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Tax Breaks

Where to Find Hidden Savings on Your 1040

Goodies galore are buried in your 2006 return. We'll help you uncover them.

Some years, doing your taxes is like playing Trivial Pursuit: The more arcane questions you can answer about deductible expenses, the more you'll save. This year, however, filling out your return is more like playing hide-and-seek.

Congress enacted a number of tax changes for 2006 so late that the tax forms had already been printed. As a result, the IRS had to find creative ways for you to claim certain deductions.

For example, let's say your income is too high to qualify for either the Hope Scholarship or the Lifetime Learning tax credit (that means adjusted gross income of more than $110,000 for married couples filing jointly or $55,000 for everyone else). You still may be able to deduct up to $4,000 of qualified college or other post-high school tuition and fees. But there's no line for this on Form 1040.

What to do? Locate line 35, labeled "domestic production activities deduction," write t in the blank space to the left, and enter your write-off (we're not kidding).


The instructions are just as cryptic if you deduct state sales tax rather than state income tax -- a tactic that makes sense if you live in a state with no income tax, such as Florida or Texas, or if you live elsewhere and your sales-tax deduction exceeds your state income-tax deduction (that's the case with some retirees).

To help you calculate your deduction, the IRS provides tables with standard sales-tax amounts based on income, family size and state of residence. (There's also a new online sales-tax calculator at You can add the tax on big-ticket items, such as cars, boats and mobile homes, to the standard amount, or you can tally all of your actual sales-tax receipts, if that results in a larger deduction.

Where do you fill in the amount? Find line 5 on Schedule A (itemized deductions), labeled "state income taxes," and write st for sales tax.

Teachers and classroom aides can deduct up to $250 for out-of-pocket purchases of school supplies, regardless of whether they itemize. The real test is finding out how to claim the break. Hint: Go to line 23 on Form 1040, which says "Archer MSA Deduction," and write e.


You're stuck with this scavenger hunt only if you file a paper tax form. So if you haven't made the leap to electronic preparation, this may be the year to give it a try. Just make sure you install all the program updates when you buy tax-preparation software, such as TurboTax, which includes tax advice from Kiplinger's. If you're among the 95 million taxpayers who have a household income of $52,000 or less, you can prepare and file your return free at

Green credits. You say you bought an energy-efficient hybrid vehicle in 2006? Then you may be able to claim a credit of up to $3,400, depending on the car's make and model. But only buyers of the first 60,000 vehicles sold by each manufacturer after January 1, 2006, are entitled to the full credit, and Toyota and Lexus hybrids hit the ceiling last summer. Your credit on a Toyota Prius sold before October 1, for example, is $3,150. But if you waited until the fourth quarter to buy your car, your credit is half that amount, or $1,575.

When you're filing your return, don't drive yourself crazy searching for a line labeled "hybrid credit" or something similar. You won't find it. Instead, calculate the credit on Form 8910 and enter it on line 55c of Form 1040.

At that point, however, your new car may collide with the alternative minimum tax. Evan Fusco bought a hybrid Toyota Highlander in early 2006, but he will lose some, and possibly all, of the $2,600 credit he expected. Evan and his wife, Tamara, who are both doctors and live in Nixa, Mo., with their three young children, have been subject to the AMT for the past few years. And -- you guessed it -- just like deductions for dependents and state income taxes, the hybrid-car credit doesn't count against the AMT.


In the AMT's weird parallel universe, taxpayers like the Fuscos have to calculate their taxes twice and pay whichever is higher -- the regular tax or the AMT. For those on the cusp of the AMT, the hybrid-car credit can be a Catch-22. If, say, your regular tax bill before applying the credit is $200 more than your AMT levy, your hybrid-car credit maxes out at $200. Attempt to apply the full credit and you'll be pushed into the AMT zone.

Save your energy. Energy-saving improvements to your home may also trim your tax bill. For 2006, you can take a tax credit equal to 10% of the cost of skylights, outside doors and windows. High-efficiency furnaces, water heaters and central air conditioners are also eligible. The credit is capped at $500, and you can't claim more than $200 for the purchase of windows. There's also a 30% credit for solar units used to heat air or water, with a maximum credit of $2,000 each for furnaces and hot-water heaters.

A special telephone-tax refund is almost sure to cut your tax bill by $30 to $60 -- and possibly more (see Really Easy Money).

Good news for high-earners. Even if you escape the AMT, you may still lose part of the full value of itemized deductions and personal exemptions if your income exceeds certain thresholds. But for 2006, you won't be nicked as much as in past years.


If your 2006 adjusted gross income tops $150,500, regardless of your filing status, your deductions will be reduced by 2% of the amount that your AGI exceeds the trigger point. That's down from the 3% bite in 2005. If your AGI were $180,000, for example, your itemized deductions would be reduced by $590 (2% of the $29,500 in income that tops $150,500).

High-earners will see a phaseout of personal exemptions -- worth $3,300 apiece in 2006 for the filer and each dependent -- beginning at $225,750 of AGI for married couples filing jointly, $188,150 for heads of households and $150,500 for individuals. In 2005, this squeeze might have wiped out the entire value of your exemption. But for 2006, the value can be reduced to no less than $1,100 per person.

Higher limits. The IRS raised the age-based allowances for long-term-care-insurance premiums for 2006. To claim the allowance, you must itemize deductions and you must have medical expenses -- including premiums -- that exceed 7.5% of your AGI. The allowances now range from $280, if you're 40 or younger, to $3,530, if you're 70 or older.

The tax credit for adopting a child has also been raised -- to $10,960.

A tougher "kiddie" tax. If your children have investment income in their own names, it could cost you more this year. Starting in 2006, until the year that a child reaches age 18, any unearned income over $1,700 will be taxed at the parents' marginal rate, not the child's. Before the change, the rule applied only to children who were younger than 14.

Go for an IRA. If you qualify for a tax-deductible IRA, you can invest up to $4,000 ($5,000 if you are 50 or older) and still deduct the contribution up to the 2006 filing deadline, which is April 17, 2007. Your full IRA contribution is deductible if you don't participate in a workplace-based retirement plan. It's also deductible if you do participate in such a plan but your AGI is $50,000 or less if you're single, or $75,000 or less if you're married and filing jointly.

And should you expect a tax refund -- as 70% of all filers do -- you can choose to split your refund and have it deposited directly in as many as three accounts. Last year, the average refund was about $2,200. Consider sending at least some of your money to your IRA. That would boost your retirement savings and, if you qualify for a deductible IRA, cut your 2007 tax bill.

Protect your refund

If you sold stock of a demutualized insurance company in 2003 and followed IRS guidance to report the full proceeds as a capital gain, you may be owed a refund. A federal court has rejected the IRS's position that policyholders had zero basis in the stock, and a trial is scheduled to determine what portion of policyholders' proceeds should be tax-free.

But that decision won't come until after the three-year statute of limitations on amending your 2003 tax return expires. To preserve your rights, fill out Form 1040X and write protective claim at the top of the form. The IRS will hold your request to file for a refund at a later date until the case is resolved.