Tax Deduction Facts You Can’t Afford to Overlook
You don’t want to pay more in tax than you have to. That means making sure you’re taking advantage of every deduction you’re entitled to. Here are some important facts you don’t want to overlook as you calculate your deductions for 2005.
You can still contribute to an IRA
You generally have until April 15, 2006, to make contributions to either a Roth IRA or a traditional IRA for the 2005 tax year. Aside from being able to set aside up to $4,000 ($4,500 if age 50 or older) for your retirement in one of these powerful savings vehicles, contributing to an IRA can have an immediate tax benefit.
That’s because with a traditional IRA, if you’re not covered by a 401(k) or other employer-sponsored plan, you can generally deduct the full amount of your contribution. (If you’re covered by an employer-sponsored retirement plan, whether or not you can deduct your traditional IRA contribution depends on your income and your filing status.) So, for instance, if you’re in the 28% federal tax bracket, a $4,000 deductible contribution to a traditional IRA could translate to $1,120 in tax savings on your 2005 tax return.
It’s a little different with Roth IRAs, though. Contributions you make to a Roth IRA aren’t deductible, so there’s no impact on your 2005 taxes. Nevertheless, a Roth IRA is worth considering because qualified Roth distributions are completely free from federal income tax.
One last note: Individuals with lower incomes ($50,000 for married couples filing jointly, $37,500 for individuals filing head of household, and $25,000 for single individuals) who contribute to a traditional or Roth IRA may also qualify for a tax credit of up to $1,000. See IRS Form 8880, Credit for Qualified Retirement Savings Contributions, for details.
New twists on dependency exemptions
New rules apply when it comes to claiming dependents for 2005. The changes won’t affect most people, but it’s worth taking the time to carefully read the IRS Form 1040 instructions to be sure.
If you’re a divorced or separated parent, you’ll want to look at the new rules closely. Prior to 2005, a noncustodial parent (the parent with whom the child lived for the lesser part of the year) generally couldn’t claim a child as a dependent unless the custodial parent signed a release or a pre-1985 divorce decree or separation agreement applied. Beginning in 2005, however, a current decree of divorce or written separation agreement can give the exemption to the noncustodial parent, even if the custodial parent doesn’t sign a waiver. If you believe this may impact you, you should discuss your situation with a tax professional.
There’s one additional twist when it comes to dependency exemptions. If you opened your home to someone who was displaced by Hurricane Katrina, you may be entitled to an additional exemption amount of $500 per displaced individual (up to a maximum of $2,000). To see if you qualify, see page 37 of IRS Form 1040 Instructions.
Deducting state and local sales taxes
If you itemize your deductions on Schedule A for 2005, you have the option of deducting state and local sales taxes rather than state and local income taxes (this is the last year this option is available). The deduction can be based on the actual amount of sales tax that you paid during 2005 (i.e., you total up all your receipts), or you can use special sales tax tables published by the IRS.
Even if the tables are used, you can generally still deduct sales tax for specific purchases like motor vehicles, boats, homes, and home building materials. This option is particularly valuable if you live in a state that doesn’t impose an income tax, or if you made some major purchases during 2005.
Charitable deduction facts
If you itemize your deductions, you’re also able to claim a deduction for qualified charitable contributions. However, the amount of your deduction is ordinarily limited to a percentage of your adjusted gross income (generally, your charitable deduction can’t be more than 50% of your AGI). Not so in 2005. The Katrina Emergency Tax Relief Act of 2005 suspended this AGI-based limitation for cash gifts made to most public charities on or after August 8, 2005, and before January 1, 2006, even if your donation is unrelated to Hurricane Katrina.
Also worth noting: If you donated a car, boat, or airplane to charity during 2005, consult IRS Form 1040 Instructions (Schedule A) or talk to a tax professional. The rules have changed for 2005.