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| Decision Center | Tax breaks for everyone
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The federal government created a special package of deductions for victims of Hurricane Katrina. Thats just part of the long list of tax deductions you can claim for 2005.
By Jeff Schnepper
Brace yourself. Your tax preparation might be more complicated than usual this year -- not because of any big changes to the tax code but because of smaller changes meant to handle specific problems -- like Hurricane Katrina relief. In addition, there are plenty of other non-storm-related tax law changes to be aware of before you file.
Congress and the Internal Revenue Service stepped in after the disaster with rule changes and tax-law changes to try to ease the pain. If you're a Katrina victim, keep this in mind. If you know someone who has been hit by Katrina problems, pass these items on.
- Katrina-related casualty losses. Normally, casualty-loss deductions (for, say, storm damage) must be reduced by $100 per casualty. Only the excess over 10% of your adjusted gross income is deductible. But both these limitations are removed from losses attributed to Hurricane Katrina.
- No limits on charitable giving for 2005. Normally, charitable contributions are limited to 50% of your adjusted gross income and are subject to an overall itemized deduction limit. All contributions to Katrina relief are excluded from both these rules.
- Housing Katrina evacuees. If you housed someone displaced by the storm free-of-charge for at least 60 days, you may claim an additional exemption of $500 for each individual -- up to $2,000. The displaced people, however, may not include your spouse or dependents. This additional exemption wont be subject to being phased out and is allowed as a deduction in computing your Alternative Minimum Tax (AMT). (For those of you who have housed people displaced by Hurricane Rita: No, you can't claim the exemption. Congress didn't extend the break to you, though it should have.)
- Charitable mileage for Katrina relief. The standard mileage allowance for charitable use of your car is 14 cents a mile. For Katrina relief, you can deduct up to 70% of the current business allowance. For the period of Sept. 1, 2005, that was 70% of 48.5 cents, or 34 cents per mile. For 2006, you can deduct up to 32 cents a mile for Katrina-related charitable driving. You can be reimbursed up to 44.5 cents without penalty.
- Filing deadlines extended. Deadlines for filing tax returns and making payments for income-, estate- and gift taxes have been extended to Aug. 28, 2006, for all affected taxpayers, including victims and volunteers.
A source of Katrina rebuilding capital
This next group affects how you can use your retirement funds -- if you need to -- to rebuild and repair after Katrina.
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- Penalty-free withdrawals. After Aug. 25, 2005 and before Jan. 1, 2007, Katrina victims may withdraw without penalty up to $100,000 from a qualified retirement plan or an Individual Retirement Account. To qualify, your principal residence on Aug. 28, 2005, had to be in the Hurricane Katrina disaster area. If you put back the money any time within the three-year period, the amounts are considered rollovers and are not included in your income. Normally, the loan limit is $50,000.
- Retroactive plan changes. Normally, you can't borrow from a plan unless it specifies first that you can. The new law says plans may be amended retroactively to allow current hardship distributions and loans.
- For home sales disrupted by the storm. This is a break for people who used money from a retirement plan to buy a home but, because of the storm, couldnt complete the deal. You had until Feb. 28, 2006, to put the money back into your plan without penalty.
- No tax on debt relief. Normally, if you get a debt cancelled -- like the balance on a credit card -- that amount of that debt becomes taxable income. This provision wont apply to the discharge of non-business debts if you lived in the disaster area and suffered economic loss due to the hurricane.
A tax break to encourage job creation
The Work Opportunity Tax Credit -- 40% of wages up to $6,000 per qualified new worker -- is now available to employers who hire people who lived in the disaster area and lost their jobs as a result of the hurricane. The credit, which can cut your tax bill by as much as $2,400, applies even if the new job is outside the core disaster area -- as long as the employee was hired by Dec. 31, 2005. If the new job is within the disaster area, the job must be started by Aug. 28, 2007, two years after the hurricane. The credit is limited to employers who have no more than 200 employees.
Tax planning for the rest of us
Katrina is a special case. But, for all of us, there are plenty of things to do and be mindful of before you file. Here's a rundown:
The mileage rate is boosted. In case anyone hasn't noticed, it costs a lot more to fill your gas tank. The IRS changed the rules on the allowable mileage rate, bumping it from 40.5 cents a mile to 48.5 cents a mile, effective Sept. 1, 2005. So, for the last four months of 2005, you could write off about 20% more in auto mileage. In 2006, the business mileage rate is 44.5 cents a mile. The medical mileage rate for 2006 is 18 cents a mile; the rate for charitable activities is 14 cents. For more, check here.
If you moved during the last four months of the year, you can write off moving mileage at 22 cents a mile, effective Sept. 1, up from 15 cents.
Mileage for charitable work, however, is still 14 cents.
Use those capital-gains rates. If you have capital gains, remember that any net capital losses over the $3,000 allowed on your 2004 tax return should be carried forward to offset those 2005 gains.
If you still have net losses, up to $3,000 may be used to offset ordinary income for 2005.
All net long-term gains are subject to a maximum 15% rate. If youre in the 15% or lower tax bracket, your tax hit is softened to only 5%.
If youre single with taxable income of not more than $29,700, you get the 5% rate. With a standard deduction of $5,000 and a $3,200 personal exemption, you can have as much as $37,900 in gross income and still qualify.
Standard capital-gains planning still applies. If you have net capital gains, sell losers to offset those gains. If you have more losers, sell at least enough to get the $3,000 offset against ordinary income.
If you have shares of stock pregnant with gains and dont expect them to appreciate further, sell those shares and shelter the gains with the losses on your losers. Worst case -- pay the maximum 15% tax. You cant go broke taking profits.
Dont let the tax tail wag the economic dog. In deciding what to keep and what to sell, consider taxes. But, thats only one consideration. Make the final decision based on your growth expectations over your holding horizon.
Dividends are special. You pay a tax rate of as much as 35% on ordinary income. But qualified dividends are now taxed at the same rate as long-term capital gains, capped at 5% or 15%.
But theres a tax trap here. Take out your calendar. To qualify for this 15% rate, you had to have held the dividend-paying stock for at least 61 days. And, those 61 days must fall between 60 days before, and 60 days after, the ex-dividend date. (That's the date by which you must own a stock to get the dividend. Check with the company for its ex-dividend date. If you sell shares after the ex-dividend date, you get the dividend.)
If youre in the 35% bracket, you can play with this one. Borrow money at interest rates that are deductible at 35% and invest where the return is taxed at only 15%.
You can even make out if your yield is lower than your cost of money. Say you borrow $10,000 at 5%. Your interest expense is $500. At a 35% rate, your deduction reduces your net after-tax cost to $325 (65% of $500).
If your $10,000 yields 4.5%, you have $450 in income. After a maximum 15% rate, you have $382.50 left (85% of $450). Thats $57.50 more in your pocket on an investment that yields less than your cost of money.
But theres another trap to watch for:
- First, you must itemize your deductions to get the deduction for investment interest.
- The investment-interest deduction is limited to your investment income. But the law says that dividends qualifying for the 15% maximum rate dont qualify as investment income for the investment-interest deduction. So youll need other investment income (such as interest, rents etc,) to offset your interest expense.
New rate brackets for 2005 mean you keep more
Every year our tax brackets are adjusted for inflation. While our rates are the same as last year, more income is now pushed into the lower brackets. If you were single in 2004, the first $7,150 in taxable income was subject to the 10% rate. For 2005, its the first $7,300.
Cant complain about that.
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