Tax Breaks

The Most-Overlooked Tax Deductions

Here are the top 19 breaks -- including six new ones -- that you shouldn't pass up.

By Kevin McCormally, Editorial Director, Kiplinger.com

November 2009

Every year, the IRS dutifully reports the most common blunders that taxpayers make on their returns. And every year, at or near the top of the “oops” list is forgetting to enter their Social Security number at the top of the tax form -- or making a mistake when entering those nine digits.

Review our breaks as a slide show.

No doubt about it: The opportunity to make mistakes is almost unlimited, and missed deductions can be the most costly. About 46 million of us itemize on our 1040s -- claiming nearly $1 trillion worth of deductions. That’s right: $1,000,000,000,000, a number rarely spoken out loud until Congress started debating economic-stimulus plans to combat the Great Recession.

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• FAQs on the New Home Buyer Credits

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Another 85 million taxpayers claim more than a half-trillion dollars’ worth using standard deductions—and some of you who take the easy way out probably shortchange yourselves. (If you turned 65 in 2009, remember that you now deserve a bigger standard deduction than the younger folks.)

Yes, friends, tax time is a dangerous time. It’s all too easy to miss a trick and pay too much. Years ago, the fellow who ran the IRS at the time told Kiplinger's Personal Finance magazine that he figured millions of taxpayers overpaid their taxes every year by overlooking just one of the money-savers listed below:

1. State sales taxes. Although all taxpayers have a shot at this write-off, it makes sense primarily for those who live in states that do not impose an income tax. You must choose between deducting state and local income taxes or state and local sales taxes. For most citizens of income-tax states, the income tax is a bigger burden than the sales tax, so the income-tax deduction is a better deal.

The IRS has tables that show how much residents of various states can deduct. But the tables aren’t the last word. If you purchased a vehicle, boat or airplane, you get to add the state sales tax you paid to the amount shown in the IRS tables for your state, to the extent that the sales-tax rate you paid doesn’t exceed the state’s general sales-tax rate. (Download IRS tables in .pdf format here).

The same goes for any homebuilding materials you purchased. These items are easy to overlook, but they could make the sales-tax deduction a better deal even if you live in a state with an income tax. The IRS even has a calculator on its Web site to help you figure the deduction, which varies depending on the state where you live and your income level.

2. Reinvested dividends. This isn't really a deduction, but it is a subtraction that can save you a bundle. And this is the break that former IRS commissioner Fred Goldberg told Kiplinger's a lot of taxpayers miss.

If, like most investors, your mutual fund dividends are automatically used to buy extra shares, remember that each reinvestment increases your tax basis in the fund. That, in turn, reduces the taxable capital gain (or increases the tax-saving loss) when you redeem shares. Forgetting to include the reinvested dividends in your basis results in double taxation of the dividends -- once when you receive them and later when they’re included in the proceeds of the sale. Don’t make that costly mistake. If you’re not sure what your basis is, ask the fund for help.

3. Out-of-pocket charitable contributions. It’s hard to overlook the big charitable gifts you made during the year, by check or payroll deduction (check your December pay stub). But the little things add up, too, and you can write off out-of-pocket costs incurred while doing good works. For example, ingredients for casseroles you prepare for a nonprofit organization’s soup kitchen and stamps you buy for your school’s fundraising mailing count as a charitable contribution. If you drove your car for charity in 2009, remember to deduct 14 cents per mile.

4. Student-loan interest paid by Mom and Dad. Generally, you can only deduct mortgage or student-loan interest if you are legally required to repay the debt. But if parents pay back a child’s student loans, the IRS treats the money as if it was given to the child, who then paid the debt. So, a child who’s not claimed as a dependent can qualify to deduct up to $2,500 of student-loan interest paid by Mom and Dad. And he or she doesn’t have to itemize to use this money-saver.

5. Moving expenses to take your first job. Here’s an interesting dichotomy: Job-hunting expenses incurred while looking for your first job are not deductible. But moving expenses to get to it are. And you get this write-off even if you don’t itemize. If you moved more than 50 miles, you can deduct the cost of getting yourself and your household goods to the new area -- including 24 cents per mile for driving your own vehicle for a 2009 move -- plus parking fees and tolls. The same holds true for any new job you take.

