Our team of Kiplinger tax experts received questions during tax season from readers who need advice about tax preparation and planning. Below you'll find all the questions sent to our experts, along with their answers. They are Kevin McCormally, Kiplinger editorial director; Mary Beth Franklin, senior editor for Kiplinger's Personal Finance magazine; Peter Blank, editor of the Kiplinger Tax Letter; and Joan Pryde, senior tax editor for the Business Forecasting Group. Questions are listed by topic, so click on the one that interests you.

Automobiles
Business and employee expenses
Capital gains
Charitable contributions
Children and dependents
Death and inheritance
Education expenses
Estate planning
Filing status
Forms
Home ownership
Investments
IRAs and 401(k)s
Medical expenses
Miscellaneous
Personal Interest
Property
Refunds and taxes owed
Self-employment
Social security benefits
State taxes

AUTOMOBILES

I've heard that because I'm subject to the alternative minimum tax, I don't get the hybrid car credit. Is it true?

We're afraid so. The credit -- which can be worth as much as $3,000 on 2007 returns -- can't be used by taxpayers who are caught in the grasp of the AMT. And, if you're on the cusp of the AMT, your money-saving credit can be downsized.

Remember, to know if you're subject to the AMT, you must figure your tax bill twice, once using the regular rules and then again with the special rules of the AMT. You pay whichever bill is higher. If your regular bill -- before applying the hybrid car credit -- is just $200 more than the AMT levy, for example, your hybrid credit would be capped at $200. Pushing your tax bill down any further would push you into the AMT… where the credit doesn't count at all.

I was involved in a auto accident in 2006, and my car was totaled. A relative told me that I may be able to take a tax deduction for the totaled vehicle. Is this true and if so, what form do I use to claim?

Yes, you may qualify for a casualty loss tax deduction. You'll find all the rules on the IRS Web site.

There are restrictions, of course. First, you must determine the amount of your loss, which is defined as the loss in value that resulted from the accident. If your car was valued at $15,000 before the accident, then had a salvage value of $1,000, for example, you'd have a $14,000 loss. But you wouldn't get a $14,000 deduction.

First, you must reduce your loss by $100, then reduce the remaining amount by 10% of your adjusted gross income. If your AGI (that's basically income before subtracting deductions and exemptions) is $50,000, then $5,000 of your loss wouldn't count. In this example, your casualty loss deduction would be $8,900 ($14,000 minus $100 minus $5,000).

BUSINESS AND EMPLOYEE EXPENSES

My husband and I are the only shareholders of our S corporation. I have heard that we can pay ourselves dividends to reduce the tax imposed on a portion of the corporation's income.

The trick is to pay yourself less salary and take more of the S corporation's profits as dividends. This way you avoid FICA and Medicare taxes on the dividends.

But be careful. IRS is currently auditing thousands of S firms whose owners took unreasonably low salaries (or no salaries) to maximize their payroll tax savings. Remember the old saying ... Pigs get fat, but hogs get slaughtered.

To learn more about the tax implications of owning a business, see the Kiplinger Taxopedia.

I was considering going to work overseas because there was a time when you could bring $80,000 back into the U.S. tax free, but that law changed in 2006. Is there any advantage to working overseas or loophole in this law?

The 2006 law did not put an end to the foreign earned income exclusion. In fact, it slightly increased the amount that Americans working abroad can earn tax free -- from $80,000 to $82,400 for 2006.

A key change, however, affects how excess income is taxed. Basically, in the past, if you had $100,000 of income and an $80,000 exclusion, for example, you'd owe tax on $20,000. Now, you'll figure the tax on $100,000 and subtract the tax on $80,000 and owe the difference.

Why the rigmarole? To push you up through the tax brackets. The tax on the $20,000 between $80,000 and $100,000 is higher than the tax on the first $20,000 of income in our graduated income tax system.

I know what conventional auto expenses I can deduct, but I was wondering about car washes and car detailing because I use the car for business.

It's clear that the cost of washing your business car can be included in your actual car expenses business deduction -- it's shown on an example in IRS Publication 463. Also, the law allows a deduction for all "ordinary and necessary" expenses paid in connection with your business. Although we couldn't find a specific revenue ruling addressing the subject, we think the cost of occasional detailing could fit into that definition.

I am in the U.S. on an H1B visa (work permit). I changed employers last year and had to pay $3,500 to an attorney to transfer my work permit to the new employer. Can I deduct this expense?

While it appears as if the visa transfer fee you paid is a deductible business expense, you may not derive much of a tax benefit for the payment. That's because the payment is treated as an employee business expense, which can be claimed only if you itemize deductions. Also, the full amount you paid is not eligible for the deduction. Only the amount in excess of 2% of your adjusted gross income is allowed as a deduction. If your 2006 adjusted gross income was $50,000 and you paid $3,500 in fees, your deduction on Schedule A would be $2,500.

I am an army reservist and travel 142 miles (round trip) from my home to my Reserve unit location. Can I deduct any of those miles?

This is a sticky area. Basically, if your reserve meeting is on the same day you go to your regular job, the mileage can be deductible (the 2006 rate is 44.5 cents a mile). But this is a miscellaneous itemized deductions, which means you get a deduction only to the extent that all your miscellaneous expenses for the year exceed 2% of your adjusted gross income. If your AGI is $50,000, then the first $1,000 of such expenses don't count. If your reserve meeting is on the weekend, the travel is considered commuting and not deductible.

There is a special rule for reservists who have to travel more than 100 miles (one way) and stay over night. They can deduct the cost of driving and the cost of meals and lodging on the Form 1040, whether or not they itemize, and without worrying about the 2% rule. As you know, you don't qualify for this break.

I have a computer repair business and I have been keeping track of the miles to and from each job site. Can I write off these miles?

Yes, you can deduct the cost of driving to your job sites; the standard mileage rate for 2006 is 44.5 cents a mile. These examples from IRS Publication 463 will help you see what counts as deductible business mileage:

Examples of deductible transportation. The following examples show when you can deduct transportation expenses based on the location of your work and your home.

Example 1. You regularly work in an office in the city where you live. Your employer sends you to a one-week training session at a different office in the same city. You travel directly from your home to the training location and return each day. You can deduct the cost of your daily round-trip transportation between your home and the training location.

Example 2. Your principal place of business is in your home. You can deduct the cost of round-trip transportation between your qualifying home office and your client's or customer's place of business.

Example 3. You have no regular office, and you do not have an office in your home. In this case, the location of your first business contact is considered your office. Transportation expenses between your home and this first contact are nondeductible commuting expenses. Transportation expenses between your last business contact and your home are also nondeductible commuting expenses. Although you cannot deduct the costs of these trips, you can deduct the costs of going from one client or customer to another.

My former employer included $1,300 of per diem in Line 1 of the W-2, making it taxable income. He did not let us know this was how it was going to be reported and receipts were not kept. He did it as an "unaccountable" plan. He did not ask for receipts or reimburse us for any expense over $25. The only record we have are paycheck stubs, which show these amounts line itemized as per diem. I know I need to use Form 2106, but am unsure about how to go about getting credit as no taxes were withheld from the per diem.

Unfortunately, if your former employer did not require you to substantiate your expenses to receive the allowance, the amount paid is treated as "paid under a nonaccountable plan" and is subject to income tax. You can deduct your actual expenses you incurred on Form 2106. Use whatever records you have to reconstruct your expenses ... credit card slips, calendar entries, etc.

CAPITAL GAINS

I am a New Jersey resident and recently sold an investment property in South Carolina. Because I was not a resident of South Carolina, I was required to pay a capital gains tax to the state of South Carolina (almost $8000). On top of this, I will have to pay capital gains (for the same property) when filing my federal tax return. Am I entitled to a credit on my federal return for the capital gains tax paid to South Carolina?

