Frequently Asked Questions

Tax & Filing News

Changed Your Name? Better Tell the Social Security Administration

More Do-or-Die Reminders

Did the IRS Get My Tax Return?

I Forgot to Include My W-2!

Investing & Taxes

Can I E-File Homemade Schedules?

How Exactly Do I Defer My Loss On A Wash Sale?

HOLDRs and the Wash Sale Rule

Covering Calls Again

When Does My Holding Period Start?

Taxes For Traders

How Do I Elect Trader Status?

Trader Trying to Track His Trades

Traders and Tax Software

Homes & Taxes

Returning to the Vacation Home

Returning Can I Sell My House for a Buck?

Cross-Country Home Owners

Marriage & Taxes

I'm Separated. Can I Be Single?

Kids & Taxes

Helping an Unborn Child With College

Gifts to the Kids

Roths for Teens

IRAs, Roths, & 401(k)s

Hedging in an IRA?

Trading in IRA, Take Two


Does IRA Rollover Count in AGI?

Roth Contributions Tanked

What Do I Owe Taxes On?

Can I Convert My SEP IRA to a Roth?

Loans and Rollovers

IRAs, Roths, & 401(k)s

An Inherited House Full of Taxes

Changed Your Name? Better Tell the Social Security Administration

Does your name match your Social Security number? If you changed your name without notifying the

Social Security Administration

, it most likely does not.

If it doesn't, you're probably one of the 2.4 million taxpayers getting a tsk-tsk letter from the IRS telling you to fix the problem before you file your tax return in April. If you don't rectify it, your refund may be held up or you may be denied either the earned income tax credit or the personal exemption a spouse gets when a couple files jointly.

This push is an effort to reduce fraud, although most of the discrepancies involve women who took their husbands' name when they got married, according to the IRS.

The proper documents (i.e. marriage certificates) can be mailed to the Social Security Administration, but they must be originals, not copies. The administration will return them to you when it is finished with them. I advise you go to your local office and take care of it in person.

Check out the Social Security Administration's

Web site for more information.

More Do-or-Die Reminders

Check out the



transcript between Martin Nissenbaum, director of income tax planning at

Ernst & Young

and me for more advice on these issues. Special thanks to those of you who joined us.

Also, here are a few more do-or-die reminders to help you get your 1999 tax return in by midnight Oct. 16.

E-File away.

You can still electronically file your tax return. Most e-filing sites are available until midnight Oct. 16, so check out our

Guide to Online Tax-Filing Sites to determine which one is right for you.

Hint: Be sure your name matches the one on your Social Security card; otherwise you can't electronically transmit your return.

Use your credit card.

You can call 888-2PAY-TAX and charge your 1999 tax payment on

American Express





, though you'll pay a "convenience" fee.

The fee averages 3% to 4% of your payment. Check out Official Payments'

Web site for the complete payment scale.

If you file electronically using


TurboTax software programs or Web sites, you can charge your tax bill using your Discover card only.

For more on credit card payments, see

Charging Your '99 Taxes. And check out this earlier

Tax Forum on filing late for some good charging tips.

Roth revisted.

At this point, you cannot make an IRA or Roth IRA contribution for 1999. The deadline for that was April 17. (April 15 was a Saturday this year.)

But if you opened a Roth IRA account or made a Roth IRA contribution for 1999, make sure you still meet the adjusted gross income limitations. If you now realize you've exceeded those limits, you have until the time you file your tax return to recharacterize that Roth IRA account or contribution. See the

Roth IRA Tax Reporting Guide for tips.


If you still owe money, make your check or money order out to the

U.S. Treasury

, not the IRS.

If you entered a smoking cessation program in 1999, you can deduct the amount you paid for the program, and any prescribed drugs to treat nicotine withdrawal, as a medical expense. However, you cannot include nicotine gum, patches or other treatments that are not prescribed by a doctor.

Remember, you can deduct only the amount of medical and dental expenses that exceed 7.5% of your adjusted gross income. Report these expenses on Schedule A:

Itemized Deductions

, found on the IRS'

Web site. Don't include any medical expenses that were reimbursed by your insurance carrier.

If you entered a smoking cessation program in 1996, 1997 or 1998, you may be able to go back and claim these expenses. Just make sure it's worth your time and effort before you go through the administrative nightmare of amending your tax return.

Did the IRS Get My Tax Return!

I electronically filed my state and federal returns through TaxCut on April 9. The federal was accepted almost immediately. I'm still waiting on the State of New Jersey. What should I do? -- Jon Zoll


Assuming you electronically filed correctly, both your federal and your New Jersey tax returns were transmitted together. TaxCut actually recommends that you e-file this way.

Then your returns were piggybacked and electronically transmitted to the IRS. In this case, your notification of receipt was for both returns. The Service then sent your state return on to New Jersey.

If you got a declaration control number (DCN) indicating your return was accepted by the IRS, make sure you put in on

Form 8453-OL

-- U.S. Individual Income Tax Declaration For On-line Services Electronic Filing

, as well as the New Jersey e-file form and mail them in. It does matter that they're late. "Just send them in," says Don Roberts, spokesman for the IRS.

But if you filed electronically in previous years, you should have gotten an

e-file Customer Number, or ECN. If you filed your tax return using this number, you would not get a DCN. In that case, you're done.

I Forgot to Include My W-2!

I filed as a trader and with over 300 trades, I spent most of my time working on MY taxes. With everything done I was off to the post office and mailed my return by 5 p.m. Just great -- except for one small error. I forgot to include my wife's W-2. Since they owe us a refund I assume that they will not issue it until our return is complete. Is there something special I should do or should I just put it in an envelope with a note and send it off? -- Steve Conklin


If you just forgot to include your wife's

Form W-2

-- Wage and Tax Statement

with your tax return, then don't do a thing. Wait for the

Internal Revenue Service

to contact you.

