an offer in compromise of 10 cents on the dollar. The dollar amount of your offer is not important. What is important is the dollar amount the IRS feels it can obtain through its collection efforts. If you offer less than what the IRS feels it can collect, then your offer will be rejected. Use Form 656 as well as Form 433-A (and Form 433-B if you are an owner in a business) in preparing your offer. Send these forms to the IRS separate from your tax return. Form 433-A is a financial statement that lists all of your assets, liabilities, monthly income, and expenses. A qualified tax professional will greatly increase your chances of a successful offer and can help you analyze any potential traps in making an offer in compromise. If you do the forms yourself, get a book that gives detailed instructions on how to do offers in compromise. If you are thinking about declaring bankruptcy, you should consult a lawyer before filing an offer in compromise.

Option #3: Bankruptcy - If done right and if certain rules are met, your federal and state income tax liabilities can be discharged by declaring bankruptcy. Consult a competent attorney who has a good knowledge of the tax laws. The timing of when you file your bankruptcy is crucial. If you file bankruptcy too soon, your tax liabilities will not be discharged.

Tip #11
Volunteer Expenses
Deduct any expenses that you incur doing volunteer work for a qualified organization on Schedule A as a cash charitable contribution. The following are some common volunteer expenses:

- Automobile - you can deduct 14 cents a mile for any volunteer related commuting or travel.
- Travel expenses - If the trip is primarily related to volunteer work.
- Long distance phone calls
- Uniforms and other specialty clothing

Tip #12
Custodial Parent
The custodial parent has the right to claim their child as a dependent unless that right is released to the noncustodial parent. If released, the waiver needs to be in writing, signed, and attached to the noncustodial parent's tax return. The waiver can be for one year, permanent, or any other way you want to do it. Form 8332 is the official IRS waiver, but you can also write up your own waiver and use it as long as it spells out who gets the deduction and is signed by the custodial parent. One item to note is that the custodial parent still has the right to claim head-of-household filing status, the earned income credit, and dependent care credit even if they have released the right to claim their child as a dependent. However, if waived, the noncustodial parent claims the $1,000 child tax credit along with the dependency exemption.

Tip #13
Alimony
Alimony payments are deductible if the following requirements are met: (1) the payments are in cash, checks or money orders (2) required by a divorce or separation instrument, (3) the payments are not for child support, (4) the payments are not part of the property settlement payments related to the divorce, (5) you and your (ex) spouse must not be members of the same household and do not file a joint tax return, and (6) you are not liable to make any payments for any period after the death of your (ex) spouse. One item to note is that if you owe both alimony and child support and during the year you pay less than the amounts required, then the amounts paid are first applied to your child support obligation before being applied to alimony.

Tip #14
Your Home
Buying your own home is one of the best tax-free investments available. Usually, any gain on the sale of your home is excluded from taxable income if you have lived in the home for two out of the past five years. The exclusion can be used as many times as you want in your lifetime, the only restriction being that the exclusion can only be used once every two years. If you qualify for the exclusion, you don't have to fill out any forms on your tax return. You simply don't report the sale of your home on your tax return. There are two exceptions to this rule. The first exception is if you have a gain on the sale of your residence of greater than $250,000 (single) or $500,000 (married filing jointly). In this case you have to recognize any gain above $250,000 or $500,000 respectively, and would need to report the sale of your home on your tax return. The second exception is if you have been taking a home office deduction or have rented out your home in previous years. You will need to recognize gain on your tax return from the sale of your home to the extent of any depreciation taken on your home after May 6, 1997.

Tip #15
Worthless Stock
If you have a stock or investment that becomes worthless, the investment is considered to be sold on the last day of the tax year for a sales price of zero dollars. A stock is worthless if the company has gone out of business or is insolvent.

Tip #16 Incentive Stock Options If you receive incentive stock options (ISOs) consider holding the shares at least one year after the exercise date in order to take advantage of the favorable capital gains rates. If the ISOs are sold before one year, you will be taxed at your normal rate. CAUTION: The Alternative Minimum Tax needs to be considered when ISOs are exercised.

