Take time now to look for savings on '05 taxes

PERSONAL FINANCE

November 20, 2005|By EILEEN AMBROSE

Before getting caught up in the whirlwind of holiday spending, take some time to save money on your coming tax bill.

You might be eligible for one of the newer tax breaks. Also, this year could be the last time to take advantage of some expiring tax provisions unless Congress acts to extend them.

The usual tax strategy is to squeeze as many deductions as possible into the current tax year and postpone income - and the taxes on it - until next year.

For example, make January's mortgage payment a month ahead and increase your mortgage interest deduction for 2005, said Bob D. Scharin, editor of RIA's Practical Tax Strategies, a journal for tax professionals. Or boost deductions by paying real estate or estimated state income taxes in December rather than the following month, he said.

This strategy is turned on its head if you fall into the parallel universe of the alternative minimum tax. Congress designed the AMT decades ago to snag rich folks who had avoided taxes, but increasingly middle-class families are paying the tax, partly because it was never adjusted for inflation.

Filers are expected to figure their taxes under the regular income tax and AMT, and pay the higher amount. (H&R Block offers an online AMT calculator at hrblock.com)

The AMT doesn't allow the same deductions as the income tax. So if you're likely to trigger the AMT this year, but not next, you might be better off postponing deductions until next year, when you can benefit from them.

Meanwhile, for this year, here are tax breaks to consider:

Sales tax deductions. Unless Congress acts, this is the last year that filers can choose between deducting on their federal return the sales tax or state and local income taxes they've paid. Deducting sales taxes favors filers in states with little or no income taxes and consumers who make big purchases.

Maryland's state and local taxes aren't considered low. But it's possible that major expenses, say a large wedding and diamond rings, could make taking the sales tax deduction worthwhile, Scharin said.

Those who don't keep track of sales taxes paid, which is most of us, can check out IRS publication 600 to get an estimate. Tax on certain big-ticket items also can be added to the IRS estimate.

Green benefits. If that major purchase you're considering is a hybrid vehicle, wait until next year, when new tax cuts for energy-saving activities kick in, said Mark Luscombe, a principal with CCH Inc., an Illinois tax information provider.

Currently, consumers buying an IRS-approved hybrid can receive a $2,000 deduction. This deduction will be replaced next year with a tax credit worth up to $3,400. Credits are better than deductions because they reduce the tax bill dollar for dollar.

"Under the new rule, there's a different credit for different hybrids," based upon fuel economy, Luscombe said.

The other caveat: The credit begins to be phased out once a manufacturer sells 60,000 hybrids, Scharin said.

Homeowners also can get tax perks for being green in 2006 and 2007. They can earn a credit for up to 30 percent of the cost of buying and installing a solar water heater or solar electric system. The maximum credit is $2,000.

And they may qualify for a 10 percent tax credit on the cost of energy improvements to their home, including adding insulation and energy-efficient windows and doors. The maximum credit over two years is $500.

"We're still awaiting IRS guidance" on what energy-efficient items will qualify for this credit, said Jackie Perlman, senior tax research coordinator of H&R Block in Kansas City, Mo. So, before buying, say, a corn-burning furnace, check with your tax professional to make sure the product qualifies, she said.

Charitable giving. After Hurricane Katrina, Congress temporarily loosened the rules for cash donations to charities between Aug. 28 and the end of the year, said Rande Spiegelman, vice president of financial planning for Charles Schwab in San Francisco. Donors this year can deduct cash contributions equal to 100 percent of adjusted gross income, twice the usual limit. The donations don't have to be made to charities dealing with hurricane-related activities.

Most people don't donate half their adjusted gross income, let alone all of it. But, "if there is someone out there thinking of making a significant gift to a church or another favorite ... charity, this would be a great opportunity to do that," Luscombe said.

Or, instead of giving cash, donate appreciated securities, Spiegelman said. You can deduct the full market value of the securities - up to 30 percent of adjusted gross income - without triggering capital gains tax, he said. If the value of securities exceeds 30 percent of AGI, any unused deduction can be carried forward for five years, he said.

Retirement accounts. Contributing to a retirement account can reduce your tax bill today and help secure your financial future. Contribution limits have been rising, and those who turn 50 this year can make catch-up contributions.

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