Tally adoption expenses. Thousands of dollars of expenses incurred in connection with adopting a child can be recouped via a tax credit, so it pays to keep careful records. The credit can be as high as $13,190. If you adopt a special needs child, you get the maximum credit even if you spend less.
Save for college the tax-smart way. Stashing money in a custodial account can save on taxes. But it can also get you tied up with the expensive "kiddie tax" rules and gives full control of the cash to your child when he or she turns 18 or 21. Using a state-sponsored 529 college savings plan can make earnings completely tax free and lets you keep control over the money. If one child decides not to go to college, you can switch the account to another child or take it back.
Use Coverdells to pay for private school tuition. Coverdell Savings Accounts allow parents and grandparents to use tax-free dollars to pay private-school tuition and other education-related costs for elementary and high-school students. You can contribute up to $2,000 to a Coverdell Education Savings Account for any beneficiary in 2014. You don't get a deduction, but money you stash in a Coverdell grows tax-deferred and can be withdrawn tax-free to pay education bills. Beyond tuition and fees, you can use Coverdell money to pay for tutoring, books and supplies, uniforms and transportation. You can buy a computer for the whole family to use and pay for Internet access, too. The contribution limit is phased out if your adjusted gross income is between $190,000 and $220,000.
Use a Roth IRA to save for college. Sure, the "R" in IRA stands for retirement, but because you can withdraw contributions at any time tax- and penalty-free, the account can serve as a terrific tax-deferred college-savings plan. Say you and your spouse each stash $5,000 in a Roth starting the year a child is born. After 18 years, the dual Roths would hold about $375,000, assuming 8% annual growth. Up to $180,000 — the total of the contributions — can be withdrawn tax- and penalty-free and any part of the interest can be withdrawn penalty-free, too, to pay college bills.
Use Savings Bonds to pay for college: If you cash in Savings Bonds to pay for your child’s college tuition, you may be able to avoid taxes on the interest. The tax break is available for EE and I Bonds issued after 1989. To qualify for the tax break, you must have been at least 24 years old when the bond was issued. The interest exclusion phases out when your modified adjusted gross income on a joint return is between $112,050 and $142,050, or between $74,700 and $89,700 for single filers and other types of returns.
Fund a Roth IRA for your child or grandchild. As soon as a child has income from a job — such as babysitting, a paper route, working retail — he or she can have an IRA. The child's own money doesn't have to be used to fund the account (fat chance that it would). Instead, a generous parent or grandparent can provide the funds, or perhaps match the child's contributions dollar for dollar. Long-term, tax-free growth can be remarkable.
Use a Roth IRA to save for your first home. A Roth IRA can be a powerful tool when you're saving for your first home. All contributions can come out of a Roth at any time, tax- and penalty-free. And, after the account has been opened for five years, up to $10,000 of earnings can be withdrawn tax- and penalty-free for the purchase of your first home. Say $5,000 goes into a Roth each year for five years for a total contribution of $25,000. Assuming the account earns an average of 8% a year, at the end of five years, the Roth would hold about $31,680 — all of which could be withdrawn tax- and penalty-free for a down payment.
Convert to a Roth IRA. Switching a traditional IRA to a Roth requires paying tax on the converted amount, but that can be a fabulous tax-saving investment because all future earnings inside the Roth can be tax free in retirement. (Withdrawals from traditional IRAs are taxed in your top tax bracket.)
Undo a Roth conversion gone bad. When you convert a traditional IRA to a Roth, you must pay tax on the amount you convert. But what if the investments in the new Roth IRA fall in value? You get a chance for a do-over. You have until October 15 of the year following the conversion to "unconvert" and avoid paying tax on the money that evaporated. You can then redo the conversion the following year.
Protect your heirs. Be sure beneficiary designations for your IRAs and 401(k)s are up to date. If your IRA goes to your estate rather an a designated beneficiary, unfavorable withdrawal rules could cost your heirs dearly.
Roll over an inherited 401(k). A recent change in the rules allows a beneficiary of a 401(k) plan to roll over the account into an IRA and stretch payouts (and the tax bill on them) over his or her lifetime. This can be a tremendous advantage over the old rules that generally required such accounts be cashed out, and all taxes paid, within five years. To qualify for this break, you must name a person or persons (not your estate) as your beneficiary. If your 401(k) goes through your estate, the old five-year rule applies.
Help your adult children earn a credit for retirement savings. The Retirement Savers Credit can be as much as $1,000, based on up to 50% of the first $2,000 contributed to an IRA or company retirement plan. It's available only to low-income taxpayers, though, who are often the least able to afford such contributions. Parents can help, however, by giving an adult child (who cannot be claimed as a dependent and who is not a full-time student) the money to fund the retirement account contribution. The child not only saves on taxes, but also saves for his or her retirement.
The bank of mom and dad. If your adult children ask for a loan to help them buy a house or start a business, beware that Uncle Sam has something to say about the deal. If the kids want to borrow more than $10,000, you may be required to charge a minimum amount of interest. And if you don't? You have to report the "phantom" interest as income anyway.
Deduct interest paid by mom and dad. UWhen parents make payments on a child’s student loan, the child can claim a tax deduction for the interest, as long as the parents can't claim him or her as a dependent, even if he or she doesn't itemize.
Make the most of the tax-free home sale profit. Up to $250,000 of home-sale profit is tax free ($500,000 if you are married and file a joint return) if you own and live in the house for two of the five years leading up to the sale. If you are bumping up on the limits, consider selling and buying a new home to start the tax-free clock ticking again. There is no limit on the number of times you can claim tax-free profit on the sale of a home.
Don't underestimate the cost of home-equity debt. Generally, interest on up to $100,000 of debt secured by your home can be deducted, no matter what you use the money for. But if you are among the growing number of taxpayers subjected to the alternative minimum tax (AMT), home-equity debt is only deductible if the loan was used to buy or improve your home.
Second homes can offer a vacation from taxes. If you're trying to figure whether you can afford a second home, remember that you'll get some help from the IRS. Mortgage interest on a loan to buy a second home is deductible just as it is for the mortgage on your principal residence. Interest on up to $1.1 million of first- and second-home debt can be deducted. Property taxes can be written off, too. Things get more complicated — and perhaps more lucrative-if you rent out the place part of the year to help cover the bills.
Watch the calendar at your vacation home. If you hope to deduct losses attributable to renting the place during the year, be careful not to use the house too much yourself. As far as the IRS is concerned, "too much" is when personal use exceeds more than 14 days or more than 10% of the number of days the home is rented. Time you spend doing maintenance or repairs does not count as personal use, but time you let friends or relatives use the place for little or no rent does.
Stay actively involved in rental real estate. Generally, anti-tax-shelter legislation prevents losses from real estate investments from being deducted against other kinds of income. But, if you are actively involved in a rental activity, you can deduct up to $25,000 of such losses ... if your adjusted gross income is less than $100,000. You don't have to mow grass and unclog toilets to qualify as actively involved; but you should make sure you're involved in setting rents and approving tenants and management firms.
Use a tax-free exchange to acquire new property. By trading one rental property for another, for example, you avoid the capital gains taxes you'd incur if you sold the first property ... leaving you with more to invest in the second.