Tax season likely to be particularly tricky

PERSONAL FINANCE

Forms contain new wrinkles and don't think of filing early

January 20, 2008|By EILEEN AMBROSE

Get ready for another tricky tax season.

Some last-minute tax legislation by Congress has once more turned something predictable and tedious into something that's confusing and, well, tedious.

This time, it waited so long to pass legislation to stop the spread of the alternative minimum tax that the IRS hasn't fully updated its systems yet. Millions of taxpayers who file certain forms must wait until Feb. 11 to get their returns processed. That's sure to delay some refunds.

On the upside, Congress created new tax breaks for homeowners. One is designed to help people hit by the subprime lending crisis.

Some tax breaks are here only for this tax season. They may be resuscitated later, though. Appearing and disappearing tax breaks have become the norm in recent years. It keeps tax book writers busy, but confuses everyone else.

"This is just no way to run a tax system. People can't follow this. You can't

plan," says Barbara Weltman, author of J.K. Lasser's 1001 Deductions & Tax Breaks. "You need some kind of permanence."

To help you navigate taxes this season, here are things you need to know:

Think twice about filing early

The IRS won't be able to process five forms related to the alternative minimum tax legislation until Feb. 11. You don't have to owe AMT to be affected.

The forms: Form 8863 for education credits; Form 5695 for residential energy credits; Form 8396 for mortgage interest credit; Schedule 2, Form 1040A for child and dependent care expenses, and Form 8859 for a first-time homebuyer credit for D.C. residents.

The IRS will reject returns with one of these forms if they are electronically filed before Feb. 11. File a paper return early with one of these forms and your return will be held by the IRS and processed later. About 13.5 million taxpayers file these forms, although most aren't early filers, the IRS says.

There are other reasons not to rush.

More financial institutions than usual may be asking for extra time to get 1099 investment income forms into the hands of taxpayers. The deadline is Jan. 31.

Also, Social Security said last week it will be sending out corrected 1099-SSA forms to about 2.7 million beneficiaries - including 32,936 Marylanders - by the end of the month. The incorrect forms over-reported benefits received for some in Medicare's Part C and D programs.

Mortgage debt forgiveness relief

It's a tragic scenario: You owe $300,000 on your home when the bank forecloses. The lender sells the house for $250,000. You owe income tax on the $50,000 difference.

Congress created a temporary break to homeowners in foreclosure or others who have negotiated forgiveness of mortgage debt. Homeowners won't have to pay taxes on up to $2 million in forgiven debt on a principal residence.

The tax break is good for debt erased last year and through the end of 2009.

Debt forgiven on a second home would still be taxed. And if you took cash out during a refinancing and used it for purposes other than improving the home, that money too would be subject to tax if it's forgiven, says Mark Luscombe, a principal at CCH, an Illinois provider of tax information.

Be aware, if you take advantage of this tax break, you will have to reduce the cost basis in the house by the amount of forgiven debt. So, if you bought the house for $350,000 and the lender forgave $30,000, your new cost basis would be $320,000. If you later sell the house for $380,000, your gain would be $60,000.

Luscombe says homeowners might not have any tax consequences anyway because singles generally can exclude $250,000 of gain from the sale, while joint filers can exclude twice that amount.

Mortgage insurance deduction

You may be able to deduct mortgage insurance premiums under another new tax break. This applies only to mortgage insurance contracts issued after 2006. The deduction runs through 2010.

Income limits apply. The full premium deduction is available to singles and married joint filers with adjusted gross income up to $100,000. The deduction is gradually reduced and disappears once income tops $109,000.

Alternative minimum tax relief

More than 20 million taxpayers dodged the AMT bullet because of the last-minute legislative fix that raised the amount of income exempted from the tax. The new exemption is $66,250 for married joint filers and $44,350 for singles.

The AMT was created decades ago to make sure the rich didn't escape taxes. Filers either pay AMT or regular income tax, whichever is higher. President Bush's tax cuts to the regular income tax years ago meant more filers suddenly owed more under the AMT formula. Plus, AMT was never adjusted for inflation so even some middle-income families are trapped by it.

The fix is good news for Marylanders, who tend to get hit by the AMT more than residents in most other states because of high taxes.

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