Keep more tax money in 2007

A bunch of new federal laws and adjustments to existing policy have created plenty of opportunities to earn more on your investments and save more on your taxes.

Finishing Up for 2006

I'll get you up to speed on what's new for '07 in a minute, but first you should be sure to still make the most of '06:

• Use up your 2006 flexible savings account

Many employers now allow you a full 15 months to use up the money you set aside in your FSA; that means that any money left in your 2006 account can be used until March 15, 2007.

• Fund your 2006 IRA

You know the drill: You can make your 2006 contributions through April 16, 2007. High-income folks who never bother with an IRA because they can't qualify for either a Roth or a deductible Traditional IRA should contribute this year.

As I explained in an earlier column, beginning in 2010 everyone can convert an existing traditional IRA into a Roth IRA regardless of income (until then, only individuals and couples with incomes below $100,000 are able to convert).

Given the huge tax break on Roths -- distributions are 100 percent tax free if you meet a few simple rules -- opening a traditional IRA with the intention of converting to a Roth can be a great move for many people. Yes, you'll owe taxes on the amount you convert, but a special tax break will allow you to delay tax owed on 2010 conversions until 2011 and 2012. And once it's in a Roth, it'll never be taxed again.

A Matter of Deduction

Now let's focus on what's new for 2007. First, the changes in retirement account contributions:

• Higher 401(k) limits

The maximum annual contribution to your 401(k) increased from $15,000 to $15,500. The maximum for individuals over 50 increased from $20,000 to $20,500. If you've been contributing the max, make sure your 2007 contribution will be increased to take advantage of the extra $500 you can set aside this year.

FYI: investing the extra $500 this year and then letting it grow at an annual 8 percent rate for the next 20 years translates into having an extra $2,330 in your retirement account.

• Higher Roth IRA income limits

Investing in a Roth is only allowed if you meet certain income limits. The good news for 2007 is that those limits have increased.

Single tax filers with incomes below $114,000 are now eligible for a Roth, as are married couples with incomes below $166,000. The previous limits were $110,000 and $160,000. If you can open a Roth this year, do so. Setting aside money today that will be tax-free when you retire is an amazing investing opportunity.

For those of you who expect to receive a 2006 federal tax refund, the IRS is ready to help you make sure you invest in an IRA. Beginning this year -- including refunds for the 2006 tax year -- you can have your tax refund sent as a direct deposit into your IRA account. Previously, you were only able to have the refund check sent to a bank checking or savings account.

If you want your refund split between multiple IRAs or bank accounts, you can fill out IRS Form 8888 to have your refund directly deposited in a maximum of three different accounts.

That's good news, but it‘s just making the best of a bad move on your part. The bottom line is that you never want to get a tax refund. All the IRS is doing is returning money you should never have paid in the first place. Either adjust your withholding on your paycheck or, if you're self-employed, put a little more elbow grease into figuring out your estimated tax each quarter so you don't end up with a big refund.

Breaking Down the Tax Breaks

Next, 2007 changes that can help you save more money on your taxes:

• Sales tax break extended

While you were busy enjoying the holidays, Congress did in fact slide through some legislation that extends the sales tax deduction for 2007. If you itemize on your tax return, you can once again choose to either deduct your state income tax on your federal return, or your state sales tax. Obviously, this is a boon for folks in states with no income tax.

• Tuition break extended

Individuals with incomes below $65,000 and married couples with incomes below $130,000 can deduct up to $4,000 in tuition and education-related fees for their dependents or themselves. This break had expired after the 2005 tax year, but Congress stepped in and extended the break for the 2006 and 2007 tax years.

If you plan on taking either of these tax breaks, filing your return is going to be confusing. Congress voted in the extensions so late in December 2006 that the current IRS forms don't include these items. To minimize your headaches, consider using an online tax program for your tax return and e-filing; if you file after Feb. 3, IRS computers will be ready to "accept" both deductions.

• Private mortgage insurance is now deductible for some

Another new law allows homeowners who need to take out private mortgage insurance (PMI) -- required when a house down payment is less than 20 percent of its purchase price -- to deduct all of their premium costs if their income is below $100,000. (You can claim a partial deduction if your income is below $110,000; anything above that amount and there's no tax break.)

This tax break is only good for new mortgages in 2007; if you pay PMI on an old mortgage you won't qualify for the deduction. And before you think about refinancing to get the deduction, be aware that this new deduction is good only for 2007; unless Congress acts this year to extend it, it will disappear next year.

This makes PMI more competitive with the piggyback option many homeowners are using these days, whereby they take out a second mortgage to cover their down payment rather than use PMI

I still think the smartest move is to roll the PMI into your mortgage by using the SingleFile PMI option offered through Mortgage Guaranty Insurance Corporation, a major player in the PMI industry. With this setup, your PMI adds very little to your monthly mortgage cost, and all your mortgage interest payments are deductible regardless of your income.

• Dialing for dollars

The IRS agreed to stop collecting a federal excise tax on long-distance phone calls and is offering a one-time refund for 2006.

You can either take the standard refund amount -- between $30 and $60 depending on your filing status and number of dependents -- or you can pore through your phone bills dating from March 1, 2003, through July 1, 2006, and claim a refund for the exact amount of excise tax you paid. This refund is good for land line accounts as well as cell phone and VOIP.

• Charity requires documentation

Up until August 2006, the IRS didn't require proof of charitable deductions under $250. But now you must have proof of every charitable contribution you make, regardless of its value. The proof can be a cancelled check, a credit card statement, or a note from the organization to which you contributed.