THURSDAY, JANUARY 25, 2018
TONY: With it being the time of year that you are gathering the information to file your tax returns, we want to make sure you do not miss some of the most overlooked tax deductions. Joining us today is Sandra Block, Senior Associate Editor at Kiplinger’s Personal Finance to share some of the most overlooked tax deductions that are missed by Americans today. Welcome, Sandra.
SANDRA BLOCK: Thank you for having me.
TONY: You have a great topic today in talking about overlooked tax deductions and tax opportunities that people miss out on all the time and being that people are going to be getting their stuff together to file their taxes for 2013 here shortly, I think it is a good time to remind people some of these deductions that they might be missing. One that we see all the time is the American Opportunity Tax Credit. Share with our audience what that is all about.
SANDRA BLOCK: This is a really valuable credit for any family that has a child in college or in this case in college in 2013. Unfortunately, because these education related tax credits are so complicated, an awful lot of people overlook them. Basically, the American Opportunity Tax Credit provides a credit for up to $2500 of college tuition and related expenses paid during the year and note that I say credit that is a lot more valuable than a deduction because that means it is a dollar for dollar reduction in your tax bill. The full credit is available to individuals whose modified gross income is $160,000 or less for married couples or $80,000 or less for singles. It phases out somewhat above those levels, but as I said if you had a child in college last year, you should have no trouble coming up with enough expenses to qualify for this credit and that basically means you reduce your tax bill by $2500. It is a really valuable thing for people who are struggling to meet these rising college costs.
TONY: Hey, Sandra, maybe address also what if that $2500 credit completely eliminates my tax liability, do I still get additional value of that credit like is it refundable or non-refundable?
SANDRA BLOCK: No, it is not refundable. Basically, you would get no tax bill, which would be nice or you would get a bigger refund if you over withheld last year, but it is not a refundable tax credit.
TONY: I appreciate clarifying that because there are of course refundable tax credits and it is hard for, I think, the average person to kind of keep that straight, so I appreciate you covering. Let’s build on this education tone and let’s discuss the impact of the lifetime learning credit.
SANDRA BLOCK: This is one that we often recommend for people who are going back to school. It is available for virtually any educational cost at virtually any school. It is a little more complicated. It is calculated as 20% of up to $10,000 of qualified expenses, which works out to $2000 a year. Again, this is a credit. The income limits are a little lower. They are $127,000 if you are married or $63,000 if you are single. You cannot claim both this credit and the American Opportunity Credit, but where I think the lifetime learning credit really comes into play is to offset graduate student costs or as I said if you are an older person going back to school to get a degree, this is one thing to look at that could cut your costs.
TONY: Can you kind of clarify if I can only benefit from a lifetime learning credit, is there a limitation of the type of school or education that I can seek for that benefit.
SANDRA BLOCK: I do not think so as long as it is accredited. For example, if you went to community college, I think it is available for that. There probably is some cutoff in terms of legitimate accredited schools, but it does not have to be your traditional four-year college where you go full time. As I said, that is why I think it is a particularly valuable credit for people who are going to school part time, going to graduate school while they are working or something like that.
TONY: Okay, so it is probably not for the golfers who want to improve their game.
SANDRA BLOCK: No, I would buy that.
TONY: I hear you, but I appreciate that clarification.
JIM: Let’s look at another one. It is amazing to me how many people miss out on the spousal IRA. They still think that if a spouse does not work, they are not able to contribute or they are only able to contribute that $250 and I think those rules were changed over 10 years ago, were they?
SANDRA BLOCK: Yes and the other reason that this is overlooked is a lot of people probably have in the back of their minds that if they are working and are covered by a 401(k) or other employer provided plan, they probably do not qualify to deduct contributions to an IRA and that is true, but what they may not realize is that if their spouse is not working, they qualify to deduct an IRA even if you, the working spouse, are covered by a 401(k) or something like that. This could really make a big dent in your tax bill and that is one advantage. The other advantage is that people who step out of the work force to take care of children or older parents often fall way behind on retirement savings and this is one way for them to sort of keep up. If you have a spouse with little or no earned income, they can make an IRA contribution of up to $5500 or $6500 if they are 50 or older and it is tax deductible as long as your combined income does not exceed $173,000 on a joint return. That is a pretty high block. That means that if you are working and you make $150,000 and your spouse is not, your spouse still qualifies to make a deductible contribution to an IRA. As I said, that is a really big benefit and it is important for people to understand that with other IRAs the spouse can make the contribution for 2013 up until April 15, 2014, so there is still time to do this and reduce your 2013 tax bill. There are not too many things that people can do after December 31 to reduce their 2013 tax bill, but this is one of them.
