2000 Tax Guide: More Tips Anyone Can Use

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Chapter 3
9 More Tips For Everyone
Tax Strategies for 2001

See if you qualify
for the Child
Tax Credit.

Don’t overlook minimum distributions at age 70½ and rack up a 50-percent penalty. Minimum distributions from qualified retirement plans and IRAs must begin by April 1 of the year after the year in which you reach age 70½. The amount of the minimum distribution is calculated based on your life expectancy or the joint and last survivor life expectancy of you and your designated beneficiary. If the amount distributed is less than the minimum required amount, an excise tax equal to 50 percent of the amount of the shortfall is imposed. Retirement distributions are discussed in Chapter 6.

Don’t double up your first minimum distributions and pay unnecessary income and excise taxes. Minimum distributions are generally required at age 70½, but you are allowed to delay the first distribution until April 1 of the year following the year you reach age 70½. In subsequent years, the required distribution must be made by the end of the calendar year. This creates the potential to double up in distributions in the year after you reach age 70½. This double-up may push you into higher tax rates than normal. In many cases, this pitfall can be avoided by simply taking the first distribution in the year in which you reach age 70½. Retirement distributions are discussed in Chapter 6.

Don’t forget filing requirements for household employees. Employers of household employees must withhold and pay social security taxes annually if they paid a domestic employee more than $1,200 in 2000. Federal employment taxes for household employees are reported on your individual income tax return (Form 1040, Schedule H). To avoid underpayment of estimated tax penalties, employers will be required to pay these taxes for domestic employees by increasing their own wage withholding or quarterly estimated tax payments. Although the federal filing is now required annually, many states still have quarterly filing requirements.

Consider funding a nondeductible regular or Roth IRA. Although nondeductible IRAs are not as advantageous as deductible IRAs, you still receive the benefits of tax-deferred income. Income thresholds to qualify for making deductible IRA contributions, even if you or your spouse is an active participant in a employer plan, are increasing. (IRAs, including Roth IRAs, are discussed in Chapter 6.)

Calculate your tax liability as if filing both jointly and separately. In certain situations, filing separately may save money for a married couple. If you or your spouse is in a lower tax bracket or if one of you has large itemized deductions, filing separately may lower your total taxes. Filing separately may also lower the phaseout of itemized deductions and personal exemptions, which are based on adjusted gross income. When choosing your filing status, you should also factor in the state tax implications.

Avoid the hobby loss rules. If you choose self-employment over a second job to earn additional income, avoid the hobby loss rules if you incur a loss. The IRS looks at a number of tests, not just the elements of personal pleasure or recreation involved in the activity.

Review post-death planning opportunities. A number of tax planning strategies can be implemented soon after death. Some of these, such as disclaimers, must be implemented within a certain period of time after death. A number of special elections are also available on a decedent’s final individual income tax return.

Take advantage of tax breaks for sales of principal residences. Single taxpayers who sell their principal residence may exclude up to $250,000 of gain that they realize on the sale or exchange. Married taxpayers filing a joint return can exclude up to $500,000. Taxpayers may use this exclusion once every two years. Only taxpayers who have owned and occupied a home as a principal residence for at least two of the five years prior to any sale or exchange may take full advantage of the exclusion. If the principal residence is held less than two years, the exclusion amount is prorated.

Check to see whether you qualify for the Child Tax Credit. For 2000, a $500 tax credit is available for each dependent child (including stepchildren and eligible foster children) under the age of 17 at the end of the taxable year. For 2000, the child credit is available only against the total of a taxpayer’s regular and alternative minimum tax liability, reduced by the foreign tax credit. However, for a taxpayer with three or more children, this limitation is increased by the excess of Social Security taxes paid over the sum of other nonrefundable credits and any earned income tax credit allowed to the taxpayer.

Phaseout of the credit begins at modified adjusted gross income levels of $110,000 for joint filers ($55,000 for married taxpayers filing separately) and $75,000 for single filers. Taxpayers will lose $50 of the credit for every $1,000 (or part thereof) of AGI in excess of their threshold. The level at which the credit is phased out completely depends on the number of qualifying children The child credit and the income threshold amounts are not indexed for inflation.

Consider forgoing the dependency deduction for a child in college. If you pay your child’s college tuition costs but your income is too high to claim an education credit, you may be better off not claiming a dependency deduction for your child and having the child claim an education credit on his or her own tax return. However, the child will not be able to claim a personal exemption on his or her tax return as the restriction of being able to be claimed as a dependent on another return still applies. Of course the child would need to have enough taxable income to benefit from the credit and you would need to compare the tax savings of claiming the dependency deduction on your return versus having the child claim an education credit on his or her return.

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