Step-By-Step Tax Guide : April 15 Doesn’t Have to Be a Nightmare

Most Americans think filing a tax return is about as much fun as getting divorced, remodeling a house or having cavities filled. But it can be done relatively painlessly--if you’re organized and systematic.

In an effort to help you get through tax season, The Times teamed up with the Big Six accounting firm of Coopers & Lybrand to create a step-by-step guide to filing your federal income taxes.

Since it’s nearly impossible to go through all of the possible permutations that could affect taxpayers, we’ve created a hypothetical family that we believe is representative of many Times readers. Our family, John and Mary Taxpayer, will deal with issues and forms that confront many American families.

The Taxpayers have two children, two cars, one dog and a home mortgage. They have some money in the bank and a little invested in a mutual fund. They refinanced their home last year--for the second time. And they pay for child care, because both John and Mary work. Together, they earned slightly less than $60,000 in 1992.

Get out a notebook and sharpen your pencils. It’s time to get started.

Step One: Get Organized

Getting your records together is the most important--and frequently ignored--part of doing your taxes. Professional tax preparers say that many Americans lose hundreds of dollars in deductions every year because they’re disorganized.

Those clever enough to create a system to store tax records last year need only pull out a file. John and Mary weren’t that smart, so they’ve got to start gathering things together.

What do they need?

Initially, W-2 forms from both of their employers, which show how much they earned and paid in federal, state and Social Security taxes. Independent contractors should receive 1099 forms with their earnings information.

John and Mary need statements from their bank and brokerage that delineate interest and capital gains--or capital losses--on their investments. These come on forms 1099-INT and 1099-DIV and 1099-B.

The Taxpayers also gather information about their deductions. That includes statements from their mortgage company detailing interest expenses (Form 1098), receipts for charitable contributions, records of medical expenses, unreimbursed business costs and personal property tax payments--such as the auto registration fees they paid to the Department of Motor Vehicles.

Finally, Mary grabs a scratch pad. She knows that she and John frequently will need to add numbers or calculate a result via some formula as they complete their return.

Step Two: Gather the Appropriate Forms

A glance at the Taxpayers’ records suggests forms they’ll need to complete:

* The standard Form 1040, rather than the simpler 1040A or 1040-EZ, because they have significant itemized deductions.

* Schedule A to list their itemized deductions.

* Schedule B to detail their interest and dividend income.

* Schedule D to list capital gains and losses.

* They can claim a credit for part of their child-care expenses, but for that they’ll need Form 2441, titled “Child and Dependent Care Expenses.”

All five forms are included in the “1040 Forms and Instructions” booklet that the IRS sent to the Taxpayers’ home. However, if they were missing a form, they could request it from the IRS by calling the toll-free forms number, 1-800-TAX-FORM. Also, many public libraries stock commonly used tax forms.

Step Three: Devise a Battle Plan

Many people start with Form 1040. But John and Mary know that they can’t complete the 1040 without filling out the schedules. Then again, they can’t complete all the schedules without doing at least part of the 1040. So what do the Taxpayers do?

They take a look at the schedules and realize that, given their circumstances, Schedules B and D don’t require any information from the 1040, while the 1040 requires completed information from those schedules. They’ll complete Schedules B and D first.

Step Four: Interest and Dividends

On Part I of Schedule B, the Taxpayers list the name of their bank and the amount of interest they earned: $600. They carry that number down to lines 2 and 4.

On Part II, they note the $250 in dividends they received from Bigtime Mutual Fund--a figure drawn from the Form 1099 they were sent by Bigtime. Schedule B also asks them to report the $250 capital gain listed on the Bigtime 1099. They add the numbers and report the $500 total on line 6.

They note the $250 capital gain again on lines 7 and 9. Then, on line 10, they subtract the $250 capital gain from the $500 total they showed on line 6 to come up with their total dividend earnings of $250. Why do they have to first add and then subtract those capital gains? To make certain that they do not pay too much tax on this amount, since capital gains are taxed at a lower maximum rate than regular dividends. They transfer the amount on line 7 to line 14 of schedule D.

Since John and Mary have no foreign bank accounts, they answer “no” to the questions in Part III. Now they’re done with Schedule B.

Step Five: Schedule D--Capital Gains and Losses

Last March, John’s brother James was $20 short when he needed to make the property tax payments for his new manufacturing company. John agreed to lend James the money, but James insisted on giving John a few shares of the firm instead. By October, John’s shares were worth $40, so he cashed out, figuring that Manufacturing Co. wouldn’t appreciate more than that.

