What You Need To Know About Taxes In 2014: Expired Tax Breaks, Obamacare Penalties & More

Kelly Phillips Erb for Forbes writes: Tax season opens in 26 days. And here’s my big prediction: a lot of taxpayers will be taken by surprise. Despite all of those “no new taxes” type promises, tax bills are expected to edge higher for a number of taxpayers for the 2013 tax year. And 2014 holds even more surprises. Here’s a quick look at what to expect:

Higher income taxpayers are going to pay more. You’re going to figure this out in a few months when you file your tax return. And it’s no fluke. It will happen again in 2014.

First, the top tax rate for taxpayers is now 39.6%. We haven’t seen those kind of rates in almost 15 years. Those Bush-era tax cuts have finally expired, giving us the 20th century tax rates (gosh, that sounds really, really old). How high will it go? The 39.6% tax rate kicks in at $400,000 for individual taxpayers and $450,000 for married couples filing jointly.

All wages are subject to Medicare tax. That hasn’t changed. But now, taxpayers who make over $200,000 ($250,000 for married taxpayers) will be subject to the Medicare surtax. If that’s you, a Medicare surtax will be tacked on to your wages, compensation, or self-employment income over that amount. The amount of the surcharge is .9%.

Even if you aren’t affected by the Medicare tax surcharge, you still may be subject to the Net Investment Income Tax (NIIT) if you have both net investment income and modified adjusted gross income (MAGI) of at least $200,000 for an individual taxpayer and $250,000 for taxpayers filing as married. Net investment income includes items like interest, dividends, capital gains, rental and royalty income, and certain income from businesses. It doesn’t include wages, unemployment compensation, operating income from a nonpassive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends and distributions from certain Qualified Plans. For the entire details on the tax – and I mean entire – check out my colleague’s “definitive” answers on the subject.

The limitation for itemized deductions – the Pease limitations, named after former Rep. Don Pease (D-OH) – claimed on individual returns for tax year 2014 will begin with incomes of $254,200 or more ($305,050 for married couples filing jointly). The Pease limitations were slated to be reduced beginning in 2006 and eliminated in 2010; as with the other tax cuts, the elimination was extended through the end of 2012. The limitations were brought back in 2013 at the original thresholds, indexed for inflation. The limitation reduces itemized deductions by 3% of the amount by which your adjusted gross income (AGI) exceeds those thresholds, up to a maximum reduction of 80%. That’s a complicated way of saying that your deductions are limited as your income increases.

Kind of a “tag along” provision is the personal exemption phaseout (PEP). Phase-outs for PEP in 2014 begin with AGI of $254,200 for individuals and $305,050 for married couples filing jointly; the personal exemptions phase out completely at $376,700 for individual taxpayers ($427,550 for married couples filing jointly).

It’s not just higher income taxpayers who will feel a difference: taxpayers who are affected by the Affordable Care Act could also feel the pain in 2014. If you do not have health insurance in 2014 – and you don’t otherwise meet certain exemptions – you’re going to have to pay up. The Internal Revenue Service calls it a “shared responsibility payment.” Other folks call it a penalty. Still others call it a tax or a fee. No matter what you call it, if you don’t have health insurance and don’t otherwise meet certain provisions, you’ll have to cough up either 1% of your taxable income or a flat fee of $95 per uninsured adult and $47.50 per child (up to $285 for a family) per month, whichever amount is higher. But don’t fret just yet: the penalty is due when you file your 2014 tax return in April 2015. By then, you’ll be paying even more: the flat fee increases to $325 in 2015 and $695 in 2016. Ouch.

There is some good news. The self-employed get something of a break in 2014: there is an option to claim a new, simplified deduction for a home office. The deduction is equal to $5/square foot of home office space – up to a maximum of 300 square feet. It’s an easy calculation ($5 x the number of square feet) and beats figuring out your own expenses and pro-rating them though that’s still an option if that works out better for you. The per square foot calculation is intended to save hours more than dollars. The deduction made its first appearance in 2013 but you can also take the deduction in 2014.

The year 2014 will see more married same-sex couples. The Supreme Court struck down the 1996 Defense of Marriage Act (DOMA) in 2013, leaving the definition of marriage to the individual states. The result, from a tax perspective, is that the IRS will consider as legally married all couples who are legally married. Even more interesting, the IRS will recognize a legally married same sex couple regardless of whether the couple currently lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.