You will owe capital gains tax on your federal tax return for the gain on the sale of the South Carolina property. However, that tax is deductible on Schedule A as a state tax payment. You claim the deduction in the year you paid the tax to South Carolina. So, if you pay the tax to South Carolina this year, you'll deduct it on the return you file next spring. If this gain is subject to New Jersey tax as well, you can claim a credit on your New Jersey return for the tax paid to South Carolina.

CHARITABLE CONTRIBUTIONS

I looked up a charity that is listed as "A public charity with a 50% deductibility limitation." What does this mean?

The tax law includes limits on how much a taxpayer may deduct each year for charitable contributions, as a percentage of his or her adjusted gross income. The basic rule limits such write-offs to 50% of AGI. For certain kinds of gifts -- such as appreciated assets like stocks or mutual fund shares -- the limit is 30% of AGI.

The law also includes limits that depend on the type of charitable organization to which you give. A "50% organization" is one that qualifies for you to take the maximum 50% deduction if you give cash to that organization. That's what your charity is. Other charities -- including veterans organizations, fraternal societies and nonprofit cemeteries -- are "30% organizations," meaning you can't deduct more than 30% of your AGI of what you donate to them.

For more details, see IRS Publication 526.

I donated 100,000 air miles to a charitable organization. How much can I write off?

Unfortunately, it's easy to compute the value for charitable contribution deduction purposes. It's $0.

Until a few years ago, there was a worry that the IRS would tax employees on the "value" of personal frequent flyer miles racked up on business travel. But it's extremely difficult to put a dollar sign on the value, so the IRS decided to ignore it. If you had redeemed your miles for tickets, then sold the tickets and then donated the proceeds of the sale to charity, you'd be in the same boat tax-wise. You'd have to report the money as income and then offset the same amount with the deduction. No income/no deductions puts you in the same place.

If we give a portion of the net sales to a sports league booster club to secure the rights to sell our products to their team members, is the contribution deductible, and if so where does it go?

The payment to the booster club is not deductible as a charitable contribution because it was not made with the intention of making a donation. In all likelihood, the payment qualifies as a business expense because you made it to secure the right to sell to team members and presumably made some money on those sales. You claim the deduction on the same form where your business income is reported...Schedule C, Form 1120, etc.

Could I report an amount of money in excess of $4,000 as a charitable deduction if the money was used to help a relative in need?

Gifts to an individual, no matter how much in need, are not deductible. Only gifts to qualified charitable organizations can be deducted as charitable contributions. In some cases, support of a relative can qualify that person as your dependent, but that's a relatively rare occurrence.

CHILDREN AND DEPENDENTS

If a child has interest income reported on a 1099-INT form (from a savings account) and I claim him as a dependent, do I claim his interest income as if it were my own?

In certain circumstance, a parent can report a child's income on the parent's return. This works when a child's only income is from interest and dividends and is less than $8,500. So, if this is your child's only income, you qualify to add it to your return.

But it would probably be a mistake. You have to file a form 8814 to go this route and, if this is your child's only income, it doesn't have to be reported at all. The first $850 of a dependent child's income is tax free. For more information, see The New Kiddie Tax.

My wife and I both have employer-sponsored childcare reimbursement accounts via different employers. The total for both plans is $9000. Can we both participate in these plans?

The maximum amount of pre-tax money that can be run through a child care reimbursement account each year is $5,000 per family. You and your wife can each participate in your employer's plan, but the total set aside can't exceed $5,000.

If your child-care expenses exceed $5,000, you can claim the child-care credit for up to $1,000 of expenses above $5,000 paid via the reimbursement account(s). The limit for the child care credit is $6,000. You claim the credit on Form 2441 -- the same form you must file to demonstrate that you qualify to treat funds run through the reimbursement account as tax free.

Is there a tax credit for failed domestic adoptions? We paid for an adoption in 2006 that fell through. However, we did eventually adopt a child in 2006, but the adoption will not be finalized until March 2007. How do we handle all of these expenses on our return?

Qualifying expenses of an unsuccessful adoption effort can be included with the costs of a subsequent successful effort. It all counts as one effort for purposes of the credit, so your limit for a 2006 adoption is $10,960. When expenses are incurred in a year prior to the year when the adoption is finalized, the credit is claimed in the subsequent year. Therefore, you will claim your credit on your 2007 return, the year the adoption of your child is finalized.

A woman and her four children lived with me for most of last year. She did not work and did not pay to live with me. Can I claim her children as dependents on my tax return?

The law does allow a taxpayer to claim exemptions for "qualifying relatives," who are not the children of the taxpayer. And, in fact, the "qualifying relatives" don't even have to be related to the taxpayer claiming them as dependents. To claim a non-relative, however, that person must live with you for the entire year, except for temporary absences for illness, education or vacation, for example. Your question says the children and their mother lived with you for "most" of the year. That could undo your right to claim the exception.

If you pass the whole year test, you probably do qualify to claim the children -- and their mother -- as dependents as long as you provided more than half of their support. This assumes none of them had income of more than $3,300 in 2006.

Can you get a deduction if you are taking care of a parent?

If you provide more than half of your parent's support and he or she did not earn more than $3,300 (social security benefits don't count) in 2006, then you may be able to claim your parent as a dependent. That's has the same tax benefit as deducting $3,300. If your parent is your dependent, you can also deduct medical expenses you pay for him or her, if you itemize deductions and the total of your medical expenses exceeds 7.5% of your adjusted gross income.

DEATH AND INHERITANCE

My wife passed away in February 2006. Is this expense deductible from my taxes?

First, our condolences on your loss. Second, funeral expenses are not deductible.

You may, however, file a joint return for 2006 and claim an exemption for her, which will help reduce your tax bill for the year.

Is a cash inhertance from a family member taxable?

No. A cash inheritance is not subject to income tax. In fact, most inheritances are income-tax free.

The big exception is the inheritance of a retirement plan, like a 401(k) or traditional IRA. In those instances, withdrawals from the plan are taxed to the heir just as they would have been taxed to the original owner (in most cases, that means 100% taxable as ordinary income).

My father-in-law died 2005, and I received pension money, which I gave to my mother-in-law for her expenses. I received a 1099-R. Must I pay taxes on this death benefit?

Death benefits are generally taxable, with a few exceptions such as payments connected with the death of someone due to specific terrorist actions or payments made after the death of a public service officer in the line of duty.

It sounds to us like what you received were pension benefits as a beneficiary. Such payments are NOT covered by the general rule that holds that most inheritances are income tax free. Instead, payments from the deceased's retirement accounts are considered "income in respect of a decedent" and taxed to the recipient just as they would have been taxed to the owner. If part of the pension your father-in-law was receiving was tax free to him -- because he had an investment in the contract -- then the same portion is tax-free to you. You may want to ask his employer's benefit office for help.

You report the pension income on line 16 of the Form 1040.

We received about $35,000 from a bank account in what I suppose you would call an inheritance due to the death of a family member. In Texas, what do I have to declare and do I owe anything for it? How does this affect my federal taxes? Also, my dying father-in-law stayed with us full-time for more than six months, so can I claim his as a dependent?

Texas no longer has an inheritance tax. On the federal level, most inherited assets -- including cash from a bank account owned by the decedent -- are tax free. You don't have to report it on your return at all, so it will not affect your deductions. If your father-in-law's income for 2006 was less than $3,300, he might have qualified as your dependent, if you provided more than half of his support for the year. If so, claiming a dependency exemption for him on your return would reduce your taxable income by $3,300. Here's a quick definition of qualifying relative, from the IRS Web site.

Generally, a person is your qualifying relative if that person:

• Lives with or is related to you,


• Does not have $3,300 or more of gross (total) income,


• Is supported (generally more than 50%) by you, and


• Is neither your qualifying child nor the qualifying child of anyone else.

For details, see Exemptions for Dependents in Publication 501.

