Bob Leins, CPA
This article is provided by federal retirement expert NITP, Inc. NITP conducts retirement seminars for federal employees throughout the country. For more information on these seminars and the 2005 schedule in cities around the country, click here.
As the New Year begins, it is the time to put the finishing touches on your tax return for 2004 as well as look forward to 2005 tax planning.
AID FOR TSUNAMI VICTIMS MAY BE TAX DEDUCTIBLE FOR 2004 IF PAID IN JANUARY 2005
Contributions are deductible for the year in which they are actually made. However, under a new law enacted January 7, 2005, donors who itemize are allowed to claim on their 2004 tax returns charitable donations made during January 2005 for the relief of the tsunami victims. See IRS.gov
NEW DEDUCTION FOR 2004 AND 2005
You may elect to itemize a deduction for state and local sales taxes in lieu of deducting state and local income taxes. This provision is effective for tax years 2004 and 2005. You may select one of two options to determine the amount of your general sales tax deduction. You may either deduct the actual amount of sales tax paid by calculating the tax on accumulated receipts or use tables created by the IRS. The tables are based on average consumption by taxpayers on a state-by-state basis and take into account your filing status, number of dependents, adjusted gross income, and rates of state and local general sales tax. This will be very attractive to those who live in a state with no state income tax as well as those who live in states with a high sales tax and low income tax.
CHANGES IN 2004 AND 2005 STANDARD MILEAGE DEDUCTIONS
The IRS has released the 2005 option standard mileage rates that may be used by taxpayers when computing the deductible costs of operating a passenger car for business, medical, moving or charitable purposes. For 2005, the standard rate for business mileage has been increased to 40.5 cents per mile from 37.5 cents per mile in 2004. The standard mileage rate for medical or moving expenses has been increased to 15 cents per mile from 14 cents per mile in 2004. The mileage rate for charitable purposes is 14 cents per mile for both 2004 and 2005.
For 2004, you can put up to $3,000 in an IRA ($3,500 if you are 50 or older) – this will increase to $4,000 and $4,500 respectively in 2005. “Classic” IRA contributions may not be deductible for many people, so if your income is below $110,000 ($160,000 for couples), contributing to a nondeductible Roth IRA might be a smarter tax strategy. A spousal IRA for a nonworking spouse can also be funded based on the working spouses “earned income”. Though you have until April 15, 2005, to make your 2004 IRA contribution, the earlier you contribute, the longer your money can grow tax sheltered.
MAX OUT YOUR RETIREMENT CONTRIBUTIONS
Participating in the TSP is one of the best tax shelters available to you during your working years. That’s because your contributions reduce your taxable earnings and grow tax-deferred. In 2004, the maximum contribution was $13,000. Anyone 50 or older by December 31 can contribute an extra $3,000. For 2005, the maximums are $14,000 plus $4,000 respectively. If you are not on track to max out your TSP plan in 2005, you have time to increase your salary deferrals for the remainder of the year at any time during the year. See TSP.Gov
FLEXIBLE SPENDING ACCOUNTS (FSAs)
(Also referred to as “FEDFLEX”)
An FSA saves you money by allowing you to pay for certain expenses, such as dependent care expenses and out-of-pocket medical expenses, with full pre-tax dollars. Figure out how much you will be spending on these items next year; withhold that amount from your pay. Be careful not to overdo it, however, because as the rules currently stand, any excess money set aside through the FSA will be lost. See our Home Page section “View Previous Articles Here” Also, see the applicable section of the OPM site.
Health savings accounts (HSAs) provide you with a tax-advantaged way to pay your family’s healthcare expenses. Electing an HAS requires a high-deductible health insurance plan that enables you to begin contributing to a HAS. Or if you are self-employed and your family is relatively healthy, consider switching health insurance plans so you can take advantage of this new tax break. See OPM.Gov “Employment Benefits”
TIME YOUR DEDUCTIONS
Will you be itemizing your deductions? For 2004, the standard deduction of $9,700 for a married couple continues to be double the $4,850.00 allowed for a single individual. Now may be the time to determine whether you will benefit by itemizing your deductions in 2005 or taking the standard deduction.
If you will be itemizing, consider paying your mortgage, real estate tax bill, state and local taxes, charitable donations, and other deductible items prior to December 31, 2005. Beware of the alternative minimum tax (AMT), however, which might cause this strategy to backfire.
Group certain expenses. Certain itemized deductions can only be taken to the extent they exceed a percentage of your adjusted gross income (AGI). While the threshold for medical expenses if 7.5% of your AGI, the threshold for your miscellaneous itemized deductions, which includes un-reimbursed business expenses, tax preparation fees, and investment expenses is 2% of AGI.
If you will be itemizing this year and are on track to exceed either of these thresholds, you might save some taxes by paying your outstanding bills by the end of the year. If money is short, consider paying by credit card, since the transaction date determines deductibility. Again, watch out for the AMT, since these deductions are limited under this tax.
Looking for a tax-advantaged way to save for a child’s education? You can now contribute $2,000 per year per child into an education savings account, and up to $11,000 per year into a 529 plan. You can even make five years of 529 contributions, up to $55,000, all at once! Just make sure not to contribute to that child’s 529 account for the next four years, and to file a gift tax return by April 15 electing to spread the contribution over five years. See “Savings for College.com”
HOW LONG MUST I KEEP INCOME TAX RECORDS?
First, it depends on the accuracy of your return. Generally, the IRS statute of limitations expires three years after filing, so you must retain all documents used to file the return for at least that long. While unlikely, if income on a return is understated by more than 25%, the IRS has six years to audit the return. To be safe, keep all documents used to prepare your return for at least five years.
Secondly, it depends on the type of record. Records of capital asset purchases, such as stocks, should be kept for seven years after the asset is sold to provide the cost basis. Homeowners should keep original purchase documents, plus major improvement receipts, for seven years after they sell their home.
As the end of another tax year has passed and you begin to organize your files, keep in mind the following oft-forgotten items:
– Receipts provided by charities for gifts of $250 or more
– Brokerage statements showing trade dates and amounts
– IRA contribution information
– Moving and job-hunting receipts.
Good recordkeeping pays off in the long run. A little organizing now can save big headaches later.