With hours to go before this year's filing deadline, Matt in Missouri is asking a question that anyone waiting in line at the post office must be wondering. Why can't they just simplify the ridiculously complicated process of filing a tax return?
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Each year, we send in W-2's and 1099's along with our 1040's. I know the information on the 1099's is already reported, and I believe the same is true of the W-2's by the companies that issued them to us. Why doesn't the IRS just enter what they already have in a mainframe and send us out a bill or refund like any business would?
-- Matt R., Jefferson City, Mo.
In short, because the tax laws are made by the U.S. Congress, which doesn’t work like any business we’ve ever heard of. (Some people would argue that it doesn’t work at all.)
For starters, under your proposal, hundreds of billions of dollars of unreported income would go untaxed. This already happens, of course. But to encourage voluntary reporting, the IRS imposes heavy fines and jail time for the worst offenders. And for every dollar that goes unreported, the tax burden is that much heavier on every dollar the IRS knows about.
You would also have to sweep away decades of tax breaks, giveaways and favored status given to various activities by tax laws that companies and industries have spent their hard-earned money buying from Congress (a process more politely known as “lobbying”). The last time Congress cleaned out the mess in this closet was the Tax Reform Act of 1986, passed as part of the tax cuts of the Reagan administration. Though many popular tax shelters were eliminated, the “simplified” return was hardly simple. Since 1986, Congress has been busy loading up the law with new tax breaks for the highest bidders.
Your proposal would also wipe out an entire industry of financial services providers — including the millions of accountants and support staff who worked overtime this past weekend to finish all of our returns. Since the financial services industry has been one of the most generous industries to Congress over the years, we suspect their jobs are pretty well protected from the impact of true tax reform.
For more on how the tax code got so ridiculously complicated, check out this story by MSNBC.com's Martin Wolk.
LOT OF GAINS
My wife and I bought a vacant lot in 2002 with the intention of building our house on the lot. About a year later while we were working with an architect on the plans for the house, we came across an existing house that we liked and decide to buy that instead of building a new house. Meanwhile the lot has appreciated in value substantially. If we sell the lot do we have to pay capital gains on the profits, or can we apply the appreciation in lot value to the loan of the house we bought?
-- Malcolm S., Bolingbrook, Illinois.
Unfortunately, you're stuck with paying tax on the gains on the lot. Capital gains from one piece of real estate can't be used to offset the cost of buying a new home. (In general, investment gains can only be offset by investment losses, which you can't claim until you sell that investment at a loss.)
You can roll gains from the sale of one piece of investment real estate into another one with what’s called a 1031 exchange, but the rules are fairly narrow and you usually have to sell one piece of property before you buy the next one. You also need to continue rolling gains from one property to the next. So it’s probably not an option unless you decide to get into real estate investing long-term.
In any case, make sure you deduct all expenses associated with the purchase of the lot — legal fees, broker commissions, etc. — when you calculate your gain.
My understanding is that losses from a passive income (rental properties) can NOT be used to lower our active income (full-time jobs) tax liabilities. Yet each time I tell this to someone, they think that this is wrong. Can rental losses be used as an (active) income deduction?
-- Eric J.
This bar bet has to end in a draw. The rules about handling passive and active income are among the most abundant land mines found scattered through the tax code.
Here's what Publication 925, Passive Activity and At-Risk Rules, has to say on the subject of rental income:
“Generally, rental activities are passive activities even if you materially participated in them. However, if you qualified as a real estate professional, rental real estate activities in which you materially participated are not passive activities.”
But before you decide you're a real estate professional, better check with a tax professional. Like all tax matters, this can have ripple effects on other parts of your return. And no two returns are the same.
For more on the subject, check out the the examples and instructions on how to report passive income elsewhere in Publication 925.
I gave nearly $650 to different Katrina relief funds. I have a receipt from Red Cross but the cash I gave to people is not documentable. Can I claim money that is not easily confirmed?
-- Keily S.,Lincoln, Neb.
For each contribution of $250 or more to a given charity, you have to get a receipt. You also need to make sure that the recipient is recognized by the IRS as a charitable organization.
For details on what counts as a charity and what doesn’t, check out Publication 526, Charitable Contributions.
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