Finance Tax Time

Based on comments and questions I have received from clients and readers it appears that there is still some confusion about the rules for taxing gain on the sale of a personal residence. Many people think the “old rules” still apply.

THE OLD RULES:

In order to postpone paying income tax in the current year on gain from the sale of your personal residence you had to “buy up” - purchase, or build, a new home that cost more than the sale price of your old home - within 2 years of the date you closed on the sale of your old home. The tax was deferred for as long as you continued to “buy up”, or until you sold your last home.

Homeowners age 55 and older could make a once-in-a-lifetime election to exclude up to $125,000.00 in gain.

These rules no longer exist!

THE NEW RULES:

Thanks to the Tax Reform Act of 1997, if you sold your personal residence after May 6, 1997 you can totally exclude from income tax up to $250,000.00 of gain if single, or $500,000.00 if married, regardless of your age at the time of the sale, if during the 5 years prior to the sale you owned and lived in the home for a total of 24 months (they do not have to be consecutive). This exclusion is not a one-time election - it is available once every 2 years.

If you are married and sell your home, which you and your spouse owned and lived in for 3 years, and realize a gain of $475,000.00 you do not have to pay any income tax on this gain. If the net gain is $525,000.00 you will only pay tax on $25,000.00 at the appropriate capital gains rate.

If you do not own and live in the home for a full 24 months you may still be able to exclude some, or all, of the gain if you had to sell the residence because of certain IRS-approved special circumstances.

You should still keep the original closing statement for the purchase of your home for as long as you own it, and maintain documentation on all capital improvements made to the home over the years just in case.

Robert D Flach is a tax professional with 34 tax seasons of experience preparing 1040s for individuals in all walks of life. He writes THE WANDERING TAX PRO weblog (http://rdftaxpro.tripod.com/weblog), the free monthly online newsletter STUFF AND SUCH (http://rdftaxpro.tripod.com/stuffandsuch) and the website http://www.robertdflach.net, with a wealth of tax planning and preparation advice and information. He also writes and publishes THE FLACH REPORT, a quarterly print tax newsletter. The above article is taken from a posting to THE WANDERING TAX PRO.

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Have you seen that ad for tax preparation software? You know the one I mean. It says that anyone, even a caveman - no, wait, that is a different commercial - even a “math impaired” or an “unorganized” individual can prepare his or her own income tax return by simply using the software package.

This is pure bull! No tax preparation software is a substitute for knowledge of the tax code. And no tax preparation software is a substitute for the services of a trained tax professional.

As with any software program the rule is “garbage in - garbage out”. If you don’t know how to enter the information, or what information to enter, you will not get the best, or even the correct, answer.

As a professional tax preparer I attend several tax preparation workshops, seminars, conferences and conventions during the year. I am constantly hearing instructors and participants alike discuss the problems with their tax preparation software, the answer often being that one has to override the system and “force” the correct entry.

IRS statistics indicate that taxpayers using do-it-yourself tax software spend an average of between 6 and 10+ hours longer preparing their tax returns (depending on the number of worksheets and schedules) than preparers who did manual calculations. Further, the IRS estimates that do-it-yourself software users spend an average of 10 to over 20 hours longer than a tax preparer, again depending on complexity.

H+R Block has sued the company that produces the tax software in the above mentioned ad, and has asked a federal judge to shut down the advertising campaign.

The bottom line is - if you don’t know what you are doing do not rely on a tax preparation software package to make up for your lack of knowledge. Using a tax professional will save you time, aggravation and money!

Speaking of tax season ads, the commercials for the Henry + Richard and Jackson Hewitt fast food tax preparation chains continue to emphasize the fact that you can walk into their office and walk out with a check, and not that they can prepare your return competently and accurately so that you pay the absolute least amount of tax possible (to be fair, H+R does have an ad that tells you they will pay the interest and penalty for their mistakes).

These chains are pushing Refund Anticipation Loans (RALs), which are very profitable. While a great thing for Henry + Richard and Jackson Hewitt, a Refund Anticipation Loan is NOT a good thing for the individual taxpayer. It is nothing more than a short-term loan at a usurious interest rate. The interest rate on some of these RALs is triple-digit, similar to a loan shark. A recent Washington State Journal article reported that the interest rate could be as high as 521%, with more than 10% of the refund going to fees!

Henry + Richard have gotten into a lot of legal trouble with their RAL programs. In December H+R Block reached a $62.5 Million settlement with an estimated 8 Million customers in more than two dozen states over Refund Anticipation Loans. But they continue to aggressively promote RALs during the tax season because of the huge profits.

Unfortunately, Refund Anticipation Loans appeal most to, and take unfair advantage of, the working poor and other low-income taxpayers who need every penny of their tax refund.