JIM: Another thing too that I think sometimes people miss the opportunity on, I know we are talking about deductions, but people think if they cannot deduct it they cannot contribute and there are other reasons to contribute to non-deductible IRAs. You might have an opportunity to convert them to Roths down the road. Three is creditor protection for IRAs depending on your state, it might vary from state to state, but there are benefits of having money in an IRA, tax benefits as well as creditor protection that you may want to look at even if you cannot deduct it.
SANDRA BLOCK: That is right and one thing that we are seeing people do more and more. Of course, you can contribute to a Roth too and you can do that up until April 15, 2014. That will not give you a tax break, but could you give you big tax breaks later on and as you pointed out, what more and more people are doing now that there is no income limits on converting to a Roth is they will make a contribution to a non-deductible IRA and then turn around and convert that to a Roth.
TONY: That is a strategy I do not think a lot of people think about.
SANDRA BLOCK: No, they do not. It is catching on. The one thing we warn people about is it looks really clean and simple, but you have some money in a deductible IRA, perhaps from a 401(k) that you rolled over a long time ago, you cannot cherry pick the amount that you want to convert. You will be taxed basically on a prorated basis, so you have to be careful of that. If you have no money, if you have never had a deductible IRA and you have no money sitting around in a rollover or something like that, you could conceivably put money in a deductible IRA, then turn around, and convert it. You would not owe any taxes on it because it is after tax and then it would have the opportunity to continue to grow tax-free until you retire.
TONY: I am just thinking as we are covering some of this stuff, I am sure people who are listening are going, “God that sounds complicated”, well the bottom line is do not go it alone. There is no reason to have to and the reason these are the most overlooked deductions that we are talking about today is because people do not get help.
SANDRA BLOCK: That is exactly right and I think a lot of middle-income people in particular do not take advantage. The high-income people tend to have an accountant on hand, middle-income people do not. They go on their own. I have to say I use tax software and it is pretty good, but that is why a lot of times people overlook these tax breaks and deductions because they are complicated and they do not realize they are out there.
TONY: Sometimes I painfully think around April 14, how many are hovering over the dining room table trying to scramble and figure things out and quite honestly sometimes to avoid maybe $100 or $200 preparation fee by actually working with an expert. That is all an option too and we appreciate that. Hey, one other thing that we should talk about relative to education deductions is what about the impact of student loan interest that is paid by Mom and Dad.
SANDRA BLOCK: Yes, this is one we put on our list because it surprised me when I found out that this was deductible. Student loan interest is deductible up to a certain amount. Generally, with most deductions, you can only claim the deduction on interest if you are legally required to repay the debt, but in the case of student loans, if the adults pay back a child’s student loans, the IRS treats the money as if it was given to the child who paid the debt, so the child can deduct up to $2500 of student loan interest even if it was paid by their parents and they do not have to itemize to use this money saving deduction. It is one of the few that you can claim even if you are not itemizing, which is probably true of most recent graduates. They do not have enough deductions to itemize. You cannot double dip here. Mom and Dad cannot claim the interest deduction, but this is a way for the student to get a break on their taxes. I think it is important to know this because so many recent graduates are really having a lot of financial problems and to get an additional tax break certainly will not hurt.
JIM: On the other end of the spectrum, you talk about parents helping their kids out that sandwich generation sometimes is helping their parents out and I know this is not on your list, but it reminded me of the number of clients where the kids are doing a lot to help Mom and Dad out. They might even be living in their household and the parents are not making enough money to even pay taxes, but they are providing over 50% of the support and a lot of times we see them missing the itemized deductions and exemptions that they might have available for that parent that they are taking care of. Sometimes you can miss it on the other end.
