The holiday decorations are put away, things have been tidied up and we've turned the page on another year.
No need for post-holiday blues, though — a new season is coming. This time instead of opening Christmas cards, we'll be opening Important Tax Documents. With the new tax and stimulus legislation passed in 2009, this tax season is shaping up to be a confusing one. The best defense against missing deductions or credits and leaving money on the table is to be aware of the changes that apply to you and bring them up with your tax preparer.
The new credit I'm happiest about is the "American Opportunity Credit" for qualified college expenses. This credit is worth up to $2,500 per dependent student on 100 percent of the first $2,000 of qualified expenses plus 25 percent of the next $2,000, for the first four years of school. In previous years the less generous Hope credit was only available for the first two years of college; then the 20 percent Lifetime Learning credit would kick in. The Opportunity credit is 40 percent refundable, meaning that even if your tax is reduced to zero, you may still receive 40 percent of the credit as a refund.
For the first time books are considered to be qualified expenses, so if you find yourself short of $4,000 of "uncovered" tuition (tuition paid less grants or scholarships), dig up those book receipts and add them in. Note that loans do not reduce the amount of eligible expenses; only "free" money reduces the amount, and housing and meal costs do not count as eligible expenses. The income limits are double those of the Hope and Lifetime credits also; phaseout begins at $160,000 for married filing jointly ($80,000 single) vs. $100,000 ($50,000 single) for the others. The Opportunity credit is available for 2009 and 2010, and can also be combined with the Lifetime Learning credit for a different student.
Computers and related technology expenses, including Internet access, are now considered to be qualified educational expenses for 529 plan withdrawals for 2009 and 2010. That gives you more to work with for the "no double dipping rule" that prevents you from using the same expenses for both an education credit or deduction and a 529 plan withdrawal. Account withdrawals should be planned out in advance so as to maximize the tax benefit and avoid making non-qualified distributions leading to penalties and taxes.
One more trap to watch for: Make sure your withdrawal is in the same calendar year you make the payment to the school; it's especially easy to miss this with the spring semester bill due in January.
While you're enjoying the happy surprise of extra tuition credit money, your children may be getting a less than pleasant surprise. When Congress enacted the "Making Work Pay" $400 tax credit in 2009, it was intended to increase the paychecks of working adults, not dependents. Unfortunately, because it was integrated into payroll tax tables, dependent workers also received the credit in the form of lower withholdings, and when it comes time to settle up, they may find a smaller refund than expected, or possibly have a balance due. Some couples may find themselves in the same position, if they have a combined adjusted gross income of $150,000 or more and separately appeared to be eligible for the credit. People who work more than one job may have received excess credit also.
Taxpayers receiving only pension income are not eligible at all, yet may have lower withholdings due to the same tax table calculations. Those receiving Social Security benefits as well as earned income may have received both the one-time $250 Social Security "bonus" payment and the $400 credit in their paychecks, and will have to credit back the amount over $400. If you find yourself in such a situation for your 2009 taxes, you may want to adjust your withholding for 2010, as the credit is still in effect for this year.
On the deduction front, the Homebuyers' credits are getting a lot of press, but there are a few notable others as well. Sales tax paid on an auto (value up to $49,500) purchased between Feb. 17, 2009 and Jan. 1, 2010, can be deducted on Schedule A in addition to income taxes (but not if you take the regular sales tax deduction option), or as an addition to your standard deduction if you do not itemize. The benefit starts to phase out at $250,000 for married filing jointly ($125,000 for single), and can be used for multiple vehicles.
The property tax deduction for non-itemizers was continued into 2009 also, but in order to claim that, or the auto sales tax add-on for the standard deduction, we have a new form to complete — Schedule L. In typical IRS fashion, the standard deduction isn't so standard anymore.
Finally, a big change is coming to Roth IRAs: In 2010, the income restriction on converting from a Traditional IRA to a Roth will be lifted, and any taxpayer, regardless of income, will be allowed to convert. Converting requires paying tax on the amount of IRA converted, which essentially locks in your taxes at today's rates, rather than waiting to pay tax on your IRA withdrawals later, at whatever the prevailing rate will be. The amount converted is added to your income for the year, increasing your tax bill.
However for 2010 only, that conversion amount can be spread out and added to income in both 2010 and 2011. In that way, the tax can also be paid over two years, perhaps preventing a bracket creep also. The risk in that strategy, though, is that 2010 is the last year former President George W. Bush administration's tax cuts are in effect, and unless they are renewed or other changes are made, tax rates will automatically increase for 2011.
There are many factors that go into whether a conversion is javascript:void(0)right for you; your tax rate now, your expected taxable income in retirement, your ability to pay the tax due from outside sources, and more. There are also some creative strategies involving segregating your IRA by asset class and taking a wait and see approach; those are best discussed with your advisor.
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