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Don’t let changes in tax code surprise you come April 16

Be aware of the kiddie tax and charity deductions — and also the “filer’s special.”

Heads up, taxpayers.

This weekend, tucked between the afterglow of Thanksgiving feasting and the adrenalin rush of Christmas shopping to come, is one of your last best chances to map out what to do before Dec. 31 to put your tax affairs in order for the April 16 filing deadline.

As in 2006, the traditional April 15 deadline lands in a weekend next year, so we all have a little more time to file. But as always, most of us have only until Dec. 31 to make many of the big decisions that will increase our refunds or trim our balances due.

Uncle Sam even is running a blue light special this season.

Virtually everyone who files will get a one-time $30 or larger tax credit that essentially is a refund of some old telephone excise taxes that federal courts say the government overcharged. The credits run as high as $60 depending on your household’s size, or more if you are a business owner or keep really good records.

There are a few changes to look out for too.

The so-called kiddie tax, a potential trap for parents who put sizable assets in their children’s names, now applies to children as old as 18, not 14 as before. Charitably inclined senior citizens get a new tax break if they donate IRA funds to their favorite cause. The rest of us potentially face some new record keeping requirements to prove we gave at all.

But despite the passage of two major tax bills in 2006 — the Tax Increase Prevention and Reconciliation Act, or TIPRA, and the Pension Protection Act, or PPA — the next income tax return most of us wrestle with probably won’t seem remarkably different from the last one, tax mavens say. So plan to start arranging potential deductions and tweaking your year-end cash flow now to arrange the best deal you can when you file.

Tough luck, kid

One of this year’s biggest potential shocks for upper income families especially, may be the change in what’s known as the kiddie tax, said Randy Gardner, a University of Missouri-Kansas City tax law specialist and co-author of 101 Tax Saving Ideas.

The kiddie tax is a calculation designed to make it more difficult for high-income households to shift large shares of that income to their children to reduce the family’s total tax obligation.

“The tax previously applied to children 14 or younger,” Gardner said.

“Now, it’s 18 and that is going to affect a lot of people,” he said.

Under the old law, parents of a child age 14 to 18 could transfer assets to an account in a child’s name and know that the first $850 of that income would be tax free and that any additional income probably would be taxed at about 15 percent, or what the child would pay as a young adult filing his or her first return.

The new law raises that age to 18 and puts new limits on the family’s potential tax break. The first $850 remains tax free, the next $850 is taxed at 15 percent and anything above that $1,700 is taxed at the parents’ rate, which can be as high as 35 percent.

Kiddie taxes apply only to what’s known as unearned income, usually stock dividends, interest payments or the like, and not any money youngsters earn working. But the new rules mean, among other things, that larger amounts of college savings in Uniform Gifts to Minors Accounts or similar plans might be taxed more heavily.

Transferring those funds into a more tax advantaged account, such as a 529 plan for college, triggers an even knottier set of potential tax complications. The cleanest way to make the change, experts say, may be selling the investment in the child’s account, paying capital gains taxes on that transaction and depositing what’s left in the new, tax friendlier account.

But talk with a tax adviser first, suggests Jackie Perlman, senior research tax analyst at H&R Block Inc. in Kansas City. It may not be necessary to cash out the child’s account if the specific investments in a portfolio won’t cause immediate tax complications.

“It just means you have some additional planning to do,” Perlman said.

Sweet charity

Following your charitable impulses to bigger tax savings next spring will be more complicated this time around.

On the plus side, if you are a senior citizen who’s required to pull money out of an Individual Retirement Account this year, you can make all or part of the distribution tax free by transferring the money directly to a church or charity.

On the minus side, it will be tougher to fudge the value of other charitable contributions if, unlikely as it seems, you were ever tempted to do that. The Internal Revenue Service this year requires receipts for all the cash you give — including to the collection plate at church, the bell ringers’ kettles at the mall or the scout troop fundraisers at work — after Aug. 17, 2006. You also may be asked to prove that non-cash contributions you claim, such as used clothing to a charity thrift shop, are in “good” condition.

“One problem is that we still don’t know how enforceable those changes are going to be,” said Aimee Sanita, co-owner of Circle Tax & Accounting Inc. in Westport.

“There are still a lot of details that haven’t been spelled out,” she said.

A new Pension Protection Act provision that allows retirees to transfer money from their traditional IRA directly to a qualified charity is a potentially huge tax break for those who qualify, said Mike Martin, CPA and tax specialist at Mike Martin & Associates Inc. in Blue Springs.

