Get Started on Your 2011 Taxes

February 8, 2012

Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

Just as the return of the swallows to San Juan Capistrano every March signals spring is near, the gentle reminders that tax season is upon us begin to arrive around the end of every January. By early February you should already have your year-end statements, including W-2s, 1099s and most of your other tax-related forms and documents.

Before you drop all those papers in the shoe box with the rest of your tax receipts, you might want to think about doing some early "spring cleaning" this year. The early bird may catch the worm, but early-bird taxpayers could find something far more rewarding for their efforts—a lot less stress and some extra money in their pockets.

Starting early can pay off

Here are some reasons why you should start preparing your tax returns as soon as possible this year:

• You may be due a refund, in which case you'll want to file early. But you won't know for sure until you run the numbers. Use e-filing and direct deposit for the fastest refund. If it turns out you owe a little, you can always hold off paying until April 15. (Note: The IRS extended the filing deadline for the 2011 tax year to April 17, 2012 because of a Washington, D.C. holiday.)
• You have until the April deadline to make last year's IRA contribution, but why wait? Preparing early will let you know how much you can contribute, whether the contribution is deductible, and whether a Roth IRA makes sense. You also have until April to make last year's contribution to a Coverdell Education Savings Account if you're eligible. Tell your account provider that the contribution is for the prior tax year—but get going, the sooner the better.
• Did you have a new addition to the family last year? Congratulations, and don't forget you must provide a Social Security number on your return for all your dependent children, even infants. Don't wait until the last minute to request a Social Security number from the Social Security Administration. Do it now!
• You'll have more time to follow up with providers in case some records are missing, such as charitable receipts or Form 1098 showing how much mortgage interest you paid. If you find errors (for example, the year-to-date information on your year-end pay stub doesn't match your W-2), you'll need time to correct them.

One note of caution: It's possible certain mutual funds could restate their distribution information after your initial Form 1099 is mailed to you near the end of January or mid-February. Though not common, when such fixes are necessary a corrected 1099 is usually mailed sometime before the end of February, so this shouldn't stop you from getting a head start.

Your mutual fund Form 1099 should break down your investment income between qualified dividends (taxed at 15% or 0%, depending on your tax bracket), long-term capital gains, and income taxed at your ordinary tax rate (short-term capital gains, non-qualified dividends, taxable interest income). Tax-exempt income should also be separated to show the portion of private activity bond interest, if any, reported to the IRS. Private activity bond interest is subject to the alternative minimum tax, unless the bond was issued in 2009 or 2010.

As you sit down to gather your information, don't forget these often-overlooked deductions:

• Non-cash charitable contributions. Most charities will provide a range of thrift values for commonly donated items. (For example, The Salvation Army posts a list of qualifying tax-deductible donations.) You'll still need a receipt to substantiate your gift in the event of an audit (an independent appraisal may be required, depending on the value of the gift). Keep in mind that any gifts of used clothing or household items must be in “good used condition or better” (take digital pictures if you’re worried about an audit). Any mileage you incur in the course of your charitable volunteer work may also be deductible, as well, so keep track.
  
  • Note: Keep in mind that you need a receipt for charitable gifts of $250 or more (if you're audited, a canceled check isn't enough). But you’ll also need a bank record for all cash donations, even if the amount is less than $250.
• Refinancing costs. If you refinanced from an original mortgage into a new loan, any points paid on the refinancing can be deducted on an annual basis amortized over the life of the loan. Unamortized points on a previous refinance can be deducted in full in the year of the subsequent refinancing—if you're refinancing with a new lender. If you're refinancing with your existing lender, you must deduct the unamortized points from the old loan over the life of the new one.
• Health insurance premiums for the self-employed. If you're self-employed and not eligible to participate in another employer-paid plan, you can deduct 100% of your health insurance premiums.
• Investment fees and tax-preparation expenses. Certain investment fees and other costs related to the production of income and/or tax preparation may be deductible (subject to the 2% of adjusted gross income floor for miscellaneous itemized deductions).
• Moving expenses. If you moved for work-related reasons, you might be able to claim a deduction for some of your out-of-pocket moving costs.
• Education expenses. If you qualify, you may be able to claim a dollar-for-dollar tax credit (or above-the-line deduction, depending on income level) for qualified education expenses incurred by you, your spouse or your children. You may also be able to deduct student loan interest.
• Work-related expenses. You may be able to deduct expenses related to your job that aren't reimbursed, including the cost of uniforms you are required to wear and union dues (subject to the 2% of adjusted gross income floor for miscellaneous itemized deductions).
• Casualty deductions. You can claim a deduction for casualty and theft losses over a certain dollar amount. If you live in a federally declared disaster area, you may qualify for other tax breaks. Confirm whether you qualify by visiting the Federal Emergency Management Agency (FEMA). You can also check out the IRS's Tax Relief in Disaster Situations for updates.
• Sales tax deduction. Barring another extension from Congress, the 2011 tax year will be the last year in which you can itemize deductions for state and local sales taxes. Taxpayers who itemize deductions and who reside in states that have sales tax but no income tax should benefit. Such states include Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming (Alaska and New Hampshire aren't included because they have no state sales tax, though Alaska does have some local sales taxes). Taking the sales tax deduction instead of the state income tax deduction might also be worth a look if you live in a state with a low income tax, depending on your circumstances.

Cost basis reporting

As of 2011, financial institutions (including Schwab) are now required to report gain/loss details to you and the IRS for investments you sell that are covered by new Emergency Economic Stabilization Act regulations. Because the changes could impact the cost basis used to compute your gains and losses, it's important to understand when and how they will apply to you.

The reporting changes are slowly being rolled out, and only cover investments you sell that have been acquired on or after certain dates:

• Equities acquired on or after January 1, 2011.
• Mutual funds, ETFs and dividend reinvestment plans acquired on or after January 1, 2012.
• Other specified securities, including fixed income and options acquired on or after January 1, 2013.

It's still a good idea to save your purchase and sale documentation, including records of any automatic reinvestments, to make sure it matches the information financial institutions will report to the IRS. You should also make sure your financial provider is reporting using the accounting method of your choice. Even though FIFO (first in, first out) is the IRS default method for both individual securities and mutual funds, most institutions (including Schwab) will report individual securities using the FIFO default method and report mutual funds using the average cost single-category method.

Knowledge is power

Even if you don't prepare your returns yourself, the potential impact of taxes can be so significant that you should at least be aware of how the tax rules affect you and nearly every financial decision you make. Schwab clients can log in to access tax tools and resources, including tax projection, preparation and e-filing software (free to clients who just want to run some projections for planning purposes, with discounts available to those who want to prepare and file their returns).

If you use other software or have your return prepared by someone else, consider e-filing this year, and use direct deposit to get your refund (if you're due one) in the shortest possible time. And avoid those up-front refund anticipation loan programs some tax preparation outfits make available—the charges typically aren't worth it.

Along with the tax return package and instructions you receive from the IRS in the mail (see the first few pages for "Important Changes …"), you can check out IRS Publication 17: Your Federal Income Tax. Investors will find Publication 550: Investment Income and Expenses chock full of valuable information on everything from how to report interest, dividends and capital gains to which investment-related expenses are deductible for income tax purposes.

So, don't put off preparing your tax return until the last minute. Getting an early start might make the whole process a lot less taxing. Give it a try this year.