SANDRA BLOCK: Yes and that is a really good point and something a lot of our readers ask about is at what point can you claim a parent as a dependent. As you pointed out, if you are providing more than 50% of their support and they meet certain income requirements, you can claim them as a dependent and even if they do not, those income requirements are kind of hard to meet if the parent even has a small pension or some investments. What a lot of people do not understand is you still may qualify to deduct if you are paying their nursing home expenses or medical expenses and those expenses combined with yours exceed 10% of your AGI, then you can deduct them. I think that is another area where it really would behoove you to talk to a professional because there are tax breaks for adults who are taking care of their parents that they may overlook.
TONY: That makes total sense and again here I am thinking as a person reaches out for advice, they need to understand if you are going to work with a tax professional, there is a reason they are asking you lots of questions because they are looking for these kinds of what might seem unique types of opportunities for tax write-offs. I know that the tax firm that we are familiar with and a lot of our clients use, they get an organizer sent to them every fall and it asks a ton of questions. People are like why do they need to know all this, because they can do a better job. It is that simple.
SANDRA BLOCK: That is right and even if you have the best tax professional in the world, or you are a whiz at tax software, if you do not have the records to provide the information they need, you are not going to be able to take advantage of these. I think that is why an organizer is really helpful because you need to keep track of these college expenses. You need to keep track of these medical costs in order to get the full deduction that you are eligible for and defend yourself if the IRS has any questions about it.
JIM: As we are talking, this is reminding me of a story of a client and you talk about the middle income people that a lot of times are do-it-yourselfers or afraid to reach out, I am just thinking of a client a few years back and there is another tax benefit with those IRAs and that is the savers credit. In this time of high unemployment, he had gotten laid off, he had put money into his 401(k) and his wife had started a new business. She did not have any taxable earnings, so he was in a situation where, with his contributions that he made, his adjusted gross income was $500 over the benchmark to get from a 20% savers credit to a 50% savers credit.
SANDRA BLOCK: Wow!
JIM: By putting an additional $500 in an IRA, because he said to me, “Jim, I did not want to talk to you because we just do not have money to put away this year.” I said, “Well let’s just take a look at it.” I said, “Well if you put on your tax return that you are going to put $500 in a deductible IRA, you will get a $750 refund.” It is amazing how a small difference like that, just an extra dollar or two in one column or another, can make such a difference and for this gentleman it certainly was worth it for him to get the advice because it made a huge difference. I mean basically the IRA paid to fund his retirement with the tax benefits that are available to him.
SANDRA BLOCK: That is a really good point. We have that on our list of tax breaks for the middle class because the savers credit very often is overlooked and as you said, it is huge if you can make it. The problem is that with the income limits that are required for that, a lot of people just feel like they do not have any money to save for retirement, but then when you look back into how much you get back, the amount that you have to put in is actually pretty small. This is definitely one that very often is overlooked, but the people who qualify for it tend not to get help.
TONY: That is true and sometimes you just have to understand when we say let us crunch the numbers, there is a reason for that because if you just assume you know what where that is going to lead us, so you have to take the time sometimes and actually do a projected tax return. Of course, if you are an early bird, you could actually get that refund before you even have to make the contribution.
SANDRA BLOCK: That is right.
TONY: It is important to make sure that you give yourself time to do proper planning. Sandra, let’s take a short break and when we come back, let’s continue on talking about some of these very important, but most overlooked tax deductions. Please stay tuned.
TONY: Welcome back as we continue our conversation today with Sandra Block who is the Senior Associate Editor at Kiplinger’s Personal Finance. We have been talking about just a phenomenal topic today because as you mentioned prior to the break, average middle America just does not sometimes take advantage of all the tax opportunities that are out there, especially if they are going it alone. Let’s kind of get back to our list of missed or overlooked tax deductions. Just before the break, we were talking about unemployment and job seekers. What is available to those who are actually job hunting across the country from a tax deduction standpoint?
