New law creates tax break hide-and-seek
Michael and Kathy Hale are losers in America’s new, and often vexing, game of tax break hide-and-seek.
The reason: They bought a first home at the end of November -- one month and seven days too soon. The date of the purchase cost them $8,000.
In an era of ever-changing tax law, the Hales’ misfortune illustrates why all taxpayers need to do a little planning for 2009 -- even if they haven’t quite wrapped up filing their 2008 returns
“I’m frustrated,” said Michael Hale, 55, a lifetime renter who opted to take advantage of the fledgling tax credit for first-time home buyers to purchase a three-bedroom residence in West Sacramento. “They’re giving $8,000 to anyone who came even a little bit after me.”
The recently passed economic stimulus package, the American Recovery and Reinvestment Act of 2009, ushered in a host of deductions and credits that can save taxpayers thousands of dollars on their 2009 taxes. The law provides tax giveaways to homeowners, college students, car buyers, environmentalists, retirees and workers.
But the breaks can be frustratingly elusive, subject to income restrictions, complex rules and short-lived effective dates.
Moreover, the president’s proposed budget also calls for reductions in some tax breaks, including the mortgage deduction for people who make more than $250,000 a year.
“You have nine or 10 months to make some adjustments that could work to your advantage,” said John Hewitt, chief executive of Liberty Tax Service, a Virginia Beach, Va., tax preparation firm. “With this massive tax change, it’s more important than ever to stop simply keeping score of what happened in the past and start planning for the future.”
What new tax breaks does the act provide, and how can you get a piece of the action?
The most lucrative new break is the one that skittered away from the Hales: an $8,000 tax credit for buying a first home. This break is actually a revised version of a tax credit that was passed in 2008. The 2008 credit was for $7,500 and it was really a no-interest loan. Taxpayers could get the money upfront, but they have to start paying it back in 2010 in 15 equal installments.
For those who qualify, the new credit is fully refundable -- meaning that you get the $8,000 even if you didn’t pay that much in tax -- and doesn’t have to be paid back if you keep the home for at least three years. It is, in effect, less of a tax break than it is a subsidy for buying. Better yet, even if you buy a house in 2009, you can take the credit on your 2008 tax return.
The Hales were tripped up by the timing. Only purchases made during an 11-month period this year, Jan. 1 to Nov. 30, qualify for the $8,000 deduction.
The Hales bought too soon because they thought that the new credit would be made retroactive. When Congress passed the bill last month, it did make the break retroactive, but only to the beginning of January. The Hales closed escrow Nov. 24.
Another catch is that the credit is income-tested. Singles earning more than $75,000 a year and married couples earning more than $150,000 start to lose a piece of it as soon as their income exceeds those thresholds. It’s gone when a single income exceeds $95,000 and when joint income is over $170,000.
Finally, if you don’t keep the home for at least three years, you may have to repay the credit.
* Workers: The provision that will affect the most people is called the “Making Work Pay” credit, which benefits everyone with wages or self-employment income. It’s $400 for single filers and $800 for married couples.
The catch: If you earn more than $75,000 when single or $150,000 jointly, you start to lose the credit. At a single income of $95,000 and married income of $190,000, it’s gone. And it’s available only for 2009 and 2010.
One caution: Employers have been instructed to provide the credit to workers upfront by taking a bit less in income taxes out of every paycheck. That’s great if you have just one income, said Jackie Perlman, an analyst with the Tax Institute at H&R; Block.
But married couples and people who have several part-time jobs could wind up paying too little tax under this plan, and wind up with a big bill -- and penalties -- at year’s end, she said. So if you are married or have more than one job, you should talk to your employer and fill out a W-4 form to boost your withholding rate to where it was before, she suggested.
* Retirees: About the only simple credit in the bill is a $250 one-time “economic recovery payment” that goes to Social Security retirement and disability recipients, as well as veterans and some other government pensioners. Everybody but the government retirees will get a check in the mail sometime this summer. They don’t have to file a form or undergo an income test.
The government retirees will have to claim their $250 when they file 2010 tax returns.
* Car buyers: In an effort to get Americans shopping again, legislators created a deduction equal to the amount of sales tax paid on a new car purchased between Feb. 17 (the date of the law’s enactment) and the end of the year.
The deduction will be less helpful for those who live in states with no income tax, because they usually are already writing off their sales taxes. But in California, where more people write off state income taxes, the deduction could be a boon.
You will be able to claim this deduction even if you don’t itemize.
But the deduction is only for 2009, and it’s income-tested, so singles earning more than $125,000 and married couples earning more than $250,000 start to lose the deduction until they’re completely phased out at single income of $135,000 and joint income of more than $260,000.
Finally, it is available only for the tax paid on up to $49,500 of the car’s price. So if you bought a $250,000 Aston Martin, your write-off would be limited to about $4,400 (assuming a 9% sales tax), not $22,500.
* College students: A more generous tax credit for those paying college bills goes into effect for 2009 and 2010. The American Opportunity Tax Credit, which temporarily supplants the Hope credit, provides as much as $2,500 in tax savings per student per year. Previously, tax credits for education ranged from $1,800 to $2,000.
The new credit phases out for singles earning more than $80,000 and married couples earning more than $160,000. It’s gone once single income exceeds $90,000 and married income is over $180,000.
* Environmentalists: Tax credits for buying energy-saving products, including double-pane windows and water heaters, are back. A similar group of credits expired in 2007, said Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill., publisher of tax information. But the American Recovery and Reinvestment Act reinstated them for 2009 and 2010 purchases and made them more generous.
Now, you can write off as much as 30% of the cost of insulation, energy-efficient air conditioners and furnaces, as well as some metal roofs, stoves and circulating fans. But the total credit available is $1,500, and it’s a lifetime limit.
* Increases in the offing: Although the proposals have not been passed, President Obama has said he wants to impose higher income and capital gains taxes on wealthy filers and restrict itemized deductions for those earning more than $200,000 to $250,000 a year. The proposal has been greeted with a firestorm of protest, but many tax experts believe that high-income filers face higher taxes ahead.
How can you plan for these changes?
Accountants suggest that you look to manage your “adjustable gross income,” or AGI, in years that you might qualify for income-tested breaks. That’s your income after you contribute to things like retirement accounts and health savings accounts. There are about two dozen income-tested breaks today, said Luscombe, including those mentioned in this article.
Your ability to qualify for these deductions and credits rests on the adjusted gross income, which can be reduced by contributing to pretax accounts, such as 401(k) retirement plans and dependent care and healthcare savings accounts.
What good does that do?
Consider a two-income family earning $180,000 with two children in college. If the couple do nothing to manage their adjusted gross income, they miss out on the American Opportunity Tax Credit for both students. That costs them $5,000 in tax. But if they each contribute $10,000 to their 401(k) plans, it allows them to dive under the $160,000 AGI threshold and claim the credit.
Using the 401(k) saves them income tax too.
And if you’re thinking about buying a car or a home, make sure you pay attention to the effective dates on the new deductions and credits so you don’t get shut out like the Hales.
“You shouldn’t buy anything that you wouldn’t buy otherwise,” said tax analyst Perlman. “But if you’re planning to get a new car or home or a boiler, you can’t delay much, because most of these benefits are here today and gone tomorrow.”
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