Six don't-miss tax breaks
You may find one or a few that can help reduce your tax liability on your 2005 return.
By Jeanne Sahadi, senior writer

NEW YORK ( As carrots go, admittedly there are sexier ones to be had. But the rabbit food of choice dangling before you this and every tax-filing season is the opportunity to minimize your tax bill or maybe even score a refund.

Getting that carrot (legally) usually means taking full advantage of legitimate tax breaks. So it pays to know what they are and how to figure out whether you're entitled to take them.

Below is a list of six key breaks that may serve you when filing your 2005 taxes this year.

Some payback for your purchases?

If you live in a state with no wage income tax or you live in a state with very low income taxes but high sales taxes, you might get a bigger break on your federal return than you're used to.

That's because for tax year 2005 you'll be given a choice: You may deduct you state and local income taxes on your federal return. Or, instead, you may choose to deduct the general sales tax you paid in 2005. So if you made big purchases last year, your sales tax outlay may have exceeded your income tax outlay.

Use your alimony to save for retirement and get a deduction.

If you're divorced and don't have a paying job, you may think you're not allowed to make an IRA contribution, because the rule is you must have earned income to do so. However, alimony received is treated as taxable income on your federal return, so, in fact, you are eligible

The ex-spouse who pays the alimony may use the payments to reduce his or her gross income.

Didn't make much last year? Take advantage of the saver's credit.

Maybe you ditched a salaried career in the past couple of years to try your hand as a small business owner. Chances are your paycheck has never been so low, since much of the money you make may be plowed back into the venture. Or maybe you're just a recent college grad in your first job. Well, here's one salad-days perq:

Low-income taxpayers may receive a credit (a dollar-for-dollar reduction of the taxes they owe) for 50 percent of their contributions up to $2,000 to qualified retirement savings plans such as 401(k)s, 403(b)s as well as IRAs.

The benefit is three-fold: you contribute to your retirement savings, you reduce your taxable income if you contributed to a 401(k) or deductible IRA, which can reduce your tax liability, and then the credit for that contribution will reduce your tax bill further.

The credit is available only to those taxpayers with an adjusted gross income of $25,000 or less ($50,000 or less for married couples). And the credit may not exceed your tax liability.

You have until April 15, 2006 to put money in an IRA and have it count as a 2005 contribution. The contribution limit is $4,000 if you're under 50, $4,500 otherwise, assuming you earned at least that much in 2005.

You don't need gains to make the most of your losses.

Many investors know they can use their stock losses to offset the taxes they owe on their stock gains in a given tax year. If the losses exceed the gains they can use up to $3,000 in losses to offset ordinary income.

But you don't have to have gains to write off losses up to $3,000 of income if you had a holding that became worthless in 2005, said certified public accountant Alan Dlugash, who chairs the Taxation of Individuals Committee for the New York State Society of Certified Public Accountants.

And by worthless he means having a value of $0. For tax purposes that holding would be considered sold as of Dec. 31, 2005, Dlugash said. So you can use that as a loss to offset up to $3,000 of ordinary income on your federal tax return.

Think broadly when it comes to home-office deductions. Requirements to qualify for big home-office deductions (e.g., a portion of your rent and utility bills) are fairly stringent and tend to be scrutinized by the IRS.

But even if you don't qualify for the big expenses, you may still deduct smaller items like the cost of hooking up a second phone or fax line, or the cost of office supplies.

Generally speaking, "any costs that you incur that assist you in earning income is deductible," Dlugash said.

The exceptions are those items you would buy for personal use anyway, such as that nice suit you wore to wow potential clients or your television.

To see which home office deductions you'd be entitled to take, check out tax publisher CCH's home office deduction site and calculator.

Move what you can above the line.

An above-the-line deduction (e.g., alimony you paid, business expenses, stock losses up to $3,000, deductible IRA contributions) reduces your gross income, and therefore your adjusted gross income (AGI).

Since eligibility for most "below-the-line" deductions which you take only if you itemize -- is tied to AGI limits, lowering your AGI will increase your chances of being eligible for other tax breaks.

So you want to make sure you deduct what you can above the line.

Take business expenses. Maybe you have a full-time salaried job. But you also borrow money to invest in a rental property with your brother. You may be able to deduct the loan interest as a business expense, Dlugash said. Ditto for any materials or classes you paid for to educate yourself about becoming a landlord, not to mention the cost of travel to and from your rental property.

If you're a homeowner, you may be able to move a portion of your mortgage interest and property tax deduction (which normally is an itemized deduction) and count it instead as an above-the-line business deduction if you have a home business, according to Dlugash and CCH. That would reduce the income on which you must pay self-employment taxes. (For more on this, click here.)

Indulge your inner procrastinator if you must.

Sure, there are three months until April 15, but if that's just too tight a timeframe for you, this year you're allowed to apply for a free, automatic 6-month filing extension, no questions asked. Keep in mind, though, the extension is only good for filing your return, not for paying what you owe. For that, Uncle Sam will insist you fork it over on time and in full.

Report: IRS holding back refunds

Money 101: Taxes Top of page

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