With April 15 looming, I thought it might be useful to review some things that are easy to overlook, especially since, as the Financial Planning Association points out, the 2001 Tax Relief Act created 441 tax changes. (The "Relief" part refers to the reduction in tax rates this legislation authorized, not to any reduction in the complexity of our tax code!)
According to a report by the General Accounting Office (the financial arm of Congress) last year, more American taxpayers are over-paying their taxes, not the opposite. In fact, the GAO says the typical person pays $400 more income tax than required.
Are we doing this out of the goodness of our hearts? Or perhaps we think the bureaucrats in Washington do a better job of spending out money than we do? I doubt it. If I had to guess, I'd say it's not intentional. I figure we either don't know how to take full advantage of the tax code or else, in the mad rush to file by April 15, we get careless and simply overlook legitimate deductions.
$400 bucks is nothing to sneeze at. So why not peruse the list below? It includes many of the deductions and tax credits that H&R Block says folks typically overlook.
Give Yourself Credit Where Credit Is Due
There are a number of special tax breaks for families, especially those with children. Credits are more valuable than deductions because they don't just reduce your income, they actually reduce your tax bill on a dollar-for-dollar basis. All are aimed at helping middle and lower-income families, but the income limits are different for each.
For starters, there's the Earned Income Tax Credit, which can potentially cut your tax bill by thousands of dollars. Mark Luscomb is Principal Tax Analyst for CCH, a leading provider of business information and software. He says, as the name implies, "earned income" includes income you receive because of a job: wages, tips, union strike benefits,or net self-employment income. It does not include dividends, interest, welfare benefits, pension or annuity income, Social Security, workers compensation or unemployment compensation.
Depending upon their income, Luscomb says a married couple that files jointly and has two kids can get a tax credit of up to $4,140. To find out if you qualify, take the time to fill in the worksheet inside the IRS 1040 instruction booklet (p.47).
The good news is a lot of families who didn't qualify in previous years, now do. That's because the "marriage penalty" that was built into the calculation has been reduced. The income limits for joint filers have been increased.
For a couple with two children, the credit is phased out once your earned income hits $34,178. The lower your income, the larger your credit. Furthermore, you may be eligible for the credit whether or not you have children. And, this is a special kind of credit which falls under the heading of "refundable." This means if you qualify, you can collect a check from the government even if you don't owe any income tax!
There's also the Child Tax Credit which, like the Earned Income Tax Credit, is generally "refundable." (That is, you can get a refund even if you don't owe any tax.) For the 2002 tax year, this amounts to a maximum of $600 per child, depending upon your income. The more children you have, the bigger your credit.
According to CCH, couples who file jointly and who have one child lose this credit once their "Modified" Adjusted Gross Income (MAGI*) exceeds $121,000. The phaseout occurs at $133,000 if you have two children. If you're a single parent with one child, you lose the Child Tax Credit when your MAGI exceeds $86,000. If you've got two kids, the income limit is $98,000.
Dependant Care Tax Credit
This one allows you a credit to offset the cost of day-care. While it's primarily designed for parents who work and have to pay for childcare, it applies to any "dependant" who needs supervised care while the taxpayer is at the office. That would include the cost of adult day-care in the case of children who are taking care of a parent or other relative.
By the way, Luscomb points out that "day-care" includes any paid supervision necessary to allow the taxpayer to continue to work -- from the babysitter to summer camp, provided it is not an "overnight" camp.
Keep in mind that you'll need Form 2441, which requires you to provide the tax ID number or Social Security number of any daycare providers you claim for this expense. Gathering this information can be a hassle if you wait until tax-filing deadline.
Parents with children attending college can take some of the sting out of the expense by using the Hope or Lifetime Learning Tax Credits, which can lop a thousand dollars or more off your tax bill.
While the income limits for eligibility are different than those for other types of credits, they, too, are phased out. For single parents, this occurs when your Adjusted Gross Income ranges from $41,000-51,000. The phase-out for couples is when their income hits $83,000-103,000.
The Hope Education Credit applies to the first two years of post- high school education costs. You get a 100% credit on the first $1,000 in expenses and up to $500 more for the next $1,000. Maximum tax credit: $1,500.
The Lifetime Learning Credit applies to expenses incurred for the third and fourth years of college as well as graduate school. This one amounts to 20% of the first $5,000 in expenses, or a maximum credit of $1,000. These higher education credits require you to attach Form #8863 to your tax return.
If You Can't Get a Credit, Look for a Deduction
If your income is too high for you to qualify for one of these credits, you might still be eligible for a break. This one comes in the form of a "deduction" that reduces your taxable income. A couple with an AGI of under $130,000 qualifies for a deduction of up to $3,000 to offset college-related costs. This is not a "per child" deduction; $3,000 is the most you get. The amount increases to $4,000 in tax years 2004 and 2005.
A "Point" About Re-Financing
With home refinancings on a tear last year, a common question concerns whether "points" paid for the new mortgage are deductible. The answer is: No. That's because points have to be amortized (spread out) over the life of the loan. However, as interest rates have collapsed, a number of people have refinanced more than once. If this includes you, the remaining value of any points on your previous mortgage (the one you just replaced), can now be deducted.
Job Hunt Deductions
Layoffs also ran high last year. Don't forget that any costs you incurred in your search for new employment are deductible. This includes things such as travel for job interviews, having a resume prepared, phone calls, etc. Unfortunately, these expenses come under the heading of "Miscellaneous Itemized Deductions," so they won't have an impact on your taxable income until they exceed 2% of your Adjusted Gross Income, or AGI.
If you had to re-locate in order to take a new job, these expenses fall under the same "miscellaneous" category. And they might not be deductible at all unless you had to move a substantial distance. See my column dated Feb. 21.
Deduct That Bad Habit
Since the government now recognizes obesity as a medical condition, if you entered a weight-loss program or joined a gym last year, you may be able to deduct the cost. This would not apply to the typical "Weight-Watchers" participant. To qualify, you need a doctor's prescription or letter of recommendation.
The same requirement -- that is, a doctor's order -- applies if you took a course to stop smoking. But to reap any benefit from these two deductions, your total out-of-pocket medical expenses have to exceed 7.5% of your AGI.
Other "Don't Overlook" Deductions
H & R Block says many taxpayers also forget they can deduct:
- Personal property taxes
- Charitable contributions
- Mortgage interest (You've got to itemize your deductions to take this, but it can really pay off.)
If you typically do your own taxes to save money, it could actually be costing you more. Consider paying someone to calculate this year's return for you. You might be pleasantly surprised. Keep in mind, you can deduct the cost of this on next year's return.
About a dozen tax preparation companies will file for you electronically if you complete a form online. If you meet the income requirement, the service will be free. (These firms have had mixed reviews, so try to select a name you're familiar with.) Check out the IRS Web site to learn more about this.
If you're due a refund and want to know if the check's in the mail, log onto the IRS site and click on "Where's my refund?" to find out the status.
Griping about taxes is practically an American pastime. But you have no right to complain if you don't take the time to make sure you're not paying more than the government requires!
*Your "Modified" Adjusted Gross Income is essentially your Adjusted Gross Income plus any foreign tax you paid last year. This might show up if you owned any "global" or "international" mutual funds.
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