DIDN’T ITEMIZE? YOU MAY HAVE OVERPAID UNCLE SAM

As many as 2 million people pay too much in taxes each year by taking the standard deduction. Are you one of them? Here’s what to do.

If you took the standard deduction this year on your tax return, you may want to take another look. You might have cheated yourself out of some tax savings.

The General Accounting Office, in a report sent to Capitol Hill just days before the 2002 tax deadline, found that filers of 1998 returns who used the standard deduction instead of itemizing paid the Internal Revenue Service almost $1 billion more than they should have.

Taxpayers have a choice of which deduction method they use to reduce taxable income, standard or itemized. They may claim whichever amount is larger.

The standard deduction amount is established annually. It is based on a taxpayer’s filing status and is listed on each of the individual tax-return forms (1040, 1040A and 1040EZ). This deduction generally is taken by taxpayers who don’t have many expenses.

Itemized deductions are calculated from allowable expenses that a taxpayer tracks throughout the tax year. They are reported on Schedule A, with some amounts limited by a filer’s income. While it takes more work, itemizing taxpayers often find the effort pays for itself through a lower tax bill.

Itemizing filers, however, are consistently in the minority. Critics of the tax code say this is because many people choose to forgo savings for simplicity. Using the standard deduction, regardless of the tax costs, means they can end their annual tax involvement sooner.

Millions of People Overpaid

House Majority Leader Dick Armey last year asked the GAO to take a closer look at taxpayer filing trends. The Congressional investigative agency studied 1998 returns (the latest year for which the IRS had complete data) and initially found half a million taxpayers neglected to deduct mortgage interest.

This year, the GAO’s examination of 1998 returns expanded to unclaimed deductions for loan points, charitable contributions and other taxes, such as real estate, personal property and state and local income.

The final tally: as many as 2.2 million filers erroneously paid Uncle Sam too much, by an average of $438 per taxpayer.

Who ignored deductions and paid unnecessary taxes? The GAO says it was mainly lower-income and middle-income taxpayers. Taxpayers in the $25,000-to-$50,000 income range accounted for the bulk of those who paid too much; filers earning between $50,000 and $75,000 were a close second.

GAO director of tax issues James White notes that his agency did not try to determine why filers claimed the standard deduction when itemizing could have saved them money. But Armey thinks he knows the answer.

Taxpayer Confusion and a Nightmarish Tax Code

Armey blames taxpayer confusion created by an increasingly complex tax code. “A tax code no one understands is a tax code that commands fear instead of respect,” says the Texas Republican.

Confusion apparently isn’t limited to rank-and-file taxpayers. The study estimates that professionals prepared almost half the 1998 returns on which taxes were overpaid because deductions weren’t claimed.

And even though the returns examined are three years old, Armey says they remain a valid indicator of taxpayer behavioral patterns. He notes that the choice to not itemize, while concentrated in the lower- and middle-income levels, appeared in all taxpayer categories.

Armey, a longtime advocate of tax simplification through assessment of a flat tax with no deductions, hopes the GAO report will bolster Congressional efforts to reform U.S. tax laws.

Amended Returns Could Pay Off

Taxpayers who cheated themselves by taking the standard deduction, however, don’t have to wait for legislation. They can use existing tax laws to recoup lost tax money.

If you discover you could have saved by itemizing deductions and are willing to tackle your taxes again, file an amended return. Form 1040X will let you negate your original standard deduction and list all the money-saving deductions you should have taken.

Generally, tax returns must be amended within three years of the original filing deadline. Since the returns were due April 15, the amending window is still open until April 15, . Sorry, it is too late to amend your and earlier income tax returns.

And if you paid too much by not itemizing deductions on your , , and returns, get several copies of Form 1040X and get to work. To get your rightful dollar back money, you must file an amended return for each affected tax year.

The Break From Multiple Refinancings

Here’s some more good news. If this isn’t your first refinancing, you’ll probably have what the tax pros call “unamortized points.” Those are the points that you paid on your previous refinancings that haven’t been allowed yet.

Those points are allowed in full for the year in which you refinance again.

So, let’s say you refinanced July 1, , and again July 1, . On the first refinance, you paid $3,600 in points on a 30-year (that is, 360 months) note. Last year, you deducted six months’ worth of amortization, or $60 (That's $3,600 divided by 360 months, multiplied by six months).

This year you get to deduct the remaining $3,540 in full. You will also deduct 6 months of the points on the new loan.

What else can you do to make up this year’s loss?

Make your January 1, mortgage payment on December 31, . The payment is for the use of the money in December and will be allowed.

Your mortgage company won’t receive it until , so the interest won’t be shown on their Form 1098. Remember to run an amortization schedule and place the additional interest payment on Schedule A on the line for “interest paid but not reported to you on Form 1098.” You can use the ReesNet.com Financial Calculator to produce the amortization schedule, and even to print it.

Run your own numbers. Make sure that you meet the safe harbors for withholdings and estimated payments.

As George Leupold, of Leupold Financial Planning Associates of Cherry Hill, N.J. succinctly put it, “Don't let the tax tail wag the financial planning dog.”

Bottom line: Unless you’re in a tax bracket that’s over 100%, a reduction in interest rates is going to save you real cash money — even after the tax loss. So don’t worry about the taxes. Just plan for them.