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Federal Income Tax Tips
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federal income tax tipsA Tax Credit is Better Than A Tax Deduction

What's the difference between a tax credit and a tax deduction? Tax credits are worth more than tax deductions. A tax credit of $1,000 will reduce the income tax you owe by $1,000. Usually, you must complete an additional form to claim the credit. A deduction is worth much less. If you are in the 28% tax bracket, some of your income is being taxed at 28%, the highest tax rate. A deduction of $1,000 will save you $280 in tax.

federal income tax tipsOn the Federal Income Tax Return
There Are Three Kinds of Tax Deductions

1. "Above the line" deductions can be subtracted directly from income. Examples are alimony payments, business expenses, IRA deduction, capital loss deduction, and others.

2. Every taxpayer is entitled to the "standard" deduction," which is $5,150 for a single person.

3. "Itemized" deductions are Schedule A deductions. Instead of claiming the "standard" deduction, you can choose to itemize your deductions on Schedule A. Examples of Schedule A deductions are medical expenses, taxes (but not federal income tax), charitable contributions, property taxes, mortgage interest and casualty and theft losses.

Should I itemize my expenses, or take the standard deduction? Calculate your taxes both ways and choose the larger deduction.

federal income tax tipsOn the Federal Income Tax, What is AGI?

There are two terms that the IRS throws around on your federal income tax return, AGI and MAGI. AGI is Adjusted Gross Income, MAGI is Modified Adjusted Gross Income. AGI is the total of all the income you are required to report, minus the deductions for alimony payments, business expenses, capital loss, teacher's expenses, health Savings Account HSA contributions, Individual Retirement Account IRA deductions, student loan interest, and tuition and fees, among others. AGI will be the amount on line 37 of your 1040 tax return.

On the other hand, MAGI is not a line on your federal income tax form. It is computed many different ways as a limit for various deductions, and is computed using AGI plus some deductions that must be added back. MAGI is a floor or ceiling for deductions, and its computation varies for different tax items.

Some deductions and credits are reduced or eliminated for taxpayers with a high AGI or MAGI.

federal income tax tipsMedical Expenses Are Deductions on Your Federal Income Tax Return

Did you pay for medical expenses that were not covered by insurance? They are deductible, if you elect to itemize your deductions on Schedule A, Form 1040. Only the amount in excess of 7.5% of your AGI is deductible. You can include the following items, as well as many others: The health insurance premiums you pay. Medicare Part B and Medicare Part D payments. Stop-smoking programs. Weight-loss program required because of obesity, high blood pressure or other medical condition. Childbirth classes. Birth control pills. Car mileage at 18 cents a mile for trips to the doctor, pharmacy and AA meetings. Your insurance co-payments. A portion of your premiums for long-term care insurance. And many others.

federal income tax tipsChild Care Is a Deduction
On Your Federal Income Tax Return

In order for you to work, did you pay child care for your child or dependent this year? You should claim the dependent care credit on your federal income tax form. The credit can be as high as 35% of your child care expenses, up to a maximum of $1,050 for one child, or $2,100 for two or more children. Remember, a credit of $1,050 will reduce your taxes by $1,050.

Did you adopt a child this year? You can claim a tax credit for the costs of the adoption, up to a maximum credit of $10,960 per child. All of the expenses of the adoption, like agency fees, court costs, attorney's fees and travel expenses qualify for the tax credit. For very high income taxpayers with a Modified Adjusted Gross Income over $164,410, the adoption credit is reduced.

Do you receive foster care payments for a child who was placed with you by a qualified placement agency? You are not taxed on any of the payments. They are excluded from your income.

Did you receive child support payments as the result of a divorce or separation agreement? They are not taxable, no matter how large. They are excluded from your income.

Did you pay alimony or spouse support? You can deduct these payments, as long as they are required by the divorce decree and you live apart from your spouse. Payments made as part of the divorce property settlement are not deductible on your federal income tax return.

federal income tax tipsCollege Expenses Are a Deduction
On Your Federal Income Tax Return

Did you pay college tuition and fees this year for yourself or your child? You may take either the Hope credit or the Lifetime Learning credit, whichever applies. If they both apply to you this year, the Lifetime Learning credit will be higher than the Hope credit when college expenses exceed $7,500. Use Form 8863, Education Credits when you prepare your federal income tax return.

