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8 ways to avoid tax-time headaches

Instead of loading up on aspirin, follow this advice

Last updated: February 2013

The middle of March might have been rough on Julius Caesar, but for most Americans, it's the April 15th tax-filing deadline that causes the most pain. Even if you expect a refund, as 75 percent of Americans do, you dread facing that annual ritual: the endless paper-sorting, the trying search for deductions, the horror of the bottom line, and the mad, last-minute dash to the post office.

Here are eight ideas for making tax season more tolerable and potentially more profitable.

1. Go digital

By automating your tax preparation and filing, you can save hours of toil. Taxpayers will spend four hours on average completing their 2012 forms, the IRS says. Intuit, the maker of TurboTax, the best-selling tax-preparation software, says its average user will be done in about two hours.

More than 119 million federal income-tax returns were filed electronically last year—at least 81 percent of all individual returns, the IRS estimates. There are lots of good reasons for that. For one, the IRS estimates that it processes refunds for e-filed forms in half the time it takes for paper returns. If you also elect to have the government deposit your refund directly into your bank account, you'll save more time. If you owe money, you can avoid writing and sending a check by using electronic funds withdrawal. Taxpayers in 37 states and the District of Columbia can file their federal and state returns in one transmission to the IRS.

There are also lots of options to prepare and file your federal forms free online. The IRS now offers free, "fillable" electronic versions of Forms 1040, 1040A, and 1040EZ to all taxpayers, regardless of income. They are available through the Free File section of the IRS website. If you don't need commercial tax-prep software to walk you through the process, this is a worthwhile option. You can prepare your forms and file them directly with the IRS free.

For more complicated tax situations, expect to pay $10 to $100 to prepare and file federal returns online through commercial tax-prep services. Of the major online tax-prep companies, H&R Block At Home, TaxACT, and TurboTax also offer downloads and CDs.

H&R Block At Home and TurboTax customers who plan to file the federal and state 1040EZ forms can photograph and upload their W-2s from their smart phones to a company server. The software will automatically populate your tax form. (TurboTax also offers its “SnapTax” for the iPod Touch, and for IRS Form1040A.) With TurboTax and Block, you can file state and federal forms from your smart phone, or finish your taxes online later. The IRS’s app, IRS2Go, lets you track your refund on your smart phone.

2. Face up to your taxes early on

Even if you're organized, chances are one or two pieces of paper—an earnings statement mistaken for junk mail or a misfiled receipt—have gone astray. Or you may have questions for a tax professional or the IRS. Build in at least two weeks to accommodate those possibilities.

February and early March are good times to chase down missing W-2s, 1099s, and other forms. Employers, brokerages, and other companies generally must make available all tax information by Jan. 31. Not sure if you've got everything? Check last year's tax forms.

Use the early weeks to consider other expenditures that might merit deductions or exclusions. Review a 2012 calendar, ideally one on which you recorded appointments and events. Did you take any part-time or freelance jobs? Did you take on a home-equity loan that charges tax-deductible interest? Did you donate a car or boat worth more than $500? (If so, you'll need to get a statement from the charity regarding the sale price.) If you use child-care providers, get their addresses, phone numbers, and Social Security numbers now. Make sure you have receipts or bank records for all charitable donations. If not, call the charity.

3. Organize your paperwork

If your system of organizing tax papers involves a box labeled "Florsheim" or "Nike," it's time for a filing-system makeover. Tax preparers and accountants say that disorganized receipts and tax forms drive them nuts—and cost their clients money.

Organizing doesn't have to be a high-tech, months-long project. Simply buy an accordion folder and use each section to store documents for a different category—charitable contributions (including the costs of any travel you did for charitable work); W-2 forms from jobs, consulting, and freelance work; Form 1099s; income and expenses from rental properties; and business and job expenses. IRS Publication 552 (PDF), "Recordkeeping for Individuals" (PDF) outlines the documents you should keep, and for how long.

When you're ready to do your tax return, tally up the materials from each folder section and give a copy of the tally to your tax preparer. Leave the accordion folder—and the shoebox—in the closet.

