Tax Tips for Single Filers, Part II

In Tax Tips for Single Filers, Part I, we covered some winning strategies for single filers when taking exemptions and deductions. Today, the series continues with more tips to ensure the IRS takes a nibble instead of a chunk out of your income.



4. Invest wisely.

As a single, you are a one-income family. Unless you marry, you won't be able to rely on someone else's pension or Social Security. So it's imperative that you prepare yourself for retirement now. That means investing wisely, part of which is keeping as much of your investment as possible in your pocket and out of the government's. Here are some things you need to know about reducing the tax burden on your investments:


A. Stocks, Bonds, & CDs

This may seem like a page out of Investment for Dummies, but some people get complacent while their securities are plumping up every year at no charge to themselves. When it's time to dig into the cash cow, they forget that that money is going to be added to their annual income for tax purposes. That means if they're teetering on the brink of a higher tax bracket, that cash-out could propel them over the edge. Furthermore, if you want to profit from lower tax rates on long-term capital gains, you must hold an investment for at least a year, beginning the day after you buy it.

If your company has given you restricted stock, you have the option to pay tax on it within 30 days by making the 83(b) election or hold off until it becomes transferable, in which case, if the stock has appreciated, your taxes will be substantially higher. The 83(b) election can be a gamble if the stock does not appreciate, but if you have a reasonable expectation that it will, paying now and reaping the benefits later just makes sense. Restricted stock benefits are usually executive territory, but it never hurts to be prepared. :)

Or maybe bonds are more your style, but you bought them at a premium. If so, you can amortize the premium, which means you can deduct it from the taxable interest the bond generates. Be careful, though, as you travel through the labyrinth of laws on amortization lest you lose the path to a deduction.

Now a word about dividends: If you're interested in buying shares in a company that pays dividends, timing is everything. Every time the company announces that it will pay out a dividend (often quarterly), it sets a date called the ex-dividend date. If you purchase shares on or after this date, you will not get the dividend for that quarter, and you will pay a lower price per share because of it. However, if you buy before the ex-date, you will pay more and get the dividend...and then have to pay taxes on it. This wouldn't be so bad except that after the dividend is paid out, the value of the security falls by the amount of the dividend. The result is that you get nothing more than what you put into it, and you get taxed on it. And perhaps feel a little foolish.

This is a particularly effective way to screw yourself if you're buying the dividends as part of a mutual fund at its year-end payout, when the stocks have been appreciating all year. In this scenario, the long-term shareholders make out good, while someone who buys in just before the dividend pays taxes on an appreciation they never saw. If your brain looks like an egg on drugs after reading that like mine does after writing it, see this page for a better explanation.

Oh, and another page out of Investment for Dummies, The Collector's Edition: If you earn dividends from stocks, bonds, or CDs, you will pay taxes on those dividends even if they get rolled over or reinvested and you never see a penny. I've overlooked this leetle fact once or twice myself, so it can even happen to clever people. ;)


B. 401(k)'s

Be aware of the differences between a traditional 401(k) and a Roth 401(k). The former allows you to contribute tax-free, but this is deceptive since you'll be taxed when you withdraw the money, probably at a higher rate than when you deposited it. The latter doesn't give you a break upfront, but you can withdraw at retirement without taxation. For young singles who don't bring home a hefty paycheck now but might by retirement, the Roth 401(k) is the better deal.

If you're quitting a job with an outstanding 401(k) loan, pay it off before you go and not just so your boss will give you a good reference. If you don't, for legal purposes it will be as though you simply withdrew the cash, and that means you'll get hit with all the relevant taxes and, if you're under 55, a 10% penalty.

In a breakthrough for singles, anyone who inherits a 401(k) from someone other than a spouse can now roll it over into an IRA. That means you can pay tax on the inheritance over the course of a lifetime instead of in one lump sum! (This is a perfect example, by the way, of how the reality of changing demographics can trickle down to the Senate floor.)


C. IRAs

For singles of this generation, who face a bankrupt social security system, the phaseout of pensions, and unstable 401(k)'s, an Individual Retirement Account (IRA) is your best shot at building a nest egg. When it comes to taxes, traditional IRAs and Roth IRAs work like the 401(k) accounts described in B., so again, the Roth is recommended for younger singles with as-yet-unfulfilled earning potential. Plus, you can deduct up to 50% of the first $2,000 you deposit, which just might be the biggest deduction you take off anything, ever. :)


D. Annuities

An annuity is a bit like an IRA or 401(k) underwritten by an insurance company and is an especially good idea for singles who don't have an employer-matched retirement savings account at work. One of the best features of an annuity is that retirees can deduct the money they paid into it once the annuity pays out.



