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Slide Show | December 2013

The Most-Overlooked Tax Deductions

Years ago, the fellow who was running the IRS at the time told Kiplinger's Personal Finance magazine that he figured millions of taxpayers overpaid their taxes every year by overlooking just one of the money-savers listed here.

Cut your tax bill to the bone by claiming all the breaks you deserve—including some you may have forgotten or never even knew about.


The Most-Overlooked Tax Deductions

State Sales Taxes

You may hear that this tax break expired . . . which it does regularly, only to be reinstated by Congress. For 2013 returns, however, it’s a go.

This is particularly important to you if you live in a state that does not impose a state income tax. You see, Congress offers itemizers the choice between deducting the state income taxes or state sales taxes they paid. You choose whichever gives you the largest deduction. So if your state doesn't have an income tax, the sales tax write-off is clearly the way to go.

In some cases, even filers who pay state income taxes can come out ahead with the sales tax choice.

The IRS has tables that show how much residents of various states can deduct, based on their income and state and local sales tax rates. But the tables aren't the last word. If you purchased a vehicle, boat or airplane, you may add the sales tax you paid on that big-ticket item to the amount shown in the IRS table for your state.

State Sales Taxes

Reinvested Dividends

This isn't a tax deduction, but it is an important subtraction that can save you a bundle. And former IRS commissioner Fred Goldberg told Kiplinger's that missing this break is what costs millions of taxpayers a lot in overpaid taxes.

If, like most investors, you have mutual fund dividends automatically used to buy extra shares, remember that each reinvestment increases your tax basis in the fund. That, in turn, reduces the taxable capital gain (or increases the tax-saving loss) when you redeem shares. Forgetting to include reinvested dividends in your basis results in double taxation of the dividends—once when they were paid out and immediately reinvested and later when they're included in the proceeds of the sale. Don't make that costly mistake.

If you're not sure what your basis is, ask the fund for help. Funds often report to investors the tax basis of shares redeemed during the year. In fact, for the sale of shares purchased in 2012 and later years, funds must report the basis to investors and to the IRS.

Reinvested Dividends

Out-of-Pocket Charitable Deductions

It's hard to overlook the big charitable gifts you made during the year, by check or payroll deduction (check your December pay stub).

But little things add up, too, and you can write off out-of-pocket costs incurred while doing work for a charity. For example, ingredients for casseroles you prepare for a nonprofit organization's soup kitchen and stamps you buy for a school's fund-raising mailing count as charitable contributions. Keep your receipts. If your contribution totals more than $250, you'll also need an acknowledgement from the charity documenting the support you provided. If you drove your car for charity in 2013, remember to deduct 14 cents per mile, plus parking and tolls paid, in your philanthropic journeys.

Out-of-Pocket Charitable Deductions

Student-Loan Interest Paid by Mom and Dad

Generally, you can deduct mortgage or student-loan interest only if you are legally required to repay the debt. But if parents pay back a child's student loans, the IRS treats the money as if it were given to the child, who then 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. And he or she doesn't have to itemize to use this money-saver. (Mom and Dad can't claim the interest deduction even though they actually foot the bill because they are not liable for the debt.)

Student-Loan Interest Paid by Mom and Dad

Job-Hunting Costs

If you're among the millions of unemployed Americans who were looking for a job in 2013, we hope you kept track of your job-search expenses ... or can reconstruct them. If you're looking for a position in the same line of work, you can deduct job-hunting costs as miscellaneous expenses if you itemize. Qualifying expenses can be written off even if you didn't land a new job. But such expenses can be deducted only to the extent that your total miscellaneous expenses exceed 2% of your adjusted gross income. Job-hunting expenses incurred while looking for your first job don't qualify. Deductible job-search costs include, but aren't limited to:

-- Transportation expenses incurred as part of the job search, including 56.5 cents a mile for driving your own car plus parking and tolls
-- Food and lodging expenses if your search takes you away from home overnight
-- Cab fares
-- Employment agency fees
-- Costs of printing resumes, business cards, postage, and advertising.

Job-Hunting Costs

Moving Expenses to Take Your First Job

Although job-hunting expenses are not deductible when looking for your first job, moving expenses to get to that job are. And you get this write-off even if you don't itemize.

To qualify for the deduction, your first job must be at least 50 miles away from your old home. If you qualify, you can deduct the cost of getting yourself and your household goods to the new area. If you drove your own car on a 2013 move, deduct 24 cents a mile, plus what you paid for parking and tolls. For a full list of deductible expenses, check out IRS Publication 521.

Moving Expenses to Take Your First Job

Military Reservists' Travel Expenses

Members of the National Guard or military reserve may write off the cost of travel to drills or meetings. To qualify, you must travel more than 100 miles from home and be away from home overnight. If you qualify, you can deduct the cost of lodging and half the cost of your meals, plus an allowance for driving your own car to get to and from drills. For 2013 travel, the rate is 56.5 cents a mile, plus what you paid for parking fees and tolls.

