Sales-tax deduction Before the last big tax reform, in 1986, taxpayers could deduct not only state and local income taxes on their federal...
Before the last big tax reform, in 1986, taxpayers could deduct not only state and local income taxes on their federal returns, but also sales taxes as well. The 1986 law eliminated the sales-tax deduction.
But now the sales-tax deduction is back, though only as an alternative to deducting state and local income taxes. You can deduct one or the other, but not both.
The obvious benefit is to residents of Washington and the six other nonincome-tax states, and to a lesser extent to those in states such as Tennessee and New Hampshire that tax only certain kinds of income.
In most cases, residents of areas with both income and sales taxes will find it more beneficial to keep deducting the income tax — but not always.
Education benefitsThere are now so many benefits for higher education that it seems only the highly educated can figure them out. But if you are a student, or have a child in college, it can be worth the effort.
The two types to pay most attention to in preparing your tax return are deductions and credits. Deductions reduce your taxable income, and thus are worth whatever the taxes on that amount of income would have been. The higher your bracket, the more valuable a deduction. Credits reduce your actual taxes, and therefore are worth the same to everyone.
First, there is a deduction of up to $2,500 for interest you paid on a student loan for yourself, a spouse or a dependent. The loan has to have been your legal obligation to repay, and your income cannot have been more than $50,000 to $65,000 (the deduction phases out in that range) for a single taxpayer or $100,000 to $130,000 for a couple.
This is an “above the line” deduction — technically, an adjustment to income — which means you can take it even if you don’t itemize.
Then there is a deduction of up to $4,000 for higher-education expenses you paid for yourself, your spouse or a dependent. The income limits are $80,000 for a single person, $160,000 for a married couple. No phase-out on this one. This deduction is also above the line.
Besides the deductions, there are two credits — the Hope credit and the lifetime-learning credit — available for higher-education expenses.
The Hope credit is a maximum of $1,500 per student, available for the first two years of college only. The lifetime credit is a maximum of $2,000 per return, available for all years of post-secondary education, including courses to obtain or improve job skills.
Eligibility for both credits phases out at incomes between $42,000 and $52,000 for a single and between $85,000 and $105,000 for a couple. But you can’t take both for the same student (though you can take one for one student and the other for another if you’re eligible), and you can’t take either for a student for whom you used the tuition deduction.
And the credits are calculated differently. The Hope credit is equal to 100 percent of the first $1,000 of higher-education expenses, and 50 percent of the next $1,000, for the maximum of $1,500.
The lifetime credit is 20 percent of the first $10,000 of expenses. The break point, according to the IRS, is $7,500 in expenses. Below that, the Hope credit is better; above that, the lifetime credit is better.
With such variable income limits, Jeffrey Kelson, tax partner in the New York office of the BDO Seidman accounting firm, urged taxpayers to check all the alternatives before concluding they are ineligible.
For details on these and other education benefits, look at IRS Publication 970.
Finally, another above-the-line deduction of up to $250 is available to teachers in elementary and secondary schools for out-of-pocket expenses incurred to buy certain kinds of classroom materials. You’re supposed to have receipts to back up any deduction you claim.
But there are subtle complications, noted Art Auerbach, a CPA with Goodman & Co. in McLean, Va. For example, the IRS tables allow you to use the table and add on certain big-ticket items, such as a car or boat, but only up to the amount of the general sales tax.
Some states impose higher taxes on certain items, but you can’t use that. And stick to the big-ticket items specified in IRS Publication 600, which contains the tables.
Taxes on other expensive items, such as jewelry or furniture, cannot be added to the table amounts, though you can include them if you use the actual receipt method.
It’s another complication, but one that could save some people money.
Tsunami donationsA special provision enacted late last year allows you to deduct for 2004 donations made as late as Jan. 31, 2005, to relief funds for victims of the tsunami in South Asia.
However, Auerbach said, that applies only to cash. If yours is one of the ski parkas piling up in Sri Lanka, you’ll have to take your deduction on your 2005 return.
Retirement accountsDon’t forget you have until the due date of your return to make a 2004 contribution to an IRA, and certain other retirement accounts. The maximum IRA contribution for 2004 is $3,000 ($3,500 for those 50 or older), and it may be deductible. If not, try a Roth IRA.
It won’t save you anything on your 2004 return (because you’re putting away money you already paid taxes on), but it is tax-free when withdrawn in retirement — a time when taxes may very well be higher.
If you’re ineligible for either a deduction or a Roth and you have, say, a teenager who had earnings in 2004, establish a Roth for him or her. Even small amounts, left to grow for 40 years, can turn into real, tax-free money.
And Jeffrey Kelson, tax partner in the New York office of the BDO Seidman accounting firm, suggested that if you are self-employed you should consider a simplified employee pension, or SEP. It’s relatively easy to use, can be set up for last year up until the due date of your return, and may allow you to set aside and deduct almost 25 percent of your earnings.
