Monday, February 13, 2006
Computing Your Taxes
Note: This is a portion of the column that ran in Barron’s on February 13, 2006. The original was co-authored by my Electronic Investor partner in crime, Kathy Yakal, but only my contribution is shown here. Please reference the original to see Kathy’s thoughts on online tax prep sites. She’s an insightful writer who also reviews financial software for PC Magazine.
TAX-PREPARATION SEASON OUGHT TO BEGIN with a basic question: Should you do it yourself or hire the job out? If you feel that you’re educated enough on the ins and outs of filing your own return, with all the complications your life presents tax-wise, then pick up a copy of a tax-preparation program to help you out.
Filing a full 1040 long form by hand by yourself could qualify as proof of insanity, especially if you’ve done any substantial trading last year. Entering data on transactions—including dates, cost bases, sales prices—plus dividends and interest and then making the appropriate calculations by hand isn’t complicated, but it is extraordinarily and unnecessarily tedious. Plus, it all but invites errors on your returns.
If you have a relatively straightforward tax situation—salary, the typical deductions for mortgage interest and state and local taxes, plus simple investment returns—tax-software Websites should be able to handle your return without much complication. The program will ask you relevant questions; you fill in the answers as you go along. The interview process should cover most of the usual tax questions, and make suggestions along the way.
It’s not a substitute for a living, breathing professional if your tax situation isn’t pretty cut and dried. But if it is, it may be possible to download your relevant data—such as W-2s from your employer, 1099s from financial institutions, mortgage and property-tax-payment data from your bank—and let you computer do most of the work. If you prepared last year’s tax return on a computer, you can transfer basic data—name, address, Social Security number, dependents—into your new return, which also reduces the tedium. And if you’re organized and use personal-finance software, such as Intuit’s Quicken or Microsoft’s Money, the process can be further automated.
Tax software also can mitigate several other hassles of filing. If you are subject to the dreaded alternative minimum tax, the software will at least inform you of the bad news. Doing your taxes by hand may require a second set of calculations. If you’re subject to the AMT, it’s probably because you’re unlucky enough to live in a state with a hefty income tax, such as New York or California. The popular tax programs also have state versions, which take your federal data and prepare your state return with relatively little extra effort. Finally, tax programs can alert you to errors and omissions, and to situations that might invite an audit.
We took a look at the tax programs and online services available with an eye for how they’ll work for a relatively active investor. This year, we also looked at how the programs adapted to changes in the tax laws, as well as how they work for dealing with the home-office deduction.
The major names in tax-preparation software continue to be TurboTax, by Intuit, and TaxCut, by H&R Block. Both overhauled their interviews for the 2005 season; TurboTax’s was somewhat more successful; the program’s ease of use improved considerably.
TurboTax’s interview, which we reviewed using its Premier edition (list price $69.95, though many retailers throw in gift cards and other freebies), allows you to import data from financial institutions that use Intuit’s .OFX file. Importing data into TurboTax is an extremely smooth process, especially if you’ve got broadband Internet access. If your bank, broker or mutual fund is part of the network, as most major ones are, pulling in tax-related data is very easy. Many employers also are tapped into the network, either directly or via a processor such as ADP, allowing employees to import their W-2 data quickly and accurately.
We imported data from several brokerage accounts that have been supplied to us for our annual review of online brokers into TurboTax. One of our accounts has quite a few transactions in it, and TurboTax brought them all in flawlessly this time. We haven’t been as lucky in past years; this facilitated import is a huge improvement.
TaxCut doesn’t have the same import capability, however. You’ll manually enter all that data from those 1099 forms that your brokers have sent. We reviewed TaxCut Premium ($49.99 list, also with various goodies from major retailers), which includes H&R Block’s DeductionPro.
If you’re manually entering your stock transactions, be sure to use trade dates rather than settlement dates. If you sold a stock on Dec. 29, 2005, for instance, even though it didn’t settle until Jan. 2, 2006, it counts as a 2005 transaction. Most brokers send out a summary 1099, informing you of the proceeds from all of your transactions over the past year. You’ll need the detailed records of each transaction to be sure the dates and amounts are correct.
Both TurboTax and TaxCut did a good job of dealing with changes to individual-retirement-account contributions, and they examine whether you’re eligible for a Roth IRA rather than a traditional one. TaxCut’s extensive audio help points out that your traditional IRAs are exempt from bankruptcy filing, and encourages users to maximize their contributions, whether they’re deductible or not.
This year, TurboTax added quite a few ways to spend your refund, in the event you’ve given Uncle Sam an interest-free loan last year. You’ll be given the chance to purchase gift cards from a wide variety of retailers, at a discount, with your refund. We think a better use of your refund is to roll it into your IRA or other investment accounts.
If you’re new to tax software, TurboTax is the way to go. TaxCut users will be well-served by picking up the 2005 version unless you want to shift the data entry load over to your computer. (Either program lets you import data from the other’s preceding year’s return.) Check the TurboTax Website (http://www.turbotax.com) to see if your financial institutions are in its system.
FOR THE PERIPATETIC TRADER, neither TurboTax nor TaxCut will make the job of preparing your Schedule D easy, though. That’s where TradeLog and GTT TradeLog come in handy (http://www.armencomp.com). These programs, published by Armen Computing, help those who actively trade to generate portfolio-performance reports as well as prepare a Schedule D.
GTT TradeLog, which is supported by Green Trader Tax (http://www.greentradertax.com), is aimed at traders who need to track mark-to-market transactions. TradeLog is for all the other active traders. Prices range from $49 for a version that is restricted to 100 transactions, to $349 for the mark-to-market version.
The programs produce a file in TXF format that can be imported into TurboTax or TaxCut for preparing your entire return. We found that TurboTax handled the larger number of transactions more elegantly and with fewer errors.