Five tips to maximize your deductions and credits
By
Andrea Coombes, MarketWatch
SAN FRANCISCO (MarketWatch) -- These days, many of us leave the myriad, line-by-line tax decisions to our professional preparer or the mystery men behind our tax software. But given the increasing complexity and ever-changing nature of the U.S. tax code, it makes sense to keep abreast of some of the most valuable perks yourself. After all, it doesn't hurt to make sure your software program is steering you in the right direction or to check in with your preparer to see whether you qualify for a tax break.
EARLY BIRD TAX GUIDE
Total tax helpOur Tax Guide offers tips and stories to lead you through the filing season for your 2006 return, and get you ready for 2007.•
5 tips to make most of deductions•
Navigating the unfathomable AMT•
Don't miss these tax-law changes•
Your Form 1099 may come late•
Did you move? Take a tax breakGet Taxing Times newsletter free"I'm blown away by all the changes," said Michelle Maton, an enrolled agent, certified financial planner and partner with Aequus Wealth Management Resources in Chicago. For taxpayers to read up on tax law to see whether it might apply to them "is a good idea," she said. "If there is something there, then either research more on your own or ask a professional. My clients are seeing something and sending e-mails, 'Does this apply to me?'"
MarketWatch talked to tax experts for ideas on some of the biggest-value deductions and credits taxpayers should consider:
1. Go the standard route or itemize?
Your first and perhaps biggest decision is whether to itemize or take the standard deduction, which for 2006 amounts to $10,300 for married-filing-jointly returns, $5,150 for single filers and those married-filing-separately and $7,550 for head-of-household filers. (Taxpayers 65 and older and/or blind receive additional amounts.)
In 2002, the then-named General Accounting Office, Congress's investigative arm, found that taxpayers who could have itemized but didn't sacrificed $945 million, or about $438 per taxpayer on average.
That's the most recent data available, but it's a fair bet that the receipt-challenged among us continue to opt for that oh-so-easy standard deduction, even when it costs us.
"Some people fail to itemize because they don't want to take the trouble to add up all their deductible expenses and they don't hold onto receipts for some deductible items," said Bob Scharin, a New York-based senior tax analyst with RIA, of Thomson Tax & Accounting.
But for one large group of taxpayers -- homeowners -- there's a relatively easy way to figure out what's the best value for you, Scharin said. Specifically, consider three major deductible items.
By adding up your deductible mortgage interest (on your principal residence plus one other residence, Scharin said), real-estate taxes, and any state and local income taxes, you can quickly see whether that dollar amount tops the standard deduction.
Then, "if you have receipts for any other deductible expense, that's great. But even if you're the type who can't find anything, you should be able to find those three amounts, because you'll have gotten those records recently," he said.
"If those exceed your standard deduction, then go ahead and itemize them and any additional receipts you have for charitable contributions, for instance, would provide an additional deduction," he said. All told, homeowners likely enjoy the highest dollar value of tax perks related to itemizing. "Deductions associated with homeownership probably tend to be the largest, [with] mortgage interest and real estate taxes being the primary" itemized deductions, said Mark Luscombe, a principal analyst with CCH Inc., a Riverwoods, Ill., tax publisher.
2. Giving to charity
But there's another valuable deduction for many itemizers: charitable donations. "That tends to affect a wide range of people," Luscombe said. Taxpayers' deductions for charitable giving totaled $145.7 billion in 2003, according to the IRS.
"For most types of charities, you can deduct up to 50% of adjusted gross income. That's a pretty high cap. For most people, they've been able to deduct all their charitable contributions as long as they were itemizing and weren't phased out of itemizing," he said, noting that the value of itemized deductions phases out for higher-income taxpayers, but that rule itself is phasing out.
See related story on tax-law changes.This year, new rules for charitable donations will likely stump plenty of people. "The IRS has become concerned that people are taking more charitable deductions in many cases than the charities are getting the benefit of," Luscombe said.
Congress passed new donation-deduction restrictions last year. The result: If you contributed any clothing or household items after Aug. 17, 2006, the items must be in "good" or better condition for you to deduct their value.
That means if the IRS questions your claim, you'll need to be able to prove the condition and the value of your donation. How to do that? That's a good question that no one seems able to answer at this point.
Consider photographing your items before donating them, and keep any and all receipts. For donations made late last year, be careful about claiming a big amount, or you may catch the IRS's audit eye.
"It's such a big [deduction] that I'm sending e-mails to all my clients about it," Maton said. "I have a lot of clients who take lots of stuff to lots of charities."
Until and unless the IRS issues more guidance, verifying the quality of your donated goods "is up to you," Maton said. "People who are taking very large deductions for this kind of thing might want to be careful."
And make note of a tax law going into effect for next year's filing: When you make cash contributions this year, in 2007, be sure to get a receipt. "They want you to prove that you actually made a transfer of money," said Bennett Berg, a Chicago-based certified public accountant and director of CBIZ Accounting, Tax & Advisory Services LLC, based in Cleveland.
