Don't Be an April Food This Tax Season

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Tax Preparation

The best way to take charge of your tax bill is to make sure you understand the effect of tax rules on your particular situation. The Colorado Society of CPAs points out that failing to understand the law can not only make you an April Fool, but can be costly as well. Here are some true taxpayer stories that highlight valuable tax lessons.

GET EDUCATED ON TAX DEDUCTIBLE JOB EXPENSES

After two-and-a-half years with an international consulting company, "Sam" left to begin a full time MBA program. After graduation, he became an investment banker with Morgan Stanley. On his tax return, he deducted nearly $35,000 as education expenses. The IRS denied the deduction. Lesson learned: Don't expect Uncle Sam to foot the bill for education expenses associated with career changes. Unreimbursed employee education expenses are deductible only if they are incurred to maintain or improve job skills in current employment or to meet the state's or employer's requirements for keeping the position.

Your Income Tax, 19.16 Yuanqiang Zhang, TC Summary Opinion 2003-58

DEPENDENCY EXEMPTIONS: PUT WAIVERS IN WRITING

In a divorce situation, the custodial parent has the right to claim the dependency exemption. However, in some instances the custodial parent may allow the non-custodial parent to claim the deduction. One father thought he had the right to claim an exemption for his son because the divorce decree, signed by his former wife, indicated that as long as he kept up with his child support payments, she would sign the necessary waiver or Form 8332 that would give him the right to claim the exemption. Despite keeping up his part of the bargain, she never completed the form or put the waiver in writing. He went ahead and claimed the deduction, which the IRS denied. Lesson learned: The custodial parent must sign an explicit waiver of the exemption or complete Form 8332. Since the custodial parent did not sign a waiver or complete Form 8332 for the non-custodial parent to attach to his tax return, the father does not have the right to claim a deduction.

Your Income Tax 40.12 Joe D. White, TC Summary Opinion 2003-18

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EMOTIONAL DISTRESSS CAN BE TAXING

One employee sued her employer for discrimination under Title VII of the Civil Rights Act. An out-of-court settlement was reached and the employee received $10,000, less applicable withholding, as compensation for lost pay and another $35,000 for her claim of emotional distress. The employee thought the $35,000 was tax free compensation under Code Section 104(a)(2)for emotional distress due to physical illness. The IRS assessed tax on the income.

Lesson learned: Under Code Section 104(a)(2), a taxpayer may exclude from gross income damages received due to personal physical injuries or sickness. The law specifies that emotional distress by itself does not generally qualify for the exclusion. There are two exceptions: (1) amounts paid by the taxpayer for medical care attributable to emotional distress can be excluded from income; and (2) damages for emotional distress attributable to a physical injury or sickness can be excluded from income.

Your Income Tax 11.7 Tonia V. Cates, TC Summary Opinion 2003-15

NOT ALL GIFTS ARE TAX FREE

One employer gave its workers holiday gift baskets consisting of turkeys and hams. Some employees complained that they were vegetarians, so the employer decided to give gift certificates instead. Unfortunately, the IRS required employees to pay income tax on the gift and payroll taxes had to be withheld as well. Because the gift certificates set specific cash values, they did not escape being included in the employees' income as "de minimus fringe benefits."

Lesson learned: All fringe benefits, unless specifically excluded by law, are taxable to employees based on their fair market value, and the employer is responsible for withholding all appropriate federal income and other employment-related taxes from the recipient's cash compensation. Holiday gifts (other than cash) that have a low fair market value are generally considered "de minimus" and are not subject to taxes.

IRS Technical Advice Memorandum 200437030

There's no avoiding the complexity of tax laws. However, you can avoid becoming a tax-time "April Fool" by understanding how the rules affect your particular situation and getting help from a CPA.

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