When Seeking Tax Breaks, Every Little Bit Helps

What should taxpayers keep in mind as they prepare their federal returns? This list was compiled after interviewing tax experts, reading Internal Revenue Service publications and keeping track of changes Congress made to the tax code last year. If you need additional information on these or other tax issues, visit the IRS's Web site at http://www.irs.gov/.

Claiming 2003 refunds: The deadline expires April 17 -- that's when the three-year window for such claims ends. The IRS estimates that 1.8 million people could lose $2.2 billion in unclaimed refunds by missing this year's filing deadline. Claims for 2004 tax-year refunds will expire April 15, 2008, for 2005 on April 15, 2009, and so on.

Long-Distance Pays Off: Taxpayers can claim a refund of up to $60 on their 2006 federal return with no questions asked, as the government tries to return $8 billion in long-distance telephone taxes that courts have ruled should not have been collected. There's a line for the refund in the federal return. The refund is for taxes billed for any phone service -- cell, fax, computer or land line -- during the 41 months from Feb. 28, 2003, through July 31, 2006, when the IRS stopped imposing the assessment. Without having to keep or produce any records, a taxpayer filing a return with one exemption can claim $30; two exemptions, $40; three exemptions, $50; and four or more exemptions, $60. For example, a married couple filing a joint return with two dependent children, a total of four exemptions, would be eligible for the maximum $60. Taxpayers who think they deserve a larger refund can claim it but will have to produce old telephone bills or other records of payment for the period if they are audited. The IRS says that it has found abuse of this refund and that it's on the lookout for instances in which entire phone bills or other improper amounts are claimed, rather than the 3 percent tax on long-distance and bundled services to which taxpayers are entitled.

U.S.-based workers and former workers of foreign embassies, consular offices and international organizations who have failed to file or filed incomplete tax returns for past years have through March 30 -- an extension from the earlier deadline of Feb. 20 -- to accept a one-time settlement offer with the IRS. U.S. citizens, green-card holders and foreign workers who owe tax must by month's end amend or file returns for 2003, 2004 and 2005 to have fines cut and taxes beyond those years forgotten. Those who don't file face possible audits and stiffer penalties.

No breaks for trash: Clothes or household items donated after Aug. 17, 2006, have to be in "good used condition" or better to be claimed as a deduction. One exception is for items in less-than-good condition but that have been appraised at $500 or more. And starting Jan. 1 of this year and applicable for the 2007 tax year, donors must keep better records -- canceled checks, receipts, credit card statements -- for all cash donations, no matter how small. That means there will no longer be write-offs for undocumented charity of $250 or less, even if given at church. So save those receipts, and keep them for three years. The IRS says a checkbook entry does not count as a bank record; a canceled check does. The new rules do not change existing requirements that taxpayers get a receipt from a charity for each deductible donation of $250 or more, whether it's money, clothing or other items.

Save green by going green: Taxpayers who made energy-saving improvements to their home can claim credits from $50 to $4,000, as long as the work is on their primary residence and the home is in the United States. A taxpayer can claim a credit of 10 percent of the cost -- up to $500 -- of installing energy-efficient insulation or exterior windows that qualify under IRS rules. And taxpayers can claim credits from $50 to $300, again up to $500 total, for other improvements, such as a $150 credit for installing an energy-efficient gas, propane or oil furnace, and another $150 credit for putting in an energy-saving water boiler. No more than $200 of the $500 maximum can be for window improvements. Installing solar heating panels or a solar water heater can provide a tax credit of up to 30 percent of the cost of each, up to $2,000, for a total maximum credit of $4,000.

Hybrid car deduction: Individuals can get a tax credit for buying a new hybrid car or light truck, which means it runs on electricity and gasoline, in 2006. The credit ranges from $250 to several thousand dollars, depending on the make and model and, most importantly, when the manufacturer hits its sales limit on the vehicles and when you bought yours. The credit you can claim diminishes in the 15 to 18 months after the manufacturer of your car sells a cumulative 60,000 or more of all its hybrid vehicles. Toyota, for example, sold 60,000 qualifying vehicles in the three months ended June 30. That means if you bought a Prius anytime from January to September 2006, you can claim 100 percent of the $3,150 tax credit for that car. But if you bought a Prius from October through December, the credit you can take for 2006 is 50 percent less, or $1,575. Full credit is still available for other qualifying vehicles. Check the IRS Web site for the latest rundown. If you lease a hybrid, the company that leases the car can claim the credit, not you.

