This guide explains what charitable donations are and how you can claim them as deductions on your tax return. It also covers how to keep records, which will assist you in determining what deductions you can claim as a result of your charitable donations. In addition, we’ve included information on other deductions you may be eligible for. The guide can also be used as a resource to help you plan for next year.
When completing your tax return, you can choose to claim the standard deduction or to itemize your deductions. Use the method that lowers your income the most.
Standard deduction. The standard deduction reduces the amount of income on which you are taxed by a fixed amount that may change from one tax year to the next. Generally, anyone qualifies for the standard deduction. It is a benefit that eliminates the need for many taxpayers to itemize deductions, such as medical expenses and charitable donations, on Schedule A of Form 1040.
For 2006, the standard deductions are:
$5,150 for Single or Married Filing Separate filers
$10,300 for Married Filing Joint or Qualifying Widow(er) filers
$7,550 for Head of Household filers
There are additional standard deduction amounts if you are 65 years or older, or blind.
Itemization. Itemizing deductions makes sense when the total amount of allowable deductions exceeds the standard deduction. If you own a home, have deductible medical expenses, or give a significant amount to charity, you will probably be better off by itemizing your deductions.
You must itemize in order to claim a deduction for your charitable donations.
There are a few things to consider when you are thinking of making a charitable donation.
Charitable donations are only deductible in the year that you make them, and for an additional five years after the original deduction in the case of a carryover. With this in mind, consider the timing of your donations.
You can subtract either itemized or standard deductions from your adjusted gross income (AGI) to arrive at your taxable income. You can deduct charitable donations only when you itemize deductions. If your itemized deductions are less than the standard deduction, $10,300 in 2006 for those married filing jointly, then you should use the standard deduction because it will give you the largest deduction and the lowest taxable income.
Itemized deductions include the following:
Medical and dental expenses that exceed 7.5% of your AGI
Taxes paid
Home mortgage interest paid
Charitable donations
Casualty and theft losses
Miscellaneous itemized deductions that exceed 2% of your AGI
Timing your donations and expenses can help you get the most of your itemized deductions. If your itemized deductions are close to, but not over, the standard deduction, consider making a charitable donation that would put your itemized deductions over the amount of the standard deduction.
For example, if you have medical or miscellaneous itemized deductions this year that are close to or exceed your standard deduction, try increasing your itemized deductions this year. This is the time to contribute to your favorite charity. On the other hand, if you anticipate that most of your medical expenses and other deductible expenses will occur next year, try making a charitable donation next year to maximize deductions next year.
Recordkeeping is an essential part of an effective tax plan. Keeping complete and accurate records can prevent a negative outcome should your tax return be audited. Without clear documentation, the IRS may disallow unsubstantiated deductions and credits, which can require that you pay penalties and interest in addition to more taxes.
The following describes the types of donations that you can make and what kind of documentation you should keep to substantiate each type of donation.
For 2006, cash donations fall into two categories: those less than $250 and those of $250 or more. Each category requires a different type of recordkeeping.
To determine where your donations fall, follow these rules:
Do not combine donations. For example, if you donated $150 to an organization and then donated an additional $150 a month later, consider these two separate donations.
If you are donating through payroll deduction, count each payroll deduction as a separate donation.
If you made a payment that is partly for goods and services—attending a benefit dinner, for example—your donation is the amount of the payment minus the value of the goods and services received.
For cash donations less than $250, use one of the following methods of documentation:
A canceled check
A legible account statement that includes the following details:
For a check donation—the check number, the amount, the date posted, and the payee
For a credit card donation—the amount, the transaction date, and the payee
For a donation made by electronic transfer—the amount, the date posted, and the payee
A receipt or written acknowledgement from the charity showing its name, the date, and the amount you contributed
Any written record made at or near the time of the donation that lists the organization’s name and the date and amount you contributed
Beginning in 2007, the last method listed above will no longer be valid. You must have a canceled check, account statement, or receipt.
For cash donations of $250 or more, you must get documentation from the charity by the time you file your return for the year. If you file late or get an extension, you have until the date you file to provide documentation.
The charity’s written receipt or acknowledgement of your donation must include all of the following. The organization may provide either a separate statement for each donation or periodic statements substantiating your donations.
The amount of the donation
An indication of any goods or services you received, if any, other than certain token items or membership benefits
A good faith estimate of the value of any goods or services you received
The IRS does not require written acknowledgement for donations you make by payroll deduction. However, for deductions of $250 or more from a single paycheck, you must keep:
A pay stub, Form W-2, or other document furnished by your employer showing the amount withheld
A pledge card or other document from the organization stating that it doesn’t provide goods or services for donations made by payroll deduction
If you donate noncash items, such as clothing or household goods, keep accurate records of exactly what you donate and the condition of each item. It’s also a good idea to take a picture of the property that you are donating.