EDUCATION EXPENSES

I withdrew funds from a 529 plan to pay my daughter's college tuition. I received a 1099-Q form reporting the distribution. Do I owe tax on this money?

The tax system has trained us -- like Pavlov's dog -- to see a 1099 form and instinctively think that it is reporting an item of income. That's not so with the 1099-Q form. Its purpose is merely to remind you -- and alert IRS -- that you made a withdrawal from a 529 college savings plan, state prepaid tuition program or Coverdell education savings account.

The distribution that is reported in box 1 of the 1099-Q is tax free if you used the money to pay tuition and related fees, books, room and board. Most payouts are used for these expenses. If you use the funds for other purposes, then only the earnings portion of the distribution is taxable.

That amount is listed in box 2 of the 1099-Q and should be reported by you as "Other income" on line 21 of the 1040 from you file for the year of the distribution. The taxable portion also is subject to a 10% penalty tax that is calculated on Form 5329.

So why is the distribution reported to you and the IRS if the vast majority of withdrawals are going to escape tax? We think the 1099-Q's main purpose is to alert an IRS agent to the distribution in the event you are audited. Then the agent can ask how the funds were used and determine if you reported the distribution if necessary.

My daughter graduated from college in May 2006. Can she get an education credit for the cost of tuition even though the payment was made in the last days of 2005?

I'm afraid not. The IRS says only if expenses were paid during 2006 can a taxpayer qualify for a 2006 credit. See the instructions for Form 8863 for more details:

Now, the tuition paid in 2005 for the 2006 semester could qualify for a 2005 credit. If she didn't claim it then, she may want to file an amended 2005 return using Form 1040X.

I read that I may deduct up to $4,000 on line 35 of 1040 for college tuition of a child. Is there a qualifying adjusted gross income limit?

Yes there is an income limit. If your adjusted gross income is not more than $65,000 on a single return or $130,000 on joint return, you can deduct up to $4,000 of qualifying expenses.

If your income is more than $65,000 but not more than $80,000 on a single return (more than $130,000 but not more than $160,000 on a joint return), you can deduct up to $2,000 of qualifying expenses.

If your AGI is more than $80,000/$160,000, you can not claim this deduction.

This deduction may not be claimed for expenses incurred for a student for whom a Hope or lifetime learning credit is claimed. For more information, see IRS Publication 970.

Can I take $4,000 tuition deduction and $2,000 Lifetime Learning credit for my son for 2006 year?

Sorry, but you must choose between the credit and the deduction. You can't claim both for expenses for the same student. The credit is sure to be worth more because you'd have to be in a higher than 50% bracket for a $4,000 deduction to be worth $2,000. And, the top federal bracket is 35%.

If we paid $18,000 for our son's college tuition last year and earned $136,000, how much of the $4,000 college tuition deduction can we claim?

If your AGI is less than $130,000, you can deduct $4,000; if it's more than $130,000 but under $160,000, the deduction is limited to $2,000.

There is no special form to file, but you must use the Form 1040 to claim this deduction. Here's how to do it:

The deduction for tuition and fees will be claimed on Form 1040, line 35, “Domestic production activities deduction.” Enter "T" on the blank space to the left of that line entry if claiming the tuition and fees deduction, or "B" if claiming both a deduction for domestic production activities and the deduction for tuition and fees. For those entering "B," taxpayers must attach a breakdown showing the amounts claimed for each deduction.

If my dad received a form 1098 with his name and social security number on it for student loan interest he paid for me, will it trigger a red flag with the IRS if I entered that amount on my tax form as a deduction?

If your dad received the 1098, then he must have been liable for the loan. So he should claim the deduction, if his income allows it. If the loan was in your name, but your father paid it for you, the IRS treats it as though he gave the money to you, then you paid the debt. So, a child who's not claimed as a dependent can qualify to deduct up to $2,500 of student loan interest paid by mom and dad.

I opened a 529 account for my daughter in my home state, New York, in February 2007.Can I claim a deduction for tax year 2006.

To deduct contributions to New York's 529 plan on your New York return, the contribution had to be made by December 31, 2006. The state does not follow the IRA rule of allowing contributions up to the due date of the return to count for the previous year.

If I put money into a Michigan 529 for our granddaughter's college, is that a tax write-off, and if you gift money to your children, is that also a tax deduction?

There is no federal tax deduction for contributions to 529 college savings plans (Uncle Sam's contribution is that earnings can be withdrawn tax free when used for qualifying college expenses). But the state of Michigan does allow state residents to deduct on state returns up to $5,000 ($10,000 on joint returns) of contributions to the Michigan 529 plan.

Also, there's no deduction for making gifts to your children. Gifts are deductible only if you are making them to qualifying charitable organizations.

ESTATE PLANNING

My wife and I are giving $20,000 to our daughter for a down payment on a home. Can any of it be deducted on our tax returns?

You can not deduct a gift to your child ... no matter how deserving she may be. To be deductible, the gift must be made to a qualifying charitable organization.

The federal gift tax is designed to prevent taxpayers from avoiding the federal estate tax by giving away all their money before they die. In the rare instances when the gift tax is due, it is owed by the giver of the gift, not the recipient.

You don't owe the gift tax in this instance because the law allows each person to give any number of recipients up to $12,000 gift-tax free each year. Because you and your wife's gift is less than $24,000, the gift tax isn't triggered.

Even if you exceed the $12,000 annual limit, the first $1 million of lifetime gifts above that level are protected from the tax by a credit. The more you use of that credit while you're alive, though, the less is available to offset the federal estate tax after your death. Few people pay the estate tax, either. This year, only taxable estates exceeding $2 million are taxed.

If a person makes gifts from a trust within three years of death, is it added back to his estate at death?

We assume you are talking about a revocable trust. If so, gifts of up to $12,000 a person can be transferred annually from a revocable trust without being added back to the donor's estate, even if the gift is made within three years of death.

Beyond that, whether from a trust or not, only certain gifts made within three years of death are added back to the taxable estate. The add-backs include gifts of life insurance, for example, gifts with retained life estates and revocable gifts.

FILING STATUS

I live with a woman, and we have two children. We are not married. She does not work. How do I file?

It sounds to me like you qualify as head of household, and you may be able to claim your partner and your two children as dependents. The basic rules for claiming a "qualifying relative" (someone who lives in the same home as you all year and is a member of your household can qualify even if she is not related to you) require that you provide more than half of the person's support, and the person may not have more than $3,300 income in 2006.

Can you file a joint return with your "live-in" if your not married?

No, you must be married as of December 31 to file a joint return. One exception: if your spouse dies during the year, you may file a joint return for the year of his or her death.

Can I file head of household if a parent who works lives with me, but I make more money then my parent?

It's possible ... if your parent qualifies as your dependent. To claim head of household status, you must pay more than half the cost of maintaining a home for your parent, you must supply more than half your parent's support, and his or her income in 2006 must have been less than $3,300.

How much income do you need to have before having to file tax returns? I only have Social Security income and some interest on savings.

The income trigger depends on your filing status. Single taxpayers under 65 (who are not claimed as someone else's dependent) can have up to $8,450 of gross income before they have to file; for singles 65 and older, the trigger for 2006 returns is $9,700. For married couples filing jointly, the numbers are $16,900 if both spouses are under 65; $17,900 if one is 65 or older; $18,900 if both are 65 or older.

Social Security does NOT count toward the filing requirement. So, if your interest income did not exceed the trigger point for your filing status, you don't have to file.

FORMS

Can a Form W-2 be accessed online if an employer has not sent one yet? Is there a deadline to receive W-2 forms?

The U.S. military provides W-2s on-line; many private employers do, too. Your best bet is to check with your firm's payroll office to see if it offers this service and, if so, how to access the information. Otherwise, you should have received your W-2 by the end of January.

If you don't have it yet, you need to contact your employer. If you can't do that (maybe the company has gone out of business), find your last pay stub for the year. It should have most of the information you need. Contact the IRS at 800-829-1040 and ask for help getting a Form 4852, a substitute W-2.