2014 also has the distinction of ushering in new Foreign Account Tax Compliance Act (FATCA) deadlines. Among them, FATCA withholding on new accounts will become effective July 1, 2014. That reflects a six-month delay from the previous January 1, 2014, deadline. 2014 will also mark deadlines for the completion of new due diligence and registration requirements – bound to cause confusion and irritation for international taxpayers. Since the FATCA rollout has been far from smooth to date, expect more FATCA news as the year passes.

And like an television infomercial… wait, there’s more! 55 tax breaks expired at the end of 2013 (that number alone is indicative of how bloated our Tax Code has become). Here’s a look at some of what you’ll miss out on in 2014, assuming no action from Congress:

• Charities won’t be able to easily snatch up retirement plan proceeds: a provision which allowed seniors to make direct gifts to a qualifying charity of up to $100,000 from their individual retirement accounts (IRAs) without reporting it first as income expired at the end of 2013.
• Teachers say goodbye to a tax deduction of up to $250 of out-of-pocket costs for school and classroom related supplies. The best part of that deduction? It was “above the line” meaning that teachers could claim the deduction even if they didn’t itemize.
• Also lost? Another “above the line” deduction – this one for tuition and fees. The deduction of up to $4,000 was available for qualified tuition and related expenses that you paid for yourself, your spouse, or a dependent. It’s now gone.
• A number of energy-efficient home improvement tax credits took a tumble. The credit of up to $500 for the installation of qualified insulation, windows, doors and roofs as well as certain water heaters and qualified heating and air conditioning systems evaporated as of December 31, 2013. The credit for solar hot water heaters, solar electric equipment and wind turbines is slated to stick around until 2016.
• Next on the list? The provision that allowed residents to deduct state and local sales and use taxes instead of state and local income taxes on their Schedule A. That benefited taxpayers, in particular, in states where there is no state income tax or relatively low state income taxes.
• Underwater homeowners also lost their available tax break when the clock struck midnight on New Year’s Eve. The Mortgage Forgiveness Debt Relief Act, which was signed into law by President George W. Bush in 2007, offered an exception to the rule that forgiven debt would be treated taxable income. Under the law, qualifying homeowners could exclude forgiven debt on a private residence that was the result of a renegotiated mortgage, short sale or foreclosure. Now, that debt is reportable – and taxable – as income until it means another exclusion.
• Finally, business owners will feel the loss of the Section 179 expense deduction. The deduction allowed small and mid-size business owners to immediately deduct an amount used to obtain qualifying equipment rather than hack the deduction into pieces over time according to a depreciation schedule. It’s a nice allowance and, until this year, business owners could deduct up to a hefty $500,000 of qualifying assets, a sizable bump from the old law. In 2014, the limit drops to $25,000. Not a typo. It was half a million dollars and now it’s just $25,000.

So, that’s your quick (well, quickish) and dirty review of what to keep an eye out for in 2014. Of course, this could all change next week – or the week after – once Congress really gets back to work. There are a few “tax extender” bills being tossed around that would retroactively reinstate some of the more popular tax deductions. I’ll update you as news becomes available.

An Often Overlooked Head of Household (HOH) filing Status Opportunity

Kent Bone for NerdWallet.com writes: Learn more about Kent on NerdWallet’s Ask an Advisor   Question: I have two new clients, both unmarried, both with children, both share the same rental home, both share the  household expenses, both have jobs, both attend school and they are not living together as a couple. They do not share bedrooms and they each pay for themselves and their own children’s living space.  The question is can they each claim the more favorable Head of Household (HOH) filing status on their current year tax return rather than the Single filing status if they live in the same home?

Basically, if you meet the following requirements, you may be able to file as head of household (See Pub 17):

1. You are unmarried or “considered unmarried” on the last day of the year;
2. You paid more than half the cost of keeping up a home for the year;
3. You have a qualifying person who lived with you in the home for more than half the year (except for temporary absences, such as school).  Interestingly, if the qualifying person is your parent, they do not have to live with you.

In their particular situations, after a thorough lifestyle interview and expense substantiation process, my new clients do appear meet the requirements as follows:

1. They both are unmarried, not surviving spouses, or non-resident aliens;
2. They both paid more than half the cost of keeping their home (household) for the year;
3. And they both have a qualifying person (a child or children), who lived with them more than half the year.

How do these facts work to meet the Head of Household requirements under section 2(b) since this is one residential unit with multiple non-related families?

