Tax Tips for Your 2012 Return

Haven't filed your taxes yet? Chances are you fall into one of two categories: You owe the IRS money, or you've managed to find a lot of things to do before tackling the paperwork, such as regrouting the bathroom tile.

In either case, April 15 is fast approaching, so it's time to gather your W-2s, your 1099s and the rest of your tax documents and get to work. Although dealing with the tax code remains a formidable task — the IRS's national taxpayer advocate, Nina Olson, estimates that Americans spend more than six billion hours a year preparing their taxes — not a lot changed in 2012. Unless your income rose or declined significantly, your tax rate probably remained the same as in 2011. (The new top rate for high-income taxpayers doesn't apply for 2012; it takes effect this year. And under the new tax law, you probably won't have to worry about the dreaded alternative minimum tax, unless you've had to pay it in the past. In that case, you're probably still out of luck.)

Here's what you do have to worry about: overlooking deductions, credits or other tax breaks so you end up paying more than you owe. Even worse, in your haste to meet the April 15 deadline, you're more likely to make mistakes that could get you in trouble with the IRS.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Mind the boomerang breaks. Congress resurrected several tax breaks that expired at the end of 2011. Among them: a $500 tax credit for energy-efficient home improvements, such as new windows, doors and skylights. Be advised, though, that $500 is the lifetime maximum, so if you claimed $500 in energy-efficient credits before 2012, you can't do so again. The old restrictions for specific projects remain — for example, the most you can claim for new energy-efficient windows is $200. (A separate credit that covers up to 30% of the cost of installing renewable-energy equipment, such as solar panels, has no limit and is available through 2016.)

The new law also revived the state and local sales-tax deduction for 2012 and 2013. The provision gives you the option of deducting state income taxes or state and local sales taxes. That's an easy choice for taxpayers in the nine states with no income tax. But in some instances, even taxpayers in states with an income tax could get a bigger tax break by deducting sales taxes, particularly if they made some big purchases in 2012. The IRS provides tables and an online calculator to show how much residents of various states can deduct, based on state and local tax rates. But if you bought a big-ticket item, such as a boat or a car, you can add the sales tax for that purchase to the total.

Tally up your medical bills. In general, you can't deduct unreimbursed medical expenses until they exceed 7.5% of your adjusted gross income (in 2013, this threshold will rise to 10% for taxpayers younger than 65). That dissuades a lot of people from even considering this deduction. But if you had a lot of un­reimbursed medical expenses last year or your income took a hit, it's worth pulling out your receipts and adding up your expenses, says Bob Meighan, lead CPA at the American Tax & Financial Center at TurboTax. During the economic downturn, he says, “we saw many people claim the deduction because their pay was reduced or their jobs were eliminated, and they still had continuing medical bills.”

In 2010, individuals with adjusted gross income of $50,000 to $100,000 who took advantage of this tax break deducted an average of $7,312, according to tax publisher CCH. And that's after reducing out-of-pocket costs by 7.5% of their AGI.

A long list of medical and dental expenses that might not have been reimbursed by your health insurance plan or flexible spending account are deductible, including payments for doctors and dentists, hospital fees, prescription medications and medical supplies. The cost of transportation to your doctor's office is deductible; the 2012 standard mileage rate is 23 cents per mile plus the cost of parking and tolls. As you struggle to get over the 7.5% threshold, remember that you can deduct medical expenses you paid for a child younger than 27, even if he or she is not a dependent.

Use the roof over your head to lower your tax bill. Most homeowners are well aware that interest on their mortgage and the local property taxes they pay are deductible. But there are other tax breaks related to your home you may not know about.

The new law revived a provision that allows taxpayers to write off mortgage insurance premiums. Lenders typically require home buyers to pay for mortgage insurance if they put down less than 20% of the home's cost. To claim the full deduction, your 2012 adjusted gross income must be $100,000 or less. That cutoff applies whether you're single or married and file jointly; for married couples who file separately, it phases out beginning at $50,000.

