Tax tactics: Use legal tax breaks to keep more of your money

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Now that tax season is here, I’ve asked David Bergstein, professional tax analyst and CPA, to offer iwillteachyoutoberich readers customized tax advice. Don’t worry if this advice doesn’t apply to you — if you have a specific question, you can get it answered below, for free, by David..

april-15th

While Ramit focuses on teaching you how to be rich, I can share with you a few pointers on taking advantage of tax breaks that may be available to you, because paying more in taxes than you owe is a sure way not to get ahead.

One of the first things to understand is that not all tax breaks are created equal. For example, there are tax credits and deductions. Credits are a dollar-for-dollar reduction in your tax bill. Deductions, on the other hand, reduce your taxable income. Say you are in the 25-percent tax bracket. A $500 deduction reduces your tax bill by $125, while a $500 credit lowers your tax bill by the full $500. If ever forced to choose, go for the credit.

So what credits and deductions do you need to know about? Well, that depends on your specific circumstances, but following are a few that apply to many individuals, particularly younger taxpayers.

It’s important to note that the tax code is now more than 70,000 pages and includes not only what is taxed, but also the tax breaks. So, to really hone in on the tax breaks best for you, your best bet is to get some help. Tax software, such as CCH CompleteTax, that walks you through the tax prep process can be an incredible time saver because it asks you questions specifically designed to identify tax breaks for which you may be eligible.

That said, here are a few credits and deductions you should be thinking about as you prepare your 2008 tax returns.

Credits of Note
Two special tax credits worth noting for 2008 are the recovery rebate and first-time homebuyer credits.

  • You may be able to claim the recovery rebate credit if you did not receive a full economic stimulus payment last year. For example, say you made too much money in 2007 to get the full stimulus payment, but were laid off in 2008. Your 2008 reduced income may make you eligible for the recovery rebate.

  • If you bought your first home in 2008, after April 9th, you may be eligible for a first-time homebuyer credit of up to $7,500, which must be repaid after 36 months in the home. The economic stimulus package enhances this credit for 2009, increasing the credit amount to $8,000 for taxpayers buying their first home in 2009 and removing the payback requirement, so long as you stay in the home for at least 36 months. Also, a bit confusing, but if you buy your first home in 2009 before July 9, 2009, and before you file your tax return, you can take the first-time homebuyer credit on your 2008 tax return. For both years, the credit begins to phase out for taxpayers with adjusted gross income above $75,000 ($150,000 for joint filers).

Other credits important to know about, particularly for younger taxpayers, include credits for post-secondary education expenses. These include the Hope Credit offering up to a $1,800 credit and the Lifetime Learning Credit offering up to a $2,000 for 2008. Both have specific restrictions, including income eligibility, and, if you take one, you can’t take the other. Looking forward to 2009, the economic stimulus package renames the Hope Credit the American Opportunity Tax Credit and temporarily increases the credit to $2,500.

Deductions You Want to Consider
Even though credits save you more than deductions, you still want to take deductions when you can.

Two common deductions that have special twists for 2008 are the standard deduction and the standard mileage deduction.

  • The 2008 standard deduction ($10,900 for joint filers and $5,450 for single filers) adds a temporary property tax deduction, which allows taxpayers who do not itemize deductions a limited deduction for state and local real property taxes. Taking this deduction can increase a single filer’s standard deduction by $500 ($1,000 for joint filers).

  • The standard mileage rate also has a twist for 2008 thanks to a mid-year rate change. For the first part of the year, the deduction was 50.5 cents per mile for business and 19 cents for medical and moving travel; and for the last half of 2008, the deduction was 58.5 cents for business and 27 cents for medical and moving travel.

Also worth noting, if you moved to take a new job, the cost of your moving may be deductible. If you were one of the unlucky ones and lost your job, the cost of your job search may be deductible.

In addition to the education credits mentioned above, there also are post-secondary education deductions. These include a higher education tuition deduction for up to $4,000 in qualifying expenses and a student loan interest deduction of up to $2,500 base on interest paid on the loan.

Finally, exemptions are another area of tax breaks to know about. There is a personal exemption of up to $3,500 available to most taxpayers. If you’re lucky enough to work for an employer that offers Qualified Transportation Fringe Benefits, you also don’t have to pay income taxes on these benefits. Additionally, if you are in the military, any pay you received while serving in a combat zone in 2008 is exempt from income tax.

