Tax Tips

It's
that time of year again. You should have your W-2 and
1099 forms in hand and your pencils sharpened. Hardly
anyone likes preparing their income tax return, but
you'll like it even less if you make mistakes and pay
more tax, penalties,
and interest than you need to.

Don't Miss Out on Deductible Tax- and Investment-Related Fees
If
you itemize your deductions on Schedule A, don't forget
you can deduct investment- and tax-related items like
investment
advisor fees, subscription costs of investment newsletters
(such as Morningstar Practical Finance), custodial
fees, and tax
advice and preparation fees, including electronic filing
fees. To be able to take advantage of these miscellaneous
itemized
deductions, they must total more than 2% of your adjusted gross income.

In
2004, if your adjusted gross income (the number
at the bottom of Page 1 of your 1040 income tax form)
was more than $142,700 ($71,350 if married filing separately),
you'll
start to be phased out of being able to take advantage of these miscellaneous itemized deductions.

For
more on miscellaneous
tax deductions, download Publication 529 on the Internal Revenue Service Web site, www.irs.gov.

Know Your Qualified Dividends from Your Nonqualified Dividends
I
bet a lot of you were frustrated last year when you
kept getting corrected 1099s from brokerage companies.
If you
received them after you had already filed your taxes,
you may have had to amend your return. This year promises
to be more of
the same.

The
problem seems to be that the brokerage firms are required
to send out 1099s by the end of January, but that
doesn't necessarily give them enough time to calculate
the "qualified" portion of dividends (or so they say).
Since the tax
treatment of qualified dividends may result in you
paying less income tax, the revised 1099 may be to
your advantage (although
in many cases, only by a small amount). So it may pay to wait a bit before filing your 2004 return.

Use
the IRS worksheet
found on Page 34 of the Form 1040 Instructions (www.irs.gov)
to help you crunch the numbers for qualified dividends
and
capital gains.

Watch Those Capital Gains and Losses
When
you sell an investment for less than you paid for it,
you realize a capital loss. The bright side is that
capital
losses can help you save on taxes. You can use capital
losses to offset--or net out--capital gains in your
portfolio.

Capital
losses are deductible dollar-for-dollar against capital
gains. In addition, individuals may deduct up to
$3,000 in capital losses each year against their taxable income.

You'll
need to know if your gains and losses are short-term
or long-term. If you held an investment a year or less,
it will be a short-term gain or loss. If you held an
investment longer
than a year, it will be a long-term gain or loss.

In
general, short-term capital gains are taxed at ordinary
income-tax
rates from 10% to 35%. Long-term capital gains, meanwhile,
are taxed at lower, preferential tax rates from 5%
to 15%. (Higher
capital gains rates apply to collectible and unrecaptured 1250 gains--see IRS Publication 550.)

In
general the netting
calculation is a two-step process:First, offset long-term
capital losses against long-term capital gains. That's
one account.
Then, offset short-term capital losses against short-term
capital gains. That's another account. If both accounts
are either
positive or negative after you've offset gains and
losses, stop here. If one account is negative and the
other positive, add
the two together.

If
both the short-term and long-term accounts have net
gains, then they retain their short-term and
long-term characteristics and will be taxed accordingly.

If
both the short-term and long-term accounts have net
losses, then
you can deduct up to $3,000 of those losses from your
income. Amounts in excess of the $3,000 may be carried
forward
indefinitely to use in future tax years.

If
you have one account that's positive and one that's
negative, just add the two
together--netting them against each other. If you have
enough capital losses, you can wipe out some or all
of your capital
gains for the year. As above, any unused losses can
be carried forward indefinitely. (Don't forget to carry
these forward to
Schedule D when you prepare the following year's tax return.)

IRS
Schedule D and its instructions walk you through this
process, but for more information read Publication 550.

Learn
When Muni Income Is and Isn't Exempt
If
you own municipal bonds, interest income you receive
is exempt from federal income tax. That income may
or may not be
exempt from state income tax. If the bonds are issued
in your state of residence, you usually won't have
to pay state and
local taxes on the interest. You can find out for sure
by contacting your state or the brokerage company where
you hold your
securities.

For
example, a New Yorker who buys a municipal bond issued
by the state of New York will not pay state or local
tax on the income. If the New Yorker buys a municipal
bond issued by a city in Massachusetts, however, he
or she will pay
state and local taxes on the interest.

Does
that mean all money you receive from municipal bonds
isn't subject to taxes? Not
necessarily. If you own a municipal-bond fund that
paid out capital gains, that money is taxable on your
federal and most
state returns. In addition, if you own municipals that
are classified as "private-activity" bonds, you may
be subject to the
Alternative Minimum Tax (AMT). You may want to consult an accountant about this type of bond.

To
see if you have both
interest income as well as capital-gains distributions, check the 1099 forms you received.

Exclude
Interest from U.S.
Government Securities
Don't
forget to exclude the interest from government securities
from your state income tax return. You can exclude
all
income from "direct" government securities (e.g., Treasuries).
Some states also allow you to exclude income from "indirect"
securities (e.g., agency bonds like GNMA, FNMA). To
know for sure, contact your state or the brokerage
firm where you hold
your bonds.

Some
mutual fund companies can be very good about sending
information on the percentage of your funds that are
invested in government securities. But I've also seen
situations where the fund company will provide this
information only if
you ask.

If
you didn't receive this type of breakdown when you
received your 1099 statements, visit your fund company's
Web
site to find the information. Or call the fund's customer service line.

A
version of this article appeared Feb. 5,
2004.