Basic Understanding of Taxes
10 Facts About the Child and Dependent Care Credit
Did you pay someone to care for a child, spouse, or dependent last year? If so, you may be able to claim the Child and Dependent Care Credit on your federal income tax return. Below are the top 10 things the IRS wants you to know about claiming a credit for child and dependent care expenses.
- The care must have been provided for one or more qualifying persons. A qualifying person is your dependent child age 12 or younger when the care was provided. Additionally, your spouse and certain other individuals who are physically or mentally incapable of self-care may also be qualifying persons. You must identify each qualifying person on your tax return.
- The care must have been provided so you – and your spouse if you are married filing jointly – could work or look for work.
- You – and your spouse if you are married filing jointly – must have earned income from wages, salaries, tips, other taxable employee compensation or net earnings from self-employment. One spouse may be considered as having earned income if they were a full-time student or they were physically or mentally unable to care for themselves.
- The payments for care cannot be paid to your spouse, to someone you can claim as your dependent on your return, or to your child who will not be age 19 or older by the end of the year even if he or she is not your dependent. You must identify the care provider(s) on your tax return.
- Your filing status must be single, married filing jointly, head of household or qualifying widow(er) with a dependent child.
- The qualifying person must have lived with you for more than half of the year. However, see Publication 503, Child and Dependent Care Expenses, regarding exceptions for the birth or death of a qualifying person, or a child of divorced or separated parents.
- The credit can be up to 35 percent of your qualifying expenses, depending upon your adjusted gross income.
- For the current year, you may use up to $3,000 of expenses paid in a year for one qualifying individual or $6,000 for two or more qualifying individuals to figure the credit.
- The qualifying expenses must be reduced by the amount of any dependent care benefits provided by your employer that you deduct or exclude from your income.
- If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer. If you are a household employer, you may have to withhold and pay social security and Medicare tax and pay federal unemployment tax. For information, see Publication 926, Household Employer´s Tax Guide.
Five Tips for Great Record-Keeping
There are many records you have that may help document items on your tax return. You´ll need this documentation should the IRS select your return for examination. Here are five tips from the IRS about keeping good records.
- Normally, tax records should be kept for three years.
- Some documents – such as records relating to a home purchase or sale, stock transactions, IRA and business or rental property — should be kept longer.
- In most cases, the IRS does not require you to keep records in any special manner. Generally speaking, however, you should keep any and all documents that may have an impact on your federal tax return.
- Records you should keep include bills, credit card and other receipts, invoices, mileage logs, canceled, imaged or substitute checks, proofs of payment, and any other records to support deductions or credits you claim on your return.
- For more information on what kinds of records to keep, see IRS Publication 552, Record-Keeping for Individuals.
8 Things to Know if You Receive an IRS Notice
The Internal Revenue Service sends millions of letters and notices to taxpayers every year. Here are eight things taxpayers should know about IRS notices – just in case one shows up in your mailbox.
- Don´t panic. Many of these letters can be dealt with simply and painlessly.
- There are a number of reasons why the IRS might send you a notice. Notices may request payment of taxes, notify you of changes to your account, or request additional information. The notice you receive normally covers a very specific issue about your account or tax return.
- Each letter and notice offers specific instructions on what you are asked to do to satisfy the inquiry.
- If you receive a correction notice, you should review the correspondence and compare it with the information on your return.
- If you agree with the correction to your account, then usually no reply is necessary unless a payment is due or the notice directs otherwise.
- If you do not agree with the correction the IRS made, it is important that you respond as requested. You should send a written explanation of why you disagree and include any documents and information you want the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the upper left-hand corner of the notice. Allow at least 30 days for a response.
- Most correspondence can be handled without calling or visiting an IRS office. However, if you have questions, call the telephone number in the upper right-hand corner of the notice. Have a copy of your tax return and the correspondence available when you call to help us respond to your inquiry.
- It´s important that you keep copies of any correspondence with your records.
For more information about IRS notices and bills, see Publication 594, The IRS Collection Process. Information about penalties and interest is available in Publication 17, Your Federal Income Tax for Individuals.
Six Job Hunting Tax Deductions
Most job seekers will agree that looking for a job is a full-time job in itself. Fortunately, Uncle Sam is here to help when it comes to deducting some of the costs related to your job search. Here are six things the IRS wants you to know:
- To qualify for a deduction, the expenses must be spent on a job search in your current occupation. You may not deduct expenses incurred while looking for a job in a new occupation.
- You can deduct employment and outplacement agency fees you pay while looking for a job in your present occupation. If your employer pays you back in a later year for employment agency fees, you must include the amount you receive in your gross income up to the amount of your tax benefit in the earlier year.
- You can deduct amounts you spend for preparing and mailing copies of your résumé to prospective employers as long as you are looking for a new job in your present occupation. Telephone calls and want-ad placement fees can also be deducted.