Traditional IRAs — the tax deferred ones introduced two decades ago — require that savers begin pulling money out of the accounts, whether they need to or not, after they reach age 70˝ and to pay income taxes on the withdrawals. The new law scraps those income taxes for any of the IRA money that is transferred to a recognized church or charity.

Savers who do this “can’t claim a deduction for making the contribution, but they are still better off not having the taxable income than they are claiming the deduction,” Martin said.

Conversely, the IRS is getting tougher about other charitable deductions. It’s still possible to top off last-minute contributions to favored churches or charities, but the new tax laws require stricter documentation for any cash donors give.

Donors also must attest that any noncash contributions are in good, usable condition in order to qualify for deductions for their donations.

Much like the way IRS clamped down on perceived inflated deductions for used-car donations a year ago, the service is taking a closer look at inflated values for used clothing, appliances and similar contributions now.

“The problem is, no one thinks there’s anything wrong with their underwear,” said UMKC’s Gardner.

Meantime, there’s one potentially lucrative charitable donation that’s always in style and easily verifiable for IRS tax calculators, said Ken Logan, a certified financial planner with Peck & Associates in Prairie Village.

“Giving appreciated stock is always good,” Logan said.

“You claim the deduction and the charity gets the gains,” he said.

Favor your 401(k)

Popping as much money as possible into your 401(k) or equivalent plan at work is another perennial tax saver that works again this year, said Chuck Weber, a CPA and certified financial planner at Weber, Dorton, Beckstrom & Co. in Shawnee.

The contributions are subtracted from your taxable income, but not tax deductible.

But that is a significant tax benefit now, plus a good deal in the future when withdrawals are apt to be taxed at lower rates than your income now, Weber said.

Individuals can contribute up to $15,000 to their plans for 2006, and $5,000 more than that if they are 50 or older.

Small business owners have other options, added Circle Tax’s Sanita.

“We do a lot of SEP-IRAs,” she said.

SEPs, for simplified employee pension plans, are highly flexible IRAs for self-employed workers and small-business owners that allow contributions as high as 25 percent of their compensation, up to $44,000 currently. And one particularly useful feature for qualified participants this time of the year is that SEP choices and contributions can be put off until the owner’s filing deadline, usually in April, but as late as October if extensions are involved.

Your investments outside retirement plans also remain potential sources of tax savings, said Martin in Blue Springs. You can gauge them by adding up your losses and gains so far, comparing those to potential losses and gains on investments you haven’t yet sold, and then gauging your chances, by Dec. 31, of selling potential losers to offset capital gains and as much as $3,000 of your ordinary income.

Finally, you may be able to bunch some of your income, bonuses, year-end billings and the like, into January to postpone income and lump some potentially deductible expenses such as early 2008 tax payments or cusp of the year medical costs into December to tweak your tax savings further.

Average tax refunds continue to rise, IRS reports

1997 — $1,295

1998 — $1,342

1999 — $1,542

2000 — $1,624

2001 — $1,714

2002 — $1,939

2003 — $1,973

2004 — $2,073

2005 — $2,144

2006 — $2,237

File these away

Standard deductions are higher

IRS is taxing less of your income this year, even if you don’t itemize. The new standard deductions* are:

Married, filing jointly — $10,300

Single — $5,150

Married, filing separately — $5,150

Head of household — $7,550

*Standard deductions are larger for taxpayers born before Jan. 2, 1942, or who are blind.

You may not need to file if…

•You are single, under 65 with income below $8,450 or 65 with income below $9,700.

•You are married, filing jointly, under 65 with income below $16,900. (This filing threshold is $1,000 higher if one of you is 65 or $2,000 higher if you both are.)

•You are married, filing separately, with income below $3,300.

•You are a head of household, under 65, with income below $10,850 or 65 with income below $12,100.

•You are a qualifying widow or widower, with a dependent child and income below $13,600. (This threshold is $14,600 if you are 65.)

Some taxpayers in special situations involving alternative minimum tax obligations, early retirement plan withdrawals, advance earned income tax credit payments or self employment income may need to file even if their incomes are lower than the filing thresholds. Also, some taxpayers who don’t have to file otherwise may want to in order to claim tax credits or special refunds for which they may be eligible.

Contacting the IRS

The Internal Revenue Service Web site, which is at www.irs.gov, is a primary source for forms, publications, answers to frequently asked questions and other information, plus additional contact information if you need that.

Taxpayers who don’t use the Internet can call the service’s basic toll-free number, (800) 829-1040, for the same help.

By GENE MEYER
The Kansas City Star

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