If you lost your home to foreclosure in 2012, sold it for less than the balance of the loan or had the terms of your loan modified, there may be relief for you, too. Ordinarily, when a debt is forgiven, the canceled debt is considered taxable income. Through 2012, though, up to $2 million of debt discharged on a mortgage for a principal residence is tax-free. And if you were unable to complete a short sale or loan modification by December 31, don't panic: The law extended mortgage-debt forgiveness through 2013.

[page break]

If Hurricane Sandy or a similar catastrophe blew your roof away, you may qualify to deduct some losses that weren't covered by insurance. There are limits, though. First, you must reduce your losses by $100. After that, your deduction is limited to the amount of your losses that exceeds 10% of your adjusted gross income. For more information on writing off casualty losses, see IRS Publication 547.

Lower the costs of raising a family. The Department of Agriculture estimates that a middle-income family will spend more than $234,000 to raise a child born in 2011 to age 18. With that in mind, you don't want to overlook any family-friendly tax breaks, particularly when it comes to the cost of child care.

If you pay child-care expenses, you may be eligible to claim the child-care credit to offset some of those costs. To qualify, you must pay someone to watch one or more children younger than 13 while you work or look for a job. The maximum credit is $3,000 for one child and $6,000 for two or more.

If you contributed to a flexible spending account for dependent-care expenses at your job, be careful: You can't claim the credit for the same expenses covered by the flex account, says John W. Roth, federal tax analyst for CCH. However, suppose you pay for child care for two or more children and maxed out on the $5,000 the law allows you to stash in a child-care flex account each year. In that case, you can use the dependent-care credit to cover up to an additional $1,000 you paid for care. You'll shave at least $200 from your tax bill.

Parents who adopt children are eligible to claim a tax credit worth up to $12,650 per child in 2012. Unlike in 2010 and 2011, the credit is nonrefundable, Roth says, which means you won't receive a refund if the credit exceeds your tax liability. You can carry forward unused credits, however, and apply them against future tax bills.

Taxpayers who claim this credit can't e-file; they must file a paper return and include Form 8839 with the return. Because this credit is so large, it's likely to attract extra scrutiny from the IRS, so keep good records to substantiate your attorney's fees, travel costs and other eligible expenses. The new tax law made this credit permanent, so if you were unable to finalize your adoption by December 31, you'll still have the ability to claim it for this year.

Manage your IRA. Another tax break that was revived allows people 70½ or older to make tax-free transfers of up to $100,000 from their IRAs to charity. However, because the tax bill was signed January 1, some seniors probably missed the opportunity to take advantage of this break in 2012.

If you contributed money from your IRA directly to charity last year in hopes that this provision would pass, you can count it as a tax-free transfer. But if you withdrew cash from your IRA in December to meet your required minimum distribution, you're out of luck. Acknowledging its failure to extend the rule before the end of 2012, Congress said that December withdrawals could be treated as tax-free transfers if the money was shifted to a charity by the end of January. It's too late now.

The good news is that the provision was extended through 2013, so if you're still charitably inclined, you'll have another chance to make a tax-free transfer this year.

Don't forget about your Roth conversion. In 2010, taxpayers had a one-time opportunity to postpone the tax bill on a Roth conversion. The first half was due with your 2011 return; the second half is due when you file your 2012 tax return. Don't expect the IRS or your IRA provider to remind you of this obligation, although your tax software or tax preparer should send up a flare. Dig out Form 8606, which you should have used to report the conversion in 2010, to figure out how much income you'll need to include on your 2012 return. And if you made another conversion in 2012, you'll have to include that, too. The chance to defer taxes on Roth conversions was a one-time deal.

Grab last-minute deductions. If you qualify, there's still time to lower your 2012 taxes by putting money in a deductible IRA. You have until April 15 to stash up to $5,000 in your IRA for 2012; anyone 50 or older at the end of 2012 can squirrel away up to $6,000. If you're in the 25% tax bracket, a $5,000 contribution will save you $1,250 on your 2012 tax bill. But if you have a retirement plan at work, the right to make deductible contributions begins to phase out at $58,000 for single taxpayers and $92,000 on a joint tax return.