Last year was one of great uncertainty when it came to taxes. Although Congress had known for years that numerous tax laws were expiring at the end of 2010, representatives and senators kept putting off key action.
10 tax tips
- Adopt a child
- Watch out for FSA limits
- Convert to a Roth IRA
- Buy a house
- Create a bunching strategy
- Give to charit
- Adjust your withholding
- Evaluate educational accounts
- Estimate your AMT exposure
- Start a business
But who needs Congress?
Regardless of what does or doesn’t happen on Capitol Hill, each year there are plenty of tax moves you can make to help reduce what you owe to the Internal Revenue Service. These 10 tax tips can do just that.
1. Adopt a child
OK, this is a major decision and not one to be made simply because of a tax break. But if you are planning to add to your family via adoption, then Uncle Sam offers a nice benefit this year.
As part of the health care reform act, the adoption tax credit was expanded. This credit helps adoptive parents pay some of the processing costs. For 2011, that amount is a maximum of
$13,360 per eligible child. The increased credit applies to the adoption of any child, not just special needs children, and includes international and domestic adoptions.
Even better, the adoption credit is now refundable, meaning the claim could produce a refund if you owe no tax.
However, the adoption tax-break enhancements are only good though 2011 unless Congress extends them.
2. Watch out for FSA limits
Medical flexible spending accounts, or FSAs, are not as flexible in 2011. These workplace plans allow employees to put pretax money into accounts and then use the money to pay for medical expenses not covered by insurance.
But one category that is no longer eligible for reimbursement is over-the-counter medicines. Beginning Jan. 1, you must get a doctor’s prescription to use FSA money to pay for over-the-counter medications. This means you’ll need your doctor’s official,
written order that you take nonprescription cold tablets.
The new over-the-counter regulations are based on the “tax” year, which runs from Jan. 1 through Dec. 31, not a workplace’s benefit plan’s year. So if your plan year runs from May 1, 2010, through April 30, 2011, any over-the-counter expenses you incur
from the beginning of 2011 are not allowed unless you have a prescription, even though your plan year runs for four more months.
3. Convert to a Roth IRA
Roth IRAs are popular because when the money is withdrawn in retirement, there’s no tax due. These accounts are enjoying a new surge of popularity now that there’s no longer an income limit on who can convert a traditional IRA to a Roth account.
This conversion option became available last year and also included the ability to spread any taxes due upon conversion over two subsequent tax years. The tax-deferral opportunity is gone. If you convert a traditional IRA to a Roth IRA in 2011, you’ll
have to pay all conversion taxes this tax year. But for some, it still might be worthwhile to convert to a Roth.
“It’s a very good idea for some people, but you have to go through some calculations,” says Steve Henley, national tax practice leader with CBIZ MHM in Atlanta. “It depends on what
you think your tax rate will be when you retire and what you think your investment rate of return will be going forward.”
4. Buy a house
The first-time homebuyer credit is no longer available, but owning a home still offers many good tax breaks.
Sure, the bipartisan National Commission on Fiscal Responsibility and Reform has suggested that the mortgage interest deduction be eliminated or at least reduced. That won’t happen any time
Other home-related costs, such as property taxes and points paid to get a lower home loan interest rate, also are deductible, as is interest on home equity loans up to $100,000.
The biggest home-related tax benefit, though, could come when you eventually sell. As long as you live in your home for two of the five years before you sell, you won’t owe taxes on up
to $250,000 in profit (or $500,000 for a married couple filing a joint return) from the sale of your principal home.
And if you did take advantage of the very first first-time homebuyer credit on your 2008 tax return, remember that when you file your 2010 Form 1040 this year, you’ll have to start paying back that $7,500 tax break.
5. Create a bunching strategy
Medical costs also could become tax savings if you have enough of them to deduct. To claim them as itemized deductions, you must have incurred medical costs of more than 7.5 percent of your adjusted gross income.
Miscellaneous itemized deductions also have a threshold you must meet before the costs can be of deductible value. That amount is 2 percent of adjusted gross income.
