I think common sense would tell you you can’t deduct something that you pay pre-tax, not that the tax law always follows common sense. But, I would disagree that most people pay into a pre-tax plan. Many people pay into post-tax group plans. It doesn’t have to be an individual plan, although it may be. Don’t forget dental insurance.
Is this true? What sort of tax reduction can one get from a 401(k) plan aside from contributing pre-tax money?
I don’t believe this is the case. There is no additional percentage deduction for “investment incentive”. (Unless of course there is new tax legislation for this year. I haven’t done my taxes for this year yet.)
There are multiple other reasons for contributing as much as possible to a 401(k) retirement plan…
… the money is pre-tax
… the money grows tax free until you withdraw it in retirement (the difference at the “end of the day” is substantial)
… most 401(k) plans have an employer matching contribution, pushing the first year’s return anywhere from 25% to 100% depending on the company
For all these reasons, one should devote as much money as possible into their 401(k). The next thing to do is to pay off credit card debt. As mentioned, a home equity loan to accomplish this will cost you less in interest.
Also, Flexible Spending Accounts should be used if you have them available to you. The money is pre-tax. If you’re in the 28% tax bracket, every $100 of medical expenses are really only costing you $72.
I thought about doing this the year I bought my house – I would take the 14,000 deduction for house buying and my wife would take the 4000 standard deduction and we would cheat the system!
Problem was, the IRS was one step ahead of me, and MFS filers who itemize limit the amount that their spouse may also take – you don’t get any free deductions. In my case, since my deduction was greater than 2 MFS standard deductions, my wife would not have been able to deduct anything.
If both MFS filers take the standard deduction, then the result should be the same as MFJ with the standard deduction.
MFS is designed to allow you to keep your finances private, and not need to share them with your spouse. It is very unlikely you could ever get an advantage using MFS, and in fact could result in you owing more tax than using MFJ. MFS caps on deductions and credits are generally 1/2 of that of MFJ. If both spouses earn about the same amount, this is not a problem, but in a case where one spouse earns 98% of the money, you may limit the deductions and credits you would normally be entitled to.
To clear up a few more misconceptions:
-
Married couples are almost always, with very, very, few exceptions, better off filing married-fling-jointly.
-
Health insurance is only a deduction if it is paid with after-tax dollars.
-
Even then, health insurance premiums will only help you if you itemize deductions (for most people, this means owning a house and making mortgage payments) and your premiums+ other out-of-pocket-medical expenses exceed 7.5 percent of your adjusted gross income (this is generally a LOT, and only helps people with huge medical expenses for the year).
-
There is indeed a “savers credit” – that is, a special credit available to anyone (whether you itemize or not) who: (1) contributes to a Roth IRA, traditional IRA, or 401(k). The catch is, if you make over [something approximating, don’t have exact figures in front of me] $25,000 (single) or $50,000(married/joint filer), you don’t get the Savers Credit.
-
The Savers credit is in addition to any REDUCTION of your taxable income which happens when you contribute to a traditional IRA (which appears as an adjustment DOWNWARD to your taxable income on your tax return) or a 401(k), which is a pre-tax deal which reduces your federal wages as they appear on your W-2.
And, as mentioned previously, there has indeed been a middle class tax cut, which will benefit a good chunk of the “middle class” population this year. Tax rates have gone down, and the “middle class” brackets that get to take advantage of these rates have expanded.
BTW, dil, I don’t have an answer off the top of my head about your investment expenses, it will require a little more research. I do know that investment expenses are an itemized deduction item, but I just have not had enough experience in that area. I’ll see what I can find in the next few days.
Thanks for the clarification. I didn’t know this. Probably because I can’t take advantage of it.
All right…my turn. I’ve got two question, both related to my house buying this last year.
-
I bought my first home in July. Are there any kinds of deductions that first-time homebuyers can take directly related to the purchase? (I know my interest is tax-deductible, but this may not help me this year since I only had 4 or 5 motgage payments.)
-
I understand that property taxes are deductible from your Federal income tax. I pay into an escrow account attached to my mortgage, and the Property tax is paid when the bill is due, at 6 month intervals. I don’t really know when I start (started) paying the tax bill on my house, and I don’t know yet when the money will leave (has left) my escrow account. If I have paid property tax, and can deduct for it, should I have received a form of some kind, like the 1099-something that comes for my student loan interest? If not, how can I find out how much interest I’ve actually paid so far, if any?
1 - nothing special that I know of for first time homebuyers. My understanding is that first-time home buyer advantages are more usually linked to special lending terms rather than income taxes.
2- Property taxes - typically you don’t get a special form per se for what you’ve paid in property taxes, but the statement your mortgage lender sends you will usually have the figure on your mortgage interest statement(called a 1098-INT… you should have received this by now, if not call them and hound them) for what they have paid on your behalf out of escrow; (you can use this figure on your taxes… but read on).