1. We accept as fact that they are unmarried, not a surviving spouse, or a non-resident alien because it is their individual responses to these issues and we have no compelling reason to question their answers.
2. They meet the requirement of more than half of the cost of keeping their household for the year as follows and tax law research will support that the following realities contribute to the facts and circumstances of this arrangement to meet the requirements.
   • They share the cost of the rental unit.
   • They both live in separate bedrooms with their children and pay over half the expenses of their individual household expenses by maintaining separate personal household items such as separate telephones, food for themselves and their children, upkeep and repairs, insurance, the sharing of utilities, and separate Christmas and birthday gifts for their children.  Expenses such as cost of clothing, medical treatments, education, life insurance or vacations are not included in the determination that more than half of the household expense requirement is met.  In short they are sharing some common areas of the single unit, but their facts and circumstances appear to point to the maintenance of a separate household by each client.
   • All the relevant facts and circumstances are supported with adequate substantiation (cancelled checks, receipts) and therefore seem to point to two different households within the same dwelling.
   • The Tax Court has ruled that the extent of a household is not determined only by its physical or tangible boundaries.  In Reardon v. United States, 158.F.Supp. 745 (D.S.D. 1958), the Tax Court found that “it would be an elevation of form over substance to say only one household existed simply because only one building was involved and certain areas were used in common.”   There are numerous Tax Court case’s to support this filing status determination where multi-family dwellings that house separate families are treated as separate households when the specific facts and circumstances support the independence from one another.

In summary then, because of their individual sets of facts and circumstances and independence from one another, I believe these two taxpayers should each use the Head of Household filing status and enjoy the greater standard deduction, if used, and the reduced tax rates indicated for this filing status.    Be sure to seek experienced tax counsel for guidance and support of this position.

Delaying IRA Contributions Can Be Costly / Make your 2014 investment now, not next April, to boost your nest egg and trim taxes

JONNELLE MARTE for the wall st journal writes:  It's a new year. And that means it's time for investors to do what they could have done last year—but didn't.

Namely: make contributions to their 2013 individual retirement accounts. Indeed, an analysis of traditional and Roth IRA contributions made by Vanguard Group customers for the 2007 through 2012 tax years showed that, on average, 41% of the dollars contributed to IRAs for any given tax year are invested between January and April of the following year. Half of those dollars are contributed in the first half of April—the final weeks when contributions for the previous year can be made.

The study found only 10% of dollars are contributed in January of the corresponding tax year, the earliest month contributions can be made. "We are trying to encourage people to change their way of thinking and think about it sooner," says Maria Bruno, a senior investment analyst with Vanguard Investment Strategy Group.

Valid Excuse?

There are legitimate reasons that big dollars flow into IRAs near the tax-filing deadline. At that point, taxpayers typically know whether their income for the prior year was low enough to qualify for deductible contributions, and can see by exactly how much a contribution would lower their tax bill.

But some advisers say the habit is one of the ultimate examples of investor laziness, nearly on par with not maxing out the company match for 401(k) contributions or not seeking retirement advice until after retirement.

"As humans we naturally procrastinate," says Mackey McNeill, an accountant and financial adviser in Bellevue, Ky.

Procrastination can be costly. The problem, advisers and retirement consultants say, is that investors who make IRA contributions at the last moment miss out on 16 months of potential gains (from January of one year until April of the following year), as well as the chance for those gains to compound over many years. Even if two investors contribute the same amount of money over the years, the person who starts earlier could end up with significantly more savings down the line.

Compare a saver who makes the maximum annual IRA contribution of $5,500 for those under age 50 in January of each year with another saver who contributes the same amount each April 15 of the following year. Over 31 years, assuming the money is invested in a moderate portfolio earning a hypothetical 7% annual return, the saver who makes full contributions in January could end up with $83,000 in additional savings after 30 years, even though both investors contributed equal amounts—about $170,500—overall, according to an analysis by Ms. McNeill.

Tax Burden

Another downside to putting off contributions: It could add to your tax bills. Money in a taxable account over that 16-month period may incur gains that would have been deferred in an IRA, says Ed Slott, an accountant and founder of IRAHelp.com, a website for retirement savers.

Some pros say investors' excuses for not contributing as early as possible are looking thin. Most people don't see their income swing wildly from one year to the next, Ms. Bruno says. They can likely use last year's tax return to decide whether to make a contribution for the current tax year each January.