Taking Action & Getting Help
As I mentioned, the above are just a handful of the many tax breaks that may apply to your circumstances. If you want to learn more about any of these, you can read up on them in the CCH CompleteTax Tax Guide 2009. If you just want to have CCH CompleteTax help figure it out for you, you can go to www.CompleteTax.com.

About the Author: David Bergstein, CPA, is a tax analyst for CCH CompleteTax.

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Tax giveaway: Do you have tax questions? I’ve arranged to have David answer your specific tax questions — plus, the best 5 questions will get free accounts at CCH CompleteTax. Each is good for tax prep for one 2008 federal and one 2008 state tax return valued at $29.90 to $49.90. Leave your questions below.

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Tax tactics: Use legal tax breaks to keep more of your money

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  1. I was hoping you might answer my question about Cobra, please. I’ve been using Cobra for health insurance since October, as I left my job voluntarily to move to another state, where I haven’t been able to find employment yet. My Cobra premiums are insanely expensive – is there any way I can deduct them from my taxes? When I had health insurance through my company, all health-care related things (flexible spending account + health care itself) were pre-tax… Thanks!

  2. I was relocated in 2008. The company bought me out – giving me a check for my equity. I just bought a home (March 2009). My equity was sitting in a savings account between sale and purchase. Will I be liable for taxes on the sale in 2008, or can I apply the purchase in 2009 towards 2008?

  3. Tim de la Torre Link to this comment

    Hey this is great! Thanks so much for the free help.

    I’ve been volunteering overseas and only receiving a stipend since graduating from college, and I never earned enough money to file taxes. I just got married and I’m now house sitting, so I don’t need much income. I make the majority of my income from stock video sales and an occasional contact job with a friend. I plan on living this way for a while and saving up money.

    #1 Do I have to pay an estimated amount every quarter to the IRS? How do I know how much to pay since my income is all over the place and I’m just a freelancer?

    #2 Do I have to pay Self Employment Tax on my earnings from my royalties in stock video sales?

    #3 If I start up a ‘business’, where I shoot stock video for a living, and do occasional other video related work, is that tax deductible? I was reading the 2009 tax book in the reference section at my local library and it said something about NOT being able to deduct expenses related to video work!

    Thanks any help in this area will be of great use to me as I start planning on how to move forward in 2009 where I know I am earning enough that I will have to file.

  4. I jointly own a home with another person, but do not currently live in the residence (the other person does). The other person went ahead and filed their tax return claiming all of the mortgage interest and property taxes from the 1098 they received as itemized deductions on their return. I was told by a tax professional that if I wanted to claim half of the interest/tax on my return as an itemized deduction (which I believe I am entitled to… if that is not correct, please let me know), since the other person has already claimed the full amount, I would end up being audited and the burden of proof would be on me to prove I was entitled to that half. Is this true, and if so, what types of items/documents could be used as proof? Thanks!

  5. Are there any downsides to taking the $8k first-time homebuyers tax credit on the 2008 return?
    My (same-sex) partner and I are in the process of buying our first home. We close on March 17. We plan to each take half of the credit on our 2008 return — because why let the IRS keep the money for an extra year?!
    But, if we do claim it on our 2008 return do we miss out on other tax credits/deductions? (For example, I understand origination points paid are tax deductible — if we claim a new house for our 2008 return can we not write off origination points on our 2009 return?)

  6. Hi David,

    Thanks very much for the post. I have one question that is really vexing me, hoping you can help.

    For the first time this year I’ve purchased (and sold) options on index ETFs, such as SPY and IWM, as part of my personal portfolio. After beginning to prepare my tax return last week, I’ve been confused as to how capital gains and losses from these options are treated.

    Do ETF options fall under the IRS definition of a 1256 contract? I understand that these include “nonequity options”, which applies to options on broad-based indices. But I can’t figure out whether an ETF option, which is based on a single ETF (itself based on a broad-based index) would qualify. I’m lost…any idea? Thanks!

  7. Hi Ramit
    Thanks for the information.
    Could you please recheck the information you posted on the ” First Time Home Buyers credit” .

    According federalhousingtaxcredit.com website, you can claim the $8000 credit on you 2008 tax return even if you have filed the return by amending the 2008 return. The website does not mention any cut off date nor the IRS form F5405.