For noncash donations less than $500, keep the following records:
A receipt or acknowledgement letter from the organization
A written record showing the name of the organization, the date, the location, and a description of the donation, your cost/adjusted basis, and the method you used to determine the value of an item.
For noncash donations of $501 to $5,000, follow the rules listed above. In addition, you must record:
How you acquired the property, for example, by purchase, gift, bequest, inheritance, or exchange. For a security, keep the name of the issuer, the type of security, and whether it is regularly traded on a stock exchange or in an over-the-counter market.
The approximate date that you acquired the property or its creation was completed. If you have a reasonable cause for not being able to provide this information, attach an explanation to your return.
The cost or other basis and any adjustments of property held less than 12 months and, if available, the cost or other basis of property held 12 months or more. This doesn’t apply to publicly traded securities.
The fair market value of the donation and how you figured it. If you had the property appraised, keep a signed copy of the appraisal.
Its cost or other basis. Include any reduction amount and how you figured it. If you choose the 50 percent limit instead of the special 30 percent limit, you must keep a record that lists the years you made the choice, donations for the current year, and any carryovers from earlier years.
The amount you claim as a deduction if you contribute less than your entire interest in the property during the tax year. Your records must include the amount of any previous deductions taken for this property and the name and address of each organization to which you contributed the other interests, the place where it is located or kept, and the name of any person in possession of the property other than the organization to whom you contributed.
The terms of any conditions attached to the gift.
A description and good faith estimate of the value of any goods or services given to you as a result of your donation, other than certain token items and membership benefits.
If your total deduction for all noncash donations for the year is more than $500, you must complete Section A of Form 8283 and attach it to your Form 1040.
If you contributed an item (or a group of similar items) for which you are claiming a deduction of more than $5,000, you must complete Section B of Form 8283. Omit publicly traded securities reportable in Section A. The recipient must complete and sign Part IV of Section B. With certain exceptions, items reported in Section B will require information based on a written appraisal by a qualified appraiser.
When you offer your services to a qualified organization and incur unreimbursed out-of-pocket expenses, keep the following written records:
Receipts showing your expenses
Written acknowledgement from the organization that contains:
A description of your services
A statement describing any goods or services the organization provided to reimburse your expenses
A description and a good faith estimate of the value of any goods or services (other than intangible religious benefits) provided to you
A statement of any intangible religious benefits provided to you
You cannot deduct personal, living, or family expenses for services you perform unless you had to be away from home overnight. Out-of-pocket expenses must be:
Unreimbursed
Directly connected with the services
Expenses you incurred only because of the services you donated
Not personal, living, or family expenses
You must have reliable written records to claim expenses for car use. Generally, your written records are considered reliable if you made written notes regularly and at, or near the time you incurred the expenses.
Your written records must show the organization’s name and the date each time you used your car for a charitable purpose. If you use the standard rate, your records must show the number of miles you drove while you performed the charitable services. If you deduct actual expenses, your records must show the costs directly related to a charitable purpose.
For the year 2006, the standard rate is generally 14 cents per mile.
However, the amount you can deduct if you used your vehicle for charity work related to Hurricane Katrina during 2006 is 32 cents per mile. Congress is allowing a special mileage rate to help people who volunteer their time for hurricane relief efforts.
The following chart summarizes the records you must keep for each type of donation:
Donation |
Required Written Records |
Cash, less than $250 |
Canceled check, receipt, or any reliable written record. |
Cash, $250 or more |
Acknowledgement letter from the organization. |
Out-of-pocket expenses of any amount |
1. Receipt or adequate record of the expense, and 2. Acknowledgement from the organization |
Payroll deductions of any amount |
1. Pay stubs, W-2, or other document from your employer listing the amount withheld, and 2. A pledge card or other document from the organization |
Noncash, value less than $250 |
1. A receipt or acknowledgment letter from the organization if it is practical to get one 2. A written record showing the name of organization, the date, location, and description of the donation, your basis in the property, fair market value, and method of valuation |
Noncash, value 250-$500 |
1. A receipt or acknowledgment letter from the organization 2. A written record including the information listed above (Noncash, value less than $250) |
Noncash, value $501-$5,000 |
1. A receipt or acknowledgment letter from the organization 2. A written record including the information listed above (Noncash, value less than $250 3. A description of how the property was acquired and the date it was acquired |
Noncash, value over $5,000 |
All of the above plus a written appraisal unless the donated property is publicly traded stock valued at less than $10,000 |
The IRS allows you to claim a deduction equal to the fair market value of each noncash item you donate to an eligible organization, with the exception of appreciated property.
This means that each noncash donation reduces your total taxable income in an amount equal to the fair market value of the item.
