Tax surprises for the unsuspecting

By HELEN HUNTLEY

© St. Petersburg Times, published February 25, 2001

It isn't what's new about the tax law that is likely to surprise taxpayers this year. Rather, it is some of the old stuff they never realized was there.

Here is a look at some tax facts that frequently trip up the unsuspecting:

TAXES DON'T STOP WHEN YOU RETIRE. When you stop working, you no longer pay Social Security tax on your income, but you may have to pay income tax on up to 85 percent of your Social Security benefits. To figure out how much, the IRS thoughtfully provides a complicated work sheet with the instructions for your tax return.

BUYING A HOUSE WON'T SAVE AS MUCH IN TAXES AS YOU THINK. To deduct your mortgage interest and real estate taxes, you have to itemize deductions, which means giving up the standard deduction. Your only real benefit is from deductions in excess of the standard deduction, which this year is $4,400 for singles and $7,350 for a married couple under 65.

THAT CHARITABLE DONATION YOU MADE MAY NOT BE DEDUCTIBLE. A lot of people get caught on this one because deductibility can be lost for many reasons. Under current law, charitable contributions only count if you itemize (see "Buying a house," above). Then the charitable deduction permitted in any one year is limited to 30 percent or 50 percent of your income, although the excess can be carried over to future years. Finally, high-income taxpayers may lose up to 85 percent of their deductions. Check with a tax expert before writing that $1-million check to your alma mater.

YOUR HIGH SCHOOL KID JUST LOST HIS TAX CREDIT. Few 17-year-olds are self-supporting, but their parents don't get to take the $500 child credit. It's available only for children 16 and younger.

YOU NEED TO KNOW WHAT GRANDPA PAID FOR THAT STOCK. If you received stock as a gift, your tax basis depends on what the donor paid for it. Only inherited stock gets a new basis. If you don't have records, the IRS requires you to make a good faith effort to reconstruct the basis or pay tax on the entire proceeds when you sell.

YOUR CAPITAL GAIN MAY BE TAXED AT 28 PERCENT OR MORE. While long-term capital gains are taxed at no more than 20 percent, short-term gains are taxed at the same rate as your other income. Holding a stock at least 12 months is the way to avoid this unpleasant surprise.

THERE IS NO 10 PERCENT DEDUCTION FOR CHARITY. Many taxpayers are under the mistaken impression that the IRS allows a reasonable deduction for charitable contributions even if nothing was given. Not only do you have to give the money, but if you are audited, the IRS will want proof of your gift. Contributions of $250 or more require a written acknowledgement from the charity. Even small contributions require some evidence, such as a receipt, a canceled check or statement.

YOU OWE TAXES ON THAT MUTUAL FUND EVEN THOUGH YOU'VE LOST MONEY. The value of your fund may have gone down, but dividends and capital gains distributions still are taxable. If you reinvest dividends, keep good records to avoid paying taxes twice on the same money.

HOME OFFICE EXPENSES ARE DEDUCTIBLE AGAIN. For years, taking a deduction for a home office was an invitation for an IRS audit. Now the law is more accommodating, but many people don't realize it. In most instances, the office still must be used exclusively for business on a regular basis.

EDUCATION CREDITS AREN'T JUST FOR KIDS. If you go back to school for more education, the Lifetime Learning Credit will reimburse you for 20 percent of your tuition bills, up to $1,000. It's the more generous Hope Scholarship Credit that is limited to tuition expenses for the first two years of college.

THE EARLY BIRD GETS TO CLAIM THE DEPENDENT. A child can be claimed as a dependent on only one tax return, which can be a sticky issue when parents are divorced. The general rule is that the exemption goes to the parent who has custody for the greater part of the calendar year, although that parent can agree in writing to give it up. But as a practical matter, the first parent to claim the exemption gets it. The other parent then has to prove entitlement and wait for a refund while the IRS straightens things out.

ALL OF YOUR INTEREST INCOME HAS TO BE REPORTED. The IRS only expects an itemized list if your interest income is $400 or more. That leaves some people with the idea that they don't have to sweat the small stuff. That would be wrong. If you got a 1099 form, chances are good that the IRS knows about the income and will check your return for a match. The only break: If your interest income adds up to less than $400, it can be reported in one lump sum.

YOU OWE WAY MORE THAN YOU THOUGHT.This unpleasant surprise sometimes occurs when people change their lives without changing their withholding or estimated taxes to match. Get married? If both of you work, you're likely to get hit with a marriage penalty because your combined incomes will put you in a higher tax bracket. Take a second job? You'd better ask for extra withholding because taxes will be higher on additional income than they would be if this were your only income. Some people forget that investment income is taxable. Others don't realize that cancellation of debt is considered taxable income to the person who owed the money.

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