Special Tricks for Tax Season

Most of us need to get set for an unusual tax filing year. The recent tax laws, phased-in provisions, and other factors will keep you on your toes.

Prepare for amended returns. Brokerage firms asked the IRS for permission to issue their Form 1099-DIVs a month late.  They have to determine which dividends qualify for the 15% tax rate and which don’t, and put them in separate boxes on the form. Since the IRS didn’t issue final regulations until Nov. 2003, the financial services firms said their systems wouldn’t be ready to do correct forms on time. But the IRS would not extend the deadline. After the 1997 capital gains tax cut, about 17% of 1099s were corrected and reissued. Expect at least that many to be corrected this year.

You might want to wait as long as you can to file your tax return this year, or don’t be surprised if you have to file an amended return after getting revised 1099s.

Not all dividends are tax-favored dividends. Distributions from mutual funds often are called dividends, but only dividends from corporate stock qualify for the 15% rate when passed through funds. Dividends from money market funds, bond funds, and real estate investment trusts are taxed as ordinary income. Also, under the rules if you purchased a stock or mutual fund the day before its ex-dividend date, you don’t qualify for the 15% rate on that distribution. Congress might change this unexpected result.

Count your holding period. Remember that the 15% long-term capital gains rate applies only to stocks held for more than one year. If the holding period was any shorter, the gains are taxed as ordinary income. A mutual fund tells you whether the gains it passes through to you are short-term or long-term gains. Rules on how to count days in close cases are in the IRS’s booklet on capital gains and losses.

The lower long-term capital gains rate applies only to assets that were sold on or after May 6, 2003. Another catch: The lower rate doesn’t apply to collectibles.

You also need to hold a stock or fund a minimum period to qualify for the 15% rate on dividends. This can get tricky. You must hold the asset for 61 days out of a 120-day period. The period begins 60 days before the day the stock or fund traded without its dividend, and ends 59 days after that day. This is where things get tricky for mutual fund owners. The Form 1099 will only determine if a dividend is qualified for the 15% rate. It won’t determine if you met the holding period requirement.  Some mutual fund companies say they are hoping to gear up their computer systems to handle the holding period issue either sometime in February or March or by next year’s filing season.

More AMT troubles. When your regular income tax declines, you are more likely to trigger the alternative minimum tax because you pay the higher of the two taxes. If you have a lot of income that is eligible for the 15% rates for long-term capital gains and dividends, the AMT might be triggered. If so, that would increase your effective rate on the tax preference income to 22%.

Couples with income between $150,000 and $382,000 are vulnerable. Especially vulnerable are who with high state and local taxes who earn $200,000 to $500,000.

You cannot do anything now to avoid the AMT for 2003. But give it careful attention in your planning for 2004. Start with the articles in the Tax Watch section of the Archive on the website.