Procrastinators still have time to change their ways. Some can catch up if they now make their 2013 and 2014 contributions—a total of $11,000 for those under 50 contributing the maximum for each year, Ms. McNeill says. Those investors can then get in the habit of making their IRA contributions at the start of each year. (Investors 50 or older can contribute as much as $6,500 to their IRAs each year.)

While a doubled-up contribution is a lot to set aside at once, she says: "You've only got to make this change for one year."

Grandparent wishes to trade stocks in 529 plans for grandkids, but not so fast

 Karin Price Mueller/The Star-Ledger   writes: Question. I have set up custodial accounts for my three grandchildren in hopes of helping out with college expenses in 10 to 15 years. They are not 529 plans, and I worry that they won’t have the same tax benefits. Can I set up self-directed 529 plans? I think I can do better than the conventional plans by actively picking stocks and trading when appropriate. I’ve been doing that with my own accounts for 30 years.
— Gram

Answer. 529 Plans are so popular because of their tax benefits.

Funds in a 529 grow tax-free as long as the money is ultimately used for qualified education expenses.

The accounts you set up are probably custodial accounts, such as a Uniform Transfer to Minors Act account. Those have some tax benefits, but they’re nowhere close to what a 529 offers.

No there are no self-directed 529 plans — at least not for trading stocks.

Each plan must be sponsored by a state and the state’s department of education, said Reed Fraasa, a certified financial planner with Highland Financial in Riverdale, and are designed so money is made on the set-up through fees.

"Allowing someone to trade stocks avoids that fee arrangement, and is contrary to the purpose of having a diversified investment plan — something most advisors would highly recommend for an education fund and something that is likely a part of each state’s charter for a 529 plan," Fraasa said.

There are self-directed 529s, but they offer a menu of investment options that is built around mutual funds, not individual stocks.

Investment options include age-based portfolios that transition from stock-heavy allocations when the children are younger to bond- and cash-heavy allocations as the children approach college age, said Brian Kazanchy, a certified financial planner with RegentAtlantic Capital in Morristown.

"The age-based options are appropriate for most as the management of the assets is brought into alignment with the time horizon of when the funds will be used," Kazanchy said. "More active investors would likely choose the individual mutual fund options to build their own portfolio allocation within a 529 plan."

He said the offerings are similar to what you might find in a company retirement plan, with 10 to 20 fund options, and most will probably be index funds.

Kazanchy said for most investors, the tax benefits of a 529 plan are too attractive to pass up.

"After all, a bird in the hand may be better than attempting to outperform enough to make up for additional interest, dividend, and capital gains taxes that would need to be paid when investing in a custodial account," he said.

If you really want to trade stocks for the education fund, there is another option, Fraasa said.

Assuming you have at least five years before the funds are needed, and assuming your earned income is below $170,000, you could establish a Roth IRA for you and your spouse, and even for your kids, as long as they also have earned income, he said. The contribution limits are $5,500 per person, or $6,500 for those over age 50.

"In the Roth you can trade at a broker/dealer and if you withdraw the funds after five years, the earnings are tax-free," he said. "The only thing is that the Roth IRA has this limit to the amount you can fund, whereas the 529 doesn’t have those low limits to the amount you can fund."

College Tax Strategy Introduction Video (Click To View)

National Institute of Certified College Planners· has produced a video on College Tax Strategy:

The Year of the You - TurboTax Commercial (Click To View)

People are talking about this TurboTax commercial that was released last week....some love it, some hate it, if you've not seen it, take a look:

What Counts Toward a Medical Deduction?

Gregory Hamel, Demand Media writes: Medical exams and procedures can result in thousands of dollars of out-of-pocket expenses, even if you have health insurance to help cover your costs. The federal government offers a medical and dental deduction to help ease the strain that health-related expenses can put on taxpayers. The medical and dental expenses deduction is an itemized deduction, which means you have to forgo your standard deduction if you want to claim medical expenses.

MEDICAL DEDUCTION BASICS

The medical expense deduction doesn't benefit everyone, because the Internal Revenue Service puts an annual income limit on your deduction. For the 2012 tax year, you can only deduct qualifying medical expenses in the amount that they exceed 7.5 percent of your adjusted gross income. For example, if your AGI is $60,000 and you have $5,000 in qualifying medical expenses for the year, you can only take a deduction of $500 because you have to subtract $4,500--7.5 percent of your AGI--from your deduction. The AGI limit is 10 percent starting in 2013 unless you or your spouse is over age 65.