5. Go with a pro.

To play the stock market, you have to know the rules, and most of us don't have time to read the rule book. That's why you can deduct investment management fees for brokers, trustees, or other individuals who fit the bill. (What is and is not tax-exempt here gets complicated, so read this before you deduct willy-nilly.)

When tax time rolls around, unless your finances are very straightforward (think 1040EZ), swing for a professional accountant instead of using TurboTax or a tax preparation service like H&R Block. A CPA can help you find your way through loopholes that faceless tax prep firms might be unaware of or, worse, might be too careless to investigate for you. In addition, a certified accountant can advise you on long-term financial planning strategies. Don't worry. You can deduct his fee next year!



Can you think of any other tax breaks for investments or for the use of professional advisers? Do you know of any tax tips for single filers not mentioned in Part I or Part II of this series?


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Tax Tips for Single Filers, Part I

Yesterday, Singletude outlined five ways in which singles get the short end of the tax rebate carrot. But enough of the negativity. The question is: What can we do about it?

Short of writing your senator and taking up the torch for tax reform, there's not much you can do to ensure that you get as big a slice of the tax return pie as a married couple. This really is a case of two against one. But you can be a savvy filer who knows his or her way around the tax code and takes advantage of every deduction open to you. Here are some opportunities to make your deductions stretch, three today and two tomorrow:



1. File as a head of household if you can.

The difference between a single filer and a head of household is that the latter has paid more than 50% of the cost of his or her home maintenance and has supported at least one dependent for over half the year. Heads of household are entitled to higher deductions and lower tax rates than those who file single, so it pays to find out if you meet the qualifications.


2. Take as many exemptions on your W-4 as you can.

If you're single and have no kids, claim one exemption for yourself. If you claim zero, you'll get a windfall in the spring, but that's because you let the government borrow your money for a whole year interest-free. You don't really want to fund some morally bankrupt politician's very own night with "Kristen," do you?


3. Deduct, deduct, deduct!

Yes, it's a pain in the brain to do the math; but no pain, no gain in the bank account. Here's what you should deduct:


Educational Expenses

Now here's one that affects millions of singles. If you're paying off student loans, you can deduct all or part of the interest if you earned less than $70,000, even if your parents helped you out with the payments.

Or maybe you took college courses this year. If so, you could be eligible for the Hope Scholarship or Lifetime Learning Credit. The first is for students in their first two years of college and provides for a deduction of up to $1,650 if your income was less than $57,000. The second applies to all other students, including graduate and returning students, and allows for up to $2,000 in deductions with similar income restrictions. If your income disqualifies you from either of these, you can take a tuition deduction of up to $4,000 if you earned less than $60,000 and up to $2,000 if you earned less than $80,000.

Finally, if you're not a student but a teacher, you're entitled to claim up to $250 of your out-of-pocket expenses for your classroom.


Medical and Dental Expenses

Obviously, you'll want to claim any medical bills you paid out of pocket, but you can also claim the long, dusty miles you drove to visit your favorite doctor. Check out the IRS's standard mileage rates for 2007 to calculate your deductions.

You can also get a break on purchases prescribed by a physician, and I'm not just talking contacts and Miracle-Ear, although medical devices and equipment are included. If your doctor advised you to start a weight-loss program or get an air purifier, that's a deduction.

In addition, you can deduct your health insurance premium if you purchased your own plan or contributed to it with taxable income (that is, if you weren't covered by an employer who deducted any required contributions directly from your salary).

Sound too good to be true for a country in health care crisis? There's a catch. For this deduction to work, your total expenses must be 7.5% or more of your adjusted gross income (AGI). (Note: AGI is tough to calculate, so sit this one out and let the professionals go to work.) However, if you're self-employed, there's a sweet spot for you--you can deduct your insurance premium, no matter how much you made.


