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Last Minute Tax Tips

The Wall Street Journal

• Updated March 31, 2012, 4:07 p.m. ET

Last-Minute Tax Tips

• By LAURA SAUNDERS

The tax filing deadline, April 17, is coming up soon—and experts say this year’s returns are littered with potential land mines.

Among them: a new form for reporting foreign financial assets (with large penalties for not filing) and a new form for small businesses reported on individual returns that will make it easier for the Internal Revenue Service to find unreported income.

But the biggest new hurdle involves capital gains on investments. Tax preparers say they are finding serious snafus involving “cost basis,” or the amount an investor paid for a stock he later sold.

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Eric Palma

This is the first year brokers have been required to provide this information to the IRS. In the past, the agency often took investors’ word for it.

Congress changed the rules in 2008 after studies showed that many taxpayers were misstating their investments’ cost basis. That number is the starting point for measuring a taxable capital gain after an investment is sold; if it is too high, taxes will be too low.

Now brokers must track and report cost basis both to the IRS and to clients. The law took effect in 2011 for stocks bought and sold last year, and the coverage will expand to mutual funds and beyond in the future.

Tax preparers say this year’s snafus involve data reported to the IRS that are sometimes incorrect and often don’t match investors’ own records. They fear that mismatches could trigger unnecessary IRS scrutiny.

The problems arise in several ways. For certain transactions, reporting requirements for brokers are less stringent than those for filers. What’s more, the IRS hasn’t stipulated how data must be presented, and firms do it differently.

And some brokers are reporting more information than is necessary. While not all of it is sent to the IRS, all of it might download into a tax-prep program. Or none of it might download, requiring laborious calculations by hand.

“There’s no consistency in how brokers are reporting information, so it’s taking a lot of extra time to do returns,” says Daniel Moore, a CPA at D.T. Moore & Co. in Salem, Ohio.

It is up to taxpayers to explain any discrepancies between a broker’s report and their tax returns. The bigger the discrepancy, the more scrutiny is likely.

Friday’s Mega Millions jackpot winner may want to live like a rock star, but advisers say he or she shouldn’t invest like one. Jonnelle Marte has details on Lunch Break. Photo: Getty Images.

The upshot: If you still are racing to file your tax return before April 17, slow down and take a long look at your 1099-B, the form that reports cost basis. If it doesn’t match your records or the broker’s trade confirmations, you might want to get an automatic six-month filing extension so that you can iron out the discrepancies. (The extra time is available simply by filing IRS Form 4868.)

Darren Neuschwander, a CPA and co-head of Green NFH in Robertsdale, Ala., says he is reluctant to sign returns given the current confusion. Mr. Neuschwander estimates that 80% to 85% of his more than 1,000 stock-trading clients have incorrect or inconsistent 1099-B forms. He expects to file extensions for most of them to work out glitches.

Robert Green, also a co-head of Green NFH, says the problem isn’t limited to people who make hundreds of trades in a year. “We had a client who only made seven stock trades last year, but on the 1099-B six out of seven didn’t match the broker’s trade confirmations,” he says. Both accountants say they have seen issues with every brokerage firm their clients use.

A spokesman for Fidelity Investments says the firm has identified some technical issues, but that less than 2% of the firm’s brokerage clients “have experienced an incorrect cost basis report for a limited period of time.” He adds that customers “can expect to receive accurate information in time for tax filing purposes.”

A spokesman for Charles Schwab SCHW +1.22%says the firm “hasn’t seen widespread issues” concerning the 3.2 million 1099-Bs it has sent out this year.

For taxpayers with questions, the broker usually gives a number to call on the 1099-B it sends to customers. One good question to ask your broker: Will there be any further corrections to this form? Waiting until information is complete could prevent your having to file an amended return.

There is a larger lesson here: With the IRS, an ounce of prevention is often worth a pound of cure, so smart taxpayers carefully check all the “third-party reports” providing information about them. Correcting mismatches, even if it means getting an extension, can keep you under the radar.

Forms to Double-Check

Tom Bloom

In addition to the 1099-B and W-2 wage statements, these are the most common third-party reports providing information about you to the IRS.

1099-C. This form covers canceled debt, such as from a home mortgage modification or bankruptcy. Forgiven debt is often taxable, but special relief may be available to home owners and taxpayers who are insolvent. See Publication 4681 at www.irs.gov.

1099-Div. Pay close attention to dividend payments. “Qualified” payouts—usually on shares held longer than two months—have a top tax rate of 15%, while the top rate jumps to 35% for nonqualified dividends.

What many taxpayers don’t know is that if a broker lends their stock and pays a dividend equivalent instead of the actual dividend, it isn’t qualified and so is taxed at the higher rates.

1099-G. This form covers state-tax refunds and other government payments. Refunds are usually taxable, unless you didn’t itemize or owed alternative minimum tax for the year.