    The last two FAQS at this url can throw some light.
    http://www.federalhousingtaxcredit.com/2009/faq.php

    Could you please respond to my comment to clear any confusion for your readers? Thanks

  8. I worked for company “A” for 3 months of the year. During this time I contributed to a 401K with a company match (which I’ve rolled over).
    When I changed jobs, company “B” offered a 401K plan without a match. I decided to contribute to a Roth IRA and a traditional IRA instead.
    Am I able to receive a deduction for the traditional IRA contributions or does the 401K plan I contributed to disqualify me?
    Thank you.

  9. Which closing costs are tax deductible?

  10. Hi,

    My wife and I closed on our first home in October. After reading about the changes to the first-time homebuyer credit in 2009, I’m curious: Since we bought our home a couple months before 2009, are we stuck with the $7500 ‘credit’ which must be paid back? Or was this 2009 change retroactive?

  11. Ramit & Dave,
    I plan on marrying near the end of this year. I have heard that it may be preferable to wait until next year for tax reasons. Should we wait until next year to marry? A moderately detailed analysis of tax implications for marriage would make a very useful post for me.
    Thank you.

  12. My question is regarding the Sales Tax Deduction. The IRS states: “If you file a Form 1040, and itemize deductions on Schedule A, you have the option of claiming either state and local income taxes or state and local sales taxes. (You can’t claim both.) If you saved your receipts throughout the year, you can add up the total amount of sales taxes you actually paid and claim that amount.”
    I live in a state with no state income tax (TX) and I itemize my deductions. The IRS provides a Sales Tax Deduction Calculator (if you didn’t save your receipts) and with no surprise grossly underestimates actual sales tax paid.

    MY QUESTION: I use my credit card for EVERYTHING. Can I use my credit card statements as receipts (and of course eliminate non-sales tax purchases i.e. gas, airfare, etc)????
    It took me about 2 hours to hash through all my statements and figure out the actual tax but my value was about 4X the amount “calculated” by the IRS.

  13. Hi David,

    I found that I owe $800 in federal taxes this year. This is before I make any IRA contributions. Now I know that it is best to max out my Roth IRA with a full $5,000 contribution (while I still can), but if I do this, I will also have to pay my $800 tax bill. However, if I put 50% in a traditional IRA and 50% in a Roth IRA, I can eliminate my $800 tax bill, but I will only be able to invest $2,500 in the Roth. What is the best strategy? I am in the 25% federal tax bracket.

  14. I am an artist with a day job. I have an MFA, exhibit my work across the country, and consider that to be my career.This year i was considering filing taxes as a sole proprietor and deducting expenses related to my art career. This year I spent a lot of money on my art career but made little in sales. Mainly due to expenses setting up what will be a 3 year long project. I’m unsure if I should include my art sales as income from a hobby or do itemized deductions for my own business. I’m guessing a lot of the expenses incurred from the project will not be deductible – i.e. travel expenses. When is it advisable to file as a hobby and what distinguishes a hobby – from what I understand the only distinction is earnings of $400 or less.

  15. Thanks so much for your expertise on this topic. My question is a little complicated. See, my aunt immigrated from China to the US in 2008 and was fortunate to find a p/t job a month after moving here. She stayed with the company for a month before landing another full-time job with another company. The thing is that she was not put on payroll until Jan. 2009. So I was reading up on the different classifications for claiming a dependent. Since my aunt made less than $3500 in taxable income in 2008, can my mother or myself claim her as a dependent? I am positive that we supported her income by more than 50 percent last year. If this is the case, what kind of tax credit do we receive from this?

    Thanks again!

  16. One of the best ways to keep more of your own money is to run a home based business and have a competent CPA/EA help you with strategies to take all legal tax deductions that are available to you. Correct documentation is critical. You can start by reading about these deductions, but you need to find a competent tax specialist to interpret them for you.

  17. I got married last summer, July 2008. Is it ALWAYS better to file jointly?
    -I am a graduate student
    -I work part-time
    -There is one dependent child in our home

  18. Hi,

    I am 26 yr old (graduated in 2005) and I make arround $90K in gross. I am single (w/ no kids/dependents) and I do not own a house. I rent (w/ no roommates) an apartment in walking distance to my work.
    My rent+utilities+autoloan+inusurance+phone/cable+misc comes arround $1900/month. As of now, I do not have any other loans(student/home/creditcards/etc). My savings are just $3K/month and I am paying arround $12K just in federal taxes.