This is true for any document you forget to attach. Wait for correspondence from the IRS. They may ask you to send the information to an address that is different from where you originally sent your tax return. So sit tight.

Form W-2 details your wife's total compensation and withholding for the year. If you included all of this information when calculating your tax bill and just forgot to attach a copy of it with your tax return, the IRS may be able to figure things out without it. But don't be surprised if your refund is held up until the IRS sees the W-2.

If you inadvertently excluded your wife's W-2 information in your tax return, you should file a

Form 1040X

-- Amended U.S. Individual Income Tax Return

, says Kathy Burlison, an

H&R Block

senior tax specialist. She recommends waiting a few weeks before you send the amended return, to ensure that the IRS has started processing your first return. "You don't want them processing the amended return before the original. It will totally confuse them."

Note that if you generate a balance due with your amended return, interest and penalties will be calculated starting April 17.

Bigger note: Even though your tax return is wrong, you still may get your refund. "Just because you got your refund does not mean that IRS won't challenge that return later," says Burlison.

The IRS runs a few quick checks and tries to get your refund back to you as soon as possible. But it does not receive verified wage information for a few months after the April 17 deadline. The

Social Security Administration

must verify your wage numbers first. Then those numbers are sent to the IRS. It's at that point that the IRS starts fact-checking your return.

So if you know your tax return is wrong, don't spend the money! And be aware that the IRS has as many as three years to ask for it back.

Can I E-File Homemade Schedules?

Regarding attachments to Schedule D, I'd like to file the 1040-PC, since the IRS can scan it, and it should result in fewer typing errors. Can I make a "see attachment" comment if I want to file a 1040-PC? -- David Hoerl


Rather than go through the tedious process of entering scores of trades into a tax software program, you obviously prefer to print out your own schedule of trades and attach it to your tax return. That's OK as far as the IRS is concerned, but you won't be able to file your tax return electronically. A detailed trade statement is not an authorized attachment for e-filing, so the IRS may just discard it. (See this previous

Tax Forum for more on attaching statements.)

By the way, if you file electronically, you're limited to reporting 97 short-term trades and 97 long-term trades on an e-filed Schedule D.

The 1040-PC is basically a condensed version of the

Form 1040

-- U.S. Individual Income Tax Return

that expedites processing because, in theory, it can be quickly scanned. But here's a secret: The IRS never created a system to read these condensed forms. So don't bother. Just use the regular Form 1040, write "see attached schedule" on your Schedule D, attach your schedules and drop it all in the mail.

The IRS has proposed allowing more trades on an e-filed Schedule D for next year, says Eddie Feinstein, vice president of electronic services at

H&R Block


How Exactly Do I Defer My Loss On A Wash Sale?

I had to sell off my position in i2 Technologies (ITWO) at a loss this month to cover a margin call. Now that the market seems to be pulling out of the recent correction, I bought some back. How can I handle this next April? Can you expand your explanation from your " mega-piece", about how the loss is added back to the basis of the repurchased stock? -- Stephen W. Mamber


First, a quick recap on the wash sale. If you buy a stock, sell it at a loss and then buy it back, you're holding the same position in which you started. So economically, your position has not changed. That's why the IRS created the rule that says if you sell a security at a loss, you can't deduct the loss on your tax return if you acquired a "substantially identical" security 30 days before or after the sale.

Let's say you bought one share of i2 Technologies at $163 on March 1. You sold it at $122 on March 31 to cover your margin call. You now have a $41 loss.

But over that weekend you decided to get back in. So on April 3 you bought your share back at $93. You've triggered the wash sale because you bought the stock back within 30 days of the sale. Now you cannot claim that loss on your tax return.

But there's hope. The wash sale rules say that you can add the disallowed loss to the basis of the repurchased stock.

The technical jargon says that the basis of the new stock equals the original price of the security less the difference between the sale price and the repurchase price. So the original share was $163, but here you sold the share at $122. Before the 30-day waiting period was up you bought the share back at $93. The basis in that new share is now the original basis ($163)


the difference between the sale price ($122) and the repurchase price ($93). Your new basis is $134 in this situation. You've just added the $41 loss to the $93 share.

On the flipside, if you had sold the stock for less than the repurchase price, the calculation is a bit different. The basis of the new security will be equal to the basis of the securities you sold plus the difference between the repurchase price and the sales price of the original shares.

Let's say the basis in the old stock was $163 and you sold it at $122. Before the 30-day waiting period is up, you buy the share back at $125. Your basis in that stock is equal to the old basis ($163)


the difference between the repurchase price ($125) and the sales price of the original shares ($122). In this scenario, $166 is your new basis.

Although it looks like you just added the disallowed loss to the new basis, it's recommended that you still walk through this exercise because the numbers are not always this straightforward.

Many thanks to Richard Shapiro, an

Ernst & Young

securities tax partner in New York, for helping with these numbers.

HOLDRs and the Wash Sale Rule

In the recent downturn, I sold several stocks. In every case, there were some shares that were sold at a loss. Can I get back into those stocks using HOLDRs before 60 days without losing the losses? Or is the answer "nice try"? -- Bob Zeek


Nice try. The short answer is: The wash sale rule does indeed apply.

Merrill Lynch's

HOLDRs offer ownership in a basket of 20 stocks through a single investment. A perk to these securities is that you have the option to redeem them (in 100-share lots) and get shares of the underlying stocks in return. (See a recent

Dear Dagen for more details on HOLDRs.)

Since that gives you direct ownership of the stocks, the wash sale rule applies. Even if you don't redeem the HOLDRs, technically you still own them, says Erik Hendrickson, a Merrill Lynch spokesman.

