But fear not: The Early Show financial guru Ray Martin is imparting words of wisdom in a three-part series designed to help you face the annual ritual of filing your income tax return.
In part one, Martin addresses getting as much money back from the government as possible. He discusses some new tax breaks, as well as others he says not to miss.
In part two, he'll tell how to avoid an IRS audit, and in part three, he'll offer advice on putting your tax refund to work for you.
This year, you need to be more careful than ever to make sure you don't miss out on some tax breaks and deductions. In fact, millions of taxpayers and their professional tax preparers are not claiming some basic tax breaks, some of which are available to almost everyone.
One reason for the confusion: Congress was too preoccupied during the elections to do its work in Washington, and waited until last December to pass a bill extending some key tax breaks that were set to expire in 2005. But, by the time Congress passed the tax bill, the IRS had already sent the 2006 tax forms and publications to the printer, so the forms didn't have the lines and instructions for three key deductions:
Educator Expenses: Teachers and educators can claim a deduction for up to $250 for out-of-pocket expenses for classroom supplies on their 2006 tax returns. If you and your spouse are filing jointly and both of you are teachers, then you can claim a deduction of $500. However, neither spouse can deduct more than $250 of his or her qualified expenses. Claim this deduction on line 23 of form 1040 — even though the line is marked "Archer MSA Deduction" – and write an "E" on the dotted line to the left of the entry.
Tuition and Fees: In 2005, about 4.7 million taxpayers claimed about $10.9 billion in deductions for tuition and fees. On your 2006 tax return, you can continue to take a deduction for qualified higher education expenses, which is available whether you itemize deductions or not. You can deduct up to $4,000 of qualified tuition and fees you paid in 2006 if your adjusted gross income is $130,000 or less for joint filers ($65,000 for single filers). This deduction is limited to $2,000 or less if your AGI is higher ($160,000 for joint filers, $80,000 for single filers), and this deduction may not be claimed for the same expenses used to claim the Hope or Lifetime Learning tax credits. Claim this deduction on line 35 of the form 1040 (which says "domestic production activities deduction") and write a "T" in the space to the left of the entry.
State and Local Sales Tax: You may deduct either your state and local INCOME taxes OR the state and local SALES taxes paid, whichever is higher. If you made a big purchase, such as a car or boat last year, or live in one of nine states with no state income taxes, then the deduction for state sales taxes could be for you. Even if you don't have receipts for sales taxes, you can use the Optional State Sales Tax Tables, which assign an amount you can deduct, on top of any sales taxes you paid on big ticket items. See IRS Publication 600. If you take the deduction for state sales taxes, enter this on line 5 of Schedule A and write "ST" next to it. According to the IRS, in 2005 an estimated 11.2 million taxpayers claimed over $17 billion in deductions for state and local sales taxes.
Phone-Tax Credit: After losing several court cases last year, the federal government stopped collecting a 3 percent tax on long distance and bundled phone services and was ordered to provide refunds to affected customers. As a result, any taxpayer who has paid a bill for long distance or bundled phone services anytime from March 2003 through July 2006 is eligible to claim a one-time-only tax credit for "federal telephone excise taxes" on his or her 2006 tax return. To claim this credit, taxpayers can simply use the standard amount allowed by the IRS, ranging from $30 to $60, which is based on the number of exemptions on your return. A more tedious option is to go through the old phone bills you paid from March 2003 through July 2006 (you've saved all those, right?!) and claim the amount of these taxes you actually paid. Either way, this tax credit can be claimed on a new line 71 of form 1040. According to the IRS, most of the 136 million 2006 tax returns expected to be filed should be eligible to claim this credit. But as of mid-February, about 10 million returns, or 3 in 10, did not include this one-time refund on their returns. And don't think your professional tax preparer will claim this for you: According to the IRS, nearly half of the 10 million returns lacking this easy-to-claim tax refund were completed by a paid tax preparer.
Other Don't Miss Tax Breaks
Retirement Savings Contributions Tax Credit: If your adjusted gross income is $50,000 or less for joint filers ($25,000 or less for single), then you can get a tax refund of as much as $1,000 if you make at least $2,000 in contributions to a retirement plan (such as a 401k or a 403b) or to an IRA. This credit is in addition to the deduction from income you get by making such retirement contributions with pre-tax dollars. To calculate this credit, use Form 8880 and enter the credit on line 51 of form 1040.
SEP IRA Contribution: If you have income from self-employment, then you can deduct a contribution to a SEP IRA (Simplified Employee Pension) of 25 percent of self employment income, up to a maximum of $15,000. You are allowed to set up and contribute to a SEP IRA by the date you file your tax return which, if you file an extension, can be as late as Oct. 17 this year.
