A Trickier Tax Season
Nothing's simple, not even the filing deadline. But there are savings to be had if you know where to look
Talk about complications. Even the deadline for filing tax returns this year has been messed up. Adding to the confusion are reinstated deductions with no obvious place on the return to claim them, a rebate on a telephone excise tax that many people are failing to claim, and an attack on tax-dodging parents who were schooling their children in the art of tax avoidance.
What deadline? It wasn't until after tax booklets with a filing deadline of Monday, April 16, were printed that the IRS saw the problem. That day is Emancipation Day in the District of Columbia—and because of the holiday in the nation's capital, everyone gets an extra day to settle up.
Uncle Sam's mistake. The treasury collected a 3 percent excise tax on long-distance phone calls for years, only to admit last year that the fee was no longer valid. The government is rebating part of the tax incurred from March 2003 through July 2006.
The easy path is to accept a standard amount of $30 to $60, based on the number of personal and dependent exemptions on your 2006 return. No proof of calls on a land line or cellphone is necessary unless you opt to plow through records, and in some cases special calculations, to claim the actual tax paid.
People who don't usually file a return because they have no net taxable income, perhaps because of untaxed Social Security benefits and limited other income, can file a 1040EZ-T form just for the rebate.
Hide and seek. By the time Congress extended three expired tax deductions, the 2006 tax forms had been printed without provision for them. People who claim the deductions must enter them on lines labeled for other items. Updated tax software can do it automatically, but otherwise it means finessing an incomplete form. The deductions:
One of up to $4,000 for college tuition, an alternative for some people who aren't eligible for the Hope or Lifetime Learning education credits. You can claim it on the 1040's line 35 and note it by appending the letter T.
One for state and local sales tax, which can be claimed as an itemized deduction instead of deducting state and local income tax. People who pay little or no state income tax or have incurred a lot of sales tax on big-ticket items may benefit. It is claimed on Schedule A's line 5 with the notation ST.
One for up to $250 on classroom supplies that teachers who dig into their own pockets can deduct. It is entered on the 1040's line 23, adding the letter E.
No kidding. Congress last May upped the fight against parents who avoid tax by shifting assets to their children. Before last year, a so-called kiddie tax treated part of the capital gains and other investment income of children under 14 as taxable at a parent's higher tax rate if the income topped a specified amount—$1,700 for 2006 and 2007. Now the potential extra bite applies through age 17, with the change made effective at the start of 2006. "Children who had outgrown the kiddie tax may now be within its reach again," says Bob Scharin, a tax analyst at publisher RIA.
Income under the cap still typically faces low tax, but once that level is reached, advisers suggest focusing more of a youngster's portfolio on tax-deferred long-term growth and tax-free municipal bonds and limiting taxable dividends and other income.
Conserving energy and tax. Saving cash at the gas pump with a fuel-efficient car can also trim income tax. Starting with 2006, buyers of hybrids can get a tax credit that saves $1 of tax for every $1 of credit. (That's better than a tax deduction, which only reduces the amount of income on which tax is figured.)
The credit—from $250 to $3,150—depends on the make and model of car and when it was bought. One twist is that a model's initial credit phases down and eventually vanishes on future sales once an automaker's overall hybrid deliveries top 60,000, something already happening for Toyota and Lexus models.
Another green incentive is a credit of up to $500 for part of the cost of improving your home's energy efficiency by upgrading heating and cooling, windows and doors, and insulation. The items must be certified by the maker as qualifying, and the maximum $500 credit applies to 2006 and 2007 combined.
11th-hour nest egg. A time-honored way to save on your taxes is to rush to make a tax-deductible deposit to an IRA or other retirement plan before the deadline for 2006 contributions. The most you can stash away depends on such factors as your income, employment, other coverage, and the type of plan.
People who qualify for a deductible IRA have until the April filing deadline to put in as much as $4,000, with an extra $1,000 allowed for people 50 or older. A married couple can save up to double the caps, even if only one spouse is employed.
Self-employed people, including those who run a business part time, have a choice of Keogh, SEP, and other retirement plans. With a filing extension, they typically can wait until even after April to make a deposit that counts for 2006, which in some popular programs can be as much as $44,000, all tax deductible.
April is also the deadline for making a 2006 deposit to a Roth IRA, which has easier eligibility rules than a deductible IRA. There's no tax deduction, but withdrawals of deposits and investment earnings from a Roth are generally tax free, unlike those from a deductible IRA.
Opening a Roth for a youngster with income from a job can pay off handsomely over time. Giving up a traditional IRA deduction may mean little or no additional tax now while the account grows into a future potential tax-free nest egg.
No thanks. Be wary of a new option to directly deposit a refund into an IRA.
Potential hitches: having a deposit for 2006 treated by the firm handling your IRA as one for 2007 or having the transfer fail if your account and financial routing numbers aren't precise or the institution isn't prepared to handle such transfers. You might want to make your own deposit with the refund or other cash.
Worthy causes. Fanciful values on gifts to charity is an IRS target du jour. Besides cracking down on overvalued cars and big targets such as conservation easements and bogus appraisals of art and collectibles, the government is also sweating smaller stuff.
Used clothing and household items donated after last August 17 must generally be in good or better shape to be deductible. And effective with cash donations in 2007, you must be prepared to document a gift of any amount with a canceled check, receipt, or other approved proof—a note to yourself won't do.
How much auditing the IRS can do on modest items is limited, but the agency is drawing a line it expects paid tax preparers to help enforce. "If you don't have a receipt and are examined, the deduction will just not be allowed," says Ed Smith, a tax partner at BDO Seidman.
Don't neglect expenditures other than donations. You can deduct gas or 14 cents a mile, plus tolls and parking, when using your car for volunteer work. Hurricane Katrina-related help is deductible at 32 cents a mile. Other deductibles can include a Scout leader's uniform, office supplies, phone calls, and even hosting a fundraiser.
Family ties. Special tax breaks are easy to neglect when it's time to utilize them. The choice of filing status is a good example. Don't jump to a conclusion about filing as married or single—there may be a tax-saving alternative.
If you're not married but provide a home for your child, parent, or other relative, you may be able to file as head of household and pay less tax than filing as single. A parent you support doesn't even necessarily have to live with you.
Someone who became a widow or widower in 2006 can still take advantage of joint filing benefits for that year and, if he or she has dependent children, may be able to do so in 2007 and 2008, too.
Free, sort of. The IRS is again promoting free online tax preparation (at www.irs.gov) in conjunction with tax-preparation firms. But you may have to do trial runs to pick among the varied offerings of the 19 participants—including big names such as TurboTax and H&RBlock. There is a ceiling of $52,000 in adjusted gross income to participate, but some firms have lower income caps, age restrictions, and limits on states of residence. Expect pitches to buy paid options and personal help.
This story appears in the March 12, 2007 print edition of U.S. News & World Report.