Most taxpayers do claim their exemptions, and according to the IRS, $842 billion was claimed from personal exemptions in 2005. But there are many other tax credits available that may be overlooked.

“Do I choose to take the standard deduction or itemize?” That’s an important question many taxpayers will need to ask themselves prior to filing their tax return. In 2007, the standard deduction was $5,350 for single, $7,850 for head of household, and $10,700 for married or filing jointly.

However, in 2002, only one-third of taxpayers who filed their returns chose to itemize their deductions, according to the Government Accountability Office (GAO). The decision not to itemize turned out to be an on average loss of $438 per taxpayer, or in overall terms – $945 million.

Procrastination is the most common reason for not itemizing. Taxpayers are notorious for waiting until the very last possible hour to file their taxes. This overwhelming rush to complete their tax filing has many taxpayers losing out on the additional tax breaks that may be available to them by itemizing. Taking the time to collect tax records and the information needed for itemized deductions is well worth the time and effort.

For most taxpayers, electing to take the standard deduction or itemizing deductions can be fairly simple. Add up your real estate taxes, income taxes (state and local), and whatever mortgage interest you’ve paid. Now, compare this total against the standard deduction. If you are over 65, don’t forget that you can add an additional $1,050 if you’re married and $1,300 if you are filing single, to your standard deduction.

Many taxpayers make the mistake of not filing an itemized return, thinking that because they don’t own a home it won’t provide any significant tax break by itemizing. However, if you have had substantial medical bills, paid trustee or investment advice fees, made large donations to charity, paid substantial state sales or income tax, or had other substantial qualifying expenses, you may be pleasantly surprised to find your tax deductions work out to be far greater when itemizing than by using the standard deduction.

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According to the Internal Revenue Service, the biggest claimed value comes from personal exemptions, which in 2005 came to $842 billion.  Most taxpayers, in fact, do claim their exemptions – but there are many other tax perks which may be overlooked.  

1.  Get Educated

If you are within the correct income guidelines, any education-related expenses you paid last year might net you a tax perk or two, including tuition deduction, a Lifetime Learning credit or the Hope credit.

Nearly a quarter of eligible taxpayers did not take advantage of the Lifetime Learning or Hope credits, according to a 2005 US Government report of approximately 1.4 million returns.  On average, each taxpayer only lost about $160, a relatively small amount.  However, one tenth of those taxpayers paid $500 surplus in taxes!

A Lifetime Learning credit can give you as much as $2000 of approved, higher education related expenses for a year.  The Hope credit can net you up to $1650 in tuition and tuition-related fees (not including supplies, books, room or board).  Both credits are income-dependent, and begin to phase out for taxpayers at an income of $47,000 (modified adjusted gross; for married-filing-jointly couples, the figure is $94,000).  The credits disappear completely for taxpayers with a $57,000 MAGI (the married-filing-jointly figure is $114,000).

It is not necessary to itemize in order to receive the fees and tuition deduction, which is worth as much as $4,000.  However, your MAGI must be less than $65,000 if you are a single filer (or $130,000 if you are married-filing-jointly).  Single filers whose MAGI ranges from $65,000 to a maximum $80,000 (for married-filing-jointly couples, $130,000 to $160,00) are only allowed a $2000 deduction; any income higher than this is ineligible for tax deductions. 

Just to make things trickier, you cannot receive the deduction if you take either of the credits.  In general, a credit will be worth more to you than a deduction; however, it is worth checking the figures to make sure which tax perk is the most worthwhile.  Phase-outs, for example, can influence which option is more valuable to you. 

2.  Itemize or standard deduction?

This is one of the most financially significant tax decisions you will make.  For 2007 returns, the standard deduction is $10,700 if married-filing-jointly, $5,350 if single, and $7,850 for the head of a household.

Congress’s investigative arm, the GAO, found in 2002 that only one-third of filing taxpayers choose to itemize.  Approximately $438 on average was lost per taxpayer–$945 million all told-due to not itemizing.

One of the major reasons for not itemizing is the extra time and trouble involved.  Many taxpayers procrastinate and end up losing out.  Instead of hunting for data and records at the last minute, taxpayers should collect them all before hitting the computer.

It is fairly simple for homeowners to judge whether itemizing is worthwhile for them or not.  Add up everything you paid for real estate taxes, mortgage interest, income taxes (state and local), and simply compare the figure against the standard tax deduction.  Be aware, if you are over 65, you can add $1,300 (if filing singly) or $1,050 (if married) to your standard tax deductions.

If you don’t own your own home, don’t write off itemizing.  Renting taxpayers may still be able to claim large medical bills, investment advice fees, trustee fees, charitable donations, investment expenses, state income taxes or even sales taxes.  All these are considered deductible expenses, and might tip the scale, making itemization the smart choice.

