Three tools to whittle that tax bill
US taxpayers still have time to make a few moves before the April deadline.
Liberal, conservative, independent, or party-line voter - it doesn't matter. When it comes to paying taxes, most Americans have the same attitude: Pay what you owe and not a penny more.
With that goal in mind and with April 15 less than three months away, taxpayers and tax preparers are still looking for ways to legally lower the tax burden to Uncle Sam. In fact, even though 2004 is now a fading memory, there are still ways to trim your tax bill. Here are a few tools you can use to build up that refund check from the Internal Revenue Service - or at least whittle down what you owe:
Not everyone, of course, has an employer-sponsored retirement account. That's where other plans like an Individual Retirement Account, a simplified employee pension plan (SEP), or a Keogh plan come into play.
"Ideally, you should be contributing to your IRA throughout the year by taking advantage of dollar-cost averaging," says Matthew Schaber, a certified public accountant from Grosse Pointe, Mich. "But if you haven't done that, it's better late than never. Depending on your income level and filing status, you may be able to deduct all or part of your contribution."
Since 1997, investors have had two main types of IRAs from which to choose: a traditional IRA and a Roth. Both allow a $3,000 individual contribution for 2004 ($3,500 if you are 50 or older). But the timing of their deductibility differs. Traditional IRAs offer an immediate deduction but gains are eventually taxed. Roths are taxed immediately but gains are forever tax-free. Which is best depends on your situation. Just remember that you can't get an extension for IRA contributions even if you request an extension of time to file the tax return.
Congress recently passed legislation giving taxpayers until Jan. 31 to make cash donations to relief groups addressing the Asian disaster and claim a tax deduction for 2004. Starting Tuesday, donors will have to claim deductions for 2005.
"This tax break should give people an extra incentive to support a great cause," says Donna LeValley, a tax attorney in Hoboken, N.J., who is also a contributing editor to "J.K. Lasser's Your Income Tax 2005." "It's rare when Congress makes a temporary change to the tax law, and charitable donations are an excellent way to reduce your tax burden to the federal government."
Donors large and small have stunned charities with their generosity in the wake of the tsunami. The American Red Cross and Catholic Relief Services have both said that they expect the tax break extension will also help extend the outpouring of donations.
Thanks to a multibillion-dollar corporate tax bill, individual taxpayers are receiving a new tax break. But it isn't an add-on; it will require a choice. For 2004 and 2005, taxpayers can deduct state sales taxes or their state income-tax amounts from their federal filings.
The choice is obvious for residents of the seven states that do not collect state income taxes but do levy sales taxes: Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. Deducting income taxes is the choice for residents of Delaware, Montana, and Oregon, which assess no sales taxes. (Alaska and New Hampshire have no taxes in either category.)
"All taxpayers get the chance to choose which deduction to take," says John Lipold, a spokesman for the IRS. "Basically, it will be up to the individuals to do the math and see which deduction, state income taxes or sales taxes, will save them more."
The sales tax deduction is available to filers who itemize their expenses on Schedule A. They will have two ways to determine how much to deduct. They can claim the total taxes paid based on actual sales receipts. (Hang onto those register tapes in case the IRS comes calling.) Or they can claim the amount found in newly created sales tax tables that the US Treasury has developed.
Most people probably will opt for the latter, given the ease of use. Even so, tax professionals advise people to choose carefully.
"Every family will be a little different," says Jackie Perlman, a senior tax research coordinator at H&R Block in Kansas City, Mo. "A family with a new baby might spend a tremendous amount of money outfitting a new nursery and find that they're better off adding up their actual sales tax receipts. They could look at the table and say 'we get a $450 deduction, but we've got receipts for $500.' "
everyone wants lower tax bills, but there's sometimes a fine line between tax avoidance and tax evasion. Manipulate the tax code too far and it could lead to an audit. To avoid that situation, tax professionals and the Internal Revenue Service are warning taxpayers against using certain methods:
• Home-office deductions. Home offices can provide taxpayers with a hefty tax break, tax experts say, but doing so has been risky in the past.
"The IRS cracked down on home business deductions many years ago, when they discovered that many people took the home-office deduction, but did not have a home business," says Eric Tyson, a coauthor of "Taxes 2005 For Dummies." "So be aware that your home business deduction may raise a red flag for an audit with the IRS."
• Not reporting all income. Thanks to computer cross-checking, the IRS has many ways of finding unreported income. "Be particularly careful if you're self-employed; anyone who pays you more than $600 in a year is required to file a Form 1099, which basically tells the IRS how much you received," says Scott Gulbransen of TurboTax in San Diego. Those who knowingly hide income face substantial penalties and, depending on the amount, criminal prosecution.
• Inaccurate returns. Check your math before sending in your return. Tax-software programs will do this for you. But if IRS computers find mistakes, you're more likely to be audited. "They figure that if they find obvious errors, not-so-obvious ones lurk beneath the surface," says Mr. Tyson.
• Tax shelters and other schemes. These may sound appealing, but make sure you understand any shelter fully before turning over money to anyone. "If it sounds too good to be true, it may be," warns John Lipold of the IRS.
Some taxpayers have novel ideas to cut their taxes. But these usually don't work. "I once had a client who thought that he could claim his daughter's car as a business expense because she could then drive herself to soccer practice.... The car, he reasoned, gave him more time to spend at the office," says Matthew Schaber, a certified public accountant in Grosse Pointe, Mich. "Clearly, this didn't pass the smell test and I dissuaded him from going through with this harebrained idea."
Before going ahead with any such idea, seek advice from an unbiased third party, such as a tax accountant.