Military Reservists' Travel Expenses

For the Self-Employed: Deduction of Medicare Premiums

Folks who continue to run their own businesses after qualifying for Medicare can deduct the premiums they pay for Medicare Part B and Medicare Part D, plus the cost of supplemental Medicare (medigap) policies. This deduction is available whether or not you itemize and is not subject the 7.5% of AGI test that applies to itemized medical expenses. One caveat: You can't claim this deduction if you are eligible to be covered under an employer-subsidized health plan offered by either your employer (if you have a job as well as your business) or your spouse's employer (if he or she has a job that offers family medical coverage).

For the Self-Employed: Deduction of Medicare Premiums

Child-Care Credit

A credit is so much better than a deduction; it reduces your tax bill dollar for dollar. So missing one is even more painful than missing a deduction that simply reduces the amount of income that's subject to tax. In the 25% bracket, each dollar of deductions is worth a quarter; each dollar of credits is worth a greenback.

You can qualify for a tax credit worth between 20% and 35% of what you pay for child care while you work. But if your boss offers a child care reimbursement account—which allows you to pay for the child care with pretax dollars—that’s likely to be an even better deal. If you qualify for a 20% credit but are in the 25% tax bracket, for example, the reimbursement plan is the way to go. (In any case, only amounts paid for the care of children younger than age 13 count.)

You can't double dip. Expenses paid through a plan can't also be used to generate the tax credit. But get this: Although only $5,000 in expenses can be paid through a tax-favored reimbursement account, up to $6,000 for the care of two or more children can qualify for the credit. So if you run the maximum through a plan at work but spend even more for work-related child care, you can claim the credit on as much as $1,000 of additional expenses. That would cut your tax bill by at least $200.

Child-Care Credit

Estate Tax on Income in Respect of a Decedent

This sounds complicated, but it can save you a lot of money if you inherited an IRA from someone whose estate was big enough to be subject to the federal estate tax.

Basically, you get an income-tax deduction for the amount of estate tax paid on the IRA assets you received. Let's say you inherited a $100,000 IRA, and the fact that the money was included in your benefactor's estate added $40,000 to the estate-tax bill. You get to deduct that $40,000 on your tax returns as you withdraw the money from the IRA. If you withdraw $50,000 in one year, for example, you get to claim a $20,000 itemized deduction on Schedule A. That would save you $5,600 in the 28% bracket.

Estate Tax on Income in Respect of a Decedent

State Tax Paid Last Spring

Did you owe tax when you filed your 2012 state income tax return in the spring of 2013? Then, for goodness' sake, remember to include that amount in your state-tax deduction on your 2013 federal return, along with state income taxes withheld from your paychecks or paid via quarterly estimated payments during the year.

State Tax Paid Last Spring

Refinancing Points

When you buy a house, you get to deduct in one fell swoop the points paid to get your mortgage. When you refinance, though, you have to deduct the points on the new loan over the life of that loan. That means you can deduct 1/30th of the points a year if it's a 30-year mortgage. That's $33 a year for each $1,000 of points you paid—not much, maybe, but don't throw it away.

Even more important, in the year you pay off the loan—because you sell the house or refinance again—you get to deduct all as-yet-undeducted points. There's one exception to this sweet rule: If you refinance a refinanced loan with the same lender, you add the points paid on the latest deal to the leftovers from the previous refinancing, then deduct that amount gradually over the life of the new loan. A pain? Yes, but at least you'll be compensated for the hassle.

Refinancing Points

Jury Pay Paid to Employer

Many employers continue to pay employees' full salary while they serve on jury duty, and some impose a quid pro quo: The employees have to turn over their jury pay to the company coffers. The only problem is that the IRS demands that you report those jury fees as taxable income. To even things out, you get to deduct the amount you give to your employer.

But how do you do it? There's no line on the Form 1040 labeled “jury fees.” Instead, the write-off goes on line 36, which purports to be for simply totaling up deductions that get their own lines. Add your jury fees to the total of your other write-offs and write "jury pay" on the dotted line.

Jury Pay Paid to Employer

American Opportunity Credit

Unlike the Hope Credit that this one has temporarily replaced, the American Opportunity Credit is good for all four years of college, not just the first two. Don't shortchange yourself by missing this critical difference. This tax credit is based on 100% of the first $2,000 spent on qualifying college expenses and 25% of the next $2,000 ... for a maximum annual credit per student of $2,500. The full credit is available to individuals whose modified adjusted gross income is $80,000 or less ($160,000 or less for married couples filing a joint return). The credit is phased out for taxpayers with incomes above those levels. If the credit exceeds your tax liability, it can trigger a refund. (Most credits can reduce your tax to $0, but not get you a check from the IRS.)

American Opportunity Credit

A College Credit for Those Long Out of College

College credits aren’t just for youngsters, nor are they limited to just the first four years of college. The Lifetime Learning credit can be claimed for any number of years and can be used to offset the cost of higher education for yourself or your spouse . . . not just for your children.

