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Tax Breaks

Two Errors to Avoid

Don't make these mistakes and pay more taxes than necessary.

Editor's note: This is the transcript of Kiplinger Editorial Director Kevin McCormally's commentary on the April 12 broadcast of Nightly Business Report.

I want to warn you about a couple of costly mistakes to avoid as you rush to finish up your 2006 return.

The first one has to do with a relatively new tax form that more and taxpayers are receiving: the 1099-Q. Now, you know that most 1099s alert you -- and the IRS -- to taxable income you're supposed to report on your return. The 1099-DIV reports taxable dividends; the1099-B, the proceeds of stock sales; and the 1099-Miscellaneous shows freelance or consulting income. So, the 1099-Q must mean more income to report, right?

Not so fast. Actually, the 1099-Q reports distributions from a state college saving plan or Coverdell education savings account. And, odds are very, very good that the payout is completely tax free. It is if the money was used to pay tuition or other qualifying college costs. Tax is due only if you used the money for other purposes, and then only the earnings are taxable. And even some of the earnings may be tax free. Read the instructions carefully before you pay tax on any part of a 1099-Q distribution.

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The second potential mistake threatens parents who paid more than $5,000 in work-related child care costs during 2006. The law offers two ways to help with such costs -- flexible spending plans that let you pay the bills with pretax money, or a child care credit that refunds 20% to 35% of qualifying costs. The potential trap is that while there's a $5,000 limit on a flex plan, you can claim the credit against up to $6,000 of child care costs.

So, even if you ran the max through a flex plan at work, you might deserve the credit on up to $1,000 of additional spending. And that would save you an extra 200 bucks.

See Kevin's previous tip.