Don’t give Uncle Sam more of your hard-earned money than you should. Just follow these five tips!
1. Choose the right filing status.
Choosing the correct filing status is complicated for many taxpayers. For example, while the term “head of household” may seem to apply to anyone who maintains a household, there is actually a strict set of guidelines for who actually qualifies to claim such a status. Taxpayers who are recently divorced, separated or widowed need to pay especially close attention to filing status rules. And remember, sometimes it is the dependent exemptions that dictate a taxpayer’s filing status.
And speaking of dependent exemptions, they can be complicated, too, especially for parents who are separated or divorced or have children in college, or for taxpayers who take care of their elderly parents. Remember, dependents may be claimed by their parents even if they worked during the year, and a dependent born anytime in 2010 is considered to have lived with the taxpayer all 12 months.
See Publication 501 Exemptions, Standard Deduction, and Filing Information for more info www.irs.gov/pub/irs-pdf/p501.pdf
2. Report income correctly . . . and in the right place.
The Form 1040 has 21 lines and too many pages to count dedicated to income, so make sure every line is completed carefully and correctly because making a mistake can be costly.
Stock Sales - Many taxpayers assume there is no need to report proceeds from a sale of stock if it results in a loss. Keep in mind that, for now, only gross proceeds are reported to the IRS. So show the loss on your tax return by reporting gross proceeds and cost basis, or the IRS will consider just the gross proceeds as taxable income.
Cancelled Debts – If you settle a debt with a creditor, the amount of debt forgiven is taxable in the year forgiven, unless an exception applies. Taxpayers whose debt forgiveness resulted from bankruptcy or who are insolvent may be able to exclude this income.
Side Jobs – In this economy, many taxpayers have taken second jobs. If your income is considered freelance or subcontractor income, it is generally reported on Schedule C.
Withdrawal from IRA or Pension – Taxpayers often withdraw from their IRA or retirement plan during the year and then forget about it when tax time arrives. Most of the time, taxes are withheld, but the income and withholding must be reported on the tax return. Don’t assume that since taxes were withheld, no more reporting is required. (And remember, early distributions from a retirement account are subject to an additional 10% penalty unless an exception applies.)
See IRS Publication 525 Taxable and Non-Taxable Income for more info www.irs.gov/pub/irs-pdf/p525.pdf
3. Deduct expenses in the right place to get the most bang for your buck!
Just like reporting income, making sure your expenses are in the right place makes a big difference.
Job Expenses – First, determine whether expenses are related to your job as an employee or as a freelancer or subcontractor. Then make sure you report those expenses accurately. Expenses that apply to you as an employee should be reported on Schedule A or Form 2106. Expenses for your freelance or subcontractor job should be reported on Schedule C, since incorrectly reporting those expenses on Schedule A or Form 2106 could cost you over 15%.
Health Insurance Premiums – Most taxpayers who have these benefits provided by their employer are already enjoying a pre-tax benefit. But if you are writing out the check, your premiums are probably deductible. If you are an employee, you’ll deduct this expense on Schedule A. If you are self-employed, however, be aware of special rules for 2010 that may allow you to deduct this expense without itemizing and also reduce self-employment tax on Schedule SE.
4. Higher education expenses – deduction or credit? Choose wisely.
One of the best legislative changes in recent years is the addition of the American Opportunity Credit for higher education expenses. Sadly, many taxpayers miss it, thinking a deduction is better than a credit.
The American Opportunity Credit allows taxpayers a credit of up to $2500 – yes, it is like extra $$$ in your pocket! While taxpayers may use the Tuition and Fee Deduction, using the Credit instead could save them BIG. And unlike the Hope Credit offered in the past, the American Opportunity Credit includes required books, supplies and equipment. A word of caution: be sure to take into account grants and scholarships received and reduce tuition accordingly in order to determine the actual amount eligible for credit or deduction.
See IRS Publication 970, Tax Benefits for Education, for more info www.irs.gov/pub/irs-pdf/p970.pdf
5. Residential energy credits – make sure your improvement qualifies.
Everyone’s going green, but if you want a residential energy credit, make sure your home improvement is green in the eyes of the IRS. For example, just because you replaced your existing heating system with a more efficient unit does not automatically qualify you for the credit; you must have the certificate stating so. For heating & cooling systems, obtain an AHRI Certificate stating that the improvement qualifies for a “Federal Energy Efficiency Tax Credit.”
For windows, insulation and other improvements, read the instructions for Form 5695, Residential Energy Credits, www.irs.gov/pub/irs-pdf/f5695.pdf and www.ahridirectory.org or www.energystar.gov for more info.
So, do your homework and get it right, and you can avoid getting that dreaded IRS notice in the mail. Pay the tax you should, but not a penny more!
by James Lowe, EA
Note: You may watch Jim's interivew by clicking here.