Start plans now on ways to cut taxes for next year

Personal Finance

February 04, 2007|By Eileen Ambrose | Eileen Ambrose,Sun Columnist

You have a lot on your plate making sure you get your tax return in on time. But it's not too early to start thinking about trimming your 2007 tax bill.

One usual strategy is to contribute to tax-friendly retirement accounts. Thanks to changes this year, more people will be eligible for individual retirement accounts. But some tax breaks are around only for this year, and you can lose out if you don't act in the coming months. For example, a tax credit for making energy-saving improvements to your home expires at year-end.

Here are some tax breaks to consider:

Mortgage insurance deduction. Congress inserted this temporary tax break into legislation passed late last year. If you buy a house or refinance a mortgage this year, you might be able to deduct all or part of your mortgage insurance premiums.

"It's only good for one year and only for mortgages issued in 2007," says Donna LeValley, contributing editor of J.K. Lasser's Your Income Tax 2007.

Lenders usually require homebuyers to take out mortgage insurance when their down payment is less than 20 percent.

In recent years, buyers putting little or no money down have avoided mortgage insurance by taking out two mortgages, says Keith Gumbinger, vice president of HSH Associates, a provider of mortgage information.

The first usually covers 80 percent of the home price and a piggyback loan covers some or all of the balance, he says.

This strategy grew popular a few years ago when interest rates were lower, Gumbinger says.

The mortgage insurance industry lobbied hard for the insurance deduction after seeing a substantial drop-off in business, he says.

The Mortgage Insurance Companies of America estimates that the deduction would save a homeowner an average of $300 to $400.

You must meet certain hurdles to qualify, though.

You will be able to deduct full premiums, whether single or a joint filer, if your adjusted gross income is $100,000 or less. After that, the deduction is gradually reduced and phases out once income tops $109,000.

The deduction also applies to mortgages refinanced this year provided borrowers don't increase their debt with the new loan, says Bob D. Scharin, a senior tax analyst with Thomson Tax & Accounting.

Retirement accounts. Contribution limits to individual retirement accounts stay the same: $4,000 a year, plus an extra $1,000 if you're age 50 or older.

But the income limits to be eligible this year for a deductible IRA or Roth IRA went up, so more taxpayers will qualify.

If you're covered by a retirement plan at work, you will be able to deduct all or part of your contributions to a traditional IRA if you're single with adjusted gross income up to $62,000. For joint filers, that limit is $103,000.

Money in a deductible IRA will be taxed as regular income when you make withdrawals in retirement.

With a Roth, there is no upfront tax deduction but withdrawals are tax-free later. To make a full or partial contribution to a Roth, your adjusted gross income can't exceed $114,000 if single or $166,000 if filing jointly (whether or not you have a retirement plan at work).

Inflation adjustments also pushed up the amount you can squirrel away in 401(k) plans, nonprofit 403(b) plans and government 457 plans. Workers in these plans can now salt away $500 more for a total of $15,500 this year. Workers age 50 and up can put in $5,000 more, as before.

IRA charitable distributions. Since last year, those age 70 1/2 and older have been able to have money taken out of a traditional IRA and directly transferred to a charity without having to pay any income taxes on the withdrawal. Another benefit: The donation counts toward the minimum distribution that older IRA owners must make each year.

Act fast. This tax break disappears at the end of this year.

"If you're 70 1/2 or older and inclined to give anyway, this is a great deal," says Rande Spiegelman, vice president of financial planning for Schwab Center for Investment Research.

The most you can donate tax-free from an IRA this year is $100,000. But you don't have to be rich to benefit from this tax break, Spiegelman says.

Unlike regular withdrawals from an IRA, the charitable distribution won't raise your adjusted gross income, he says. That can reduce the chance that your Social Security benefits will be taxed or that you won't qualify for certain tax breaks because your income is too high, Spiegelman says.

Be aware, if you make tax-free donations from an IRA, you won't get a charitable tax deduction on top of that.

Drive green, save green. Those who buy a new hybrid are entitled to a credit worth hundreds or even thousands of dollars depending on the model. Credits phase out based on how many cars the manufacturer sells.

For instance, if you have your heart set on the popular Toyota Prius, buy it before April. The original credit for the Prius was cut in half in October, and now stands at $1,575. In April, the credit is chopped in half again to $787.50. In October, it disappears.

"Fortunately, if you like Ford or Honda, they're still at the full credit," LeValley says.

Home energy credits. Time is running out to earn a credit for making your home energy efficient by adding insulation and exterior windows or putting in a qualified hot water boiler or other improvements. The maximum credit is $500 for improvements made last year and this year.

Congress recently extended the life of another credit worth up to $2,000 each year for the cost of adding solar panels or a solar water heater in your home. It expires at the end of next year.

Cash donations. A reminder: As of January, even the smallest cash donation to a charity must be documented if you want to deduct it.

Proof can be a receipt from the charity, a canceled check or other bank statement.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@ baltsun.com.

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