The credit is worth up to $2,000 a year, based on 20% of up to $10,000 you spend for post-high-school courses that lead to new or improved job skills. Classes you take even in retirement at a vocational school or community college can count. If you brushed up on skills in 2013, this credit can help pay the bills. The right to claim this tax-saver phases out as income rises from $53,000 to $63,000 on an individual return and from $107,000 to $127,000 for couples filing jointly.

A College Credit for Those Long Out of College

Those Blasted Baggage Fees

Airlines seem to revel in driving travelers batty with extra fees for baggage and for changing travel plans. Such fees add up to billions of dollars each year. If you get burned, maybe Uncle Sam will help ease the pain. If you're self-employed and travelling on business, be sure to add those costs to your deductible travel expenses.

Those Blasted Baggage Fees

Credits for Energy-Saving Home Improvements

It appears 2013 will be the end of the road—for real—for a tax credit that’s worth 10% of the cost of qualifying energy savers, such as new windows and insulation. (It expired before, in 2011, but was retroactively revived for 2012 and 2013.) If you made qualifying improvements in 2013—and you did not use up the maximum $500 credit (only $200 of which can be for windows) in earlier years—be sure to cash in with your 2013 return.

Another credit for saving energy is still alive, though, and it has no dollar limit. This credit goes to homeowners who install qualified residential alternative energy equipment, such as solar hot water heaters, geothermal heat pumps and wind turbines. Your credit can be 30% of the total cost (including labor) of such systems installed through 2016.

Credits for Energy-Saving Home Improvements

Bonus Depreciation ... And Beefed-Up Expensing

Business owners—including those who run businesses out of their homes—have to stay on their toes to capture tax breaks for buying new equipment. The rules seem to be constantly shifting as Congress writes incentives into the law and then allows them to expire or to be cut back to save money. Take “bonus depreciation” as an example. Back in 2011, rather than write off the cost of new equipment over many years, a business could use 100% bonus depreciation to deduct the full cost in the year the equipment was put into service. For 2013, that bonus depreciation is 50%. That’s still a sweet deal not to be missed if you qualify for a 2013 purchase—it’s just not as sweet as it was earlier.

Perhaps even more valuable, though, is supercharged "expensing," which basically lets you write off the full cost of qualifying assets in the year you put them into service. The dollar limit for expensing seems to change every year. For 2013 purchases, it can apply to up to $500,000 worth. The $500,000 cap phases out dollar for dollar if you put more than $2 million worth of assets into service in 2013.

Bonus Depreciation ... And Beefed-Up Expensing

Break on the Sale of Demutualized Stock

Despite years of litigation, this issue is still up in the air.

In 2013, the IRS finally found a court that agrees with its tough stand on the issue of demutualized stock. That's stock that a life insurance policyholder receives when the insurer switches from being a mutual company owned by policyholders to a stock company owned by shareholders. The IRS's longstanding position is that such stock has no tax basis, so that when the shares are sold, the taxpayer owes tax on 100% of the proceeds of the sale. In 2009 and again in 2011, federal courts sided with taxpayers who challenged the IRS position. Shortly after the IRS won its case in early 2013, the court in one of the earlier cases came up with a complicated method to pinpoint a basis. Rather than agreeing with experts who say the basis should be 100% of the stock’s value at the time of the demutualization, the court’s method set the basis in the case at hand at between 50% and 60% of the stock’s value when the taxpayers received it. Sooner or later, the Supreme Court may have to settle things.

In the meantime, if you sold stock in 2013 that you received in a demutualization, you have a couple of choices. Claim a basis and, if the IRS rejects your position, file an appeal. Or use a zero basis, pay the tax on the full proceeds of the sale and then file a "protective refund claim" to maintain your right to a refund if the matter is eventually settled in your favor.

Break on the Sale of Demutualized Stock

Social Security Taxes You Pay

This doesn’t work for employees. You can’t deduct the 7.65% of pay that’s siphoned off for Social Security and Medicare. But if you’re self-employed and have to pay the full 15.3% tax yourself (instead of splitting it 50-50 with your employer), you do get to write off half of what you pay. That deduction comes on the face of Form 1040, so you don’t have to itemize to take advantage of it.

Social Security Taxes You Pay

Waiver of Penalty for the Newly Retired

This isn’t a deduction, but it can save you money if it protects you from a penalty. Because our tax system operates on a pay-as-you earn basis, taxpayers typically must pay 90% of what they owe during the year via withholding or estimated tax payments. If you don’t, and you owe more than $1,000 when you file your return, you can be hit with a penalty for underpayment of taxes. The penalty works like interest on a loan—as though you borrowed from the IRS the money you didn’t pay. The current rate is 3%.

There are several exceptions to the penalty, including a little-known one that can protect taxpayers age 62 and older in the year they retire and the following year. You can request a waiver of the penalty—using Form 2210—if you have reasonable cause, such as not realizing you had to shift to estimated tax payments after a lifetime of meeting your obligation via withholding from your paychecks.

Waiver of Penalty for the Newly Retired

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