Most Overlooked Tax Deductions

Every year, the IRS dutifully reports the most common blunders that taxpayers make on their returns. And every year, at or near the top of the “oops” list is forgetting to enter their Social Security number at the top of the tax form -- or making a mistake when entering those nine digits.
But think about it for a minute: Do you think that’s the most common mistake... or simply the easiest to notice?

One thing we know for sure is that the opportunity to make mistakes is almost unlimited, and missed deductions can be the most costly. About 45 million of us itemize on our 1040s -- claiming more than $1 trillion worth of deductions. That’s right: $1,000,000,000,000, a number rarely spoken out loud until Congress started tying itself up in knots trying to deal with the budget deficit and national debt.

Another 92 million taxpayers claim about $700 billion worth using standard deductions -- and some of you who take the easy way out probably shortchange yourselves. (If you turned 65 in 2011, remember that you now deserve a bigger standard deduction than the younger folks.)

Yes, friends, tax time is a dangerous time. It’s all too easy to miss a trick and pay too much. Years ago, the fellow who ran the IRS at the time told Kiplinger's Personal Finance magazine that he figured millions of taxpayers overpay their taxes every year by overlooking just one of the money-savers listed below.

State sales taxes

Although all taxpayers have a shot at this write-off, it makes sense primarily for those who live in states that do not impose an income tax. You must choose between deducting state and local income taxes or state and local sales taxes. For most citizens of income-tax states, the income tax is a bigger burden than the sales tax, so the income-tax deduction is a better deal.

The IRS has tables that show how much residents of various states can deduct, based on their income and state and local sales tax rates. But the tables aren’t the last word. If you purchased a vehicle, boat or airplane, you get to add the sales tax you paid to the amount shown in the IRS table for your state.

The same goes for any homebuilding materials you purchased. These add-on items are easy to overlook, but big-ticket items could make the sales-tax deduction a better deal even if you live in a state with an income tax. The IRS has a calculator on its Web site to help you figure the deduction.

Reinvested dividends

This isn't really a tax deduction, but it is an important subtraction that can save you a bundle. And this is the break that former IRS commissioner Fred Goldberg told Kiplinger's that a lot of taxpayers miss.

If, like most investors, your mutual fund dividends are automatically used to buy extra shares, remember that each reinvestment increases your tax basis in the fund. That, in turn, reduces the taxable capital gain (or increases the tax-saving loss) when you redeem shares. Forgetting to include the reinvested dividends in your basis results in double taxation of the dividends -- once when they are paid out and immediately reinvested in more shares and later when they’re included in the proceeds of the sale. Don’t make that costly mistake. If you’re not sure what your basis is, ask the fund for help.

Out-of-pocket charitable contributions

It’s hard to overlook the big charitable gifts you made during the year, by check or payroll deduction (check your December pay stub).

But the little things add up, too, and you can write off out-of-pocket costs incurred while doing work for a charity. For example, ingredients for casseroles you prepare for a nonprofit organization’s soup kitchen and stamps you buy for your school’s fundraising mailing count as a charitable contribution. Keep your receipts and if your contribution totals more than $250, you’ll need an acknowledgement from the charity documenting the services you provided. If you drove your car for charity in 2011, remember to deduct 14 cents per mile plus parking and tolls paid in your philanthropic journeys.

Student-loan interest paid by Mom and Dad
Generally, you can only deduct mortgage or student-loan interest if you are legally required to repay the debt. But if parents pay back a child’s student loans, the IRS treats the money as if it was given to the child, who then paid the debt. So, a child who’s not claimed as a dependent can qualify to deduct up to $2,500 of student-loan interest paid by Mom and Dad. And he or she doesn’t have to itemize to use this money-saver. Mom and Dad can’t claim the interest deduction even though they actually foot the bill since they are not liable for the debt.

Job-hunting costs

If you’re among the millions of unemployed Americans who were looking for a job in 2011, we hope you kept track of your job-search expenses... or can reconstruct them. If you’re looking for a position in the same line of work, you can deduct job-hunting costs as miscellaneous expenses if you itemize. Such expenses can be written off only to the extent that your total miscellaneous expenses exceed 2% of your adjusted gross income. Job-hunting expenses incurred while looking for your first job don’t qualify. Deductible job-search costs include, but aren’t limited to:

• Food, lodging and transportation if your search takes you away from home overnight
• Cab fares
• Employment agency fees
• Costs of printing resumes, business cards, postage, and advertising

The cost of moving for your first job

Although job-hunting expenses are not deductible when looking for your first job, moving expenses to get to that job are. And you get this write-off even if you don't itemize.

To qualify for the deduction, your first job must be at least 50 miles away from your old home. If you qualify, you can deduct the cost of getting yourself and your household goods to the new area. If you drove your own car, your mileage write-off depends on when during 2011 you moved. For moves from January 1 through the end of June, the standard mileage rate is 19 cents a mile; for moves during the second half of the year, a 23.5 cents a mile rate applies. In either case, boost your deduction by any amount you paid for parking and tolls.

Military reservists’ travel expenses

Members of the National Guard or military reserve may tap a deduction for travel expenses to drills or meetings. To qualify, you must travel more than 100 miles from home and be away from home overnight. If you qualify, you can deduct the cost of lodging and half the cost of your meals, plus an allowance for driving your own car to get to and from drills. For qualifying trips during January through June, 2011, the standard mileage rate is 51 cents a mile; for driving during the second half of the year, the rate is 55.5 cents a mile. In any event, add parking fees and tolls. And, you don’t have to itemize to get this deduction.

Deduction of Medicare premiums for the self-employed

Folks who continue to run their own businesses after qualifying for Medicare can deduct the premiums they pay for Medicare Part B and Medicare Part D and the cost of supplemental Medicare (medigap) policies. This deduction is available whether or not you itemize and is not subject the 7.5% of AGI test that applies to itemized medical expenses. One caveat: You can’t claim this deduction if you are eligible to be covered under an employer-subsidized health plan offered by your employer (if you have a job as well as your business) or your spouse’s employer.

Child-care credit

A credit is so much better than a deduction; it reduces your tax bill dollar for dollar. So missing one is even more painful than missing a deduction that simply reduces the amount of income that’s subject to tax.

You can qualify for a tax credit worth between 20% and 35% of what you pay for child care while you work. But if your boss offers a child care reimbursement account – which allows you to pay for the child care with pre-tax dollars – that might be a better deal. If you qualify for a 20% credit but are in the 25% tax bracket, for example, the reimbursement plan is the way to go. (In any case, only expenses for the care of children under age 13 count.)

You can’t double dip. Expenses paid through a plan can’t also be used to generate the tax credit. But get this: Although only $5,000 in expenses can be paid through a tax-favored reimbursement account, up to $6,000 for the care of two or more children can qualify for the credit. So, if you run the maximum through a plan at work but spend even more for work-related child care, you can claim the credit on as much as $1,000 of additional expenses. That would cut your tax bill by at least $200.

Estate tax on income in respect of a decedent

This sounds complicated, but it can save you a lot of money if you inherited an IRA from someone whose estate was big enough to be subject to the federal estate tax.

Basically, you get an income-tax deduction for the amount of estate tax paid on the IRA assets you received. Let’s say you inherited a $100,000 IRA, and the fact that the money was included in your benefactor's estate added $45,000 to the estate-tax bill. You get to deduct that $45,000 on your tax returns as you withdraw the money from the IRA. If you withdraw $50,000 in one year, for example, you get to claim a $22,500 itemized deduction on Schedule A. That would save you $6,300 in the 28% bracket.

[Source: Kiplinger]

Year-End Tax Planning Made Easy...

Compared to this time last year, discussion about immediate changes for individual income taxes is pretty quiet. No uproar this year over the Bush tax cuts ending makes end-of-year tax planning a little easier. Your tax adviser can inform taxpayers how to lower their tax liability as the year comes to an end.

"Managing financial health is like so many other things; it's not where you start, but where you finish," said Kathy Pickering, executive director of The Tax Institute at H&R Block. "The end of the year is right around the corner, but there are ways for taxpayers to take actions now that will help reduce their taxable income and tax liability."

