Lawrence Farber

Except for children under age 19 at year-end (or under age 24 if full-time students), you can claim exemptions for dependents only if you provided more than half their support in 2006. Ordinarily, you get an exemption for an unrelated or distantly related dependent (like a cousin) only if that person lived with you the entire year, excluding temporary absences such as vacation trips. But your parents, close relatives, or in-laws don't have to satisfy that requirement. What's more, if you're unmarried, you can file as head of household even if your dependent parent lives elsewhere, allowing you to pay tax at a lower rate than a single person. 

To be eligible for an exemption, an adult dependent's 2006 gross income must generally be less than $3,300. But untaxed income like Social Security benefits or municipal bond interest doesn't count. You must also meet the support test. You get a passing grade if you spent more on your parent's living expenses last year than he or she did. If your parent put some income into savings, you can ignore that. What matters is how much each of you actually paid for support items like food, clothing, and shelter.  

What if you provided support for both your parents, but your contributions add up to less than the total amount they spent on themselves? Don't give up yet. Say their combined expenses came to $20,000 last year, or $10,000 apiece, and you contributed $12,000. By earmarking more than $10,000 of your $12,000 total for the support of either parent, you can claim an exemption for that one. 

The place-of-residence rule doesn't always work as you'd expect. Suppose you support your mother's sister (your aunt) and her husband. If they don't live with you, you can claim an exemption only for your aunt; your uncle is neither your blood relative nor your in-law. But you could claim exemptions for your deceased brother's wife (your sister-in-law) and their children wherever they reside. The same holds true for your spouse's relatives if you file a joint return. Even if you're widowed or divorced, you can claim exemptions for your former spouse's parents, brothers, or sisters, as long as you meet the income and support tests. 

When a couple is divorced or formally separated, the parent having custody of a child is entitled to the exemption, regardless of which one paid more of the child's expenses. Even without a legal document proving custody, you can claim the exemption if you lived apart from your spouse for at least the last six months of 2006 and the child stayed with you. 

If you didn't have custody, you can still claim the exemption, provided your ex waives it in writing, preferably by filling out Form 8332. Be sure to attach a copy of the waiver to your return. If the waiver covers more than one year-for example, alternate years or all future years-attach the original waiver to the first year's return and a copy to every later return on which you claim the exemption. If the waiver is incorporated in a court decree or separation agreement, you can attach that document instead. 

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Check out the many ways that your dependents can lower your tax bill.

Your 2006 taxes: Mining personal exemptions

Sorting through that pile of checks you wrote last year to keep your practice going takes effort, but your reward will be extra tax savings. Here's a rundown of good places to hunt for deductible expenses you might otherwise overlook, and some ways to maximize the tax benefit of the write-offs you can claim for 2006.  

It's important to distinguish between the two. Expenses for repairs that keep your office in normal, efficient operating condition-for instance, patching minor damage to fixtures or repainting walls-are deductible on your return for the year you incur them. But improvements that add to your property's life or value, like replacing the roof, must be depreciated, so recovering their cost takes years. If you contract for both types at the same time, the IRS might consider all the work as a single improvement project and require you to depreciate the entire cost. For more information, see IRS Publication 946, How to Depreciate Property, at 

Last year a Milwaukee neurologist had the walls of his reception room patched and repainted and added a bathroom. Following his accountant's advice, he instructed the contractor to submit separate proposals and invoices for each category. Accordingly, he can claim all of the repair costs on his 2006 return, while depreciating the rest. 

An exception to the rules for building improvements extends to work that's done to provide greater access for the elderly or disabled. If you spent, say, $20,000 on such facilities last year, you can write off a maximum of $15,000 for 2006 and add the remaining $5,000 to your building's cost basis. 

Also in the area of improvements, if you're taking steps to boost the energy efficiency of your office building, the Energy Policy Act of 2005 may allow you to claim a deduction on your 2006 return for a portion of your expenses as owner or lessee. Write-offs are available for improvements to interior lighting systems; heating, cooling, ventilation, and hot water systems; or the building's shell. The amount of the deduction depends on the degree of energy efficiency achieved, as certified by a licensed engineer or contractor. 

Check out each of these practice expense categories for increased write-offs.

