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Deducting sales tax, insurance premiums


Jim Wilhelm, a partner with SC&H Group, leads the income tax department, providing tax compliance and consulting services to private and public companies throughout the region.
Baltimoresun.com's tax-advice column features three experts from the Hunt Valley accounting firm SC&H Group answering questions about preparing your return every Monday until April 16.

Tony, Baltimore: If you itemize, is it legal to deduct the taxes on a new car purchase? I believe it used to be but is it now?

SC&H Group: If a taxpayer is itemizing their deductions, he or she chooses between deducting state income taxes paid or sales & use tax paid during the tax year. The law allowing for the sales tax deduction expired, but was reinstated late in 2006.

You determine your potential sales tax deduction by tabulating actual sales taxes paid throughout the year -- (please tell me no one will ever do this!) -- or using the IRS tables provided in the instructions to Form 1040. In addition to the sales tax table amount, a taxpayer can add sales taxes paid on certain other purchases, including automobiles, boats, airplanes, homes or home building materials -- if the rate was the same as the general sales tax rate (which it is in Maryland). Then compare your total sales tax deduction to your income tax deduction and choose the larger amount.

Usually taxpayers in low or no income tax rate states will benefit from the sales tax deduction option, though if one purchased a vehicle, boat or other item noted above, that option could prove more beneficial than deducting your income taxes.

Dave, Joppatowne: Are the monthly premiums paid for Medicare insurance tax deductible as medical expense?

SC&H Group: Insurance premiums paid for health insurance coverage are deductible as medical expenses on Schedule A. Medicare Part B premiums withheld from Social Security payments are eligible for this deduction, as are Part A premiums, if voluntarily enrolled and the taxpayer is not covered by Social Security.

Any payroll taxes paid for Medicare are not deductible as medical expenses. You can claim a deduction for medical and dental expenses only for the portion of total expenses that exceeds 7.5% of your adjusted gross income.

Medical expenses sometimes overlooked include medical expenses paid for nondependents (in certain circumstances), medical mileage (18 cents per mile), smoking cessation programs and vision corrective surgery.

James, Laurel: I have a minor child who is an actress and need to know which form(s) to use. Her mother has already filed and claimed her as a dependent. She earned most of her income in theaters, traveling around the country and in Canada. While her earnings were significant, her expenses were also. Any help that you can give me on this shall be greatly appreciated.

SC&H Group: If your daughter earned more than $8,450 then she is required to file a federal income tax return. In order to report your child's income and expenses you should use Form 1040. The income your child earned from acting will be treated as business income if the primary purpose of her acting is for income or profit and she acts on a continuous and regular basis. If this is the case she should report her income and expenses on Schedule C. If not then the activity is considered a hobby and she should pick up the income on line 21, other income, of her form 1040. Your child may deduct all or part of the expenses that she incurred. Please consult Federal Publication 535, which will assist you in determining what expenses you may deduct.

On a cautionary note, many states have specific rules about entertainers and their filing requirements. Often, entertainers are required to file nonresident state tax returns in the states in which they provided services. You may also need to file a Canadian income tax return. Canada and many states have relatively low thresholds for filing requirements compared to the $8,450 federal minimum. If the activity is significant, you should consider hiring a professional to assist you.

Pam, Columbia: I took a small amount of money out of my retirement account in 2006 and at the time paid the penalty and federal income tax. My tax preparer added that amount to my taxable income, when I thought that I already paid federal taxes. I should only have to pay state tax on that additional money. Is that correct?

SC&H Group: Distributions from retirement plans are subject to federal and Maryland income taxes. The withholding from the distribution may have helped to "cover" the taxes owed on that amount; however, the gross distribution should still be reported on both returns. There is a Maryland subtraction for a certain amount of pension income, depending upon certain variables like age, disability and Social Security earnings. Review Form 502 instructions for the pension exclusion rules.

In addition, there are several exceptions to the 10% penalty from retirement plans, even if you are under 59 1/2. Consider reviewing the instructions to Form 5329 to see if any of these exceptions apply to your situation.

Phil, Bel Air: Does the deductibility limit of $4,000 apply to both nondeductible IRAs and Roth IRAs as a whole, or separately? Also, do Roth IRAs require the filing of the 8606?

SC&H Group: The maximum annual contribution is the amount that may be contributed to both types of IRAs combined. You may not contribute more than $4,000 total to both types of IRAs in one year, unless you are eligible for "catch up" contributions. Neither Roth nor nondeductible IRA contributions are tax deductible.

You must file Form 8606 if any of the following circumstances are true: 1) You made a nondeductible contribution to an IRA for 2006, including a repayment of a qualified hurricane or reservist distribution; 2) You received distributions from a traditional, SEP, or SIMPLE IRA in 2006 and your basis in traditional IRAs is more than zero. For this purpose, a distribution does not include a rollover (other than a repayment of a qualified hurricane distribution), qualified charitable distributions, conversion, recharacterization, or return of certain contributions; 3) You converted an amount from a traditional, SEP, or SIMPLE IRA to a Roth IRA in 2006 (unless you recharacterized the entire conversion); 4) you received distributions from a Roth IRA in 2006 (other than a rollover, recharacterization or return of certain contributions)

Answers to selected questions are published on Mondays. This is the final installment of Tax Talk for 2007.

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