Example: You donate some used clothing, appliances, and household items in good condition, with a combined fair market value of $700 dollars. That $700 dollars is subtracted from your adjusted gross income when you enter your donations on your tax return and reduces your overall tax bill.
Due to a provision contained in the Pension Protection Act of 2006, which the President is expected to sign on August 17, 2006, noncash donations of used clothing or household items made after the date the bill is signed must be in "good" condition to qualify for a deduction. Congress did not define "good" condition, and the IRS will be issuing guidance in the future.
Meanwhile, we advise that you deduct donations of used clothing or household items made after August 17, 2006 only if the organization intends to sell or use the donated items for its charitable purposes. In particular, if an item is heavily worn, don’t assume that the organization will sell or use it. To be sure, ask the organization if it will be sold or used.
For the latest information regarding this tax law change, visit the DeductionPro technical support Web site.
Special rules apply to property such as stocks, bonds, artwork, or collectibles, that have increased in value since the original acquisition.
The IRS requires that you take the lower of the cost/adjusted basis versus the current fair market value if you have owned the property for less than one year prior to the donation.
If you owned the appreciated property for more than one year, you can claim the deduction based either on the fair market value or on the cost/adjusted basis.
If you choose to take the fair market value as a deduction, then that deduction is subject to either the 30% or 20% charitable deduction limit depending upon the type of the organization.
If you choose to claim the cost/adjusted basis as a deduction, then that deduction is subject to either the 50% or 30% charitable deduction limit. See Charitable Deduction Limits.
Example: You donated a stock holding, which has increased in value, to the Salvation Army. You have held this stock for over one year prior to your donation and you are eligible to claim the current fair market value as a deduction.
When you take the fair market value as a deduction, your deduction limit for that property is:
30% of your adjusted gross income if you gave it to a 50% limit organization
20% of your adjusted gross income if you gave it to a 30% limit organization
Since the Salvation Army is a 50%-limit organization, you can deduct its fair market value up to 30% of your adjusted gross income.
See Limits by Organization for more information.
There are a few important pieces of information required by the IRS when you claim a deduction for the donation of inherited property.
Inherited assets are considered long term (owned longer than a year), regardless of when the decedent acquired the property. In response to When did you acquire the item(s)?, select Various dates, more than one year ago to ensure that DeductionPro accurately calculates the property as a long-term holding. In addition, make sure to select Inheritance in response to How did you acquire the item(s) donated?
Generally, if you receive property as a gift, your holding period includes the holding period of the giver (the person who gave you the gift). For example, if your uncle purchased stock on 11/15/1999, and gave you the stock on May 6, 2005, your acquisition date is 11/15/1999. Your basis in the property is the same as the giver’s basis.
Exception: If you receive a gift that is worth less on the date of the gift than the giver’s adjusted basis, your acquisition date depends on whether the property has increased or decreased in value since you received it.
Value of Property on Date of Contribution |
Date Holding Period Begins |
Your Basis |
Greater than on date received |
Date giver acquired the property |
Giver’s basis |
Less than on date received |
Date your received the gift |
Value on the date you received the gift |
Example 1. Your uncle purchases XYZ stock on 11/15/1999 for $20,000 and gives it to you on 2/15/2005 when it is worth $15,000. You donate the stock on 1/15/2006 when it is worth $18,000. Your acquisition date is 11/15/1999 and your basis is $20,000.
Example 2. Assume the same facts as in Example 1 except the stock is worth $12,000 when you donate it. Your acquisition date is 2/15/2005 and your basis is $15,000.
The IRS requires you to get an appraisal if your noncash donation exceeds $5,000 in value. A description of the property along with the appraisal information is required in Section B, of Form 8283. For more information about appraising a charitable donation, refer to IRS Publication 561, Determining the Value of Donated Property.
Note: "Blue book value" is not valid as an automobile appraisal.
The Pension Protection Act of 2006, which is expected to take effect August 18, 2006 once it is signed by the President, requires an appraisal for an item of clothing or a household item if:
The item is valued at over $500.
The item is not in good condition.
The donation takes place after August 17, 2006.
The American Jobs Creation Act of 2004 passed into law in October of 2004 has provisions that limit the amount donors can deduct to the actual amount that the charity receives from the sale of a vehicle donated to a charity. If the charity actually uses the car, donors can claim the fair market value as a deduction. The charity is required to send an acknowledgement to the donor with the amount received from the sale or if the vehicle is used by the charity, a description of the intended use and a certification that the vehicle is not being sold. If the vehicle is being used by the charity, a donor may take the fair market value as a deduction.