Your 2006 taxes: Don't miss these business deductions

The most effective way to ease the pain is by reducing the amount of your gains subject to tax. For example, say you built up a large stake in a mutual fund by buying 1,000-share lots at various times. You paid $45 a share in 2001, $22 in 2002, and $35 in 2004-an average of $34 per share. Last November you sold 1,000 shares for $60,000. Based on average price paid, your cost was $34,000, giving you a taxable gain of $26,000. But the IRS will let you figure your profit using the $45,000 cost of the initial lot, even though you hadn't told the mutual fund company to sell those particular shares. Consequently, you can choose to report a net gain of only $15,000 on your 2006 return. (Note that you would've had to use average cost if you'd opted for that method on previous sales from the same fund, so think carefully and run the numbers before you choose how to calculate your profit.) 

Take full advantage of losses to offset as much of last year's gains as possible. If they topped your gains, you can deduct up to $3,000 of the excess from your regular income and carry the remainder over to future years. 

Suppose you have great stock-picking talent, which enabled you to reap large profits in 2006 with no debits. If you've recently married, make sure to look at your spouse's finances to see if there's any help there. One physician, who was crowing over her stock market gains, married a man last year whose dowry included sizable capital losses carried over from 2005 and earlier. Since the happy couple will be filing jointly for 2006, his losses can count against her gains.  

Don't neglect other possible sources of capital losses, which, as the term implies, are first deducted against capital gains, then against other income. If you paid more than face value for corporate bonds that matured last year and you didn't amortize the premium annually while you owned them, you can claim a capital loss on your 2006 return. You can also deduct nonbusiness bad debts and worthless securities. When the contractor building a Chicago internist's new home went belly-up in 2006, the doctor lost his deposit. But he can claim a short-term capital loss for the amount. Keep an eye out for any similar type of losses that you might have. 

Use these tips and guidelines to lighten the taxes on dividends, interest, and capital gains.

Your 2006 taxes: Keep more of your investment earnings

"Sunset provisions" in laws enacted since 2001 threaten an end to some generous tax breaks for many doctors. Hamstrung by political and economic conditions, Congress and the Bush administration have had only limited success in countering this disturbing trend. But they did manage to pass a few key measures in recent months that, with proper planning, can lead to substantial tax savings in the years ahead. These guidelines will help you make hay while the sun still shines: 

Give investment profits more chance to grow. 

Dr. Martin's stock portfolio includes several issues that would net him a total profit of around $200,000 if he sells them now. Since he's held them for more than a year, his gain would be taxed at 15 percent. But he thinks they have potential for further substantial growth over the years ahead. Trouble is, the tax bite is scheduled to increase by a third-to 20 percent-if he waits too long. 

Suppose that holding on would add $25,000 to his profit. Taxed at 20 percent, the $225,000 gain would shrink to $180,000. By selling now, Martin can reap a sure $170,000 after-tax gain ($200,000 minus 15 percent, or $30,000). Is the $10,000 difference worth the risk that the market will turn against him? 

Martin also owns a stock that's declined $12,000 in value. If he opts to hang onto his winners until 2010, he'd be wise to take his loss this year. That way he can deduct a maximum of $3,000 annually from his highly taxed regular income in 2006 through 2009. In his 35 percent bracket, this would save $4,200 of tax. By contrast, if he takes the loss in an intervening year, he'd be required to offset some of it against his 2010 gains taxed at 15 percent. In the worst case, Martin might end up saving only $1,800.  

Go for dividend income to cut market risks. 

The revised law provides the same two-year extension for the 15 percent rate on dividend income. That's good news for Dr. Payne. Because he's dubious about the market's medium-term outlook, he's reducing his stake in an aggressive-growth mutual fund and putting the money into a more conservative fund that concentrates on stocks in well-established companies paying high dividends. Without the change in the law, Payne would've had to pay tax on the dividend income at his top-bracket rate of 33 percent after 2008. Now he'll enjoy the tax break an additional two years. 

Payne should select the income fund with care, though. The 15 percent rate generally applies to cash dividends declared on common stocks in a fund's portfolio. But if the fund invests in bonds or other debt securities, the special rate doesn't apply to any portion of the fund's dividend representing interest income from those sources. Dividends paid by real estate investment trusts (REITs) generally don't qualify either, and gains distributed to fund shareholders are ineligible for either the 15 percent dividend or capital gains rate if they come from the sale of assets the fund owned short term (a year or less).  

Take advantage of recent changes in the law to lower Uncle Sam's take in the years ahead.

Author | Lawrence Farber

Articles

Your 2006 taxes: Mining personal exemptions

Your 2006 taxes: Don't miss these business deductions

Your 2006 taxes: Keep more of your investment earnings

5 smart ways to cut your tax bill