Remember the wash sale rule says that if you sell a security at a loss, you can't deduct the loss on your tax return as long as you acquire a "substantially identical" security 30 days before or after the sale. Read our

mega-piece for further details on the wash sale.

Let's say you sold 100 shares of



, the biotech company that uses human genetic information to develop pharmaceuticals, at a loss. (FYI: If you bought the stock on March 1, your position is down 48.4% as of April 27.)

Instead, you decided to buy 100 shares of

Biotech HOLDRs

(BBH) - Get Report

(which, by the way, are also down 44.1% over the same period). In this instance, you'd have a partial wash sale.

Here's why. There are 22 shares of Genentech in each round lot of the Biotech HOLDRs. (Check out this

section of the

American Stock Exchange's

Web site for more details.) So the loss on 22 of the Genentech shares you sold would be disallowed.

Keep in mind that the disallowed loss can be added to the cost basis of the repurchased security. In other words, you can add the disallowed loss on your Genentech shares to the cost basis of your Biotech HOLDRs.

But if you redeem the shares of the HOLDRs, you must attach that loss to the HOLDRs' Genentech shares only -- you can't apportion it among all the stocks in the HOLDRs, says Jim Calvin, an investment management tax partner at

Deloitte & Touche

in Boston and editor-in-chief of the

Journal of Taxation of Investments


See this previous

Tax Forum to help you figure out your basis in the HOLDRs after redemption.

Covering Calls Again

Last week, I

discussed the tax implications of writing covered calls, but I didn't address what happens, taxwise, when the underlying stock is called away and the seller doesn't want to give it up. So let's do that now.

First, some review: Calls are a type of option that gives the purchaser the right to


a security at a specified price at a certain time. It's a way of betting that a stock will rise. Investors who sell covered calls are taking the other side of that deal. When they


(or in market parlance, "write") calls, they agree to deliver shares of a particular stock if the buyer of the call exercises his option. The seller, or writer, gets a fee called a premium for taking on this obligation. If all goes well for the writer, the option will expire -- in anywhere from a few days to a year or longer -- and the writer walks away with the premium.

A call is "covered" when the seller owns the underlying stock. But what if those shares are called away -- that is, the buyer exercises the option -- and the seller doesn't want to deliver them?

The seller has two choices, both of which bring up some hairy tax issues. He can buy the option back or go into the market and buy new shares of the stock to deliver to the buyer.

Let's say you sold a $20 call for $3 in premium. That means the buyer has the right to buy the stock at $20 a share. But the stock now is trading at $30. Obviously, the buyer wants to exercise his call, pay you $20 for the stock and pocket $10 in profit. But let's say you originally bought the shares for $2, and you'd rather not generate huge capital gains taxes by selling them now. Or maybe you believe the stock is going to go even higher. Either way, you're holding on.

You can buy the option back, no doubt at a higher price. Let's say you bought it back for $10 and wound up with a $7 loss on the deal. Can you take that loss on your tax return?

No. You cannot declare that loss until you sell your original long position. But you can bank the loss until you do.

Your other option is to go into the market and buy more stock at $30. Your buyer is only going to give you $20 for each of them, though. So you have a $7 loss -- the $10 price difference minus your $3 in premium -- on each share in this deal.

Again, you can't take this loss until you sell your original long position.

It's important to be aware of these implications because "many times investors write calls with no intention of selling the stock," says Rande Spiegelman, a senior manager in


investment advisory services group in San Francisco. "Most people write calls thinking the stock is going to go down. But they have to be prepared if stock goes up."

There's one quirk in the tax laws that allows you to declare the loss on that trade if you wrote a "qualified" covered call. This type of call must have more than 30 days to expiration and have a strike price (the price at which the holder has the right to buy it) that is within $2.50 to $5 of the stock's price on the day it is sold.

The tax rules surrounding options trades are precarious, so be sure to check out

Publication 550

-- Investment Income and Expenses

for more details.

When Does My Holding Period Start?

What would the actual buy date be for a stock that was exercised from a call option? In January, I bought Tibco Software (TIBX) May 20 call options, and in March, I exercised those options. I am trying to figure out what would be the actual purchase date of those shares? Would it be the day I bought the call option or the day I exercised the option? -- Rahul Desai


If you exercise your options and end up with stock, your holding period begins the day after you exercise your options, says Richard Shapiro, an

Ernst & Young

securities tax partner in New York. In your example, the holding period began in March, not in January when you bought the calls.

How Do I Elect Trader Status?

I'm a full-time trader in 2000 and would like to elect trader status on my tax return. Is there a deadline, or do I just elect it on my 2000 tax return when I file? -- Brian Hruz


The only way the

Internal Revenue Service

knows you're a trader is by the way you complete your tax return, so technically, your deadline to file as a trader is the day you file your tax return. Unless you decide you want to mark your trades to market. In that case, then, you must have made the election on your 1999 tax return -- but we'll get to that in a minute.

There are a few distinctions that make a trader's tax return look different from, say, mine.

As an example, trading-related expenses are considered ordinary business expenses and are 100% deductible on

Schedule C

-- Profit or Loss from Business

. Ordinary investors -- like me -- can only deduct investment-related expenses in excess of 2% of their adjusted gross incomes, and they must be reported on

Schedule A

-- Itemized Deductions


For more details on how to make your tax return look like a trader's, check out this

piece from our

Taxes for Traders series.