For more information about forms you should have received by now -- and what to do if you haven't -- see our tax form checklist.

I received a W-2 with no wages, federal income withheld, social security wages, or social security tax withheld ( boxes 1 through 4 ). Box 5 was my estimated pension payout in March 2008, and tax withheld in box 6 . How can they withhold on something I have not received?

We are assuming the W-2 was for 2006. The only thing we can think of is that the W-2 is for deferred compensation that is subject to a special timing rule. It is hit with Medicare tax currently, but not FICA because you were over the wage base for 2006. Income tax won't be due until the money is paid out to you in 2008. Have you asked your payroll department about this?

What are the receipts or records that I should keep and for how many years? In case of an audit, I want to be sure that I have all the necessary items.

How long you need to hang on to tax records depends on what's involved.

The general rule is to keep your tax records until the statute of limitations on your tax return has expired. In most cases, that's three years after the due date of a return. Your return for 2006 is due April 17, 2007, so the auditing period ends April 15, 2010. If you haven't been alerted to an audit by then, it's probably safe to toss most of the records.

In some cases, though, the IRS gets six years to come after you. The extended jeopardy applies if you fail to report income that is 25% or more of the amount of gross income you do report. And if you fail to file a return or the IRS can prove that you committed fraud, there's no limit. Using the six-year rule, April of 2007 is the time to toss returns for 2000 and earlier years.

You can't pitch things willy-nilly, though. Although most of the paperwork can be thrown away, some of the financial papers connected with your tax return have a life beyond the statute of limitations.

You need to hang on to brokerage statements and other papers that help you establish the tax basis of assets you still own. Because the basis is the value from which any gain or loss will be determined when you sell the asset, these papers will figure in a return sometime in the future. The basic six-year rule is also somewhat misleading because items on one return often carry over to future years. For example:

• If you make nondeductible contributions to an individual retirement account and file Form 8606, you need to keep that form and related information from your IRA sponsor until all funds are withdrawn from your IRAs.

• If one year's return includes losses you can't deduct because of the passive-loss rules, hang on to the return and associated records until after you dispose of the passive activity and get to use the loss. Then you should keep the records for another three or six years until the statute of limitations on the return reporting the loss has expired.

When you're cleaning out your tax files, err on the side of caution -- particularly when it comes to your investments.

What about your tax forms themselves? Six years is probably long enough to hold on to them -- except those that have a bearing on future returns.

HOME OWNERSHIP

I own a house and I am paying the mortgage. The loan (and Form 1098) is in the name of a relative because otherwise I could not get the loan. Can I deduct the mortgae interest?

As a general rule, to be eligible to deduct mortgage interest, you must be liable for repayment of the mortgage. Because you are not on the mortgage, IRS says you cannot deduct the interest.

However, the Tax Court has allowed a deduction in the case of a couple whose poor credit rating kept them from getting a mortgage on a house they wanted. Relatives bought the home so the couple could live there.

The couple made all the mortgage payments, although the relatives were liable on the loan. The couple also made all repairs and improvements and were the home's only occupants. In the Tax Court's view, the couple were the equitable owners of home and could deduct interest paid on the mortgage. The couple assumed all the benefits and burdens of ownership, and their relatives would have sought restitution from them had they defaulted and the relatives had to pay. If you fit these facts, then you have authority to deduct the mortgage interest.

Does the interest paid out for a mortgage offset your income?

Yes, if you itemize deductions, you may deduct mortgage interest paid on up to $1.1 million of debt used to buy or improve your first or second home as long as the debt is secured by the property. If you deduct $10,000 of mortgage interest, for example, it would reduce your taxable income by $10,000 and, if you were in the 25% tax bracket, the deduction would reduce your federal income tax bill by $2,500. If you own a home, you also get to deduct property taxes paid on the property ... if you itemize.

You itemize only if the total of your itemized deductions -- medical expenses in excess of 7.5% of your AGI, mortgage interest and property taxes, state income or sales taxes, charitable contributions and miscellaneous expenses such as employee business expenses -- exceeds the standard deduction amount for your filing status. For 2007, for example, the no-questions-asked standard deduction for single taxpayers is $5,350; for married couples filing jointly, it's $10,700. See the instructions for Schedule A for details in itemized deductions.

Each year, about three-fourths of all taxpayers do NOT itemize deductions because the standard deduction for their filing status is more than the total of their qualifying deductible expenses.

I refinanced my house in 2006, and had to pay points and various fees. Which of the fees are deductible?

A portion of the points you paid on the refinancing can be deducted on your 2006 return. Unlike points charged when you buy a home -- which can be deducted in full in the year you pay them -- points on a refinancing are deducted ratably over the life of the loan.

That means 1/30th a year if it's a 30-year mortgage. And, in the first year, you must account for when you paid the points. If in July, for example, you'd deduct just half a year's worth -- or 1/60th in this example -- in year one.

One important exception: If you refinanced a loan that had previously been refinanced, then you may deduct on your 2006 return any as-yet-undeducted points on the first refinancing. (This assumes you refinanced with a different lender. If you refinanced with the same lender who did the first refinancing, you must add the points on the second refinancing to the remaining points on the first ... and deduct them over the life of the loan.) Remember, we don't make the rules, we just try to explain them. Good luck.

We moved from Denver to California for a job. We left 14,000 pounds in storage in Denver for four years until we return. Is the storage charge deductible?

Four year is pushing it. The IRS says: You can include [in your job-related moving expenses] the cost of storing and insuring household goods and personal effects within any period of 30 consecutive days after the day your things are moved from your former home and before they are delivered to your new home.

Is the total loss on the sale of a second home deductible?

If the place qualified as a rental property -- that is, you rented the house and did not use it yourself more than 14 days a year or more than 10% of the number of days it was rented -- then you can deduct your loss.

If it was your second home and did not qualify as a rental property, however, none of the loss is deductible. If you received a 1099-S form for the sale, you have to report it on Schedule D even though you get not tax benefit for the loss. See the instructions for Schedule D.

We sold our Arizona home last year where we spent 8-9 months a year. The rest of the time we lived in Indiana. Can we claim the Arizona home as our principal residence for tax purposes?

We don't see why not. Generally, the IRS says, your main home is the one where you live most of the time ... and it seems clear that your Arizona residence qualifies.

In some cases, an argument can be made that a home that doesn't meet the time test still can qualify as your main home for purposes of excluding tax on the gain. But that's the exception, not the rule.

We bought a house in April of 2004 and spent about $15,000 remodeling (windows, floors, new heating and cooling, etc.). We sold the house in FEbruary 2006 because my husband, who is in the military, got orders to relocate. We made about $11,000 on the sale. Do we owe capital gains because we weren't in the home for 24 months? Or do my husband's orders help us as special circumstance? How about the $15,000 we spent on improvements?

Don't worry. Because you sold your home in connection with a job-related move, you get a partial exclusion. That doesn't mean you get to exclude part of your profit from taxable income, it means you get to use part of the $500,000 exclusion that would have been available had you owned and lived in the house for two of the five years before the sale. If you owned and lived in the place for 22 months, for example, you would qualify for 22/24th of the $500,000 exclusion, which means you would qualify to treat up to $458,333 of profit as tax free.

The cost of capital improvements to a home, such as installing a new heating and air conditioning system and new windows, increases the owners' tax basis, which would further reduce the taxable profit to be sheltered by your exclusion.

Assuming you can exclude the entire gain from taxable income, you don't have to report the sale on your tax return.

We purchased a single family home on a lake with the intent to move our family up there, but we never moved. Last year we sold it to purchase a home. Will we have to pay capital gains tax, or is there a way to get around this?

Sorry, but we think you're stuck with capital gains taxes on the profit. (On the bright side, if you owned the home more than one year, the top capital gains rate is 15%.)

