Upper-income taxpayers should make these moves throughout the year to keep their bill low at tax time. Here are the areas where you should look for savings:
Tax Savings For: Work | Car and Home | Charitable Contributions | College Savings | Inheritance | Investments and Retirement Savings | Rental Property | Your Children
Give yourself a raise. If you got a big tax refund this year, it meant that you're having too much tax taken out of your paycheck every payday. Filing a new W-4 form with your employer (talk to your payroll office) will insure that you get more of your money when you earn it. If you're just average, you deserve about $225 a month extra.
Go for a health tax break. Be aggressive if your employer offers a medical reimbursement account — sometimes called a flex plan. These plans let you divert part of your salary to an account which you can then tap to pay medical bills. The advantage? You avoid both income and Social Security tax on the money, and that can save you 20% to 35% or more compared with spending after-tax money. The maximum you can contribute to a health care flex plan is $2,500.
Change in family = change in flex plan. If you get married or divorced, or have or adopt a child during the year, you can change the amount you're setting aside in a medical reimbursement plan. If you anticipate more medical bills, steer more pretax money into the account; if you anticipate fewer, you can pull back on your contributions so you don't have to worry about the use-it-or-lose-it rule.
Pay child-care bills with pre-tax dollars. After taxes, it can easily take $7,500 or more of salary to pay $5,000 worth of child care expenses. But, if you use a child-care reimbursement account at work to pay those bills, you get to use pre-tax dollars. That can save you one-third or more of the cost, since you avoid both income and Social Security taxes. If your boss offers such a plan, take advantage of it.
Switch to a Roth 401(k). But if you are concerned about skyrocketing taxes in the future, or if you just want to diversify your taxable income in retirement, considering shifting some or all of your retirement plan contributions to a Roth 401(k) if your employer offers one. Unlike the regular 401(k), you don't get a tax break when your money goes into a Roth. On the other hand, money coming out of a Roth 401(k) in retirement will be tax-free, while cash coming out of a regular 401(k) will be taxed in your top bracket.
Pay tax sooner than later on restricted stock. If you receive restricted stock as a fringe benefit, consider making what's called an 83(b) election. That lets you pay tax immediately on the value of the stock rather than waiting until the restrictions disappear when the stock "vests." Why pay tax sooner rather than later? Because you pay tax on the value at the time you get the stock, which could be far less than the value at the time it vests. Tax on any appreciation that occurs in between then qualifies for favorable capital gains treatment. Don't dally: You only have 30 days after receiving the stock to make the election.
Stash cash in a self-employed retirement account. If you have your own business, you have several choices of tax-favored retirement accounts, including Keogh plans, Simplified Employee Pensions (SEPs) and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement.
Hire your children. If you have an unincorporated business, hiring your children can have real tax advantages. You can deduct what you pay them, thus shifting income from your tax bracket to theirs. Because wages are earned income, the "kiddie tax" does not apply. And, if the child is under age 18, he or she does not have to pay Social Security tax on the earnings. One more advantage: The earnings can serve as a basis for an IRA contribution.
Choose the right kind of business. Beyond choosing what business to go into, you also have to decide on the best form for your business: a sole proprietorship, a subchapter S corporation, a C-corp or a limited-liability company (LLC). Your choice will have a major impact on your taxes.
Don't be afraid of home-office rules. If you use part of your home regularly and exclusively for your business, you can qualify to deduct as home-office expenses some costs that are otherwise considered personal expenses, including part of your utility bills, insurance premiums and home maintenance costs. Some home-business operators steer away from these breaks for fear of an audit. But a new IRS rule makes it easier to claim this tax break. Instead of calculating individual expenses, you can claim a standard deduction of $5 for every square foot of office space, up to 300 square feet.
Watch start-up costs. Generally, the costs of starting up a new business must be amortized, that is, deducted over years in the future. But you can deduct up to $5,000 of start-up costs in the year you incur them, when the tax savings could prove particularly helpful.
Tote up out-of-pocket costs of doing good. Keep track of what you spend while doing charitable work, from what you spend on stamps for a fundraiser, to the cost of ingredients for casseroles you make for the homeless, to the number of miles you drive your car for charity (at 14 cents a mile). Add such costs with your cash contributions when figuring your charitable contribution deduction.
Put away your checkbook. If you plan to make a significant gift to charity, consider giving appreciated stocks or mutual fund shares that you've owned for more than one year instead of cash. Doing so supercharges the saving power of your generosity. Your charitable contribution deduction is the fair market value of the securities on the date of the gift, not the amount you paid for the asset, and you never have to pay tax on the profit. However, don’t donate stocks or fund shares that lost money. You’d be better off selling the asset, claiming the loss on your taxes, and donating cash to the charity.
Be creative with your generosity. A charitable-remainder trust can avoid capital gains taxes on appreciated assets, allow you to receive income for life and receive a tax deduction now for a charitable contribution that will be made after your death. A charitable-lead trust can avoid taxes on appreciated assets, earn an immediate tax deduction and still provide an inheritance for your heirs later. A donor-advised fund can earn you a tax deduction for the full value of appreciated assets now, even though you don't have to determine the recipients of your generosity until later years.