Student Loan Interest Deduction: You can deduct up to $2,500 of interest you pay on qualified student loans, whether you itemize deductions or not. The full $2,500 deduction is allowed for joint filers with adjusted gross income of up to $100,000. Claim this deduction on line 33 of form 1040.
Residential Energy Tax Credit: A new tax credit allowed on 2006 tax returns is for the costs of several home improvements that make your home more energy efficient. For example, homeowners can claim a tax credit of up to $500 of the costs of insulation and heat-reducing metal roofs and up to $200 for energy-efficient windows. Homeowners can also claim a credit of 30 percent, up to $2,000, for the costs of solar water heating or photovoltaic energy saving home improvements. The credit is calculated on IRS form 5965 and entered on line 52 of form 1040.
Foreign Tax Credit: Investors who owned foreign stock mutual funds in taxable accounts should review their form 1099 carefully for any reported foreign taxes paid by the mutual fund. A tax credit is available when a mutual fund you own pays taxes in a foreign country. Look on the form 1099 that the fund sent to you, You'll see a line item for foreign taxes paid, which you can claim as a tax credit. If the amount of foreign tax credit claimed is more than a few hundred dollars, you may need to complete Form 1116.
Miscellaneous Deductions: Don't forget a group of deductions for various expenses, including job search costs, out-of-pocket costs for business phone calls, subscriptions for work-related publications, dues for professional associations, tax preparation fees, investment advice fees, union and professional dues, uniforms and protective clothing, and more. When the total of all of these expenses exceeds 2 percent of you're adjusted gross income, the amount over that limit is deductible.
Charitable Donations Get Tricky
Under a new provision of the Pension Protection Act, which was signed into law in Aug. 17, 2006, donations of property such as household items or clothing made after then must be in "good" or better condition for the deduction to be allowed. If the IRS questions your deductions for used household items, you'll need to provide proof of good condition, either by producing photographic evidence or a written statement of condition from the charity that received the donation. Also, the IRS will deny deductions of items of "minimal monetary value" such as underwear and socks.
The most common form of small gifts is cash. But giving cash may no longer be a good idea because, starting in 2007, all such gifts, regardless of the amount, must be supported by a receipt, such as a cancelled check, bank records, paycheck statements, credit card statements or other written documentation from the charity. So the IRS will deny your claim of the cash you give during religious services if you do not produce a receipt as proof of it.
Charitable Gift Funds Become More Popular
For the reasons above, charitable gift funds have been increasingly recommended by financial advisors to their clients lately. Charitable gift funds are tax-qualified public charities that are set up and administered by mutual fund companies and financial institutions. Essentially here is how it works: You set up your own charitable gift account and make a contribution to it. The contribution will qualify for a charitable gift deduction. Then you recommend (but not command) that the fund dole the money out to various charitable organizations that you select. In effect, the account you to set up is your own mini-private foundation without the cost of establishing a private foundation for yourself.
The charitable gift fund administrator will check out the charities you recommend to ensure that they are qualified under the IRS regulations. If the charities check out, the fund makes the requested distributions to your charities, and they handle all the administrative aspects of the distributions. Until your account is completely distributed, it can continue to grow tax-free. And, some funds allow you to direct distributions to an unlimited number of charities whenever you want, in amounts as low as $100 per distribution. Donor-advised funds associated with mutual fund companies and investment houses will allow you to designate how your account is invested, giving you a choice of several investment pools containing various mutual fund alternatives. The largest and most well known of these charitable funds is the $2.2 billion Fidelity Investments Charitable Gift Fund, which claims to be the largest grant-making organization in the United States. Other charitable gift funds include The Vanguard Charitable Endowment Program, The National Philanthropic Trust, Schwab Fund for Charitable Giving, and the Eaton Vance U.S. Charitable Gift Trust.
Hire a Pro and Pay Less Tax?
There are no studies that suggest that tax professionals get bigger refunds for their clients. In fact, a government study indicated that 49 percent of the tax returns in which taxpayers may have overpaid due to failure to claim itemized deductions were prepared by a third party.
Not having the time or resources to prepare your own tax return is the most popular reason for using a professional tax preparer. Using a tax pro with experience in the unique and legitimate tax strategies of your specific industry or situation can also help you maximize your tax savings.
But don't be tempted to save a tax pro's fee by following last year's forms prepared by a pro and doing this years return yourself. If you do, at least hire a tax pro to look over what you did to determine if you prepared your return correctly, or if there are new forms you might need to file.
A professionally prepared tax return is well worth the reasonable fee most pros charge. But having a "Preparers Signature" at the bottom of your return doesn't mean it has more credibility with the IRS. The IRS requires preparers to provide their name, Social Security number and signature in the "Paid Preparer" section so the IRS can verify that they are reporting their income from this activity.