DEDUCTIBLE MEDICAL EXPENSES

In general, any expense you that is medically necessary to keep you healthy is tax deductible. Fees paid for the services of health care practitioners like doctors, surgeons, chiropractors, psychiatrists, psychologists and acupuncturists are deductible. Amounts you pay for medical equipment necessary for your health, like false teeth and other dental appliances, hearing aids, glasses, contact lenses, artificial limbs, wigs and wheelchairs can also be included. The cost of training and maintaining a service animal is deductible.

TRAVEL COSTS

Costs related to travel to receive health care can be included in the medical expense deduction. According to the IRS, you can deduct the cost of bus, taxi, train, or plane fares or ambulance service paid to receive medical care. You can also deduct out-of-pocket car expenses, such as gas and oil, when using a vehicle for medical reasons. You can take a mileage deduction of 23 cents per mile on 2012 returns for medical use of a personal vehicle instead of deducting your actual out-of-pocket expenses.

NONDEDUCTIBLE EXPENSES

Although medically necessary costs are generally tax deductible, you can't deduct every type of health-related expense. Procedures aimed at improving appearance, such as cosmetic surgery, hair transplants and electrolysis, are not deductible unless they promote the proper function of the body or help fight disease or illness. The cost of nutritional supplements and vitamins is not deductible unless a doctor specifically recommends them to treat a medical condition. Medical expenses paid out of health savings accounts and flexible spending accounts are not deductible.

Deductible Vs. Nondeductable IRAs

Mark Kennan, Demand Media writes: Individual retirement accounts aren't called "deductible IRAs" or "nondeductible IRAs." Instead, deductible or nondeductible refers to how your contributions are treated on your taxes. How those contributions affect the taxes on your withdrawals depends on whether you're taking them out of a traditional IRA or a Roth IRA.

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TRADITIONAL IRAS

Traditional IRAs accept both deductible and nondeductible contributions. If you or your spouse is covered by an employer-sponsored retirement plan and your modified adjusted gross income exceeds the annual limits, you're limited to making nondeductible traditional IRA contributions. If you're not covered, or you are but your income isn't too high, you have the option of making nondeductible contributions if for some reason you don't want to deduct your contribution on your tax return for the year that you make it.

DISTRIBUTIONS FROM TRADITIONAL IRAS

If your traditional IRA contains nondeductible contributions, slightly different rules apply to your withdrawals. No matter when you take the money out, each distribution is prorated between your nondeductible contributions and the rest of your account because the nondeductible contributions portion comes out tax free. For example, say you have $50,000 of nondeductible contributions and your traditional IRA is worth $200,000 -- 25 percent of your account is nondeductible contributions. If you take out $10,000, $7,500 is taxable and $2,500 isn't. Your account now only has $47,500 of nondeductible contributions in it.

ROTH IRAS

Roth IRA contributions are always nondeductible, no matter your financial circumstances or participation in an employer plan. That's because Roth IRAs are after-tax savings accounts and offer tax-free distributions on qualified withdrawals. To take qualified withdrawals, you have to wait at least five years after the start of the first tax year you made a contribution. Also, you must be either at least age 59 1/2, permanently disabled or taking out up to $10,000 for a first house. Failing to meet one of the criteria means you're taking an early withdrawal.

EARLY ROTH IRA WITHDRAWALS

Early withdrawals from Roth IRAs are less painful because of the distribution ordering rules. Instead of prorating your distribution, you're allowed to take out all your contributions -- tax-free and penalty-free -- whenever you want. After you've depleted your contributions, only then do you tap your earnings, which are taxed and penalized on early withdrawals. For example, say your Roth IRA has $50,000 of contributions in it. Any distribution up to $50,000 comes out tax free.

Inventory for Dummies: Taking Stock with Author Lita Epstein

Julia Wilkinson for EcommerceBytes.com writes: Getting and sourcing inventory can be fun; storing it, not so much. And counting it and valuing it? Most of us would rather do anything else. But valuing your inventory and keeping track of it is important for online merchants - you need to calculate the Cost of Goods Sold for your Income Statement, and you need to know the value of your inventory for your Balance Sheet.

It's not as complicated as it sounds, though, once you know the correct method and tools to use.