SANDRA BLOCK: If you itemize, you can deduct job-hunting costs as miscellaneous expense and the list of qualifying expenses is pretty long. What is important to understand is that you can claim these expenses even if you did not get the job, so we hear so many sad stories about people who spend months and months applying and sending out hundreds of resumes and do not get a job. They still may have some expenses that they can deduct. Now you can only deduct to the extent that your total miscellaneous expenses exceed 2% of your AGI, but if you are out of work, your AGI may not be that high, so the bar could be more reachable. Qualified expenses include transportation cost; you drive some place, parking and tolls, food and lodging expenses if you have to travel, cab fares, employment agency fees, and cost of printing resumes, business cards, postage and advertising. If you are looking for a job, keep records of all of this cost because there is a very good chance that you may be able to deduct those expenses.
JIM: Something that is right along that same line is moving expenses. Are there some deductions available for that?
SANDRA BLOCK: Yes and moving expenses are a really valuable deduction because it is one of the few that you do not have to itemize to claim. Now you cannot deduct your moving expenses if you just move across town to take a job. You have to move at least 50 miles and meet some other standards, but again the list of qualified expenses is quite long and that would include obviously packing up and moving all your stuff, the cost of getting from point A to point B, perhaps staying in a hotel, putting up your family in a hotel and all kinds of things. I would really urge anyone who moved last year or is planning to move this year for a job to put together a file folder and just start keeping track of all those expenses because we all know how expensive moving is. These days, with the job market being what it is, you cannot count on your employer to cover those costs. They used to, but I think a lot of employers do not anymore, so I really think that this is a tax break that people need to pay attention to and could benefit from.
JIM: There are a lot of deductions I think that are overlooked when you come to those miscellaneous deductions that you were talking about earlier with job seekers. If they get a union job, are not union dues deductible and there is a lot of different expenses.
SANDRA BLOCK: Union dues that falls into the miscellaneous category, so definitely that can be one. Professional association fees and things like that you can add on, so look at the list of miscellaneous items. Again, you want to keep track of as many as you can so you can get yourself over the hump of the 2% AGI.
JIM: I think the big mistake many Americans make is they look at all this, oh man, it is just so complicated and they default to the 1040 EZ because it is easy to get done, but as we are talking about this, I mean we are not talking just $10 or $15 it might save you, it could be hundreds or even thousands. It is worth it to maybe get that advice or have someone look over it that knows what they are doing. Have it checked from time to time because if you miss these over the last three years, one thing is you can go back and amend your return. If we talked about something that maybe you did two years ago, maybe you go back and check. It could mean a refund for you.
SANDRA BLOCK: That is right. Again, I have seen some statistics on the percentage of Americans who just do not bother to itemize and claim the standard deduction, when in fact itemizing would save them money. Yes, it is a little more work, but the payoff can really be significant.
TONY: Now let’s talk about one that seems to be scary for taxpayers who are working from their home. Let’s talk about the home office deduction.
SANDRA BLOCK: I hate to say I am excited about this, but it is kind of a big deal. A lot of self-employed people do work from home and have a dedicated space in their home from which they work have not claimed the home office deduction in the past because it is widely believed to be a huge red flag for an audit, so they do not take advantage of this potentially money saving deduction. Just last year, the IRS came out with a new formula that basically allows you to use the size of your home office and then deduct five dollars per square foot up to a max of 300 square feet or $1500. If you use this formula, you still have to follow the old rules of having a dedicated office space, but it means that you are not having to sit down and figure out what percentage of all your costs account for your home office. Since the IRS has put out this formula, I think a lot of individuals and their tax preparers will feel more comfortable claiming this deduction because it almost sounds like kind of a safe harbor for people. You will not have to fill out a 43 line form listing your actual expenses and this is a $1500 deduction that is really valuable to people who work from home and in particular need all the deductions that they can get, because unlike salaried people they do not have their employers kicking in for health care and other things. I am hoping that I would like to really get the word out on this to self-employed people because I think it is a valuable tax deduction that they have not taken in the past that they really should feel comfortable about taking in the future.