The other big perk to filing as a trader is the option to elect to mark your trades to market, which allows traders to value their securities as if they were sold for fair market value on the last business day of the year. Making this election also permits traders to report an unlimited amount of losses on Schedule C. (Remember, the rest of us are limited to a maximum of $3,000 in net losses reported on

Schedule D

-- Capital Gains and Losses

.) While this would've been a great year to mark to market, because losses abound, you were required to have made your 2000 election on your 1999 tax return. If you did not make this election in '99, you cannot mark your trades to market in 2000. If you decide you'd like to do so in 2001, remember to make this election on your 2000 tax return in April.

Check out this

column for more details on the deadlines for this election.

Trader Trying to Track His Trades

I am an active trader in a handful of specific stocks. Since I jump in and out of trades within each stock on a daily to weekly basis (including short-selling), I'm greatly affected by the wash-sale rule. I understand how this rule applies to me, but I'm looking for a software program that will simplify my accounting of these wash-sale "losses," including any cost basis adjustments that would apply. Are you aware of any such accounting programs? Are you aware of, or do you recommend any commercially available trader accounting software to simplify tax reporting (able to handle 1000+ trades on an annual basis)? For what it's worth, I am not a professional trader, just an individual who actively trades and is starting to get bogged down in the IRS-required accounting. -- David Garza


I am not allowed to trade stocks so I don't have firsthand experience with your dilemma. But based on readers' emails and my walk through the product,

GainsKeeper may be your answer. Not only can the program handle the wash sale, but the ability to track short sales was recently added, says Bill Beaulieu, GainsKeeper's manager of Web tax solutions. In addition, GainsKeeper allows you to specifically identify which lots you want to sell.

The downside: The program won't be able to track options trades until the end of the year and you can only import data from Excel spreadsheets. If you're currently keeping track of your trades using a different method, you would have to re-enter everything. (Check out

Mark Ingebretsen's


column for more on GainsKeeper.)

As advanced as the standbys, like

Intuit's Quicken


Microsoft Money

, have become, they still can't handle the wash sale.

But readers, please

chime in. If there's a great product out there that we should know about, please let me know. I'll pass the good news on to your fellow readers.

Traders and Tax Software

I'm filing for trader status. I have capital gains and am using TurboTax Deluxe to file my tax return. How do you write the note "Section 475 election to Schedule C" next to the negative amount (to make the balance zero) on Schedule D, line 17? And, how do you write the note "Section 475 election from Schedule D" on Schedule C, line 1. I tried to input the note next to the number on those lines, but it only takes a number. -- Norman Yap


If you are working with a tax preparation software that will not allow you to insert that note, just print it out and write it in by hand. The drawback to printing out your return is that you can't file it electronically -- but this is the case for most traders. (An electronically filed

Schedule D

-- Capital Gains and Losses

can't handle more than 194 trades.)

Since there's no box to check to alert the

Internal Revenue Service

that you're filing as a trader, the only way to prove to Uncle Sam is by the way you file. So here's a quick reminder of how to fill out Schedule D and

Schedule C

-- Profit or Loss From Business

as a trader.

First, report all your gains and losses on Schedule D. That way, your gross proceeds from sales tie into your

Form 1099s from your broker.

Then work through the form until you get to line 17 (total net gain) or line 18 (total net loss). At this point, you want to make the balance on Schedule D zero so you can transfer it to line 1 (gross receipts) on Schedule C. You need to do this zero calculation by hand on Schedule D. Then write "Section 475 election to Schedule C" next to that negative amount.

The tax preparation programs will not carry your number from Schedule D to line 1 of Schedule C, so you must override the amount in the system. Be sure to write "Section 475 election from Schedule D" next to line 1. Check out this

story from our Taxes for Traders series for a visual example.

While I believe you should not override numbers when preparing your tax return, this is one of the very few exceptions to the rule.

Returning to the Vacation Home

In your article Throw Another Shrimp on the Barbie -- It's Deductible! about "taking a vacation from your vacation home," you state that to qualify for deducting expenses, you must stay in the home for more than two weeks or 10% of the rental period, whichever is greater. Are you sure that you didn't mean less than two weeks or 10%? If I don't use it at all in a given year, I can still deduct the expenses against the rental income. Your statement gave me the impression that unless I personally used it more than a minimum amount of time, I could not deduct the expenses. -- Keith Woods


You were not the only one to ask this question, so I thought it was worth revisiting.

For tax purposes, there's a distinction between renting out a vacation home and having an actual rental property. The difference: You must spend time in your vacation home. You can't spend time in a rental property.

To qualify as a vacation home for tax purposes, your home must meet the following residence test.

The test says that your vacation home is considered a residence during a tax year if your personal use exceeds 14 days or 10% of the days the property is rented to others at a fair rental. Check out

Section 280A(d)(1) for more details.

If you meet that test and rent your vacation home, you can deduct rent-related expenses up to the amount of your rental income. That means you cannot claim a loss on the rental. (See this previous

column for more details.)

But if you do not spend that specified amount of time in your vacation home, it's considered a rental property for tax purposes, says Bob Trinz, editor at


, an information provider to tax professionals.

As rental property, the rules become much more onerous. Even if you actively participated in managing your rental property, it's considered a "passive activity" for tax purposes as long as it's rented for at least seven days a year and you personally don't use it more than 14 days a year.

If you generate a loss from a passive activity, you can offset that loss only against passive-activity income. You can't offset passive losses against your compensation, capital gains, interest or dividends. If you don't have any passive income, you can carry those losses forward until you do have some. You also can deduct your losses when you sell off your interest in the activity.

For more on the passive loss rules, check out this previous

Tax Forum.

Can I Sell My House for a Buck?

I have a house and an adjacent piece of property. I am in the process of selling the property to a developer. I would like to sell the house, which I am living in, to my son for $1 and close on the same day when I sell the adjacent property. Can I consider this one sale and claim that I do not have to pay tax on the sale because this is my principal residence, which I have owned for 40 years? -- Ed Berger


If you sell your house to your kid for $1, you are giving it to him. That's not a sale.