Today, Bookkeeping for Dummies author Lita Epstein comes to our aid to demystify this business task, and well before tax time. Read on and get her tips for what's critical to do, and what mistakes to avoid.

Methods of Inventory Valuation
There are several methods business owners can use to value their inventory. Below is a summary, excerpted from Epstein's article, How to Manage Business Inventory and Its Value. (But don't panic; as Epstein explains later, one of two of these methods are most likely the best ones for you to use as an online seller, depending on what you sell).

LIFO (Last In, First Out): You assume that the last items put on the shelves (the newest items) are the first items to be sold. Retail stores that sell non-perishable items, such as tools, are likely to use this type of system. For example, when a hardware store gets new hammers, workers probably don't unload what's on the shelves and put the newest items in the back. Instead, the new tools are just put in the front, so they're likely to be sold first.

FIFO (First In, First Out): You assume that the first items put on the shelves (the oldest items) are sold first. Stores that sell perishable goods, such as food stores, use this inventory valuation method most often.

(For example, when new milk arrives at a store, the person stocking the shelves unloads the older milk, puts the new milk at the back of the shelf, and then puts the older milk in front. Each carton of milk (or other perishable item) has a date indicating the last day it can be sold, so food stores always try to sell the oldest stuff first, while it's still sellable.)

Averaging: You average the cost of goods received, so there's no reason to worry about which items are sold first or last. This method of inventory is used most often in any retail or services environment where prices are constantly fluctuating and the business owner finds that an average cost works best for managing his Cost of Goods Sold.

Specific Identification: You maintain cost figures for each inventory item individually. Retail outlets that sell big-ticket items, such as cars, which often have a different set of extras on each item, use this type of inventory valuation method.

LCM (Lower of Cost or Market): You set inventory value based on whichever is lower: the amount you paid originally for the inventory item (its cost), or the current market value of the item. Companies that deal in precious metals, commodities, or publicly traded securities often use this method because the prices of their products can fluctuate wildly, sometimes daily.

What Valuation Methods Work Best for Online Sellers?

So, what type of valuation method does Epstein think would work best for most online sellers? "Averaging is definitely the simplest method to use," explained Epstein. "Its biggest advantage is that it smooths out the ups and down of purchasing inventory if the marketplace is one that goes up and down throughout the year."

She also cautions, "For a new business, I would recommend staying away from LIFO, since there is a push legislatively to ban that form of inventory valuation, and changing to another valuation method could require major work restating past financial reports." She says LIFO is already banned in every major industrial nation other than the US. FIFO can also be a good alternative, "but it does require more precise record keeping, so I would still recommend averaging to keep bookkeeping simpler," she says.

What if you are dealing with a range of product that are each unique, and can vary widely in price? Epstein explains, "For this type of business, specific identification would be the best inventory valuation method to use." She gives the example of "the online seller who is dealing with technology or other high-end product where almost every item sold is unique, such as built to order computers."

However, she cautions that "when setting up the books, it is always good to review your business plans with an accountant and confirm you are setting up the books in the best way for the type of business you plan to run."

Inventory Tracking Software: Beyond Paper Ledger Books
What inventory tracking method does Epstein recommend? Does anyone use paper ledger books anymore?

"I'm sure there are some people out there who still keep paper ledgers, but a basic accounting software package, such as QuickBooks, is much better and reduces the possibility of error," explains Epstein. One of the primary advantages of computer based accounting is that the financial transaction and related information only needs to be entered one time, and all the affected accounts will be automatically updated with the entry.

This is as opposed to doing accounting on paper, where transactions need to be entered multiple times depending on how many accounts are impacted, she says. "Then as the information is summarized at the end of an accounting period, mathematical errors of addition and subtraction can be added to potential problems."

Another problem is "as information is transferred on paper from the individual accounts to the general ledger summaries, entry errors can be made." But with a computerized accounting system, "any additions, subtractions or multiplications are all done for you by the software. As long as the original entry is correct, all calculations using that entry will be right."

The Paper Trail: Documents to Save
What documents associated with inventory do sellers need to save? Paper receipts, credit card receipts, or both? And what do you do about items you may buy at a yard sale, for example, where receipts are not usually given; is a handwritten list of the items and their cost good enough?

"It's a good idea to keep any proof of purchase for inventory," says Epstein. "If there is a question about the bill after it's been paid, you will have the detail you need. Also if the IRS questions the numbers on your tax return, you will have the proof needed to justify your costs and expenses."

