Act now to save money on 2006 income taxes

Think it’s too early to start your income tax preparation? Despite a later filing date of April 16, a recent flurry of tax legislation and expiring tax credits and deductions that Congress may retroactively extend at year’s end calls for early preparation.

Already, the IRS has held a number of regional seminars on the 2006 income tax law changes. Here are seven points of focus to facilitate your preparation and reduce frustration.

1. Get organized. Waiting until the last minute to organize pertinent documentation wastes valuable time and may cause you to overlook important deductions or make mistakes.

• Create a checklist. Checklists help organize your thoughts, pull together materials and remind you of items otherwise forgotten or overlooked. Many checklists are available on the Web. Search for “checklists for tax preparation,” and you’ll find numerous checklists to download.
• Gather pertinent documentation. Ideally, you have saved receipts and other supporting documentation for preparing the tax return. If not, look to your checkbook register, bank and credit card statements for needed documentation. In the event of an IRS audit, lack of documentation may result in additional taxes and penalties.

2. Identify last-minute savings opportunities. You still have time to reduce taxable income. Consider the following possibilities:

• Maximize elective deferrals to your retirement plan. Elective deferrals reduce the amount of your income subject to federal income tax. The basic limit for 2006 is $15,000. If you are 50 or older, you can defer up to $20,000. In some cases, your salary and/or employer’s plan provisions may cap elective deferrals at a lower amount. Check with your human resources or payroll staff about this.
• Fund a traditional IRA. If you are younger than 50, you can contribute the lesser of earned income or $4,000. Those 50 and older can contribute the lesser of earned income or $5,000. Also consider a spousal IRA. You must be legally married at the end of 2006 and file a joint tax return to take advantage of this. The same contribution limits apply. Whether deductible or nondeductible, make IRA contributions earlier rather than later to maximize tax-deferred income.
• Withdraw required minimum distributions (RMDs) from your IRA. RMDs must begin no later than April 1 following the year you are 70.5 years old.

Failure to withdraw the required amount results in a penalty tax equal to 50 percent of the shortfall amount — the difference between the required amount and the amount actually withdrawn. If you have more than one traditional IRA, you must calculate the RMD for each IRA separately. You can total the RMDs and take the aggregated amount from just one IRA.

• Increase your tax withholding from paychecks. To eliminate or reduce the penalty for underpayment of estimated tax, consider increasing your withholding for remaining paychecks. You may be subject to the underpayment penalty if you received income from sources other than your employer and you elected “no withholding” or did not have an opportunity to elect withholding.
• Coordinate capital gains and losses. Review stock and other capital assets. Are some ripe for sale? In other words, it may be appropriate to lock in a gain or sell an asset that has underperformed for some time. Such tax harvesting can offset gains with losses, which lowers taxable net gains.

3. Take advantage of deductions.
4. Take advantage of tax credits. A tax credit reduces taxes paid, whereas a deduction reduces the amount of taxable income. Thus a tax credit is more valuable than a deduction.

• Child Tax Credit. You may be able to reduce taxes up to $1,000 for each qualifying child under age 17.
  Eligibility for the credit is limited based on your adjusted gross income. The phase-out depends on your filing status.
• Child and Dependent Care Tax Credit. If you paid someone to care for your child (age 13 and under) or dependent (spouse or other dependent of any age who is physically or mentally incapable of self-care), this credit can reduce your tax liability.
• Retirement Savings Contributions Credit. You may be eligible for this credit if you could contribute to an employer-sponsored retirement plan or to an IRA, are at least 18, are not a full-time student, cannot be claimed as a dependent on another taxpayer’s return and meet certain other rules. If eligible, the credit is up to $1,000, or $2,000 if filing jointly.
• Hybrid Car Tax Credit. The credit is available for qualifying vehicles purchased after Dec. 31, 2005. For a list of qualifying vehicles and the amount of credit allowed, log on to the IRS Web site at www.IRS.gov.
• Qualifying Alternative Fuel Vehicles (AFVs). Purchase of an AFV between Jan. 1, 2005, and Dec. 31, 2010, may yield a tax credit of up to $4,000.
• Home Energy-Efficiency Improvement Tax Credits. Purchase and installation of energy-efficient products qualifies for a tax credit of up to $500. Additional credit is available for certain other qualified purchases and applies only to the taxpayer’s principal U.S. residence. The total credit caps at $2,000.
• Earned Income Tax Credit (EITC). Generally available to taxpayers with 2006 earned income under $38,348, the EITC may also provide a refund.
• Credit for Federal Telephone Excise Tax. In August this year, it was announced that this tax no longer applies to long-distance telephone service — even if you have bundled local and long-distance service. You can claim this credit on your tax return for excise taxes paid since Feb. 28, 2003.

Take this credit on your tax return, and you’ll receive interest on the claim refund. Local telephone service continues to be taxable.

5. Decide how to apply special hurricane rules. If the qualified hurricane distribution applies to you, then under special rules retirement plan withdrawals (qualified hurricane distributions) are not subject to the 10 percent early withdrawal tax. The distribution is taxable, but is included in gross income ratably over three tax years, beginning with the year of distribution. If you took a qualified hurricane distribution in 2006, the three-year rule applies unless you elect otherwise. The maximum amount receivable is $100,000 for all retirement plans such as 403(b), 401(k) or IRAs.
6. Identify which new tax forms apply to you. As of press time, here are the new tax forms for individual taxpayers and other form information:

• Form 5695, Residential Energy Credits.
• Form 8888, Direct Deposit of Refund.
• Form 8909, Energy-Efficient Appliance Credit.
• Form 8913, Credit for Federal Telephone Excise Tax Paid.
• Form 1040EZ-T, Claim for Refund of Federal Telephone Excise Tax.
• Draft 2006 Forms, www.irs.gov/taxpros/lists/0,,id=97784,00.html
• Final forms, www.irs.gov/formspubs/lists/0,,id=97817,00.html
• Watch for the revised Publication 553, Highlights of 2006 Tax Changes at www.irs.gov. It should be available around March. The current publication addresses 2005 tax changes.

7. Know where to go for help.

• The IRS Web site, www.irs.gov, offers a number of fact sheets, tax tips and a toll-free help number, 1-800-829-1040. There are helpful hints for choosing a tax preparer, including the IRS Return Preparer Program, since tax-return preparer fraud continues to increase. Types of such fraud include intentional inflation of personal or business expenses, false deductions, unallowable credits and excessive exemptions. Even if you are unaware of the mistakes, you, not the preparer, are responsible for paying the additional taxes and penalties.
• Low Income Taxpayer Clinics. These clinics and their volunteers are independent of the IRS but do receive some funding assistance from the service. Volunteers who staff the clinics come from various organizations such as attorney referral systems, local societies of accountants or non-profit tax professional organizations.

Locations for these clinics are available on the IRS Web site.

• The Internet offers copious tax helps, but use caution because some tips may or may not be reliable.
• Tax preparation software and services are viable resources.

Finally, if you do delay preparation, request an extension. You can get an automatic six-month extension to Oct. 16, 2007. You still need to pay any taxes that may be due. To avoid a late payment penalty, at least 90 percent of your total tax liability is payable by the April 16 deadline.

EDITOR’S NOTE: This educational information is not intended as legal or tax advice. Individuals with legal or tax questions should consult a legal or tax adviser who can provide specific information to their unique situations.

Sherre Stephens is a certified employee benefits specialist and director of executive and institutional benefit design for GuideStone Financial Resources of the Southern Baptist Convention.