April 13, 2004 -- Over the next two days, taxes will be weighing on the minds of millions of American parents.
It is projected that more than 32 million families will face a tax bill this year, but additional tax relief may be available for millions of parents because of the new tax laws Congress passed last year.
For example, many tax brackets were lowered. Those who were paying 27 percent now pay 25 percent; those who paid 30 percent now pay 28 percent; those who paid 35 percent now pay 33 percent; and those in the 38.6 percent bracket will now pay 35 percent.
Similarly, there are new enhanced tax credits and deductions available for the 2003 tax year that can still be taken advantage of, even though the April 15 filing deadline is fast approaching. It is important to make sure that you are taking advantage of new laws that work to your family's benefit, and that you take proper precautions to make sure the Internal Revenue Service does not rain on your post-tax celebration.
Child Tax Credits
So far, the child tax credit is the biggest source of mistakes on 2003 tax returns, with more than 2.3 million people having already made errors related to it. Assuming your family meets income requirements, the child tax credit is $1,000 for each child under the age of 17 in 2003, up from $600 per child in 2002.
However, when completing your 2003 tax return, do not forget to subtract any advance credits you may have received last summer. Specifically, 25 million taxpayers received an advance credit of up to $400 per child last July or August. If you were one of these taxpayers, you will have to subtract the amount of your advance and only take a partial credit. For example, if you received an advance credit of $400 for each of your two children (a total of $800), rather than getting a tax credit of $2,000, you should account for a credit of $1,200. These advance credits were based on the amount of income you earned in 2002. If your income rose in 2003, you may have received a larger check than you were entitled to, but the government is not collecting any overpayments, so you can keep the money.
With more than 4 million babies born each year, many new parents may be eligible for a child tax credit. If you had a baby or adopted a child in 2003, you would not have received the advance child tax credit, and may be eligible for the full credit if you meet certain income requirements. To be eligible, married couples filing jointly can earn up to $110,000; married couples filing separately can earn up to $55,000 each; and single filers can earn up to $75,000. The credit phases out if your income exceeds these amounts.
Although you may financially support your kids well into their adulthood, you need to be careful about claiming them as dependents, especially if they file their own returns and claim themselves.
The IRS sent 169,500 notices to taxpayers who claimed a personal exemption, but were also claimed on another taxpayer's return as a dependent in 2002. While dependents can lower your taxable income by as much as $3,050 for each dependent in 2003, you need to be sure to understand the eligibility requirements of dependents. Specifically, dependents must be related; not file their own tax return; be under 19 years old, earn less than $3,050 a year or be full-time students under 24 years old; and have more than half their total support during the year provided by the person who claims them as a dependent. Keep in mind that the exemption amount for dependents decreases as your income increases. The exemption for married couples filing jointly begins to decrease at an adjusted gross income (AGI) of $209,250; for single filers, it decreases with an AGI over $139,500.
Savings for the Sandwich Generation
Tax relief for the nearly 78 million baby boomers — also known as the sandwich generation because they are often raising children and caring for elderly parents — can be found in the increased dependent care credit. With more than 25 percent of American families involved in elder/parent care, this credit is especially important. "Dependents" include children under the age of 13 as well as any relative who is physically or mentally incapable of self-care, such as an elderly parent. In order to take the credit, these dependents must be claimed on your tax return and your expenses must be used to allow you to work.
The amount of the credit for 2003 is based on your adjusted gross income. Specifically, you can take a credit of 20 percent to 35 percent of the first $3,000 of dependent care expenses for one dependent (up from $2,400 in 2002) and $6,000 for two or more dependents (up from $4,800). If your AGI is under $15,000, you would be eligible for the maximum credit of 35 percent. The credit amount ranges from 21 percent to 34 percent if your AGI is more than $15,000, but less than $43,000; above $43,000 would qualify you for a 20 percent credit. For example, assuming $6,000 in expenses for two dependents and an AGI of $50,000 (20 percent rate), you could take a credit of $1,200.
Closely related to dependent care credit are flexible spending accounts (FSA), which allow you to defer up to $5,000 in pre-tax dollars for medical and dependent care expenses. However, keep in mind that dependent care expenses paid for by your FSA reduce the amount of the dependent care credit you can claim dollar for dollar.
In 2002, if your FSA allowed you to defer $5,000 and you used the maximum of $4,800 for dependent care, you would be ineligible for the dependent care credit. However, given the increase in the dependent care credit to $6,000 for two or more dependents, even if you spent your entire FSA account ($5,000) on dependent care, you would still be eligible to take a credit on $1,000 of expenses.
To provide relief from the marriage tax penalty, Congress increased the standard deduction for married couples by 17 percent, from $7,850 in 2002 to $9,500 in 2003.
This new amount is now exactly double the amount for single filers which is $4,750. As a result of this change, approximately 3 million married couples who previously would have benefited from itemizing their tax returns will save more this year by claiming the standard deduction.
Depending on your AGI, you may be able to deduct your alimony payments. Alimony is a payment to or for a spouse or former spouse under a divorce or separation instrument. Be aware, however, if you do not provide your former spouse's Social Security number, you may have to pay a $50 penalty and your deduction may be disallowed.
Your Child's College Savings or Your Retirement
Another change in this year's tax law is a new tax rate for stock dividends. The new rate is 15 percent, down from as high as 38 percent. Your 1099-DIV prepared by your mutual fund firm or broker will tell you which portion of your dividends will be taxed at the new lower rate.
Unfortunately, many mutual fund companies and brokers didn't get this right and they sent out several hundred thousand 1099-DIV forms that are probably wrong.
If you received two 1099 forms from your mutual fund company, do not throw away either. Although the differences between the two may be too subtle to detect, the second form is probably correct.
The form is not required to file your taxes — you just need the information — so call your mutual fund company and ask them to detail the correct dividend tax information. If you already filed and erroneously applied the 15 percent rate to dividends that do not quality, the IRS will send you a bill for the difference along with interest calculated from April 15 (currently at 4 percent).
This year, depending on your AGI, you may be able to deduct a portion of the tuition bill for your children or even yourself.
There are two credits available: the Hope Scholarship credit and the lifetime learning credit. The Hope Scholarship credit, valued at up to $1,500, can be applied to the first two years of college tuition and fees. In addition, the lifetime learning credit can be applied toward the educational years beyond college. The lifetime learning credit, depending on your AGI, can be as high as $2,000.
Home Sweet Home
If you purchased a house in 2003 or refinanced your mortgage, the points you paid are fully deductible.
Last year, 1,085,000 new homes were sold, compared with 973,000 in 2002. The points on a new mortgage can be completely deducted in the year of purchase, whereas the points paid during a refinancing can be written off over the life of the loan. Additionally, if you paid the property tax bill of the seller at the time of closing, you may write off that amount on this year's tax bill as well.
E-mail Mellody with your personal finance questions.
Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is Good Morning America's personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.