The rule that allows taxpayers to claim tax-free profit from the sale of a home applies only to your principal residence.

The old rule that allowed home sellers to put off tax on the sale of a home if they bought a more expensive home also only applied to principal residences ... so it wouldn't have helped you, either.

Can you tell me if siding for a house is deductible because before they put the siding on, they also put insulation and told me it would help lower my heating costs. Actually it is saving me some and does keep the house much warmer than before.

Check out this Energy Star site. ENERGY STAR is a joint program of the U.S. Environmental Protection Agency and the U.S. Department of Energy. It has the details on when insulation qualifies. Your contractor may be able to help, too.

I paid almost $700 in homeowners' associaton fees. Is any of it tax deductable?

If the homeowners' association fees are for your residence, then, no, the fees are not deductible. If the expenses are for a property that you rent, however, the costs are deductible expenses.

During 2006, I purchased a condominium in Florida. Would there have been a sales tax payment associated with this purchase? If so, would I be allowed to deduct it in addition to the amount stated in the IRS tables for state sales tax deductions? Also, are there any other taxes associated with the condo purchase that would normally be deductible?

Sorry, but there are no sales taxes on a condo to add to the sales tax table amount. Transfer taxes or stamp taxes on the purchase of a home are not deductible; instead you add them to the basis of the home, which could be helpful to you because profit on your second home will be taxable when you sell -- unlike profit on a principal residence (up to $250,000 of profit on which -- $500,000 if you file a joint return is tax free). Raising your basis will reduce your taxable profit when you sell, dollar for dollar.

You can deduct the mortgage interest and property taxes on the condo.

I recently had work done on my home water heater ventilation system and wanted to know if the cost of that work is tax deductible?

There's no deduction for such work. But if you installed a new, energy-efficient boiler as part of the work, you may qualify for a tax credit for energy-efficient equipment. Check out this Web site.

In The Kiplinger Taxopedia it mentioned a deduction for pigmented roofs. Can you please clarify what a pigmented roof is?

A pigmented roof is one that is painted with a specially coated dark-colored paint to keep the roof cool. They are used primarily in commercial buildings. A cooler roof reduces heat leakage and promotes energy savings.

We hired a "painter" to repaint the entire interior of a home we bought last year, but he did a terrible job. I'm going to have to redo alot of his work. Can I claim anything as a loss on my taxes?

Sorry, but we can't think of any tax benefit to help offset your pain.

I replaced my whole central heat and air unit in 2006 with more energy efficient one. I've heard I can take a tax credit. Is this true and what amount is credited?

You may qualify for a credit worth up to $500. Check out the government's Energy Star Web site for details.

INVESTMENTS

I own a signifcant sum of stocks that were originally purchsed for a Uniform Gift to Minors Act (UGMA) account. The account has been growing since 1980, and all dividends have been re-invested. I am considering selling the stocks, but I have no account records prior to 2005 with which to figure the cost basis of the shares. How do I determine the capital gains for tax purposes BEFORE I sell? I am not averse to paying my taxes, but I need to accurately predict the tax burden to determin if the sale is worthwhile.

Am I better off donating portions the portfolio to a charity then re-buying the stocks as suggested in Max Out Tax Savings When You Give.

Giving the stocks to charity and then buying them back is clearly simpler -- but much more costly. If you donate the stock, you deduct the current fair market value and don't have to worry about the basis. That can produce a nice tax break, but, if you're in the 25% bracket, it will cost you four times as much to buy back the stock as you save in taxes.

The best tool I have seen for reconstructing basis in this kind of situation is called BasisPro. It's part of a service called Gainskeeper, which is available for $349 per quarter. Also, the same service is available as part of TurboTax Premier tax preparation software. (Kiplinger provides expert tax advice to TurboTax, but we are not connected with the BasisPro service.)

With BasisPro, you enter the stock you sold (or are planning to sell) and tell the program when you bought it. It connects with a data base that includes corporate actions (like splits, spin-offs, mergers, etc.) and dividend action and figures the basis of your shares. You can find more about BasisPro at the TurboTax site.

Unfortunately I own stocks that have become worthless. Can I deduct the losses? Can I just add them to the losses that I report on Schedule D?

Yes, if the stocks became worthless in 2006, you report the loss on Schedule D as though you sold the stock for $0. You report the worthless security on line 1 or 8 of Schedule D (Form 1040), depending on whether it's a short- or long-term loss. Enter "worthless" in columns (c) and (d), for the date sold and sales price, and the amount of the loss in parentheses in columns (f). As with other capital losses, the loss offsets 2006 capital gains dollar for dollar, then up to $3,000 of excess loss can be carried over to the Form 1040 to offset other kinds of income. Any excess is carried over to next year's return.

How do we keep track of the basis on our DRIPs?

It is daunting to keep track of basis. But, if you have all of your 1099s that report the dividends on which you paid tax -- and if you reinvested all of your dividends -- you have a record of your growing basis. Also, if you have copies of your old tax returns -- on which you reported the dividends as they were earned (and reinvested), they will help you reconstruct your records.

One other thing: TurboTax software Premier edition now includes a very cool tool that will figure your basis for you after you sell stock. Called "Basis Pro," this section of the program asks a few simple questions: When you originally bought the stock and when you sold it, and whether you reinvested dividends. It then connects to a database that includes corporate actions (dividend payments, mergers, acquisitions, spin offs etc.) back to 1950 or so and figures your basis. (Full Disclosure: Kiplinger is a partner with TurboTax and provides expert tax advice for the program and the company's Web site.)

You don't need the program if you didn't sell stock last year, but it might help in a future year when you do sell.

Dividends reinvested in mutual funds increase the tax basis when fund is sold. Does this also apply to reinvested stock didivends?

Yes, each reinvestment buys you additional shares of stock, thus adding to your total basis.

Unlike with funds, though, you can't use an average basis for stocks. You need to keep track of the basis of each share to correctly figure your tax when you sell. On exception is if you sell your entire block of stock. In that case, your basis would be the total of all direct purchases and all reinvested dividends.

We have had some HCA stock. HCA bought all the outstandiing shares and sent us checks. We have no idea what to do, how much is taxable.

When HCA went private last year, it bought back all shares owned by the public. The tax law treats this exactly the same way as if you had sold your shares in the open market.

You should report your gain or loss on Schedule D of the 1040 form. HCA should have sent you a 1099-B form showing how much it paid for your shares. If it didn't send you the form, total up the checks you received. Those are the proceeds you should report from the sale.

The trickier part is knowing your "basis," that is, what you paid for the shares. You subtract the basis from the proceeds of sale to determine if you have a taxable capital gain or a tax-saving capital loss. If your records don't show what you paid, check with your broker for help. And, remember, if you reinvested dividends over the years, those reinvestments bought additional shares and added to your overall basis in the stock. (Failing to account for reinvested dividends will mean overpaying your tax.)

The Premier edition of TurboTax software (for which Kiplinger provides expert in-product and on-line advice) includes a cool tool -- Basis Pro -- that will figure your basis for you, based on when you purchased the HCA shares, including any corporate actions (such as mergers or stock splits) and reinvested dividends.

This past summer, a privately owned company I had shares in (all long term) had the good fortune to be acquired in an all cash transaction. There was a 24 month holdback contingency for various reasons. How do I handle the current proceeds and when and how do I handle the potential additional proceeds?

From the facts you present, you are entitled to report the gain on the sale of your stock as the proceeds are received. Practically speaking, you have made an installment sale of your stock. On your current return, report the initial payment you received. The excess over your basis in the shares is long-term capital gain. In the year you receive any holdback proceeds, report the full amount as long-term gain in that year.

Is money paid during 2006 for financial/retirement planning advice deductable?