Job-related Expenses

Falling under the category of Miscellaneous Deductions, these must amount to more than 2% of your AGI when added to your other miscellaneous items. They're tricky, ambiguous deductions and should be verified with an accountant when in doubt. For instance, you can deduct the purchase and upkeep of a company uniform but not of street clothes worn to work. You can deduct miles traveled to a job interview, but if you're hired, you can't deduct the same trip as a daily commute. Here's a general rundown of what you can deduct:

--Job-seeking expenses, including mileage costs
--Tools used on the job
--A computer or cell phone if your employer requires you to use it for business
--Specialized clothing or uniforms that you only wear to work
--Union dues
--Subscriptions to professional journals
--Continuing education in your field

Again, there's a lot of room for interpretation and, thus, a lot of room for error, so be careful. For more detailed info on the above deductions, go here.


Self-employment

It's said that with freedom comes responsibility, and this is true for no one as much as the self-employed filer. The deductions available to an independent contractor could be a post unto themselves and are beyond the scope of this blog. There are stringent regulations regarding the separation of personal and business use of rented spaces, equipment, transportation, etc. If you're self-employed or thinking of becoming self-employed, you can read an overview here and here.


Relocation

If you've relocated for a job (not just because you didn't care for it in sunny Michigan anymore), you can take deductions on expenses your employer didn't reimburse if your new office is 50 miles further from your home than your last place of business. Moving expenses are a bit of a gray area, but you can usually deduct:

--Travel for yourself and any dependents accompanying you, including pets
--Accommodations en route
--Shipping
--Storage of shipped items for a limited time

For fuller descriptions of these deductions, read this.


Hobbies

Guess what? If you perform as a sword swallower at circus sideshows on the weekend or sell your postmodern trashcan sculptures at the flea market, this counts as a hobby, and you can deduct associated expenses. The catch? You have to actually make money off the hobby (no, writing in your journal doesn't count), and you can't deduct more than you earned.


Charitable Contributions

If you have a soft heart for PETA or the Red Cross, make sure Uncle Sam doesn't take advantage of your goodwill. Get a receipt for your donations and tell the IRS, "Paws off!"

Note that this deduction also applies to expenses incurred in volunteer work. So if you had to, say, buy a dorky uniform that makes you walk like a penguin or drive a considerable distance to the soup kitchen, deduct the Mumble jumpsuit and the mileage.


Energy-efficient Transportation

Got ethanol? If you need a new car, make it a hybrid. Until 2010, you can save up to $3,000 in taxes depending on the fuel efficiency of your new ride.


Gambling

Fond of poker? Blackjack? Slots? Like it more than your poker face warrants? That's why you can deduct your gambling losses. But hold 'em, Tex. You can only deduct losses from your winnings (meaning that, yes, you have to win), and you can't deduct more than you won. You'll also have to be an immaculate bookkeeper to prove how you hit the jackpot and how you got rivered.


Casualty and Theft

If you had the misfortune to be a victim of crime this year and suffered a loss of substantially more than $100, you can deduct the market value of your stolen property minus $100.


Alimony

Perhaps you're wondering why this isn't classified as Casualty and Theft. If you got divorced and the courts didn't like you, this one's for you.


Legal Advice

If you ran into trouble with the law this year, you might be able to deduct the cost of that speeding violation or the pliers you bought to break into your neighbor's basement. Just kidding. You can't do that. But if you hired a lawyer to resolve specific issues, such as a job or--ironically enough-- tax dispute, the government may show you some sympathy.


State and Local Taxes

Finally, you did know that you can deduct your taxes from your taxes, right? If your state, county, and/or city charge(s) income tax, deduct it from your federal tax. OR, if you sprung for that yacht this year, take a deduction on your sales tax instead. If you own a home and paid property tax, this is the place to deduct it, too.



Exhausted? Well, we're just getting warmed up. Tune in again for more tax tips for the single filer!


What other deductions do you take as a single filer? (Since this is a boring question, also tell us a good joke to cheer us up when we're frowning over our W-2's.)


Other Sources
Tax Savings for Single People
Tax Rate Schedules for Single Filers
How to File Taxes as a Single Person
Screw Uncle Same--Take Your Tax Deductions
We Know: 10 Common Tax Deductions (You May Have Forgotten to Take)
Miscellaneous Itemized Deductions You Can Take on Your Federal Income Tax Return
IRS Tax Deductions--7 You CAN'T Take
Taxes and the Network Marketer


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