Taxes are my personal finance Achilles heel. Every year, I promise myself I’ll be better organized than the last. With freelance income and a rental property — in addition to the usual stuff (mortgage and charitable deductions, for example) I generate a fair amount information that needs to be sorted and organized so that my accountant can do his job.
If there ever were a time to get on top of your tax situation, this year is it. No one knows exactly what changes will occur next year, but with the looming crisis of the fiscal cliff, as well as tax benefits like the protection against taxes resulting from certain cancelled real estate debt set to expire at the end of the year, taxpayers and tax professionals can expect to be grappling with a multitude of changes.
For the average taxpayer, what are some year-end tax moves?
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“Forty percent of taxpayers are living paycheck to paycheck,” says Lisa Greene-Lewis, CPA and TurboTax blog editor. For them, every penny they can save in taxes counts. Here are some top moves:
Monetary donations to your favorite charities are always welcome, of course. But there are other tax deductions that may be available to you. “If you are volunteering for a charity then you can deduct your cost of travel which can include miles, airfare, and hotel as long as it’s directly related to the charity and it’s not personal,” says Greene-Lewis. In 2012, the volunteer mileage rate was 14 cents/mile. You must itemize to take advantage of charitable donation deductions, and you must volunteer or donate to a qualified charity.
Cleaning out your closet may also entitle you to a tax deduction, if you donate those items to a qualified charity. Figuring out how much to deduct for your used clothing or household items can be tricky, though. To help, TurboTax offers a free tool called It’s Deductible that allows you to track deductions of cash or goods throughout the year.
Maximize American Opportunity Credit In 2012
The American Opportunity Tax Credit was a centerpiece of 2009’s stimulus bill,” says Karla Dennis, Enrolled Agent and CEO of Cohesive Tax. She goes on to explain, “The newest education tax break expanded the Hope Credit, supplying a credit of up to $2,500 of the cost of tuition and related expenses. Up to $1,000 from the credit could return to the taxpayer as a refund.”
But this tax break may not be around much longer. “The American Chance Credit was initially meant to end in 2010, but it was extended until 2012. Nevertheless, this could be the credit’s final year. Congress wants ways to cut the federal deficit, and letting tax breaks expire is a way to save some dollars. If you have eligible education costs, make sure you claim the American Chance Credit as soon as you can.”
Defer Income — or Don’t
The usual tax advice is to try to defer income to the following year. For example, “If you did really well at work and you are expecting a bonus but it will move you up to a higher tax bracket, you may want to ask your employer to defer that bonus until January,” says Greene-Lewis. Or self-employed individuals may be able to hold off billing clients until early 2013.
However, this year you may want to rethink that advice. “Impending tax rate modifications will make accelerating income in 2012 the exception to the traditional tax adage of deferring income,” Dennis warns. “The top income tax bracket in 2012 is 35 percent. If Congress doesn’t act, the highest tax rate could go to 39.6 % in 2013. So in case you are in the leading income tax bracket, you might want to accelerate earnings into 2012 and pay taxes at a lower rate.”
The National Society of Accountants urges taxpayers to ‘”Run the numbers” for regular tax liability and AMT (alternative minimum tax) liability, and possibly explore if certain deductions should be more evenly divided between 2012 and 2013, and which deductions may qualify, or will not be as valuable, for AMT purposes.’
Prepare for the 1099-C Tidal Wave
Early next year, taxpayers will start receiving 1099-C form reporting “cancelled” debt for 2012. The IRS estimates over 5.5 million of these forms will be filed. Taxpayers must include Cancellation of Debt Income (CODI) in their gross income unless they can show that they meet specific requirements that allow them to exclude it. One of the main exclusions, the Mortgage Forgiveness Debt Relief Act, is set to expire at the end of this year unless Congress extends it. Given other more pressing issues, there is concern that it will expire.
What does that mean for taxpayers? Those who are trying to sell their home through a short sale and believe they qualify for that exclusion, which allows up to $2 million in debt to be excluded from income (for married couples), should try to complete the sale before year end. If they can’t, however, it’s still possible they may qualify for the insolvency exclusion which does not expire.
In addition, any taxpayers who settled a debt this year for less than the full amount due shouldn’t wait until they receive a 1099-C to act. Read our series on options if you receive a 1099-c and use the worksheet in IRS publication 4681 to find out if you qualify to exclude that amount from your 2012 income.
[Related Article: Just Received a 1099-C? Don't Freak Out!]
Take a Casualty Loss Deduction
If you were a victim of one of many of the natural disasters that swept the country this year — tornadoes, floods, fires, or more recently, Hurricane Sandy — you may be entitled to a casualty deduction. But be forewarned: not everyone who had unreimbursed losses will qualify. “Tax relief for casualty losses generally are limited to those with the unfortunate confluence of poor insurance coverage, low adjusted gross income (AGI), and good documentation,” warns Rob Clarfeld, CPA, CFP®, and the Founder and CEO of Clarfeld Wealth Strategists and Financial Confidantes™ in a blog post at Forbes.com.
As the IRS explains:
Generally, you may deduct losses to your home, household goods, and motor vehicles on your federal income tax return. However, you may not deduct a casualty or theft loss that is covered by insurance unless you filed a timely insurance claim for reimbursement. Any reimbursement you receive will reduce the loss. If you did not file an insurance claim, you may deduct only the part of the loss that was not covered by insurance.
You figure the amount of your loss using the following steps.
● Determine your cost or other basis in the property before the casualty or theft.
● Determine the decrease in fair market value (FMV) of the property as a result of the casualty or theft. (The decrease in FMV is the difference between the property’s value immediately before and immediately after the casualty or theft.)
● From the smaller of the amounts you determined in (1) and (2), subtract any insurance or other reimbursement you received or expect to receive.
● Apply the deduction limits, discussed later, to determine the amount of your deductible loss.
Even then you don’t get full credit for those losses because you have to reduce each casualty or theft loss by $100 ($100 rule) and then further reduce the total of all your losses by 10% of your adjusted gross income (10% rule). Still, for those who lost so much to this year’s disasters, this tax deduction may provide a measure of relief as they try to recover.
What are you doing to prepare for big tax changes in 2013? Share your strategies in the comments below.
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