David Gardner: Five biggest misses I see on tax returns – Boulder Daily Camera
With tax season (finally) over and preparers enjoying a well-earned rest, it may not be your first thought to review your tax return. We look at many of them in the busy season. While most are in good shape, pay close attention to these areas to make sure your careful tax planning results in actual savings.
State-specific tax breaks: Most states have their own tax breaks that may not be familiar to most filers. In Colorado, we benefit from a retirement pension subtraction for those who have reached age 55 by the end of the tax year. This subtraction is up to $20,000 per person (or $24,000 for those who have turned 65). It reduces income taxes for those collecting Social Security or a pension, and those with IRA distributions including Roth conversions.
Colorado also has a very generous 529 college saving plan contribution deduction, although there are proposals to limit it to $15,000 per beneficiary for married couples. In addition, Colorado permits deducting charitable contributions even if you don’t itemize your federal taxes. Finally, through this year there are state income tax benefits for electric and plug-in hybrid vehicles. This is not an exhaustive list, but it emphasizes the importance of knowing your state’s income tax landscape.
Company stock options and equity: In terms of the magnitude and the complexity of the issues, nothing compares to transactions related to company stock. First, when it comes to exercising incentive stock options (ISOs) you need to make sure that Alternative Minimum Tax is computed, the minimum tax credit is carried forward to the following years, and then the credit is used when you sell the shares.
When selling restricted stock, avoid double taxation and make sure the wage income recognized when you received the shares is factored into the calculation when selling them. The same thought applies to an employee stock purchase plan. You need to consider the amount you paid for the stock and the discount, which was taxed as employment income, when computing your profit when you sell shares. Finally, if you’re fortunate enough that your company qualifies for qualified small business stock treatment, your tax preparer should know because you may not owe any tax on a stock sale at all.
Backdoor Roth gone awry: Don’t get me wrong, I love backdoor Roth IRAs. They allow many higher earners to fund a Roth IRA every year without paying additional tax, as long as the tax forms are prepared correctly. The law requires that you first make a non-deductible IRA contribution and then convert those funds into a Roth IRA in a separate step. If you’ve made a proper backdoor Roth IRA contribution, it should not appear as a taxable distribution on line 4b on the first page of Form 1040. If you see a suspiciously round number on that line such as $12,000, it’s possible that you’re being wrongly taxed.
The dreaded zero basis: If you’re selling investments outside of a retirement plan, IRA, or other tax-advantaged account, then you’ll owe capital gains taxes on your profit. The issue can arise where the basis of a stock is indicated as “missing.” The financial company has somehow lost track of the cost of your investment. Also if you have inherited investments, generally you get to reset the cost basis to its value at the date of the donor’s death or six month afterwards. You need to let the investment company know that the basis needs to be updated. In cases where basis is missing or wrong, it’s important to research this so you don’t pay taxes on gains that don’t exist.
Educational benefits: These can be hard to optimize for tax preparers. If you’re taking 529 plan distributions to pay for undergraduate costs, they should be matched up with college expenses to avoid taxes and penalties. If you qualify for the American Opportunity Tax Credit or Lifetime Learning Credit, you could receive $2,500 in tax credits per year. But don’t double dip and use the 529 plan money to pay for those same college expenses that qualify you for the credit.
Remember that when it comes to taxes that a mistake is not forever. You can amend your tax return up to three years after the filing deadline. If you catch an error you probably have time to fix it.
David Gardner is a Certified Financial Planner professional at Mercer Advisors practicing in Boulder County. The opinions expressed by the author are his own and are not intended to serve as specific financial, accounting, or tax advice. They reflect the judgment of the author as of the date of publication and are subject to change.