Flat out the right thing to do
WSJ (I know, I know, I'll post the article in the comments section) has an article about taxes today. Longtime fans of this blog know I'm a big fan of the flat tax. Bleeding heart McLieberman (I'm sorry Mc, please come back) says that the flat tax only helps the rich.
Key quotes from the article, "Nearly a million taxpayers hurt themselves in a single year by taking the standard deduction, even though they could have paid an average of nearly $500 less in taxes each had they itemized."
And, "Overall, as many as 2.2 million tax filers, representing roughly 2% of the total, may have paid nearly a billion dollars more than they needed to in taxes, an average of $438 per return, because of failing to itemize, according to the GAO study."
One thing you can bet is that these mistakes are made by folks on the lower end of the income scale as the higher you go, the more likely you are to get professional help.
Bottom line, a flat-tax democratizes the tax process. Its progressive by the fact that everyone gets the benefits, and it rids the current system of the implied penalty paid by the poor because they don't understand and take advantage of all the tax-deductions.
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How to Do Your Taxes This Year
New Crop of Deductions Offers
Savings, but Many People
May Fail to Take Them
By TOM HERMAN
March 8, 2006; Page D1
A raft of new tax breaks could help lower tax bills for millions of people this year. But if past behavior is any guide, many won't take advantage of them.
The ever-expanding list of deductions, credits and other tax breaks that Congress has carved out over the years has become so confusing that taxpayers often make costly mistakes by overlooking them. More than a million people may have overpaid their taxes for 2004, for instance, because they didn't take advantage of a special break introduced that year allowing them to deduct either their state and local income taxes or their sales taxes, according to a recent government report. This deduction could again save money for many people filing their 2005 returns. The provision expired at the end of last year, but Congress is working on extending it.
The latest changes to the tax rules are likely to add to the confusion. Deducting the cost of the number of miles you drove your car for business is more complicated this year. Many taxpayers now need to figure out their miles driven both before Sept. 1 and since that date through the end of 2005, because the government changed the mileage allowance to account for higher gasoline prices.
[Find the Deductions]
See the answers below.
Another big change comes in deducting casualty losses, such as those from theft or storm damage. Just 90,000 taxpayers claimed this deduction in 2003, mainly because the losses must exceed 10% of your adjusted gross income before they can be deducted. That threshold has been eliminated if your losses resulted from hurricanes Katrina, Rita or Wilma.
Even some relatively simple tax breaks are often overlooked. Nearly a million taxpayers hurt themselves in a single year by taking the standard deduction, even though they could have paid an average of nearly $500 less in taxes each had they itemized, according to a study by the congressional Government Accountability Office from 2002, the latest research available. One reason, tax professionals say, is that some people don't realize they can deduct their state and local taxes on their federal return if they itemize. For people in states and cities with high local taxes, that can mean substantial savings on their federal tax bill.
Overall, as many as 2.2 million tax filers, representing roughly 2% of the total, may have paid nearly a billion dollars more than they needed to in taxes, an average of $438 per return, because of failing to itemize, according to the GAO study. These people may also have missed out on other deductions, such as charitable giving and property taxes, the study says. To be sure, if you discover you missed a deduction in the past, you can file an amended return, generally within three years.
The purpose of many deductions in the tax system is to create incentives for certain types of behavior, such as giving to charity. Others are intended to help certain taxpayers, such as those with large medical bills.
But the system also is ripe for abuse, which led Congress several decades ago to create the Alternative Minimum Tax to prevent people, especially high-income taxpayers, from using deductions and other breaks to effectively wipe out their tax liability.
Last year President Bush's Advisory Panel on Federal Tax Reform proposed overhauling the tax system to reduce its complexity. "There is little confidence that we really know how much we should be paying in taxes in any given year," the panel's report said. Treasury officials have said the tax reform plan is still being worked on, but that there is no timetable.
About two-thirds of taxpayers claim the standard deduction, which is simpler than itemizing deductions but may cause many people to miss out on certain tax breaks. If you are married and filing a joint return with your spouse, for example, the basic standard deduction for 2005 is $10,000. Most upper-income taxpayers itemize because the total amount of their deductions exceeds the standard deduction. IRS statistics show around 90% or more of taxpayers with incomes of $100,000 or higher itemized their deductions for 2003. Besides deductions, the tax laws also provide certain types of credits, such as the child tax credit.
Even professional tax preparers can't always catch all your deductions, unless you remember to tell them all your financial details. One common error comes when homeowners don't deduct all the mortgage "points" they are entitled to. Points are a type of prepaid interest that people often pay lenders upfront. Buyers generally can deduct all the points they paid in the year they take out a mortgage.
[writing it off]
But the rules are different when you are refinancing, in which case you generally have to spread the points over the life of the loan. Tax preparers say a common error occurs when someone refinances a mortgage for a second or third time. Then, the remaining balance of the points may be taken as an itemized deduction. Many people forget to deduct those old points.
Another commonly overlooked deduction: certain types of medical expenses. Most people can't claim medical bills on their returns, because the expenses must exceed 7.5% of your adjusted gross income before they become deductible. Still, 8.7 million returns, with total medical expense deductions of about $56 billion, were claimed in 2003.
Tax preparers say many people don't realize the IRS allows people who suffer from specific physician-diagnosed diseases, such as obesity and hypertension, to deduct out-of-pocket costs of weight-loss programs. A common oversight: transportation expenses for medical purposes. But costs for programs that are designed merely to improve your general health aren't deductible. Also, the costs of low-calorie foods purchased while in the program aren't deductible, either.
One more area where taxpayers often slip up: gambling. Tax preparers say many people are aware that they have to pay taxes on their gambling winnings but some don't realize they can deduct their losses. However, gambling losses can be used only to reduce the amount of your winnings, not as a deduction against other income. The IRS says gambling earnings totaling about $19 billion were reported on about 1.5 million returns for 2003. In the same year, gambling losses, totaling nearly $12 billion, were claimed on about 895,000 returns.
Some lottery winners have tried an unusual tax-saving tactic that the courts have since rejected. These people have tried to convert their winnings from being taxed as ordinary income (at a federal rate as high as 35%) into long-term capital gains (taxable at a top rate of only 15%). A Pennsylvania couple who won the lottery, after receiving several annual installments of their prize, sold the right to their remaining payments for a lump sum. They then reported their proceeds as a capital gain. The IRS disagreed, and a federal appeals court recently sided with the agency that the lump-sum payment for the right to lottery payments is ordinary income.
For additional information, IRS Publication 17, which summarizes the rules for individual investors, is available free on the IRS Web site (www.irs.gov). The agency also recently put out Publication 4492, which explains changes for taxpayers affected by the hurricanes.
The Ernst & Young Tax Guide 2006 includes a handy two-page summary of 50 of the most easily overlooked deductions. Among them: appraisal fees for charitable donations or casualty losses, labor-union dues, and margin account interest expense.
Plus, it makes Steve Forbes happy.
P.S. I love the flat tax. But then what else can I say? I'm the conservative on the blog.
I guess that's sort of correct, you are "on the blog."
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