If the merchandise you sell was purchased at a yard sale, she advises you make a detailed list of what was purchased and what was paid, along with the date purchased and the location at which it was purchased. "As long as you do this regularly and have a good paper trail for the IRS, there shouldn't be any difficulty if you get audited," she says.

Common Mistakes to Avoid
What are the biggest mistakes businesses (of any type, online or off) make with managing inventory? "Not having a good inventory control policy is probably the biggest mistake."

"Inventory shrinkage from breakage or theft is the biggest problem for most retailers." Inventory is like cash sitting around, she explains, "So you need to think about ways to protect that cash from being used inappropriately." She advises that you be sure you put a strong system of controls for inventory coming into and going out of your business.

Similarly, "Holding on to inventory is a cost most sellers forget to consider," says Epstein. "Inventory that sits around and doesn't sell is taking up space that can be used by items that might move more quickly and earn the company more money."

If a seller has inventory that sits around for several months, reducing the price is certainly one option to get rid of the item. "Another option may be to offer the item for free as long the as buyer also purchases something else," she suggests.

Counting Your Inventory: When and Why
What do sellers need to do around the end of the year re: inventory to get ready for their taxes due for that year? "All businesses must do a physical count of inventory at least once a year," explains Epstein.

Many businesses do it more frequently as a part of their inventory control system to make sure that what is on the shelves matches what is in the computer inventory system, she added.

"A periodic inventory count enables you to track inventory shrinkage. If the problem increases with each count, you need to consider the possibility that someone on staff is either taking the inventory or mishandling the inventory causing breakage." You need to investigate further when you see inventory shrinkage, she counsels. "The sooner you find the problem, the less of impact it will have on your business's profits."

At the end of year you need to have an accurate of the inventory on hand, so you can calculate what was sold and match that to the inventory information calculated by your computer system, she says.

Storage Tips?
For sellers who store inventory in their own home (or maybe a small rented storage space), Epstein has some organization tips. "I store my book inventory in the garage," she says. She cautions that you should make sure whatever storage containers you are using protect the viability of the product you're storing, especially if you store your inventory in a rented space that does not have climate controls.

Also, "remember that if you are using a space to store inventory in your home, that space can be written off as a business deduction on your taxes."

Recommended Resources
Besides "Bookkeeping for Dummies," what resources might Epstein recommend to help small sellers who have no formal business training to learn how to effectively manage inventory?

A good book to read on inventory management is Essentials of Inventory Management by Max Muller, she says. "It delves not only into the basic accounting methods we've discussed but also looks at key managerial decisions that need to be made when managing inventory."

How to Value Charitable Stock Donations / The Answer Can Be Surprisingly Tricky

Tom Herman for the Wall St Journal writes: Question: For a gift of appreciated securities to charity, how is the gift valued? Is it the a) average of high and low price for the day, b) average of open and close for the day, c) other?

— R.V., Bedford Hills, N.Y.

Answer:With stock prices up sharply, many taxpayers are donating shares they've owned for more than a year and that have surged in value. Donors typically can deduct the stock's full market value, and don't owe a capital-gains tax.

But if you donate stock you've owned for a year or less, you typically can deduct only your cost, not the market value.

Also, remember you can't deduct anything unless your donations go to a qualified charitable organization—and unless you itemize your deductions.Nearly two-thirds of all individual income-tax returns claim the standard deduction each year, instead of itemizing.

Our reader asks how to calculate the value of the donation. First, let's assume there is an active market for the contributed stock, and that the stock traded on the day of the gift.

In that case, "the mean between the highest and lowest quoted selling prices on the date of the contribution" will determine the value of the contribution, said Martin Hall, a partner at the law firm Ropes & Gray LLP, and Carolyn Osteen, a retired partner at Ropes & Gray and a consultant to the firm, in their book on tax aspects of charitable giving.

For example, the Internal Revenue Service says in Publication 561, "if the highest selling price for a share was $11, and the lowest $9, the average price is $10."

And if there were no sales on the gift date? If there were sales "within a reasonable period before and after the valuation date," you take the average of the highest and lowest prices "on the nearest date before and on the nearest date after the valuation date," the IRS says. "Then you weight these averages in inverse order by the respective number of trading days between the selling dates and the valuation date."

P.S.: Don't donate stock that has gone down in value. Instead, sell those losers. Those "realized" capital losses can be valuable for tax purposes.