Tax strategies for saving money when filing tax returns

As you get ready to file your 2000 tax return, take a quick look at the list that follows. It's a summary of little-known tax strategies that may save you money when you file your tax return. It pays to take a look. You may wind up owing Uncle Sam less than you thought, or get a bigger refund than you expected, even if only one of these strategies applies to you. Give our office a call to see exactly how a tax strategy applies to your personal situation.

Back out of an IRA conversion. If you converted a traditional IRA into a Roth IRA in 2000, you knew you'd have to report the taxable part of the traditional-IRA withdrawal on your 2000 return. But you may not have planned on a year-end surge in your income (for example, from a bonus or stock market gains). That extra income propelled you into a higher tax bracket, or will rob you of tax breaks (such as the education credit) that phase out at higher levels of adjusted gross income (AGI). You can't back out of your bonus or stock market gains (nor would you want to!), but you can back out of that taxable Roth IRA conversion. Through a mechanism known as 'recharacterization,' you can undo the conversion and turn the Roth IRA back into a traditional IRA. Net result: Without the taxable income from the conversion, you may avoid being taxed in a higher bracket and/or may keep your AGI below the point where you would lose tax breaks.

Turn a nondeductible Roth IRA contribution into a deductible IRA contribution. Did you make a $2,000 Roth IRA contribution in 2000? That may help you years down the road when you take tax-free payouts from the account (if you're eligible), but the contribution isn't deductible. If you realize you need the $2,000 deduction that a contribution to a regular IRA yields, you can change your mind and turn that Roth IRA contribution into a traditional IRA contribution (again, via the 'recharacterization' mechanism). The IRA deduction is yours if neither you nor your spouse is covered by an employer-provided retirement plan. If you and your spouse are covered, the deduction starts to phase out when AGI exceeds certain limits depending on filing status (for example, for 2000 the phaseout for joint filers starts at $52,000 of AGI).

Make a deductible IRA contribution, even if you don't work. As a general rule, you can't make a deductible IRA contribution unless you have wages or other earned income. However, an exception applies if your spouse is the breadwinner while you manage the home front. You can make a deductible IRA contribution of up to $2,000 even if you have no earned income. What's more, even if your spouse is covered by an employer-provided retirement plan you can still make a fully deductible IRA contribution as long as your joint AGI as specially computed doesn't exceed $150,000.

Get tax-free gain from a home used as rental property. Say a couple of years ago you left your condo in the city and moved into the country home you inherited from Mom. You've been renting the condo to others, but now you get an offer you can't pass up and you sell it. Up to $250,000 of gain from the sale is tax-free if you owned and used the condo as your principal residence for at least two of the five years preceding the sale. However, you will have to recognize gain attributable to depreciation allowable with respect to the rental of the residence after May 6, 1997. So most of your gain will be tax-free, even if you held the condo as rental property for the last couple of years. Up to $500,000 of gain is tax-free for joint filers meeting certain conditions.

Claim a moving expense deduction because of your spouse's job. Job-related moving expenses (the cost of moving household goods and personal effects plus lodging en-route) are above-the-line deductions, which can be claimed even by non-itemizers. This writeoff generally is available only if (1) you start a new job or business at the new location (or are transferred by your employer), and (2) the new job location is at least 50 miles farther from your old home than your old job was from your old home. Even if you don't qualify, however, you can claim the writeoff if your spouse does. The fact that your move was driven by your job-related needs, not your spouse's, doesn't matter.

For example, you're sick of a long, tough commute from distant suburbs to your city office. You sell your home and buy a condo that's a ten-minute walk from work. Your spouse decides to return to the job market after a long absence and lands a job in public relations. You can't qualify for moving expense deductions on the strength of your move, because you didn't change your job or your work location. But you can deduct moving expenses if the distance between your spouse's job and your old home is at least 50 miles (this is a special distance test for those returning to the job market). Your spouse must stay at the new job for certain minimum time periods, however.