As taxpayers are left to wonder if the 2-percent payroll tax holiday will expire Dec. 31 or whether Congress will make any tax law changes as part of a plan to reduce the federal deficit, taxpayers can make the following money-saving moves now to potentially decrease their 2011 tax bill.

Make charitable donations
Charitable functions and gift giving take center stage this time of year. It's important for taxpayers to remember for charitable donations to be tax-deductible, they must be made to qualified, tax-exempt organizations (IRS-approved nonprofit religious, educational or charitable groups), and claimed as itemized deductions on tax returns. The Salvation Army donation guide can be used to estimate the value of non-cash items.

Offset capital gains with capital losses
After the Dow Jones Industrial Average hit a 30-month high Jan. 1, it was a roller coaster ride with investments losing and gaining again and again throughout the rest of the year. Even with those market fluctuations, there is some good news:

    1.Those with a large net capital gain in 2011 could reduce their tax liability by selling stock before Dec. 31 if it would generate a loss.
    2. Capital losses don't just offset capital gains. If capital losses exceed capital gains, up to $3,000 of capital losses can be used to offset ordinary income, such as     wages.

Look to the future and maximize retirement plan contributions
Taxpayers who have not contributed the maximum to their 401(k) may consider increasing contributions for the remainder of the year; contributions are made pre-tax, which reduces taxable income and potentially the overall tax bill.

Also, taxpayers eligible to deduct IRA contributions can make traditional IRA contributions to decrease 2011 income until April 17, 2012, and thus reduce tax liability on 2011 tax returns.

Pay it forward
Those who haven't taken full advantage of the American Opportunity Credit should consider paying spring college tuition before Dec. 31 to benefit from the tax break on their 2011 returns. Also, taxpayers could pre-pay their December mortgage payment due in early January or make an additional student loan payment to claim the highest possible interest deduction (up to $2,500) on the 2011 tax return.

Go green at home and on the road
Home energy-efficiency improvements are eligible for a tax credit of 10 percent of the cost, with a $500 lifetime maximum. This includes windows and doors, insulation, roofing, HVAC and non-solar water heaters meeting specific energy guidelines. The maximum lifetime credit for external windows is $200.

Taxpayers can claim a credit for the purchase of a neighborhood vehicle (e.g., low-speed four-wheel vehicle), a conversion kit, or a plug-in electric drive vehicle, such as the Chevy Volt and the Nissan Leaf.

Claim casualty losses from disaster
Taxpayers in a federal disaster area who sustained disaster-related casualty losses (e.g., damaged or lost property) can claim their losses on a tax return for the year the disaster occurred or on the prior year's return. Your tax adviser can help you determine which year would result in the greatest tax savings.

Your Taxes May Be Going Up...

According to Bob Jennings [provided by FOXBUSINESS]:

In a recent tax planning meeting with one of our clients, we shocked them with what their income tax future looked like for 2013 if -- on the off-chance -- Congress continues to do nothing to provide a long-term permanent set of tax laws.
They had no idea what tax breaks were expiring this year and next year, and how much it would cost them personally in extra income tax. But they aren't alone, many Americans and even tax professionals aren't aware that their tax bill could rise dramatically next year.
These clients are your average American family and their situation is a good example of the law changes that will affect all of us. Here's their tax situation with a table summarizing the expiring tax laws that are scheduled to occur in 2011 and 2012.

Meet the Smiths: 26-year-olds Bill and Joan have been married for five years and have two young children. Bill earns about $65,000 a year in sales and Joan has gone back to work and earns about $35,000 annually. Bill owes quite a bit on his college student loans and will pay about $3,000 in interest on them in 2013. With Joan working again, they are paying $3,000 for year-round child care. Joan inherited some AT&T stock from her grandmother, which pays her $1,000 in dividends every year. Finally, counting home mortgage interest, they have about $20,000 in itemized deductions.
The first big change affecting the Smiths will be a combined increase in income tax rates, and a tightening of tax brackets as a result of the expiration of the Bush tax cuts. We estimate this will cost them $960 in 2013.

Bill will lose the complete deduction of his student loan interest in 2013, costing about $840. The pair's allowable deduction for child care will drop to $2,400 from $3,000, and they will also see their credit for children drop in half, costing another $1,000.

The marriage tax penalty will come roaring back to hit the Smiths in 2013, costing an estimated $500. The tax on their dividend income will go increase to $280 from $150, adding another $130. Finally, although we did not calculate the effect, without Congressional action to once again "fix" the alternative minimum tax, the Smiths could owe this ugly tax as well!

Luckily for the Smiths — but not for many Americans — other major changes for 2013, which do not personally affect them, include a phase out of itemized deductions and personal exemptions if their income starts to climb.

In summary, because of tax laws expiring this year and next, we estimate that the Smiths will owe $3,598 more in income tax in 2013 than in 2011 with no change in their income.

Major Individual Income Tax Benefits Expiring 12/31/2011:
• Personal tax credits applied against income tax no longer apply
• Higher alternative minimum tax exemptions revert back to extraordinarily-low thresholds
• $250 school teacher expense deduction ends
• Mortgage insurance premium deduction expires
• State and local sales tax deductions expire
• Tuition and related fees deduction end
• IRA to charity tax-free transfers stop
• 2% Social Security tax reduction ends

Major Individual Income Tax Benefits Expiring 12/31/2012:
• Marriage penalty equalization ends
• Dividends taxed at capital gains rates removed, taxed at regular rates now
• Capital gains low tax rates expires
• Removal of itemized deduction phase out for higher income Americans
• Removal of personal exemption phase out for higher income Americans
• Child care deduction limit of $3,000 reverts to $2,400
• Child credit reduces from $1,000 per child to $500 per child
• Low 10% tax bracket for low income Americans is eliminated
• Lower income tax rates and smaller brackets expires
• Refundable adoption credit and reduced deduction
• American Opportunity college education credit expires
• Major reduction in earned income credits and refunds
• Income tax exemption for debt forgiven on home foreclosures and repossessions
• Deduction for student loan interest ends
• Education IRA limit drops from $2,000 to $500

Bob Jennings is a CPA, EA and CFP and author of "Understanding Social Security & Medicare."

Keep Good Records Now to Reduce Tax-Time Stress

Keep Good Records Now to Reduce Tax-Time Stress 

You may not be thinking about your tax return right now, but summer is a great time to start planning for next year. Organized records not only make preparing your return easier, but may also remind you of relevant transactions, help you prepare a response if you receive an IRS notice, or substantiate items on your return if you are selected for an audit.

Here are a few things the IRS wants you to know about recordkeeping.

1. In most cases, the IRS does not require you to keep records in any special manner. Generally, you should keep any and all documents that may have an impact on your federal tax return. It’s a good idea to have a designated place for tax documents and receipts.

2. Individual taxpayers should usually keep the following records supporting items on their tax returns for at least three years:

• Bills
• Credit card and other receipts
• Invoices
• Mileage logs
• Canceled, imaged or substitute checks or any other proof of payment
• Any other records to support deductions or credits you claim on your return

You should normally keep records relating to property until at least three years after you sell or otherwise dispose of the property. Examples include:

• A home purchase or improvement
• Stocks and other investments
• Individual Retirement Arrangement transactions
• Rental property records

3. If you are a small business owner, you must keep all your employment tax records for at least four years after the tax becomes due or is paid, whichever is later. Examples of important documents business owners should keep Include:

• Gross receipts: Cash register tapes, bank deposit slips, receipt books, invoices, credit card charge slips and Forms 1099-MISC
• Proof of purchases: Canceled checks, cash register tape receipts, credit card sales slips and invoices
• Expense documents: Canceled checks, cash register tapes, account statements, credit card sales slips, invoices and petty cash slips for small cash payments
• Documents to verify your assets: Purchase and sales invoices, real estate closing statements and canceled checks

For more information about recordkeeping, check out IRS Publication 552, Recordkeeping for Individuals, Publication 583, Starting a Business and Keeping Records, and Publication 463, Travel, Entertainment, Gift, and Car Expenses. These publications are available at www.IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Rising Impact of Stealth Taxes

Congressional gridlock over whether to cut or raise income taxes is obscuring a different threat to six-figure earners: a host of stealth taxes implemented in the name of deficit reduction. Many of the provisions, as with the dreaded alternative minimum tax, have never been adjusted for inflation. As a result, they have morphed into tax traps for upper-middle-income earners. Here are three of the most glaring examples.

