EDITOR'S NOTE: This article was originally published in the July 2012 issue of Kiplinger's Retirement Report. To subscribe, click here.
The tax code is not exactly a gripping beach read. But by getting a head start on your tax planning this summer, you can employ a number of maneuvers that could trim your 2012 payment to Uncle Sam. Perhaps you can fine-tune your charitable giving or arrange for tax-deductible elective surgery.
Tax strategizing could be especially tricky this year, though. Bush-era tax cuts are set to expire on January 1, boosting rates for ordinary income, qualified dividends and long-term capital gains. Although Congress is expected to intervene, lawmakers won't make key decisions until a lame-duck session, or even later. And with Republicans opposing President Obama's insistence on hikes on upper-incomers, the outcome of the presidential election "could be one of the most important factors in tax planning," says Bob Meighan, vice-president of TurboTax.
Such uncertainty will have its biggest impact on your investment strategies. Typically it's best to defer income -- and the tax bill -- to a later year. But if tax rates rise next year, maybe 2012 is the time to sell some appreciated stock. Future tax rates also could affect the timing of Roth conversions (which would be more costly if rates go up) and large charitable gifts (the deduction for which would deliver bigger tax savings if rates rise). While many taxpayers will hold off until year-end to make investment moves, Meighan says they should take time now to prepare "what-if scenarios" for both tax hikes and continued tax cuts.
The uncertainty doesn't end with tax rates. Several popular tax breaks expired at the end of 2011, including the deduction for state and local sales taxes, the credit for energy-related home improvements, and the break for direct contributions from traditional IRAs to charity. There's a "good probability" that lawmakers will vote to extend these benefits before the end of the year, says Bob Scharin, senior tax analyst for Thomson Reuters, a publisher of business and tax information.
Of course, you can make many tax moves now even if you don't know what the future holds. Here are some of them.
Do good deeds. Be sure you have the documentation to back up your charitable deductions. For cash contributions, save canceled checks or credit-card statements. For non-cash donations, such as clothing and household goods, keep a written record describing each item and its fair market value. For all donations of more than $250, you must get an acknowledgement from the charitable organization.
Meighan suggests taking photos of your non-cash gifts before you send them off to the Salvation Army or other qualifying group. "The IRS is becoming more diligent in challenging donations," he says.
Congress has not yet extended the popular tax break that allows individuals 70 1/2 and older to make a tax-free distribution of up to $100,000 from an IRA directly to a charity. But if you want to use your IRA to make a charitable donation this year, you don't have to wait for Capitol Hill to act. Just tell your IRA custodian to transfer the funds directly to your favorite charity. If lawmakers retroactively reinstate the provision, direct transfers anytime in 2012 will qualify. If for some reason Congress fails to make the retroactive fix, the payout is taxable, and you can deduct the donation as a charitable gift if you itemize deductions.
If you're planning to use appreciated stock for a donation, it "makes more sense to contribute the property rather than selling it and giving the cash," says Marc List, a certified public accountant at CBIZ in Boca Raton, Fla. Say the stock you bought at $1,000 is now worth $1,500. If you have owned the stock for more than a year, giving it directly to the charity earns you a deduction equal to $1,500. If you sell it and give cash, you'd pay a 15% long-term capital-gains tax on the $500 profit, meaning part of your intended generosity goes to Uncle Sam rather than the charity.
Remember to save receipts for out-of-pocket expenses for any volunteer work you perform. You can take a write-off for office supplies, the costs related to fund-raising events and even the ingredients for meals you make for charities serving the poor. Keep a log of the number of miles you drive your car for charity; you can deduct 14 cents per mile. (Read IRS Publication 526, Charitable Contributions, at www.irs.gov.)