"A lot of people were saying, 'I've given at my church, $20 a week,' yet had no proof. You can't do that any more," he said. Cash donations "must be supported by bank records, payroll check stubs, credit-card statements or other written communication from the charity, showing the name of the charity and the date and amount of the contribution," he said.
3. On Education:
You don't have to itemize to gain some valuable tax perks, and plenty of those perks are aimed at education. If you're in school or a parent with kids in school, you'll want to see whether you qualify.
There's the $4,000 above-the-line (that is, you don't have to itemize to get it) deduction for college tuition and fees, the Hope credit for up to $1,650 for each of the first two years of qualified higher education expenses, and the Lifetime Learning credit, a maximum of $2,000 for qualified tuition expenses. (Both credits offer higher dollar amounts to students in certain hurricane-hit areas.)
About one-fourth of eligible taxpayers neglected to take the Hope or Lifetime Learning credit available to them, according to a review of about 1.4 million tax returns by the U.S. Government Accountability Office in a report dated July 2005. The money lost as a result was relatively small, about $169 on average. But 10% of those filers paid $500 more than necessary in taxes, according to the GAO.
And, unlike many other credits, the two education credits are available to filers who pay the alternative minimum tax. Both education credits start phasing out at a modified adjusted gross income of $45,000 ($90,000 for married-filing-jointly) and both credits drop to zero for those with a MAGI above $55,000 ($110,000 for married-filing-jointly), in 2006.
Meanwhile, the $4,000 deduction is one of those tax breaks that's not on the Form 1040 for 2006, since the perk expired until Congress re-enacted it late in December, after the IRS printed its forms.
See full story.The tuition deduction, now available in 2006 and 2007, starts phasing out for single filers with an adjusted gross income of $65,000 or more and for joint filers with an adjusted gross income of $130,000 or more.
4. A credit to you:
Whether you itemize or not, don't miss the tax credits available to you. While some of the credit caps seem small compared with deductions, "a given dollar of credit is more valuable because a dollar of credit offsets a dollar of tax while a dollar of deduction only offsets a dollar of taxable income," Luscombe said.
And, for one more year, some credits are available to taxpayers who fall into the alternative minimum tax, including the dependent-care credit, the credit for the elderly and disabled, and the Hope and Lifetime Learning credits.
Unfortunately, for taxpayers who bought a hybrid vehicle in part to enjoy that tax credit -- more than $3,000 in some cases -- if you fall into the AMT you're out of luck.
But AMT taxpayers, like regular taxpayers, may be able to glean some benefit from the child tax credit.
The $1,000 child tax credit is "probably the biggest credit [in terms of] affecting the most people," Luscombe said. Still, he said its income phase-outs disqualify higher earners: The child tax credit phases out starting with a modified adjusted gross income of $110,000 for joint filers, $55,000 for married taxpayers filing separately, and $75,000 for single filers.
Also, don't forget see whether you qualify for the credit for child and dependent-care expenses. "People should keep in mind the dependent-care credit if they have children who are going to day-care or summer day camp," Scharin said (sleep-away camps don't qualify).
The credit amount varies with income, but the lowest is 20% of up to $3,000 of expenses if you have one qualifying child or 20% of up to $6,000 of expenses for two or more.
There's also a saver's credit, capped at $1,000, aimed at encouraging retirement saving. "To get the maximum you have to put away $2,000. It's basically a 50% credit," Luscombe said. The credit starts to phase out for those with an AGI of $50,000 for joint filers, $37,500 for head-of-household filers and $25,000 for single and married-filing-separately filers.
Finally, consider the foreign tax credit. "This could arise when someone invests in an international mutual fund, and the fund may be paying taxes to other countries," Scharin said. "It's not just for the person who has these esoteric investments and is going abroad."
Look on the Form 1099 you receive from your mutual-fund company or broker for a box related to foreign taxes paid. Some taxpayers need to fill out Form 1116 to claim the credit, but "if those taxes are not more than $300, or $600 if married filing jointly, then you don't need to fill out the Form 1116. You can just report the amount on the 1040," he said.
"If it's even $50, it's a dollar-for-dollar reduction on your tax bill."
5. Hard to qualify, but valuable.
Then, there are those valuable deductions for which few taxpayers qualify, such as the medical-expense deduction, available only to those itemizers whose medical expenses top 7.5% of their adjusted gross income. Compare 7.5% of your AGI to the total you spent on medical expenses over the year. If your medical outlays are larger, you're eligible to deduct the difference.
"In recent years, the IRS has been getting a little more generous as to what can qualify as medical expenses," Luscombe said. Some "long-term-care expenses and insurance premiums can now qualify, and smoke cessation programs and weight loss programs that meet certain criteria. Some of those things in the past were excluded," Luscombe said.
"A lot of people in their employer-health plans [can include] what they paid in medical-insurance premiums," he said.
See this IRS page for more information.Then, there are casualty losses, another itemized deduction that can be sizable for some taxpayers, Luscombe said. But it's a tough perk to claim: "The casualty losses have to exceed 10% of adjusted gross income." One note: theft losses also qualify.
Andrea Coombes is a reporter for MarketWatch in San Francisco.
