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Find the Best Deductions

Sunday, March 6, 2005; Page F01

Here are some pleasant possibilities for this year's tax calculations.

• 1. Sales tax deduction. Back before the last big tax reform, in 1986, taxpayers could deduct not only state and local income taxes on their federal returns, but sales taxes as well. The 1986 law eliminated the sales tax deduction.

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But now the sales tax deduction is back, though only as an alternative to deducting state and local income taxes. You can deduct one or the other, but not both.

The obvious benefit is to residents of the seven non-income-tax states, and to a lesser extent to those in states such as Tennessee and New Hampshire that tax only certain kinds of income. In most cases, residents of areas with both income and sales taxes will find it more beneficial to keep deducting the income tax -- but not always.

Those who have made a major purchase, such as a car, and who don't have a very high taxable income may be better off deducting their sales tax. The law works much the way it did during the pre-1986 regime, so that taxpayers can choose to use Internal Revenue Service tables or they can use receipts from their actual transactions.

But there are subtle complications, noted Art Auerbach, a CPA with Goodman & Co. in McLean. For example, the IRS tables allow you to use the table and add on certain big-ticket items, such as a car or boat, but only up to the amount of the general sales tax. Some states impose higher taxes on certain items, but you can't use that. And stick to the big-ticket items specified in IRS Publication 600, which contains the tables. Taxes on other expensive items, such as jewelry or furniture, cannot be added to the table amounts, though you can include them if you use the actual receipt method.

It's another complication, but one that could save some people money.

• 2. Education benefits. There are now so many benefits for higher education that it seems only the highly educated can figure them out. But if you are a student, or have a child in college, it can be worth the effort.

Among this panoply of benefits, the two types to pay most attention to in preparing your tax return are deductions and credits. Deductions reduce your taxable income, and thus are worth whatever the taxes on that amount of income would have been. The higher your bracket, the more valuable a deduction. Credits reduce your actual taxes, and therefore are worth the same to everyone.

First, there is a deduction of up to $2,500 for interest you paid on a student loan for yourself, a spouse or a dependent. The loan has to have been your legal obligation to repay, and your income cannot have been more than $50,000 to $65,000 (the deduction phases out in that range) for a single taxpayer or $100,000 to $130,000 for a couple. This is an "above the line" deduction -- technically, an adjustment to income -- which means that you can take it even if you do not itemize.

Then there is a deduction -- of up to $4,000 -- for higher education expenses you paid for yourself, your spouse or a dependent. The income limits are $80,000 for a single person, $160,000 for a married couple. No phase-out on this one. This deduction is also above the line.

Besides the deductions, there are two credits -- the Hope credit and the lifetime learning credit -- available for higher education expenses. The Hope credit is a maximum of $1,500 per student, available for the first two years of college only. The lifetime credit is a maximum of $2,000 per return, available for all years of post-secondary education, including courses to obtain or improve job skills.

Eligibility for both credits phases out at incomes between $42,000 and $52,000 for a single and between $85,000 and $105,000 for a couple. But you can't take both for the same student (though you can take one for one student and the other for another if you're eligible), and you can't take either for a student for whom you used the tuition deduction.

And the credits are calculated differently. The Hope credit is equal to 100 percent of the first $1,000 of higher education expenses, and 50 percent of the next $1,000, for the maximum of $1,500. The lifetime credit is 20 percent of the first $10,000 of expenses. The break point, according to the IRS, is $7,500 in expenses. Below that, the Hope credit is better; above that, the lifetime credit is better.

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