Tax breaks Catch them while you still can
SAN FRANCISCO — Two-thirds of U.S. taxpayers claim the standard deduction, but if ever there was a time to make the most of valuable tax deductions and credits, it might be now, before it's too late.
Given the general tenor in Washington these days, there's no telling which tax breaks will survive and which will disappear.
Already some tax perks are gone. Remember Schedule L? On that now-defunct form, taxpayers could claim above-the-line deductions (that is, no itemizing necessary) for certain disaster losses, sales taxes paid for the purchase of a new car and a limited amount of property taxes. Those benefits are not available on your 2011 return.
And the tax credit for homeowners who make energy-efficient improvements? That's worth just $500 in 2011, down from $1,500 in previous years — and it's a lifetime total so if you claimed it before, there's a good chance you've wrung that tax break dry. Tax mines that could blow up your return
"Over the last couple of years we've lost a few credits and deductions," said Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based tax publisher and a unit of Wolters Kluwer.
That makes doing your taxes "maybe a little bit simpler," he said, but "those deductions were all saving someone some money probably."
And the outlook for other tax breaks is far from certain. The so-called tax extenders — a group of tax breaks that Congress generally renews each year — expired at the end of 2011. That includes, among other things, a provision for older Americans to make a tax-free IRA distribution to a charity, a deduction for college tuition and a deduction for state and local sales taxes.
It's not the first time the tax extenders have expired. In the past, lawmakers renewed them and other tax breaks retroactively. But, while lawmakers eventually may extend some or all of these perks, it's no sure thing in the current political climate.
And that means a lot of tax uncertainty ahead.
For instance, businesses enjoyed a bonus depreciation perk on 100 percent of the cost of qualified property in 2011; in 2012, that's down to 50 percent and it's unclear whether the more generous allowance will be resurrected. Similarly, small businesses enjoyed a $500,000 limit for expensing business assets under Code Section 179 in 2011; that drops to $125,000 in 2012 and will fall to $25,000 in 2013 if Congress doesn't act, according to CCH Inc.
Paying for college costs? The American opportunity credit is worth up to $2,500 (and up to $1,000 of that is refundable) for certain higher-education expenses, but under current law it's not available after 2012. In 2013, that credit goes back to being the Hope credit, worth up to $1,500, nonrefundable.
And consider the tax credit for adopting a child. It's a refundable credit worth more than $13,000 in 2010 and 2011. In 2012, the credit is down to $12,650 and nonrefundable. In 2013, it's scheduled to disappear (a much smaller credit will remain available for adoptions of special-needs children).
Of course, the Bush-era income-tax rates, set to expire at the end of 2012, would affect the broadest swath of taxpayers.
If lawmakers don't act, the top income-tax rate rises to 39.6 percent from 35 percent now, the other tax brackets inch higher and the lowest tax rate becomes 15 percent, from 10 percent now.
Will Congress bring back any of these tax breaks? That's tough to say in the current climate of gridlock and lawmakers' focus on deficit reduction.
"Given the repeal of the estate tax, it wouldn't surprise me" if lawmakers let the Bush-era tax cuts and other tax breaks lapse, said Jack Nuckolls, the San Francisco-based national director of private client tax services at accounting firm BDO.
He's referring to the fact that Congress allowed the estate tax to expire in 2010 for one year — a situation that stunned many tax professionals, many of whom expected lawmakers to reinstate the estate tax for that year retroactively. (Eventually, the Tax Relief Act, passed late in 2010, gave estates the option of paying the estate tax or avoiding the estate tax but facing less-generous cost-basis rules for heirs.)
Still, absent an overhaul of the entire tax code — where tax breaks are eliminated and tax rates are reduced, which is much desired by some lawmakers but difficult to attain — some say Congress is likely to extend many of the most popular tax breaks.
"The basic approach of the Republicans is 'no tax increases,' and eliminating a tax break without reducing tax rates looks to them like a tax increase," Luscombe said. And Democrats "might like phase-outs for the wealthy but they want tax breaks generally for the middle-class and poorer people."
Whatever lawmakers end up doing, Nuckolls said, don't expect much tax-law legislation before the election in November.
So, what's a taxpayer to do? Planning ahead for your 2012 tax return is no easy task, though some planners say pulling income into this year may make sense, particularly for high-income taxpayers, in case higher tax rates do kick in next year.
High-income taxpayers also face a limit on itemized deductions that's set to kick in again next year — that would suggest maximizing deductions as much as possible this year.
At this point in time, of course, it's near-impossible to change your 2011 tax situation, though you do have until April 17 to make a 2011 IRA contribution.
But one big decision taxpayers still must make — and many may be getting it wrong is whether or not to itemize.
It's time to make the most of valuable tax deductions and credits, before it's too late. Just one-third of tax returns claimed itemized deductions in 2009, according to CCH. Certainly, taking the standard deduction — worth $5,800 for single filers on 2011 returns, up from $5,700 a year earlier (double that if you're married-filing-jointly) — is a good call for many taxpayers. And it's much easier than tracking receipts and calculating your tax breaks. But at least one study found that many people who take the standard deduction are overpaying taxes.
As many as 2.2 million tax returns claimed the standard deduction when itemizing would have reduced their tax bill, according to a 2002 report, based on 1998 data, by the U.S. Government Accountability Office, the investigative arm of Congress. Taxpayers overpaid by an estimated $945 million, with about 24 percent of those taxpayers overpaying by more than $500 each and 76 percent overpaying by $500 or less. GAO report
Meanwhile, other data show that taxpayers are claiming hefty sums, and likely reducing their tax bills substantially. For instance, for people with adjusted gross income of $50,000 to $100,000, the average deduction claimed for interest paid is $10,133; for taxes paid, $6,247; and for charitable contributions, $2,775, according to CCH Inc., based on 2009 data. (The figures are the average for the taxpayers in that income group who claim the deduction.)
Among taxpayers with adjusted gross income of $250,000 or more, the average deduction claimed for interest is $25,527; for taxes paid, $48,317; and for charitable contributions, $18,488.
Next time you start up your tax software or get out your tax forms, make sure you run the numbers to see whether itemizing makes sense for you.
Andrea Coombes is MarketWatch's personal finance editor, based in San Francisco.