Nearly everyone is feeling some financial pain these days, whether from job loss, stock market losses or the real estate collapse. That means many taxpayers are facing unfamiliar issues, deductions and traps on their 2008 tax returns and in their tax planning.
The questions are legion, and the answers often aren't simple, let alone what a sensible person might assume. When can you deduct losses, job hunting expenses or moving costs? If you're strapped for cash, can you tap into retirement accounts without penalties? If you want to help others, what are the tax angles?
Frequent changes to the tax law further complicate matters. Example: You might have heard the stimulus passed in February exempts $2,400 of unemployment benefits from inclusion in your taxable income. That, however, is for 2009. If you're preparing 2008 returns, all your unemployment checks are subject to federal income tax (although not Social Security and Medicare taxes). Still, some states, including California and Michigan, don't tax unemployment benefits -- so check yours. Note that any severance payments you receive are subject to income, Social Security and Medicare taxes.
One confusing area: losses. As a general rule, the tax code isn't very generous when it comes to writing off non-business losses, although Congress and the IRS have made a few notable taxpayer-friendly changes recently. (One is for losses suffered in a presidentially declared disaster area; for details, see IRS publication 547, "Casualties, Disasters and Thefts.")
Just last week, the IRS, under pressure from Congress, issued new rules that will allow victims of Bernard Madoff's $65 billion Ponzi fraud and similar schemes to claim investment-theft losses that could generate billions of refunds of taxes they paid over the last five years.
Many more taxpayers, however, have been hit by plunging stocks than have come into contact with floods, wildfires or con men, and there's little good news for them.
Sure, losses you've taken on the sale of stocks and mutual funds in taxable accounts can be used to offset any capital gains. But only $3,000 of your net capital losses each year can be deducted against ordinary income -- meaning income from your salary. The rest are carried forward to offset whatever gains you may have in the future, plus $3,000 of ordinary income a year. For more on making the most from your stock losses, go here.
What about retirement accounts? That's what clients have been asking William Stevenson, president of National Tax Consultants in Merrick, N.Y. "People never really thought about losses in retirement plans before. They're still in shock,'' he says. The answer: No matter how steep the losses in your pretax 401(k) or pretax IRA, you can't deduct them, since the money in those accounts was never taxed to begin with. On the other hand, losses in Roth IRAs and 529 college savings accounts (both funded with already-taxed money) may be deductible and worth taking in certain cases.