So you would not be eligible for the personal home sale exclusion of $250,000. Remember, the home sale rules say that if you lived in your home and owned it for two of the previous five years, a single person can exclude up to $250,000 of the gain from taxable income; if you're married, the exclusion is $500,000.

Since it's a gift, the house's fair market value would cut into your lifetime unified gift and estate tax freebie of $675,000 for single people; or double that for married couples. Even worse, if the market value is more than $675,000, you may owe gift tax.

In this instance, you'd have two separate transactions: a gift to your son and the sale of the land. The land sale would not qualify for the home sale exclusion in this situation. So any gain on that sale would be fully taxable.

Consider selling the house for closer to fair market value. That way, you'll avoid gift-tax issues. And then, even though you're selling two properties to two people, you can claim it as one sale as long as you can prove the land was part of the home and has been used for personal purposes, says Doedtman. So is there a garage on the property? Picnic tables? Badminton nets? If so, you'll be able to use the home sale exclusion on the overall amount of the sale.

Cross-Country Home Owners

I jointly own with my wife a house in Connecticut as well as one in Texas, where I am a consultant. My wife claims Connecticut as her residence. She does not work and spends six months there. I claim Texas as my residence. If we sell the Connecticut house, can we claim the $500,000 exemption or only a $250,000 exemption? -- Hal Bogardus


Home-sale rules say that as long as the home was your principal residence and you owned it for two of the last five years, you will not owe tax on the first $250,000 of any gain from a sale. If a married couple meet both tests, the exemption jumps to $500,000.

It sounds like both of you meet the test that requires both of you to have owned the home for two of the last five years. But it sounds like only your wife uses the home as a principal residence, so only she would be able to claim the home-sale exemption.

But your wife must prove that the Connecticut home was her principal residence for two of the last five years before she can take the deduction, notes Maggie Doedtman, a senior tax-research and training specialist at

H&R Block

in Kansas City.

The good news is that the two years do not have to be consecutive. "If she has been doing the six-month thing for the last five years, then she should be OK," says Doedtman. In this case, she still will have used the home for 2.5 years of the last five.

See this previous

Tax Forum for more details on home-sale rules, and check out the

Internal Revenue Service's

Publication 523

- Selling Your Home


I'm Separated. Can I Be Single?

My wife and I are not legally divorced, but have not lived together for two years. Can we still file our income taxes married filing jointly or do we have to file separate? If we must file separate, can we just file single? According to TurboTax, my taxes are lower filing single than married separate. -- Bryan Hall


I'm sorry to say that as long as you're still legally married at Dec. 31, 2000, you must file your tax return as either married filing jointly or married filing separately. You can't file as a single person. I know the rates are better for single people than married filing separately taxpayers.

You are considered married at year-end if you are married and living apart but not legally separated under a divorce or separate maintenance decree. A separate maintenance decree says you're still married but are legally separated. State law governs this so check with your local authorities. (If you had either a divorce or separate maintenance decree, then you could file as a single person.)

If you both agree, you can still file married filing jointly. "You don't actually need to live together," says Doedtman.

If your child or children lived with you during 2000, then you may qualify as the head of household. Those tax rates are better than the married filing separately rates. There are other requirements that you must meet to declare yourself head of household for tax purposes, so be sure to read the

Internal Revenue Service's

Publication 504

-- Divorced or Separated Individuals

for more on these requirements.

Helping an Unborn Child With College

My wife and I are high-income, low-net worth (i.e. young) people who live in New York and are expecting our first child any day. We plan to put away about $5,000 a year for education. 1) Is this enough to fund four years of private college and expenses? 2) Are we better off in the New York saving plan with its conservative approach but tax savings or in a UTMA that we can control? We are not risk-averse and self-direct all of our other investments -- Chris Aries


Congratulations on the soon-to-be birth of your child. My husband and I also are expecting our first child, and I think it ridiculous that, because the costs of college are so outrageous, we all have to start saving while the child is still in the womb!

The tuition at a four-year private institution averages about $25,000 a year, or a bit over $100,000 total with inflation, according to Joe Hurley, author of

The Best Way to Save for College

. By the time your child is ready to hit


, the total cost may be closer to $245,000, according to

American Century


But your plan to save $5,000 may not leave you too far off the mark. If you invest $417 ($5,000/12) a month, assuming an 8% return, you'll end up with around $200,000. So if you're really concerned, you may want to pad your annual savings a bit.

The decision to go with a state savings plan or a more self-directed account strictly is an individual one.

As a refresher, because Uncle Sam has done very little to help us save for college, the individual states decided to take action to help their constituents. While each state's plan is different, they all generally allow you to invest tax-deferred dollars on behalf of a future college student. When the money eventually is withdrawn for college, that money will be taxed at the student's income tax rate. In many cases, you do not need to be a resident of the state to use its plan. For more on these plans, check out this previous


When determining which state plan is right for you, investigate what each plan invests in. Then decide if those investment choices are too conservative for your tastes. New York's plan does tend toward the conservative side, says Hurley. The plan has age-based portfolios, so the older your child is, the more conservative the portfolio.

Aside from the usual perks of a state college savings plan, New York also allows you to deduct up to $5,000 of your plan contributions on your state tax return.

Better still,

Gov. George Pataki

recently signed a bill to improve the range of investment options in the New York plan. While the options have not been specified yet, they should be announced within the next week or so. So it might be worth waiting for them, suggests Hurley.


Uniform Transfers to Minors Act

also may be an option if the state plans are not up to your speed, but there is one big downfall. (As an aside, the Uniform Gift to Minors Act was updated in 1983 and then dubbed a UTMA.)