If you give away an old car, though, there are new rules starting in 2005. Concerned that taxpayers were habitually over-stating the value of cars and other vehicles given to charities, Congress ordered an end to letting the donor estimate the value. Now, within 30 days of the time the charity sells the vehicle, it must issue a Form 1098-C to the donor telling him or her the selling price. That sets the deduction. Now, if the charity fixes up the car and sells it, gives it to a needy person, or uses it in its charitable efforts, you can still deduct the estimated fair market value at the time of the gift using used-car value guides available at banks and car dealers. Don’t assume the prices listed in such guides pinpoint the value of your car, however. You’ve probably heard stories about owners of old clunkers who decided the tax deduction for giving them away would be worth more than they could get by selling them. As you undoubtedly suspect, the IRS frowns on that approach.
If the vehicle you plan to bestow on a qualified organization—a high school shop class, for example—is a pile of junk, the allowable deduction is probably closer to salvage value than the average retail price shown in used-car guides. On the other hand, if you give away a cream puff and the charity uses it for transportation or gives it to a needy person, you may deserve a larger deduction. You may need to visit used-car lots and talk with dealers or mechanics to arrive at a fair figure. When claiming a high deduction, keeping a photo of the car is always a good idea.
Do you have a favorite charity that you want to donate to? If you don’t and you are relying on an ad that you have seen or heard about donating to a charity, make sure that you are donating the car to a qualified charity. You can only claim a deduction if your donation goes to a tax-exempt organization that is recognized by the IRS.
The IRS provides a list of qualified charities in Publication 78, Cumulative List of Organizations, which you can find on the IRS Web site, www.irs.gov. You can also contact the IRS at 1-877-829-5500 (or for TTY/TDD help, call 1-800-829-4059) to see if the organization is qualified.
Religious organizations such as churches, synagogues, and mosques, as well as government entities do not have to register with the IRS. Your donations to these organizations are deductible.
Be aware that many organizations that run car donation programs are for-profit organizations that contract with the charity to run its vehicle donation program. These for-profit organizations may advertise, pick up your vehicle, and sell it at auction. The for-profit organizations may be paid a percentage of net proceeds. In some cases, the charity receives a flat fee for the vehicle that may not reflect the price of the car at auction. Towing, advertising, staffing, and other administrative costs may considerably reduce the amount that the charity eventually receives. You may want to contact the charity to see what percentage of the proceeds from your car it will receive.
If your car doesn’t run, don’t worry. Most charities will pick it up. Make sure that you transfer the title of the vehicle to the charity or complete the paperwork your state requires to transfer ownership of the vehicle. Keep a copy of the documentation transferring ownership. You do not want to be held liable for the vehicle if an accident or parking violation occurs after you have given up possession of the vehicle. You will receive an acknowledgement from the charity showing that you made the donation.
For donations in 2006, the charity should send a written acknowledgement no later than 30 days after the donation. The IRS now provides a form, Form 1098-C, for donations of motor vehicles, boats, and airplanes for each donation greater than $500.
If the vehicle that you donate is worth $5,000 or less, you can enter either the amount from the charity’s acknowledgement letter or the fair market value of the donation on the Noncash Donations tab of DeductionPro.
If you plan to donate a vehicle worth over $5,000, a certified vehicle appraiser must appraise it. And remember, you can only claim vehicle donations if you itemize deductions.
A qualified organization is a nonprofit group that is religious, charitable, educational, scientific, or literary in purpose, or that works to prevent cruelty to children or animals. A qualified organization or charity, as defined by the IRS in Publication 526, Charitable Contributions, fall under the following five categories:
A community chest, corporation, trust, fund, or foundation organized or created in or under the laws of the United States, any state, the District of Columbia, or any possession of the United States (including Puerto Rico). It must be organized and operated only for one or more of the following purposes: religious, charitable, educational, scientific, literary, prevention of cruelty to children or animals. Some organizations that foster international or national amateur sports competition also qualify.
War veterans’ organizations
Domestic fraternal societies
Certain nonprofit cemetery companies or corporations
The United States or any state, District of Columbia, a U.S. possession (including Puerto Rico), a political subdivision of a state or U.S. possession, or an Indian tribal government or any of its subdivisions that perform substantial government functions
There is a limit to how much you can deduct for a single year, but few taxpayers have to worry about reaching the ceiling. The limits are based on the type of organization accepting the donation (whether it’s a 50% or a 30% limit organization), as well as the type of property you are donating (whether it is depreciated or appreciated property).
This list describes in general terms the types of organizations that are considered 50% limit organizations:
Churches, synagogues, mosques, and other religious organizations and their affiliates
Federal, state, and local government entities
Non-profit schools, hospitals, and volunteer fire companies
Public parks and recreational facilities
Certain private operating foundations
Non-profit agencies organized for charitable, religious, educational, scientific, or literary purposes. Most public charities fall into this category.