Two of the new stealth taxes were created by last year's landmark health care reform bill. First, the Medicare payroll tax is going up. The tax is now 2.9% on all wages; employers and employees each pay 1.45%. Starting in 2013, individuals making more than $200,000 (and couples making more than $250,000) will have to kick in an additional 0.9% on wages above that amount.
A second, much heftier increase also takes effect in 2013, in the form of an unprecedented new 3.8% Medicare tax on investment income. It will strike filers whose "modified adjusted gross income" -- roughly speaking, wages plus investment income -- tops $200,000 for individuals or $250,000 for couples. (The tax will apply to whichever is less: investment income or the amount by which modified adjusted gross income exceeds the income threshold.) Investment income will include taxable capital gains, dividends, interest income, annuities, royalties, and rents. The thresholds for both of the new Medicare taxes will not be indexed for inflation. So they'll snag an increasing number of taxpayers over time.

Finally there's the taxation of Social Security benefits. In 1984, when the Social Security system faced a funding crisis, Congress enacted a law to make the wealthiest recipients pay income taxes on their benefits. Specifically, up to 50% of Social Security benefits became taxable when half of these benefits, plus a retiree's other income -- including retirement plan payouts and investment income -- exceeded $25,000 a year ($32,000 for couples). Back then, only about 10% of retirees had incomes that topped that level. In 1994 a second layer of tax was put in place: 85% of your Social Security benefits became taxable if half of your Social Security benefit plus your "other" income topped $34,000, or $44,000 as a couple.

Once again, none of those crucial thresholds were indexed to inflation; today the Social Security tax still kicks in at $25,000. As a result, about a third of retirees are now paying federal income tax on their Social Security benefits. A decade from now, an estimated 45% will owe the tax.
Don't expect relief from the government on any of those stealth taxes. Your best bet is to generate as much income as possible from sources that don't trigger them. One way to accomplish that is to put your retirement savings into a Roth IRA or Roth 401(k), where contributions are made with after-tax dollars, and all future investment gains and withdrawals are tax-free. At the end of the day, you may never be able to shield yourself completely from stealth taxes. But you can at least minimize the bite.

[Source: Janice Revell in Fortune Magazine]

Eight Tips for Taxpayers Who Receive an IRS Notice

Eight Tips for Taxpayers Who Receive an IRS Notice 

Every year the Internal Revenue Service sends millions of letters and notices to taxpayers, but that doesn’t mean you need to worry. Here are eight things every taxpayer should know about IRS notices – just in case one shows up in your mailbox.

1. Don’t panic. Many of these letters can be dealt with simply and painlessly.
2. There are number of reasons the IRS sends notices to taxpayers. The notice may request payment of taxes, notify you of a change to your account or request additional information. The notice you receive normally covers a very specific issue about your account or tax return.
3. Each letter and notice offers specific instructions on what you need to do to satisfy the inquiry.
4. If you receive a correction notice, you should review the correspondence and compare it with the information on your return.
5. If you agree with the correction to your account, usually no reply is necessary unless a payment is due.
6. If you do not agree with the correction the IRS made, it is important that you respond as requested. Write to explain why you disagree. Include any documents and information you wish the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the lower left part of the notice. Allow at least 30 days for a response.
7. Most correspondence can be handled without calling or visiting an IRS office. However, if you have questions, call the telephone number in the upper right corner of the notice. Have a copy of your tax return and the correspondence available when you call.
8. It’s important that you keep copies of any correspondence with your records.

For more information about IRS notices and bills, see Publication 594, The IRS Collection Process. Information about penalties and interest charges is available in Publication 17, Your Federal Income Tax for Individuals.

Eighteen Ways to Get Tax Free Income

A two-year tax cut extension? That compromise between Congress and the president was nice, but you can do better. You can get a 0% tax rate on many kinds of income.
It’s pretty hard to avoid paying taxes on your paycheck. But there are all kinds of ways to pick up money that the Internal Revenue Service can’t touch—such as from inheritances, fringe benefits, airline miles and rebates.
Remodel
Sweat equity is tax free, if you know what you’re doing. Buy a fixer-upper and live in it for at least two years. If you’re talented at painting and carpentry, you’ll make a nice profit when you sell, and you can take advantage of the $500,000 exemption on capital gains for your principal home. For singles, the exemption is $250,000.
Moonlight
The first couple of thousand dollars a year you pocket from outside jobs is likely to be tax free. Reason: You probably have all sorts of expenses, such as for continuing education, a home office, professional association dues and a computer, that you can write off against freelance income.  Since these are expenses that you usually can’t otherwise deduct, your early freelance dollars are pure gravy.
Get reimbursed
Ask your employer to cover more of your work expenses (like those professional dues) in lieu of giving you a raise. So long as your expenses are documented, the reimbursement is not income to you. Your company will save on payroll taxes, too. But don’t mess with country-club dues; these aren’t deductible.
Earn airline miles
If you pick these up by taking deductible business trips and then use them on a vacation, they should, in principle, be taxable. But they aren’t. This is a political hot potato, and the IRS gives frequent fliers a free ride.
Take the bus
You can pull up to $230 a month out of your paycheck, pretax, to cover mass transit, vanpooling and commuter parking.
Hustle rebates
Those grocery-store coupons may not be worth your time. But the $50 rebates you get on phones and computers definitely are. As a reduction in the cost of an item for personal use, a rebate is not considered taxable income.
Be nice to Uncle Joe
If he leaves you money in his will, you don’t owe a dime of income tax on it.
Pay off credit cards
Where else are you going to earn 18% on your money? To top it off, this 18% dividend is totally tax free.
Rent your house out
If you rent out a house for 14 or fewer days, the income is scot-free. Not only that, you don’t have to prorate or reduce your otherwise deductible mortgage interest and property taxes. Unlike the remodeling gambit, this one works on vacation homes, too.
House sit
You get a rent-free place to stay by keeping watch in a house whose owner is off on an overseas assignment. The $20,000 you save on rent is like getting a $20,000 raise, except that it’s tax free.
Get a cash-back card
The best of the breed give you 2% back, and the rebate is tax free if the charge was for a personal purchase. For more, read this.

Be a good neighbor
You babysit the neighbor’s children, and in return he paints your garage. You’re both earning money, in effect, by providing services. While the IRS can assess taxes on people in barter exchanges that involve account books and transactions with strangers, there’s no way to levy a tax on helping out a friend.
Have a charity tag sale
You were going to send $500 to Doctors Without Borders anyway. Do it this way. Have a tag sale, unloading tchotchkes from your attic, and advertise that 100% of the proceeds will go to the worthy cause. If you haul in $490, that sum becomes, in effect, tax free income for your day of labor.
Own a house
You get a dividend in the form of not having to pay rent. This dividend is tax free. It has nothing to do with mortgage interest. You have a tax free dividend even if you pay cash for the home.
Take up plumbing
…or electricity or carpentry or car repair. When you work overtime at your company in order to have the bucks to pay pros to do various chores, you owe taxes. But when you hire yourself to do chores, there’s no income to tax.
Set up an HSA
In combination with a high-deductible health insurance policy for your family, you set up a health savings account and put $6,150 a year ($7,150 if you’re over 55) of tax-deductible money into it.
You can use the bucks right away to pay uncovered medical costs. But you don’t have to eat into the account in this fashion. Instead, pay your doctor bills out of your checking account. Then let the $6,150 compound tax free until you are retired.
If you use the HSA later in life for medical costs (which will be considerable; Medicare is going bankrupt) then both the principal and the earnings come out tax free.
Hire the kids
If you own your own business, make your teenage children into employees. If the pay is reasonable for what they do, you can deduct the payroll, lowering your high-bracket net income. On the receiving end a child laborer owes no federal income tax on earned income below the $5,700 standard deduction.
If the kid also has investment income, the exact value of the freebie gets more complicated. But, in round numbers, $5,000 of summer job income is going to be free of income tax.
You will, however, have to cough up for Social Security and Medicare taxes.
Get paid in lodging
If part of your compensation is a free apartment, and if your presence on the premises has a business purpose, then you don’t owe tax on the benefit. This works for hotel managers, apartment supes and roustabouts on offshore rigs.
Clergy members get a better deal: Their housing allowance is tax-free even if paid in cash.