    After going through so many articles here and at other online sites, I realized that I do not qualify for any kind of tax deductions or credits (except for stimilus). Does this mean for someone in my situation, it is mandatory to pay those $12, 000 in tax + $6, 000 in medicare/ss taxes?

    I usually save my $$$ in ING savings accounts which do not pay much interests and also I end up paying taxes on that earned interest. Considering the current market situation, buying a home might not be a good option (esp. just to save on taxes).

    Please suggest some strategies or tips for someone in my situation to make a proper investment and save on taxes at the same time.

    Thanks,
    Ary

  19. Hello,

    Here is the situation, I own a townhome that I lived in from January till October. This was my sole, primary residence during this time frame (i.e. January till October). The month of November and December were rented out to a tenant.

    I am trying to enter the correct information based on the above in TurboTax but I am not sure if I am doing it right. Here is what I think my options are,

    OPTION 1 Claim the town home as a rental property for full year. The interest/property tax/association fee become an expense on the property.

    OPTION 2 Claim the town home as personal property for full year. The interest/property tax become a tax deduction.

    OPTION 3 (I think this is what I should do). Since I lived in the town home for 10 months. I should claim 10 months of interest/property taxes as deduction. For the other 2 months when the town home was rented, I should claim the interest/property tax as expenses on the town home.

    Does the above make sense? Any gurus that can offer insight?

  20. In 2005, I sold my primary residence for a $90,000 gain. I was a junior in college at the time (crazy real estate market, I know…got lucky with the timing). I had lived in the house for 1.5 years, not long enough to meet the 2 year threshold not to pay capital gains. I sold because I was doing a semester abroad. I paid the capital gains on my 2005 taxes.

    Now someone told me that because i had a qualified excuse, I should have been able to deduct 3/4 of the $250k primary residence capital gains deduction (since I lived there for 1.5 of the 2 years).

    a) is this true
    b) can I now file an amended tax return for that year and get the capital gains taxes paid back?

  21. Hi,
    I got married in 2008 and moved from Texas(no income tax) to California(lots of income tax). The move occurred on August 20. I am looking for help on my California taxes. I am filing jointly with my wife for both my federal and my state returns. I transferred positions with my company, so I have 1 W-2 with my earnings and my wife has 2 W-2′s (Teacher in texas, and new job in Cali).

    After filling everything in online for federal and state taxes, I noticed something interesting. When I add my wife’s earnings from her teaching job in Texas, and finish the California returns, my return from California is reduced by a significant amout (~700). All this income was earned in Texas, so I do not see why my California numbers are affected by this.

    Do you have any ideas on why California would claim this money? I am using online tax software offered by Taxact.com.

    Calfornia taxes too much,
    Johnny

  22. Great post!

    Quick question. If I have already filed this year, is there any chance I can still take advantage of some of the credits you mentioned above? If so, at what cost?

    Thanks!

  23. Just curious if we really are going to get these answered. I haven’t heard anything, has anyone else?

  24. [...] A few weeks ago, I offered you the opportunity to ask David Bergstein, professional tax analyst and CPA, your tax questions and a chance to get a free account at CCH CompleteTax. [...]

  25. I moved to Kansas to be a partner in a logistic company. I never filled out any W-2 or W-4. I assumed, and I know what assuming can do, that monies was being set aside for taxes. We had a falling out and I moved back to Dallas. On my last day in Kansas, the bookeeper asked me what my SS# was and I spat it out and left. Lo and behold, I get a 1099 in the mail from those guys. I was never given the business expenses for tax purposes, and they think I am going to file this way. I alone brought in all of the profit, and he and I split the profits 50-50. What do you suggest I do. I realize I must file a return, but have been wronged by my x-partner. Also, in his other businesses, they pay the workers under the table in cash without paying any tax or fica. Help !!!!!!!

  26. I have the same question already listed but could not find an answer. My husband voluntarily left his job as we could not sell our home. We moved back to our house and took a contract opportunity which did not offer health insurance. We have been on Cobra for all of last year. Can we deduct this on our taxes? I know we don’t qualify for the subsidy, but can we deduct this as a medical expense?
    Thanks!