These targets mean that if your adjusted gross income is $50,000, your medical write-offs must be more than $3,750 and your miscellaneous expenses more than $1,000 in order to benefit you on your Schedule A.
Start planning your tax-deductible expenditures early in the tax year, and you’ll make sure you clear these deduction hurdles. This is known as creating a bunching strategy, since it
usually entails moving, or bunching, expenditures into one tax year so you can take advantage of itemizing them.
6. Give to charity
You don’t have to meet a threshold to deduct your charitable donations. As long as you give to an IRS-qualified organization within the tax year, you usually can claim as an itemized deduction the full amount that you give.
Typically, folks wait until the end of the year to donate to charities. Consider spreading your giving throughout the year.
The groups that get your dollars or goods will appreciate the donations earlier in the year when their accounts might be running a bit low. And by giving early, you won’t have to worry about your philanthropic nature competing with your holiday gift-buying
tasks at year’s end.
7. Adjust your withholding
When it comes to payroll withholding, you want to be Goldilocks and get it “just right.”
If you overwithhold federal taxes, you’ll get a big refund. That’s nice once a year, but you’ve sacrificed control of your dollars for the other 364 days.
If you underwithhold, you’ll end up owing the IRS at filing time. Owing a little isn’t too bad, but a big tax bill could cause you to face penalties for not paying enough throughout the year.
It’s easy to change your withholding. Just give your payroll office a new W-4. And to make sure that form will get your withholding as close as possible to your eventual tax liability,
you can use Bankrate’s payroll deductions calculator or the IRS’ interactive allowances calculator.
8. Evaluate educational accounts
College costs increase every year, but tax-advantaged savings accounts can help. The key is determining which plan best suits your needs.
Every state offers at least one 529 plan, a savings account set up for a child to help pay for future college costs. Your contributions to a 529 plan are not tax deductible, but the earnings are not taxed. When you take out funds to pay for eligible expenses,
the distribution also is tax-free.
The American Recovery and Reinvestment Act of 2009 added computer equipment and services to the list of allowable 529 expenses. But that option expired at the end of 2010.
Tax-free money from another educational savings plan, the Coverdell Education Savings Account, still can be used in 2011 for computer costs. However, Coverdell accounts, which were expanded as part of the Bush tax cuts, lost some other valuable options
If Congress doesn’t renew the expired Coverdell provisions, such as the ability to contribute up to $2,000 a year and use the tax-free money for precollege school expenses, you might want to consider rolling Coverdell money into a 529 Plan.
9. Estimate your AMT exposure
Although Congress annually enacts changes to the income levels for the alternative minimum tax, or AMT, many middle-income taxpayers still find each year that they are subject to this parallel and costly tax.
This extra tax calculation, in which many commonly claimed deductions are not allowed, is required if you earn more than a certain threshold income. It was created in 1969 to ensure that wealthier taxpayers pay at least a minimum amount of tax.
The main problem with the AMT is that it’s not indexed to inflation, hence the need for yearly legislative action to increase the amount of income exempt from the AMT. But just as problematic is that many deductions allowed under the ordinary tax system
— state and local income taxes, real property taxes, miscellaneous deductions and the usual amount of medical expenses — cannot be used to offset the AMT.
If you’re in a higher tax bracket and fear that you might end up paying the alternative tax, talk with your tax adviser sooner rather than later to consider ways to limit your AMT exposure.
10. Start a business
Whether you operate your own business as your main source of income or as a sideline venture, tax laws offer several ways to save.
The Small Business Jobs and Credit Act of 2010 increased the Section 179 tax deduction. This provision allows you to deduct qualifying expenditures in the tax year in which they are made rather than depreciate it over several tax years. For 2011, the
maximum Section 179 deduction is $500,000.
If your company is a bit bigger and in the manufacturing sector, the domestic production activities deduction could help. It allows you to claim a percentage of your taxable income to help reduce your company’s tax bill. The main requirement is that the
manufacturing be based in the United States, but the range of qualifying activities is wide. Details can be found in the instructions for IRS Form 8903, which you’ll
file to claim the deduction.