Examples of 50% limit organizations are:
American Breast Cancer Foundation
American Cancer Society
American Diabetes Association
Americans for AIDS Research
American Foundation for the Blind
American Heart Association
American Society for Prevention of Cruelty to Animals
Arthritis Foundation
Boy Scouts of America
CARE (Cooperative for Assistance and Relief Everywhere)
Cystic Fibrosis Association
Disabled American Veterans
Ducks Unlimited
Girl Scouts of America
Goodwill Industries
Habitat for Humanity
Junior Achievement
Make A Wish Foundation
March of Dimes
Multiple Sclerosis Foundation
Muscular Dystrophy Foundation
National Audubon Society
Red Cross
Salvation Army
September 11th Victims Relief Fund
The Humane Society
The Leukemia and Lymphoma Society
United Way
Veterans of Foreign Wars
Vietnam Veterans Memorial Fund
Vietnam Veterans of American Wars
YMCA
YWCA
Generally, 30% limit organizations are private, non-operating foundations, fraternal organizations, veterans organizations, and non-profit cemeteries. Examples of 30% limit organizations in the Kansas City metropolitan area are:
The American Legion
The Ash Grove Charitable Foundation
National Public Radio
The Way Foundation
The rules on charitable deduction limits are complicated; very few taxpayers need to worry about them. Basically, your deductions for gifts to public charities, colleges, and religious organizations can’t exceed 50% of your adjusted gross income. Within that overall limit, gifts of appreciated property, that is property that has increased in value since you originally acquired it, can’t total more than 30% of your adjusted gross income.
Stricter limits apply to gifts donated to certain types of organizations such as National Public Radio that fall into the 30% contribution limit. The current-year deduction for appreciated property given to 30% limit organizations can’t total more than 20% of your adjusted gross income.
The key to remember is that you can claim charitable-donation deductions of up to 20% of your adjusted gross income without worrying about the complexities of the IRS contribution limits rules. In fact, unless you’re giving appreciated property, you don’t need to concern yourself with these rules unless you plan on claiming charitable-donation deductions of 30% to 50% of your adjusted gross income.
If you give more than you can deduct in a single year based on these contribution limits, you can carryover the excess deductions to next year’s return. Carryover deductions can only be used for up to five years after the original deduction. The IRS will not allow you to take a carryover deduction after five years have passed. DeductionPro does not determine any carryover deductions you might have because this value cannot be accurately calculated until you begin preparing your tax return. See Carryovers for more information on this topic.
The following describe the three main rules that determine your charitable deduction limits:
For items such as cash, out-of-pocket expenses, and non-appreciated property that you have donated to a 50% limit organization, the 50% limit applies. So for this type of donation, you cannot claim more than 50% of your adjusted gross income as a deduction.
Most organizations you donate to will be able to tell you if the 50% limit applies to them. If you need help determining what category an organization falls into, check IRS Publication 78. The following types of organizations are 50% limit organizations:
Churches and their conventions or associations
Educational organizations with a regular faculty, curriculum, and enrolled students who attend classes on-site
Hospitals and certain associated medical research organizations
Organizations formed to receive and distribute donations on behalf of publicly supported state and municipal colleges and universities
Federal, state, the District of Columbia, a U.S. possession (including Puerto Rico), or Indian tribal governments or government subdivisions that perform substantial government functions
Publicly supported corporations, trusts, or community chests, funds, or foundations operated for charitable, religious, educational, scientific, or literary purposes, to prevent cruelty to children or animals, or to foster certain national or international amateur sports competition
Organizations that may not qualify as publicly supported but meet tests showing they respond to the general public’s needs. In general, more than one-third of their support must come either from publicly supported organizations or from other qualified individuals
Most organizations operated for the benefit of, or controlled by, qualifying organizations
Private operating foundations
Private non-operating foundations that make qualifying distributions of 100 percent of contributions within two and a half months following the year they receive the contribution. You’ll need to attach confirmation from the foundation that it distributed your donation on time.
A private foundation whose contributions are pooled into a common fund and whose substantial contributors can specify which public charities will receive funds. The foundation must distribute the income within two and a half months following the tax year it received the donation, and the donated property must be distributed not later than one year after the donor’s death or the spouse’s death if he or she can name the recipients.
You can donate up to 30% of your adjusted gross income if you donate:
Appreciated capital gain property held longer than one year that you donate to a 50% limit organization. However, the 50% limit applies if you choose to claim your cost/adjusted basis, rather than the fair market value.
Property other than capital gain property you donated for the organization’s use.
Property other than capital gain property you donated to qualified organizations other than 50% limit organizations. This includes gifts to veterans’ organizations, fraternal societies, nonprofit cemeteries, and certain private non-operating foundations.
You may deduct 20% of your adjusted gross income for any gifts of capital gain property you donate to qualified organizations other than 50% limit organizations.