(Source: Forbes Magazine)

Can You Trust Your Tax Preparer?

On January 31st, Jackson Hewitt, the second largest tax prep firm in the country, sued No. 1 H&R Block over Block's claims it can find errors in two-thirds of tax returns prepared by "other" tax preparers. Jackson Hewitt obviously resents the insinuation. Whatever the outcome of the case, though, it's safe to say the entire industry isn't exactly a bastion of reliability. The Inspector General of the U.S. Treasury found a 61 percent error rate in prepared tax returns.
But if you're looking to the Internal Revenue Service to provide some supervision and oversight of tax preparers, well, that's not going to happen until at least 2014. Last year, the IRS announced a new program that requires the estimated 1 million U.S. tax preparers to register with the IRS, be tested for competency, and agree to ongoing continuing ed classes. All good news. Yet yesterday the IRS released a report saying it needs a few more years to get its new tax preparer review system up and running.
That leaves the estimated 83 million Americans who hire a tax preparer to vet them on their own. Given the high error rate, that's no small job. And even once the IRS program is in place, it's not going to magically catch every schnook and rube. Keep in mind that any error the IRS finds that raises your tax bill is your legal responsibility. You can negotiate the matter with your tax preparer, but from the IRS's vantage point, you're the one who is on the hook. That's why it's important to do your homework.
A few of these red flags are obvious, but the IRS suggests you be especially wary of tax preparers that do any of the following:
• Guarantee you'll get a refund.
• Get paid by charging you a percentage of the refund.
• Don't ask you for supporting documents, such as your W-2 or 1099s.
• Offer to create documents to support false or exaggerated deductions.
• Ask you to sign a blank form that they will fill in later.
• Refuse to give you a photocopy of your return.
• Refuse to list his or her Social Security number and sign the return, as required by law.
• Aren't available year-round. (Some preparers set up shop during the mad tax rush and then sort of disappear.)
Another red flag is if a tax preparer tries to push his or her bona fides by telling you they're already part of the IRS's new oversight system. The fact is, some preparers have already been assigned their official tax-prep ID number, but that's all that has happened. No tests have been given, no education provided. Any preparer using this as a selling point is being disingenuous.
How to Find a Top-Notch Tax Pro
If you've got a somewhat complicated tax story, hiring a solid Certified Public Accountant can be a smart move. But otherwise, using a tax software program can get the job done and removes the risk of an unscrupulous preparer steering you into a too-aggressive tax dodge.
If you're going to work with a human being, asking friends and colleagues for references is always a good place to start, but a little more legwork wouldn't hurt, either. You can check with your state board of accountancy to see if there are any known problems with a CPA you are considering. And taking a quick spin through the Better Business Bureau website will let you see if there are any complaints registered against him or her. It also can't hurt to run a check on someone you're already working with.
When you're interviewing a tax preparer, ask how many times his or her clients have been audited -- by federal and state -- and how many times the client has wound up owing more upon review. That's a fair question, and no pro should take umbrage. And while you're at it, ask how errors and audits are handled. Are you charged more for the extra time? Will the preparer cover any extra money owed? And again, it's helpful to clarify this even if you're already working with someone.
Finally, cross your fingers that maybe, just maybe, Washington will get serious about overhauling the individual tax code. President Obama gave it a passing mention in his State of the Union address. The reality is that the incredible complexity of the code is a Petri dish for errors and outright fraud. And it all comes at a huge cost: We spend $163 billion a year on tax prep.

(Source: CNN Money Watch)

It Pays to Be Average...

Taxpayers who stand out tend to draw the attention of Internal Revenue Service auditors. Claim too much in interest, health expenses or charitable deductions, and it's like waving that proverbial red flag in front of the tax man.
The agency knows, to the dollar, how much people at your income level typically write off for these categories. When you claim a higher-than-average amount, it doesn't necessarily mean that you're cheating, but it raises questions. You could be claiming a much higher medical deduction because your family had a horrible year, healthwise. And that over-the-top charitable write-off could just signify your extreme generosity.
But it might also signal that you're not claiming enough income to cover the vast amount you say you're paying in deductible expenses, so a really out-of-whack Schedule A (where deductions are claimed) can cause problems.
None of that has stopped Americans from making the most of their deductions, according to CCH, a tax research firm. In 2007, the last year for which these statistics are available, the average return claimed $26,268 in itemized deductions, up 4.5 percent from 2006. For example, returns claiming between $50,000 and $100,000 in income claimed, on average, $7,102 in medical expenses; $6,050 in state and local taxes; $10,659 in interest and $2,693 in charitable deductions, according to the firm, which crunched IRS data to compile these figures.
Being way above average doesn't mean you should leave cash on the table, it just means that you should be extra careful about documenting the deductions and income that you have. And if you're way under average, you might go back over your credit card statements and checking account records to make sure you're not forgetting items you should be claiming. Check out the table below to see what 2007 deductions looked like in your tax bracket.

Average Itemized Deductions
Adjusted Gross Income	Medical Expenses	Taxes	Interest	Charitable Contributions
$15,000 to $30,000	$7,074	$3,147	$9,245	$2,189
$30,000 to $50,000	$6,153	$3,830	$9,055	$2,189
$50,000 to $100,000	$7,102	$6,050	$10,659	$2,693
$100,000 to $200,000	$9,269	$10,798	$13,734	$3,757
$200,000 to $250,000	$21,554	$18,164	$18,570	$5,895
$250,000 or more	$37,143	$50,267	$27,865	$20,930
*Source: CCH, 2011

Most Overlooked Tax Deductions

Years ago, the fellow who was running the IRS at the time told Kiplinger's Personal Finance magazine that he figured millions of taxpayers overpaid their taxes every year by overlooking just one of the money-savers listed here.  Cut your tax bill to the bone by claiming all the breaks you deserve -- including some you may have forgotten or never even knew about.

State Sales Taxes
This write-off makes sense primarily for those who live in states that do not impose an income tax. You must choose between deducting state and local income taxes or state and local sales taxes. For most citizens of income-tax states, the income-tax deduction is a better deal.
If you purchased a vehicle, boat, airplane or even home-building materials, you get to add the state sales tax you paid to the amount shown in IRS tables for your state, to the extent the sales tax rate you paid doesn't exceed the state's general sales tax rate.

Reinvested Dividends
This is the break former IRS Commissioner Fred Goldberg told Kiplinger's that a lot of taxpayers miss.
If, like most investors, you have mutual-fund dividends automatically invested in extra shares, remember that each reinvestment increases your "tax basis" in the fund. That, in turn, reduces the taxable capital gain when you redeem shares.
Forgetting to include the reinvested dividends in your basis -- which you subtract from the sale proceeds to pinpoint your gain -- means overpaying your tax.

Out-of-Pocket Charitable Deductions
You can write off out-of-pocket costs incurred while doing good works.
The money you spend on ingredients for casseroles you prepared for a soup kitchen, for example, or on stamps you buy for your school's fund-raiser counts as a charitable contribution.
Also, if you drove your car for charity in 2010, remember to deduct 14 cents per mile.

Student-Loan Interest Paid By Mom and Dad
Generally, you can only deduct mortgage or student-loan interest if you are legally required to repay the debt. But if parents pay back a child's student loan, the IRS treats it as though the money was given to the child, who then paid the debt.
A child who's not claimed as a dependent can qualify to deduct up to $2,500 of student-loan interest paid by Mom and Dad. And he or she doesn't have to itemize to use this money-saver.

Job-Hunting Costs
If you're among the millions of unemployed Americans who were looking for a job in 2010, keep track of your job-search expenses. If you're looking for a position in the same line of work, you can deduct job-hunting costs as miscellaneous expenses if you itemize, but only to the extent that the total of your total miscellaneous itemized deductions exceed 2% of your adjusted gross income. Job-hunting expenses incurred while looking for your first job don't qualify.
Deductible job-search costs include, but aren't limited to:
• Food, lodging and transportation if your search takes you away from home overnight
• Cab fares
• Employment agency fees
• Costs of printing resumes, business cards, postage, and advertising

Moving Expenses to Take Your First Job
As we just mentioned, job-hunting expenses incurred while looking for your first job are not deductible. But, moving expenses to get to that position are. And you get this write-off even if you don't itemize.
To qualify for the deduction, your first job must be at least 50 miles away from your old home. If you qualify, you can deduct the cost of getting yourself and your household goods to the new area, including 16 1/2 cents per mile for driving your own vehicle for a 2010 move, plus parking fees and tolls.

