Yes, a simplified federal tax code would make life easier for many Americans. But since that's not the case, you may want to set aside a little time for a year-end tax checkup.
Making a smart tax move – or avoiding a bad one – may sound boring. But certain money-saving steps could turn into a beautiful holiday gift to your household.
Among the items that might warrant some attention this month: charitable donations, home improvements, and retirement accounts. To help you get started with your federal income tax, here are some tips and new rules that experts say taxpayers need to be aware of:
Before donating used items to charity, take a picture of them. It's not for sentimental reasons. Clothing and other in-kind gifts donated to charity after Aug. 17 must be in "good used condition" to qualify for the deduction. Photos might help prove that you complied.
"If it's something the organization will be able to sell," it probably meets the condition, says Maggie Doedtman, advice manager at H&R Block, a tax-service provider in Kansas City, Mo. In addition to taking photos, ask the charity to write "in good used condition" on your receipt.
Also note: Starting next year, small gifts of cash to charity aren't deductible. So come January, instead of dropping a $10 bill onto a collection plate at church, "throw a check in," Ms. Doedtman says.
Save on energy, save on taxes. "There are some new energy credits for energy improvements in the home," says Mark Luscombe, tax analyst at CCH, a Riverwoods, Ill., information service. But they "are only available this year and next."
A conservation-minded tax credit will cover up to $500 for items such as improved insulation, more efficient windows, and a better heating or cooling systems. Installing solar-powered systems to heat your home or water can generate credits up to $2,000 each.
And buying a hybrid car can get you a sizable tax credit worth $250 to $3,150, depending on the model. The size of the credit also hinges on when you bought the car and what company built it. The credit begins to shrink the second quarter after an automobile manufacturer has sold 60,000 hybrid vehicles.
Toyota hit that limit in May (the first carmaker to do so), but you can still receive half the original $3,150 credit if you buy before March 30, 2007. After that, you can get one-fourth of the original credit for another six months.
Don't ignore retirement incentives. Workers should take full advantage of 401(k) plans offered by employers willing to match a percentage of their contributions. It's free money – in many cases, an instant 50 percent return on investment.
Increasing contributions to a 401(k) before year end or to an individual retirement account (IRA) by April 16, could also make you eligible for the federal saver's credit. Designed to help people of modest incomes, this credit is worth 10 to 50 percent of the first $1,000 you save each year ($2,000 for joint filers).
The benefit shrinks as your income rises, however, and disappears for people with adjusted gross incomes of more than $50,000 for joint filers, $37,500 for heads of household, or $25,000 for other filers.
Then there's the other end of the retirement equation: distributions. Individual retirement accounts (IRAs) mandate that people over age 70-1/2 pull out a minimum amount every calendar year. The penalty is a steep one, 50 percent, notes retirement expert Ed Slott in Rockville Centre, N.Y. (Note: There's a three-month grace period that applies to a retiree's first distribution year.)
Offset some capital gains. In this perennial strategy to lower your tax bill, sell some investments that have lost value since they were purchased to counterbalance capital gains from mutual fund distributions or the sale of other investments.
But beware of the "wash sale" rule. The IRS says you can't claim a loss if you buy back the same stock or mutual fund (or a substantially identical one) within 30 days of selling it.
Empty all flexible spending accounts. If you have an employer who lets you tuck away pretax dollars to fund expenses such as healthcare, day care, or dependent care, make sure you've spent that money by the end of the year. Otherwise, you lose it.
Try to avoid the AMT. The alternative minimum tax was originally designed to cap the amount of taxes wealthy people can avoid paying. But the measure is affecting more and more people. As a result, millions of citizens must do their income tax twice each year: once to see what they owe, and once to see whether they really owe even more under the AMT.
The Internal Revenue Service has an online questionnaire to help you figure out if you owe it: http://apps.irs.gov/app/amt/index.jsp? Tax preparer H&R Block also has a handy calculator on its website (www.hrblock.com). To check whether you might be affected, click on "calculators" at the top of the page, then scroll down a bit to "AMT estimator."
The exercise could cause you to rethink the time-tested tactic of "bunching" deductible expenses into the current year to lower your tax liability. It's often a good idea, but some moves – such as paying your January property tax in December – could trigger the AMT.
People with $42,500 or less in adjusted gross income ($62,500 for joint filers) don't need to worry about the tax in 2006. But above that, look out.
The AMT allows some deductions, such as interest on your home mortgage, but limits others such as state, local, and real estate taxes, and personal exemptions. Stock options, too, can boost your liability.
"Unfortunately, it's pretty hard to avoid," says Mr. Luscombe of CCH. For many people, it comes down to "living in a high-tax state and having too many kids."
Tax breaks come and go, and over the weekend, Congress revived a bunch of them to lighten the tax load for Americans next April.
Among the 20 tax breaks it restored: the deductibility of state sales taxes. For the past few years, the measure has been a boon for people in states with limited or no income taxes. They include Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. In other states, filers with big sales tax bills (such as people who bought yachts) could deduct that amount instead of their state income tax, says Mark Steber, an analyst at Jackson Hewitt, a leading tax-preparation firm based in Parsippany, N.J.
Another provision brought back to life allows teachers to deduct up to $250 for school supplies they purchase. College students received a break, too, as Congress renewed deductions of up to $4,000 for higher education costs for individuals with incomes of $65,000 or less.
Even before the last-minute moves were made, some new opportunities were already set to come knocking in April. One is split refunds. For the first time, you can have a tax refund split among two or three direct-deposit accounts, including an IRA. Money funneled into an IRA by April 16 can count as a 2006 contribution, but remember to specify "for 2006."
Many taxpayers can also receive a one-time bonus in the form of a refund for the now-canceled federal tax on long-distance telephone calls. This credit is for taxes paid between Feb. 28, 2003 and Aug. 1, 2006. Few people will want to cull through old phone bills to tally this up. So the IRS offers a standard credit of $30 to $60, based on household size. It will show up on line 71 of Form 1040. People whose income is low enough that they don't need to file a return will use a form called 1040EZ-T to claim the credit. How do you know if you are eligible? The IRS website says you can call your phone company if you're not sure.