4. Consider your sales taxes

Once again, you can deduct either state and local sales tax or state and local income tax on your federal form, whichever is greater. Don't bother adding up those receipts if you live in a high-income-tax state like California, Massachusetts, Minnesota, or New York. Even a major house-remodeling project, four-star vacation, or new car might not produce enough sales tax to exceed your state income-tax bill.

If you live in a no-income-tax state—Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming—you'll most likely gain with the sales-tax deduction. You'll most likely gain in New Hampshire or Tennessee, too, because they tax only interest and dividends. If you haven't kept sales receipts, the Form 1040 instructions provide a default figure that is based on income and the number of exemptions. In fact, the accountants we spoke with said the IRS's default figure is usually higher than the amount that many people actually spend. Use the IRS Sales Tax Deduction Calculator to figure the amount of state and local sales tax you can claim. (You should still save all records from a home renovation. See tip no. 6.)

Similarly, most people needn't bother tallying unreimbursed medical expenses for income-tax purposes. You are only allowed to deduct the amount of your medical and dental expenses that exceeds 7.5 percent of your adjusted gross income, and if you have health insurance, you're unlikely to reach that threshold.

5. Assess your alternative minimum tax liability

About 4 million taxpayers are expected to be hit in the 2013 tax-filing season with the alternative minimum tax (AMT). The AMT was originally intended to snare the wealthy with inordinately high tax deductions. But now it's snagging middle-income taxpayers with big families, people who pay lots of state and local income tax, and those with high real-estate taxes.

For tax year 2012, the exemption amount for AMT for individuals and heads of household has increased to $50,600 ($78,750 if married filing jointly, $37,225 if married filing separately). The IRS has a 2012 AMT Assistant tool that will help you figure out your potential tab.

6. Mind the cost basis

CPAs told us that their top migraine moments involve establishing the cost basis of old investments, including stocks and real estate. The cost basis is the purchase price plus costs associated with selling the investment, and any capital improvements in the case of real estate. You pay capital gains tax on the difference between that and your selling price, so the higher the cost basis the less tax you'll owe. (You can claim up to $3,000 in investment losses in a given year; the balance can be carried forward to future years.)

The law now requires brokerages and investment companies to provide investors with cost-basis information for stocks and exchange-traded funds bought in 2011 or later on IRS Form 1099-B. (In 2012, the rule extends to mutual funds and dividend-reinvestment-plan shares, and in 2013 it covers options, bonds, and other investments.) But shares purchased before 2011 aren’t covered by the law. So if you have no original receipts or if you received the investment as a gift, you'll have to find your cost basis. (The cost basis of inherited property is what it was worth on the day the person from whom you inherited it died.) You'll also need to decide which hurts more: Paying a preparer for an hour or more of sleuthing or chasing down the cost basis yourself.

If you're the do-it-yourself kind, check first with your brokerage or fund company. A spokesman for Fidelity Investments told us representatives often can provide that information over the telephone. But if it's more challenging—say, you sold several investments—it might take a few days. 

If the investment was purchased BCE (Before the Computer Era), you'll need an idea of the year—and ideally the month and day—when the investment was made. The firm's shareholder-services department might be able to provide the historical price. And don't bother sweating over small investments of, say, $1,000 or less; just take your best guess. For more on calculating cost basis, get IRS Publication 551 "Basis of Assets" (PDF).

It's always worth calculating a home's cost basis if you sell. If you didn't keep good records of your home renovations, take some time to mentally travel from room to room and on the outside to recall capital improvements and estimate their cost at the time. (Assuming you meet certain criteria, you also get a tax exclusion: $250,000 for individuals, $500,000 for couples filing jointly.)

7. Get an extension if you need it

There is no shame in requesting an extension to file, and there's no penalty if you pay your estimated taxes by April 15 and that payment is at least 90 percent of what your final return shows. This year’s extension deadline is Oct. 15.

8. Start organizing for the new year

While the year is young, invest in another file folder to organize papers for 2013. In addition to keeping paper copies, consider storing your tax documents on a Web-based storage server, or “cloud.” H&R Block, Jackson Hewitt, and TaxACT now sponsor similar free services for clients and nonclients. The companies say they use bank-level security encryption. Or, purchase software like Quicken to keep track of your receipts. The earlier you get organized, the less you'll have to beware the ides of April 2014.


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