The law allows a deduction for the cost of investment-related advice designed to help you earn taxable income. Ask your planner what portion of his/her fees fit in those categories. Even if part of the fee does, though, you might not get any tax benefit. Such costs are considered miscellaneous expenses, which are deductible only to the extent that all of your miscellaneous expenses exceed 2% of your adjusted gross income.

IRAS AND 401(K)S

I am trying to reduce the amount of money I have to pay the IRS this year. I thought about opening an IRA. Is there an income limit for contributions to be deductible?

That depends on whether you are covered by a retirement plan -- such as a 401(k), 403(b) or pension plan -- at work. If so, there are income limits for deducting traditional IRA contributions.

The right to deduct such contributions is phased out as income rises between $50,000 and $60,000 on a individual return and between $75,000 and $85,000 on a married-filing-jointly return. If your income is less than the bottom figure, you can deduct up to the maximum contribution level of $4,000 ($5,000 if you were 50 or over at the end of 2006) for 2006. And, you have until April 17 to make that 2006 contribution. The deduction will reduce what you owe in tax for 2006.

If you are not covered by a retirement plan at work, there are no income limits on IRA deductibility.

We retired in April 2005. We have our retirement money invested and being managed by a financial adviser. Last year we had the adviser pay federal taxes monthly out of our investments. This year we hired a CPA to do our taxes. He is recommending that we pay both state and federal taxes at the end of the year so that more of our money stays invested and grows. Is this a good idea, or are we going to get in trouble with the IRS for not paying our quarterly payments on time?

If you can have enough withheld from IRA payouts at year end to cover your tax bill, this can make sense. Withholding is treated as though it was paid evenly throughout the year, no matter when IRS gets the money.

You can't however, make a big estimated payment in December for the full year's taxes, if the income was being earned during the entire year. Estimated taxes are owed as income is earned ... and considered paid when it's actually paid. If you earn your income evenly through the year, then estimated payments are due evenly, too.

If I roll over my 401K to a traditional IRA after changing employers, do I need to calculate the cost basis on the stock in the 401K for tax purposes?

Assuming you have not made after-tax contributions to the 401(k), there is generally no reason to do so because you have a zero cost basis. When the stock is sold inside the IRA and the proceeds ultimately are paid out to you, the full amount will be taxed as ordinary income.

One exception is if you own your employer's stock inside the 401(k). In that case, you may want to segregate that stock and keep it out of the rollover. If you put the stock in a taxable account, you would have to pay tax on the cost of the stock when it was purchased for your 401(k). This is the one time you'd need to know the cost basis, to figure that tax bill.

Why pay the tax sooner rather than later by rolling the stock into the IRA? It can make sense if the stock has appreciated smartly since it went into your account. You are taxed only on the cost of the stock, meaning the tax on appreciation while the employer's stock was in your account continues to be deferred, and, when you ultimately sell the stock, that appreciation will be taxed as a long-term capital gain. The tax rate will be 15%. If you rolled the stock into the IRA, the appreciation would ultimately be taxed (upon withdrawal) in your top tax bracket.

Can I withdraw funds from either a Roth IRA or a traditional IRA without paying taxes and penalties as long as I put the same amount back into the IRA account during the same calendar year?

The calendar year doesn't matter.

The law allows you to roll over money from one IRA to another once a year. (That's once a year for each IRA you have.) You have 60 days after you receive the money from IRA number one to have it safely deposited in IRA number two. Miss that deadline and the withdrawal is considered a distribution. If it's a traditional IRA, that means the money will be taxed and, if you're under 59½, hit with a 10% early withdrawal penalty.

If it's a Roth IRA, things are different. Miss the deadline and you can't put the money back in a Roth, but part or all of it might be tax-free. You can withdraw the total of your Roth contributions at any age tax- and penalty-free. If any part of the withdrawal is considered earnings, though, that amount can be taxed and penalized if you are under age 59½ and the account has not been opened for at least five years.

I have to transfer stocks from my IRA account to a regular account to satisfy the IRS required minimum distribution rule. I know I have to pay taxes because of this distribution, but what happens if I sell a stock later that was transferred and on which I have paid the tax because of the RMD? Do I have to pay more tax, and if so is the tax promulgated from the stock's date of original purchase or the date of distribution? I feel I may be paying tax twice.

You won't pay tax twice ... if you keep good records.

When the stock comes out of the IRA, the full value will be taxed as part of your required minimum distribution. And, your tax basis of the shares will become the value upon which you pay tax.

Let's say you pull $15,000 worth of stock out of your account as part of your RMD. Regardless of what you actually paid for the shares when they were purchased inside your IRA, your tax basis is now $15,000. If you sell for less, you'll have a tax-saving loss; if you sell for more, you'll have a capital gain ... but only for appreciation AFTER you pull the stock out of the IRA.

Your holding period begins on the day the shares come out of the IRA, so you'll need to hold the shares for more than one year in the taxable account before you get long-term gain treatment on your profit.

I am a consultant with an LLC but file one tax return with a schedule C for my LLC. In some cases my clients require that I work through one of their resource providers, making me a W-2 employee for some clients. Can I put money away into my SEP IRA for both the W-2 income and my self-employed income?

Only self-employment income can go into the SEP. You can make a Roth IRA contribution based on the W-2 income, unless your AGI is too high. For 2006, the right to make Roth contributions (up to $4,000 if you were under 50 at the end of the year, $5,000 if you were 50 or older) is gradually phased out as income rises from $95,000 to $110,000 on single returns and from $150,000 to $160,000 on joint returns. If you qualify, you have until April 17 to open and contribute to a Roth for 2006.

I've gotten a much larger-than-expected raise for 2007. How does increasing my 401k contribution help reduce my tax bill?

Every dollar you put in your 401(k) reduces your 2007 taxable income by $1 and your federal tax liability by $1 multiplied by your tax bracket.

If you're in the 28% bracket with your new raise, then an extra $1,000 into the 401(k) will cut your tax bill by $280. The 28% bracket starts when taxable income for 2007 exceeds $128,500 on a joint return. The bracket below that (running from $63,700 to $128,500) is the 25% bracket. An extra $1,000 into the 401(k) would save you $250. If your state has an income tax, there will be state income tax savings, too.

For 2005, someone age 50 and older can contribute up to $20,500 to a 401(k). That limit does not include any company match. Before you increase your contributions to the maximum, you may want to ask a plan administrator if there are any restrictions that might limit your contributions to less than the federal maximum. Certain "highly compensated employees" (those making more than $100,000 in 2007) are sometimes limited based on how much other employees contribute to the plan.

I withdrew $2,000 from a traditional IRA in December 2006. I know I have 60 days to put the money back in. If I do, do I still have to claim this early withdrawal on my taxes?

Yes, you need to report the distribution from your IRA on your 2006 return. The IRA custodian will report the payout to the IRS, so the agency expects to see it reported on your return. If you get the money back into an IRA within the 60-day rollover limit, however, no tax will be due. If you roll over the full amount, you will enter the $2,000 distribution on line 15a of your Form 1040 (or 11a if you use the 1040A) and enter $0 on line 15b of the 1040 (11b on the 1040A). Write "rollover" next to the number to let the IRS know this was a tax-free rollover.

If you move money from one IRA to another in the future, you may want to use the "direct transfer" route. When one IRA custodian sends the money directly to another, you don't have to report the transfer on your return at all.

In 2010, if I convert one of my IRA's to a ROTH IRA, how will the taxes be computed on the conversion? I have several IRAs and do not want to trigger taxes on these IRA's if possible.

Only the amount you convert will be taxed in 2010. In fact, you don't have to convert the entire IRA. Say you have three $50,000 traditional IRAs and want to convert $25,000 to a Roth (because that's the most you can convert without pushing yourself into a higher tax bracket). You could simply convert $25,000 of any one of your traditional IRAs. The remaining $25,000 would stay in the traditional IRA, as would the balances of the other two accounts.

