Make The Most Of Your Tax Rebate

Note: Make The Most Of Your Tax Rebate

Those federal tax rebates you've been hearing about? The IRS is due to send the first checks on May 9. Payments will continue for months. But don't get too excited. If you have a decent income, you may get little or nothing.

Still, your children might get rebates. Ditto for your parents, if they're retired.

Note: Even children get rebates as well as retired parents.

So here are a few ideas for using the rebates. Discuss them around the family dinner table.

Not all of these ideas will stimulate the economy, as Washington intended. But hey, it's your family's money.

The basic rebate amount equals the income tax owed for 2007 with limits. There's a cap of $600 for single taxpayers. For married couples filing jointly, the cap is $1,200.

There's a $300 rebate for every child who was under 17 at the end of last year.

Say a hypothetical John and Mary Smith file a joint return. They have three young children. They might expect a $2,100 rebate: their $1,200 plus $900 for their three children.

But they might not get it. To get a full rebate, their adjusted gross income (AGI) must be no more than $150,000.

Over that threshold, there's a 5% phaseout.

Suppose the Smiths report AGI of $170,000 in 2007. That's $20,000 over the limit.

Five percent of $20,000 is $1,000. Their rebate would be reduced by that $1,000. Instead of $2,100, the Smiths would get $1,100.

The size of the rollback increases as a taxpayer's AGI rises. So if the Smiths' AGI is $192,000 or higher, they would get no rebate.

The calculation is the same for single taxpayers. The phaseout starts at $75,000 of AGI.

A childless single taxpayer would get no rebate with AGI over $87,000. If any taxpayer has children, the top end of the parent's phaseout range is extended by $6,000 for each child.

If your AGI tops the phaseout ceilings, you won't get a rebate. But your children might.

To get a rebate, they can't be claimed as dependents on your tax return. They must file a 2007 return. They must have paid tax or had at least $3,000 of earned income.

What To Do?

If your kids ask for advice about handling that money, what should you tell them?

"Tell them to pay down credit card debt," said Jamshed Gandi, a CPA in San Francisco who is a spokesman for the California Society of CPAs.

Interest rates on credit card balances may be as high as 20%, Gandi says. Paying down such a debt is the same as earning 20% per year on an investment, after-tax, with no risk.

If your children don't have credit card debt, they may want to pay down other debts such as student loans. That will depend on the interest rate being charged.

Say your children have no high-interest loans to pay down. The next alternative may be boosting 401(k) contributions.

If their employers are matching 401(k) contributions, your children should contribute at least enough to get the maximum employer match.

Say your daughter earns $40,000 a year. Her employer offers to match 401(k) contributions 50 cents on the dollar, up to 6% of pay.

So her maximum match would be $1,200: 50% of $2,400. If your daughter contributes less to her 401(k), she should adjust her periodic contributions so an amount equal to all or part of her rebate goes into the plan, up to the level where she'd get the maximum match.

Contributing more to a 401(k) might not make sense. Your daughter, in a low tax bracket, wouldn't get much benefit from the upfront tax deferral.

Instead, the next choice on the list might be contributing to a Roth IRA. In 2008, the top contribution for people under 50 is $5,000.

Roth IRA contributions deliver no initial tax advantages. But investment income is untaxed, inside the account.

And all withdrawals are tax-free, after five years. You also must be older than 59 1/2.

Say your daughter is 28. She puts $600 into her Roth IRA. Her money earns an average of 9% a year.

By the time she's 60 that $600 — excluding any other contributions she makes over time — will have grown to around $9,500. Your daughter could withdraw it all, tax-free, or let it keep growing in her Roth IRA.

Advice For Your Parents

So your children have several ways to profit from tax rebates. What if the money goes to your parents, who have relatively low income in retirement?

If they're concerned about running short of money, they can invest it, says Tom Ochsenschlager, vice president of taxation at the American Institute of Certified Public Accountants.

He suggests an exchange-traded fund. Many are low-cost and tax efficient.

"If your parents are comfortable with what they've saved, they might consider a contribution to a 529 plan for their grandchildren," Ochsenschlager said. These plans offer tax-free investment buildup and tax-free withdrawals if the money is spent on higher education.

Note: These are the info about how to make most of your tax rebate.