Calculation options add up to big difference

Decisions about how you file will affect how much tax you owe

GARY KLOTT GANNETT NEWS SERVICE

Originally published Sunday, March 17, 2002

How much of your income will end up being shared with the U.S. Treasury this tax season will depend in part on some of the decisions you make when filling out your 2001 income tax return.

As you work your way through the tax forms, you'll often face options for computing certain deductions and calculating the tax on various types of income. And some of these options can make a significant difference in your tax bill.

Mutual fund profits

For example, investors who decided to hedge their bets and cashed in some of their shares in a mutual fund last year might be able to minimize the tax bite by taking advantage of the "average basis" method for figuring their capital gain.

The averaging method can be a big help to investors who made a partial redemption of shares that were acquired at different times and different prices.

Unless you specifically instructed the fund manager at the time of the sale which specific shares to unload, the IRS generally makes you assume on your tax return that the first shares you acquired were the first shares sold. If your fund has steadily risen in value, this "first-in, first-out" assumption could result in the biggest taxable gain possible. (That's because the shares presumed sold would be those purchased at the lowest price.)

As an alternative, most mutual fund investors have the option of computing their gain based on the average cost of all shares in their account. If your fund has steadily risen in value, the average cost method will usually produce a smaller gain than the first-in, first-out method.

Roth IRA conversion

If you converted a traditional IRA to a Roth IRA last year, you have the option to undo the conversion this tax season. Some investors, particularly those who saw the value of their Roth IRA portfolio tank with the stock market, will find they can save a substantial amount of tax this way.

So long as you roll the money back into a traditional IRA by Oct. 15, the IRS will pretend as if the conversion to the Roth IRA never happened.

This option was mainly intended to help taxpayers who later discover that their income was too high to qualify for a Roth IRA conversion. (Only taxpayers with adjusted gross incomes of $100,000 or less are eligible to convert.) But a conversion can be reversed for any reason.

"If you've got Enron stock in there, I would guess you'd want to undo it," said David Rhine, regional director of family wealth planning at Sagemark Consulting in Rochelle Park, N.J.

Because funds converted to a Roth IRA are fully or partly subject to tax as if the money were withdrawn, reversing a conversion after your IRA portfolio has declined in value and then reconverting back to a Roth IRA will mean a smaller tax.

College credits

Parents whose income is too high to qualify for the Hope or Lifetime credits for their child's college tuition can claim the credit on the child's tax return. The one proviso is that the parents must forgo claiming a dependency exemption for the child on their tax return. Just make sure your child will receive enough benefit from the credit to make up for the loss of the dependency exemption.

Lump-sum pensions

Many older workers who received a lump-sum distribution from a company pension plan last year have two options to reduce tax on the payout. One is a 10-year averaging formula. The other is special capital gains tax treatment for the taxable portion of the distribution that represents the time you were in the pension before 1974.

The options are available to workers born before 1936.

Joint vs. separate returns

Married couples have a choice of filing a joint return or separate returns. Filing jointly will almost always result in a lower tax, says Thomas Pudner, personal financial planning manager at the accounting firm KPMG in McLean, Va. Probably the most common situation in which a couple might be better off filing separate returns is if one spouse had unusually large medical expenses, said Pudner.

Underwithholding penalties

If it appears you might be subject to an IRS penalty for failing to pay enough tax last year through withholding or quarterly estimated tax payments, you may be able to minimize the penalty or even escape it by filling out Form 2210, "Underpayment of Estimated Tax."

Taxpayers aren't required to fill out the form. In fact, because the form is lengthy and complicated, the IRS instructions invite taxpayers to skip the form and let the IRS compute the penalty for them. But you may be able to save some money by filling out the form.

The form allows you to compute your penalty using a different formula than the IRS will. One alternative formula that helps many people reduce the penalty is the "annualized income installment method," which can be a salvation for workers who didn't receive income evenly throughout the year.

Check EIC eligibility

Low- and moderate-income workers should be sure to check their eligibility for the earned income tax credit, which is one of the most valuable tax breaks. About 25 percent of households eligible for the credit fail to claim it, according to the General Accounting Office.

The income-eligibility limits for the credit have been raised for 2001 returns. The credit has also become more valuable.

Help with filing

IRS office

The South Sound Internal Revenue Service office is at 402 Legion Way S.E. in downtown Olympia. The office is on the third floor and is open 8 a.m. to 4:30 p.m. weekdays.

Staff at the Olympia office will help you prepare 1040EZ and 1040A forms, and the following 1040 forms: Schedule A/B, Schedule EIC, Schedule H, Schedule R, Form 2441 (child-care credit) and Form 8812 (additional child tax credit).

The office staff will not prepare Schedule C and D forms or partnership or corporate returns.

By phone

- TeleTax: 800-829-4477. Call for recorded tax information for nearly 150 tax topics and for automated refund information.

- Tax help: 800-829-1040. Often your tax questions can be answered by reading tax forms, but more help is available here 24 hours a day, seven days a week.

On the Web

- IRS: www.irs.gov

- National Taxpayers Union: www.ntu.org

- AARP also has a Web site at www.aarp.org/taxaide

The Olympian Copyright 2002

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