- If you travel to an area to look for a new job in your present occupation, you may be able to deduct travel expenses to and from the area. You can only deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity compared to the amount of time you spend looking for work is important in determining whether the trip is primarily personal or is primarily to look for a new job.
- You cannot deduct job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one.
- You cannot deduct job search expenses if you are looking for a job for the first time.
How to Get a Bigger Tax Refund
As a general rule, deductions reduce your taxable income and tax credits reduce your tax bill. Tax credits are a dollar-for-dollar reduction of your tax liability, while some deductions require you to reach a certain threshold before you can deduct.
Taxpayers can choose to take either the standard deduction or itemized deduction, depending on which will give them the biggest tax advantage. If the taxpayer has a lot of medical care, property tax, mortgage interest, state and local taxes, or charitable donations, he or she is better off itemizing especially if the expenditures exceed the standard deduction.
Some deductions that are often overlooked are:
- Car mileage used for business, medical, or charitable purposes
- Alimony payments
- Classroom expenses
- Moving expenses when relocating for a new job
- Self-employment tax
- Self-employment health insurance
- Job search expenses
The following tax credits may help to reduce your tax bill:
- Earned Income Tax Credit for working, low-income people
- Education Tax Credits for educational expenses
- Child and Dependent Care Credit for childcare expenses or care for a disabled person who is unable to care for himself or herself
- Child Tax Credits for each qualifying child in the household
- Energy Tax Credit for homeowners
- Hybrid Car Tax Credit
Married & Filing Individually: Pros & Cons
Most married couples file jointly in order to claim tax deductions and credits that can lower their tax bill and put them in a lower tax bracket. But there are times when it is beneficial to file separately.
If one spouse has a lot of medical expenses and a low income, by filing separately, the partner with the doctor bills may be more likely to meet the 7.5 percent threshold that is needed to deduct medical costs. The partner with the higher income will have a higher threshold before he/she can start deducting medical expenses.
Additionally, when both partners sign a joint return, they are both legally liable for the tax bill and any issues that may come up. Therefore, if one spouse engages in questionable tax-filing techniques, it might be wise for the other partner to file separately.
The downside to married taxpayers who file separately are higher tax rates and the loss of many tax deductions and credits. These include:
- earned-income credit
- adoption expense credit
- child and dependent-care credit
- educational tax credits
- qualified education loan interest deduction
- child tax credit may be reduced
- capital gains losses that can be deducted will be cut in half
Furthermore, if one spouse itemizes, both must itemize, splitting the items to be listed on a separate Schedule A for each. The partner with few deductions would lose out if the amount is less than the standard deduction.
In choosing whether to file jointly or separately, married taxpayers must weigh the pros and cons and decide for themselves which is the best filing status. In most cases, filing jointly is more advantageous because of the availability of more tax deductions and credits and a lower tax rate.
Commonly Overlooked Medical Deductions
Medical costs can be deducted on Form 1040, Schedule A as long as they are more than 7.5 percent of your adjusted gross income. This includes medical and dental expenses for everyone listed on your tax return. Fees paid to doctors, chiropractors, psychiatrists and psychologists are acceptable as well as payments for hospital services, long-term care services, nursing services, and laboratory fees.
Some additional but often overlooked, medical deductions are:
- Insurance premiums for medical care
- travel expenses to and from medical treatments, including gas, tolls and parking fees, or you can deduct the standard mileage rate for medical expenses
- uninsured medical treatments, such as eyeglasses, contact lenses, false teeth, hearing aids, crutches, wheelchair, seeing eye dog and artificial limbs
- Alcohol- or drug-abuse treatments
- Laser vision corrective surgery
- Medically necessary treatments or devices prescribed by a physician, such as a humidifier to relieve chronic breathing problems
- Acupuncture treatments
- Smoking cessation programs or drugs prescribed to alleviate nicotine withdrawal
- Weight-loss program for a specific disease or diseases, such as obesity, as diagnosed by a physician
- Admission and transportation to a medical conference relating to a chronic disease
- Home remodeling to make it more accessible for a handicapped resident
For a complete list of which medical costs are deductible and which are not, check out Publication 502.
Tax Refunds: Direct Deposit Facts
Every year millions of Americans anxiously await their yearly tax refunds and every year thousands of checks get sent out through the mail. For some taxpayers, waiting around for a check can be more strenuous than having to pay back Uncle Sam; if so; here is some useful information regarding tax refunds:
- If you mailed in a complete tax return, your refund check will be issued within six weeks of the date it is received. For electronically filed returns, checks are issued within three weeks after the acknowledgement date.
- Refunds from amended returns can take up to 12 weeks to be issued after being received. Injured spouse claims may take even longer, depending on the circumstances.
- There are two options available to taxpayers for receiving their federal tax refunds. Refunds can be sent by paper check through the mail or direct deposit (electronic fund transfer) into a savings or checking account.