While you may have control over the actual investment choices in a UTMA, you do not have ownership of the account. When your child hits the age of majority, either 18 or 21 depending on your state, the account becomes his. He then can run off to Bermuda and buy a hut on the beach with your hard-earned money.

At least with the state plans, you control the money purposely set aside for college.

To research all the states' plans, compare investment options, contribution limitations and fees, check out the

College Savings Network's

Web site. And if you missed my recent chat with Hurley about these plans, click

here for the transcript.

Gifts to the Kids

I would like to give some stock to my child and am wondering what the implications are if the fair market value of the asset is under $10,000 at the time of the gift. What is the tax basis for my child? What is the capital gain I would report? Is this a good way to shift money to a child and avoid capital gains tax? It would seem to be too good to be true, but my first glance at IRS publications seems to indicate that the child would have my cost basis as her basis going forward. -- Bob Sweet


Thanks to the soon-to-be-dropping capital gains rates, now is a great time to give assets to your kids.

Typically, if you're in the 15% ordinary income tax bracket, your long-term capital gains are taxed at 10%. Starting Jan. 1, 2001, any gains from the sale of property held more than five years will be taxed at 8%.

For taxpayers in higher tax brackets, the reduction in the capital gains rate applies only to assets purchased after Jan. 1, 2001 and sold for a gain at least five years later. Gains on those sales will be taxed at 18%, rather than the current 20%. Check out this recent

Tax Forum for more details.

If your child is over age 14, she is most likely in the 15% tax bracket. (If she is under 14, she would pay taxes at your rate.) If you give her assets that have been held for at least five years, she only will owe 8% on any gains generated from a sale starting in 2001.

The other perk to giving your kid assets is that she assumes your holding period. So if you've held the assets for four years, and she waits another year to meet the five-year requirement, she can sell and get the lowest, 8% cap gains rate.

You can give up to $10,000 a year to any one person with no tax implications. If you are married, you and your spouse can give up to $20,000 to a single person in a single year. You don't have to be related to the person receiving the gift, so feel free to include your friends, neighbors or helpful tax columnists.

Gifts under $10,000 do not cut into your lifetime unified estate and gift tax credit of $675,000 (which will gradually increase to $1 million for individuals, $2 million for couples, by 2006). That means if you're single, the first $675,000 of assets are not subject to estate taxes at your death.

But any gift over $10,000 will cut in to your credit. So if you're single and you give $12,000 to your little brother, the $2,000 will come out of your lifetime exclusion. (If you're married, you could split the gift with your spouse, and it wouldn't have to count against your lifetime exclusion.)

Your child receives your cost basis with your gift. So when she sells the asset, her gain or loss will be based on the difference between the asset's fair market value on the day of the sale and the amount


originally paid for it.

If the assets, instead, were part of an inheritance from you, your child would receive a "step-up" in the original basis to the fair market value on the day of your death.

Roths for Teens

Can a working teen contribute into a Roth IRA? Is there a minimum age or trustee required? Can that teen deposit stock certificates that were purchased directly from the company (such as Microsoft) in a Roth IRA? -- Patricia McLaughlin


Any teen-ager who has earned income can open and contribute to a Roth IRA account.

Ideally, earned income is reported on a

Form W-2

-- Wage and Tax Statement

. So if your teen has a job at, say, the local


, those wages would be reported on a W-2. But mowing the neighbor's lawns for cash also counts as earned income. Just be sure to keep track of the checks.

"There is nothing in tax law that says the account can't be in the kid's name," says Doedtman. But some brokers or banks will require that you open a custodial account instead. That means you must open the Roth IRA on your teen's behalf and you'll be the custodian of the account until she reaches the age of majority in your state. Call your favorite mutual fund company for more details.

You can contribute only cash to the Roth IRA. The account can buy stocks once it's established but you cannot transfer stocks in.

Hedging in an IRA?

I have an IRA so I am limited as to the different ways I can hedge. What would you recommend is the best way to offset a down market in an IRA? -- Candace Orleans


I'm not sure why you want to hedge your IRA. A good time to create a hedge position is when you have a position with large gains and you're afraid the market is going to fall but you don't want to sell everything and pay capital gains tax, says Spiegelman. Instead, you buy a little insurance premium that -- let's hope -- costs less than the tax hit you'd incur if you dumped everything.

But you don't owe capital gains tax on any sales in an IRA. So if you're afraid that the market is going to keep sinking, just sell your precarious holdings and put your money in more comfortable positions.

If you really can't sleep at night because your retirement money is slipping away, then consider reallocating your portfolio into more conservative holdings. And depending on your IRA custodian's investment policies, you may be able to purchase put options to protect big gains in your long positions. A put option is the right, but not the obligation, to sell a specific amount of a given stock at a specified price by a certain date. In periods of turmoil, put options can help you sleep at night without to having dump shares into the falling market.

Note that you can't sell short or use margin in your IRA, says Spiegelman.

As always, your best line of defense against a perilous market is a solid asset allocation -- especially in your retirement account.

Trading in IRA, Take Two

Aside from the 10% penalty, which is charged on any withdrawals, are their any other downsides to trading and living off an IRA? Looks to me like the 10% withdrawal is not so bad as opposed to paying short capital gains on your trading profits. Of course, good money management is important and you should have a nest egg in another IRA for your old age. For those of us who do not qualify for trader status, using the IRA is the best way to go. -- Bill Lovett


Not having enough money set aside for retirement is the biggest hazard to trading and living off your IRA account. "It could end up being a recipe for disaster," says Bill Fleming, director of personal financial services for


in Hartford, Conn. So it is imperative that you have other funds set aside for your golden years.

