December 2009 Archives

End of Year Tax Planning

Taxes are imposed not only to generate revenue for various government entities, but can also be used to motivate certain behaviors as well as deter some behaviors. For example, contributing money to your retirement plan is federal income tax-free so that encourages people to save for their future. Pennsylvania imposes a tax on cigarettes as a means to discourage people from smoking. For the purposes of our discussion, let's only talk about federal income tax planning for the end of 2009.

Each year, Congress makes some changes to the tax code based on various factors including the state of the economy. This year is no different. Not all changes affect everyone; some are based on your stage in the lifecycle, your employment status, your income level, or the composition of your household. Taxpayers should also understand the difference between tax deductions and tax credits. Tax deductions are used to reduce the amount of your income that is subject to taxation. A tax credit actually reduces the amount of taxes you pay. Two other important terms to understand are the types of credits - refundable and nonrefundable. A nonrefundable credit will reduce the amount of taxes that you owe stopping when your balance reaches 0. A refundable credit creates the possibility of not only reducing your taxes to 0 but paying you the balance. For example, your tax bill is $500 and you are eligible for one of the nonrefundable credits that are worth $1000. The end result is your tax bill is 0 and you gain no benefit from the unused $500 of the Nonrefundable credit. Using the same example, if your tax bill is $500 and you are eligible for a $1,000 refundable credit, your tax bill is 0 and you receive a refund of the remaining $500 from the IRS.

Refundable and nonrefundable credits

Economic Recovery Payment - This past spring people receiving payments from the Social Security Administration, Department of Veterans Affairs and the Railroad Retirement Board automatically received the $250 Economic Recovery Payment. While this event is not taxable for 2009, it is reportable and could reduce the amount received from another new credit, the Making Work Pay Tax Credit.

Making Work Pay Tax Credit

Refundable - $400 single - $800 married filing jointly claimed on tax return but already benefit due to income tax withholding changes implemented by employers this past spring.

Special Credit for Certain Government Retirees

Refundable $250 for certain government retirees who are not covered by social security.

American Opportunity Tax Credit

For 2009 and 2010 this credit makes changes to the existing Hope education credit by including required course materials to the list of qualifying education expenses and allowing the credit to be claimed for four years instead of two. The maximum amount of the credit is increased to $2,500 per student and up to 40% of the credit may be refundable.

Unemployment Compensation

Taxpayers can exclude up to $2,400 of unemployment compensation from their gross income.

First-Time Homebuyer Credit

IRS definition of first-time homebuyer is that you did not own any other main home in the three years prior to the purchase. Purchase made in 2009, credit is 10% of purchase price up to $80,000. The maximum credit is $8,000 and you must remain in the home for 36 months following purchase.

Sale of Main Home

If in 2009 you sold your main home and neither you nor your spouse used it as a main home then this nonqualified use could contribute to taxation of any gain on the sale or exchange. Previously the rule was that if you sold your main home that you had lived in for 2 of the past 5 years, $250,000 of any gain for singles and $500,000 of gain for couples filing married jointly was excludable from taxable income.

Children Investment income

Children can have investment income of up to $1,900 for 2009 before it is taxed and it will be taxed at the parent's rate.

Standard Deduction for taxpayers who don't or can't itemize has increased - These guidelines are for individuals who are under 65 and not blind or disabled

$11,400 MFJ or Qualifying Widower

$8,350 HOH

$5,700 Single or MFS 

Again this year even if you don't itemize and you paid at least $500 in real estate taxes you can deduct a maximum of $500.

Exemptions have increased to $3,650.

New Vehicle Purchase

If you buy/bought a new vehicle between February 17 and December 31, 2009 you can deduct sales tax and certain fees for the first $49,500 of the vehicle purchase price. The vehicles must be new and could be a passenger automobile, light truck, motorcycle of a motor home.

Earned Income Credit

Married filing jointly households with at least one person working and no children who earned up to $18,440 to households earning up to $48,279 with 3 or more children are eligible for this valuable refundable  credit which can amount to as much as $5,657.

Child Tax Credit

Children age 16 and under qualify households for as much as $1,000 tax credit apiece. Any unused amount from this nonrefundable credit becomes refundable as the additional child tax credit.

Section 529 Accounts

Families who had been investing in section 529 plans to fund college for their kids and are now using those funds to pay tuition and expenses will be pleased to know that the definition of qualified higher education expenses now includes the purchase of computer technology, equipment and internet access that are to be used by the beneficiary and his/her family during the years the beneficiary is enrolled at an eligible educational institution.

Residential Energy Credits

Nonbusiness energy property credit

30% of the cost of qualifying expenses up to a maximum credit limit of $1,500 for improvements placed into service in 2009 and 2010 for homeowners who make energy efficient improvements to their main home. Expenses that qualify include insulation, exterior windows and doors, heating and air conditioning systems, certain roofs and stoves.

Residential energy efficient property tax credit

Solar hot water heaters, geothermal heat pumps and wind turbines that are installed at your main home are eligible for a 30% credit.

Good news for retirees

Recognizing that the economic downturn could be disastrous to retirees who suffered extreme value losses of their investments, for 2009 taxpayers are not required to take the required minimum distribution from their IRA's or most other defined contribution plans. Generally, once you attain the age of 70 ½ you must start taking distributions from your tax-deferred accounts and pay the taxes owed. Some seniors who routinely wait until the end of the year will be pleased to know that if they aren't dependent on this income, they can defer payment until next year.

Thoughts about what to do with your refund.

This year, not only will you be able to divide your refund into as many as 3 separate bank accounts, you will also have the option to use some of your refund to purchase US Savings Bonds - I Series.

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