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Anne Powelson Anne Powelson
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Tax cliffs

September 12, 2012
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Many tax benefits gradually fadeout over as income increases. But not all: Tax cliffs have a hard and fast line where $1 more in income can cost far more in tax benefits. Don't believe me? Check out these three tax cliffs.

Earned Income Credit and Investment Income: Threshold not to pass: $3,200 in investment income. Benefit at risk: from $2 to $5,891. Earned income credit is a reward for working and is figured on four criteria: Adjusted Gross Income, Earned Income, Marital Status and Qualified Children. The credit is not a set amount; it varies from as little as $2 to as much as $5,891. But all along the range, if your investment income exceeds the cap ($3,200 in 2012) you're no longer eligible. Investment income can come from interest, dividends, sales of stocks, redeeming savings bonds AND rental property.

Student Dependent over age 24 and Helpful Parent(s): Threshold not to pass: $3,800 gross income for the student. Benefits at risk: College credits of up to $2,500, Head of Household Filing Status, and exemption deduction. When your children are under age 24 (at the end of the year) and full time students, they can be your dependents so long as you pay more than half their support. Over age 24, rules change; then they are your dependent only if you provide more than half their support AND their gross income is below the exemption amount, $3,800 in 2012. (Exceptions exist for permanently and totally disabled children.) Gross income is all income including taxable scholarships and, if a self-employed student, the amount from line 7 of Schedule C (NOT Line 31 Net Profit.)

Retirement Savers Credit: Threshold not to pass: Varies by Filing Status. Benefit at Risk: Up to $600. The Retirement Savers Credit benefits lower income filers contributing to either employer or individual retirement plans. The credit is 10, 20 or 50 percent of up to $2,000 in eligible retirement plan contributions. Which percent applies depends on your Adjusted Gross Income (AGI). It is not a refundable credit and can only be used against your tax liability. So, though in theory the credit is worth a maximum of $1,000 for most filers and $2,000 Married Filing Joint (MFJ), it is unlikely at the low income necessary to be eligible that a taxpayer owes enough in taxes to take advantage of the full credit. But there are still some significant cliffs. One example: a MFJ couple, with an adjusted gross income (AGI) of $34,500 could be eligible for a credit of $2,000. This would cover their full tax liability of $1,450. But a couple with an AGI of $34,501 could only be eligible for a credit of $800, though they have almost the same tax liability. Like the prior examples, these are the 2012 thresholds, and subject to change each year.

Walking along a cliff can be exhilarating and provides some great views. Knowing about tax cliffs and staying back from the edges is exhilarating as well, and can provide some tangible benefits. And, just like with a real cliff, knowing what's ahead and planning may keep you from slipping over the edge.

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