The result was a $20 capital gain that John and Mary need to report on Schedule D.

They lay out the investment in James’ firm, in Part I of Schedule D because they held the stock for less than a year, making the $20 a short-term gain. In column b, he notes when he bought the shares. In column c, he notes when they were sold. In column d, John lists the sales price of $40. The $20 purchase price goes in column e, and the net gain of $20 goes in column g. John also notes the $20 gain on lines 7 and 8.

In Part II, John lists the sale of his stake in Bigtime Mutual Fund, since he owned those shares for more than a year. He notes the purchase and sales dates and the appropriate prices in their respective boxes and lists his $300 loss in column f.

On line 14, he notes that Bigtime did distribute $250 in capital gains during the year. (You’ll recall that figure as the one John and Mary were adding and subtracting on Schedule B.) He carries down his $300 loss and his $250 gain to line 17 and “combines” those two numbers to come up with a net long-term loss of $50 on line 18. Line 19 asks him to add the numbers on lines 8 and 18, which leaves him with a net deductible loss of $30.

For taxpayers who have a net capital gain, however, the calculations on Part IV of the form might lead to a lower tax bill than if they simply reported the capital gain on the 1040. That is because Schedule D calculates the tax on long-term capital gains at a maximum rate of 28%, producing a small savings for married couples with more than $86,500 in income who otherwise would be paying about 31% tax on their income. The figure for single taxpayers is $51,900.

Step Six: The 1040--Page One

Since the rest of the schedules that John and Mary are using require them to list their “adjusted gross income” as reported on lines 31 and 32 of the 1040, they now turn their attention to the 1040.

They’re only going to fill out the front page, however, because the back page requires information from Form 2441 and Schedule A.

The top of the 1040 asks for John and Mary’s name, address and Social Security numbers. But instead of writing that in, they use the IRS address label that’s attached to the front of their booklet. That not only saves them time, it helps the IRS process their return faster.

They’re married, filing jointly, so they check box 2 under filing status. And they check lines 6a, 6b and list their children’s names and Social Security numbers on 6c. On line 6e, tey write 4 --the total number of exemptions they are claiming.

Line 7 asks for their total wages. John gathers up their W-2 statements and writes his income and his wife’s on his scratch pad.

John transfers the total to line 7.

WAGES

John--$48,000

Mary--$11,079

Total--$59,079

Line 8a asks for taxable interest income. John writes $600, as noted on his Schedule B. On line 9 he lists the $250 they earned in dividend income, also from Schedule B. On line 10, John notes the $85 state tax refund received by the couple in 1992.

He skips to line 13, where the Taxpayers report their $30 capital loss from Schedule D. He combines lines 7, 8a, 9, 10 and 13 and writes the total--$59,984--on line 23.

Since the Taxpayers didn’t contribute to an IRA or Keogh account during the year, they skip that section and repeat the $59,984 on lines 31.

From past experience, John and Mary know that their itemized deductions are going to amount to more than the standard deduction noted on line 34, so they pause here and pull out their Schedule A to figure their itemized deductions.

Step 7: Schedule A--Itemized Deductions

Schedule A is divided into several parts because some expenses are only deductible to the extent that they exceed a set amount of your income.

Before you get to deduct medical and dental expenses, for example, you must pay out more than 7.5% of your adjusted gross income to health care providers. Generally speaking, you would have to be very sick or underinsured to qualify for this deduction.

John and Mary illustrate the point. Their total medical expenses amount to $755--$720 for insurance premiums and $35 for visits to their HMO physician. They note that amount on line 1. On line 2, they list their adjusted gross income from lines 31 and 32 of the 1040: $59,984. Line 3 asks them to multiply their income by 7.5% and note the result--in this case: $4,499.

Since the $4,499 “deduction floor” is greater than their expenses of $755, they can’t take a deduction. They write “none” on line 4.

The second section asks about deductible taxes paid. To complete line 5, John must add up the state tax and state disability insurance payments recorded on the couple’s W-2 forms:

He transfers the total of $1,498 to line 5.

STATE TAXES

State withholding:

John--$946

Mary--17

State disability:

John--397

Mary--138

Total--$1,498

On line 6, John lists the Taxpayers’ property tax payment of $2,394. And on line 7, he reports the personal property taxes they paid to the Department of Motor Vehicles for registering their cars, $714.

He totals those amounts and writes $4,606 on line 8.

Line 9 asks for their mortgage interest expenses: $13,500--a figure drawn from a statement sent by the mortgage company.

Line 10 allows the family to deduct some of the points they paid in refinancing the house, both in 1992 and 1991.

