Don't make your annual income tax filing a last-ditch effort to beat the clock and find an extension agreement with state and federal tax authorities. By taking specific steps, you can prevent the kind of nightmarish situation in which you find yourself scrambling to file your tax return before April 15. Things you should keep in mind when preparing and filing your fiscal paperwork include the concept of tax basis, the need to hire a professional, and the intricacies of the child tax credit.
Use Tax Software
You can use tax applications to prevent errors and losses that could result from many back-and-forths with the IRS and you state's fiscal authorities. Read our review of the major software providers before deciding which one to use. Go for those applications with an overall rating of 10 – meaning "Excellent" – such as TurboTax, which has been my favorite for a decade.
When selecting a software provider, pay attention to things like accuracy, ease of use, and help and support. Other factors to consider include pricing, disbursement options – meaning how you receive your refund or pay your fiscal liability – and tax situations supported, namely 1099 income, home owners, simple and complex federal tax returns, business filings and stock investors.
Hire a Fiscal Specialist
If everything tax-related is not your strong suit, enlist the help of someone versed in the subtleties of IRS stipulations. Various professionals can help you navigate the intricacies of tax legislation, including enrolled agents, tax accountants, fiscal attorneys and certified public accountants. Go to your local chamber of commerce and get a list of reputable accounting and law firms specializing in taxation. You also can contact the American Institute of Certified Public Accountants, which maintains a comprehensive online resource on taxation as well as a directory of states' CPA societies.
Heed the Concept of Tax Basis
"Tax basis" means the value the cost of an asset, specifically the value that is fiscally ascribed to the resource. When taxation specialists talk about your assets, they refer to everything you own, including money in a bank account or stashed under the mattress, investments like stocks and bonds, and your mortgage-free house. Depending on the asset, the procedures to calculate the tax basis can vary. Note also that tax basis is distinct from financial basis because tax accounting follows a set of rules that often are dissimilar to financial accounting standards.
Things can get a bit complicated when it comes to figuring out the tax basis of specific types of investments, such as mutual funds or corporate shares. Various rules apply to different scenarios, and I have tried to sum them up below. The whole idea is to accurately determine the tax basis of investments you sold, so that you can properly calculate your gain – or loss if the sale price is lower than the tax basis.
Mutual fund transactions – You can use four different methods to calculate the tax basis of mutual fund shares you've purchased.
- Average basis single-category: Take the total value of your investment and divide it by the number of shares.
- Average basis double-category: Use the same approach as in the average basis single-category, but divide your total investment value by the total number of shares, depending on how long you've held the shares.
- FIFO (first in/first out): Use the tax basis of the shares you've bought first as the per-share value of the first batch, applying the same approach for the second and third and fourth batches – and so on. For example, say you bought 10 shares at $10 apiece, 20 shares at $15 apiece, and 10 shares at $20 apiece. If you sold 20 shares, the unit cost (or per-share tax basis) equals 10 shares multiplied by $10 plus 10 shares multiplied by $15, that sum divided by 20. The resulting tax basis equals $12.5.
- Specific identification: Use the price ascribed to the specific shares you sold.
Stock value during a divorce – If you receive corporate stock during a divorce, use the same unit value your former spouse assigned to the stock.
Bequeathed shares – If you received stock as gift, take the lower of the stock's value at the time you got the shares or the stock's initial price (meaning when the original owner bought them).
Inherited stock – Use the fair market value of the shares on the day your benefactor died.
Keep an Eye on Your Children – And Their Tax Credits
Don't make a mistake when calculating your child tax credit. Read the Internal Revenue Service's 10 Facts about the Child Tax Credit to become familiar with the ins and outs of that section as well as eligibility requirements. Here's the gist of what the IRS says:
Amount – If you have a qualifying child aged 16 or younger, you can lower your federal tax liability by up to $1,000.
Qualifying child – To qualify, a child must meet criteria like residence, age, relationship, citizenship, support and dependent.
Age – Your child must have been younger than 17 at the end of your fiscal year.
Relationship – To qualify for the child tax credit, the youngster must be related to you biologically or through a legally recorded adoption arrangement. The IRS generally grants the credit if the individual is your daughter, son, stepson, niece or nephew, to name a few.
Support – You must prove to the IRS that you have provided more than 50% support to the child during the fiscal year under review.
Dependent – To receive the child tax credit, you must claim the youngster as a dependent on your federal income tax return.
Citizenship – The child on whom you want to claim the fiscal credit must be a U.S. citizen or a legal permanent resident.
Residence – To qualify, a child must live with you, that is, at your principal residence, for more than six months.
Numerical Threshold – You cannot claim the child tax credit if your income exceeds a certain amount, depending on your filing status. For 2013, the phase-out amounts were:
$110,000 if you're married and you and your spouse file jointly
$55,000 if you're married but file a separate income tax return, and
$75,000 if you file as head of household or widow(er).
Additional Child Tax Credit – You are entitled to extra child fiscal credit if your child tax credit exceeds how much in taxes you owe the federal government.
To avoid nightmarish fiscal scenarios and make mistakes that could trigger IRS audits, pay attention to things like tax basis and child tax credit, among other items. Both concepts may be complex, depending on your fiscal situation, so don't hesitate to reach out to a professional if you cannot navigate the sometimes arcane world of IRS regulations.