THE COLOR OF MONEY
It's never too early to start preparing income tax returns
By Michelle Singletary
Have you recovered from filing your 2004 tax return? If so, get ready for next year.
And no, I'm not kidding.
"Everybody worries about filing their taxes at the end of the year but in reality they need to be working on their 2005 tax return now to do what they can to minimize their taxes for the year," said David Bergstein, a CPA and business development manager for CCH Tax and Accounting, a provider of tax and accounting software and services.
I agree. We need that long to figure out what to do and how to do it correctly.
In fact if there were an exam on basic tax issues, from selling a home to investing and saving for their retirement or a child's college education, most taxpayers would fail, according to a survey commissioned by CCH CompleteTax, an online arm of CCH Tax and Accounting.
What didn't people know?
• How many years must you live in your home to qualify for the capital gains exclusion on the sale of the home?
Only 16 percent of U.S. adult taxpayers knew that you must live in your home two of the last five years to qualify for the capital gains exclusion of $250,000 ($500,000 if married filing jointly) when you sell your property. Taxpayers 55 and older were more likely than those under 55 to answer correctly; still, only 24 percent in the older age group identified the correct answer, versus 12 percent of those under 55.
• Can you correctly identify education savings programs with tax benefits?
Most taxpayers (77 percent) couldn't. They include the Hope Credit and the Lifetime Learning Credit, for people who pay higher education costs. There is also the Coverdell Education Savings Account and state-sponsored 529 plans, where earnings grow tax-deferred and withdrawals are tax-free if used for approved education expenses. For more information get IRS Publication 970, "Tax Benefits for Education."
• Can you carry over capital gains to offset investment losses?
Sixty-seven percent of those surveyed didn't know. Only 9 percent knew that investors cannot carry over gains to offset loses. When you sell a capital asset, such as stocks, the difference between what you sell it for and what you paid for it is treated for tax purposes as either a capital gain or a capital loss. You have to report all capital gains. You can only deduct capital losses. If your capital losses exceed your capital gains, the amount of the excess loss that can be claimed is limited to $3,000, or $1,500 if you are married filing separately. If your net capital loss is more than this limit, you can carry the loss forward to later years.
• From which retirement plan, if any, can you take tax-free distributions?
Only 27 percent of taxpayers correctly said that distributions from Roth IRAs are tax-free.
If you didn't know the answers to the questions, don't feel bad. It's understandable. But try to inform yourself.
Here are some things to keep in mind for 2005:
• IRA contribution limits increase to $4,000, up from $3,000 in 2004. If you're 50 or older there's a $500 catch-up contribution, so you can put away $4,500.
• Simple IRA contribution limits increase to $10,000, up from $9,000 in 2004. Catch-up contributions increase to $2,000, up from $1,500 in 2004.
• 401(k), 403(b) and 457 plan contribution limits increase to $14,000, up from $13,000 in 2004. Catch-up contributions increase to $4,000, up from $3,000 in 2004.
• Unless the tax code is changed again, this is the last year educators can deduct up to $250 of expenses paid for purchases of books and classroom supplies.
• The rate for operating your car (including vans, pickups or panel trucks) increases to 40.5 cents, up from 37.5 cents a mile, for all business miles driven.
• The IRS says the average refund was $2,117. If you had a really large refund or you had to pay more tax because not enough was withheld, consider changing your W-4 form.
Michelle Singletary writes for the Washington Post.