If you have made any nondeductible contributions to any of your traditional IRAs, you'll need to figure what percentage of the total balance (in all of your IRAs) is after-tax money. That portion of the amount you convert would be tax-free.

If my income exceeds the limit for getting the tax deduction for contributing to a traditional IRA, is there any reason to still put money into an IRA?

The advantage of a nondeductible, traditional IRA contribution is that once the money is inside the IRA tax shelter, it grows tax-deferred, and that means it grows faster than if it were in a taxable account because you enjoy compounding on money that would otherwise go to the IRS. Even when you take into account the fact that IRA withdrawals of the earnings will be taxed (while withdrawals from the taxable account will not), you'll come out ahead, assuming you're in the same tax bracket. One fly in the ointment, though, is that withdrawal of those earnings from the traditional IRA will be taxed as "ordinary" income, and that means your top marginal rate will apply. Any earnings in the taxable account that qualify as long-term gains or qualified dividends get a special rate. That can eat into the advantage of the tax shelter.

Yes, it's complicated. Have you considered a Roth IRA? The income cut-offs are far higher than for deductible IRAs (2006 limit is $110,000 on a single account and $160,000 on a joint account). With a Roth, there's no deduction going in, but all withdrawals are tax free.

My income comes from disability pensions, interest income, dividend income and long-term capital gains from the sale of a house. May I make contribution to my Roth IRA for 2006?

Sorry, but none of this income qualifies as compensation for purpose of making an IRA contribution. If you are married and your wife has compensation for 2006, she can contribute up to $4,000 ($5,000 if you are over age 50) to your Roth IRA, assuming your adjusted gross income on a joint return is less than $160,000.

Can I roll over my 401k distribution to Roth IRA?

Currently, you can't roll directly from a 401(k) to a Roth IRA. You have to move your money to a traditional IRA, then covert the traditional to a Roth (that's very easy to do). Starting next year, direct rollovers to Roth IRAs will be allowed.

Remember, any amount you covert to a Roth will be taxed in the year of the conversion. You might want to make the conversion in stages over two or more years to make sure the extra income doesn't push you into higher tax brackets.

Also, be sure to have the 401(k) money sent directly to the IRA, or have your company write the distribution check to your IRA account, not to you personally. If the payout goes to you personally, your firm is required by law to withhold 20% for the IRS.

I only contributed $3,500 to my ROTH IRA last year, and I know I will contribute more than $500 before April 15 this year. How can I apply $500 of my contribution this year for my 2006 tax return?

The deposit form for the IRA should ask if it is a 2006 or 2007 contribution. The IRA sponsor is responsible for reporting annual contributions to the IRS, so it needs to know how to allocate contributions made in the January-April 15 period between the current and the previous year. If it's not clear on the form how to designate $500 as a 2006 contribution, ask the IRA sponsor.

My wife is ten years younger than I am (I'm 78). My IRA is worth about $95,000 as of December 31, 2006. What is my required minimum distribution?

That's a tricky question. The general rule for required minimum distributions is that you use what's called the "uniform lifetime table," which sets life expectancy numbers for IRA owners who are either unmarried or married to someone who is no more than ten years younger. A different table, with different numbers, is used when the spouse is more than ten years younger. You say your wife is ten years younger, but what matters is your ages at the end of 2007.

If you will still be 78 and your wife will be 68, you use the uniform table and your divisor is 20.3. So, you would divide your 2006 yearend balance by 20.3 to determine that your required minimum distribution for 2007 is $4,688.

If, however, you will be 78 and your wife will be 67 at the end of the year, your divisor would be 21.0, delivering a lower RMD of $4,521. We suggest you ask your IRA sponsor to confirm my numbers.

Also, you can find the tables in IRS Publication 590.

Is interest on CDs and IRAs taxable?

Is the CD inside the IRA? If so, the interest is NOT taxable as it accrues; rather, the interest is taxed with it is distributed from the IRA. (This assumes it's a traditional IRA; if it's a Roth IRA, distributions are tax-free in retirement.)

If the CD is not in an IRA, however, the interest is taxed in the year it is paid. You should get a 1099-INT from the bank showing how much interest was earned in 2006 if the interest is taxable; and not receive one if the CD is in an IRA.

I know that the Roth IRA income limit for contributions rose to $166,000 for 2007. Will it increase in 2008, go back to the 2006 levels, or remain the same as 2007?

Starting this year, the limits are indexed for inflation, so it's likely they will rise a bit each year from here on out. They certainly won't fall back to the '06 levels.

I had $100 deducted from my pay once a month toward a retirement fund, and the company also contributed toward it on my behalf. Is this something that I can declare as a deduction?

It sounds like you're participating in a 401(k) or 403(b) defined-contribution retirement plan that includes a company contribution. Your own contributions -- the $100 a month -- are "pre-tax" money. That is, the IRS ignores that part of your salary. And, because you're not taxed on it in the first place, you don't deduct it.

Assume, for example, that you make $20,000 a year and that $1,200 of it went into the retirement account. Your W-2 would show just $18,800 of taxable wages. This puts you in the same position as if the W-2 reported the full $20,000 and you then deducted the $1,200.

The IRS Pub 17 states: "If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year." Does this mean I don't have to withdraw the excess, and I don't have to file any additional tax forms?

No. If you contributed more than the limit for any year, then you must either remove the excess or pay the 6% penalty for that year.

The provision you're referring to works like this: Let's say you contributed $5,000 to your Roth in 2006 but were limited to contributing $4,000. You'd either need to remove the excess $1,000 or pay the 6% excess contribution penalty for 2006.

Now, if you don't withdraw the $1,000 and count it as part of your 2007 contribution -- contributing just $3,000 of new funds, for example -- the $1,000 would not be considered an excess contribution in 2007. An excess contribution is taxed until it is either removed or absorbed by a future year's contribution.

You have until the due date of your return (April 17 this year) to remove the excess without paying the penalty.

I took a hardship withdrawal from my 401(k) last year for closing costs on the purchase of our new home. On my 1099R it shows that 10% was withheld. Is that enough, or will I end up paying more taxes on it and ruin any chance of receiving a refund?

It's hard to know if 10% is enough. If the full amount of the withdrawal is taxable -- after you subtract your exemptions and deductions -- the lowest federal tax bracket is 10%, so the withholding would just cover the tax bill.

If you're in a higher tax bracket, then you'll owe tax beyond the 10% withholding. On single returns in 2006, the 10% bracket covers the first $7,550 of taxable income. Taxable income (and, again, in this instance we're talking income that is actually taxed, so it's after subtracting exemptions and deductions) between $7,550 and $30,650 is taxed at 15%. Then the 25% bracket kicks in and the 28% bracket starts at $74,200.

You can find all the tax brackets here on the IRS Web site.

To the extent you owe tax on the withdrawal beyond the 10% that was withheld, the excess will cut into your refund or boost the amount you must pay with your return.

MEDICAL EXPENSES

How and what weight loss programs are deductible? I read that if a doctor's dianosis is obesity, you can deduct the weight loss program. Is this true?

Yes, you can include the cost of such programs in your deductible medical expenses if they are for the treatment of a specific medical condition diagnosed by a doctor, such as obesity, hypertension or heart disease.

The catch is, like all medical expenses, the cost is deductible only if you itemize and then only to the extent that all unreimbursed medical expenses exceed 7.5% of your adjusted gross income. If you AGI is $50,000, for example, the first $3,750 of your medical expenses don't count.

What impact does the interest on my investments have on my adjusted gross income total in regards to the 7.5% rule to deduct medical expenses? Does the interest count as part of my adjusted gross income?

Yes. Interest income is included in adjusted gross income. So, for example, because medical expenses are deductible only to the extent they exceed 7.5% of AGI, every $1,000 of interest income would reduce your medical expense deduction by $75.

Find out more about deducting medical expenses in The Kiplinger Taxopedia.

