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Know your tax breaks

Congress and the president have finally agreed on a tax bill. So what does that mean for your taxes this year?

Everything else being equal, your 2010 tax strategy will be much like previous years.

The compromise tax plan passed by Congress early Friday morning extends reduced tax rates for capitals gains and dividends into 2011 and 2012 for all individual taxpayers. The bill also calls for a one-year reduction in Social Security payroll taxes paid by workers, renewing benefits for the long-term unemployed for another 13 months and restoring some tax breaks aimed at the middle class.

The bill also cleared up the biggest bone of contention — the continuation of reduced tax rates for income including those that make more than $200,000 a year — which were extended for two years. That means the status quo for income tax rates will remain unchanged for the next two years.

"It's a tax year like years before, and there are basic moves and things you can do to reduce your taxes," said Mark Steber, chief tax officer for Jackson Hewitt Tax Service, a tax preparation firm.

Don't overlook tax breaks that apply to lifestyle changes such as adding a child, taking care of a dependent parent, or going back to school.

"Lifestyle changes now are not just getting married or having a child. It really is more complex, like taking care of a dependent parent," Steber said.

Some tax breaks are no longer around.

In 2009, federal income tax on the first $2,400 of unemployment benefits was not taxed as income. That is not the case this year. And unemployment benefits do not appear to be excluded from income in 2011 under the compromise tax plan, said a briefing by CCH, a provider of tax, accounting and audit information.

HOUSING: Taxpayers who went through a foreclosure, short sale or loan modification on a primary residence do not have to pay federal income taxes on forgiven debt resulting from the transaction. For more details and limitations, check out IRS.gov.

On the other side of the housing coin, there is a federal tax credit for qualified 2010 primary home purchases for transactions that closed by Sept. 30. (An earlier June 30 closing deadline was extended by three months for homes under contract.) Again, check out IRS.gov for more details.

RETIREES: One big change for tax year 2010 applies to retired taxpayers age 70 ½ years or older who have traditional Individual Retirement Accounts, 401(k)s and other tax-deferred retirement plans. The requirement to take minimum distributions was temporarily suspended by Congress in 2009 to shield retirees from having to withdraw money from accounts that had lost value from the late 2008 market sell-off.

Now that suspension is over. So account holders who did not take a required minimum distribution last year must take their 2010 distribution before Dec. 31, 2010. Those who do not are subject to tax penalties. (The requirement does not apply to tax-free Roth IRAs).

"They can take more than the minimum, but they have to take at least the minimum. It applies to anyone who is in a retirement account who is over 70 ½ years," said Rich Arzaga, certified financial planner at San Ramon, Calif.-based Cornerstone Wealth Management.

Taxpayers who turned 70 ½ between July 1, 2008, and July 1, 2010, and who did not take their first-time minimum distribution last year have until April 1, 2011, to do so. But they would also have to take their 2011 distribution by Dec. 31, 2011.

IRAS: Taxpayers have until Dec. 31, 2010, to take advantage of an opportunity to convert a traditional tax-deferred IRA into a tax-free Roth IRA while having the option to spread out the income tax dues on the conversion into tax years 2011 and 2012. (While the ability to spread out the tax over two years goes away in 2011, income restrictions have been permanently lifted for converting traditional IRAs into Roth IRAs.)

EVERGREEN TAX STRATEGIES: Tax breaks come and go like the leaves on a deciduous tree blown by political winds, but there are some evergreen strategies that can always apply.

These include making January's mortgage payment in December to obtain a larger itemized deduction for mortgage interest on a 2010 return. Selling losing stocks, bonds and mutual funds that are not part of a retirement account by Dec. 31 can also help reduce taxes. The strategy can be used whether you itemize or take a standard deduction.

"You can deduct up to $3,000 of capital losses against your ordinary income. That never hurts," said Robin Christian, senior tax analyst at Thomson Reuters Tax & Accounting. Losses above the $3,000 threshold can be used to offset future capital gains.

CHARITIES: Making a charitable donation is another evergreen strategy, but it can be used only if you itemize. For tax year 2010, the standard deduction is $11,400 for married couples filing jointly, $8,400 for head-of-household filers and $5,700 for single filers.

"(The standard deduction for married couples) is a pretty big amount. So an evergreen thing to do is to bunch your deductions so you can take all of your charitable contributions this year," said Christian. "Instead of doing $7,000 every year you could do $14,000 every other year. That would push you over the standard deduction. Then you claim your standard deduction in the off years."

Tax breaks related to lifestyle changes:

• Having or adopting a child: Claiming a son or daughter as a dependent may significantly reduce a federal tax liability. You may be entitled to a $3,650 exemption per dependent as well as a Child Tax Credit of up to $1,000 per qualifying child. Those who adopt a child and pay adoption expenses may be able to claim a refundable credit for qualified expenses of up to $13,170 per child.

• Caring for an adult parent financially: An aging parent may qualify as a dependent if the taxpayer is responsible for at least 50 percent of the parent's expenses, such as for food, medical care and lodging. Taxpayers may be able to claim a deduction if they are paying for the parent's medical expenses or for expenses related to assisted living facilities or nursing homes. In addition, if they are paying for senior care for a parent, they may be eligible to claim a credit of up to $2,100.

• Continuing an education (for yourself, spouse or dependent child): Up to $2,500 of student loan interest paid may be claimed as a direct deduction against your income. (A direct deduction can be claimed by taxpayers who itemize and those who claim the standard deduction). The loan must be for tuition, fees, books and other qualified expenses for a student enrolled half-time or more.

Source: Jackson Hewitt Tax Service

Know your tax breaks 12/18/10 [Last modified: Friday, December 17, 2010 8:00pm]

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