Military Reservists' Travel Expenses
Members of the National Guard or military reserve may tap a deduction for travel expenses to drills or meetings. To qualify, you must travel more than 100 miles from home and be away from home overnight.
If you qualify, you can deduct the cost of lodging and half the cost of your meals, plus 55 cents per mile for driving your own car to get to and from 2010 drills. In any event, add parking fees or tolls. You get this deduction regardless of whether you itemize.

Health Insurance Deduction to Reduce Self-Employment Tax
Business owners have always been allowed to deduct health insurance premiums for themselves and their family in computing adjusted gross income on the front page of Form 1040. For 2010, they can also deduct the cost of those health insurance premiums in calculating self-employment tax on Schedule SE.
The IRS has hidden this write-off on line 3 of Schedule SE. On that line, you are told to add your self-employment income from lines 1 and 2, subtract the amount claimed on line 29 of Form 1040 (your health insurance premiums) and enter the net amount on line 3.

Child-Care Credit
It's easy to overlook the child-care credit if you pay your child-care bills through a reimbursement account at work. Although only $5,000 of such expenses can be paid through a tax-favored reimbursement account, up to $6,000 (for the care of two or more children) can qualify for the credit.
So, if you run the maximum allowed by your work plan, you can claim the credit on as much as $1,000 of additional expenses you pay for work-related child care. That would cut your tax bill by at least $200.

Estate Tax on Income in Respect of a Decedent
This sounds complicated, but it can save you a lot of money if you inherited an IRA from someone whose estate was big enough to be subject to the federal estate tax. Basically, you get an income-tax deduction for the amount of estate tax paid on the IRA assets you received. Let's say you inherited a $100,000 IRA, and the fact that the money was included in your benefactor's estate added $45,000 to the estate-tax bill.
You get to deduct that $45,000 on your tax returns as you withdraw the money from the IRA. If you withdraw $50,000 in one year, for example, you get to claim a $22,500 itemized deduction on Schedule A. That would save you $6,300 in the 28% bracket.

State Tax Paid Last Spring
Did you owe tax when you filed your 2009 state tax return in the spring of 2010? Then, for goodness sake, remember to include that amount with your state-tax deduction on your 2010 return, along with state income taxes withheld from your paychecks or paid via quarterly estimated payments.

Refinancing Points
When you buy a house, you get to deduct points paid to get your mortgage in one fell swoop. When you refinance a mortgage, though, you have to deduct the points over the life of the loan. That means you can deduct 1/30th of the points a year if it's a 30-year mortgage -- that's $33 a year for each $1,000 of points you paid. Not much, maybe, but don't throw it away.
Even more important, in the year you pay off the loan -- because you sell the house or refinance again -- you get to deduct all as-yet-undeducted points. There's one exception to this sweet rule: If you refinance a refinanced loan with the same lender, you add the points paid on the latest deal to the leftovers from the previous refinancing ... and deduct the amount gradually over the life of the new loan.

Jury Pay Paid to Employer
Many employers continue to pay employees' full salary while they serve on jury duty, and some require the employees to turn over their jury fees to the company coffers. The only problem is that the IRS demands that you report those fees as taxable income. To even things out, you get to deduct the amount paid to your employer.
But how do you do it? There's no line on Form 1040 labeled "jury fees." Instead the write-off goes on line 36, which purports to be for simply totaling up the deductions that get their own lines. Add your jury fees to the total of your other write-offs, and write "jury pay" on the dotted line.

American Opportunity Credit
This tax credit, which has been extended through 2012, is available for up to $2,500 of college tuition and related expenses paid during the year. The full credit is available to individuals whose modified adjusted gross income is $80,000 or less ($160,000 or less for married couples filing a joint return). The credit is phased out for taxpayers with incomes above those levels. This credit is juicier than the old Hope credit -- it has higher income limits and bigger tax breaks, and it covers all four years of college. And if the credit exceeds your tax liability (regular and AMT), it is partially refundable.

Making Work Pay Credit
You've probably been enjoying the fruits of this credit via reduced payroll tax withholding throughout the year. But to lock in your savings -- by reducing your tax bill by $400 if you're single or $800 if you're married and file a joint return -- you'll need to actually claim the credit on your 2010 tax return -- and you'll use Schedule M to do so.
The credit is equal to 6.2% of your earned income, capped at $400 or $800. For single filers, it starts phasing out at $75,000 of adjusted gross income and dries up at $95,000. The phase-out zone for couples is $150,000 to $190,000.

Credit For Energy-Saving Home Improvements
You can claim a tax credit equal to 30% of the cost of energy-saving home improvements up to a maximum of $1,500. This cap applies to both 2009 and 2010 combined, so if you claimed the maximum $1,500 in 2009, you don't get another crack at it for 2010. The credit applies to biomass fuel stoves, qualifying skylights, windows and outside doors, and high-efficiency furnaces, water heaters and central air conditioners.
For 2011, this credit goes back to pre-2009 limits (for example, $500 maximum credit for all years with no more than $200 for windows).
There's also no dollar limit on the separate credit for homeowners who install qualified residential alternative energy equipment, such as solar hot water heaters, geothermal heat pumps and wind turbines. Your credit can be 30% of the total cost (including labor) of such systems installed through 2016.

Additional Bonus Depreciation
As part of the year-end law extending the Bush tax cuts, 50% first-year bonus depreciation was extended and expanded retroactively to let filers write off 100% of the cost of qualified assets placed in service between September 9, 2010 and December 31, 2011. In effect, filers get to claim unlimited expensing. This break applies only to new assets with recovery periods of 20 years or less, such as computers, machinery, equipment, land improvements and farm buildings. So don't miss out on this big tax benefit if you placed business assets in service late in 2010.

Break on the Sale of Demutualized Stock
We're talking about stock that a life-insurance policyholder receives when an insurer switches from being a mutual company owned by policyholders to a stock company owned by stockholders. The IRS's long-standing position is that such stock has no "tax basis" so that, when the shares are sold, the taxpayer owes tax on 100% of the proceeds of the sale. But after a long legal struggle, a federal court ruled that the IRS is wrong. The court didn't say what the basis of the stock is, but many experts think it's whatever the shares were worth when they were distributed to policyholders.
If you sold stock in 2010 that you received in a demutualization, be sure to claim a basis to hold down your tax bill.

Home-Buyer Credit
We put this last because it's hard to imagine any taxpayer missing this big a tax break. But some deadlines were extended and you don't want to miss out if you qualify for the credit. First-time home buyers and longtime homeowners qualify for this break in 2010 as long as they either closed a home sale by April 30, 2010 or entered into a binding contract to purchase a home by April 30th and closed on the deal no later than September 30th. The credit is $8,000 for first-time home buyers (someone who didn't own a home in the three years leading up to the purchase of a new home) and $6,500 for longtime homeowners (those who continuously owned a home for at least five of the eight years leading up to the purchase of a new home).
The credit gradually disappears and is phased out for taxpayers with adjusted gross incomes between $125,000 and $145,000 (for singles) and $225,000 and $245,000 (for married couples who file jointly).
Also, if you purchased a home in 2010 and want your credit quicker, you are allowed to claim it early by filing an amended 2009 tax return.

(Source: Kiplinger)

Five Best Ways to Avoid Unwanted IRS Attention...

http://financiallyfit.yahoo.com/finance/video-top-5-tips-for-filing-a-clean-tax-return-24029633

How to Avoid a Tax Audit...

April 15th is right around the corner and we all know what that means: tax time. For many, the worst fear about taxes isn’t filling out the paperwork or paying what’s owed, it’s being audited by the IRS. So what can you do to stay off the radar? As you gather paperwork and prepare to file your personal or business taxes, keep these tips in mind to help you avoid an IRS audit.