Partial swap of annuity contract is tax-free. It always has been possible to swap one annuity contract for another (for example, to get a better yield) without paying a current tax. Late last year, the IRS said it will follow a court case holding that the direct transfer of part of the funds in one annuity contract to an annuity contract with another company also is a tax-free swap. So if you made a direct transfer of part of your money in an annuity contract in 2000 to an annuity contract with another company, you don't owe tax on the switch.
It may pay for you not to claim a dependency deduction for a child in college. This can work to your family's benefit if you pay college tuition for your child, your income is too high for you to claim education credits, and your child has enough taxable income to make use of most or all of the credit. If you forego the dependency deduction, your child can claim the education credits on his or her return (even though you paid the education expenses). The tax-cutting value of the education credits that the child can claim may be greater than the value of the dependency exemption for the child. Note, however, that the child can't claim a dependency exemption for himself or herself if you are eligible to, but don't, claim a dependency exemption for the child.
Write off the cost of a tutor as an education expense. You can deduct the cost of education that maintains or improves the skills required in your business or employment, but not costs to meet the minimum requirements of your trade or profession, or to qualify you for a new job. 'Education' doesn't have to be of the classroom variety. For example, suppose you're a sales executive who suddenly had to become an e-commerce expert. You hired a consultant to be your tutor and teach you everything you need to know. That cost is deductible as an education expense. But you can only claim it on Schedule A, Form 1040 as a miscellaneous itemized deduction. Such deductions can be claimed only to the extent their cumulative total exceeds 2% of your AGI.

No current tax or low tax on sales of small business stock. Normally, gains on stock sales are taxed at a maximum rate of 20% (if held for more than one year) or at the same rate as your other income (if held for one year or less). And you can't avoid a tax on your gain by reinvesting in other stock. But special rules apply when you sell shares of qualified small business stock. A number of technical conditions have to be met. Two important ones: (1) The shares must have been originally issued after Aug. 10, 1993, and (2) you must have bought in when the shares were originally issued. There's no current tax on the sale if you held the shares for more than six months, and you reinvest the sales proceeds within sixty days in qualified small business stock issued by another qualifying corporation. And if you held the shares for more than five years, and don't reinvest in other qualified small business stock, then as a general rule half of your gain is tax-free, and the other half is taxed at a maximum rate of 28%. In effect, your maximum tax would be 14% of your total gain on the sale of qualified small business stock.

Home improvements may be medical expense deductions. Home improvements generally aren't deductible. But a medical expense deduction may be claimed if you make a medically necessary home improvement, such as a lift or elevator for a handicapped person, or a therapy spa for an arthritis sufferer. The cost of such an expense is deductible as a medical expense to the extent it exceeds any resulting increase in value of the property. For example, if a qualifying improvement costing $5,000 increases the value of your home by $2,000, the medical expense is $3,000. Note, however, that medical expenses can be claimed on Schedule A, Form 1040 only to the extent they exceed 7.5% of your AGI.

Employee pay can help you write off business equipment. A tax break for small businesses allows you annually to expense-that is, to currently deduct-the cost of machinery and equipment up to a certain amount ($20,000 for 2000, $24,000 for 2001 and 2002). Assets that aren't expensed can only be written off over a period of years (usually five or seven) via depreciation deductions. However, among other conditions, the maximum annual expensing amount is limited to your taxable income from any active trade or business for the year in which you buy the equipment and place it in service. So if there's no money coming in during your startup year, there's no expensing for that year. Fortunately, your salary as an employee counts as taxable income for expensing purposes. So if you start up a sideline business as a sole proprietorship and buy computers, printers, scanners, etc., you can write off their cost (up to the annual dollar limits) even if there's no business income yet, as long as your salary in that year at least equals what you spent on the equipment. The expensing deduction can offset your other income.

Eligible for the home-office deduction? It may pay to skip it. Thanks to liberalized rules, it's easier to claim a home-office deduction on your 1999 return than it was for 1998. But just because you're entitled to this writeoff doesn't necessarily mean that you should claim it. What's the problem? You may forfeit the chance to exclude the entire gain when you sell your home at a profit. The up-to-$250,000 exclusion of homesale gain (up to $500,000 for certain qualifying married persons filing jointly) applies only if you own and use your entire home as your principal residence (your main home) for at least two of the five years preceding the sale. If you meet this ownership and use test for only part of your home, you're treated as selling two properties: a principal residence (eligible for the exclusion); and a home-office business property (ineligible for the exclusion). In addition, even if you meet the dual test for the entire home, the depreciation you claim after May 6, '97 will result in part of the gain (probably a small part) not being eligible for the exclusion.
Weighty deductions for heavy sport utility vehicles (SUVs) bought for business use. A car used for business generally is treated like any other type of business asset, with one notable exception: Annual depreciation and expensing deductions are capped. For example, if you bought a business auto and placed it in service last year, your 2000 combined depreciation and expensing deduction for it can't exceed $3,060, regardless of the cost of the car. But you may be in luck if you bought one of those popular SUVs for business use. That's because the annual depreciation and expensing caps don't apply to trucks or vans (and that includes SUVs) that are rated at more than 6,000 pounds gross (loaded) vehicle weight. So, for example, if you bought one of those lumbering giants for $45,000 in 2000, and used it 100% for business, you can write off $25,000 of its cost on the 2000 return (expensing plus depreciation).