Deduction Planning: This goes hand-in-glove with income planning (which we discussed last week in Part III). If you believe that your marginal tax rate will be greater for the 1999 tax year (this year) than it will be for the 2000 tax year (next year, filed in April 2001), you'll want to accelerate deductions into your 1999 tax return. If you believe that the opposite is true (that your 2000 marginal rate will be greater), then you'll want to defer deductions into next year to claim on your 2000 tax return.
But deduction planning is difficult because many deductions are affected by your Adjusted Gross Income (AGI). For example, your overall itemized deductions will be reduced by 3% of the AGI exceeding $126,600 if you are single, married filing jointly, head of household, or qualified widow(er) ($63,300 if you are married, filing separate). And, as you are likely also aware, certain itemized deductions may only be claimed if they exceed a certain percentage of your AGI: 7.5% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses.
Deduction planning is also made difficult because of the standard deduction. If your itemized deductions don't exceed your standard deduction, they do you absolutely no good. If you find yourself in this situation, you might consider "bunching" your itemized deductions every other year. The strategy lets you take the standard deduction one year and then double-up the deductible expenses you pay in the following year to push you over the standard deduction threshold. One example is making charitable contributions every other year rather than every year (and then doubling them). Another example is paying two years' worth of property taxes in the same year. If you normally have deductible work-related expenses each year (buying work boots, for example), buy what you will need for two years instead of one year. Bunching can really work to your advantage if done correctly.
But, as a cash-basis taxpayer (which virtually all of us are), please remember these important deduction tips:
Child Tax Credit: A tax credit of $500 per qualifying child under the age of 17 is available to you for 1999. The credit is phased out when your modified AGI exceeds $110,000 for married-joint filers, $55,000 for married-separate filers, and $75,000 for all other taxpayers.
The HOPE Credit: This is a credit of up to $1,500 per student for qualified tuition and fees paid by the student, or on behalf of the student. This means that the credit could be available for either the student or the student's parents... depending on circumstances. The student must be enrolled at least half-time, and the credit is available for only the first two years of the student's post-secondary education.
The Lifetime Learning Credit: This is a credit of up to $1,000. The student is not required to be enrolled on at least a half-time basis (which means that part-timers can qualify). And, the education does not necessarily have to be for the acquisition of a post-secondary degree or specific business purpose. As with the HOPE credit, eligible students would include you, your spouse, or your dependents. But, be aware that both the HOPE and Lifetime credits start to phase out when your modified AGI reaches $80,000 for joint filers ($40,000 for other taxpayers), and are completely eliminated when modified AGI reaches $100,000 for joint filers ($50,000 for other taxpayers).
Child and Dependent Care Credit: If you pay somebody else to care for your child under age 13 to allow you to work, this credit may available to you. The credit is on an inverted scale with respect to your AGI... which means the higher your income, the lower your credit.
Adoption Tax Credit: If you have recently adopted a child, you may be eligible for this credit. The total credit can amount to $5,000 per adopted child (or up to $6,000 per "special needs" child). The credit begins to phase out if your AGI exceeds $75,000. But, for many people, this could be a valuable (and overlooked) credit.
One Final Thought on Credits: While these credits may reduce your "regular" tax, they may not reduce your Alternative Minimum Tax (AMT). So, depending on your situation, it's very possible that the positive impact of these credits will be voided by the imposition of the AMT.
For 1998, there were certain special provisions that allowed these credits to be applicable for both regular and AMT tax purposes. But those provisions have expired. In the recent tax-cut legislation passed by Congress (which was vetoed by the President), these provisions were extended and would have exempted these credits from the dreaded AMT. But, because of the veto, these credits may not be as valuable to you as they might be... because of the imposition of the AMT.
Discussions are ongoing in Washington to exempt these credits from the AMT. But as of this writing, it's been all discussion and no action. So, when you're doing your tax credit planning, make sure that you understand how the AMT might impact you, and plan (or re-plan) accordingly.
Next week... our final installment. Plan on it!
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