1099-Int. This covers interest you earned. Even if you don’t receive a form, you may still owe tax. Examples: accounts earning less than $10 annually; interest from private loans to a relative.

1099-K. For individual returns reporting a Schedule C business—such small shop or restaurant—this new form shows payments received from third parties—credit- or debit-card firms, PayPal and the like.

While the IRS won’t make the business owner distinguish these payments from ones made in cash on the tax return, the agency now has the right to use this information when it is looking for unreported income—so taxpayers cutting corners should take note.

1099-Misc. This covers miscellaneous income, as opposed to wages earned by an employee. Check whether the income is subject to self-employment tax: An executor’s fee often wouldn’t be, while a payment for consulting work would be. For more information, see the instructions to Schedule SE at www.irs.gov.

1099-Q. Education account distributions, such as from 529 plans, are reported here. Try to make withdrawals in the same tax year as the expense is paid to avoid IRS questions.

1099-R. This form covers pension or IRA distributions. Check whether federal income tax has been withheld already in order to avoid a tax overpayment.

1098. This form is for mortgage interest you paid. The lender has to report only interest payments over $600, but you can still take a deduction for lesser amounts. Remember also that origination fees, or “points,” are deductible only on a first mortgage on a principal residence; with refinancings the deductions are spread over the loan’s life.

1098-E. This form is for student-loan interest paid. Most joint filers with adjusted gross incomes less than $150,000 (or $75,000 for single) can deduct up to $2,500.

Tax-Wise Moves You Can Still Make in 2011

Tom Bloom

Make contributions to a regular or Roth IRA by April 17. The upper limit to put in is $5,000 ($6,000 if you are 50 or older), and you must have earned income at least equal to the contribution.

Regular IRA contributions are usually tax-deductible, but withdrawals are taxable. Roth account contributions aren’t deductible, while withdrawals are usually tax-free. Income and other limits apply for both.

Taxpayers stymied by the limits can do a “backdoor” Roth IRA: put up to $5,000 ($6,000, 50 or older) in a “nondeductible” regular IRA, and then convert it to a Roth account soon after. Income taxes are due on the conversion, but they will be minimal because the account won’t have earned much.

Contribute to SEP IRA and other pension plans. Unlike with regular IRAs, deductible contributions to SEP IRAs and other pension plans may be made until Oct. 15 for taxpayers with filing extensions.

Contribute to health savings accounts. You may deduct up to $6,150 per family ($3,050 single) for a health savings account if you had an approved “high-deductible” health plan linked to the health-savings account. The contributions may be made until April 17.

Oft-Overlooked Tax Benefits

Tom Bloom

Charitable gifts, part one. Employees who donate to charities via payroll deduction often forget to include the donations on their personal tax returns. The number isn’t on the W-2 form, notes Melissa Labant of the American Institute of CPAs, and often there is no letter from the charity.

Charitable gifts, part two. Donors may not deduct their labor or time, but they may deduct mileage or uniforms. For 2011 the allowance is 14 cents a mile. Board members or certain others may also deduct unreimbursed expenses for attending a conference. See IRS Publication 526.

Medical expenses. The hurdle here is high—7.5% of adjusted gross income (10% if the taxpayer owes alternative minimum tax). But the array of qualified expenses is far broader than what insurance typically reimburses, extending to breast reconstruction after cancer surgery, tuition for student with severe learning disabilities and acupuncture, among other expenses. For a list, see IRS Publication 502.

If one partner of a couple filing jointly has high bills, it may make sense for the couple to pick the “married, filing separately” status. It’s one of the few times going this route can lower the total tax bill.

Sales-tax deduction in lieu of income-tax deduction. Taxpayers in states without an income tax, such as Texas, Nevada, Wyoming and Washington, routinely take this deduction. It also may make sense for taxpayers with a low state income-tax bill but an outsize purchase or two—such as a car, boat or engagement ring—that incurs high sales taxes.

New Forms This Year—and Why They Matter

Tom Bloom

Form 8938. This is for U.S. taxpayers with foreign financial accounts above a certain threshold, which can be as low as $50,000.

Covered assets include bank and brokerage accounts; foreign retirement accounts; direct and indirect ownership of partnership interests, such as offshore hedge and private-equity funds; and offshore pensions and annuities.

The penalties for not filing are harsh: up to $10,000 for each 30 days.

Note also that this form, which is due with the tax return, often must be filed in addition to the Foreign Bank Account Report, which is due to the U.S. Treasury Department by June 30.

Form 8949. Investors must fill out this form with information from 1099-B forms provided by brokers (described earlier), in order to complete Schedule D, Capital Gains and Losses. Often multiple versions will be required, depending on whether the broker reported the taxpayer’s cost basis to the IRS or not.

Errors to Look Out for This Year

Forgetting Roth IRA conversion income from 2010. Taxpayers who converted regular IRAs to Roth accounts in 2010 got a one-time boon: Pay tax on half the income in 2011 and half in 2012.

