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| The Basics | You have more tax shelters than you think
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Yes, the wealthy are able to shelter away large amounts of income from federal income taxes. But we all get more income sheltered than we imagine.
By Jeff Schnepper
How many times have you done your taxes and, three weeks later, learned you had missed the opportunity for a deduction? Too many, Im sure. How can you not miss these deductions the next time? Start planning now.
Ive found a number of deductions that my own clients often miss. Here are 10 of them that can affect your tax bill for 2005 and your tax planning for 2006.
Noncash contributions
Charity, as I hope everyone remembers, begins with a tax deduction. If you didnt have the cash when it came time to contribute, I hope you charged it. The deduction is allowed in the year of charge, not when you actually pay the bill. Get a receipt from the charity to which you made a donation and, if youre still worried about documentation, get the credit card company to send you their record of the transaction.
Now, lets say you emptied your closets and gave everything to Goodwill or a similar charity. The value of your donated items -- clothes, furniture, whatever -- is deductible. Get a written receipt. With noncash charitable contributions, the rule is simple: No receipt means no deduction if you get audited.
If you've already dumped your old clothes in a Salvation Army box and walked away without a receipt, take the deduction anyway. Youve legitimately made the contribution. You just may not be able to prove it in an audit. Play the audit lottery. Youre still an honest person. (If you can, reconstruct as much as you can the list of items you donated and then figure out their market value. The easiest way is to go to a Salvation Army or thrift store and check prices there. And then, of course, get that receipt.)
New points on refinancing
With interest rates so low over the past year, lots of homes have been refinanced, sometimes more than once.
Any points you pay to refinance your home can be deducted on a monthly basis over the life of the new loan. So, if you refinanced your mortgage on June 1, 2005, for a 20-year term, seven out of 240 months have passed. If you paid $2,400 in points, you can write off $70 ($10 a month for seven months) for 2005. You can write off $120 for 2006 and each year thereafter until the points have been deducted in full. The amount may not be huge, but every little bit helps.
Old points on refinancing
This is one deduction lots of people miss. All unamortized points on an old refinancing are deducted in the year of a new refinancing.
So, lets say you refinanced on June 1, 2004, and paid $2,400 in points. You refinanced again on June 1, 2005. You can deduct all the remaining points on the 2004 loan. Thats $2,280 plus the $50 you could deduct for January through May in 2005. Likewise, if you refinance the 2005 loan in 2006, you will be able to write off the remaining balance on your 2005 points.
Health insurance premiums
Any health insurance premiums you pay, including some long-term care premiums based on your age, are potentially deductible. You have to add these, however, to your medical expense pot. Medical expenses have to exceed 7.5% of your adjusted gross income (AGI) before they give you any tax benefit.
But if youre self-employed and not covered by any other employer-paid plan, you can deduct 100% your health insurance premiums above the line. Above the line means the expense is included in adjusted gross income and doesnt get lumped in with itemized deductions. That means that you not only dont have to exceed the 7.5% floor, you dont even have to itemize!
Educator expenses
Pay attention, teach! This may be your last chance for this one.
If youre a qualified educator, you can get an above the line deduction of as much as $250 for materials you buy in 2005. That includes books, supplies and even computer equipment. You qualify if youre a kindergarten through grade 12 teacher, aide, instructor, or principal.
Unfortunately, this lovely special provision expires on Dec. 31, 2005. It's unclear if Congress will extend it.
If Congress does not extend the law, all these educator expenses are allowed only as miscellaneous itemized deductions. You can deduct only the amount of your miscellaneous deductions that exceed 2% of your adjusted gross income.
Student higher education expenses
One for the teachers, one for the students.
For 2005, if your adjusted gross income isnt more than $65,000 ($130,000 on a joint return), you can get an above the line deduction of as much as $4,000 for any higher education expenses you paid.
See if you qualify for the Hope or Lifetime Learning Credit. The Hope credit is worth $1,500 per student subject to income limits. The Lifetime Learning Credit is worth $2,000 per return. Compare, and go with the one which gives you the biggest benefit.
Clean fuel deduction
You can get another above the line deduction of up to $2,000 in 2005 of the cost of buying a clean fuel vehicle. Thats a car that uses a significant source of energy other than gasoline. Make sure you buy the vehicle by Dec. 31, 2005. Right now, the deduction is scheduled to drop to $600 in 2006.
Hybrid cars qualify. A hybrid car combines an electric motor with a gas fueled internal combustion engine.
Cars that the IRS has blessed include the Toyota Prius, the Honda Insight, the Honda Civic Hybrid, the Ford Explorer Hybrid and the 2006 models of the Lexus RX 400h. Check the IRS Web site for a complete list.
You get the deduction in the year you start using the car, and you must be the original owner. Take it on your Form 1040 by writing in clean fuel.
Investment and tax expenses
Many of us forget tax planning and investment expenses because they are part of miscellaneous itemized expenses. Their total must exceed 2% of your adjusted gross income before you get any tax benefit.
Expenses to track include your employee business expenses, tax preparation fees and even the portion of your legal or accounting fees relating to tax planning. For example, in a divorce, the legal time spent relating to the tax aspects of alimony and child support would qualify. So too would the tax aspects of estate planning.
Many people shortchange themselves on the deduction of investment expenses. They remember the safety deposit box fees. But how about the annual fee paid your broker and any IRA fees you pay directly? You may remember the cost of your investment publications on subscription -- such as Forbes, Fortune, Business Week, Worth and Barron's. But how about the investment newspapers you buy off the newsstands? You keep track of your long distance phone calls to your broker and investment adviser, but how about the mileage to go see them?
Casualty deductions
We get hurricanes in the South. We get wild fires in the West.
If President Bush declared your area a disaster area, you can claim your loss either for 2005 or for 2004. You can confirm whether you qualify on the Federal Emergency Management Agencys Web site.
If you choose to revise your 2004 return, you will need Form 1040X. (You can download that from the IRS Web site.) You also should get interest back to April 15, 2004. Unless your income for 2005 was substantially less than 2004, thats probably the way to go. At least numb some of the pain.
Retirement tax credit
This one is even better than a deduction. Its a credit -- a dollar for dollar reduction in your tax -- not just in your taxable income. And, it also can come with a deduction.
This deduction is designed to give moderate and low-income taxpayers an incentive to save for retirement.
Make a contribution into your retirement account. That money isnt taxed currently. So, its like you got a deduction off your income. In addition, you get a credit of as much as 50% of the first $2,000 invested. Thats as much as a $1,000 reduction in your tax.
You get the $1,000 tax reduction as well as the $2,000 reduction in your income. Thats a nice rate of return on a $2,000 investment.
The tax credit disappears as your adjusted gross income increases. But singles with AGIs up to $25,000, heads of households with dependents up to $37,500 and joint filers with AGIs up to $50,000 will qualify. Contributions to your 401(k), 403(b), SEP, traditional or Roth IRAs will qualify as well.
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