If your income is over $150,500 ($75,250 if married filing a separate return), your itemized deductions are reduced by the smaller of (a) 80% of your itemized deductions other than medical expenses and (b) 3% of the excess of your adjusted gross income over the cutoff. DeductionPro does not calculate the reduction for you.
You can carry over donations that exceed the adjusted gross income limits until it is used up or for up to five years, but not beyond. The total deduction cannot exceed 50 percent of your adjusted gross income for that year. You must figure the same percentage limits for carryovers that you originally used. For example, donations subject to the 20% limit are still 20% limit contributions.
For each category of contribution, you can deduct carryover contributions only after first deducting all allowable contributions in that category for the current year. If you have carryovers from two or more previous years, use the carryover from the earlier year first.
DeductionPro does not determine any carryover deductions you might have because this value cannot be accurately calculated until you begin preparing your tax return.
Often times, you may be unaware of deductions, credits, and adjustments you can take on your tax return. In addition to charitable donations, mortgage interest, and real estate taxes, there are other ways to reduce the amount of tax you pay including:
Other taxes. Don’t forget to deduct any state income taxes, local income taxes, and personal property taxes you paid. If you are using a tax preparation package and you paid estimated state taxes during the year, include these on your federal return.
Job-hunting expenses. Expenses incurred while searching for a job in your present or most recent line of work are deductible even if you do not get a new job. Eligible expenses include things like periodical subscriptions, fees paid to recruitment firms, resume preparation and printing, and transportation costs to and from job interviews.
Medical expenses. You can deduct medical expenses incurred during the year if they are not reimbursed by insurance or paid with pre-tax earnings to the extent the expenses exceed 7.5 percent of your adjusted gross income. Medical insurance (including COBRA payments) and long-term premiums are deductible as well.
Education Credits. If you are a student or if you have a child in college, you have several opportunities to reduce your taxes. With the Hope and Lifetime Learning Credits, a credit of up to $1,500 per student or $2,000 per return, respectively, is available. You must meet certain eligibility requirements to take these credits. Phase out limits apply.
Child Tax Credit. The child tax credit is $1,000 per child in 2006.
Education Deductions. You may be able to claim an above-the-line deduction of up to $4,000 for tuition and fees paid to eligible higher education institutions. Phase out limits apply.
Student Loan Interest. You may be able to claim interest you paid on your student loans. Individuals can take a Student Loan Interest deduction of up to $2,500 for eligible loans. This deduction is available even if you do not itemize.
More complex tax returns and new tax law changes may increase the odds that you may not take all of the deductions or credits you are legally entitled to claim.
Add up the gains and losses you have for the year based on your investments. If trades to date have resulted in a net gain, look at the securities in your portfolio that show paper losses. It might be wise to sell some stocks, using the loss to offset the gain and reduce your tax bill.
Important: You cannot deduct a loss on the sale of securities if you purchase substantially similar securities within 30 days before or after the sale. The loss on such a sale (called a "wash sale") is added to the cost of the securities you buy.
On the other hand, if your sales for the year have produced a net loss, consider some year-end profit-taking. Remember that $3,000 of net losses a year can be used to offset income other than capital gains with the excess of extra capital losses carried over to future years. You might want to consult your investment advisor before selling any investments.
You cannot take a deduction on your federal return related to saving for college. However, your state may have a deduction available if you contribute to a Section 529 Plan. Call your local H&R Block tax or financial advisor office for information on plans available in your state.
Qualified tuition programs (QTPs), also called Section 529 Plans, allow anyone to set up a fund for another person’s higher education (often for a child or grandchild) without relinquishing control of the money. The fund grows tax-deferred and the distributions are tax-free when used for qualified higher education expenses. (The taxable portion, if any, is taxed to the beneficiary, presumably, at a student’s lower tax bracket.)
Most qualified tuition programs allow contributions in excess of $100,000. A contribution in excess of $11,000 in any year can be treated as if it were given over five years for purposes of calculating gift tax. For those who want to contribute a smaller amount, QTPs usually have monthly contribution features as well. If the funds are not used for the original beneficiary’s higher education expenses, they can be rolled over to a QTP for a relative, usually a sibling. A beneficiary’s first cousin is included in the definition of an eligible relative.
All qualified tuition programs can be established by a state or an agency or instrumentality of the state. These plans are either set up as a savings plan or a prepaid tuition plan. Professional money management firms usually manage the savings plans. These plans may offer a limited number of investment options. Contributors are able to rollover funds from one plan to another once in any 12-month period for the same beneficiary. Normally, states do not restrict enrollment in a QTP to residents of that state, but state residents may be eligible to take a deduction for all or part of their contributions.
Private colleges and universities can also establish QTPs, but only for prepaying qualified higher education expenses.
