Limbo Your Way to Lower Taxes

The Major Phase-Outs

The list of tax breaks that phase out at certain levels of
adjusted gross income is long and growing — 25 at last count, says Mark
Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based
publisher of tax information.

Some of the most significant on 2008 returns and beyond:

• Child
  tax credit of $1,000 per dependent under age 17 starts
  to phase out at $75,000 for singles, $150,000 for married
  couples


• Hope
  tax credit to finance college bills of a freshman or sophomore starts to
  phase out at $48,000 for singles, $96,000 for couples


• Lifetime
  learning credit for education expenses starts to phase out at $48,000 for
  singles, $96,000 for couples


• Tuition
  and fees deduction, which can reduce taxable income by up to $4,000, begins
  to phase out at $65,000 for singles, $130,000 for couples

New phase-outs for 2009 returns:

• First-time
  homebuyer tax credit of $8,000 begins to
  phase out at $75,000 for singles, $150,000 for couples


• Adoption
  tax credit starts to phase out for both singles and married couples at
  $174,730 in income


• American
  Opportunity tax credit of up to $2,500 per college student starts to phase
  out at $80,000 for singles, $160,000 for couples


• Making
  Work Pay tax credit starts to phase out at $75,000 for singles,
  $150,000 for couples


• Vehicle
  purchase deduction, to offset sales taxes on new cars bought in 2009,
  starts to phase out at $125,000 for singles and couples

Avoid the Phase-Outs

There’s really only one way around the
phase-outs: to reduce your adjusted gross income enough that you dive under the
phase-out thresholds. Other than earning less money — not recommended
— the only strategy is to claim the most you can in above-the-line
deductions. They range from self-employment retirement plan savings to
rental-income expenses, and they work because, unlike most deductions, they’re
subtracted before adjusted gross income is calculated. The more you can
hack away at your income above the line the more you can drive your AGI below
the phase-out thresholds and increase your write-offs.

Here’s how to do it:

• Save
  for retirement in a tax-favored plan. You can set aside up to $16,500 a
  year (more if you are 50 or older) in an employer-sponsored retirement plan,
  such as a 401(k) or 403(b). We know, we know. You never want to put another
  penny in a plan that can lose 50 percent in a year. Well, you don’t
  have to put the money in stock funds, and you can still get the above-the-line
  write-off. The self-employed can save up to 25 percent of their self-employment
  income each year, or $46,000.


• Use
  your employer’s pretax plan for child care or health care expenses.
  A dependent care account might let you set aside up to $5,000 annually to pay
  for a nanny, preschool, or summer day care. A health savings account allows you
  to save for medical bills that aren’t covered by insurance, such as
  orthodontia and elective surgery. Let’s say you and your working
  spouse earn $140,000 in joint income and have $8,500 in day-care bills plus
  unreimbursed medical expenses such as deductibles and orthodontia. Pay the
  $8,500 through pretax savings accounts and you cut your adjusted gross income
  from $140,000 to $131,500.

Assuming a 30 percent marginal tax bracket, a couple who
paid for day care and health expenses through tax-advantaged accounts
(qualifying them, too, for $5,000 in income-tested child tax credits) and saved
$11,000 apiece in employer-sponsored savings plans could save $10,650 in taxes
by bringing their AGI below the thresholds for key tax breaks.