My husband and I are employed by the same employer, but we do not have medical coverage. Can we write off what we pay on our own for insurance?

What you pay for medical insurance counts as a deductible medical expense, but there are a couple of catches. First, you claim the deduction only if you itemize deductions (most people claim the standard deduction instead). Then your medical expenses are deductible by itemizers only to the extent that they exceed 7.5% of your adjusted gross income. So, if your combined AGI is $100,000, the first $7,500 of medical expenses don't count.

You may want to consider buying a high deductible health plan that would qualify you to contribute to a health savings account. Money you put in the HSA -- which can then be withdrawn tax-free to cover medical bills, including that high deductible -- IS deductible, regardless of whether you itemize and without regard to that 7.5% haircut.

I paid my health insurance premium out of my check after tax, so it is included in my gross income. How can I deduct this large amount on my tax return?

Health insurance premiums are a deductible medical expense, but the catch is that very few taxpayers really get to deduct the cost. First, to get a tax benefit, you must itemize deductions ... and most taxpayers do not because they are better off using the standard deduction.

Second, medical expenses are deductible only to the extent that the total of your unreimbursed expenses exceeds 7.5% of your adjusted gross income. So, if you make $50,000, the first $3,750 of your medical expenses doesn't count. If you do itemize and have significant medical bills, you deduct medical costs on Schedule A.

You may want to ask your employer if it can arrange to have your premiums paid with pre-tax dollars. Section 125 of the Internal Revenue Code allows an employer to provide a portion of an employee's salary in benefits rather than cash. Instead of paying a certain amount to an employee as taxable income, the employer uses it to purchase benefits for the employee. Many employers do this for health insurance. If yours will, you'd be sure to get a tax benefit.

MISCELLANEOUS

I opened a custodial account for my grandson with my son as the custodian. I withdrew the funds from my IRA. Is there a credit allowed on my 2006 income taxes?

Nice gesture, but, sorry, no deduction. Gifts are deductible only if you give the money to a qualified charitable organization. In fact, because you withdrew the gift money from your IRA, your tax bill will probably go up because withdrawals from traditional IRAs are taxable.

During 2006 I received a settlement from an insurance company for pain and suffering damages as a result of an accident. Am I required to show this on my 2006 tax return as income?

In 1986, Congress changed the law on the taxability of damages and held that punitive damages and those awarded for emotional distress or mental anguish are generally taxable.

One important exception, however, makes damages received for mental suffering from physical injuries tax-free. It sounds like the award you received qualifies.

Where do I list the $250 educators' expenses deduction on a 1040A?

You must file the full-fledged 1040 to claim the educator's deduction. And you claim it on line 23 as we noted in 13 Most Overlooked Deductions.

This break lost its place on the tax forms because it expired at the end of 2005 and wasn't reinstated until the 2006 forms were set. Still, teachers and their aides can deduct up to $250 they spent in 2006 for books and classroom supplies. If you qualify, put your deduction on line 23 of the Form 1040, the line now used for the Archer medical savings account (MSA) deduction, and write "E" on the dots to the left. If you also claim the MSA deduction, write "B" (for both) on the line and attach a breakdown of how much you're claiming for each. You get this deduction regardless of whether you itemize.

PERSONAL INTEREST

Can I claim a deduction from the interest I incurred or paid to certain banks for my credit cards for 2006?

Sorry, but so-called personal interest -- on credit cards, car loans, etc. -- is no longer deductible. Interest on a loan secured by your home -- either a first or second mortgage, for example, or a home equity line of credit -- is deductible if you itemize. Also, money borrowed for investments that produce taxable income is also deductible, but only to the extent that the taxpayer reports taxable investment income.

Personal interest was deductible in the past, but Congress changed the law more than two decades ago.

PROPERTY

Is there an easy way to understand and figure out the depreciation and amortization on our vacation home, which we rent out six weeks of the year?

Come on ... you want taxes to be easy?

You figure your depreciation on Form 4562, basically, by dividing your tax basis in the property (purchase price, plus improvements, minus the cost of land) by 27.5 because a residential rental property is depreciated over 27½ years. First-year depreciation is reduced depending on when in the year you put the house in rental service.

Then you have to allocate the depreciation between personal (nondeductible) and rental (deductible) use on the Schedule E, where you report your rental income and rental expenses. Here's a section from my book, Cut Your Taxes, that explains the allocation methods available.

To figure your vacation-home deductions, you have to allocate expenses between personal and rental use. There are two ways to do this -- the IRS method and another approach that has been approved in court cases. The one that's best for you depends on your circumstances.

According to the IRS, you begin by adding up the total number of days the house was used for personal and business purposes. Your deductible rental expenses are the same proportion of the total as the number of rental days is to the total number of days the place was used.

For example, assume you have a cabin in the mountains that you use for 30 days during the year and rent out for 100 days. The 100 days of rental use equals 77% of the total 130 days the cabin was used According to the IRS formula, 77% of your expenses—including interest, taxes, insurance, utilities, repairs and depreciation—would be rental expenses.

The IRS is particular about the order in which you deduct those expenses against your rental income. You deduct interest and taxes first, then expenses other than depreciation, and then depreciation. The sequence is important, and detrimental, because of the rule that limits rental deductions to the amount of rental income when personal use exceeds 14 days or 10% of total use. Remember that property taxes not assigned to rental use could be claimed as regular itemized deductions instead. But by requiring you to deduct those expenses against rental income -- that might otherwise be offset by depreciation you won't get to claim -- the law squeezes the write-off for taxes as an itemized deduction.

By using a different allocation formula, though, you can limit the interest and tax expenses used to offset rental income and thereby boost the write-off of other rental costs. Courts have allowed taxpayers to allocate taxes and interest over the entire year rather than over just the number of days a property is used. In the example above of 100 days of rental use, that method would allocate just 27% (100 ÷ 365) of the taxes and interest to rental income. That would leave more rental income against which other expenses can be deducted. The extra taxes and interest can be deducted as a regular itemized deduction.

Although the court-approved formula can pay off when the 14-day or 10% test makes the property a personal residence, the IRS version can be more appealing if the place qualifies as a business property. You need to look at the specifics of your situation to determine the best method for you.

I sold a property last year for the same amount I paid for it nine months earlier. So there was net loss due to realtor fees. Are realtor fees deductible?

The fees are deductible against the proceeds of the sale when figuring your profit or loss on the sale. If you bought for $100,000 and sold for $100,000, and the agent took a $10,000 fee, your loss is $10,000. Because you owned the property for less than one year, you have a short-term capital loss. (We assume this was not your home; losses on the sale of a home are not deductible.)

If we own a vacation rental real estate property, are actively managing it and have a loss, can this loss be deducted on our tax return?

That depends on your income. Here's a section from Kiplinger's Cut Your Taxes that explains things:

Surviving the Passive-Loss Rules

As part of the crackdown on tax shelters, Congress severely limited the ability of investors in "passive activities" to deduct losses from those investments against other kinds of income. Rental real estate is specifically labeled a passive activity.

That could have been a knockout blow for a lot of landlords who count on tax losses to make their real estate investments financially feasible. But the law includes a major exception to the passive-loss rules that makes rental real estate an oasis in the otherwise barren tax-shelter landscape. And special relief has been added for real estate professionals. First a look at the basic exception, then at the special rules for real estate pros.

If you qualify for exception, you can continue to deduct up to $25,000 of rental real estate losses against other income, such as your salary or interest and dividends.

To qualify, you must actively participate in the management of the property. Fortunately, the demands for passing that test aren't particularly onerous. You don't have to be on call for middle-of-the-night repairs, or to cut the grass and collect rents. The IRS rules don't say exactly what you do have to do, but even if you hire a management firm to handle day-to-day matters, you can be actively involved as long as you approve tenants, set the rent and okay capital improvements.

The $25,000 exception isn't for fat cats, though, no matter how actively they're