Coverdell Education Savings Accounts. These were formerly called Education IRAs. You can contribute up to $2,000 a year to a Coverdell Education Savings Account (ESA) for a child. This $2,000 maximum contribution is reduced if your income is above a certain amount. You can’t contribute if your modified adjusted gross income is $110,000 or more ($220,000 if you file a joint return).
You can contribute up to the due date of your tax return, generally, April 15 of the following year.
Distributions are allowed for elementary and secondary education expenses, including tuition, tutoring, home computers and peripherals, and Internet access.Distributions from QTPs and ESAs should be coordinated so that only enough is distributed to cover the qualified education expenses in any one year. If too much is taken out, at least some of the earnings will be taxable. Account balances and distributions from these savings plans may also impact the amount of financial aid a student is able to get in any one year.
Some folks like to separate their tax records into current and long-term files. You may want to implement some form of this idea. Current tax files should include all the items mentioned below for the current tax year (for example, if you received a bonus check from your employer in the first quarter, keep it in your current general finance file).
Your long-term file should contain at least six years of tax returns (more on that below) and relevant supporting documents. The same goes for home improvement receipts, canceled checks, and pay stubs for the previous tax year.
If you operated a home-based or other small business, be sure to maintain separate files for your personal records and your business records. This will make it easier for you to know which deductions and credits you’re entitled to take as a business owner and which you’re entitled to take on the personal portion of your return. Working off a separate set of records prevents accidental duplication and potentially confusing overlap of what goes where.
If the IRS wants to check your records, they may ask to see original receipts and tax forms. It’s a good idea to file your information from the tax year in a folder, large envelope, or binder. You can store these yearly files in boxes or on shelves.
Above all, always file your tax records in order by date, organized by category. Keeping up with your receipts, pay stubs, and various financial forms as the year goes along will make it easier to find the numbers you need at tax time.
This can be a simple log that lists the type of gambling activity, how much money you won or lost, the location or address of the establishment, the date, and the names of others who were present with you, if applicable. Also be sure to keep any Forms W-2G you receive. These are especially valuable because they will show any taxes withheld from your winnings.
Keep documents like pay stubs, W-2 forms, records of tips you were paid, sales receipts or contracts for big-ticket items such as the purchase or sale of an automobile or home, investment records, along with contributions to retirement accounts, bank and brokerage statements, and Form 1099s, and mortgage interest statements.
Save all papers regarding insurance claims and medical expenses along with dates and specific information about what was paid, when it was paid, and what was reimbursed by insurance (if applicable).
If you make payments toward an item that is tax deductible using a credit card, electronic transfer of funds, or personal check, make sure you record the check number (or keep your credit card and/or bank statements), dollar amount, payee’s name, and date of the transaction. If you make a payment in cash, you need to get a signed and dated receipt showing the amount and reason for the payment.
People who are self-employed or use their home for business need to keep a special set of records. We recommend that you contact your tax professional for advice and additional information.
If you suffered a theft or casualty loss, document it by including the property’s value, the date the property was first noticed missing or damaged, and proof that it was yours. It might be necessary to have a copy of the police report, if one was filed, especially if the item was very valuable.
Deductions are the key to reducing your taxable income. They’re easy to overlook—you won’t get a notice in the mail about any of them—but TaxCut or your H&R Block tax preparer can help you take advantage of all the deductions that apply to your tax situation. Here’s a list of the most commonly overlooked deductions:
We recommend that you keep track of your itemized deductions each year even if you’re in the habit of taking the standard deduction. A lot of people don’t bother with itemized deductions and end up paying more tax than they owe. Here are some ways for you to get the most out of your itemized deductions.
Medicare B. Did you have payments for Medicare B insurance deducted from your Social Security benefits? You may deduct any premiums that you paid for Medicare B as a medical expense.
Vehicle excise or personal property tax. If you get a bill every year from your state or local government charging you a tax for owning a vehicle, you may be able to deduct that tax. You can also get the tax deduction if you lease a vehicle and your finance company bills you for the tax. The rule is that you can deduct the tax if it depends on the value of your vehicle. If you’re not sure how the tax was calculated, ask your local tax authority.
Job-hunting expenses. If you’re between jobs, it pays to save your receipts for job-hunting expenses. These expenses are deductible as a miscellaneous itemized expense if they were incurred to locate a new job in the same line of work. For example, phone bills, resume advice, and travel expenses may all be deductible.
Real estate taxes. Real estate taxes are deductible. Don’t forget taxes you paid indirectly, such as taxes paid through a mortgage escrow account. If you bought a house, check your settlement statement for any taxes for which you reimbursed the seller at the closing. These taxes are deductible, too.