Stub checkYour last paycheck stub of the year may include useful tax information not included on your W-2. Three possibilities are union dues, charitable contributions you made through an automatic-payroll deduction and your employee share of medical coverage.
Drive, he saidMost taxpayers remember they can deduct business uses of their cars, but medical and charitable uses can be deductible, too.
For example, do you drive congregants to religious services? Do you deliver meals to shut-ins? Did you drive yourself or dependents for medical treatment? All of these are potential deductions, as are cab fares or parking for these purposes.
A little for a long termThe federal tax benefit for long-term insurance premiums is very modest, but some states allow credits or deductions.
Special statusA taxpayer can deduct medical expenses paid for someone who would have qualified as a dependent (meaning provided more than half that person’s support), but for the fact that the person had too much income or failed the joint-return test.
As more families have older relatives in nursing homes or long-term-care facilities, this provision is increasingly useful.
You may deduct only the amount by which your total medical-care expenses for the year exceed 7.5 percent of your income, but care of an elderly parent may get you over that threshold, especially if you have other medical costs.
And Baby makes how many?• First, add Baby to your exemptions — but make sure you’ve gotten Baby a Social Security number. That’s required for all dependents. If you haven’t already, apply to the Social Security Administration right away. The process usually takes about two weeks. If you don’t have the number by the April 15 tax deadline, you can get an extension by filing Form 4868 with the IRS.
• The child tax credit available to many parents is now as much as $1,000 per child. It starts phasing out for couples with income $110,000 and over and for singles with $75,000 or more.
Moving experienceIf you shifted to a new job, or to a new location at your old employer, that was more than 50 miles farther from home than the previous one, and you moved because of this, you may be able to deduct your moving expenses.
Watch your headIn general, you can deduct interest on loans to buy, build or improve a home and second home. But the total indebtedness for which this deduction is allowed has a ceiling of $1.1 million, and in wealthier areas of the country more taxpayers are bumping up against this restriction.
Mutual fundsCheck the 1099 from your mutual fund carefully (for that matter, carefully check any 1099 from an individual stock) and be sure you differentiate ordinary dividends from qualified dividends on your Form 1040. “Qualified dividends,” if you have some, will qualify for the 15 percent tax rate.
Deduct your car-tab taxes
The motor-vehicle excise tax you paid for transit projects may be itemized and deducted from taxable income when filing Internal Revenue Service Form 1040. List the amounts on Schedule A, line 7: “Personal property taxes.”
Seattle monorail tax: The Seattle Monorail Project’s car-tab tax of 1.4 percent, within Seattle city limits only, is deductible. The amount is shown as “Monorail Tax” on the green vehicle registration that came with your Washington license tabs.
Sound Transit tax: Sound Transit’s car-tab tax of 0.3 percent, charged throughout the urban parts of Snohomish, King and Pierce counties, is also deductible. It is shown as “RTA Excise” on the green vehicle registration.
Other fees aren’t deductible: Federal tax rules say that only vehicle taxes that are based on value may be deducted. Do not claim the statewide $30 car-tab fee, local processing fees, or your total car-tab payment.
Home-buyer alert• Points, the upfront amount you may have paid to get the mortgage on your principal residence, are deductible. Points masquerading as loan origination fees, maximum loan charges, loan discount and discount points are also deductible. (Points paid on a loan secured by a second residence cannot be deducted in the year of purchase but must be deducted over the life of the loan.)
Hybrid tax cut
The IRS has certified the 2005 Honda Insight, Civic Hybrid and Accord Hybrid as eligible for the clean-fuel vehicle deduction. That means that a taxpayer who buys one of those hybrid vehicles new may claim a tax deduction of up to $2,000 on Form 1040.
The Hondas join the ’05 Toyota Prius and Ford Escape Hybrid, which the agency certified late last year.
Under recent legislation, the clean-fuel deduction is up to $2,000 for certified vehicles first put into service in 2004 and 2005, but it will be cut to $500 for vehicles placed in service next year and eliminated after 2006.
The deduction must be taken in the year the vehicle is originally used, and the taxpayer must be the original owner. However, individuals do not have to itemize deductions to claim the deduction. It can be taken as an adjustment to income on Form 1040.
• Speaking of which, points for a refinance must be amortized over the life of the loan. But homeowners who retired that mortgage to refinance yet again may now deduct any points paid to get the first refinance.
• This is counterintuitive, but points paid by the seller are deductible by you, the buyer.
Home again• Property taxes are deductible for filers who itemize. But municipal and county fees for trash collection and sewer service are not deductible — even though many times they are added to your real-estate-tax bill. Homeowner association dues aren’t deductible either.
• When going through receipts from past years, collect and save those that represent major additions and improvements to your house. The expenses are not tax-deductible per se, but you can add them to your cost “basis” when you sell. That means your capital gain will be smaller, which could keep you below the tax-free maximums of $250,000 for an individual and $500,000 for a married couple filing jointly.