For example, as an itemizer you can choose a valuable perk, which may be worthwhile if you live in a state with low or no income tax-deduct your state sales tax in lieu of your state income taxes.

3.  Credit Where Credit’s Due

As a general rule, tax credits are more valuable to you than tax deductions, as they directly reduce your tax payment dollar for dollar.  As well as claiming education credits, remember to claim a child tax credit for every child up to the age of 17.  If you qualify, this can be worth $1,000 per child. 

Parents may also be able to take credits for child care and dependent expenses, including summer day-camp and day-care costs (although not sleepover camp).  This perk could save you up to $2,100 on your tax bill.

If you have invested in a mutual fund overseas or internationally, you may have already paid foreign taxes.  Check your statements to see if you are eligible for a ‘foreign taxes paid’ credit.

Lower-income taxpayers should be aware of the saver’s credit.  This one caps at $1000, and is designed to encourage retirement saving among taxpayers with lower incomes.

4.  Big benefits in Small Business!

Section 179’s expense election can give business owners who have purchased equipment such as trucks, furniture or computers (some limitations apply) as much as $125,000.

Likely the most valuable deduction you will receive, you don’t even have to spend the money to benefit.  If a contractor decides to purchase two new vehicles, financing the majority of the cost, you could purchase one of those vehicles on credit, netting yourself a $60,000 deduction while avoiding spending that amount of money.

Better still, the deduction can reduce the taxable income of your spouse.  If you are a contractor whose wife works at a W-2 job, your depreciation under section 179 can be placed against her W-2 income to offset it, even if it has already been taken to zero. 

An extremely valuable strategy is for people starting up businesses to use their Section 179 exclusion to zap their partner’s income down almost to zero.  This is worthwhile because starting a business is so capital-intensive.

5.  Charitable donations

Many taxpayers fail to utilize the full advantages of charitable tax deduction, which can give you up to half of your adjusted gross income.

Before you begin doing your taxes, collect your receipts and think hard about your charitable giving over the past year, including donated clothes and toys.

Among itemizing taxpayers, charitable contribution deductions are the fourth most valuable deductions.  In 2005, the IRS reported that taxpayers claimed $172 billion in these deductions.

Sadly, the rules have tightened somewhat this year.  Proof in the form of written receipts or bank records is now required from the recipient for cash donations, not of $250 and above like last year, but of any amount at all. 

The IRS states that any donated second-hand items must have been in ‘good’ condition at least.  25% of the price you initially paid for clothing is considered to be thrift shop value, and can be deducted. 

Plan for Next Year

Planning ahead can net you some of the best tax perks around.  Putting money into a retirement account such as a 401K is a great way to save on taxes, by reducing your taxable income.

Another tax perk which can be very valuable is the annual tax exclusion for gifts.  A gift from one person to another up to $12,000 in value is tax-free.  Tax-free gifts from a parent or grandparents can be a tremendous help in our current economic slowdown.

As long as the gift is below $12,000, the recipient does not even need to file a report or gift tax return.

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Here are five simple rules to remember when looking for tax breaks:

1. Don’t lie. If you can’t exempt, defer, or cancel out a certain part of your income, you must pay taxes on it.  Hiding, renaming, or lying about your money is a sure way to get audited, fined, and even arrested in some cases.

2. Obey the spirit as well as the letter of the law. Congress creates doesn’t create tax breaks just to be nice. Sometimes they want to boost the economy, sometimes they want to save the environment – whatever the reason, make sure that it applies to you. Bending tax law to fit your situation can be illegal. If you’re not sure, consult a tax professional.

3. Take tax credits before deductions. Tax credits are better than tax deductions. A tax credit removes a lump sum from your tax bills; deductions reduce your taxable income, so their worth varies according to your tax bracket. For example, say you are in the 30% bracket. A $1000 tax credit directly reduces your tax bill by $1000. A $1000 deduction, on the other hand, would only save you 30% of $1000, or $300.

4. File the right form. Some tax breaks require you to use a certain tax form. You may need to file the “long form,” or 1040, rather one of the simplified forms (1040A or 1040EZ). Be sure to read all the instructions carefully and talk to a tax professional if you have problems.

5. Beware the Alternative Minimum Tax. The alternative minimum tax, or AMT, is often referred to as a “shadow tax system,” because it doesn’t follow the same rules as your regular income tax. The AMT was established to make sure everyone pays a certain minimum tax, no matter how many deductions you qualify for. If your regular tax falls below this minimum, you will have to pay an alternative minimum tax.

You can begin today – find out what tax benefits you qualify for and start taking a ‘break’ from high taxes!

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