Cost of tax preparation. Tax software expenses, tax preparation fees, and other tax preparation and filing expenses are all deductible on your tax return as a miscellaneous itemized expense. Be careful to deduct them on the return for the year in which you paid the costs. For example, the cost of preparing and filing your 2005 tax returns is deductible on your 2006 tax return if you paid the tax preparation expenses in April 2006.
Estate tax on income in respect of a decedent. Did you receive income that you must include as taxable income on your return because you are the beneficiary of someone who died? A common example is a distribution from an inherited IRA. You have to include the IRA distribution in income. If the estate of the person who dies was large enough to trigger estate tax, ask the executor to tell you the amount of estate tax attributable to the IRA distribution. This amount is tax-deductible.
Always have last year’s federal and state tax returns handy when you’re doing your taxes. There are a number of items that can save you money if you know where to look.
Capital loss carryover. If your capital losses are greater than your capital gains, you won’t have to pay tax on the capital gains. You can also deduct up to $3,000 ($1,500 if married filing separately) of the capital loss, offsetting other income you may have. Any losses above the cutoff are called a capital loss carryover and are treated as a capital loss on the next year’s return. So, if you have a capital loss one year and a capital gain the next year, remember to use your capital loss carryover to reduce your taxes in the later year.
State tax you paid in April with your return. Did you owe taxes when you filed your 2005 state tax return? That check you wrote in April can help you when it’s time to pay your 2006 taxes. State income taxes are deductible in the year they’re paid, but a lot of people forget about that April tax payment when they’re doing their taxes for the next year.
Reinvested dividends. Often a mutual fund account is set up to automatically reinvest dividends in additional share purchases. When you get around to selling stock that was purchased this way, your basis—the amount you subtract from the sales price to figure your gain or loss—should include these reinvested dividends. It’s up to you to keep track of the reinvested dividends unless your fund does it for you.
Credit for excess Social Security tax. If you work for more than one employer during the year, look into the credit for excess Social Security tax. Each employer you work for will withhold Social Security tax as if you didn’t work for anyone else. Once your wages reach the Social Security limit—$94,200 in 2006—any Social Security tax withheld after that is treated as a credit against the regular tax you owe for the year if you have more than one employer.
You can leave assets to a charity outright through your will or you can establish a charitable trust. By creating a charitable trust, you may claim a current income tax deduction, reduce capital gain taxes, and reduce estate taxes.
You can establish either a Charitable Remainder trust or a Charitable Lead Trust. Under a Charitable Remainder Trust, you donate assets to a trust. You or your beneficiary receive a fixed amount or a percentage of trust assets annually from the trust during your lifetime or for a specified number of years. At the beneficiary’s death or the end of the trust term, the charity receives the remainder of the trust.
You may claim a current income tax deduction for the present value of the charity’s remainder interest. If you donate appreciated assets (property that has increased in value) to a trust and the trust sells the assets, the trust does not recognize capital gains. If you had sold the property you would have had to pay tax on the capital gains. Your estate taxes may be reduced because the size of your estate is reduced by the amount of the assets you donated to the trust.
A Charitable Lead Trust pays income to a charity for a specified number of years. At the end of the trust term, the remainder passes to you or your heirs. Generally, a trust does not generate a tax deduction unless it is a non-grantor trust. However, estate taxes may be reduced because the part of the asset value going to the charity is removed from your estate.
If you are interested in setting up a charitable trust, contact a financial or legal advisor.
Tax time is much more than the period from January 1 through April 15. It’s actually a year-long event because the borrowing, spending, and investment decisions you make all year shape your tax bill well before your filing deadline.
There’s no better time than now to start working on your tax plan so you won’t miss important opportunities to trim your tax bill.
H&R Block provides a variety of tips and tools to help you make the most of next year’s tax plan. Visit www.hrblock.com from any of the links below to make use of our exclusive tax planning tools and information:
Tax-Free Fringe Benefits. Fringe benefits may be more lucrative than you think. Take full advantage of your company’s extra incentives and put money in your pocket.
Filing Status & Rates. Discover how your filing status and marginal rates work together in your return. Educate yourself about the factors involved to significantly enhance your tax planning process.
Withholding & Estimated Tax. You earned it; you deserve it. Avoid giving the federal government an interest-free loan by lowering your monthly tax payout.
Dependents & Family. Get tax tips that affect you and your family. We’ll even show you how your kids can actually save you money on your next tax bill.
Savvy Deductions. Knowing the ins and outs of deducting is a complex proposition. Optimize your return with the creative modifications offered here.
Investments. Learn how your portfolio can be an effective tool in adjusting your filing position. There has never been a better time to evaluate your net gains and losses.
Business Strategies. Tax time can often make or break a small business. Alleviate the strain of tax season with lucrative strategies.
IRAs, 401(k)s, & Other Retirement Plans. Many tax-advantaged options are available for your retirement savings.