Tip #17
Form W-4
An employee fills out a Form W-4 when they are first hired on a job. The W-4 determines how much federal and state taxes are withheld from your paycheck. You may want to give your employer a new Form W-4 if the taxes being withheld are too much or too little. If you are getting a big refund every year, you could do a new Form W-4 and claim more allowances in order for your employer to not withhold as much taxes from your paycheck. If you owe taxes each year, you want to claim fewer allowances on your W-4 so your employer withholds more taxes from your paycheck. When you have a life change such as getting married, divorced, buying a home, having a child born, or a child leaving home, you should probably file a new W-4 with your employer to reflect your current situation.

Tip #18
Baby's Social Security Number
If you had a baby last year, you need to get a Social Security Number for your child before you file your tax return. The IRS will not allow you to claim a dependency exemption, child tax credit or Earned Income Credit without a valid Social Security Number for your baby.

Tip #19
Child Support
Child support is not taxable income and does not need to be reported on your tax return. If you receive both alimony and child support and during the year you receive less than the amounts required, then the amounts received are first applied to child support. If the full amount of child support is received then any excess would be considered alimony and would be taxable as alimony income on your tax return.

Tip #20
Head of Household
If you can claim your parent as a dependent and you pay over half of the cost of maintaining your parent's household, then "Head of Household" filing status can be used on your tax return. Head of Household has better tax rates and a higher standard deduction than "Single" filing status. You can even claim Head of Household status when your parent is in a nursing home or lives in their own home.

Tip #21
IRS Audit Prevention
The IRS uses patterns and statistics in deciding which taxpayers to audit. By decreasing the red flags in your tax return, your chances of being audited or receiving and IRS notice are significantly reduced. Here are some of the red flags that you can avoid.

1. Make sure there are no math errors on your return. The easiest way to do this is to have a tax preparer do your return or to use tax software.
2. If at all possible, don't put down whole numbers such as $10,000 or $4,000 on your tax return.
3. Make sure that your tax return numbers match the 1099s you receive from your broker, employer, or investment company. EXAMPLE: Your 1099 from your broker shows $55,342 in gross proceeds from stock sales. If the only stock you sold during the year was through your broker, the gross proceeds shown on Schedule D of your tax return should be $55,342.

Tip #22
Loss on Sale of Home
You cannot deduct the loss on the sale of your home. There isn't a reporting requirement, so you don't need to report the sale of your home on your tax return. An exception to this rule is if the home is an investment property. If you are renting the home to someone else and are not using the home for personal purposes, then you would report the sale of your home on your tax return and deduct the loss.

Tip #23
Donations from your Paycheck
Remember to deduct charitable contributions withheld from your wages such as United Way contributions that you volunteered to have taken out of your paycheck. The amount of any charitable contributions taken out of your salary will usually be shown in box 14 of your W-2 along with a description of the donation. You can also usually find the amount on the last pay stub of the year.

Tip #24
Helping an Adult Child with their House Payment
If you are helping an adult child pay their mortgage and real estate taxes, don't directly pay the bills. Make a gift to your child and have them pay the mortgage and taxes. Unless you are a co-owner in the house, you are not entitled to take any mortgage interest or real estate taxes paid for your child's residence. Also, if you directly pay the bills, your child will not be able to deduct the interest and taxes on their tax return.

Tip #25
Automobile Expenses
You can either deduct your actual automobile expenses or you can use a standard mileage rate. The standard mileage rates for 2006 are 44.5 cents per mile for business, 18 cents per mile for medical travel or job-related moves, and 14 cents per mile for volunteer work for a charitable organization. Commuting expenses are not deductible. However, if you are commuting to a temporary work location, your commuting expenses could be deductible. Automobile expenses for a sole proprietorship business are deductible on Schedule C. Rental property auto expense goes on Schedule E. Job related auto expense goes on Schedule A as a miscellaneous itemized deduction. Automobile expense for your volunteer work for a qualified charitable organization is deductible on Schedule A as a cash charitable contribution. Medical care automobile expenses are deducted on Schedule A as medical expenses.