Interesting Tax Lessons from the Filing Deadline- October Edition

Another filing season down.

With the stress of the second filing deadline gone, I can finally enjoy the rest of the fall and get ready for the holidays.

And even with the late night at work on Wednesday (and many late nights the past couple of weeks), I still really enjoy getting to do what I do. Every day I delve into people’s financial lives, and I encounter new scenarios the intrigue me.

As I did at during the first deadline, I want to share some interesting tax lessons that I saw when reviewing and preparing returns for October 15th:

1. Prior Year State Tax Payments Still Count as an Itemized Deduction: In my line of work, a lot of clients owe back taxes to both the state and the IRS. As such, they enter into installment agreements to pay back the taxes that they owe.  Luckily my clients, if they itemize, can deduct payments made to the state in the current year and any past due payments that they made during the filing year.  I saw several returns where our clients could take advantage of the deduction and didn’t realize it. For one client, the deduction resulted in an additional $20,000 added to his schedule A.

2. Death of a Spouse Can increases Cost Basis in a House: Figuring out the profit on a house can be tricky, especially one that has increased in value a lot. I reviewed a return where the preparer was trying to figure out the profit on a house that her client owned for 30 years. Not only had the house increased in value almost seven figures, there were several improvements and the taxpayer’s wife had died a few years ago. The main mistake I saw on the return was the preparer not taking into account the increase in basis when the taxpayer’s spouse died.

If taxpayers own a home as Joint Tenants with Right of Survivorship and one spouse dies, the surviving spouse increases his or her basis in the property by one half of the property’s value on the date of the spouse’s death. For example, if the property was worth $900,000 when the taxpayer’s wife died, the husband’s basis increases by $450,000 (one half of the value).  His original basis will remain the same – one-half of the adjusted basis pre-death. So let’s say they purchased the house 30 years ago for $200,000 and made $100,000 in improvements, the survivor’s original adjusted basis would be $150,000. The new adjusted basis would be $600,000! That negates a lot of profit that might otherwise have been taxable.

3. Pre-Tax Reimbursement Costs More Than You Think: This last lesson I was actually explaining to a new coworker. Our firm reimburses half of our membership at the gym across the street. However, because of how the deduction works, the reimbursement is made pre-tax but the cost of the membership is taken post-tax. The total cost of the membership is $120. Our employer takes $60 out of each semi-monthly check (after tax) but adds $30 to our income each check.

The coworker was excited that her membership only costs $60 month. However, I pointed out to her if she wants to know the true cost she also has to consider the tax she has to pay on the pre-tax reimbursement.  In other words, the $60 pre-tax income added to her paycheck every month equates to $42 in after tax income, if she’s in a combined 30% federal and state tax bracket. That means the membership is really costing her $78 per month ($60 membership plus additional $18 in tax). This likely doesn’t matter, unless you’re like me and track every penny that you spend. But it’s still a fun mental exercise when figuring out the true value of pre-tax and post-tax benefits.

Maybe it’s a bit nerdy to get excited about these types of issues, but it’s fun to me. I will definitely enjoy the next few months of down time, but I’m sure come the new year, I’ll be excited to start the prep season all over again.