JIM: I think that is something that we run into all the time where people are just afraid to take that deduction and I think it has been about seven or eight years where the IRS has kind of changed their stance on it that hey, this is legitimate as long as people keep good records, that is the key, you definitely can take those deductions. Again, in these times of high unemployment, you see a lot of people start businesses from their home and being that they have never been in business before, they are somewhat intimidated by thinking they are doing something that is not quite right. The code clearly provides for these deductions, so if you started a business three years ago, you can go back and amend the last three years’ returns and it could be a significant number that you could see coming back.
SANDRA BLOCK: That is right. I should point out that the streamlined method is only available starting in 2013, so if you were going to go back beyond that you still have to use, I think, probably use the old method of actual expenses. I think this is a signal, as you said, that this is a legitimate deduction. People should not be afraid to take it. It is not available if you are employed and just working from home, unless your employer requires you to work from home. I think the trend now is we are seeing so many people, either by choice or because they do not have any other job, working for themselves and I think if they are working for themselves, any deduction you can claim is very valuable and you should take it.
JIM: One final thing we want to talk about and it is not on your list here, but when you talk about all these deductions, a lot of times we have coined it as being negative taxable income where your deductions exceed what you need to zero out your taxes. Especially today with people being between jobs, high unemployment or people in retirement, a lot of times they look at well we got all these deductions, we do not need to really do anything. We will just take the standard deduction and move on because we did not owe anything. Well, sometimes they are missing a tremendous opportunity. We talked earlier about things like Roth conversions or pulling money out of tax-deferred accounts or maybe repositioning some money that would be subject to capital gains or selling a property or stocks that might be subject to capital gains. If you have an opportunity where you have all these deductions, there may be some tax planning you can do that will benefit you even further going forward. What have you seen?
SANDRA BLOCK: Yes, I think that is a really good point. More and more for people at all levels of the income scale, so many things are pegged to your adjusted gross income. If you are in a situation where perhaps your AGI income has dropped, there are opportunities, as you said, even if you sort of zeroed out your taxes you may want to, for example, if you sell some securities and if you are in the 15% tax bracket, you qualify for zero percent capital gains on long-term securities, well that is something definitely. Then you could sell some securities, raise the money and not pay any taxes at all. I think that certainly, it is worth looking at not just your potential deductions, but what is your income and how can you maximize that income this particular year to take advantage of certain tax breaks that may disappear as your income increases.
JIM: Tony was talking about that organizer that gets sent out and part of that organizer, has there been any major changes in either your expenses or your income and all those things can trigger new opportunities. I know a lot of people get to the point where their deductions are phased out and they just kind of default to, “Well, I will just keep doing it the way I have always been doing it.” A change in those circumstances or a change in the tax law can make a big difference. As you mentioned, this home office deduction, this brand new thing where you do not have to keep too many records on it, you can default to the square footage so you do not have to keep all the percentage of expenses might be an easier way for someone who is starting a business to easily take a deduction without having all the extra work that had been involved in the past.
SANDRA BLOCK: That is right and as I said, I think this one I am particularly interested in because people just have not been claiming it at all.
TONY: Yes, at least they do not have anything to fear anymore, so there is at least a standardized process and that should hopefully provide people comfort. Well, listen we have covered a chock full of ideas today, just lots of different opportunities for people to take advantage of. I think the core theme here is do not overlook opportunities. This is not tax evasion, this is just doing what is right and fair for you to pay your fair share, but of course do not necessarily go it alone. Do not feel like you should not seek advice, because just in some of the things we talked about today could provide much more savings than the cost of even having a professional tax preparer or software program. We greatly appreciate, Sandra, your discussion today and your knowledge. You have been doing this for over 20 years and writing on this subject, so we greatly appreciate your input. If we are looking for more tax ideas, we will ring your phone again in the future.
SANDRA BLOCK: Thank you very much.
JIM: Thanks for joining us this week and tune in again next week as we explore another phase of the real wealth process. Remember, if anything you heard in today’s show you would like to get more information about, contact your real wealth advisor and also if you feel that any of this information would be helpful to a friend or family member, just click the forward to a friend.