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Tax Relief 101: Real Estate Deductions

Your home is your best tax shelter and this week’s “5 Tips” by Gerri Willis is focused on finding all those deductions you can use. The tips are pretty much common sense except for #2, which I didn’t know before reading. You should save all the receipts from home improvements and repairs because they can be deducted when you sell the home. So if you replaced your siding and it cost $2,000 then that’s $2,000 you can deduct from the profit of the sale, thus reducing your capital gains tax.

via CNN Money.


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Tax Relief 101: Sales Tax Deduction Rules for 2006

We learned last year that taxpayers who itemize have the option of claiming their state and local income taxes or their state and local sales taxes as an itemized deduction on their 2005 returns and that this year will be the last year you will have that option (on your 2006 returns for your 2005 Tax Year).

The rule is that you can deduct actual state and local sales taxes (actual means you must keep receipts) or you can deduct values taken from the sales tax tables. By using the optional general sales tax tables, you don’t need to keep receipts. When you use the optional tables, you can add the tax on big purchases such as a car, plane, boat, mobile home, or home renovation to the total. So if you read off the table that you are eligible to claim a $779 deduction for sales tax and you just bought a $10,000 car in Maryland, you can add $500 (MD Tax is 5.0%) to the optional table value for a total deduction of $1,279.

Where are the sales tax tables? Where is Publication 600?
The tax tables that were available as Publication 600 last year were rolled into the 2005 Instructions for Schedules A & B (Form 1040) on pages A-10 to A-11.

For more information, please read the press release from the IRS.


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Deducting Donations – IRS Tax Rules

With my girlfriend wanting to donate a car, my roommate donating old furniture, and minor cash donations, I thought that I’d do a little research into the rules and procedures governing the deduction of donations from your taxes. It’s a little early, considering 2005 tax returns aren’t due for another ten months (tick tock!), but it’s better to know the procedure before crunch time than scrambling last minute.

Eligibility:
In order to deduct charitable donations from your taxes, you basically need to satisfy two conditions:

  1. Itemize Your Deductions – Folks taking the standard deduction won’t get a tax benefit for charitable donations.
  2. Donate to a Qualified Organization – Normally you can just ask and they’ll tell you, but IRS Publication 78 (it’s been upgraded to a search and is not a PDF) has a list of the common ones.


(Click to continue reading…)


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Schnepper-Malagoli Charitable Tax Grab

While doing research for my last FSA article, I came upon an article written by Jeff Schnepper (article was taken down from MSN) that was listing ideas for cutting your 2004 taxes. I skimmed the article, most of which is common knowledge, until I hit upon something called the Schnepper-Malagoli Charitable Tax Grab. You can read the excerpt in full below but essentially you can rent out part of your home tax free (up to 15 days) to a charity (or anyone really), then donate to the charity, and walk away with extra money (and a warm fuzzy feeling) in your pocket as long as there was no pre-arrangement.

Here’s one you don’t have. It’s called the Schnepper-Malagoli Charitable Tax Grab. You can rent your home to anyone during the year — up to 14 days total — and pay zero tax. (Internal Revenue Code Section 280A (g), for those of you who feel compelled to look it up.)

So your church, synagogue or any recognized charity rents your home for a board meeting. They pay you $500. That money is completely tax-free.

Without any compulsion or prearrangement, you also contribute $600 to the charity. If you’re only in the 25% bracket, you save $150 in tax. You also got $500 tax-free from the rental. That’s a total of $650 more in your pocket, less the $600 contribution. You’re up $50 and the charity is up $100. One meeting per month (12 is less than 15) and you’ve “made” $600 and the charity is up $1,200!

Was it intended when Congress drafted the tax code? Clearly, no. Is it completely within the clear wording of the code? Absolutely, yes! Just because it’s a loophole doesn’t mean you can’t legally do it. And, there’s nothing wrong with doing well as you do good.

It’s brilliant, anyone ever heard of it (it has a doozy of a name)?


 Taxes 
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Tax Relief 101 – Retirement Savings Credit

Welcome to the next installment of Tax Relief 101, where I find interesting and legitimate ways to relieve your tax burden. This time, we’re going to look at the retirement savings credit that I didn’t even know about until today. Basically if you make under $25,000 and contribute to a retirement account, the government is willing to give some of that money back to you as a tax credit today (as much as $1,000). It’s an incentive for low-income earners to put away money for their retirement.

The form you must file to get this is F8880, Credit for Qualified Retirement Savings Contribution. Essentially, the math is as follows:

’04 Traditional/Roth IRA contributions
+ ’04 retirement plan contributions
- distributions since 2001,
—————————————————-
or,
$2,000,
whichever is smaller.

