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Consumer Watch: Tips for a tax windfall

Military credits and deductions yield big savings

Feb. 17, 2011 - 03:21PM   |   Last Updated: Feb. 17, 2011 - 03:21PM  |  
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Don't let taxes take any more of a bite out of your wallet than absolutely necessary.

That means staying on top of recently extended tax deductions, as well as taking advantage of some previously enacted perks that come into play in 2010 tax filings. It might also mean getting some free help in preparing your taxes.

Some reminders from Army Lt. Col. Janet Fenton, deputy chief of legal assistance policy for the Army Judge Advocate General and a member of the Armed Forces Tax Council:

First-time homebuyer credit

Service members should pay close attention to this one, Fenton said.

• The Internal Revenue Service has been sending letters to people who took the initial $7,500 tax credit for first-time homebuyers in 2008, reminding them that they have to repay it starting with tax year 2010. But if you're in the military and no longer living in that house because of permanent change-of-station orders to more than 50 miles away, you don't have to repay it — even if you still own the house.

The IRS doesn't specifically identify those who might fall into this category, so just because you get the letter doesn't mean you have to repay. Still, Fenton stresses that you must file IRS Form 5405 to claim a waiver of the repayment. If you stay in the house, however, you are not eligible for the waiver.

• For those who received the $8,000 first-time homebuyer tax credit in 2009 or 2010, you don't have to repay the tax credit unless you lived in the house for less than 36 months. Again, there's a waiver for military members who move more than 50 miles away on PCS orders.

If you took this credit and moved within 36 months, file IRS Form 5405 to claim a waiver of the repayment, Fenton said.

Don't just ignore it because you're entitled to a waiver; the IRS may not know you are eligible.

"Eventually, the IRS will marry up the fact that there was a sale, or rental income" and ask questions, Fenton said.

You'll probably have fewer hassles in the long run if you document it upfront. You can also get a waiver if you no longer live in the house because it was foreclosed, or condemned, or if there was a short sale.

A similar credit applies to longtime homeowners who buy a replacement residence, under the same general rules that apply to the first-time homebuyer credit in 2009 or 2010. A credit of up to $6,500 was extended to longtime homeowners who bought a replacement principal residence, if the homeowner lived in the same principal residence for any single five-year period during the eight years before the replacement home was purchased.

The credit was available to those who bought a home by April 30, 2010, and closed on it by Sept. 30, 2010. However, you might still be eligible for the homebuyer credit if you served outside the U.S. for at least 90 days between Jan. 1, 2009, and May 1, 2010.

If you meet all the other criteria, you have until May 1, 2011, to enter into a contract to purchase a new home and claim the credit. You must be able to close on the house by July 1, 2011.

Generally, when claiming the first-time homebuyer credit, you must not have owned a home or had an interest in a home for the past three years.

Deductions of note

The tax bill signed into law late last year extended some otherwise-expired tax breaks that might be of interest to military families:

• Quite a few military spouses are educators, and many educators spend money out of their own pockets for books, supplies and other classroom equipment. The educator expense deduction allows for up to $250 of out-of-pocket expenses as an adjustment to your gross income. This applies to K-12 teachers, instructors, counselors, principals and aides. It doesn't apply to expenses for home schooling.

• If you itemize deductions, you have the option of claiming either state and local income taxes or state and local general sales taxes. This might be an option for service members who are residents of a state that has no income tax.

If you have kept receipts of everything you bought during 2010, you can tally those for your returns. If that's not an option, or you would rather do it the easy way, go to the IRS sales tax deduction calculator at http://apps.irs.gov/app/stdc.

Military spouse residency

Last year, some military spouses who asked for state tax relief under the 2009 Military Spouses Residency Relief Act were denied because they didn't produce enough evidence to show connections to their claimed domicile state, Fenton said.

At that time, states were scrambling to sort out how they would handle the new federal law, which exempts the income of some military spouses from state taxes. The exemption applies to spouses who maintain domicile in one state but live in a different state because they moved there with their service members on military orders.

In many states, this was simply a matter of claiming it on the state tax return itself, without requiring proof that your domicile is in a different state. But others do require proof. Virginia, for example, has Form 763S, which includes a separate page of questions and document requests for military spouses.

"I hope this year, more states' instructions will address it upfront," Fenton said.

While it may seem easy to claim the exemption in some states, she said, there could be challenges down the road. States are working on a program that allows them to share information about people claiming MSRRA protection.

"So Virginia would know if someone is claiming Virginia residence and filing from Ohio," she said. "Virginia wants to tax them."

Bottom line: You may not have to pay taxes in the state where your service member is stationed, but you may still have tax obligations to your domicile state.

Spouses can't simply pick a state with no income tax to be their domicile. You must have information and documents to support the claim.

"We encourage people filing under MSRRA to seek legal advice so that in future years they don't get a challenge as to their eligibility," Fenton said.

Free help with your taxes

• Start at your installation's tax center. They're often located separately from the legal assistance office, but that office will be able to tell you where it is.

Anyone with an ID card is eligible for assistance, within limits — if you own a business or lots of rental property, for example, you won't be able to get your taxes done there.

These centers operate under the IRS Volunteer Income Tax Assistance program, which allows the military to do taxes for those with one rental property, because so many military people have not been able to sell their property when they move on PCS orders.

• Military OneSource also offers access to free online tax preparation. The Defense Department is paying to provide the H&R Block At Home Basic electronic tax filing program through the website.

To use it for free, those eligible must use the link on the Military OneSource website to create an account and access the customized version, officials say. Do not go to the public H&R Block website to create a user account.

• Military OneSource also offers access to tax consultants seven days a week from 7 a.m. to 11 p.m. Eastern time. Call the Military OneSource Tax Hotline at 800-730-3802.

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