Two caveats about this: some smaller banks or flakier lenders may not have the tax figure on the 1098. (The big dogs, like Wells Fargo, include the prop taxes as a matter of course) In this case you need to either refer to something the county may have sent you about your property tax bill for the year [I get one every year even though escrow pays the bill], or else call your county to find out. Secondly, if you bought your house in '03, it is entirely possible, and even likely, that as part of your closing costs you ponied up some to pay a portion of the year’s property taxes. You need to dig out your closing papers and look at all the line items to see what you paid at closing for property taxes. You can count this too, though many people don’t realize it or forget.
I know the Child Care Credit is completely separate from itemized deductions. I believe it decreases as your income goes up, so it can be better to use the pre-tax spending accounts if those are offered at your workplace; I did the math and at our income level, the pre-tax account was better for us.
There’s also that per-child tax credit, completely separate from the child care credit; that phases out as the income goes up. FWIW, lowering your taxable income via 401(k), pre-tax spending accounts etc. can help you take advantage of that.
I don’t honestly know if either of these is available to short-form filers (we have mortgage interest so we go straight to the long form) but I’d guess they do.
Some other things you can look into for deductions:
- State / local income taxes are deductible. May not be enough to put you over the standard deduction amount but it’s certainly worth checking.
- Personal property taxes (e.g. car taxes, not just registration fees) should also be deductible.
Thanks, drpepper. Funny you mention Wells Fargo, because they are the bank that holds my mortgage. I did get a 1098 from them, and I never thought to look on there about tax stuff. I will when I get home.
I doubt I’ll get more than the standard deduction this year, but next year will be a whole other story.
I’ll second what you said about checking the closing paperwork. We refinanced this year shortly before the first semi-annual tax payment was due, and we had to pay that tax payment as part of closing costs. It did not appear on the 1098 form, which startled me at first until I realized what had happened, and sought my closing paperwork. Do NOT get this confused with the escrow prepayment you presumably also made at closing. Even though that’s intended to cover taxes, it doesn’t count as a tax payment until the mortgage company actually pays it out as such.
On the new-homebuyer question: the only thing I could think of is if you paid discount points or loan origination fees (typically some percentage of the loan amount); those are deductible as long as you paid them up front rather than adding them to the loan principal. I think they’re still deductible even then, but might be “over the life of the loan” (I’m not sure how that’s handled).
burundi and I are gonna have a fun tax year: we got married in May, and we bought a house in November. My guess is that we’ll still end up taking the standard deduction. Although we paid plenty in housebuying costs (including a point on the loan), I don’t think we’ve got a chance of exceeding standard deduction, not with only three house payments in 2003.
But I am curious about this saving incentive: together we don’t earn $50,000, and I contributed about $800 to an IRA last year. Where can I find out more about this?
Daniel
That reminds me of another question that applies to me…
Besides buying a house in June, I got married last March. Are there any issues about filing for the first time as a couple that I should be aware of? I assume it’s just a matter of combining out W-2s and filing jointly. But I just don’t want to miss any little incidental things, especially if they might mean a bigger refund. 
Watch TurboTax. This year its giving me a child care credit I’m not entitled to. And it didn’t ask me for the taxes I paid as part of an stock option exercise. Two years ago it allowed me to deduct daycare - even though I already had (and told it I had) a DCSA. That was the year it told me I’d filed with the IRS and paid up, but the IRS never got the return. Thank God, filing late I discovered I was about to claim a daycare deduction I wasn’t entitled to. (On the other hand, the penalties and interest part of “oops” wasn’t fun). I still use it, I just print it out, check it over manually, and then send it in.
Also, here is how we (a two income family) take our deductions. We have two children. We both withhold at the higher single rate with no deductions. Plus I pull and extra $100 a pay period from my check. That enables us to have a mere $3000 tax bill each April.
Now granted, most two income households probably don’t need to have that much extra pulled to come up that short. But if you do pay in this year, consider refiling your W-2s to pull more out.
LHoDThe form pertaining to the savers credit is 8880… you can pull it up on the IRS website (www.irs.gov), I found a link but I’m not sure if it will work. Print it out and crunch the numbers: http://www.irs.gov/pub/irs-pdf/f8880.pdf
Also, Mama Zappa is correct about the “points” paid on a mortgage loan being deductible as an itemized deduction.
See here for more details (page “A-3”): http://www.irs.gov/pub/irs-pdf/i1040.pdf
(this is simply the instructions for the 1040)-- it also refers you to Publication 936 for more details, also available on the IRS website. It’s really a good resource (the irs website, that is), if you have the patience to do a little research on what topic you’re interested in.
audilover, can’t think of anything special off the top of my head for newly married couples, I think you’ve got a handle on it.