As you stated above, if you trade exclusively in your IRA, you do not qualify as a trader for tax purposes. (See this recent

Investor Forum for more details.) So if you withdraw any of your IRA money before age 59 1/2, you will be smacked with a 10% penalty. That's in addition to the ordinary income tax you will owe on that money. But remember, your short-term capital gains rate is your ordinary income tax rate.

So when you make withdrawals from your IRA, you will owe both -- the taxes and the penalty.

There is a way to avoid the 10% penalty though.

At any time before 59 1/2, you may begin taking withdrawals penalty-free, not tax-free, from your IRA as long as you annuitize the payments, says Fleming. That means you must withdraw equal payments at least once a year based on the life expectancies of you and your designated beneficiaries. (See

Section 72(t)(2)(A) of the tax code for more technical jargon.)

There's a big catch here, though. If you choose to annuitize, you must continue to take these distributions for at least five years or until you reach age 59 1/2, whichever is


. If at any time you fail to take your scheduled payments, you will retroactively owe the 10% penalty on all your previous withdrawals.

But unless your trading activities can guarantee a certain amount of money each year, annuitizing may be too risky.

Check out

Publication 590

-- Individual Retirement Arrangements

for more details on annuitizing your payments.


I'm seriously thinking of investing my IRA funds into a few HOLDRs, and I have a few questions: If I don't sell any of the HOLDRs, do I still owe any taxes at the end of the year? Is it like a mutual fund where even if you don't trade, you still might end up paying some taxes? Say I'm ready to retire. Do I have to sell the HOLDRs as one entity or can I just sell some of the stocks within the HOLDRs? This is a bit confusing since a recent Dear Dagen said, "you actually own all the underlying stocks in the portfolio and can redeem HOLDRs shares for the underlying stocks." -- Tushar Dhoraje


If you own the HOLDRs in a tax-deferred account like an IRA, you won't have to worry about year-end taxes. And you won't have Stuart's ongoing cost-basis calculation headache, either.

But don't jump too quickly. This is your retirement money. HOLDRs have been

very volatile. For instance, the

B2B Internet HOLDR


is down 60% since its inception in late February.

But assuming you have other savings, selecting two or three HOLDRs might be a reasonable way to diversify.

Remember, your IRA is a tax-deferred account. You can contribute up to $2,000 each year, pre-tax. You aren't required to start withdrawing from the account until you reach age 70 1/2. At that point, you'll owe ordinary income tax on your cash withdrawals.

While the HOLDRs may make an occasional distribution, if they're in your IRA, who cares? You defer the tax hit on all trading and distributions until you pull cash out of the account later in life.

As you saw in the answer to Stuart's question, when you own HOLDRs, you essentially own the underlying stocks. So when you're ready to start taking cash distributions, your account has a choice: It can sell the HOLDRs as a unit or redeem the HOLDRs for the actual shares. If it's the latter, you'll have approximately 20 stocks in your account, and you can sell whichever shares you choose.

Does IRA Rollover Count in AGI?

Should my adjusted gross income include the amount that I converted from my traditional IRA? For instance, with an income of $95,000 and a converted amount of $20,000, this puts me over the amount where I can make contributions. -- Khanh Bui


To be eligible to convert your traditional IRA to a Roth IRA, your annual adjusted gross income cannot exceed $100,000. But do not include the amount you're going to convert when determining your eligibility.

Same goes for your contribution eligibility. You can contribute up to $2,000 as long as your adjusted gross income is less than $95,000 for a single person, and $150,000 for a married couple filing jointly. Your contributions amount will "phase out," or slowly decrease to zero, as your income hits $110,000 (if you're single) or $160,000 (for married couples filing jointly). For married people filing separately, your contribution phases out at $10,000 (that's not a typo).

Remember to include the rollover amount in your income when you're ready to calculate your final tax bill.

Roth Contributions Tanked

If you make the maximum contribution into a Roth IRA early in the year, but later find that your income level for the year will exceed the maximum allowable to make a Roth contribution, my understanding is that you have to recharacterize the contribution and any investment gains into a traditional IRA. But what if your investment for the year decreased in value? Suppose you invested the full $2,000 in stocks that decreased in value to $1,000. What amount do you recharacterize -- $2,000 or $1,000? If the rule is to recharacterize the full $2,000, wouldn't it be more beneficial to simply withdraw the remaining Roth investment and take the capital loss? -- Christopher Chan


You are sailing in uncharted territory here. There is nothing written in the IRS tomes that specifically addresses this situation. I guess


just assumed the go-go market would go on forever.

Typically, to be eligible to contribute to the Roth, your adjusted gross income must be below $95,000 if you're single (Contributions are phased out up to $110,000.) or below $150,000 if you're married (Contributions are phased out up to $160,000.). If you're married and filing separately, contributions are phased out between zero and $10,000.

If you contributed the full $2,000 and you since have realized your adjusted gross income has exceeded the limitation, you must pull out that contribution -- or recharacterize it -- to avoid getting hit with excess contribution penalties.

If your contributions have increased in value while in the Roth, you must withdraw those earnings as well. And you'll owe tax on them.

Even our experts were stumped when asked what to do about contributions that have declined in value. But we've come up with some reasonable solutions for you.

If the Roth account has a balance greater than $2,000, you can pull out your $2,000 contribution and move it to a nondeductible IRA. Since all contributions to a nondeductible IRA are after-tax, there is no adjusted gross income limitation on contributions. And the money is still set aside for your retirement.

If, on the other hand, that $2,000 contribution was the only money in the account, you could simply convert the entire account to a nondeductible IRA. Again your adjusted gross income does not matter. Check out our

Roth IRA Tax-Reporting Guide for more details on how to convert your Roth IRA back to a nondeductible IRA.