Education breaks: If a child or other family member was enrolled in higher education in 2006, you may qualify for a break. The Hope Scholarship credit of up to $1,650 for each student and the lifetime learning credit of up to $2,000 for each student are available to single filers with income of less than $55,000 and joint filers with income of less than $110,000. A tax deduction of up to $4,000 on tuition costs is available to single filers with income of less than $80,000 and joint filers with income of less than $160,000. But there are complicated restrictions on how these breaks can be used. Check with the IRS for more details.

Backdated options: Companies may pay the extra 20 percent tax, plus interest, owed by rank-and-file employees who in 2006 exercised stock options that they didn't know were backdated. But firms may not pick up that tab for top executives and other insiders. Backdating, which is legal if properly disclosed, occurs when an option's award is dated at a point when the stock price was low, which can boost the recipient's profit.

IRA Contribution: You can contribute to your individual retirement account up to April 17 and have it count for the 2006 tax year, but there are restrictions. You can put in up to $5,000 if you turned 50 before 2007 -- $4,000 if you didn't -- and reduce your taxable income by that amount. But, if you have a retirement plan at work, then the contribution allowed for tax purposes phases out for single filers whose adjusted gross income is more than $50,000, with no deduction allowed once income reaches $60,000. For married couples covered by retirement plans at work, the phase-out begins when adjusted gross income is more than $75,000 and no deduction is allowed when it reaches $85,000 or more.

Donations from an IRA: The day after someone turns 70 1/2 , he can donate up to $100,000 in what would have been taxable income from an IRA without having to pay tax on that money. The recipient must be a public charity, not a private one such as a family foundation. The gift must be made directly from the IRA to the charity; it may not pass through the account holder's hands because if it does -- even for a second -- the money will count as income. Although the donation does not count as taxable income for the year, the money can be counted toward the amount a person must withdraw each year after the age of 70 1/2 from a traditional IRA to avoid penalties. If you made such a donation from an IRA in 2006, you have to check a box on your tax return.

Split refunds: For the first time, taxpayers can divvy up a refund by having it electronically deposited in up to three accounts, including checking, savings and retirement accounts, but not a 401(k). To do so, a taxpayer must complete federal income tax return Form 8888 and attach it to his main tax form. Make sure your financial institution accepts direct deposits on the accounts in question.

Military Breaks: Members of the military called to active duty any time since Sept. 11, 2001, and through Dec. 31, 2007, who serve six months or more can take out money from IRAs, 401(k)s or other personal retirement plans without incurring the typical 10 percent early-withdrawal penalty. If the money is redeposited within two years after active duty ends, it won't be subject to taxes. Members of the military may also be able to defer paying taxes if they can prove that military service hindered their ability to pay by lowering their income or otherwise hurting them financially.

Bundling health-care costs: Taxpayers might be able to bundle expenses from two years -- in this case 2005 and 2006 -- so that medical costs for 2006 reach the threshold of 7.5 percent of adjusted gross income needed before these costs can be itemized as deductions. But remember that the year you pay a medical bill is the year it counts for taxes. If you realized in 2005 that your medical expenses wouldn't hit the 7.5 percent mark, you could have pushed some elective procedures (such as a child's getting braces) into 2006 or waited to pay some bills received in 2005 until after Jan. 1, 2006.

Windfall pitfall: If you received a one-time windfall, such as an inheritance or an advance on a book contract, be sure to find out if taxes have been paid or whether you will have to pay them -- otherwise you could be accruing penalties and interest charges.

Kiddie tax: Starting in 2006, children up to 18 years old get a tax break on $1,700 in unearned income, such as interest or dividends. The first $850 is tax-free, and the next $850 is taxed at a rate of 15 percent or less. But anything more than $1,700 can be taxed at the higher parental rate. Under the old law, parents of a child age 14 to 18 could transfer assets to an account in the child's name and count on the first $850 being tax-free, with anything more than that taxed at a rate of 15 percent or less, rather than at the parents' rate, which can be as much as 35 percent. The change made it smart for parents to consider switching those income-producing assets into a tax-advantaged 529 college savings plan last year. It's too late to do it now for 2006 taxes -- but not for 2007. Anyone with children around age 14 should think about transferring children's assets into a new 529 plan opened in the child's name. To avoid federal gift taxes, each parent can contribute no more than $12,000 a year on average over five years to a 529 plan in a child's name.