Beware Disgruntled Employees, Exes & Neighbors
The IRS has been getting a lot of press about their whistle-blower program for good reason. It works. Informants are paid a minimum of 15% and a maximum of 30% of the amount owed by businesses or individuals. Bill Raabe, a tax expert at Ohio State University is quoted in CNNMoney as saying, “You’ll have spouses—or ex-spouses probably, as well as ex-employees turning in their employers.”
In 2008 alone, the IRS received 476 tips identifying 1,246 questionable taxpayers, according to the article. “Many claims are for substantially more than the $2 million threshold and involve business or wealthy individuals,” IRS Whistleblower Office director Stephen Whitlock is quoted as saying.
Your best bet? Keep your taxes legitimate and your tax information private.
Deductions
In general, you probably want to avoid deducting anything out of the ordinary, like claiming use of your entire house as a home office. And while they may feel like family, pets are not legal dependants as each dependant must have a valid Social Security Number.
Another way to avoid an audit is ensuring you don’t deduct the same expense on different forms. And if there is a deduction that you think may stand out, such as a large amount spent on building repairs, offer an explanation if possible.
Prove It
In terms of paperwork and documentation, do you have a record of everything? On top of IRS forms and summary reports, you’ll need to substantiate deductions. This means receipts, copies of checks or other documentation that proves a deduction was a business expense.
For business expenses, the magic dollar amount is $75. If the expense is less than $75, a simple notation somewhere will be enough substantiation. However, if the expense is higher than $75, a more detailed piece of evidence is needed, such as a receipt.
Do the Math
Check your math and cross reference numbers. Does the amount of income on one form match the number on another form or a supporting document? While the IRS system corrects some minor errors, providing correct numbers and calculations is up to you.
Plan Ahead
The IRS says it can audit you up to three years after filing your taxes, though Schnepper says most audits are conducted within 18 months of filing taxes. A lot can happen in that time, so think about how you can plan ahead. This may include saving all expense receipts, logging the miles you drive for business expenses, or taking a photo of the space you claim as a home office.
The Professionals
Lastly, consider the services of a tax professional. They know what they’re doing and can point out elements of your tax return that may get flagged for an audit. Plus, should you get audited you can look to them for help in putting together your case.
There is one bit of good news if you are selected for an audit--according to the IRS, this reduces your chances of being audited again the following year.

(Source: Legalzoom.com)

What's New on Your 1040...

What's New on the 2010 Form 1040

by Bill Bischoff
Monday, January 24, 2011

By now, some of you may already have your 2010 W-2 and 1099s in hand. If not, it won't be long. So it's not too soon to think about starting your 2010 Form 1040. Before you begin, there are some key changes to note. Here's what you need to know.
Due Date is April 18
Even though April 15 falls on a Friday this year, the deadline for your 2010 Form 1040 is Monday April 18. Reason: Emancipation Day is a District of Columbia holiday, and it falls on April 15. So the tax filing deadline for the whole nation is deferred to April 18 . If your return won't be ready by then, you can extend the deadline all the way out to October 17 by filing Form 4868 on or before April 18.
No More Phase-Outs for Itemized Deductions and Exemptions
For years, high-income folks have seen their write-offs for the most popular itemized deduction items (including mortgage interest, state and local income and property taxes, and charitable donations) reduced by a nasty phase-out rule. Another nasty phase-out rule reduced or eliminated personal and dependent exemption deductions. Thankfully, both phase-outs were completely repealed for 2010 as part of the Bush-era tax cuts. So you can write off the full amount of your itemized deductions and exemptions on your 2010 Form 1040 without any worries and without having to fill out phase-out worksheets to penalize yourself. More good news: the recent tax cut extension legislation repealed the phase-outs for 2011 and 2012 as well.
Liberalized Adoption Credit
For 2010, the maximum adoption credit was increased to $13,170 (up from $12,150 in 2009). In addition, the credit was made 100% refundable for the 2010 tax year (previously, it was nonrefundable). That means you'll receive a check for any leftover adoption credit after your federal income tax bill has been reduced to zero. To claim the credit, fill out Form 8839 (Qualified Adoption Expenses), and enter the credit on line 71 of Form 1040.

One-Time Break for Self-Employed Individuals
Self-employed folks can generally deduct their health insurance premiums on page 1 of Form 1040 (use line 29 for 2010). The deduction reduces their federal income tax bills, which is nice. However, the self-employed have never been allowed to deduct those premiums when calculating their self-employment tax bills on Schedule SE. Good news: for 2010 only, you can deduct health insurance premiums on line 3 of Schedule SE. So those premiums will reduce both your income tax bill and your SE tax bill. Unfortunately, this break will not be available for 2011 and beyond unless Congress extends it.
Homebuyer Credit Repayment Rules Kick In
As I explained in an earlier column, you may have to repay part or all of the credit claimed for a 2008 or 2009 home purchase with your 2010 Form 1040.
In most cases, however, only those who purchased homes in 2008 will be affected. They will generally have to repay 1/15 of the credit with the 2010 Form 1040. If this rule impacts you, fill out Form 5405 (First-Time Homebuyer Credit and Repayment of the Credit), and enter the repayment amount as an addition to your tax bill on line 59 of Form 1040.
Real Estate Tax Deduction for Non-Itemizers is Gone
For 2008 and 2009, unmarried individuals who did not itemize could write off up to $500 of state and local real property taxes by claiming an increased standard deduction. Married joint-filing couples could write off up to $1,000. This add-on standard deduction deal for real estate taxes expired at the end of 2009, and it was not reinstated for 2010.

Deductions for Sales Taxes on New Vehicle Purchases Are Gone
The 2009 Stimulus Act created a temporary write-off for non-itemizers who paid state and local sales taxes on new vehicles purchased between 2/17/09 and 12/31/09. The write-off came in the form of an additional standard deduction allowance. Similarly, itemizers were allowed to claim an extra itemized deduction for such taxes. Both breaks lapsed at the end of 2009, and they were not reinstated for 2010.
Break for Unemployment Benefits Is Gone
In 2009, the first $2,400 of unemployment benefits was federal-income-tax-free. This break was not continued for 2010. Therefore, 100% of 2010 unemployment benefits generally must be reported as income on Form 1040 (use line 19).
Your Tax Preparer Might E-File Your Return This Time
Over the last few years, Congress has made tax-law changes that place increasing pressure on professional return preparers to electronically file more and more returns. As a result, your preparer might be forced to e-file your 2010 Form 1040 even if your returns for earlier years have always been done on paper. Get used to it.

Hot Off the IRS Newswire....

IRS will start accepting returns with itemized deductions (Schedule A) on February 14th.

Protect Yourself from Your Stockbroker...

When you invest in stocks, you accept some risk. Your stocks may drop in value, shrinking your investment. That kind of risk is unavoidable, but other brokerage-related risks are not. The SIPC and FINRA can shield you from disaster.
First off, meet the Securities Investor Protection Corporation, or SIPC. When you shop for a brokerage, make sure that it's a member of the SIPC -- it should say so right on its website. SIPC-member brokerages protect the cash, stocks, and other securities they hold for their investors. If your brokerage goes belly-up and any cash or stocks you held in your account suddenly go missing, the SIPC can help. There's generally a maximum protection value of $500,000 per customer, which includes up to $250,000 in cash. Some brokerages offer additional protection -- just ask about that. Wealthy investors might want to split their assets between several brokerages, to avoid exceeding any single brokerage's SIPC protection limits.
Throughout your investing life, it's a good idea to periodically make sure that your brokerage is still an SIPC member. If it ever stops sending you statements, or does so sporadically, that's a big red flag.
Our watchdogNext up is the Financial Industry Regulatory Authority, or FINRA, the largest independent regulator of more than 4,500 brokerages and more than 630,000 registered securities representative. It writes and enforces rules that make life easier for us investors.
FINRA often imposes fines on its members for stepping out of line. It recently ordered Schwab (Nasdaq: SCHW) to pay investors more than $18 million after the broker glossed over one of its bond funds' true risks. It fined Goldman Sachs (NYSE: GS) $650,000 for not disclosing that two of its representatives were being investigated by the SEC. H&R Block (NYSE: HRB) got fined $200,000 for insufficiently supervising some sales of financial products, while Citigroup (NYSE: C) had to pay $1.5 million for supervision shortcomings related to a financial scam involving cemetery burial trusts.
In addition to penalizing misbehaving firms, FINRA also aims to educate investors, supporting financial literacy efforts and offering guidance on its website. It also resolves disputes and monitors brokers. Investors can look up brokers on its website, to see whether they have any marks against them.
Investing in just about anything carries some risks, but you can help your portfolio grow not only by looking for upside potential, but also by minimizing your downside potential.