The Hope credit is a federal income tax credit for the cost of tuition and fees during the first two years of college, if the student is pursuing a degree. Maximum credit per student per year is $1,650 and may be taken by the student or the parent, but not both. If the student takes the Hope Credit, the parent may not claim the student as a dependent. Note that the college expenses you pay with tax-free money from a Coverdell education savings account or a 529 plan are not eligible for the Hope Credit. Also, if you take the above-the-line deduction for college expenses, you cannot claim the Hope credit.

The Lifetime Learning credit is also available if you paid the costs of higher education for yourself, spouse or dependent this year. It is not necessary for the student to be in the first two years of college or in a degree program. The maximum credit is $2,000 per year per taxpayer. There is no limit on the number of years you can take this credit.

If you don't take the Hope credit or the Lifetime Learning credit, you can take a deduction from gross income of up to $4,000 for the cost of college tuition. You don't have to itemize to take this deduction on your federal income tax. Remember, a tax credit saves you more money, sometimes 4 or 5 times more, than a deduction.

Did you pay college expenses at a college in a region affected by Hurricane Katrina? You may double the amount of the Hope credit or the Lifetime Learning credit. You can also include the expenses of room and board when you compute the amount of the credits.

Did you pay for education related to your current line of work, that your employer did not reimburse? If you itemize your deductions, you can deduct the portion of your education expense that exceeds 2% of your AGI.

Are you paying interest on your student loans? If you are, you can deduct up to $2,500 of the interest paid this year. The deduction is reduced if your MAGI exceeds $50,000. Even if you don't itemize your deductions on Schedule A, you can take this deduction.

If you redeem U.S. savings bonds, and use the money to pay for college, you are not taxed on the interest they earned. The exclusion is reduced if your MAGI is over $63,100.

Did you withdraw money early from an IRA, before age 59 1/2, to pay for higher education for yourself, your spouse or dependent? The penalty for premature withdrawal of IRA funds is waived.

federal income tax tipsCharitable Contributions on Your Federal Income Tax Return

Did you contribute to a charity with cash, check or credit card? You can deduct the amount, if you itemize your deductions on Schedule A. The maximum deduction is 50% of your AGI, but any unused deduction can be carried forward to next year's tax return (5 year carryforward). If any one donation at one time is more than $250, you must have a receipt from the charity. These non-profit organizations can be churches, schools, sports, fraternal organizations, as well as the Scouts, Red Cross, United Way, and many others.

If you volunteer at a charitable organization, you can deduct out of pocket expenses, parking and tolls, and car mileage at the rate of 14 cents per mile. However, you can't deduct the value of your time.

federal income tax tipsBusiness Use of Your Car is Deductible
on Your Federal Income Tax Return

Did you use your personal car for business without reimbursement? You can deduct either your actual car expenses or deduct 44.5 cents a mile for business driving, plus parking and tolls. You must keep a log of date, destination and purpose of each trip. Enter this as a miscellaneous itemized deduction on Schedule A.

federal income tax tipsMore Income Tax Deductions and Credits for Your Federal Income Tax Return

If you paid for job expenses that are ordinary and necessary to do your job, you can deduct them on Schedule A with your federal income tax return, as a miscellaneous itemized deduction. The deduction is the amount you paid in total, minus 2% of AGI. If you have several job expenses, use Form 2106, Employee Business Expenses. Some of the deductible expenses are work tools, subscriptions to professional magazines, uniforms, special laundering, work shoes, union dues and fees, job hunting costs if you are unemployed, cell phone and PDA, and many others.

Was your car damaged in an accident that insurance did not cover? This is called a casualty loss, and you can deduct the amount of the loss, minus any insurance payment received, minus $100. The deduction is limited to the amount you paid for the car, and is reduced by 10% of your AGI. You must itemize these deductions on Schedule A and complete Form 4684, Casualties and Thefts.

Did you buy a new electric car? Did you know that you can claim a tax credit of 2.5% of the cost of the car on your federal income tax return? The maximum credit is $1,000.

Did you lose money in the stock market? If you owned the stock for a year or more, and sold it this year at a loss, you can deduct up to $3,000 as a long-term capital loss this year. The balance of the loss can be carried forward to next year's federal income tax return (unlimited loss carryforward).

If you sold several stocks this year, there are special rules for calculating your short term gain or loss and your long term gain or loss.

Are you a teacher who buys classroom supplies with your own money? You can deduct up to $250 of these expenses on your federal income tax return. This deduction is "above the line," so you can claim it even if you don't itemize your deductions. The deduction is expected to be renewed for this year. In a previous year, 3.3 million teachers took an average deduction of $250 each for classroom supplies.

With these tax tips, you can save money this year on your federal income tax.

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