How much, though? To determine that, John needs his scratch pad.

John jots down the $3,000 in points that the Taxpayers paid when they refinanced last year. But that cost must be amortized over the life of the loan. So John divides $3,000 by the 360-month loan term and multiples the result, $8.33, by the number of payments he made on the new loan in 1992--in this case, six. He notes the result, $50, which is the deduction he can claim for refinancing points on the couple’s 1992 return.

The Taxpayers also refinanced in 1991, paying $2,000 in points. Last year, they deducted $67 worth of those points. The new refinancing allows them to deduct the remaining $1,933 in points from the old loan all at once. So John adds that sum to the $50 deduction on the new refinance.

DEDUCTIBLE POINTS

$3,000 360: $8.33

$8.33 x 6: $50

$50 + $1,933: $1,983

John transfers the total, $1,983, to line 10.

The Taxpayers have no investment interest expenses, so they simply add the mortgage interest and points and report the total--$15,483--on line 12.

The next section of Schedule A asks about “gifts to charity.” John pulls out his receipts and adds up the couple’s charitable contributions:

CHARITABLE CONTRIBUTIONS

United Way--$350

Heart fund--$125

Muscular Dystrophy--$150

Church--$214

Boy Scouts--$25

Girl Scouts--$25

Total $889

He records the total--$889--on lines 13 and 16.

The Taxpayers don’t have any moving expenses or casualty and theft losses, so they skip to the section on “miscellaneous deductions.”

Miscellaneous deductions cannot be claimed unless they amount to more than 2% of your adjusted gross income. That’s $1,200 for the Taxpayers. And since their only deduction here is the $60 they paid to rent a safe deposit box, they write “none” on line 24.

Now it’s time for some adding up. John adds lines 4, 8, 12, 16, 24, 25 on Schedule A and records the total of the family’s itemized deductions--$20,978--on line 26.

John and Mary are ready to forge ahead to the child-care form, which will provide more of the information needed for Page 2 of the 1040.

Step 8: Form 2441--Child and Dependent Care Expenses

First, the basics. John fills in their names and his Social Security number at the top of the form. Then, in Part I, he writes the name, address and employer identification number of their child-care provider and the $5,200 they paid last year.

On line 3, he writes “2” for the number of children requiring child care. Line 4 is another spot to record the amount paid, $5,200.

Line 5 calls for a calculation. John multiplies $2,400 by the number of children on line 3, up to a maximum of two. He writes the result--$4,800--and repeats that figure on lines 7 and 8.

John lists his $48,000 income on line 9 and Mary’s $11,079 income on line 10.

On line 12, they note their adjusted gross income--$59,984--and compare that to the table on line 13. Their income is more than $28,000, so they multiply their $4,800 in deductible expenses by .20 to determine their credit--$960--which is listed on lines 14 and 16.

Now they return to the 1040.

Step 9: Form 1040--Page Two

On line 32, John repeats the Taxpayers’ adjusted gross income--$59,984--from the bottom of page one of Form 1040.

On line 34, he notes their itemized deductions of $20,978 from Schedule A. Subtracting that sum from line 33, he comes up with $39,006, which he notes on line 35.

John multiples the personal exemption figure--$2,300--by the number of people in the Taxpayers household--four. He records the result--$9,200--on line 36.

One more subtraction results in their taxable income--$29,806. Now comes that moment of trepidation when Mary looks up their tax due in the tax tables. John notes the figure--$4,474--on lines 38 and 40.

Here’s where the child-care credit from Form 2441 pays off. John notes the $960 credit on lines 41 and 45. It’s subtracted directly from the taxes owed, so their tax drops to $3,514 on line 46. That sum also is noted on line 53.

For one last time, Mary pulls out the W-2 forms to figure how much she and John already have paid in federal tax through employer withholding:

FEDERAL WITHHOLDING

John--$3,318

Mary--36

Total--$3,354

John notes the total--$3,354--on lines 54 and 60. He subtracts it from the $3,514 owed on line 53 and finds that they must pay an additional $160 to the IRS.

Step 10: Finish Up

John and Mary sign their return and make copies of the 1040 and schedules for their tax records. They staple copies of their W-2s to the front of the original 1040 and send it, the original schedules and their $160 check to the IRS.

Step 11: Throw a Party

After battling through the grueling task of filing their returns, John and Mary figure they deserve it.

NOTE: This is a sample tax return for a hypothetical family and is to be used for illustrative purposes only. Please consult your tax preparer or the IRS for specific questions about your taxes.