That first installment is due this year, but taxpayers are on their own because there is no official reminder.

Forgetting to repay a first-time-homebuyer tax credit. Congress passed different versions of this benefit during the financial crisis. The 2008 version is a loan that must be repaid over time. It and other versions may have to be repaid if the taxpayer moves.

A version of this article appeared Mar. 31, 2012, on page B7 in some U.S. editions of The Wall Street Journal, with the headline: Last-Minute Tax Tips.

Top Five Tax Breaks Every Small Business Owner Needs to Know

Small business owners, including entrepreneurial start-ups, franchises and mom-and-pop stores, are the cornerstone of the U.S. economy. According to the U.S. Small Business Administration, there were more than 27 million mom-and-pop and other small businesses in the U.S. in 2011. These small businesses typically account for more than 60 percent of all net new U.S. jobs. To support and encourage small business growth and hiring, the government has created billions of dollars in tax relief, including the Small Business Jobs Act, the HIRE Act and the Tax Relief and Job Creation Act.

In observance of National Mom-and-Pop Business Owner’s Day, on March 29, we are recognizing mom-and-pop and other small business owners with important tax tips and advice to help them achieve the best bottom line on their business and personal taxes.

The following five tax breaks small business owners should keep in mind when filing a return this tax season:

1. Married business owners – If you and your spouse operate a business together and file a joint return, you may be able to be treated as sole proprietors instead of as a partnership. A partnership requires a federal tax identification number even when there are no employees, potentially registering the business with the state for a fee, and a separate tax return for the business. Filing as two self-employed individuals is faster because the business filing is part of the personal tax return, there is no requirement for a federal tax identification number when there are no employees, and there is generally no registration requirements at the state level;
2. Healthcare insurance - If you pay for medical insurance for yourself, your spouse and your dependents, up to 100 percent of that expense may be deductible. This deduction can be claimed whether or not you itemize deductions on your return and is subtracted directly from your total income;
3. Business property – If you purchased any equipment, machines or other business property in 2011, you may be able to deduct the full cost on your 2011 tax return;
4. Payroll - The wages and expenses of having an employee are deductible for a small business. These expenses include: the business share of Medicare and Social Security taxes; unemployment compensation; worker’s compensation insurance; and, employee related benefits; and,
5. Travel - If you use a personal vehicle for business purposes, you may be able to deduct the associated expenses. To claim this deduction, it is critical to keep track of the mileage on the vehicle from the first day of the year, or the first day the vehicle is used for business, through the end of the year, or the last day of the calendar year the vehicle is used for business.

Tax Considerations Not to Miss As Deadline Nears

Many U.S. taxpayers leave valuable tax refund dollars on the table each year by failing to claim all of the credits available to them on their annual income tax returns. Working with a tax preparer who is up-to-date on the tax code can help identify all of the applicable credits, such as those related to dependents, education and retirement fund contributions.

Like tax deductions, credits serve to reduce the amount of tax an individual pays. Unlike tax deductions, which are a reduction in the amount of a taxpayer’s income that is subject to tax, credits serve to allow a direct reduction of the tax due, lowering an individual’s tax burden dollar for dollar.

When filing a 2011 tax return, we advise taxpayers to pay close attention to these five commonly overlooked credits:

1. Earned Income Tax Credit – This credit provides eligible individuals and families with low to moderate earned income with up to a $5,751 refundable credit for those who qualify. The credit is available for taxpayers with or without children and is based on income earned from wages, tips, salary and self-employment;
2. Child and Dependent Care Credit – Taxpayers who worked and had dependent care expenses for a dependent child under age 13, or for a dependent or disabled spouse, may be able to claim a credit for these expenses. This nonrefundable credit is calculated based on dependent care expenses and income. It can reach a maximum of $1,050 for the expenses for one qualifying child, or $2,100 for more than one child;
3. American Opportunity Tax Credit – Parents who are paying a child’s qualified tuition and related higher education expenses may be able to take advantage of the American Opportunity Tax Credit, which requires the student to be enrolled at least half-time in one of the first four years of post-secondary education. If the student does not meet the requirements for the American Opportunity Credit, taxpayers may be able to claim the Lifetime Learning Credit. However, taxpayers cannot claim both a Lifetime Learning Credit and the American Opportunity Tax Credit for the same student in the same year;
4. Residential energy efficient property credits – To qualify for the credits, the home must be the taxpayer’s principal residence, located in the U.S., and the property or improvements must have a reasonable life expectancy of at least five years. These credits are available on the installation of solar water heating systems, solar energy production systems and qualified fuel cell power plants, among other energy efficiency improvements;
5. Retirement savings contributions – Taxpayers who contribute to an IRA or an employer-provided retirement account, such as a 401(k), may be eligible for a credit based on up to $2,000 of their contribution for the year. This is in addition to any deduction or exclusion from income for the contribution.