6. Military reservists’ travel expenses. Members of the National Guard or military reserve may tap a deduction for travel expenses to drills or meetings. To qualify, you must travel more than 100 miles from home and be away from home overnight. If you qualify, you can deduct the cost of lodging and half the cost of your meals, plus 55 cents per mile for 2009 for driving your own car to get to and from drills. In any event, add parking fees and tolls. You get this deduction regardless of whether you itemize.

7. Child-care credit. A credit is so much better than a deduction; it reduces your tax bill dollar for dollar. So missing one is even more painful than missing a deduction that simply reduces the amount of income that’s subject to tax.

If you pay your child-care bills through a reimbursement account at work, it's easy to overlook the child-care credit. Although only $5,000 in expenses can be paid through a tax-favored reimbursement account, up to $6,000 (for the care of two or more children) can qualify for the credit. So, if you run the maximum through a plan at work but spend even more for work-related child care, you can claim the credit on as much as $1,000 of additional expenses. That would cut your tax bill by at least $200.

8. Estate tax on income in respect of a decedent. This sounds complicated, but it can save you a lot of money if you inherited an IRA from someone whose estate was big enough to be subject to the federal estate tax.

Basically, you get an income-tax deduction for the amount of estate tax paid on the IRA assets you received. Let’s say you inherited a $100,000 IRA, and the fact that the money was included in your benefactor's estate added $45,000 to the estate-tax bill. You get to deduct that $45,000 on your tax returns as you withdraw the money from the IRA. If you withdraw $50,000 in one year, for example, you get to claim a $22,500 itemized deduction on Schedule A. That would save you $6,300 in the 28% bracket.

9. State tax paid last spring. Did you owe tax when you filed your 2008 state tax return in the spring of 2009? Then, for goodness’ sake, remember to include that amount in your state-tax deduction on your 2009 return, along with state income taxes withheld from your paychecks or paid via quarterly estimated payments.

10. Refinancing points. When you buy a house, you get to deduct in one fell swoop the points paid to get your mortgage. When you refinance a mortgage, though, you have to deduct the points over the life of the loan. That means you can deduct 1/30th of the points a year if it’s a 30-year mortgage. That’s $33 a year for each $1,000 of points you paid -- not much, maybe, but don’t throw it away.

Even more important, in the year you pay off the loan -- because you sell the house or refinance again -- you get to deduct all as-yet-undeducted points. There’s one exception to this sweet rule: If you refinance a refinanced loan with the same lender, you add the points paid on the latest deal to the leftovers from the previous refinancing--and deduct the amount gradually over the life of the new loan.

11. Jury pay turned over to your employer. Many employers continue to pay employees’ full salary while they serve on jury duty, and some require employees to turn over their jury pay to the company coffers. The only problem is that the IRS demands that you report those fees as taxable income. To even things out, you get to deduct the amount you pay to your employer.

But how do you do it? There’s no line on the Form 1040 labeled Jury fees. Instead the write-off goes on line 36, which purports to be for simply totaling up the deductions that get their own lines. Add your jury fees to the total of your other write-offs and write “jury pay” on the dotted line.

12. Property-tax deduction for nonitemizers. This break, new in 2008, also works in 2009, but millions of taxpayers who claim the standard deduction may miss it. Normally, to write off property taxes, you must itemize deductions. But this new rule lets homeowners who don’t itemize boost their standard-deduction amount -- by up to $500 if they’re single and up to $1,000 if they’re married and file a joint return -- to account for property taxes paid during 2009. You’ll need to include extra paperwork -- a Schedule L -- with your 2009 tax return to get this break.

13. Casualty-loss deduction for nonitemizers. For 2009, taxpayers who claim the standard deduction can add casualty losses to their standard-deduction amounts -- if the loss occurred in a presidentially designated disaster area. Also, the casualty-loss deduction for losses in presidentially declared disaster areas is not subject to the usual reduction equal to 10% of your adjusted gross income. If you suffered such a loss, be sure you let Uncle Sam help you out by lowering your tax bill. As with the property-tax deduction for nonitemizers, you’ll need to file a Schedule L with your return to pump up your standard deduction to include the loss.

