Even if you don't itemize, don't overlook above-the-line tax deductions

By: Sandra Block

Smart consumers are skeptical of offers that sound too good to be true. If those miracle weight-loss products advertised on late-night TV really worked, we'd all look like aerobics instructors, and manufacturers of elastic waistbands would go out of business.

But when it comes to your taxes, you really can reduce your tax bill without breaking a sweat. The secret: above-the-line deductions. These deductions are taken on the first page of your tax return, above the line for your adjusted gross income. Even if you take the standard deduction instead of itemizing, you may qualify for these tax breaks.

Quick guide to tax forms Your tax situation will determine the kind of tax return you must file with the IRS. A quick guide to figuring out which form to use: 1040EZ Taxable income below $50,000. Single or married filing jointly. Under age 65. No dependents. Interest income below $400. 1040A Taxable income below $50,000. Capital gains distributions from mutual funds, but no other gains or losses. Only deductions are for IRA contributions, student loan interest, educator expenses and/or tuition and fees. No itemized deductions. 1040 Taxable income of $50,000 or more. Itemized deductions. Self-employment income. Income from sale of property. Source: IRS

Itemizers shouldn't overlook these deductions, either. Above-the-line deductions reduce your AGI, which may make you eligible for other tax breaks tied to your income, says Jackie Perlman, senior tax analyst for H&R Block. For example, itemizers can't deduct unreimbursed business expenses unless they exceed 2% of AGI. Shrinking your AGI will increase the chance you'll qualify for that deduction, she says.

To get the full benefit of above-the-line deductions, you have to know what they are. A look at some deductions that could save you money:

Individual retirement accounts. The maximum contribution for an IRA is $3,000 in 2002, or $3,500 if you're age 50 or older. If you're not covered by a retirement plan at work, you can deduct your IRA contribution.

If your company offers a pension or retirement-savings plan, such as a 401(k), you can't deduct the full IRA contribution if your AGI exceeds $34,000 a year if you're single or $54,000 if you're married and file jointly. Singles with AGI up to $44,000 and married couples with AGI of up to $64,000 qualify for a partial deduction.

Don't overlook the spousal IRA. If your spouse isn't working or isn't covered by an employer plan, you can contribute up to $3,000 on your spouse's behalf or up to $3,500 if your spouse is 50 or older. You can deduct the full contribution as long as your combined AGI doesn't exceed $150,000, Perlman says. If your AGI is between $150,000 and $160,000, you may be eligible for a partial deduction.

You have until April 15 to contribute to an IRA for 2002.

Student loan interest. You can deduct up to $2,500 in interest paid on federal student loans. The deduction phases out for single taxpayers with AGI of more than $50,000 or married taxpayers with AGI of more than $100,000. The deduction is available for the full term of the loan, assuming you meet the income thresholds. A rule that limited the deduction to the first 60 months of loan payments was eliminated in 2002.

Higher education expenses. A new above-the-line deduction for 2002 allows taxpayers to deduct up to $3,000 in college tuition and related expenses. Single taxpayers with AGI of up to $65,000 and married taxpayers with income of up to $130,000 qualify. The deduction is a useful tax break for families that earn too much to qualify for the Hope Scholarship or Lifetime Learning Credits.

Classroom expenses. If you're a teacher and spent your own money on books, school supplies, computer equipment and supplementary educational materials, you can deduct up to $250 of your unreimbursed costs.

Alimony. Alimony, including back alimony, is deductible in the year in which it's paid. Property settlements and child support aren't deductible.

Early withdrawal penalties. Did you cash a certificate of deposit before it matured in 2002, triggering an early-withdrawal penalty? You can deduct the lost interest on your tax return. You don't have to itemize, but you must use the longer Form 1040 to take the deduction (see box for guide to tax forms). If you're not sure how much to deduct, check the Form 1099 from your bank, Perlman says. The amount should appear under "forfeited interest."

Taxpayers often mistakenly believe this deduction also extends to penalties triggered by an early withdrawal from an IRA, Perlman says. Unfortunately, those penalties — usually 10% of the amount withdrawn — aren't deductible, she says.

Moving expenses. The cost of a job-related move is an above-the-line deduction, as long as your new job is at least 50 miles farther from your former home as your former job.

Hybrid vehicles. If you bought a hybrid car in 2002, you can take an above-the-line deduction for up to $2,000 of the cost. The IRS says the Toyota Prius, the Honda Insight and a hybrid version of the Honda Civic are eligible for the deduction. The deduction is limited to new cars, and you can take it only for the first year you use the car.

Protecting Your Assets

Have you ever wondered what would happen to your assets if you were sued, in a car accident and it was your fault or if you became disabled or even died? Most people consider this question but do very little about taking the necessary steps to protect their assets.

The first thing to do is to have a plan in place before anything bad happens to you. Even if you are one of the luck ones and nothing ever bad happens, eventually as a fact, everyone dies.

When you die, your bank accounts are frozen, and an executor is appointed to wrap up your estate. This means finding everyone you owed money to, and settling the debts. If you have a family, and all your assets are in your own name, your spouse could be unable to access your funds for up to 2 years.

There are three major concerns when it comes to protecting your assets: estate duties, income taxes, and lawsuits.

Estate duties

When you die, the government claims a percentage of the value of your estate. This amount varies from country to country, and it could be anything from 20% to as much as 55%.

The solution to the estate duty problem is to ensure that your estate is worth as little as possible when you die. Moving your assets into a living trust could be a good solution, as the trust is not taxed upon your death.

Income tax

How do you legally reduce your tax liability? One way is to decrease your income to an absolute minimum. Anything you need could be paid for by a business. For instance, if you need a new laptop, it could be paid for by your corporation or living trust. It is a legitimate business expense, as long as you use it for generating income, and not just for playing games.

The expenses of a business are deducted from its income before taxes are calculated. For individuals working for an employer, taxes are deducted before you even get your paycheck. That means that your personal expenses are paid for with after-tax income. If a separate legal entity can pay some of these expenses, it reduces the amount of money you need to earn, and the amount of tax you need to pay.

Lawsuits

The first thing that happens when someone wants to sue you is that his or her lawyer will try to find out what you are worth.

It is not difficult to find out someone's net worth by examining public records. These days, on the internet, it is even easier. What you need to do is look like a poor target. This could mean transferring as many assets as possible into a separate legal entity, which you do not own, but do control. This could be a living trust, or a corporation.

It might also mean that you ensure that properties in your own name are mortgaged to the hilt, so that your net asset value (the difference between what you own and what you owe) is as low as possible. Ideally, you want your assets and your income to be as small as possible, so that you are not worth suing you.

In conclusion

Everyone has different financial needs. Laws are different from country to country, and from state to state. It is essential that you get professional advice from a competent financial advisor before doing anything.

If you are in financial trouble, it is already too late. If you transfer assets in order to put them out of reach of your creditors, it may be seen as fraudulent and illegal. You need to have a plan in place before you are sued, and before anyone tries to take your assets away.

You may think that you are too young to worry about asset protection, but it is not too early to get a plan in place. It is a cliché, but still true: If you fail to plan, you plan to fail.