All you need to break the code
Now that tinkering with the tax code has become a favorite congressional pastime, the annual filing season is more of an ordeal than ever, with laws kicking in and phasing out virtually every year.
This time around there are new breaks for songwriters, homeowners and onetime dot-com millionaires whose shares turned to dust. There are new hurdles for children with income, people who donate cash to charity and buyers of hybrid cars. A variety of income thresholds have been indexed to inflation, giving some a chance to claim breaks they might otherwise have missed. As always, there are a handful of nagging challenges when it comes to claiming breaks that aren’t specifically noted on tax forms.
And for millions of Americans, filing season has only just started, because last-minute changes by Congress made it all but impossible for the Internal Revenue Service to process certain forms before Monday of last week.
Ready? Here’s what you need to know about the work-in-progress tax code:
Laws passed in the last two years ushered in a host of new deductions and hazards to watch out for. Specifically:
Mortgage insurance write-offs. Mortgage insurance premiums are now deductible, but there are caveats. The insurance has to be on a mortgage that you used to buy your main or second home in 2007 -- not before. Jackie Perlman, tax researcher for H&R; Block in Kansas City, noted that the deduction is reduced for single or joint filers earning more than $100,000 and disappears entirely once income hits $110,000.
Debt cancellation exclusion. Before last year, if you lost your house in foreclosure or were forced to sell it for less than the loan amount, you’d typically be subject to “debt cancellation income.” The short version: The IRS assessed income tax on the money you didn’t have to pay back.
Let’s say you had a home with a $500,000 mortgage and a market value of $450,000. Before Congress passed a three-year exception to help people cope with the sub-prime crisis, if the lender took the home in foreclosure and you walked away owing nothing, the $50,000 difference was taxable income to you.
For 2007 through 2009, debt cancellation on your primary residence, whether as the result of a so-called “short sale” or a foreclosure, is not taxable. (Taxpayers are likely to get a 1099C showing the phantom income, however, so you must fill out a Form 982 to exclude that income from tax, Perlman said.)
Charitable receipts. The IRS will no longer take your word for the $20 you put in the collection plate each week, said Mark Luscombe, federal tax analyst at CCH Inc., an Illinois-based publisher of tax information. You need to either write a check or get a receipt for every donation. This documentation does not need to be sent with your return, but you should keep it just in case you’re audited.
AMT credit. If you paid the alternative minimum tax in a prior year because of a phantom gain, you might qualify for a refundable credit in 2007, Luscombe said. The credit phases out for singles earning more than $156,400 and married couples earning more than $234,600.
This break was designed to help former dot-com workers who received incentive stock options during the boom, only to have the value of these options evaporate later.
Many of these people owed hundreds of thousands of dollars in tax on phantom gains because of a glitch in the AMT law. They had complained for years that they were being made destitute by taxes owed on gains that had never materialized. This credit helps some in this group, those who paid AMT taxes prior to 2004, reclaim a portion of those taxes.
Song sales. If you wrote a song -- or inherited one -- and sold the rights for a profit, you get to take preferential capital gains treatment on the sale. That can save some songwriters 20 percentage points in tax.
Child exemptions. The clarification of rules stipulating who can claim a child as a dependent allows some unmarried partners and grandparents to take tax write-offs for children they support who might live with a parent.
Kids and taxes. Children under the age of 18 may have to pay tax on unearned income at their parents’ marginal rate. (The old law threatened kids with being subject to their parents’ rates only until the age of 14.) Full-time students can be subject to kiddie tax rules until they’re 24.
Here today, gone tomorrow
Two popular breaks expired in 2007, giving taxpayers one last chance to claim them.
Tuition and fees. Your 2007 tax return is your last opportunity to claim the tuition and fees deduction, a lucrative break for taxpayers paying college bills for themselves or a dependent.
Like many other tax breaks, this is income-tested. Singles earning less than $65,000 annually and married couples with less than $130,000 in adjusted gross income can claim a write-off of up to $4,000 for college costs paid last year.
The maximum deduction drops to $2,000 for singles earning between $65,000 and $70,000 and for married couples earning between $130,000 and $160,000. Those who earn more can’t take the deduction at all. If you paid college expenses in one of the last three years but missed this deduction, as many people did, file a 1040X to amend your return and get a refund.
Educator expenses. Last year also marked the end of the educator expense deduction, which allows schoolteachers to write off up to $250 in out-of-pocket costs to equip their classrooms.
Home energy improvements. If you bought energy-efficient equipment, ranging from new windows to water heaters, you might qualify for an energy improvement tax credit. If you bought a water heater or air conditioner, you could qualify for a credit of up to $300. You could get up to $150 for a new furnace, $50 for a furnace fan, up to $200 for replacing windows and up to $500 for buying insulation materials. But the credits are good only for products bought and put in service in 2006 and 2007. (The one exception -- a solar credit that can be worth as much as $2,000, has been extended to 2008.)
You won’t find a mention of two important write-offs anywhere on the 1040.
Adoption tax credits. If you finalized an adoption in 2007, you can claim a credit of up to $11,390 per eligible child. The credit cannot exceed your actual adoption expenses, which include attorney fees, court costs and travel expenses, unless you adopted a “special needs” child. Such children must be U.S. citizens or residents who can’t be returned to their parents. In these cases, the taxpayer can claim the full $11,390 credit, even if their adoption expenses were less.
This credit phases out for taxpayers with more than $170,820 in income. It’s gone for those earning $210,820 or more. If you are married, you must file a joint return to take this credit, but the phaseout ranges are not affected by whether you are married or single.
To claim the adoption tax credit, you need to fill out Form 8839 and check the box on Line 54 of the 1040.
Hybrid and alternative-fuel vehicle credits. Taxpayers who bought one of a range of fuel-efficient cars qualify for tax credits. They vary widely based on make, model and date of purchase.
That’s because the credits are based on a complex formula that involves energy savings over the life of the car compared to similar vehicles.
That’s an equation that the IRS and the Environmental Protection Agency had to work out. Add to that the complication that legislators decided to phase out the credits based on how many cars were sold by a manufacturer.
Once a carmaker sold 60,000 hybrids, buyers of that company’s cars received diminishing breaks. That worsened the deal for purchasers of Toyota and Lexus vehicles in mid-2007.
For a complete listing of the 2007 cars that qualify for hybrid credits, see chart below. To claim a fuel-efficient-vehicle credit, fill out Form 8910 and write the credit amount on Line 55 of the 1040.
Thank you, inflation!
If you got a lousy raise last year, you get a little solace at tax time. That’s because many parts of the tax code are now adjusted for inflation. The standard deduction for a married couple filing jointly, for example, is $10,700 for 2007, up from $10,300 for 2006. Personal exemptions now reduce your taxable income by $3,400 each rather than $3,300. In addition, the income levels at which you would start to lose some lucrative breaks, including the Hope and Lifetime Learning education credits and the student loan interest deduction, have all risen to reflect inflation. So if your income rose less than the inflation rate, you may qualify for some breaks that eluded you last year.