Filing Late? Seven Last-Minute Tax Tips

C H I C A G O, April 3, 2002 -- The deadline for tax returns is only 12 days away, but if you are like millions of other Americans, your 1040 form may be stashed somewhere under a pile of credit card bills and mail-order catalogs.

In fact, roughly 40 percent of all Americans wait until the tax deadline day, April 15, to file their taxes. About 130 million individual tax returns will be filed this year, with about half of Americans doing it themselves, and the other half using a tax professional. Even if someone does your taxes for you, there is important work you need to do on the front end, and 2002 is definitely the year to get the ball rolling sooner rather than later.

The $1.35 trillion tax cut passed by Congress and signed by President Bush last June included 441 tax law changes that will make the filing process even more taxing.

This year, the IRS has reported that it plans to randomly select 50,000 tax returns for a special audit. In previous years, the IRS has targeted only suspicious returns. That is bad news for later filers. All too often, last-minute filing results in overlooked deductions, mathematical inaccuracies and trouble with the Internal Revenue Service. Here are some simple steps you can take to make filing your taxes less painful.

1. Gather Your Statements

No one said doing your taxes was fun, but it can be a terrible experience if you are not organized. Take the time to get all the paperwork together. Gather all your W-2 wage statements. These come directly from your employer and were required for all the work you performed in 2001 by the end of January 2002. In addition, if you have any investments (including a savings account), you need a Form 1099 from each bank, brokerage firm, investment company and mutual fund you invested with in 2001.

There are many different types of 1099 forms, including a separate form for interest, dividends, proceeds received from stock and security investments, government payments, royalty and rental income, distributions from IRAs and other retirement plans, and social security income. If you realize that you are missing forms, immediately contact your employer or the firm in which your money is invested and request they be re-sent to your attention. If you don't have them in time, consider filing for an extension on paying your taxes. Some mutual fund companies and brokerage firms say it could take up to two weeks for you to receive a duplicate of your 1099s.

2. Take Pictures, Keep Receipts

After you have accounted for and organized all of your forms and information, pull together your exemption, deduction and tax credit information. Just as you organized your income statements, you will need to do the same with all of your deductions. In addition, there are a handful of categories that commonly trip people up and raise suspicion from the IRS.

For instance, the IRS may question your deduction of a home office — and they will often do so two years after you have filed for said deduction. The IRS may ask for proof that you used the equipment or portion of your home exclusively for business. In order to protect yourself, take pictures of your home office to prove that it is, or was, being used exclusively for business purposes. Likewise, with all deductions, the key is to save all your receipts for at least three years and document everything in writing. The major deduction categories are: home, education, medical, work and charitable.

3. Be Careful With Line 47

The IRS estimates that 15 to 20 percent of the 91 million paper returns filed last year contained a detectable error. Already more than one million Americans have made mistakes on their tax returns this year because of a new line on Form 1040, specifically line 47. Many people made errors on that line, because they are unclear if they owe federal income taxes on the tax-cut checks they received last year.

Here is what you should do: For those who received a tax rebate check last year ($300 for singles or married people filing separately, $500 for head of household and $600 for couples filing jointly) leave the "rate reduction credit" line, which is line 47, blank. This line is meant for taxpayers who did not receive the maximum benefit last year, or whose 2001 income or tax amounts qualify them for a larger rebate. If you mistakenly fill in this line, your return will likely be flagged for an error prompting an official letter from the IRS, and almost certainly delaying any additional refunds you are due.

4. Paper Or Plastic?

Due to extra mailroom precautions resulting from last year's anthrax scare, the IRS is encouraging taxpayers to consider paying their taxes online. In fact, the IRS has projected 45 million tax returns will be filed electronically. Using IRS e-file is an option for those who feel comfortable behind a keyboard and monitor, but e-filing taxes require work on the front end.

In order to file your taxes electronically, you need to purchase, download from the Internet, or access software online. According to the IRS, e-filing is more accurate than paper filing and has less than a one percent error rate. In addition, paying electronically allows your refund to be direct deposited to your bank account, thus potentially decreasing the amount of time you need to wait for your refund. Also, in 37 states, you can file your Federal and state return at the same time, easing the process.

