Top 10 tax questions from Bankrate readers
Every tax situation is as individual as the
filer. But there are some tax questions that seem to come up with
regularity. Here are the 10 most common tax questions -- and answers
-- we encountered this filing season.
1. Do I owe capital gains
and if so, how can I reduce them?
Many of our readers last year were wheeling and dealing and looking
for help in reducing capital gains on their property sales. Generally,
if you own an asset for investment purposes -- for example, real
property, stocks or mutual funds -- you must pay taxes on any capital
gain you make from the sale of the asset. But this tax season there's
good news if you made money on investments: Law changes have reduced
the capital gains rates for most investors.
Even before the law change, capital
gains tax rates were lower than tax rates for ordinary income.
In most cases, the rate now is 15 percent on assets held for more
than a year (referred to as a long-term gains), whereas a taxpayer
could face taxes up to 35 percent on ordinary income reported on
a 2003 return. Lower-income investors could pay as little as 5 percent.
Bankrate tax expert George Saenz explains how
capital gains can get complicated when you're selling
only a portion of your property. He also looks at ways to minimize
capital gains on real estate sale proceeds. Sometimes it's simply
a matter of timing
your sale. Or you might explore a property
swap as a way to defer taxes on investment holdings. But in
some instances, says Saenz, a good price on a property makes the
cost worth it.
If you lose
money on the asset's sale, it still might do you some tax good.
You can use that to reduce other gains and, if you lost more than
you made, it can help reduce some of your regular taxable income.
(A note here: The rules are different for sale of your house, which
the Internal Revenue Service views as your primary residence rather
than a way for you to make money when you sell. Check out question
2. Is property I inherited
An inheritance is generally not subject to income tax. That holds
even if your inheritance
comes from a non-U.S. benefactor. However, income earned on
the inheritance such as interest, dividends and rents is subject
to income tax.
And keep in mind, when you sell inherited property
you'll face capital gains taxes. The good news here: when you figure
that gain, the IRS allows you to consider the property's fair market
value as its worth on the date the original owner died, rather than
its price when it was actually purchased. This generally will give
you a larger basis and lower tax bill. You can read more about this
3. My son had an after-school
job? Does he have to file a tax return?
The IRS generally holds children responsible for filing their own
tax returns and for paying taxes, but the agency also looks at the
total of the child's earned and unearned income. Earned income is
income received from a job. Unearned income includes interest, dividends
and capital gains.
A child doesn't have to file a 2002 return as
long as the youngster's unearned income last year was less than
$750. As for earned income, a child who made less than $4,700 doesn't
have to file a return either. (The limit edges up to $4,750 on 2003
returns.) But if the youngster had tax withheld, the only way he
or she can get that money back is to file a return.
You can read more about kids and taxes in Bankrate's
look at filing
requirements for young taxpayers, as well as our tip discussing
the reporting of a child's
Can I deduct the miles I drive to work?
Sorry, but commuting is a personal expenditure and not deductible.
Bankrate's Tax Talk adviser explains why.
employee business expenses -- including use
of your car for your job -- could provide you with a tax deduction.
Some auto costs also pay off at tax time if you're only partially
5. I work from my home.
What deductions can I take?
If you work from your home, either as self-employed or as an employee,
you have several tax deduction options. As an employee, some tax
breaks include depreciation on a computer or cellular telephone
required to do your job, professional dues and license fees, travel
expenses and a home
office that you use to fulfill your job duties. These expenses
for an employee are limited to the amount in excess of 2 percent
of your adjusted gross income. Bankrate's tax adviser also takes
a closer look at the guidelines for a worker who completes
some of her full-time job duties at home.
If, however, you're self-employed, even as a
side job to your salaried work, such expenses that are directly
related to your entrepreneurial venture can be used more directly
to reduce your independent income. Check out these dozen
deductions for the small business owner.
6. I just sold my house.
How do I report the sale and taxes?
Homeowners got a big break in 1997 when tax law regarding house
sales was changed. Before then, when you made money on the sale
of your home, you only were able to postpone payment of tax on that
cash. You also had to report your sale details on a separate tax
form so the IRS could keep track of your eventual earnings to be
Now, however, as long as you've owned and lived
in your home for two of the last five years you're pretty much off
the tax hook. Up to $250,000 profit from a house sale ($500,000
if married filing jointly) is not
taxable. That means if you bought your home for $150,000 and
sold it five years later for $300,000, then you don't owe tax on
your $150,000 profit. And there's no additional tax form to file.