(Source: Motley Fool)

Kids Can Save You on Income Taxes

Associated Press

Children can mean extra tax deductions and credits

By CAROLE FELDMAN , 01.18.11, 02:13 PM EST
WASHINGTON --
As any parent knows, the pitter patter of little feet - and bigger ones too - can be a drain on the wallet.
But when it comes to taxes, your children can mean extra deductions and credits.
First, for each dependent child, you can take a $3,650 personal exemption. The more children, the more exemptions you can take. Each personal exemption serves to reduce your income.
Children under age 19 can be claimed as dependents; those under 24 if they are full-time students. Children 24 or older who are full-time students can be claimed provided their income is less than $3,650. Age limits do not apply to disabled children.
If parents are divorced, only one may claim the child as a dependent. Child support is not taxable as income, although alimony is.
The child tax credit has been expanded and will impact more people, said Greg Rosica, tax partner at Ernst & Young. For parents to qualify for the credit of up to $1,000, their child must be under 17, must be claimed as a dependent on the parents' tax return and must have lived at home for more than half the year. Only U.S. citizens, nationals or legal residents are eligible. As with many other credits, this one begins phasing out at higher incomes.
If the credit exceeds the income tax owed, taxpayers may be eligible for the Additional Child Tax Credit, which is refundable. That means you may be able to get the money even if you don't owe taxes.
For the 2010 tax year, there's also an expanded credit for parents who adopt a child. Mark Steber, chief tax officer for Jackson Hewitt, called it ""larger and more lucrative" than prior adoption credits. The maximum credit is $13,170 for each child, up from $12,150 in 2009. "In general," the Internal Revenue Service says, "the credit is based on the reasonable and necessary expenses related to a legal adoption, including adoption fees, court costs, attorney's fees and travel expenses." Eligibility for the credit begins phasing out for taxpayers whose adjusted gross income exceeds $182,520.
In another change from 2009, the adoption credit is refundable. Thus, qualified people will get the money even if they have no tax liability. There's a special form that must be filled out, Form 8839. Documentation showing the adoption was completed also must be provided. That means taxpayers who want to claim the credit cannot file electronically.
Another credit available to many parents with lower incomes is the Earned Income Tax Credit. The maximum income a family can have and still qualify is now $48,362. Actual credit amounts vary, depending on income, family size and other factors. Though a family with three or more children typically qualifies for the largest amount, the average credit last year was about $2,000.
As children get older and outgrow their clothing, consider donating the items they can no longer wear to charity. If the charitable organization meets the criteria established by the IRS, the donation could translate into a tax deduction. But remember that used items usually sell for far less than new ones. Only the fair market value of the item is deductible, and the item must generally be in good condition.
For parents of older children, the American Opportunity Credit could provide some relief from the cost of higher education. The credit, in its second year as an expanded version of the Hope credit, is a maximum $2,500 of the cost for tuition and other higher education expenses. The credit can be used for the first four years of college, compared to the first two years for the Hope credit. Students must be enrolled at least half-time. "If you have multiple students that you're paying for, you get to claim the credit for each of them," said Kathy Pickering, executive director of the Tax Institute at H&R Block.
The credit, which is partially refundable, also phases out at higher incomes.
For those that don't qualify for the American Opportunity Credit, another option might be the tuition and fees deduction of up to $4,000. The deduction doesn't require someone to attend school at least half-time.
"You cannot use both for the same expenses," Pickering cautions.
The IRS advises that "though the credit will usually result in greater tax savings, taxpayers should calculate the effect of both on the tax return to see which is most beneficial - the tax credit or the deduction."
The tuition deduction was included in the tax law passed by Congress last month. Because it came so late in the year, the IRS said it needs time to update its systems. As a result, people claiming the tuition deduction will have to delay filing returns until mid-February.

Here's the Skinny...

This year's tax season will look a lot like last year's, with a few sweeteners added.
Most of the tax changes that were put in place in 2009 to spur the economy remained in effect in 2010, even though the recession was officially declared over. Among them: the Making Work Pay tax credit, which put a little extra money in the hands of 95 percent of U.S. taxpayers. Homebuyers and those who installed energy-efficient furnaces, windows and other items in their homes also could benefit, along with college students or their parents, schoolteachers and adoptive parents.
"There's really not much from a change perspective," said Greg Rosica, a tax partner ait Ernst & Young accounting firm.
But new sweeteners include elimination of the phase-out of itemized deductions and personal exemptions for higher-income taxpayers.
Low-income taxpayers benefit from a raise in income limits for the earned income tax credit. Congress in December also approved a patch for the alternative minimum tax that will protect about 20 million middle-income families from an additional tax bill of $3,900 or so.
The late action by Congress on the AMT and other provisions means that taxpayers who itemize deductions, teachers seeking a deduction for out-of-pocket expenses, and those filing for the tuition and fees deduction will have to wait until the Internal Revenue Service updates its systems before filing their returns. Terry Lemons, the IRS' senior spokesman, estimates the delay could last until mid-February. "We have to be very careful to make sure we have it right," he said.
Tax experts said the delay shouldn't affect taxpayers too much. "The rush of the tax filing season isn't until mid-February to begin with because people don't get all their information together to begin filing," Rosica said.
Taxpayers also will have a few extra days to file. Returns aren't due until April 18 because of Emancipation Day, celebrated April 15 in the District of Columbia.
Mark Steber, chief tax officer for Jackson Hewitt said taxpayers will have to be more vigilant this year because of the lateness of the changes.
As a result, this year, more than ever, is a good time to file electronically, Lemons said. "You're going to get a more accurate return," he said. "You're going to get the latest tax information."
Nearly 99 million tax returns were filed electronically last year, up 3 percent from the previous year. The total represents nearly 70 percent of returns filed.
About 77 percent of taxpayers received a refund on 2009 returns, averaging $2,994 each.
For the 2010 tax year, "economic factors might point to a slightly higher refund percentage," said Bob Meighan, vice president at TurboTax, which makes tax preparation software. He cited continued high unemployment.
Though the jobless rate remains close to 10 percent, the unemployed lost a key tax break. "All unemployment insurance is taxable this year," said Mark Luscombe, principal analyst at CCH, a tax preparation service. For the 2009 tax year, the first $2,400 of unemployment benefits had been excluded.
Another recession-battling tax break not renewed was the deduction for sales and excise taxes on the purchase of a new car. However, Congress did extend the state and local sales tax deduction, which primarily benefits those in areas without state and local income taxes.
Deductions reduce the income on which you are taxed. Credits reduce the amount of tax owed and generally are considered more advantageous to the taxpayer.
If you seek professional help on your return, make sure your tax preparer has registered as required with the IRS. Later this year, most tax preparers will have to pass an exam certifying their skills. Certified public accountants and some others are exempt.
"It's setting a standard of excellence for the industry," said Kathy Pickering of the Tax Institute at H&R Block.
All taxpayers can claim a $3,650 per person exemption for themselves, their spouse and each qualified dependent. That's unchanged from last year, as is the standard deduction for married couples filing jointly ($11,400) or singles ($5,700). The standard deduction for heads of households increased slightly, to $8,400.
The capital gains rate remains at a maximum of 15 percent. For those taxed overall at the 10 percent or 15 percent rate, the capital gains rate is 0.
Many tax deductions and credits are unavailable to people with higher incomes. Among them: the first-time home buyer credit; the American Opportunity credit for college tuition, related fees, books and other required course materials; and the deduction for tuition and fees.
Before 2010, wealthier people couldn't realize the full benefit of their personal exemptions and itemized deductions. That's changed for 2010, 2011 and 2012. "Overall income limits for personal and dependency exemptions and itemized deductions do not apply," the IRS said.
However, the agency noted, "for taxpayers at all income levels, limitations continue to apply to particular itemized deductions, such as medical and dental expenses, certain miscellaneous itemized deductions and casualty and theft losses." For example, only medical expenses that exceed 7.5 percent of adjusted gross income may be deducted.
Tax experts urge people to take advantage of all the deductions they are due.
For charitable deductions, people are pretty good at keeping track of cash but not as good when it comes to goods, Luscombe said. They often forget out-of-pocket expenses, including travel or transportation.
Taxpayers who are at least 70 1/2 years old could make a donation to a charity direct from their individual retirement accounts without paying taxes on the amount. But there's no double-dipping. They cannot also claim the amount as a charitable donation.
And in another change affecting retirement accounts, people could convert their traditional IRAs to Roth retirement accounts regardless of income. Taxpayers had the option of counting the amount of the conversion as taxable income in 2010 or deferring it over two years, 2011 and 2012.
Middle-class taxpayers will benefit from the patch to the alternative minimum tax, which originally was aimed at ensuring that people weren't wrongly escaping taxes by claiming deductions. The AMT is not indexed for inflation, so every year Congress passes a patch so millions more taxpayers aren't affected.
The patch for the 2010 tax year increases the exemption to $72,450 for a married couple filing a joint return and qualifying widows and widowers, up from $70,950 in 2009. For singles and heads of households, it's $47,450, up from $46,700.
Also adjusted for inflation was the maximum income level you could have and still qualify for the earned income credit, as well as the value of the credit itself. Income levels and the amount of credit are based on the number of children in the household.
During 2010, the vast majority of taxpayers benefitted from the Making Work Pay tax credit, aimed at combatting the recession. There were income limits, however, and taxpayers will have to file Schedule M to claim the credit, which is up to $400 for singles or $800 for married couples filing jointly. Since payroll withholding was adjusted so you could get the immediate benefit of the credit, you could find yourself owing money if both spouses worked or if you have more than one job.
The homebuyers' credit also continued - for part of the year. If you were a first-time home buyer and bought your home before May 1, 2010, you may qualify for a maximum $8,000 credit. There's a separate credit, too, for long-time homeowners, up to $6,500. These, too, phase out at higher income levels, and the price of the home may not be over $800,000. You also must have used the home as your primary residence for at least three years, or you'll have to repay the money.
Members of the armed forces and certain federal employees serving outside the United States have longer deadlines to buy homes and still qualify for the credit.
Again this year, there's added documentation required, such as the HUD-1 settlement statement. As a result, people claiming the credit will not be able to file electronically.
Those who bought homes in 2008 and claimed the credit owe the government some money. That credit actually was an interest-free loan and must be paid back over 15 years. Those who took the maximum credit, $7,500, will have to add $500 to their taxes due. "It might catch people unaware," said Barbara Weltman, author of tax books for J.K. Lasser.
You'll also have to file a paper return if you claim the expanded adoption credit. The maximum is $13,170 for each child, up from $12,150 in 2009.
The energy credit, worth a maximum $1,500, also remained in place. Homeowners who installed energy-efficient windows, furnaces, air conditioners or other items may qualify for a credit of 30 percent of the cost of the items. But there's a catch: The items had to be installed by Dec. 31.
College students or their parents may qualify for the American Opportunity Credit, worth $2,500 toward tuition and other qualified higher education costs. Students must be attending school at least half-time. Congress also extended the higher education tuition and fees deduction.
And a final word of advice: If you're waiting for forms to arrive in the mail, don't. The IRS decided not to mail them this year, a cost-saving measure that reflects the reality that increasing numbers of people are filing electronically.