14. Hope credit for college juniors and seniors. Parents of college kids know the $2,000 Hope credit is just for the first two years of college; after that, the lower Lifetime Learning credit applies. But wait! That’s not how it works for 2009. Instead, the credit has been renamed, increased and expanded. It’s now called the American Opportunity Credit, and it will rebate up to $2,500 for each qualifying student for the first four years of college. The full credit is available to individuals whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing a joint return. The credit is phased out for taxpayers with incomes above those levels. The income limits are higher than last year’s. (More on the American Opportunity Credit here.)

15. Making Work Pay credit. You’ve probably been enjoying the fruits of this credit via reduced payroll tax withholding since spring 2009. But to lock in your savings–by reducing your tax bill by $400 if you’re single or $800 if you’re married and file a joint return–you’ll need to actually claim the credit on your 2009 tax return—and you’ll use brand-new Schedule M to do so. The credit is equal to 6.2% of your earned income, capped at $400 or $800. For single filers, it starts phasing out at $75,000 of adjusted gross income and dries up at $95,000. The phase-out zone for couples is $150,000 to $190,000.

16. Sales-tax deduction for new vehicles. If you bought a new car, truck, motorcycle or motor home after February 16, 2009, and before the end of the year, you can deduct the sales tax paid -- up to a maximum purchase price of $49,500 per vehicle -- either as an itemized deduction or, if you claim the standard deduction, as a supercharged standard deduction. The benefit begins phasing out for married couples with adjusted gross income over $250,000 and singles with AGI over $125,000, and it is completely gone for single filers with AGI of $135,000 or more and joint filers with AGI of at least $260,000. Nonitemizers need to file a Schedule L with their return to get the benefit; itemizers who elect to deduct state income taxes will claim the car sales tax as a separate itemized deduction.

17. Credit for energy-saving home improvements. The tax credit equal to 10% of the cost of energy-saving home improvements is increased to 30% for 2009 and 2010, up to a maximum of $1,500 in the two-year period. The credit applies to biomass fuel stoves, qualifying skylights, windows and outside doors, and high-efficiency furnaces, water heaters and central air conditioners. The dollar limit on a particular type of improvement, such as the $200 cap on the credit for windows, has been repealed, so don’t limit yourself to the old rules. Finally, there’s also no dollar limit on the credit for qualified residential alternative energy equipment, such as solar hot water heaters, geothermal heat pumps and wind turbines. Your credit can be 30% of the total cost of such systems.

18. Break on the sale of demutualized stock. Taxpayers won an important court battle with the IRS in 2009 over the issue of demutualized stock. That’s stock that a life insurance policyholder receives when the insurer switches from being a mutual company owned by policyholders to a stock company owned by stockholders. The IRS’s longstanding position was that such stock had no tax basis, so that when the shares were sold, the taxpayer owed tax on 100% of the proceeds of the sale. But after a long legal struggle, a federal court ruled that the IRS was wrong. The court didn’t say what the basis of the stock should be, but many experts think it’s whatever the shares were worth when they were distributed to policyholders. If you sold stock in 2009 that you received in a demutualization, be sure to claim a basis to hold down your tax bill.

19. Home-buyer credit. We put this last on the list because it’s hard to imagine any taxpayer missing this big a tax break. But the rules changed late in the year, so snafus are certain. For most of the year, only first-time home buyers qualified for this credit. A “first-time buyer” is defined as someone who didn’t own a home in the three years leading up to the purchase of a new home. But big changes apply to homes purchased after November 6, 2009. First, in addition to the $8,000 credit for first-time home buyers, there’s a $6,500 credit for longtime homeowners, those who continuously owned a home for at least five of the eight years leading up to the purchase of a new home. The new law also increases how much buyers may earn and still claim the credit. For deals closed before November 7, the right to the first-time buyer credit gradually disappears as adjusted gross income rises between $75,000 and $95,000 on single returns and between $150,000 and $170,000 for married couples who file jointly. For purchases after November 6, the phase-out zones–for both the $8,000 credit and the $6,500 credit -- are $125,000 to $145,000 for singles and $225,000 to $245,000 for married couples. More questions? See FAQs on the Home Buyer Tax Credits.

For clear, concise year-round tax-saving help for non-experts as well as tax professionals from The Kiplinger Tax Letter, click here.

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