The Most Important Tax Changes to Know Before Filing Your 2010 Return

By John Persinos
January 21, 2011

Each year, the U.S. tax code seems to grow in complexity as existing rules are amended or new rules are implemented. As taxpayers, we know these changes can mean a fatter refund... or an unexpected bill come tax time.

This year is no different. The tax code is constantly in flux, and moves made for 2010 returns are likely to leave some taxpayers cheering and others in disappointment. Hopefully you were able to take advantage of the good ones and avoid the bad ones. After all, you want to give what's due to Washington -- but not one penny more.

As you prepare for tax season, note these important changes before you file your 2010 tax return:

1. If a Loved One Passed Away, You Avoid the Estate Tax -- In 2010 Only. The federal estate tax, known by its political opponents as the "death tax," was eliminated for all individuals who died in 2010. Under the old 2009 tax rules, the first $3.5 million of an estate was exempt from federal estate tax and the top tax rate was 45%. Though it was eliminated in 2010, this de facto tax break is not going to be as generous in future years.

After considerable wrangling among Democrats and Republicans in Congress, President Obama in late December signed a bill that allows the first $10 million of a couple's estate to pass to heirs without taxation. The balance would be subject to a 35% tax rate.

2. You Can Spread Out the Tax Bill Related to IRA Conversions. The income qualification for a Roth IRA was removed in 2010, and many individuals took advantage of the opportunity to convert their traditional IRA to a Roth IRA. The major benefit of a Roth IRA is that it allows your money to grow totally free of taxation, whereas a traditional IRA merely defers taxes.

The IRS won't be assessing the typical 10% penalty for 2010 conversions, but the money transferred will be taxed as ordinary income. And if you converted in 2010, you can pay your conversion-related tax bill over two years instead of one.

3. Option to Deduct State and Local Sales Tax Extended. Tax legislation passed in December 2010 will extend a number of tax breaks that have been introduced in the past few years and were set to expire, including the option to deduct state and local sales tax instead of state and local income tax on one's federal return.

4. Deductions for Teacher-Purchased Supplies and Parent-Paid College Tuition Eliminated.  In 2010, teachers will no longer be allowed to deduct the cost of classroom supplies that they purchased personally.

There's also bad news for hard-pressed parents with kids in college: The deduction of up to $4,000 for college tuition and fees is no longer allowed in 2010.

5. Tax Breaks on Unemployment Benefits Eliminated. If you're like millions of Americans and you struggled with unemployment in 2010, this new rule seems to add insult to injury. In 2009, you could exclude up to $2,400 of unemployment benefits from your taxable income. In 2010, this tax break for unemployment benefits is eliminated.

6. Direct Charitable Donations from Your IRA -- Reinstated For 2010 & 2011. IRA holders who are age 70 ½ or older who donate a portion of their IRA money directly to a charity can count that donation toward their minimum required distribution. The provision allowing such a move expired at the end of 2009, but was reinstated for tax years 2010 and 2011 pursuant to the passage of the 2010 Tax Act in December.

There are other ways to be charitable while maximizing the tax benefits. Click here to learn how to Slash Your Taxes Using Charitable Giving Plans.

7. Last Chance to Claim Generous Tax Credits for Energy-Efficient Home Improvements. Tax incentives to "go green" will get stingy next year. The tax credit for 30% of the cost of energy-saving home improvements (up to $1,500) reverts to 10% next year and is capped at $500.

8. Decreased Business Mileage Deduction. If you drive a personal vehicle for business-related purposes, the mileage deduction in 2010 is dramatically lower this year. At 50 cents a mile versus the 55 cents per mile allowed in 2009, the deduction is nearly 10% lower in 2010.

Are you interested in getting more tax season tips? Click here to view additional tax-time articles from InvestingAnswers: 10 Ways to Make Tax Season Less Painful, The 5 Smartest Tax Moves to Make in 2011, Save Thousands on Your Tax Bill by Lowering Your Property Assessment.