Of course if that was your only contribution, you could just close the account and withdraw the remaining $1,000. Since your original contribution was $2,000, you do have a $1,000 loss that you should take as a miscellaneous itemized deduction.

Unfortunately, the rules say you cannot recognize that loss until all your IRA accounts -- both traditional and Roth -- are empty, says Martin Nissenbaum, director of income tax planning at

Ernst & Young


If this Roth was your


IRA account, you could report that $1,000 loss on line 27 of your

Schedule A

-- Itemized Deductions

, says Nissenbaum. If you don't itemize, you cannot report that loss.

And you thought the Roth was supposed to be an


way to save for retirement.

What Do I Owe Taxes On?

When converting from a traditional IRA to Roth IRA, do you have to pay taxes on the whole amount or just the gains? I liquidated a 401(k) years ago and rolled it into an IRA. The amount rolled was around $20,000, and I have made $5,000 after buying and selling a stock. Do I only pay taxes on gains from the 401(k) (and how would I find out those past details?) and from current IRA, or on the whole $25,000? -- Rich Dixon


You will owe tax on all of it.

I'm assuming you only contributed pretax money to your 401(k). If that's the case, you never paid tax on any of those contributions. If your contributions generated earnings, great. But you never paid tax on that money either.

Rolling the money from a 401(k) to an IRA is a tax-free transaction. So you still aren't paying Uncle Sam a dime.

But remember, you only can contribute after-tax dollars to a Roth. Since you haven't paid any taxes on the money in your IRA, you'll owe ordinary income tax on the whole amount.

If you made after-tax contributions to your 401(k), they would be distributed to you before the remainder of the account was rolled into the IRA. (Check out this previous

Tax Forum for more details on after-tax 401(k) contributions.) If you made nondeductible contributions to your IRA, you would not owe ordinary income tax on those contributions when you roll the account to the Roth. But you would owe tax on any earnings those contributions generated.

Can I Convert My SEP IRA to a Roth?

Is it too late to convert from a SEP IRA to a Roth IRA using 1999 AGI numbers? -- Brian McGonigle


Yes, it's too late. To qualify for 1999, your SEP IRA -- or any other IRA -- must have been converted to a Roth IRA by end of the calendar year, says Maggie Doedtman, a senior tax-research and training specialist at

H&R Block

in Kansas City.

A Simplified Employee Pension plan is like a profit sharing plan in some ways, says Clarence Kehoe, partner and director of employee benefits at

Anchin, Block & Anchin

, a New York accounting firm. Your employer can contribute up to 15% of your compensation to the plan. But that money is not placed in a big trust, like it would be in a normal profit-sharing plan. With a SEP IRA, each employee's contributions are put into a separate individual IRA.

That means the employee can control the money. So assuming your adjusted gross income does not exceed $100,000, you can convert the IRA to a Roth in 2000. Remember, you'll owe ordinary income tax on the amount you convert.

See this previous

Tax Forum for more on the Roth IRA rules and check out the IRS'

Publication 590 --

Individual Retirement Arrangements


Loans and Rollovers

I recently changed jobs and have an outstanding loan from my former employer's 401(k). When I received my quarterly statement, included was detailed information about potential tax consequences. I contributed both pre- and post-tax dollars to this 401(k). Is it true that I cannot roll over the post-tax dollars? My employer will use my account balance to pay off the loan. Will the post-tax dollars be included in this offset? If not, must this money be paid out to me? I called the 401(k) administrator but did not receive very helpful answers to these questions. -- Ronald Johnson


Let's take your questions one at a time.

If you make both pre-tax and after-tax contributions, your employer is required to keep two separate accounts for you for tax purposes, says Sean Hanna, editor in chief of the

401kWire Web site.

You cannot roll after-tax contributions into an IRA, but you can roll earnings those contributions have generated into an IRA, since you haven't paid taxes on them yet, says Lee.

As for your after-tax contributions, they will be distributed to you. You can't put them into another retirement vehicle, but try to resist the urge to spend them on a new car. They're your savings, so stick them in a mutual fund and let them continue to grow for you.

And since it sounds like your loan came from your pre-tax 401(k) account, you'll have to pay it back from the balance of the pre-tax contributions. Your after-tax account can't be used to pay it off.

An Inherited House Full of Taxes

My mother died last year. Her house was sold, and the proceeds, after expenses, were split between my two brothers and myself. One of my brothers, a lawyer, told me the proceeds are not taxable to us because they represent an inheritance. He checked this with a tax consultant, who agreed. Do you? -- William G. Daughan


It depends on how much the house was sold for and how much your mother's estate was worth. There are two taxes to worry about -- capital gains and estate. Let's take capital gains first.

If the proceeds were greater than the house's appraised value, the excess is subject to capital gains tax.

The home should have been appraised before it was sold. Let's assume its fair market value was appraised at $500,000. If the house sold for $560,000, that extra $60,000 is subject to capital gains tax, says Sandy Schlesinger, partner and chairman of the wills and estates department at

Kaye Scholer Fierman Hays & Handler

, a New York law firm.

But who pays it? If the home was sold while still in your mother's estate, the estate would pay the tax. If the house was distributed to you and your brothers, and the three of you decided to sell it, you would split the capital gains tax. Assuming you all had equal ownership, you would each report $20,000 in long-term capital gains.

Now, the estate tax.

Everyone is entitled to a lifetime gift and estate tax exclusion of $675,000. If the house was the only asset in the estate and is worth less than $675,000, there should be no federal estate tax. (The state estate tax laws may be different.)

If your mother hadn't used up any of that exclusion in the past by giving away very large assets, the house should be free of estate tax.

If her estate was worth more than $675,000, any amounts above that would be taxable. But the estate would owe the tax, not you and your brothers. But your share of the estate would be reduced by the amount of the tax.