(Source: Associated Press)

How Congress Screws Up the Tax Process Year after Year...

If you’re among the one-third of taxpayers who itemize deductions on their federal tax returns, the IRS says you can take your time filing your 2010 tax return. Or rather you have to take your time. The IRS won’t let itemizers (or people who claim either the college tuition or educator expense deductions) file until mid- to late-February. Why? Because Congress didn’t pass the 2010 tax act until mid-December. The IRS needs time to reprogram its computers to accommodate new tax rules—actually old rules since the tax act mainly extended last year’s law through 2012.
The situation echoes another a few years back when Congress waited until late December to “patch” the alternative minimum tax for 2007 returns. The patch boosted the AMT’s exemption and extended applicable credits, thus sparing more than 20 million taxpayers from owing additional tax. But the 4 million taxpayers still subject to the tax had to wait more than a month while the IRS rewrote its computer programs.
The IRS made sure that wouldn’t happen again this year. When the chairmen and ranking members of the Ways and Means and Senate Finance Committees told IRS Commissioner Doug Shulman back in November that they would patch the AMT for 2010, Shulman had his programmers update their computers with the promised—but not enacted—fixes. Fortunately, Congress followed through so taxpayers who owe AMT for 2010 can file whenever they’re ready—unless they want to itemize their deductions, which, of course, virtually all of them will.
Delaying tax filing is only the most tangible result of last-minute and temporary tax legislation. Over the past decade, the federal individual income tax has changed every year. Congress legislated some of the changes far in advance, but others popped up right before—or sometimes after—the new tax year started. People can’t plan when they don’t know which tax laws will apply. And they waste a lot of time and effort adapting to and complying with ever-changing rules.
The delay won’t affect procrastinators but people like me who want to file as soon as they have all of their W-2s and 1099s for the year won’t like it. I’m lazy about adjusting withholding to match my expected tax liability—it’s easier to use a safe harbor that overwithholds—so I typically get a large refund. But having already given the government a zero-interest loan during the year, I want my refund as soon as possible (in recent years so I could pay my daughter’s latest tuition bill). This year’s refund will come later than usual. Fortunately I’ve paid my last tuition bill so I can afford to wait. But there’s still the principle of getting that refund quickly.
Those of you who pay estimated taxes and haven’t already made your January payment might want to trim that payment back if you expect a refund. On the other hand, sticking with a safe harbor saves your doing the arithmetic needed to make sure you won’t get hit for underpayment.
There is one bit of good news: Because the IRS resides in the District of Columbia, which celebrates Emancipation Day on April 15 this year—a Friday—tax returns aren’t due until April 18. Itemizers may have to wait many weeks before the IRS will let them file their returns, but they’ll have three extra days to mail them.

(Source: Forbes Magazine)

Fair is Fair...

Each year for the past decade, Nina Olsen, the National Taxpayer Advocate at the Internal Revenue Service, has issued a report to Congress on the most serious problems facing taxpayers. She usually focuses on individual provisions of the code, such as the Alternative Minimum Tax, or vexing tax administration problems. This year, Nina reached a quite different conclusion: The most serious problem encountered by taxpayers is … the Tax Code. The whole damn thing.



As the report says, “The most serious problem facing taxpayers—and the IRS—is the complexity of the Internal Revenue Code.”



Olsen estimates that individuals and businesses spend 6.1 billion hours preparing their returns. That’s equal to a year’s labor by 3 million full-time workers. Individual taxpayers are so befuddled by the Code that she reports 89 percent either pay a preparer or buy commercial software to help with the paperwork. The total cost of compliance in 2008, Olsen estimates, was $163 billion, or more than 11 percent of total income tax collections. The average out-of-pocket cost per taxpayer: $258. Something is very wrong when we have to pay a vendor $258 just to perform the most basic of civic duties.



Not only is the Tax Code massive—3.8 million words by Olsen’s count—but it is a constantly moving target. Her report estimates there have been more than 4,000 changes in the law over the past decade, and 579 last year alone. It is no wonder nobody understands it.



More troubling, all this complexity is driving people to cheat. More than 60 percent of self-employed workers (whose income tax is not withheld) either under-report income or over-report deductions. Olsen attributes at least some of this behavior to taxpayers’ belief that they are paying more than their fair share while others are avoiding tax. Nobody, she says, wants to be a “tax chump.”



Of course, complexity isn’t the only reason to rewrite the tax code. It is also hideously inefficient and grossly unfair. It picks economic winners and losers, subsidizing those activities that politicians think are “good” and penalizing those that are deemed “bad.” Often, the more money you make, the more you are rewarded. And far too often, two households making exactly the same amount of money and living in roughly similar circumstances find themselves paying wildly different amounts of tax.



Nina is wrong about one thing. She says the time to reform the tax code is now. Actually, it was long before now. But that’s no reason why President Obama and Congress shouldn’t get started.

(Source: Forbes Magazine)