- As of the 2006 tax year, taxpayers using the direct deposit option can have the total amount of their refund divided into as many as three separate accounts. As an example, a taxpayer can divide their refund as they wish into their checking, savings and retirement account. The minimum amount that can be deposited into each account is $1.00.
- If you plan to divide your tax refund into separate accounts you will need to fill out Form 8888, labeled “Direct Deposit of Refund to More Than One Account,” when choosing their refund option. However, taxpayers filing Form 8379 do not have the option of dividing their refunds.
Facts about Direct Deposit:
- More than half of federal tax refunds are received through direct deposit.
- Direct deposit has been around for 30 years.
- More than 61 million people had their tax refund deposited directly into their bank account in 2007.
- Direct deposit can also be used with prepaid accounts.
- Using direct deposit can avoid undeliverable checks returned to the post office and the possibility of lost, stolen, or forged checks.
- Direct deposit is simple, safe, and convenient.
How to Receive Direct Deposit:
To receive your tax refund by direct deposit you will need to provide the following information on your U.S. Individual Income Tax Return (Form 1040).
Provide the routing number of the financial institution that holds your account. You can use a check to verify this number or contact your bank to get it.
Provide the account number of the account you wish to have the check deposited into. Contact your bank if you don’t have it.
Type of Account
Indicate whether the account you indicated is a savings or checking account.
How to Check the Status of Your Refund:
Visit www.irs.gov and click the “where’s my refund” option. To check your status online, you will need to provide your Social Security number, your filing status, and the exact whole dollar amount of the refund indicated on your tax return.
Reach the Refund Hotline by calling 800-829-1954. Allow four (4) weeks after you mail your return before calling the hotline. When you call, you will need to provide your Social Security number, your filing status, and the exact whole dollar amount of the refund indicated on your tax return.
Spending Your Tax Refund
How To Spend Your Tax Refund
Pay Credit Cards
By making an extra payment or paying more than usual, you can reduce the balance on credit cards. Reducing your balance will also help you save money on interest charges.
Open a Savings Account
You can use your refund to open a savings account, unless you already have one. By putting your refund in a savings account you can save for the future, like buying a house or a car, while generating interest on your money. Interest is money you receive from saving it in an account.
Also, putting your refund in a savings account is an excellent way of setting aside money for emergency situations. Most financial experts recommend that you keep at least 6 months of your monthly income set aside for emergencies.
Add To Your Retirement
You can use your refund to open an Individual Retirement Account (IRA). If you already have an IRA use your refund toward your annual contribution. Most IRA contributions can be used as a tax deduction.
If you have a 401k, using the money from your refund can be another smart way of adding to your retirement, especially if your employer matches your investment.
Invest In Stocks
Investing in stocks can start with as little as a few hundred dollars. Although there is a gamble involved, a majority of stocks often produce a nice return and can provide an excellent way of building your personal wealth.
Refinance Your Home
With currently low interest rates, you can put your refund toward the closing cost to refinance your home. Money from a refund may not cover the entire cost to refinance, but it covers a good portion of the cost.
Not only does refinancing allow you to take advantage of a lower rate, many homeowners are refinancing to change their type of loan. Homeowners with adjustable-rate mortgages are switching to fixed rates or changing their 30-year fixed rate into a 15-year deal.
Fix Your Home
You can use your refund to finally take care of those home improvements you have been meaning to get around to. By using your refund for home improvements, you not only improve the look of your home, but also increase the value.
Buy Health Insurance
Your refund can be a good excuse to finally buy some health insurance. Health insurance can help alleviate any financial burdens that may fall upon your family should anything suddenly happen to you.
Fix Your Car
Most people neglect to properly maintain their vehicles because of the high costs of labor and parts. You can use your refund to pay for any repairs or service needs, such as new tires or a tune-up. A well maintained car with properly inflated tires will also save you on gas money.
Dental and Health Checkups
Most people put off health and dental checkups because the cost of high premiums and treatment. You can use your refund to take care of dental work or health costs.
Taxpayers with a Health Savings Account (HSA) can use their refund to add money into the account. A HSA is a medical savings account used to pay for qualified medical expenses at any time without federal tax liability.
Buy To Save
You can also use your refund to buy items that may save you money in the end. This can include a deep freezer that will save you on food cost or new insulated windows around your home to help save on heating costs.
Invest In Your Future
Refunds can provide a great opportunity to invest in your career. If you have a home business, you can use your refund to buy new software or equipment that will improve your business. You can also use your refund to go back to school, to pursue your career goals or study for an advanced degree.
Invest In Your Child’s Future
If you have children who are planning on going to college, you can use your refund to start or add to a college fund.
If your child is already in college, you can use your refund to pay for tuition and other school expenses. If your child has a school loan, you can also use the refund to help pay off the loan.
Donate To Charity
For some, refund money is merely extra money. If this is the case, you may consider sharing the wealth by donating a portion of your refund to a charitable organization or relief fund. By donating some or all of your refund, you can ensure your money was put to good use. You can also use your donation contribution as a tax deduction.