If you need your refund quickly use direct deposit. With direct deposit your refund should be deposited into your bank account within 10 days. If that is not good enough investigate other methods of short-term borrowing. Even a cash advance from a credit card is “more better” than a Refund Anticipation Loan, providing you pay back the advance as soon as the refund arrives.

copyright (c) 2006 by Robert D Flach LLC

Robert D Flach is a tax professional with 34 tax seasons of experience preparing 1040s for individuals in all walks of life. He writes and publishes the free monthly online newsletter STUFF AND SUCH (http://rdftaxpro.tripod.com/stuffandsuch) and several other websites, as well as several print newsletters and reports on tax planning and preparation. For more information on his websites go to http://rdftaxpro.tripod.com/websites

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Jimmie Clemons, retired, received a Form W-2G reporting $44,800.00 in winnings from a casino. As his gambling losses for the year were more than $44,800.00, he did not report any winnings or losses on his 1040.

The Tax Court, in Jimmie L Clemons T.C. Summary Opinion 2005-109, upheld the IRS position that gross gambling winnings must be reported as income on Page 1 of the tax return, with losses, to the extent of winnings, allowed as a “miscellaneous” Itemized Deduction. The losses can be deducted in full on Schedule A, and are not subject to the 2% of AGI exclusion.

While Jimmie was able to deduct $44,800.00 in losses to wipe out his $44,800.00 of income, the fact that the winnings were included in his Adjusted Gross Income caused 85% of his Social Security benefits to be taxed!

As a tax professional with a practice in New Jersey, and my share of regular lottery players and senior citizens who frequent the casinos of Atlantic City as clients, I have seen many examples where a taxpayer with net gambling losses for the year is royally screwed by “Uncle Sam”.

* Because of the way Social Security and Railroad Retirement benefits are taxed, there often exists a situation where you would be taxed on $1.85 for every additional $1.00 of income. If you have $3,000.00 in gambling winnings and $4,000.00 in substantiated gambling losses you could end up increasing your AGI by $5,550.00 ($3,000.00 x 185%). Even if you can take full advantage of an itemized deduction of $3,000.00 in losses, you still could end up paying $383.00 in federal income tax in the 15% bracket, or $638.00 in the 25% bracket, on a net loss for the year of $1,000.00.

* Even if you can deduct enough losses to wipe out your gambling income, an increased AGI could reduce your allowable medical and miscellaneous job and investment related deductions, reduce or even wipe out a multitude of deductions and credits that are affected by AGI, and even cause you to fall victim to the dreaded Alternative Minimum Tax (AMT).

* You can only receive the full tax benefit from deducting gambling losses if the total of your other Itemized Deductions equals or exceeds the allowable Standard Deduction. What if a single taxpayer with $5,000.00 in winnings and $6,000.00 in losses has only $2,000.00 in other deductions (i.e. state and local taxes and charitable contributions). While he can deduct $5,000.00 in gambling losses, he only gets a tax benefit for $2,000.00 of the losses: $5,000.00 losses + $2,000.00 other deductions = $7,000.00 Schedule A - $5,000.00 Standard Deduction = $2,000.00 tax benefit. If he is in the 25% bracket he still ends up paying $750.00 in federal income tax on $1,000.00 in losses.

I should point out that losses from any type of wagering transaction can be deducted against your gambling winnings. If you win in the slots your deduction is not limited to losses from slot machines. You can deduct losses from the lottery, 50-50s, bingo, table games such as poker and blackjack, charity raffles, horse racing, keno, etc., up to the amount of your total winnings. It is a good idea to keep your losing lottery, raffle and racetrack tickets for the year, and keep track of slot activity by using a player’s card, in case you make a big score. If you are unlucky enough to be chosen for an audit of your losses here is a word of advice - make sure your losing racetrack tickets to not have footprints on them.

You should also know that winnings from a “no purchase necessary” marketing sweepstakes or contest are not considered to be gambling winnings for the purpose of calculating deductible gambling losses. The IRS defines gambling winnings as winnings from a “wagering transaction”. A recent IRS “Technical Advice Memorandum” (TAM 200417004) states that such winings are not gains from a “wagering transaction” because the winner did not furnish “consideration” for the chance to win the prize. If you win the Publisher’s Clearing House sweepstakes, or a trip to Club Med by being the 10th caller to a radio station, you must report the winnings, or the market value of the trip, as income on your Form 1040, but you cannot deduct any losing lottery tickets, slot machine losses, or any other kind of gambling losses against this income.

The unfair way gambling winnings and losses are treated on the 1040 is similar to the unfair way most taxable legal awards and settlements and the related legal fees are treated. Let us hope that the President’s Advisory Panel on Federal Tax Reform will address these inequities in the tax code in its report.

Robert D Flach is a tax professional with 34 tax seasons of experience preparing 1040s for individuals in all walks of life. He writes THE WANDERING TAX PRO weblog (http://rdftaxpro.tripod.com/weblog), the NJ TAX PRACTICE BLOG (http://rdftaxpro.tripod.com/newjerseytaxpractitionernetwork), and the website http://www.robertdflach.net, which has a wealth of tax advice and information. He also writes and publishes THE FLACH REPORT, a quarterly tax newsletter. The above article is taken from postings to THE WANDERING TAX PRO.

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