One additional point: do not use your plastic to pay your taxes. In addition to the usual finance charges you will pay, you are subject to an additional fee of 2.5 percent on whatever you owe if you use credit cards.

5. Filing For an Extension

If you absolutely cannot make the April 15 deadline, and you do not live in the handful of states, including Maine and Massachusetts, which observe Patriots' Day and have an extra day to file, you must file for an extension.

You are allowed an additional four months (until Aug. 15, 2002) to file your taxes, if you file Form 4868, Application for Additional Extension of Time to File. Furthermore, if by August you are still in a sweat over filing your taxes, you can file Form 2688 and receive a final extension until October 15, 2002. Unlike the first extension, in order to delay your filing until October, the IRS requires you to explain why you need the additional time.

Although an extension entitles you to more time, it does NOT allow you to delay paying the bill. You are still required to pay the taxes you expect to owe by April 15. While you are not required to calculate your tax liability exactly, your payment must represent a bona fide and reasonable estimate or the extension could be disallowed and late penalties may be applied. The IRS requires the total amount you pay to represent 90 percent of your tax liability for the year.

Mellody's Math: Assuming a taxpayer owes $10,000 — after all withholdings and deductions — these three scenarios illustrate why you SHOULD NOT ignore the April 15 deadline and you should file for an extension and file August 15!

Taxpayer 1 pays the $10,000 he owes on April 15, but does not file his taxes (his wife is out of the country, he lost a form … ). He ends up owing the IRS only the $10,000 he paid. (No additional fee is incurred if he pays his exact taxes, but does not file on time.)

Taxpayer 2 files for an extension and pays 90 percent ($9,000) of his estimated taxes. He ends up owing the IRS: $10,020 (the $9,000 he submitted on April 15 + $1,000, the rest he owes + $20 in interest on the $1,000.)

Taxpayer 3 does nothing and lets April 15 pass without paying the $10,000. He ends up owing the IRS: $12,239 (the original $10,000 tax bill, + $239 interest +$200 late penalty fee + $1,800 late filing penalty.)

On the flip side, if you do not file your taxes, and the government owes you a refund, the government has three years to send it to you. For example, this is the last year to receive any refunds owed from the 1998. While you will not face any penalties for not filing, the economics are against you, as your money is sitting interest-free in the government's account. According to the IRS, the average refund for early filers this year is $2,210. If you do not file, you could run the risk of losing money that you are owed. At the end of last tax season, $89 million in refunds went unclaimed by about 95,000 taxpayers.

6. Self-Discipline

Do not make the mistake of letting the IRS compute your estimated taxes if you expect to incur a penalty for underpayment.

If you leave the computations up to the IRS, they will spread your estimated income evenly over four quarters and assess the damages accordingly. Instead, do your best to calculate your own estimate by analyzing what you paid in taxes last year and what variables have changed to increase or decrease the amount you owe. You can save money by calculating penalties based on when your income was actually realized.

7. Now or Never for your IRA

While the IRS offers a filing extension, they are not as generous when it comes to contributions into an Individual Retirement Account (IRA). The deadline for the 2001 tax year is April 15, 2002. Even if you obtain an extension to file your income tax return, you have to make the contribution by April 15.

With the uncertain state of Social Security, investing in an IRA is a retirement must-do. Remember: when investing in a Roth IRA your contributions are taxed but your earnings grow tax-free. By contrast, in a traditional IRA, your contributions and earnings grow tax-deferred. All things being equal, a Roth IRA is the most ideal IRA for those who qualify, because of its greater flexibility. Remember, it is important to tell the sponsor of your IRA which tax year your contribution is for, to insure you allocate the appropriate amount for the given year.

Mellody Hobson, president of Ariel Capital Management in Chicago, is Good Morning America's personal finance expert. Click here to visit her Web site, ArielMutual Funds.com. Ariel associates Matthew Yale and Anne Roche contributedto this report.