Then, based on your salary, you divide that number by 2 [< $15k], 5 [$15k-$16.5k], or 10 [$16.5k-$22.5k] (a Bankrate article has the full table). That means the maximum credit you can get for this is $1,000.

What this allows you to do is if you’re one of the few folks earning the lower end of one of the brackets, just contribute some more to your employer’s retirement plan and push yourself down into a lower bracket. This will give you the benefit of reducing your taxable income and earning you the credit. The restrictions are what you’d expect: you cannot claim this if you’re a full-time student, younger than 18, or claimed as a dependent.

Finally, if you decide to claim this credit, you’ll need to file Form 1040 or Form 1040A, the 1040EZ isn’t allowed.

I hope you’ve found this tip helpful!


 Taxes 
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Your Tax Return as a Subtle Financial Planner

I forget what show I was watching, but it was one of those shows where you have all that Bloomberg ticker crap taking up 75% of the screen and little faces jibber jabbering in the leftover space, but the guy talked briefly about how your IRS 1040 (the full incarnation of the form everyone fills out for taxes) gives you subtle reminders of the things you should do to help plan your financial future. I didn’t watch the whole thing but I thought it’d be fun to go through each relevant line (yeah, I’m a sadist) and see how it could be used as a subtle yearly financial plan reminder.

Line 8a – Taxable Interest
Line 8b – Tax-exempt Interest
There are investment vehicles out there that are tax exempt at certain government levels. For example, an EE/E bond is exempt from State and local income taxes but not from federal taxes. This is a reminder that sometimes your most conservative assets may be better placed in a tax-exempt bond than in a savings account bearing 3.0%. Of course, you sacrifice flexibility but you should know tax-exempt investments are out there but you do keep Uncle Sam’s grubby little paws off your loot.

Line 13 – Capital gain or (loss)
This is something you can only capitalize on if you remember it before December 31st. If you have a loss and want to write it off, sell it to offset a gain you may have had. Just remember not to repurchase shares in the same company within 31 days or the “wash” rule will bite you (and you won’t be able to write off the loss). Did you buy shares of JDS Uniphase and got burned badly in the bubble? Yeah, me too, write it off now because they’re never going to break even for you.

Line 15a – IRA distributions
Line 25 – IRA deduction
Contribute to a Roth or any other type of IRA? These lines are a reminder that perhaps you should be planning for your retirement because Social Security won’t be enough to sustain a lavish retirement lifestyle! :) Retirement planning, especially for young workers, is critical because it is something that benefits with the passage of time. The more you sow now, the greater the benefits you will reap in the future. You want to be living in luxury when you’re retired, not a cardboard box. (You cannot deduct Roth contributions on your return, I just intended for that line to serve as a reminder to plan for retirement)

Line 33 – Penalty on early withdrawal of savings
Tsk tsk! That IRA or 401k isn’t a slush fund you can withdraw on to buy that shiny [whatever]. Let line 33 be a reminder that you will be penalized for mortgaging a portion of your retirement for gratification now. Alright, I’m just kidding about the severity but you should be readily dipping into your retirement for every thing. Sometimes it makes financial sense, but most (90%) of the time it’s a bad idea. (Example of good ideas? In times of hardship, dipping into the retirement savings may be unavoidable)

Line 49 – Education credits
The government will help you educate yourself, even if your employer will not. Learn about Hope Credit and Lifetime Learning Credits and see how you or your dependents may benefit from them.

Unless I’ve missed anything glaring, those 5 “lines” cover a lot of the basic financial planning advice given out these days. Consider all investment opportunities with respect to the tax advantages, plan for your future, don’t mess up your future by needlessly borrowing from it, and always educate yourself. I’m not saying that the dreaded tax form should be your financial advisor, a human being almost always beats a piece of paper, but it gives you a couple subtle reminders for things you may have forgotten or conveniently ignored. Take a look at your return and see if you’ve taken advantage of everything you could’ve.


 Taxes 
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Tax Relief 101 – Understanding Capital Gains and Losses

This is the third post a series of Tax Relief advice articles, be sure to read the first one about Deducting State Sales Tax Instead of State Income Tax and the second one about the Alternative Minimum Tax. You can see the whole collection under the category of Tax Relief 101.

If you invest in anything whatsoever, capital gains and losses are a necessary and often misunderstood aspect of your taxes. What differentiates a long term capital gain and a short term capital gain? If I miss on an investment, how can that pain be lessened by gains you’ve had in other investments? What’s this I’ve heard about dividends being taxed at a lower rate? Get your pens and pencils and read on.

