Where What When

Year End Tax Planning

Well, another tax season rolls around. You already know my motto: When it comes to taxes, timing and planning can be very significant. There are always issues. In fact, due to last minute Congressional action, three tax deductions have no lines on the tax form to list them! Here are some pointers:

The Standard Deduction

Every tax return is allowed to claim a fixed amount as a deduction. This is $10,300 for marrieds and $5,150 for singles. However, you can “itemize” your deductions if they will add up to more. The items you can deduct are state taxes paid, real estate taxes paid, mortgage interest, charity, and, sometimes, medical and job expenses. Actually, the government allows you to deduct sales taxes instead of state income taxes if you prefer. There are tables to help you calculate your sales tax deduction. You can only itemize those deductions that you paid before yearend. For example, you need to have given charity and paid state income taxes before December 31.

Your medical expenses are deductible, but only to the extent they exceed 7.5 percent of your income. They include just about anything that is needed for your health: doctors, dentists, therapists, etc. Medical expenses can also include special educational expenses for learning disabilities (which can be very expensive) and travel for medical needs. Nursing home expenses as well as some premiums for long-term care insurance are deductible. Medical expenses have been allowed for central air conditioning systems, swimming pools, and house modifications for those who need them for specific medical reasons. One person managed to deduct clarinet lessons to correct an overbite!

If you made deposits into a “cafeteria plan,” check the rules about deadlines, because there is a “use or lose” aspect to these plans. If you don’t use the money set aside for medical expenses by the deadline, it is forfeited. To review, a cafeteria plan allows you to deduct medical expenses in full ( plus other benefits). If your employer does not offer this plan, he might not be aware of its benefits.

Charity

Some new laws regarding charity apply. Used clothes must now be in good condition or you get no deduction at all. Nobody has yet defined what is meant by good condition, but I would recommend that you video your clothing before donating it. I cannot think of another way, short of an appraisal, of proving what you gave. Wouldn’t it be great if someone figured out a way to send our good-condition used clothing to Israel? An organization devoted to this purpose would have a policy of only accepting good-condition clothes, which would validate your donation as well.

Starting in 2007, cash charity is not deductible at all, unless you have a receipt or a cancelled check. So all those dollars you give to a pushka or meshulachim are not deductible! Your only choice is to give a check. Another option would be to purchase scrip from the Agudah and give that.

The best way to give charity is to donate appreciated stock. You get a deduction for the fair market value of the stock, even though you paid less. Another great way to give started this year. If you are age 70-and-a-half, you can give your IRA money directly to a charity. This can be very effective and must be explored.

Tuition

College tuition paid qualifies for various tax deductions, all of which have limitations. I sometimes see people who spend a lot on tuition one year and then nothing the next year. If your daughter is in seminary, you want your final payment to be made in 2007, so that you get tax benefits for 2007 as well. Paying all of it in 2006 could result in a loss of $1,500 on your 2007 tax return.

You can establish a Coverdell (educational) IRA for children, and the interest earned will not be taxed. These funds can be used for grade school as well. However it is only the interest that is tax free, not the funds you put into the account.

A parent can set up a savings account for college for their children, called a section 529 plan. Here in Maryland it is handled by T. Rowe Price 1-888-4MD-GRAD (1-888-463-4723). See the web site www.collegesavingsmd.org These funds can be used for tuition, books, supplies, and even room and board. The advantage of these plans is that there is a tax deduction for up to $5,000 per child on the State of Maryland return. Get the details before you jump in.

Pensions

Putting money into pensions is one of the most popular tax saving devices. If you have a pension plan at work, it is important to participate. If the employer is matching your contribution, then not participating is practically a sin. For those without pension plans, you can still contribute $4,000 (per spouse) to your own fund, called an IRA. If you are 50 or older, that increases to $5,000.You have until April 15, 2007 to pay into your IRA, and it will still count for 2006. Only one spouse has to work to enable both spouses to contribute to an IRA. In addition, there are two kinds of IRAs. The new kind is called a Roth IRA. Deciding which is better for you will require some calculating and forecasting.

Children

The simplest of all deductions is for your children. Each family member provides a deduction of $3,300. You can deduct other relatives in certain situations. In addition, you get a $1,000 reduction in taxes for each child under 17. This is a full $1,000 in savings – a “tax credit” not a tax deduction. You can deduct grandchildren if you support them, but – and this is a big but – they have to live with you. This is a new law, and there are issues that are subject to interpretation, some of them hairsplitting. When parents are divorced or when children live with other relatives, you have to read the rules carefully.

Miscellaneous Deductions

There are miscellaneous deductions. They include tax preparation fees, investing advice, job hunting (including resumé prep), work travel, work clothes and supplies, education needed for work, union dues, IRA custodial fees, and, possibly, home office expenses for those who have to work at home. These are all totaled and are deductible to the extent that they exceed two percent of your total income.

Some employees have to spend money on job-related expenses. These expenses provide a larger savings if deducted by the employer. An important strategy is to reduce your salary and create an expense account. For example, if your compensation is $50,000 per year, out of which you, the employee, have to spend $2,000 on expenses, a good approach would be to negotiate for $48,000 in wages and $2,000 for expenses. Make sure you save all receipts and submit them to your employer. This will result in reducing your taxable income from $50,000 to $48,000. The same approach is good for health insurance premiums.

Potpourri

Certain deductions will not help those who are paying the alternative minimum tax. This parallel tax system limits deductions for various items, including children and state income taxes. This alternative tax can hit hard with a big surprise.

You can deduct up to $2,500 in student loan interest and up to $6,000 in child care expenses, and even expenses for moving if needed for a job change. Time your payments for maximum savings. For example, let’s say that a couple will incur $7,000 in childcare expenses in one year and $5,000 the next. For the first year, you will not get a benefit from $1,000 of your payments. It would be advantageous to delay paying $1,000 to year two in order that you will be able to claim the two-year total of $12,000.

If you have sold stocks for a profit, you should consider also selling the losers you are holding, since the losses will count against the gains. You can buy them back but must wait 30 days to do so.

If you are a low earner with children, you can receive the earned income credit. Make sure your income from investments is below $2,800, or you will be completely ineligible.

If you are near a “cliff,” some creative ideas can help. A cliff is when your income goes up a little and your deductions really drop off. For example, if you earn under $160,000, you can deduct $2,000 for college education. If you earn over that amount, then you cannot. If you put one dollar in an IRA, you will be back under the limit and you will save $800 on income taxes. Not bad for a dollar.

Another example involves the credit for retirement savings. A couple earning $32,000 could save $749 by putting $1,000 into an IRA. That means that you put $1,000 into your retirement account and it only costs you $251 out of pocket.

Social security benefits are tax free – if your income is on the low side. Don’t push it up by selling stocks or making IRA withdrawals. These can have a snowball tax effect!

Some good news: If you sell your house for a profit, the first $500,000 in profit is tax-free. In addition, a new energy bill took effect in 2006, which provides tax credits for home energy savings, like new windows, and also provides savings if you purchase a hybrid car.

If you have money in a foreign bank account overseas, it has to be reported. If you don’t, there are some very, very strict rules – that is, five years in jail and a $250,000 fine.

Let me stress that all of the above items come with rules, details, and limitations. It is important that you be thorough and get good advice. Don’t assume anything on your own. For instance, I have seen people who bought a house believing that they would save a lot on taxes, only to discover that the savings were smaller than they assumed. But with good planning, you can hopefully effectively implement these suggestions and save on your taxes.

Eli Pollock is a CPA in Baltimore. He can be reached at elipollock2@yahoo.com

© Where What When – 2007

Top

Article List - February 2007