Even if you don't meet the two-year residency
rule, you still may get a reduced tax break on your home sale. The
IRS has made claiming a partial exclusion even easier by defining
circumstances that qualify for this tax break.
But if you happened to lose
money on the sale, sorry. It's not an allowable capital gains
And all homeowners, whether their place is on
the market or not, can read more on how
a house can help out at tax time in this Bankrate story.
7. I've heard that you
can claim more exemptions and therefore receive more dollars in
your paycheck. Is this true? How do I do this?
It's a good idea to periodically check out your tax situation and
your paycheck withholding amount. You can claim more exemptions
if you have several dependents or expect to have deductions, such
as a home mortgage, that will reduce your eventual tax bill. The
more exemptions you claim, the less income tax your boss will take
from your pay, giving you more money to meet your daily expenses.
If you always get back a big refund, that means
you're giving Uncle Sam too much each pay period. Take your cash
back now by filing a new W-4 with your employer to adjust your exemptions.
Check out Tax Talk's recommendations on figuring
exactly how many exemptions you should claim.
Be careful here. Miscalculated
exemptions -- by you or your boss -- could be costly.
8. Can I use my IRA money
to help buy a house?
Individual retirement accounts are a great way to save for your
retirement years. But in some cases, the IRS allows you to use some
of that money now. This is the case if you're a first-time home
buyer. You can take up to $10,000 for the home down payment. If
the funds come from a deductible IRA, you'll have to pay taxes on
the cash, but you won't face any additional penalties for the early
Saenz says using such an IRA
distribution to purchase a new home is an excellent tax-planning
tool for first-time home buyers trying to save up enough money to
purchase a house. The tax you have to pay, says Saenz, generally
will be offset with the deduction of home mortgage interest and
taxes if you buy the home early in the tax year. And you will own
a home that you may not otherwise have been able to afford without
using the IRA money.
Check out Tax Talk's added advice
on the steps you need to take to ensure you don't face the 10-percent
penalty. And this tax tip explains other instances when the IRS
says it's OK
to tap your nest egg early.
9. What are the tax breaks
for second homes?
Owning a second home can be great. Not only do you have a place
to go when you need a break from your day-to-day grind, it can provide
added income if you rent it out and you get several tax advantages
Exactly what those tax breaks are depend in
part on whether the second home is only for your personal use or
you earn some rental income from it. If the property is never rented
to others, then you can deduct the taxes and interest you pay on
the property on Schedule A along with your primary home's interest
and taxes. If you do rent it occasionally, that rent could be taxable
income to you -- if you lease the property for two weeks or more
a year. Tax Talk has details and recommendations on defining
a second home for tax purposes.
And a second home isn't limited to four walls
and a roof. It can include a timeshare unit, a boat
or a recreational
vehicle, as long as it has sleeping, cooking and bathroom facilities.
10. Finally, the issue
of who qualifies as a dependent for tax-filing purposes raises lots
of questions. For example:
- I live with my parents and have a child.
Do my parents or I get to claim the baby as a dependent? The dependent
exemption generally belongs to the person who provides more than
half of the support. Support includes amounts spent for food,
lodging, clothing, education, medical and dental care, recreation,
transportation and similar necessities. If your folks are providing
more than half of these amounts for you and the baby, they are
entitled to the exemptions.
- My husband and I are divorced. We have two
kids? Can we each claim one as a dependent on our tax returns?
Generally, the parent
who has custody of the children is the one entitled to claim
them as dependents. If you are the custodial parent and the divorce
decree does not state that your ex gets the exemption, then you
are entitled to claim both children. Check out out Tax
Talk column for more on this situation.
- Can I claim my working child as a dependent?
You can continue to claim a child as a dependent, regardless of
the child's income, if he or she is younger than 19 at the end
of the tax year or is a full-time student under the age of 24.
The child, however, might need to file
a return even if he or she is claimed on your taxes.
- My mom is in a nursing home that I pay for.
Can I claim her as a dependent? The key to claiming
a parent as a dependent also rests on just how much support
you provide to mom or dad.
tip on the basic IRS rules for claiming dependents has more
We hope that one of your questions was among
this group and you now have all the answers you need to file your
return. If not, ask
our Bankrate tax expert. And if you simply want to see what other
taxpayers are concerned about, check out earlier Tax
Talk questions and answers.
-- Updated: April. 28, 2003