Long Term vs. Short Term Gains
If you’ve owned the investment for over 366 days (1 year plus 1 day), then it is taxed as a long term capital gain. If you’ve owned it for less than a year, it’s taxed as a short term capital gain. It’s as simple as that.

Recently, the long term capital gains tax rate was lowered by 5% for every tax bracket (effective until 2008) . Now, the rates are 5, 15, 25, and 28%. If your income is taxed in the 10-15%, your maximum long term capital gain tax is 5%. Everyone else is taxed at the 15%. The 25% rate applies to real estate you’ve sold that you claimed any depreciation on (Section 1250 property). The final 28% category is for small business stock and collectibles.

Short term capital gains? They’re taxed as income for the year! If you’re in the 15% tax bracket, it’ll be taxed at 15% (instead of at 5%). That’s why they say that short term capital gains can eat into your stock profits because of the significantly higher (10% difference) tax rate.

Capital Losses Offsetting Capital Gains
If you make a bad pick (or two or twenty), any losses you sustain can be used to offset any gains you had this year. If you had a particularly bad year and had no gains, up to $3,000 of the losses can be used to offset your other income. If you’ve lost more than $3,000, then you can carry it to the following year. That’s why you hear advice from professionals about selling stocks in which you’re in the red in order to offset the gains you’ve had. One important rule you must understand is the “Wash Rule” which only allows this offset if you do not repurchase the stock within 30 days, otherwise this is thrown out.

Dividends Taxed at 5, 15%
Remember the two tax brackets for gains? Well now dividends are taxed at those rates, 5% for 10-15% taxpayers and 15% for everyone else.

I hope I’ve covered a few of the big concepts of capital gains taxes that give people the most trouble and dispelled some of the misconceptions people carry around. I wouldn’t let capital gains taxes dictate your investment strategy but it’s a very important aspect to always keep in mind.


 Taxes 
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Tax Relief 101 – Understanding Alternative Minimum Tax

This is the fourth post a series of Tax Relief advice articles, you can see the whole collection under the category of Tax Relief 101.

If you’re like me, you’ve heard about this ugly Alternative Minimum Tax (AMT) monster that will come and make you pay more taxes. And just like me, you know nothing about it. In this installment of Tax Relief 101, the AMT monster will be explained so you understand why it’s here and what it means for you.

Background: Back in the days of yore, a lot of high-income folks were finding very creative ways to get out of paying as much tax as they were expected to. The government obviously found this very frustrating so they created an alternative set of rules to assess tax liability because they felt that at a certain level of income, you should pay at least a certain amount. The AMT is simply your tax liability calculated by those alternate rules and but it’s starting to apply for more people than before and it’s pissing all those people off.

Basics: When you’re doing your taxes, you’ll arrive at a number which is how much in taxes you will pay for last year. It will be higher than what you wanted to pay. Then, you calculate how much you would pay according to the AMT rules and what you owe is the larger of the two numbers (awesome!). Technically, you pay your regularly-computed tax and then the difference between that and the AMT is considered your AMT.

How To Calculate:
Easy Way: Get some good tax software and it will calculate it for you.
Hard Way: You can compute your AMT using Form 6251 which you can download from IRS.gov. Just get the software.

So basically AMT is Congress’ way of getting you to pay a minimum amount, even if you have completely legal deductions that would reduce your tax liability! Is there anything you can do? No, unless Congress changes the rules. The only good news is that a portion of your AMT can be credited back to you in future years. This is how you do it:
1. Figuring Available Credit – First you need to figure out how much of the AMT you paid the year before is eligible to come back and help you this year. You need to figure how much of the AMT from that year is the result of timing issues, that is anything you did to delay reporting income as opposed to something that just reduced your reportable income. You can use Form 8801 to figure out how much credit is eligible.
2. Figuring How Much Credit You Can Use – Then, after you’ve figured how your regular tax and AMT for this year, you can use any available credit from the prior year to cover the difference between regular tax and AMT if your regular tax is greater!

Example: In 2004, you owe $10,000 in regular tax and $8,000 according to the AMT, thus your tax liability for 2004 is $10,000. You calculate that you have $4,000 in credit from the AMT from 2003. You may use $2,000 of that credit, the difference between regular and AMT, and apply it towards your tax liability of $10,000 so that you only owe $8,000 of tax for 2004.

So basically, high-income people were pushing off their income to be taxed in a later year so Congress created the AMT to capture the tax this year and give them credit next year when they do report it. It’s a interest-free loan from your pocket to the US Government. The downside is that now it’s affecting people without high-incomes who are taking deductions they should be taking.

Ultimately, what this means to you is that you need to do more math (or your tax program/accountant does more math), but at least now you have an inkling as to why you need to do more math.


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