NEWS AND RESOURCES

Tip of the Month for January 2003

Be Prepared This Year
With the New Year upon us, now is the time to begin preparing your tax paperwork for April 15. Since the Internal Revenue Service collects on taxable income, the easiest way to cut your tax bill is to reduce your taxable income. You can do that by claiming deductions when you file your tax return. The best way to take these deductions depends on your personal circumstances. There are three deduction methods: standard, itemized or special.

Standard deductions. Each year, most taxpayers claim the standard deduction. The amount is adjusted annually for inflation and varies depending upon a taxpayer's filing status. Married couples that file joint returns are given the biggest standard deduction, while couples opting to file separately get the smallest. In between are the amounts for single taxpayers and those who qualify for head-of-household status. The standard deduction is increased a bit for blind and elderly taxpayers.

Itemized deductions. Taking the standard deduction may be easy, but it could cost more than it should. Individuals who spend a lot on medical care, mortgage interest, state and local taxes, charitable contributions or a variety of miscellaneous items frequently are better off itemizing. When these expenditures exceed the standard deduction, you save on your taxes. By keeping track of these expenses and listing them on Schedule A, you could come up with a substantially larger dollar figure than the standard deduction amount. There are a couple of things to keep in mind when you itemize.

First, the paperwork. There's that extra form, Schedule A, to contend with, and it must be filed along with the longest of the individual returns, the 1040.

Next, and more to the tax-saving point, not every dollar you spend can be subtracted from your income. Tax law sets thresholds a filer must meet before some deductions can be claimed. In the medical category, only expenses that exceed 7.5 percent of your adjusted gross income can be deducted. If you didn't spend at least that much, then none of your costs are deductible. You have to reach a 2-percent-of-income threshold before you can use miscellaneous deductions such as unreimbursed job expenses and investment and tax preparation costs. There also are restrictions on how much in casualty losses you can deduct, as well as limits on the deductibility of very large charitable contribution amounts. And once you do total your itemized deductions, the actual amount you can claim may be reduced if you earn a lot.

Married couples that file separately also must work together when it comes to deciding which deductions route to take. Even though each partner will fill out a separate return, if one spouse decides to itemize, the other must do so, too.

Finally, some taxpayers must itemize even if the standard deduction would be more favorable. They include nonresident aliens, dual-status aliens and individuals who file returns for periods of less than 12 months.

Special tax deductions. In addition to standard and itemized deductions, there is a third group of tax-reducing options known as above-the-line deductions. Their name comes from their paperwork placement; they are found on page one of Form 1040, just above the line where adjusted gross income is tabulated. Eligible taxpayers, regardless of whether they itemize or claim the standard deduction, can take these deductions as long as they file that longest of individual tax returns.

These additional tax breaks include deductions for:

  • Expenses by teachers and other educators for classroom supplies

  • Contributions to a traditional individual retirement account

  • Interest paid on a student loan

  • Payment of tuition and fees to an eligible educational institution

  • Money placed in a medical savings account

  • Costs of moving to take a new job

  • One-half of self-employment taxes paid

  • A portion of self-employed health insurance costs

  • Contributions to self-employed retirement plans

  • Penalties paid on early withdrawal of savings

  • Alimony payments

Several miscellaneous (and not regularly incurred) costs, including performing arts expenses, jury duty pay given to an employer and the purchase of a clean-fuel vehicle, including hybrid gas-electric cars. While there's no Schedule A to complete, with its percentage-of-income thresholds and deduction phase-outs, in order to claim many above-the-line deductions taxpayers must meet certain qualifications and may have to fill out some worksheets to make sure they are eligible.

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