Capital gains, AMT and SUVs dominate 2004 filing season

by Roger Russell

The alternative minimum tax, sport utility vehicles, taxpayers who try to prepare their own returns, and legislation passed a year ago that created multiple capital gains rates are just a few of the hurdles that practitioners faced this tax season.

“One thing I learned is we should kill all congressmen that pass mid-year non-retroactive tax laws,” said Newport News, Va.-based CPA Rob Carmines. “I can’t even say how many corrected 1099s we received. Last year’s legislation created a new class of qualified dividend, but with a very onerous definition of ‘qualified.’”

“The real problem is that very few of the brokerage houses wrote software to take care of the May 5, 2003, date,” he added. “They didn’t bother because May 5 only has relevance this year. If they had made the rate change retroactive to January 1 or prospective to December 31, it wouldn’t have been a problem.”

“Capital gains rates for 2003 are crazy,” agreed Christopher Fenn, CPA, a professor at Robinson College of Business at Georgia State University, in Atlanta. “There are nine possible rates that can apply depending on the type of asset and the date it was sold.”

Claudette Huggins, owner of three Jackson Hewitt locations in Gallipolis, Ohio, said that the biggest headache was the number of taxpayers attempting to do their own returns, and then realizing that they needed professional help. “More and more people are trying to do returns themselves and getting into trouble,” she said. “We’ve had a lot more amended returns this year from people trying to do it themselves.”

Holliston, Mass.-based Fiducial franchisee Larry Novick agreed. “A former client has been preparing his own returns with one of the off-the-shelf programs for a couple of years, but he wanted me to check this year’s return. He had made Roth IRA contributions since 2002, but the program never bounced it back to let him know he wasn’t eligible because he makes more than the $160,000-a-year limit. Now, he has to go back and amend his returns and pay excise tax on the contributions.”

“The sad part is, if he never came in to me, I’m not sure the [Internal Revenue Service] would ever have picked it up,” said Novick. “But as a preparer, I have a fiduciary duty to let him know about the liability. The moral of the story is that taxpayers shouldn’t be penny-wise and pound-foolish. Those do-it-yourself software programs can end up costing the taxpayer a lot more than what they would pay a professional.”

Although the AMT has been trickling down from its original target of high-income individuals for years, it still surprises taxpayers who are liable for the first time. “They never expected they might be faced with it,” said Huggins. “We had more clients hit with it this year than ever before.”

Andrew Martin, manager of tax services for Fiducial, agreed. “The AMT now impacts more than three million taxpayers annually — many of whom would consider themselves middle class,” he said.

The AMT often appears unexpectedly, according to Georgia State’s Fenn. “I was talking to a guest at a party, who explained how he was going to exercise some incentive stock options without paying tax. I had to tell him that the exercise would be tax-free for regular tax purposes, but he would have to pay the alternative minimum tax.”

Many of the taxpayers who took advantage of low interest rates by refinancing their homes over the last year didn’t understand the amount of interest that can be deducted, according to Fenn.

“Most people who refinance usually borrow more in the second loan than the first,” he said. “What they don’t realize is that the amount of interest that’s deductible is based on the amount of the old loan plus the amount of the new loan that’s applied to home improvement.”

“For example, a taxpayer has a $100,000 mortgage on a home he bought for $200,000 a number of years ago,” he explained. “The home is now worth $300,000 and his mortgage has been paid down to $50,000. If he refinances for $200,000, he can deduct interest on it up to $100,000. If he uses $50,000 to add a bathroom and a swimming pool, that becomes part of the acquisition loan and he can deduct the interest attributable to that. But interest attributable to the remaining $50,000 portion is not deductible if he uses it for personal reasons. However, if he uses it to purchase a car he uses in business, he can still deduct the interest.”

Some taxpayers with income from money market funds were confused over how much tax they owed on income from the funds, noted Fenn. “Money market accounts usually report income earned as ‘dividends,’ but they’re not dividends — they’re interest income, so they’re not entitled to the 15 percent break,” he said.

More taxpayers have learned how to get around the annual ceiling on automobile depreciation, according to Linda de Marlor, president of Rockville, Md.-based Tax-Masters Inc. “Everyone is concerned about meeting the over-6,000 pound requirement,” she said. “I keep a list in my purse of ones that qualify.”

Since only passenger cars are subject to the annual depreciation ceiling, SUVs, trucks and vans over 6,000 pounds are extremely popular for those who use a vehicle in their work.

“We see a lot of people buying SUVs that wouldn’t have if not for the increased depreciation allowance,” de Marlor said. “I’d love to open a dealership next to our office.”

For the IRS, the 2004 filing season has set records in several categories.

Through April 9, tax professionals filed more than 36.6 million returns electronically, an 11.8 percent increase from last year. Home computer use for e-filing neared 12 million, up 20 percent. The Free File program reached 2.9 million returns, a 22 percent increase over the same period last year.

The General Accounting Office recently assessed the IRS’s performance during the 2004 filing season, and found that it had “improved in most areas compared to this time last year and the year before,” based on key filing season activities.

In particular, the GAO found improvements in access to IRS phone assistance and Web site usage. However, according to the report, the accuracy of responses to tax questions declined for the second year in a row.

“Although it cannot be quantified,” the report said, “the improvements overall in the 2004 filing season performance appear to represent a payoff from the IRS’s modernization and increased emphasis on service since 1998.”

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