Stay tuned to tax law changes and reduce your tax bite

With recent economic downturns and important pieces of tax legislation being passed over the past year, you may be wondering what changes you need to make now to protect yourself in the future. Keeping abreast of tax law changes and tax-saving strategies is one way you can protect your assets. Let’s look at some key changes made from the new laws: the homebuyer tax break, charitable IRA rollovers and the sales tax deduction.

Interest-free home loans

A new tax break is the so-called “first-time homebuyer credit,” a moniker that’s somewhat misleading because the incentive isn’t a true tax credit and isn’t strictly limited to first-time homebuyers. Available for qualifying homes purchased after April 8, 2008, and before July 1, 2009, the credit must be repaid over 15 years — so it’s more like an interest-free home loan from Uncle Sam.

The act defines the “first-time homebuyer” as someone who hasn’t owned a principal residence during the previous three years. Those who qualify can claim a credit equal to 10% of the purchase price, up to $7,500 (half that amount for married filing separately). The credit begins to phase out, however, when adjusted gross income (AGI) reaches $75,000 ($150,000 for joint filers) and is eliminated for taxpayers with an AGI that exceeds $95,000 ($170,000 for joint filers).

You may not qualify, but perhaps your children — or grandchildren — will. The combination of this credit and lower home prices may make now a great time to give them some money they can use toward a down payment. Plus, the increase in the annual gift tax exclusion to $13,000 this year means you can give a child $1,000 more tax free than you could have last year ($2,000 more if you and your spouse split the gift) without dipping into your $1 million lifetime gift tax exemption. If you and your spouse jointly make the maximum annual exclusion gifts to both your child and his or her spouse, they will have $52,000 for a down payment — an amount that may put them in a better position to qualify for a mortgage in a tight credit market.

Charitable IRA rollovers

This tax break — which had expired at the end of 2007 — has been extended through 2009. The charitable IRA rollover (technically called a “qualified charitable distribution”) allows individuals age 70¹/₂; or older to transfer up to $100,000 directly from an IRA to a qualified charity without triggering income taxes on the distribution. The rollover even counts toward the taxpayer’s required minimum distributions (RMDs) for the year.

“What’s the big deal?” you might ask. “Can’t you achieve the same result by taking a taxable distribution from your IRA, donating the funds to charity and then claiming an offsetting charitable deduction?” For many people, that’s true. However, this strategy won’t work if you’re constrained by the 50%-of-AGI limit on charitable deductions. A charitable IRA rollover may also provide a tax advantage if your AGI is high enough to reduce your itemized deductions or other benefits, or if you live in a state that doesn’t allow charitable deductions for state income tax purposes.

Making a large donation from your IRA under either method provides additional benefits. For example, it will reduce the amount of your future RMDs, because the amount of your annual RMD is equal to the size of your IRA divided by a factor based on your age. This may even help you stay in a lower tax bracket. Also, the donated IRA assets are removed from your taxable estate. And, of course, you benefit your favorite charity — which may be particularly grateful at a time when both donations and income from endowments are down and many charities are struggling.

There are a number of requirements for making a charitable rollover. For instance, certain charitable entities don’t qualify, including donor-advised funds, supporting organizations and private foundations. Also, you must comply with several requirements, including transferring the funds directly from the IRA to the charity and substantiating your donation with the same type of documentation required for other charitable gifts.

Sales tax deduction

The option to deduct state and local sales taxes in lieu of state and local income taxes has been extended. Most people will still be better off deducting income taxes, but if you live in a state with no income tax, the sales tax deduction will likely benefit you. The deduction also may benefit those who:

• Reside in states that tax only interest and dividends,
  
  
• Reside in states where sales tax rates are significantly higher than income tax rates,
  
  
• Have income that isn’t subject to state income tax, such as retirement plan distributions, Social Security benefits or U.S. government bond interest,
  
  
• Frequently cross borders to shop in neighboring states, or
  
  
• Buy expensive items such as boats or luxury cars.

Take into account the tax consequences when deciding whether to make a large purchase this year or next — as of this writing, the sales tax deduction hasn’t been extended past 2009. Even if it is extended, it may make sense to bunch large purchases into one year if it will cause your sales tax deduction to exceed your income tax deduction. Similarly, you may benefit by shifting state income tax payments between years. For example, if you’re making a large purchase this year, you might pay your fourth-quarter 2009 estimated state income tax payment after, rather than before, year end, so that you can deduct it in 2010 while deducting sales tax in 2009.

Also consider the alternative minimum tax (AMT). Just like the deduction for state and local income taxes, the sales tax deduction can’t be taken for AMT purposes. So if you have to pay the AMT, you’ll lose some or all of the benefit of the deduction.

Generally, the best way to maximize your sales tax deduction is to save your receipts. If you haven’t saved them throughout the year, however, you can use IRS tables to estimate your sales taxes. Sales tax paid on large-ticket items such as vehicles, boats, airplanes, home construction, remodeling or refurnishing may be deducted in addition to the table amount.

Keep taxes top of mind

Recent tax law changes have created several opportunities for reducing your 2009 tax bill, including many not mentioned here. More changes may have been made after this issue went to press, and additional ones are likely to occur in the coming months. Even if you’ve just filed your individual income tax return, it’s wise to be thinking about next year’s tax deadline and to contact your tax advisor for information on the latest tax law changes. Otherwise, you may miss out on many tax-saving strategies. •